Explore Porter’s Five Forces and how they help businesses gain competitive advantage. See how each force is important to consider when a business is weighing its profitability.
Launching a new product or service in the market without considering the existing and potential competitors is detrimental for any business. Also, there is no guarantee that the supplier or buyer will continue to help a business. Thankfully, tools such as Porter’s Five Forces have been beneficial for businesses to gain a competitive advantage in any industry and scenario.
What are Porter’s Five Forces?
Porter’s Five Forces is a framework that lets a business identify the level of competition and operating environment. This tool is used in the strategic management process to formulate and adjust the business strategy.
Put simply, these forces determine whether the business will be able to cater to customers and make profits or not against the competing forces.
The five forces that will be explained in more detail below are
- Rivalry Among Competitors in Industry
- Threat of New Entrants
- Threat of Substitutes
- Buyer Power
- Supplier Power
Background to Porter’s Five Forces
Introduced by Harvard Business School professor Michael Porter in a 1979 Harvard Business Review article, the framework was used to explore the micro-environment of the business. That means it only looks at factors directly affecting the business in a specific or similar industry.
The relationship among the five forces in a micro-environment can be better understood on the basis of horizontal competition (ones who buy and supply from and to the business) and vertical competition (types of rivals such as existing and new brands, and substitutable products or services), as shown below.
Porter’s Five Forces Model Explained
Rivalry Among Competitors in Industry
This is the central force determining the competitors/rivals the business is up against. It signifies the impact of how strong or weak the current competition is.
The competition is strong if the market has too many competitors offering a similar product. Conversely, there will be a weak competitor impact when there is a fewer number of rivals.
Strong competition reduces the chances of earning desired revenue. This is because the consumer can choose any other business that sells the same product or service at a cheaper price.
A business needs to figure out its pricing strategy to gain a competitive advantage when there are more rivals. It also should offer products that are comparatively more innovative than the competition.
Factors Causing Rivalry Among Competition
According to Porter, a few definable factors characterise rivalry in the same industry.
- Either there are many competitors or there are companies with equal power or size.
- The industry the companies are in, grows slowly in relation to their expansion objectives.
- There is no differentiation of the product or its cost among the competitors.
- The companies cannot cut down on the fixed costs of the products and the companies are forced to cut prices.
- Exiting from the market is difficult as it can destroy the reputation.
- The competitors continually compete, in terms of ideas and innovation, to out beat each other.
Threat of New Entrants
A vertical force in the five forces diagram, it refers to the potential rivals who can enter the market and create more competition with a better product positioning and pricing.
A new competitor can easily enter the industry when there is little to no barrier.
There are barriers of entry that a business has to consider in this type of force. Some are brand loyalty, exclusive suppliers, high initial investment requirement, government regulations, patented technology, etc.
A business will not have to worry about new entrants when it has a loyal customer base or proprietary technology.
Factors Causing Threats for New Entrants
There are more or less five to six factors to consider.
- Economies of Scale - It means the company has to enter the market on a large scale or suffer losses initially by pricing products at low costs.
- Product Differentiation - It’s harder and more expensive to bring customer loyalty as a new brand.
- Capital Requirements - There is a lot of expenditure in some industries just to break in.
- Cost Disadvantages - For a new company, it can be challenging to get the best resources initially. The vendors with whom they have not been in a relationship may charge a high amount, for instance.
- Distribution Channel Access - Securing distributors as a new business also requires investment and workarounds for optimal costs.
- Government Policy - Government regulations can put a dent to the efforts of an entrant.
Threat of Substitutes
This threat can easily occur if there is a better product than what the business offers. There are different situations when it can happen.
- If the consumer does not have to pay an extra cost for switching to an alternative and have no brand loyalty
- If the price of the product goes higher and the consumer is looking for a less pricey alternative
- If the alternative product has better quality than the quality of the product the business is currently offering
- If the alternative product has the same or better features
It is also referred to as the bargaining power of the customer.
A business can only ask a premium price from its customers only when the product is unique in the market. As an example, you can think of the iPhone and its compatibility with other Apple devices. Switching to an inexpensive smartphone is not preferable for any iPhone user even though there is a cost advantage for the buyer. And, they are willing to pay a premium price to enjoy all the privileges of compatibility.
One of the main factors to consider is that the buyer/consumer has too much capital to spend on the suppliers. So even if one supplier is unavailable, the buyer has other options.
Suppliers have a cost advantage in that they can quote higher prices if they control the source of the raw materials that the business needs.
