It’s incredibly difficult to enter an unsaturated market in the current business climate. If you’ve got a business idea, chances are somebody’s already doing something similar. So how can you make sure your business succeeds in this competitive environment?
Thankfully, several tools and frameworks are available to help you make informed strategic decisions – like Porter’s Five Forces Model. This management tool can help you understand the competitive dynamics of your industry, and it’s based on the idea that there are five forces that influence competition.
In this article, we’ll look at Porter’s Five Forces Model and discuss how you can use it to improve your business strategy. We’ll go over the following topics:
- What is Porter’s Five Forces Model?
- Detailed Explanation of the Five Forces
- Limitations of Porter’s Five Forces Model
- How to Use Porter’s Five Forces Model?
- Strategies To Use the Five Forces Model in Your Business
- Extending the Model: Porter’s Sixth Force?
- Wrapping up: Impact of Digital Transformation on Porter’s Five Forces Model
What is Porter’s Five Forces Model?
In 1979, Harvard Business School professor Michael Porter introduced a revolutionary concept that would forever change how businesses evaluate their competitive environment. Known as the Five Forces Model, this tool was designed to help companies understand their industries’ complexities and subtleties and assess their own viability within them.
Background of the Model
Porter, a renowned scholar and economist, argued that businesses must look beyond the apparent competitor dynamics to understand the holistic competitive landscape truly. He was passionate about promoting a broader, more nuanced perspective of industry structure and competition, one that accounts for a multitude of factors, both internal and external.
Rather than merely concentrating on direct competition, Porter proposed that five forces shape the destiny of a business in any industry. These forces are:
- Competitive Rivalry,
- Supplier Power,
- Buyer Power,
- The threat of Substitution, and
- The threat of New Entry.
Understanding the Five Forces Model
Each force represents a different aspect of the competitive environment. Together, they constitute a comprehensive framework that allows businesses to analyze their industry in a structured manner. This analysis can reveal insights into market trends, future threats, and opportunities that might go unnoticed.
It’s crucial to note that these five forces are interconnected and influence each other. They don’t act in isolation. Their collective impact on a business can be profound, shaping its strategy, affecting its profitability, and determining its potential for sustainable competitive advantage.
Implications in Business Strategy Development
This model isn’t merely an academic theory; it has practical, tangible implications for businesses of all sizes and across various sectors. Since its inception, executives, strategists, and business analysts worldwide have used Porter’s Five Forces Model extensively, providing valuable insights that inform strategic decision-making.
Overall, Porter’s Five Forces Model is a powerful tool for understanding the forces that shape competition within an industry. By understanding these forces, businesses can position themselves in a way that enables them to leverage their strengths, improve weaknesses, anticipate changes, and ultimately achieve a competitive edge.
Detailed Explanation of the Five Forces
We will delve into each force in more detail, exploring its implications and how they can be used strategically.
This force is all about how intense the competition is in your industry. A few different factors determine it:
- The number of competitors in the industry. How many other businesses are competing for the same market share?
- The size of the competitors. Are the businesses in your industry small, medium, or large?
- The aggressiveness of the competitors. How willing are they to compete? Will they cut prices, launch new products, or expand into new markets to gain market share?
- The intensity of the competition. How much are the businesses in your industry fighting for customers?
Here’s an example to illustrate the concept of competitive rivalry. A local bakery in a small town may have a few competitors, but the competition is moderate since there are enough customers to go around for everyone. On the other hand, a national chain of bakeries in a large city would face much more intense competition since there are limited resources and customers for all the businesses in the area.
This force looks at suppliers’ power in your industry and how easy it would be for them to raise prices or reduce the quality of their products. The determining factors include:
- The number of suppliers in the industry. The more suppliers there are, the less power they have collectively.
- The importance of the supplier to the industry. If a supplier is essential to your industry, they have more power.
- The availability of substitutes. They have less power if other suppliers can provide a similar product or service.
Let’s look at an example. A laptop manufacturer requires a highly-sophisticated computer processor for their products. Only two suppliers produce these processors, so the laptop manufacturer has limited options and must accept whatever terms the suppliers offer – whether it’s a higher price or inferior quality.
