Porter’s 5 forces model is a tool that is widely taught in business schools and various training centres. Among other things, this tool makes it possible to analyse the competition in a market.
Porter’s forces refer to the following elements
- The intensity of competition,
- The bargaining power of customers,
- The bargaining power of suppliers,
- The threat of new entrants,
- The threat of substitutes.
This model is used mainly for the purpose of developing corporate strategy. Created by Professor Michael Porter (Professor of Strategy at Harvard University, USA) in 1979, it was developed to fill the gaps in the SWOT analysis model.
This tool revolutionised the way in which the various competitive forces present in a market are analysed and thus helped companies to develop competitive advantages.
What does Porter’s 5 forces model base its analysis on?
Michael Porter started from the premise that the definition of competition should be extended to other factors, forces, present in markets. The term “competitor” is thus designated as any form of economic player, which is then likely to be a factor reducing the ability of companies present in a market to generate profit.
He then defined what is known today as Porter’s 5 forces. According to him, these forces determine the competitive structure of a market by influencing the profitability of an industry.
Between them, the 5 forces become potential threats to the development of a business, when defining corporate strategies.
It is thanks to this configuration of Porter’s five forces that we can analyse the key success factors (i.e. the strategic elements that need to be mastered in order to avoid profit being captured by these five forces to the detriment of the firms in question) and thus identify the competitive advantages of a company.
Because of its dynamics and hierarchy, the model presented by Porter makes it possible to characterise the environment in which companies operate in a given market. The objective is not to focus on a single company. This analysis tool therefore allows you to understand the external factors of a company. In fact, for all competitors in the sample market, the competitive analysis will be the same, and the key factors identified will be identical. The only element of differentiation will be the ability of companies to master Porter’s strengths.
What are Porter’s 5 forces?
As explained above, this analysis is based on the definition of 5 competitive forces that support the market and reduce the profitability of a company. But what exactly do these 5 forces represent?
1. The bargaining power of customers
In a market, customers have more or less influence on the degree of competition because of their level of bargaining power. This means that they have influence on the price and conditions of sale (quality of services, payment terms, delivery times etc.).
It is their level of concentration (i.e. their high or low number) that will determine this influence and the profitability of the market.
Few customers in a market with multiple suppliers have, in fact, more bargaining power.
Other determining factors are:
- they are few in number in the market (oligopsony)
- they have a large market weight (size)
- there is a threat of backward integration (customers can produce the supply themselves)
- alternative sources of supply exist
- the transfer cost (cost that customers have to bear in order to change supplier) is either low or high but predictable (which amounts to saying that the supply is standardised)
Finally, we come back to a basic economic theory of supply and demand: in a market, supply and demand intersect, so if supply is greater than demand, customers have significant bargaining power.
What are the risks? If the bargaining power of customers is high, the company will be involved in a price war and a constant competitive battle. The solution is to create a major innovation so that you no longer have to differentiate on price but on another, more profitable aspect.
2. The bargaining power of suppliers
The bargaining power of suppliers should be analysed here, i.e. their ability to impose conditions (whether in terms of costs or quality) on firms present on a market.
The main elements to be analysed are the number and size of suppliers on the market, the degree of scarcity of the products sold by these suppliers and finally the cost of changing suppliers.
Thus, suppliers have a high degree of power when :
- they are concentrated and few in number
- there is a threat of downstream integration from suppliers
- competitors are numerous and dispersed
- the switching cost (the cost to a customer of changing supplier) is high
- Customers are few in number
3. The threat of substitutes
A substitute product is a good that can be used instead of another, which meets the same need. It is therefore an alternative to the offer that firms propose; for example, markets for supermarkets, reading devices for books, etc.
These substitute products are considered a real threat as soon as their value/price ratio is higher than that of the established offer. In other words, if they provide greater value for the same or slightly higher price than the original offer, then the threat of substitute products is strong.
Conversely, if the value of the substitutes does not appear to be higher (or even lower than the original offer) and the price is higher or the same, then the threat is low.
In relation to this threat, the following points should be considered
- the advantages and disadvantages of the substitute product
- the relationship between the value of the substitute product and its price
- how easy it is for a customer to change supplier
However, there are a number of solutions that can help a company to focus on a market or the threat of substitutes, including: lowering the price of their offering, increasing its value (for example by adding features or services), abandoning the current offering and switching to the substitute (if they have the resources and skills), or even abandoning the market.
4. The threat of new entrants
New entrants” is an economic term used to distinguish new firms entering a market. The degree of threat from new entrants will therefore depend on the level of difficulty for new firms to enter the given market.
