What are Porter’s five strengths?
Porter’s Five Strengths is a model that identifies and analyzes five competitive strengths that shape each industry and helps determine the weaknesses and strengths of an industry. The analysis of the five forces is frequently used to identify the structure of an industry in order to determine the business strategy. Porter’s model can be applied to any segment of the economy to understand the level of competition within the industry and improve the long-term profitability of a business. The Five Forces model is named after Harvard Business School professor Michael E. Porter.
Porter’s five forces
Understanding Porter’s Five Forces
Porter’s five strengths are a business analysis model that helps explain why different industries are capable of maintaining different levels of profitability. The model was published in Michael E. Porter’s book, “Competitive Strategy: Techniques for Analyzing Industries and Competitors” in 1980. The Five Forces model is widely used to analyze the industrial structure of a company and its strategy for business. Porter identified five undeniable forces that play a role in shaping every market and industry in the world, with a few caveats. The five forces are frequently used to measure the intensity of competition, the attractiveness and the profitability of an industry or a market.
Porter’s five forces are:
1. Industry competition
2. Potential for new entrants to the industry
3. Power of suppliers
4. Power of clients
5. Threat of substitute products
Key points to remember
- Porter’s five strengths are a framework for analyzing a company’s competitive environment.
- The number and strength of a company’s competitive competitors, potential new entrants to the market, suppliers, customers and substitute products influence the profitability of a business.
- The five strength analysis can be used to guide the business strategy to increase competitive advantage.
The first of the five forces refers to the number of competitors and their ability to undermine a business. The greater the number of competitors, the greater the number of equivalent products and services they offer, the less the power of a business. Suppliers and buyers are looking for competition from a business if they are able to offer a better offer or lower prices. Conversely, when competitive rivalry is weak, a firm has more power to charge higher prices and set the terms of agreements to achieve higher sales and profits.
Potential for new entrants to an industry
The power of a business is also affected by the strength of new entrants to its market. The less time and money it takes a competitor to enter the market of an enterprise and be an effective competitor, the more the position of an established enterprise could be considerably weakened. An industry with high barriers to entry is ideal for existing businesses in this industry, as the business would be able to charge higher prices and negotiate better terms.
Power of suppliers
The next factor in the five-force model is the ease with which suppliers can increase the cost of inputs. It is affected by the number of suppliers of key inputs to a good or service, how unique these inputs are, and how much it would cost a business to switch to another supplier. The fewer suppliers in an industry, the more a company will depend on a supplier. As a result, the supplier has more power and can increase input costs and push other trade benefits. On the other hand, when there are many suppliers or low switching costs between competing suppliers, a company can keep its input costs lower and increase its profits.
Power of customers
One of the five strengths is the ability of customers to lower prices or lower their power levels. It depends on the number of buyers or customers of a company, the importance of each customer and the price to pay a company to find new customers or markets for its production. A smaller, more powerful customer base means that each customer has more power to negotiate lower prices and better deals. A business with many smaller independent customers will find it easier to charge higher prices to increase profitability.
The Five Forces model can help companies increase profits, but they must constantly monitor any changes in the five forces and adjust their business strategy.
The threat of substitutes
The last of the five forces focuses on substitutes. Alternative products or services that can be used in place of a company’s products or services pose a threat. Companies that produce goods or services for which there are no close substitutes will have more power to raise prices and obtain favorable conditions. When close substitutes are available, customers will have the option of giving up buying a business product, and the power of a business may be weakened.
Understanding Porter’s five strengths and how they apply to an industry can allow a company to adjust its business strategy to better use its resources to generate higher income for its investors.