Competition is one of the biggest threats to a business, and no matter whether it’s just a startup or a large corporation. It is very important to know who your competitors are and how their actions on the market can influence your position.
Investors and market analysts are constantly looking for opportunities to analyze the market in order to better understand the positions and strengths of companies in a particular industry. One of the tools of fundamental analysis, which goes beyond the simple study of financial performance, is Michael Porter’s Five Forces model. In this article, we are going to consider the technique in detail, learn how to use it, and find out who needs it.
What is Michael Porter’s Five Forces model?
It is a popular model that helps analyze competition on the market and the way it may influence your products. The theory was developed by Michael Porter in 1979. Since that time, it has undergone few changes but it is still relevant and popular in the modern business environment.
According to this model, there are five driving forces on the market, which determine a possible level of income of a company. Michael Porter distinguished the following forces, each of which stands for a particular side of product success. Five forces are:
- The intensity of competition in the industry.
- The emergence of substitutes.
- Problems with suppliers.
- Consumer issues.
- The threat of new competitors.
The essence of Porter’s theory is in the differentiation of competitive forces and the analysis of individual indicators. The theory is successful, judging by the fact that M. Porter collaborated with many companies, and at the same time, businesses always achieved success in the competition.
According to M. Porter, the main company’s weakness is its managers who look at the problem of competition too narrowly. They consider the firms that occupy the same segment of the market as their main threat. While competition is a combination of the main forces that influence the economic viability of a company.
Let’s consider each force separately:
The intensity of competition in the industry
The model involves an analysis of the industry and of what factors are behind the problems of competition. M. Porter tells about the “threshold of entry.” Air transportation is an example. When starting a business in this sphere, from his point of view, it is quite easy: one just needs to have one plane. You can start the first scheduled flight. However, there are many airlines that provide the same services. The passenger can choose, and if the ticket is cheaper, fly another flight in an hour. Or use another type of transport, etc. With this the entry threshold into the business and regulated competition, the profitability is quite low. The intensity of competition is also determined by:
- A large number of similar companies that carry out the same type of activity or providing the same types of services.
- A typical similarity of produced goods.
- The level of costs for the production of goods and services (consistently high cost).
- A high entry barrier (market maturity and saturation).
Profitability also depends on the internal structure of the industry and exposure to the “storm exposure to external forces”.
The emergence of substitutes
There is always the possibility of the emergence of new types of goods of the same purpose on the market. The task of management is to anticipate the possibility of commodity substitution and to respond to such facts in a timely manner. A new product on the market may be cheaper or meet other improved requirements. The threat of the emergence of a new product can be prevented by organizing proper well-developed pricing and marketing policies of a company:
- Price competition is able to shift customers’ attention to low prices instead of focusing on product quality.
- Advertising attacks attract attention to the product and distract consumers from the possibility of its substitution.
- The production of new attractive products within a company reduces the possibility of goods substitution.
- The improvement of the quality of service during sales and distribution of goods will reduce the competitiveness of substitutes.
Problems with suppliers
Suppliers have the same competitive environment defined by the same criteria. Within the frameworks of the analysis of Porter’s forces, their strength is determined by:
- The presence of large supplier companies. The possibility of a monopoly.
- The uniqueness of goods supplied.
- An option when the industry where the goods are delivered is not the main one for the supplier.
- Lack of supply will lead to the bankruptcy of the company itself.
- The ability to join the buyer company through vertical integration.
- Raise the price of their goods.
- Reduce the number of products and services provided.
Customers influence competitiveness no less than other factors. Their strength depends on such factors as:
- Consolidation of consumers.
- The degree of importance of a product to a customer.
- The breadth of product use.
- The level of awareness about substitutes and the scope of goods.
A strong consumer can:
- Influence the level of prices in order to reduce them.
- Demand high quality.
- Require a better service.
- Face manufacturers with each other.
The threat of new competitors
The risk of emergence of new players in the existing niche is determined by the economic attractiveness of a market segment and the threshold of entry into a business. Here, such factors as the following ones play the key role:
- The price attractiveness of entering the market.
- A low cost of production organization (services).
- Ease of entering a business (the entry threshold).
Where is the model used and what for?
The Michael Porter five forces model is widely used in management, business, or marketing. As we have found out the technique helps analyze the situation on the market and take the necessary measures to prevent possible threats for your business.
The analysis allows coping with the following objectives: determine the intensity and severity of the competitive forces in the industry, as well as find a position in which a business will be maximally protected from the influence of competitive forces and will be able to influence them.
Michael Porter has developed one simple rule: the weaker the influence of 5 forces is, the more possibilities to gain profit a company has. And vice versa, if there is a high and tense influence of competitive forces, then it will be harder for a company to cope with competition and succeed.
How the model is used: situation analysis and strategy building
M.Porter explains that the principle of his method of the 5porter forces of competition lies in a systematic and integrated approach to building a strategy of relationships with all market participants.
For successful and competitive work it is necessary to:
- Analyze the industry, identifying the factors behind the competition.
- Determine the structure of the industry, its appeal, and the entry threshold.
- Understand industry dynamics. How quickly changes are taking place, the direction of development.
The range of interested individuals is expanding as much as possible. The main strategic task in all sectors is to find a unique consumers’ need that your company will satisfy by providing your services or goods. For this, the following procedure is defined:
- Gather a group of specialists who are aware of all sides of your company activity.
- Define the prioritization of a company, for example, making a profit, achieving a monopoly, expanding, etc.
- Highlight the most powerful factors of the five forces.
- Concretize problems that your company faces in terms of a particular force.
- Find those factors that can be weakened.
- Draw up a plan of action to fulfill the plan into reality.
As all these steps are over and you have gathered the necessary information and made certain decisions, you can visualize the findings using Porter’s five forces template. If you consider the topic at a meeting or conference, it is impossible to avoid the use of digital tools. Moreover, they can make your workflow easier.
Convenient premade templates for Porter five forces analysis display
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We hope that we answered your question of “what are Porter’s five forces”. Now, you understand that not only competitive companies may influence your success on the market. The problem of competition is much deeper. If you’re aware of the model, you’ll be able to make a comprehensible analysis of your business and adjust your future business plan. It is important to remember that the market tends to undergo changes, so it is necessary to keep pace with it and timely react to its changes. This is the right way to a successful business.