Porters Five Forces

Introduction and definition

Porters Five Forces is a tool for evolving business strategies on the

basis of the nature and level of competition in an industry.
The name comes from Harvard professor Michael Porter and the Five
Forces concept that he devised for understanding the competition in an
industry and, therefore, its attractivenessthe ease with which profits can
be made in the industry.
Put another way, Porters Five Forces concept helps understand where
power lies in a given situationthe analysis tells you where you are in
relation to your competitors, and ultimately, the chances of your own
profitability in your business situation compared with those of your rivals.
It is used both by new entrepreneurs planning to enter an industry and by
established corporations reviewing their sustainability in a sector.

Porters Five Forces Model | Template

The five forces that influence a companys performance in an industry or
business situations are:
1. The bargaining power of buyers
2. The bargaining power of suppliers
3. The competitive rivalry among the competitors in the
industry
4. The threat of substitute products
5. The threat of new entrants, or barriers to entry into the
industry
This is depicted in further detail in the template below.
Image Credit: MIT OpenCourseWare
Five Forces example: Fast-food industry
To understand the impact of Porters Five Forces model, let us now look at
each of the forces as though it is acting on a particular industry, say the fast-
food industry of burgers, pizzas, and sandwiches.

(1) Bargaining power of buyers

The buyers have high bargaining power in a place where there are many
fast-food joints, as they can choose any one of them.
For example, if the queue is too long at one outlet, the buyer can probably
go to another outlet just across the road. The determinant of the high
buyers bargaining power, in this case, is the high number of sellers to cater
to the buyers. But the high bargaining power of the buyer is a disadvantage
to a fast-food restaurant operating at the place.

(2) Bargaining power of suppliers

The main suppliers in the fast-food industry are dough, dairy produce, and
meat vendors. Their bargaining power is low since there would be a number
of suppliers of these items.
The determinant of the low suppliers bargaining power here is the lack of
differentiation among the suppliers products (the existence of a number of
reliable suppliers). So, this is an advantage for a fast-food outlet or chain.

(3) Competitive rivalry among competitors

The industry is chock-a-bloc with competitorsthere are big brands such as
McDonalds and KFC, and medium and smaller brands, including local
restaurants and bakeries, selling a variety of snacks and quick-eats.
The determinant of the high competition is the high number of eateries
selling quality products. This situation is a disadvantage to a fast-food
eatery.

(4) The threat of substitute products

Restaurants and other eateries are quite capable of selling the types of
products sold by a fast-food joint, such as a burger or a sandwich. So, the
threat of substitute products is quite high for a fast-food restaurant.
The determinant of the high threat of substitutes is the lack of
differentiation among the products available (except perhaps in the case of
McDonalds or KFC, whose products are seen as unique)obviously a
disadvantage for a fast-food outlet.

(5) The threat of new entrants, or barriers to entry

An entrepreneur requires a complex set of permissions to open a restaurant.
In addition, good infrastructure needs to be built up. Then there is the task
of creating unique products to set apart the restaurant from its competitors,
which may include multinational chains.
Any businessperson would baulk at the prospect of entering this business.
The determinant of the low threat of new entrants is the requirement of a
number of permissions (tough barriers to entry) and the established
products. Therefore, this is an advantage for a fast-food joint.
The competitive scenario
From the analysis above, we infer the following scenario of competitiveness
in the fast-food industry:

High bargaining power of buyers: A disadvantage for a fast-

food outlet
Low bargaining power of suppliers: An advantage
High competitive rivalry among competitors: A disadvantage
High threat of substitute products: A disadvantage
Low threat of new entrants: An advantage
There are two advantages compared with three disadvantages. Therefore,
unless a fast-food eatery is able to create unique products and develop a
reputation for service and hygiene, it will soon go out of business.
The Porters Five Forces analysis indicates a high level of competitiveness
and a low level of attractiveness for the fast-food business.
Porters Five Forces, by helping evaluate the competitiveness in an industry,
enables companies to come up with strategies to reduce buyers and
suppliers power, reduce competition and the threat of substitutes, and stop
the entry of newcomers. Changes in any one force will compel companies to
reassess their market situation.

Explaining high profits, big losses

The Five Forces model is also useful for understanding why high profit is
the rule in some industries, while huge losses are the norm in some other
industries.
For example, in the soft drinks industry, Pepsi and Coca Cola are able to
sustain profits, whereas airlines face a perpetual struggle to come out of the
red. Why?
A Five Forces analysis of the two industries would give many reasons.
Just a couple of them here:
(1) while Pepsi and Coca Cola do not face much buyer threat (the millions of
customers have little individual influence on the business), buyer threat to
airlines is high (lower fares can take away customers);
(2) Pepsi and Coca Cola hardly face any threat of substitutes (what can
replace them?), while airlines face a high threat of substitutes (from airlines
offering lower fares or a better level of service).
You can yourself find the determinants of each of the five forces in any
industry and the impact of the forces by using the framework below. The
model can also be used to look at personal situationsfor example, a career
change.

Limitations of Porters Five Force Model

The Five Forces model was conceived by Michael E. Porter of The Institute
for Strategy and Competitiveness based at the Harvard Business School.
Porter, who presented the model in his work Competitive Strategy:
Techniques for Analyzing Industry and Competitors, developed it
because he felt that the SWOT (strengths, weaknesses, opportunities, and
threats) analysis was not specific enough for the requirements of industry.
There have been criticisms of the Five Forces model from economists, who
put forward examples of other forces that may affect an industrial scenario,
such as government regulations.
Porter implicitly dismissed these criticisms, saying that these were not
forces as such, but only aspects that affected them.
Business managers use the Five Forces model mainly to initiate an analysis
of competitiveness. They depend on other frameworks to develop their
strategies.
All said, the attractiveness of an industry to a company depends on the type
and quality of the companys organisational and financial resources. In the
corporate jungle, it is the fittest that survives.