Using Porter’s 5 Forces

Created by Harvard professor and economist Michael Porter, Porter’s 5 Forces model is a simple yet powerful business strategy tool. It helps to assess the viability of the market and the balance of power existing in it. Management and marketing use it to guide decisions when looking to explore new markets or segments. It assists in evaluating the appeal and profitability of the market or sector.

This framework, as its name suggests, comprises of five “forces,” namely:

• Competitive rivalry
• Bargaining power of suppliers
• Bargaining power of buyers
• Threat of substitutes
• Threat of new entrants

We explain these in the following sections and how you can use them to gauge attractiveness and potential profitability.

Competitive Rivalry

This is arguably the first and most factor you need to consider when looking to understand your environment or industry and how to ensure profitability. It is vital to weigh up the degree of competition to contend with. Know your direct competitors, the products or services they provide, and what they do that gives them an advantage. While you should consider the number and diversity of rivals, less competition isn’t always the best, although attractive. Fewer competitors might suggest a market that will not last for long.

Bargaining Power of Suppliers

The ability of suppliers to influence prices should be considered when assessing market attractiveness and profitability. Suppliers aren’t necessarily just companies that sell raw materials but those that provide inputs or support to your business.

The number of companies available that can deliver the inputs your organization needs can influence bargaining power. When you have fewer suppliers to work it, you are somewhat at a disadvantage already when negotiating. This vulnerability of sorts can hurt your profitability.

It is not only helpful to ensure there are many suppliers but also that you can switch easily from one to another. Take into account possible effects, if any, that switching between suppliers might have.

Bargaining Power of Buyers

You want to think about what power buyers can have on the prices to charge in order to ensure profitability. Customers are well aware that they are the reason for companies’ existence and will look to exploit that. The bargaining power of buyers is arguably more apparent if what you offer are products, especially one that is not very different from what the competition offers. You may have more room to negotiate better prices when providing services.

Therefore, it is vital to assess what power buyers have – their number will influence this to a degree. A proper understanding of the situation will enable you to know how flexible you may need to be to secure your position in the market.

Threat of Substitutes

You won’t only have to deal with direct competition but also indirect competition. It is easy to pay little to no attention to the latter at the initial stage, even though the threat it constitutes is real. Changes in technology over time can alter how customers want to solve their problems or these problems themselves can change.

Indirect competition comes from products that can serve as substitutes to yours. They are not the same as yours but users can use them to achieve a similar goal. The typewriter is a classic example of the threat substitutes can pose. Technology change shifted focus to personal computers over time. Typewriters are hard to come by these days as users find them less convenient to use.

You should have a plan in place on how to approach changes as they occur. Explore what’s changing with customers over time. What’s changing in their lives and how easily can they find substitutes for your products? An understanding of the changing user behavior can expose opportunities you can exploit to remain relevant.

Threat of New Entrants

Last but not the least, you should think about possible new entrants when gauging market viability and expected profitability. Are there barriers to entry of any sort? How easy is it for companies to enter or exit a sector or market?

Market sectors with significant barriers to entry typically have fewer companies. In many cases, organizations are not expressly or legally restricted. They are usually kept out by huge capital requirements and only a few having such are able to set up. Patents and licenses are also among possible restrictions to entry.

On the other hand, there are usually many more companies in a less-regulated market with no barriers. It is often hard for a single company to control a significant share of the market unlike what obtains when there are barriers. The competition here is more intense and can drive down prices and profitability. Consider the extent of competition you’d have to face in your market. Is there any way your company can enjoy some protection from competition? Think about barriers that could be to the benefit of your business.

Assessing all Porter’s 5 Forces or factors can enable you to figure out what changes you can or must make to put your business in an advantageous position. You will have to back them up with research and, in some cases, assumptions.