For a business, it is necessary to chart out that if it is creating a unique product that is able to differentiate itself in the market, or to what extent it is willing to pay the supplier so that the ultimate profit is higher. A business should consider that the supplier will have a cost advantage in this regard.
It is then essential for the business to find other suppliers and how much it will cost to switch to a new supplier.
Factors Causing Supplier Power
- The already existing competitors can have a monopoly over the suppliers.
- The consumer’s product requirements may change and suppliers may overcharge the business who wants to differentiate their products
Watch these essential videos to learn about Porter’s Five Forces
Porter’s Five Forces Analysis Examples
We are now looking into two case studies done by Rohit Sanghvi and Omer Chicho. The former researcher on Academia.edu has explained these forces using Uber as an example. The latter, on Samsung.
- Threat of new entrants: Moderate threat as Uber required large initial capital investment but new rivals can enter with lower costs. Uber's free app makes switching costs low.
- Bargaining power of suppliers: Moderate power as drivers own their vehicles so can choose to work with Uber or competitors. Hard for Uber to substitute individual drivers.
- Bargaining power of buyers: Strong power as customers can easily switch between ridesharing services like Uber, Lyft etc. Customers are price sensitive.
- Threat of substitutes: Weak threat currently as taxi services are closest substitute but higher cost. Public transportation also a potential substitute.
- Competitive rivalry: Weaker force as Uber has large market share and capital investment compared to main rival Lyft. But lack of differentiation limits Uber's potential.
Key Aspects of Uber’s Success
- Leveraging technology: Uber developed an app that connects drivers and riders seamlessly. The app is free for customers to download and use.
- Asset-light model: Uber doesn't own the vehicles, drivers provide their own cars. This minimizes overhead costs.
- Focus on scale and network effects: Uber focused on rapid expansion and building a large customer base. The bigger the network, the more valuable the service.
- Use of dynamic pricing: Uber uses real-time data to adjust prices based on demand. This helps balance supply and demand.
- Building a strong brand: Uber invested in marketing and partnerships to become synonymous with ride-sharing and car services.
- Disrupting the taxi industry: Uber aimed to provide a better, more convenient service than traditional taxis. The tech-enabled model was a competitive advantage.
- Partnerships for expansion: Uber formed partnerships with organizations and third-parties to aid rapid global expansion.
- Industry rivalry: Faces intense competition from major players like LG, Apple etc. Adopts strategies to remain competitive.
- Barriers to entry: High barriers in emerging markets. Samsung enters cautiously and exits unprofitable markets.
- Buyer power: Buyers have options but rely on after-sales service. Samsung targets diverse income segments.
- Supplier power: Many suppliers so Samsung can negotiate but cannot easily undo supply chains. Conducts due diligence.
- Threat of substitutes: High threat as many product substitutes. Samsung uses differential pricing to attract consumers away from cheaper options.
Key Aspects of Samsung’s Success
- Leveraging technology and innovation: Samsung invests heavily in R&D to develop cutting-edge products and differentiate itself. This provides a competitive advantage.
- Vertical integration: Samsung has presence across the entire supply chain, from components to finished products. This gives it greater control and efficiencies.
- Economies of scale: As a large conglomerate, Samsung achieves lower costs through its huge production volumes and massive scale.
- Brand equity: Samsung has built a strong brand known for quality, design and innovation. This helps command premium pricing.
- Global distribution: Samsung has an extensive global distribution and sales network reaching millions of customers worldwide.
- Localization: Samsung adapts products and marketing for local markets. This increases acceptance and market share.
- Strategic pricing: Samsung uses differential pricing to target diverse income segments and compete at all price points.
- Partnerships: Collaborations with vendors, carriers, retailers etc. help Samsung expand its ecosystem.
Hope you have understood the basics of Porter’s Five Forces and why business should use them to gain a competitive edge. Taking up any business strategy courses will be a lot easier, now that you gained insights into this useful framework that organisations still use today.
When to use the Porter's Five Forces?
Porter's Five Forces are used to understand where a business currently stands in the market and to determine if it can make profits. It is necessary for businesses to compete in any industry.
Which of the Porter's Five Forces is the strongest?
The most powerful force is the rivalry among competitors as a business first has to analyse the competition before it looks into the threats of substitutes, potential of new entrants, and creating unique products for buyers.
Is Porter's Five Forces still relevant today?
Porter's Five Forces were based on the older economic times before digitalisation and globalisation took place. Technology and consumer power have taken centre stage today and the threat of new entrants has reduced in scope relatively as there is global competition. But, as a network of competitors, substitutes, consumers, suppliers, and new entrants, this framework still guides the decision-making process today. You can say that these five forces are not outdated but need to be revisited according to today's times.
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