However, since many suppliers can provide these components, the same manufacturer enjoys much flexibility when they procure products to manufacture less technical parts, such as keyboards or screens.
Buyers have power when they are fewer in number than the businesses they are buying from when they are very price-sensitive, when the quality of the product is essential, and when there are a lot of choices.
The implications of buyer power can be significant for businesses; your buyers will likely switch to a lower-priced supplier, or they may dictate specific terms to you because you cannot afford to lose their business.
Here’s how it works. Let’s say you are selling office stationeries to a large retailer. The retailer can easily purchase the same products from many other suppliers, so they have the power to drive down prices or demand better quality.
On the other hand, if you are selling highly specialized products such as a customer relationship management (CRM) software solution, buyers don’t have much choice and, therefore less power over you.
Threat of Substitution
Sometimes, a company will release a product that customers can easily replicate using their resources or a combination of other products. This threat of substitution can be a significant issue for businesses.
Take, for example, the photography industry. With digital cameras, people can now take high-quality photos without spending money on a professional photographer. This has led to a significant decline in the demand for traditional photography services.
Another example might be mid-level graphic design services. Unless you work for a high-end client, your potential customers could use software like Canva to create their designs at a minimal cost.
The Threat of New Entry
The final force is the threat of new entry, and this looks at how easy it is for new businesses to enter your industry. How low are the monetary and non-monetary barriers to entry?
If it’s easy for new businesses to enter your industry, the competition will be stiff, and you’ll likely experience a lot of pricing pressure. On the other hand, if it’s difficult for new businesses to enter your industry, you might have a bit more breathing room.
Marketplaces like Amazon KDP have become far too saturated due to the low barriers to entry. Anyone can publish any book they want without an editor, cover artist, or ad campaign budget – so if you are trying to make money as an author, it’s now increasingly difficult.
Limitations of Porter’s Five Forces Model
Porter’s Five Forces Model provides an invaluable analytical framework that has undoubtedly changed how businesses perceive their competitive landscape. However, it’s important to remember that no model is perfect, and Porter’s is no exception. Despite its strengths, there are limitations that users should be aware of.
Predicting Future Trends
The first limitation is that initially conceived in the 1970s, the model may need to be fully equipped to predict future industry changes. In a rapidly evolving business environment characterized by disruptive technologies and constant innovation, the pace of change can outstrip the model’s capacity to anticipate upcoming trends and shifts. Porter’s Five Forces provide excellent insights into the current state of the competition but may need to catch up when foreseeing future trajectories.
Applicability in Complex Market Structures
Another potential drawback is the model’s applicability in complex market structures. For example, markets characterized by multiple buyers and sellers, or those marked by rapid changes in demand and supply, can prove challenging for the Five Forces framework. Here, the interactions between different forces may become too intricate to map onto the model neatly.
Overlooking Company-Specific Factors
Moreover, Porter’s Five Forces Model focuses more on the industry and often overlooks company-specific factors. While it expertly outlines external competitive forces, it may not sufficiently account for a company’s strengths and weaknesses. Therefore, it might be best used with other business models and strategies considering these internal elements.
Complementing with Other Strategic Tools
Given these limitations, using Porter’s model in conjunction with other strategic analysis tools is advisable. Techniques like SWOT analysis, PESTEL analysis, or even the modernized version of Porter’s model known as the “Sixth Force” can complement the insights obtained from the Five Forces framework. Such an integrative approach can paint a more comprehensive and precise picture of a business’s strategic position.
How to Use Porter’s Five Forces Model?
We’ve covered the Five Forces, its strengths, and its limitations — but what can you do with that information?
Well, now that you understand the dynamics of your industry, you can use this information to make informed strategic decisions.
For example, if you’re in a highly competitive industry, supplier power is high. You may need to find new suppliers or develop a relationship with a key supplier to maintain your competitive edge.
If rivalry is high, you may need to focus on differentiation and innovation to set yourself apart.
The Five Forces Model can also help you assess opportunities and threats in your industry. For example, if you see new entrants entering the market, this could be an opportunity to expand your business.
Alternatively, if you see industry profit margins shrinking, this could be a sign of a potential threat to your business.
