Five Forces Model by Michael Porter
Five Forces Model by Michael Porter
Five Forces model of Michael Porter is a very elaborate concept for evaluating company's competitive position. Michael Porter provided a framework that models an industry and therefore implicitly also businesses as being influenced by five forces. Michael Porter's Five Forces model is often used in strategic planning.
Porter's competitive five forces model is probably one of the most commonly used business strategy tools and has proven its usefulness in numerous situations. When exploring strategic management models, you also might want to check out the BCG matrix, SWOT analysis, IFE matrix, and SPACE matrix models.
Why would I need to use Porter's Five Forces model?
In general, any CEO or a strategic business manager is trying to steer his or her business in a direction where the business will develop an edge over rival firms. Michael Porter's model of Five Forces can be used to better understand the industry context in which the firm operates. Porter's Five Forces model is a strategy tool that is used to analyze attractiveness of an industry structure.
What is good about Porter's Five Forces model?
Porter has the ability to represent complex concepts in relatively easily accessible formats. His book about the Five Forces model is written in a very easy and understandable language. Even though his model is backed up by some complex model, the model itself is simple and easily comprehensible at all levels.
Porter's Five Forces model provides suggested points under each main heading, by which you can develop a broad and sophisticated analysis of competitive position. This can be then used when creating strategy, plans, or making investment decisions about your business or organization.
Does Porter's Five Forces model really work?
Theoreticians have different view on this. While some agree that Porter's Five Forces model is the ultimate explanation of how world works, others disagree. It depends in what time frame we judge the state of the facts. Even Michael Porter himself acknowledges that time is of essence when it comes to how his forces interact with each other.
Numerous economic studies have shown that different industries can sustain different levels of profitability. This can be attributed to differences in industry structures.
What is the basic idea behind Porter's Five Forces model?
Porter's Five Forces model is made up by identification of 5 fundamental competitive forces:
- Barriers to entry
- Threat of substitutes
- Bargaining power of buyers
- Bargaining power of suppliers
- Rivalry among the existing players
Some later economists also consider government as the sixth force in this model.
When putting all these points together in a graphical representation, we get Porter's Five Forces model which looks like this:
Force 1: Barriers to entry
Barriers to entry measure how easy or difficult it is for new entrants to enter into the industry. This can involve for example:
- Cost advantages (economies of scale, economies of scope)
- Access to production inputs and financing,
- Government policies and taxation
- Production cycle and learning curve
- Capital requirements
- Access to distribution channels
Patents, branding, and image also fall into this category.
Force 2: Threat of substitutes
Every top decision makes has to ask: How easy can our product or service be substituted? The following needs to be analyzed:
- How much does it cost the customer to switch to competing products or services?
- How likely are customers to switch?
- What is the price-performance trade-off of substitutes?
If a product can be easily substituted, then it is a threat to the company because it can compete with price only.
Force 3: Bargaining power of buyersNow the question is how strong the position of buyers is. For example, can your customers work together to order large volumes to squeeze your profit margins? The following is a list of other examples:
- Buyer volume and concentration
- What information buyers have
- Can buyers corner you in negotiations about price
- How loyal are customers to your brand
- Price sensitivity
- Threat of backward integration
- How well differentiated your product is
- Availability of substitutes
Having a customer that has the leverage to dictate your prices is not a good position.
Force 4: Bargaining power of suppliers
This relates to what your suppliers can do in relationship with you.
- How strong is the position of sellers?
- Are there many or only few potential suppliers?
- Is there a monopoly?
- Do you take inputs from a single supplier or from a group? (concentration)
- How much do you take from each of your suppliers?
- Can you easily switch from one supplier to another one? (switching costs)
- If you switch to another supplier, will it affect the cost and differentiation of your product?
- Are there other suppliers with the same inputs available? (substitute inputs)
The threat of forward integration is also an important factor here.
Force 5: Rivalry among the existing players
Finally, we have to analyze the level of competition between existing players in the industry.
- Is one player very dominant or all equal in strength/size?
- Are there exit barriers?
- How fast does the industry grow?
- Does the industry operate at surplus or shortage?
- How is the industry concentrated?
- How do customers identify themselves with your brand?
- Is the product differentiated?
- How well are rivals diversified?
Rivalry is the fifth factor in the Five Forces model but probably the one with the most attention.
What are the assumptions behind the Five Forces model?
From the risk-return perspective, Five Forces model indirectly implies that risk-adjusted rates of return should be constant across firms and industries.
How can I analyze my business from inside?
Porter's Five Forces model views the business from outside. It focuses on assessing competitive position within industry. If you wanted to analyze your firm from within, you might want to consider the SWOT model. The SWOT model has some aspects of external view as well but complements Porter's Five Forces model in the internal view. Another model that you might want to consider is the Balanced Scorecard and IFE/EFE matrix.
Who is Michael Porter?
Michael Porter is a professor at Harvard Business School and is a leading authority on competitive strategy and international competitiveness. Michael Porter was born in Ann Arbor, Michigan.
I like Porter's Five Forces model -- where can I read about it?
Michael Porter published his work in his book called Competitive Strategy: Techniques for Analyzing Industries and Competitors. This book has been translated into 19 languages and has been named a best-seller many times.
Michael Porter has been active not only in competitive strategy theories but in other fields, most notably in health care. Michael Porter's key books include the following:
Competitive Strategy: Techniques for Analyzing Industries and Competitors, 1980
Competitive Advantage: Creating and Sustaining Superior Performance, 1985
Competition in Global Industries, 1986
The Competitive Advantage of Nations, 1990
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