On the other hand, the arrival of new entrants can be stopped or slowed down by the implementation of barriers to entry (e.g. patents, standards, protectionist measures, brand image, investments to be made or the time needed to make them profitable, etc.).
These are all means that make it difficult for newcomers to enter the market. Furthermore, competition in a market with major players with a high level of recognition is already a strong barrier to entry in certain markets.
The main elements to be analysed to define the degree of this threat are therefore based on
- the critical size to be reached to be profitable.
- the average amount of initial investment required to start up
- the level of regulation required to carry out the activity in question
5. Competition intensity
This element is placed at the centre of the matrix and represents the struggle between competitors in the market to increase or maintain their positions. This competitive intensity will depend on several factors such as
- the size and diversity of the competing companies
- the number of competitors in the market
- the growth of the market
- the degree of differentiation of competitors
Bear in mind that there are more or less intense power relations between competitors, but that this aspect will depend largely on the sector in which the market is located, its development prospects, the existence of barriers to entry or the number of companies present on the market, the size of competitors, etc.
It is placed at the centre of the matrix because it takes into account all the forces previously analysed.
Porter’s 5+1 forces
A 6th force was later added to Porter’s model: the power of the state. Indeed, the importance of public legislation and regulations implemented in private affairs led the actors to add this 6th force to the matrix.
This is known as Porter’s 5+1 forces model.
The power of the state represents the policy and legislation that determines how each of the forces will operate in the market. Indeed, market entry may be subject to approval or licensing, or conversely, it may be subject to subsidies or other forms of state aid.
Thus, it represents, to a greater or lesser extent, a form of competition in the market.
Why use Porter’s 5 forces model?
Porter’s 5 forces analysis is a key tool for an entrepreneur who is considering entering a market, whether it is a business start-up or even the development of the business in a new sector, with a new offer etc. Its objective is to evaluate the forces present in a market, to diagnose all the external factors that threaten the activity of a company, and to allow a structural analysis of a given sector.
For an established company, it represents a real strategic tool for competitive intelligence and enables the anticipation of the arrival of new competitors or the growth or decline of a market. Since the economic environment is constantly evolving, keeping a constant eye on the market allows, on the one hand, to develop new offers (or the existing offer), and on the other hand, to set up the company’s strategy for this offer and to make the right strategic decisions.
The entrepreneur must be constantly on the lookout for new opportunities and anticipate potential threats to his business:
- the arrival of one or more new competitors on the market
- the launch of a new product that constitutes a credible alternative to the current offer
- analyse your market and synthesise the elements of your monitoring
- prepare your negotiations and your arguments with suppliers and customers more effectively
- identify and limit or reduce the negotiating power of your suppliers
- identify new purchasing opportunities or innovations
- adapt your purchasing strategy according to all these axes.
- reduce the number of suppliers for vital supplies
How to use Porter’s 5 forces model?
Even if Porter’s five forces are the same for all firms sharing a market, the way in which the company prioritises these forces is up to it. Thus, each actor has his own interpretation of the threats, and by giving a weight to each of these five forces, the company will be able to prioritise the threats to be countered and determine the strategy to be put in place to deal with them (what we will call the KSF or key success factors).
In any case, an entrepreneur who wants to analyse Porter’s 5 forces model to analyse the environment in which he or she wishes to evolve will have to list the various points to be studied and carry out an in-depth study on each of them.
After analysing each of these forces by defining the level of their individual impact (strong, weak or medium) and considering the situation as a whole, the entrepreneur will be able to use the information from his analysis to make the right strategic decisions. All that remains to be done is to distinguish the elements that constitute threats and those that, on the contrary, constitute development opportunities through various competitive approaches such as
- an innovation strategy to enter new markets
- a pricing strategy to attract customers
- a differentiation strategy to offer products or services that are different from those of competitors
- a specialisation strategy to find markets with little competition (niche markets),
- or a strategy of cost domination to offer the most competitive prices possible
- Define your E-Commerce strategy
Advantages and disadvantages of Porter’s 5 forces model
Porter’s 5 forces model is an easy tool to use because it has what is called a “fixed structure”, with these 5 forces analysis, it can give key insights into the threats and opportunities in the market. However, it also has some limitations.
Simple to implement and structured tool
Allows you to analyse your competitive position in depth.
Allows you to be proactive on your market and to anticipate (new entrants and substitute products)
Each of the forces must be prioritised in a relevant way in order to put in place an effective strategy (this therefore depends on each company and each sector of activity)
The matrix only takes into account external factors, omitting internal factors, resources and skills of a company which are crucial to its position in a typical market
This matrix can be a barrier to collaboration, as it is based on threats and not on opportunities.
Image credit: Viktorija Grachkova