What is Porter’s Five Forces model?
The Porter’s Five Forces model is a tool businesses use to understand and analyze the five competitive forces that impact an industry. It helps organizations identify the strengths and weaknesses of their industry. Michael Porter, a Harvard Business School Professor, created this model to focus on the different industry factors that could potentially impact an organization’s success.
This model eases the process of building your business’ marketing and operational strategies, as it helps you better understand how your industry’s structured. Once you analyze the Five Forces model, you’ll notice which driving forces impact the success of both your company and competitors. It helps you create more informed business strategies that lead to long-term profitability, productivity and efficiency for your organization.
Breakdown of each of the five forces
There are five main forces that affect how well a company performs in its industry. Identifying each of these forces allows you to understand how to use them to your advantage to increase profitability. These five forces include:
1. Competitive Rivalry
This force refers to how many other companies you’re competing with in your industry and how their products or services compare to yours. The more competitors and valuable products there are, the more difficult it is for your organization to be the leader in your industry. Customers tend to choose companies with the best deals or lower prices, so if you have less competition, you’re able to sell your products at higher prices.
For example, if you owned a mortgage technology company, you’d have an easier time negotiating prices with customers, as there are very few mortgage technology platforms available in this industry for your customers to choose over you.
2. Bargaining Power of Customers
This model focuses on the power your customers hold over your business. If you have only a few customers who regularly purchase your services or products, they would have more power than if you had several customers. Having only a few committed customers or clients means they have more power to negotiate prices that better fit their needs and budget.
For example, if you’ve owned your business for years and have several regular customers, you’re able to confidently set prices that you believe work best for your organization and match the quality of your products. You’ll face lower risk if you lose a customer who’d rather not pay the prices you’ve laid out for your products.
3. Power of Suppliers
Similar to your customers, your suppliers have the potential to hold a significant amount of power over your organization as well. How much power they have depends on how many suppliers can make the specific product you need and the costs for you to switch suppliers. If you have a large selection of suppliers who can make the products you need at an affordable price, then you typically have more power. This makes it easier for you to request prices that work best with your budget and move on to a different supplier if your current one demands more than you can afford.
For example, if your business sells unique handmade soaps that are difficult for other suppliers to make, the logical option is to stay with your current supplier and pay their requested prices and fees.
4. Threat of Substitution
This model refers to how easy it is for customers to replace your product with another. It also occurs if your customers can function fine without using your product or can perform the service you provide on their own. If your business offers a service or product that’s difficult for customers to replace, your company holds more power, which increases the likelihood of retaining customers and charging more for your products or services.
For instance, if a client was using a content marketing company to write all of their blog posts, they’re able to easily replace this company by hiring copywriters on their team to write the content themselves.
5. Threat of New Entry
This focuses on how easy it is for people to start a business in your industry and sell similar products to your target market. If a significant amount of time and money goes into building a successful business in your industry, then you’ll most likely have fewer competitors. This gives you the ability to charge higher prices for your products and gives you more negotiation power over customers.
For instance, most internet marketing companies require a lower budget and less equipment than most companies starting out. This means it’s easier for another internet marketing company to enter the industry and pursue another company’s clients.
How your business can use this model to be successful in your industry
Use the Five Forces model to conduct a detailed analysis on your industry, its competitors and any potential threats that could interfere with profitability. Ways to use this model to analyze your industry include:
- Identify your industry’s competitors: Use search engines to type in keywords, view different product reviews and read industry articles to find potential competitors in your business. List them in a spreadsheet with tabs detailing each company’s products, features, prices, customer service offerings and target market. This helps you better understand you compare with the competition and how to stand out.
- Prepare for any potential entrants into your industry: Determine how easy it is for other companies to enter your industry and identify any potential barriers that could stand in their way, like startup costs, patents and potential government regulations.
- Decide which products pose a potential threat of substitute: Search for companies that have products that could potentially replace yours and determine if your customers can easily replace your service by simply doing it themselves. Establish the values of your company and why customers need your products.
- Determine the bargaining power of your suppliers: Research suppliers in your industry to determine if there are others available at more affordable costs. This helps you determine how much leverage you have over your current suppliers.
- Conduct market research to learn the potential power of your customers: Learn how valuable and beneficial your product is to consumers by conducting market research to determine how many other similar products and services are available to them. Collect feedback from customers to build a strategy that engages them and makes you stand out from the competition.
Carefully research and analyze your market and competition to determine where your potential threats to profitability could be. Use the Five Forces Model to develop a strategy that helps you overcome these obstacles and thrive in your industry.