What are Porter’s Five Forces?
Porter’s Five Forces is a model that analyzes a company’s competitive environment. Understanding these five forces can help you recognize where you stand within an industry with regard to your competitors, your substitutes, your customers, your suppliers, and new entrants. This model will help you analyze your competitive advantages, if you have one, along with which of those might be your USP. For each of the forces, you will determine where the power lies on a scale of high to low. Understand, the power will be completely different depending upon the company; however, when you combine all of the forces and look at them as a whole, this can help you understand your strengths and weaknesses. Although businesses perform differently, the underlying drivers of profitability are the same in every industry.
Force 1: Bargaining Power of Buyers
When considering the bargaining power of buyers, you should start by asking yourself if your products or services are B2B, B2C, or both. Buyers have the ability to drive down prices due to substituting goods and services. It is important to know your portion of the market because they can dictate the market price. Why are your customers coming to you? If your prices are high, are your customers expecting a certain level of service? Consider the costs associated with each customer, are they too expensive to lose?
Force 2: Bargaining Power of Suppliers
Every company has its suppliers, whether that be for merchandise, food, software, etc. Most companies have a few suppliers for the same products. A great question to first ask yourself is whether or not there is another supplier for that product or service. If there isn’t, then the bargaining power of suppliers increases and they can have more control over the prices and even demand a shorter term of credit. However, if there are other options for suppliers, you must consider the cost of switching. This can be expensive, especially if you are looking to import from another country.
Force 3: Threat of New Entrants
Industries and markets are always evolving, and depending on the industry, people may come and go quite often. Factors to consider might include a new competitor bringing new features or new technology to the industry, or finding cheaper, better methods of accomplishing tasks. Although this threat will always be a concern, there are ways to gain more control of the situation. Having unique differentiation is always a good place to start, however, research and development can only help your company and make it more difficult for others to compete. The lower you can keep your costs, the more control you will have.
Force 4: Threat of Substitute Products and Services
The threat of substitutes has nothing to do with brands, but the product or service itself. Products or services that have many substitutes might find themselves more vulnerable because this leaves consumers with options. If there are many substitutes, factors such as weather, price, mood, or setting could play a role. If there are not many substitutes, that leaves you with more control over the market.
Force 5: Rivalry Among Existing Competitors
Depending on the size of the market and the number of players, there’s going to be competition. If the industry is growing, there are going to be more competitors, but if the industry is stagnant, the competition is only going to try harder to capture the audience. You also have to consider what the fixed cost is to enter the market. If it is high, competition might not want to enter, but if costs catch up, it could be more expensive to exit the market.
Porter’s Five Forces ultimately helps companies understand the industry and where they are positioned within. You can utilize this to learn where you can take advantage of opportunities to minimize the impact of the forces and increase your positioning.