Porter’s Five Forces Model: Understanding the Competitive Nature of Your Industry
You have a great idea and want to start a business. You feel like you’ve developed a great product or service for consumers to consider in the marketplace. You believe you can make a huge profit margin on your product or service and have a great return on investment (ROI). Unless your product or service is one-of-a-kind and doesn’t exist anywhere in the world, you should consider understanding Porter’s Five Forces model before bringing your product to market.
Dr. Michael Porter, a professor at Harvard Business School, created the framework and concept known as “Porter’s Five Forces Model.” According to Dr. Michael Porter, “There are five competitive forces that shape strategy in an industry. Knowledge of the five forces can help a company understand the structure of its industry and reframe a position that is more profitable and less costly.” vulnerable to attack. The five forces that determine the competitive intensity of an industry are:
1. Threat of entry
2. The power of providers
3. The power of buyers
4. Threat of Surrogates
5. Rivalry between existing competitors
These five forces are critical for new entrepreneurs and entrepreneurs to understand before introducing their products or services to the market or entering a specific industry. In this article I am going to provide a simplified explanation of the five forces for new entrepreneurs and entrepreneurs to understand their purpose.
threat of entry – Each industry serves a limited market. Companies within a specific industry compete for a substantial part of that market. What happens when a new company enters the industry? The new company consumes a part of the market. The pre-existing companies lose a part of their clients and with it a part of their income. If too many companies enter the industry, it affects the ability of companies to gain a significant share of the market. As the number of suppliers in the industry increases, it affects the overall demand for the products or services that companies offer, which affects the offer price. “The threat of entry thus puts a cap on an industry’s profit potential. When the threat is high, incumbents must keep their prices low or increase investment to deter new entrants (Porter, 1979).” To protect the industry from new entrants, incumbents create barriers to prevent new companies from entering the industry. Without going into detail, Dr. Michael Porter cautions that there are seven main sources that established companies leverage for barriers to entry: supply-side economies of scale, demand-side benefits of scale, switching costs. of customers, capital requirements, ownership advantages regardless of size, unequal access to distribution channels, and restrictive government policy.
The power of providers – Suppliers are companies that create special supplies, raw materials, personnel or specialized equipment to serve companies within specific industries. The power of a provider depends on its size and financial strength. A vendor that services a variety of industries or offers a unique product or service not offered anywhere else could be extremely powerful, especially when it comes to cost. A strong supplier can drive up costs and make it difficult for companies to increase their profit margin or pass those costs on to their customers. “Powerful suppliers, including labor providers, can squeeze profitability out of an industry that cannot pass on cost increases to its own prices (Porter, 1979).
The power of buyers – “Buyers are powerful if they have bargaining power relative to industry participants, especially if they are price sensitive, and use their influence primarily to pressure prices down (Porter, 1979).” Powerful buyers who purchase large quantities of goods or services from an industry could influence prices in that particular industry. The powerful buyer might threaten to buy out a company’s competitor if he believes the company’s price is too high. Power buyers might also demand higher quality or better service, which can have opposite effects and increase costs for the company you’re buying from. It is extremely important as a new business owner or entrepreneur to create a product or service that is attractive to multiple buyers. Having a healthy portfolio of buyers with the same purchasing power would help alleviate the fact that one buyer has too much influence.
Threat of substitutes – “When the threat of substitutes is high, industry profitability suffers. Substitute products or services limit an industry’s profit potential by capping prices… Substitutes not only limit profits over time. but also reduce the bonanza an industry can reap in good times (Porter, 1979).” The most important point that an entrepreneur or entrepreneur needs to understand about the threat of substitutes in an industry is how it affects demand and prices. Substitute goods provide the consumer with an alternative to preferred goods, either directly or indirectly. Cross-elasticity of demand refers to the sensitivity of the quantity demanded of a product or good to the change in the price of another product or good. To keep this simple, if the consumer is very sensitive to changes in the price of a preferred good, the demand for that good will decrease, while the demand for the substitute good will increase more. “If an industry does not distance itself from substitutes through product performance, marketing, or other means, it will suffer in terms of profitability and often growth potential (Porter, 1979).”
Rivalry between existing competitors – “High rivalry limits the profitability of an industry. The degree to which rivalry reduces an industry’s profit potential depends, first, on the intensity with which firms compete and, second, on the basis on which they compete (Porter, 1979). “Business owners and entrepreneurs need to carefully study and analyze the number of companies within the industry they want to operate in and how intense the rivalry is between those companies. Fierce rivalry within a saturated industry could wreak havoc on profitability of that industry. Companies within an industry that are of the same stature and compete on price make it extremely difficult for that industry to be profitable. An example, companies that offer similar or identical products and services will often lower prices of your products or services to gain a competitive advantage As a new business owner or entrepreneur entering a saturated industry that has a price war, it is extremely difficult to turn a profit, especially if incumbents have the advantage of economies of scale. scale.
According to Porter, there are many factors that drive the intensity of rivalry and the basis on which companies compete. Business owners and entrepreneurs should do more research on Porter’s five forces model to gain a deeper understanding of the contributing factors. In conclusion, according to Porter, “Understanding the forces that shape industry competition is the starting point for developing a strategy. Each company should already know what the average profitability of its industry is and how it has been changing over time.” “The Five Forces reveal why industry profitability is what it is. Only then can a company incorporate industry conditions into strategy.”
Porter, ME “How Competitive Forces Shape Strategy.” Harvard Business Review 57, no. 2 (March-April 1979): 137-145.
Harvard Business. “The Five Competitive Forces That Shape Strategy.” YoutubeYouTube, June 30, 2008, http://www.youtube.com/watch?v=mYF2_FBCvXw.