Michael Porter(1947-) the Harvard business school professor was conducting research about the competitiveness in different industries during the 70s of the last century when he came up with a new model to understand the attractiveness and potential profitability of a marketplace by analyzing the competition and the rivalry thought five different factors. that’s the ” Porter’s Five Forces Model ” published in 1979.
Each industry has its particularities and they all differ from each other in terms of the opportunities they provide, but some factors don’t change and intervene in every field and marketplace. Porter, in his model, identifies 5 factors, or what he calls forces, that shape every industry and help determine its strengths and weaknesses, these forces represent the key source of competitive pressure;
Competitive rivalry: the central aspect of the model, measures the extent of the competition among the firms by looking at the number of the competitors and their strengths in comparison to our business. The more intense is the rivalry the more companies are willing to take competitive moves like decreasing their prices and providing more incentives to attract clients. while in mild rivalry the profits are generally high with no need to make any of these moves.
Suppliers’ power: represent the pressure that suppliers can put on businesses especially by rising their prices or reducing the quality of the products or services they provide, in this way they influence the firms’ pricing and therefore their profits. The higher is the suppliers’ bargaining power is the easier it is for them to exercise pressure on companies. Suppliers are powerful when they’re few, when there are no substitutes or when the cost to switch suppliers is high.
This pressure exerted by suppliers increases the competition within the industry and reduces profitability.
Customers’ power: just like suppliers, customers can, as well, exert pressure on the businesses and influence their prices and profits. Customers are powerful when they’re few in comparison to the suppliers, when there are a lot of suppliers to choose between with low switching cost, or when they purchase significant quantities. Customers then have the power to drive prices down and therefore reduce the profitability in the industry.
Threat of substitutes: substitutes are alternatives, from other industries, that serve the same needs as your products/services.
A high number of available substitutes on the market can drive the prices down because the customers then have too many options to choose from, especially when the substitution is easy and cheap to make, businesses then must lower their prices in order to attract clients. On the other hand, when there are no or few substitutes it can result in a monopoly where a specific enterprise is the only supplier of a particular commodity which makes them have “all” the control over the prices.
Threat of new entrants: that is people/businesses’ ability to enter your market, the easier it is the more threatened is your business because new entrants mean new competitors and stronger rivalry within the industry. This depends on the barriers the market sets, these barriers can be:
. High investment to start up;
. Government regulations;
. Difficult access to suppliers;
. Difficult access to distribution channels;
. Economies of scale;
. Highly differentiated products;
. Difficult access to favorable locations, proprietary of technology and production materials..
The higher these barriers are the hardest it is for new businesses to enter your market and the less threatened is your business, and vice versa.
The five forces model
According to Porter, businesses are not only in competition with their direct competitors but are also in a constant “fight” with a broader set of rivals: customers and suppliers who have bargaining power, new entrants who can just come in and take over a part of their market share and substitute products/services that can, as well, place a constraint on their profits. Porter says that his 5 forces model is such a holistic way of looking at an industry and understanding the structural underlying drivers of profitability and competition.