Strategies To Use the Five Forces Model in Your Business
To close out the article, let’s run through some winning strategies for using Porter’s Five Forces to your advantage.
Start with Analyzing Your Business
Analyze your current business concept. Create a document and write out each of the five forces, with space underneath to brainstorm how to improve your position.
Print out the document or forward it around to your team. Ask everyone to think about how your company stacks up against each factor and how you could potentially improve.
Look at your competition – but don’t get tunnel vision. Porter’s framework provides a way to look beyond your competition and understand the dynamics of your industry.
This can help you develop a more well-rounded strategy that considers what your rivals are doing and the other forces at work in your market.
Analyze Your Business’ Future
Use Porter’s Five Forces to make informed decisions about future opportunities and threats.
If you’re considering expanding into a new market, for example, Porter’s Five Forces can help you assess the attractiveness of that market and understand the risks involved.
The same goes for potential threats – if you see industry profit margins shrinking, for example, this could be a sign that a particular market is about to become saturated.
The Five Forces Model can help you develop a more targeted and well-rounded strategy, but it’s not the only tool in your arsenal.
Don’t be afraid to get creative and use other methods to develop new ideas. Brainstorming, market research, and competitor analysis can all help you create a more comprehensive strategy.
Use the Five Forces to track your progress. As your business evolves, tracking how the Five Forces affect your position is vital.
Are new entrants entering the market? Is supplier power changing? Is rivalry increasing?
Leverage Buyer Power
Businesses can use buyer power to their advantage by strengthening customer relationships. For instance, they can engage in customer service improvements, loyalty programs, and targeted marketing efforts.
Understanding what drives your customers’ purchasing decisions can help you tailor your products and services more effectively and increase customer retention.
Manage Supplier Relationships
Businesses can also strategically manage their supplier relationships to mitigate the impact of supplier power. By diversifying suppliers, negotiating contracts, and even considering vertical integration, companies can lessen their dependence on any one supplier and ensure a stable supply chain.
In today’s fast-paced, technology-driven environment, innovation can be a potent tool against the threat of substitution. Constantly developing and improving your products or services, adopting new technologies, and staying attuned to changing customer needs can help you remain competitive and make your offerings more resistant to substitution.
Build Barriers to Entry
Another strategy could be building entry barriers to ward off the threat of new entrants. This can be achieved through measures such as securing patents, investing in brand recognition, achieving economies of scale, or building a robust network of distribution channels. By making it difficult for new competitors to enter your market, you can help preserve your market share and profitability.
Extending the Model: Porter’s Sixth Force?
While Porter’s Five Forces Model has been invaluable in understanding the competitive landscape, some scholars and practitioners have suggested expanding the model to incorporate a “sixth force.” This proposed addition attempts to update the model to reflect the complexities of the modern business environment.
The Concept of the Sixth Force
The sixth force is often defined differently by various theorists and practitioners. However, one of the most commonly cited sixth forces is “complementary products and services,” sometimes called “complementors.”
Complementors are companies or entities that directly sell or provide a product or service that is complementary to your own. For example, in the technology industry, software developers (complementors) create apps that enhance the functionality and value of smartphones. This interplay significantly impacts the smartphone manufacturer’s competitive landscape.
The Impact of Complementors
Complementors can have a profound effect on a company’s competitive environment. They can enhance the value of a company’s product, attract more customers, and create a more robust ecosystem around its offerings. At the same time, they can also become potential competitors, especially if they decide to create a similar or substitute product.
Wrapping up: Impact of Digital Transformation on Porter’s Five Forces Model
If you have been struggling to ‘make it’ within your industry, it may be time to take a step back and assess your standing. Thanks to Porter’s Five Forces, you can do just that.
In the digital age, Porter’s Five Forces Model is more relevant than ever. Technological advancements like time-tracking tools, global e-commerce platforms, and digital services have altered the five forces – entry barriers, buyer power, substitute threats, supplier power, and competitive rivalry – creating an intensified and digitized global competitive arena.
Furthermore, the emergence of digital ecosystems has highlighted the influence of “complementors” as a potential sixth force in strategy formulation. Despite its complexity and speed of change in this transformation era, Porter’s model remains invaluable for understanding competition and informing strategic decisions that lead to sustainable success.