What is Porter’s Five Forces Model?
Porter’s Five Forces Model is a comprehensive framework for assessing and analyzing the market components that are affecting the running business or can affect the new opening business firm. This model helps understand the current position of a firm in the marketplace and also the position of a firm that may look to move into another sector or firm which may want to establish itself.
This model argued that proper analysis of the competitive five forces helps an organization to develop an effective corporate strategy that can help to sustain itself in the long run.
This model suggests five competitive forces they are:
- The threat of new entrants
- Competitive rivalry
- The threat of substitute products or services
- The bargaining power of buyers, and
- The bargaining power of suppliers.
These five forces are used to analyze the industry’s competitive position to find out their weaknesses and strengths and how they are achieving those positions. Through properly analyzing the business firm can develop their strategies which may help to achieve competitive profitability in the long run.
Porter’s five forces model suggests that the threat of substitute products or services, competitive rivalry, and the threat of new entrants are the forces that come from horizontal competition, and the bargaining power of customers and the bargaining power of suppliers are the forces that come from vertical competition.
In horizontal competition, all organizations have somehow the same products or services which may differ in quality and they compete with each other to be selected by customers. But in vertical competition, people have different factors of satisfaction may one person liked one product at a time but maybe another person does not like the same product at the same time, thus it is more challenging for organizations to catch their ideal customers.
From the above discussion, it may be concluded that the ultimate goal of Porter’s five forces model is identifying market trends, challenges, and variables that affect the customer’s demand and need to best fit in the competitive market.
Components of Porter’s Five Forces: Defining
Let’s understand the components of Porter’s five forces in detail.
Threats of New Entrants
In a competitive market, there is a probability of entry of new competitors. Threats of new entrants are fairly high in local products or services that required low capital investment. Similarly, threats of entrants are low for a business that requires huge capital investment. Also, threats of new entrants are high in profitable markets and vice versa.
Entrants of new competitors affect the positions of already existing competitors, which may their position significantly weakened. Barriers to entry, economies of scale, huge capital requirements, high switching costs, and government policies decline the competitive rate.
Competitive Rivalry among Competitors
This is the competition between organizations providing the same goods or services. Rivalry competition is less where there is less number of product or service sellers and rivalry is high where there are huge numbers of sellers of the same products. Such competitors are involved in a price war, competitive advertising, and new product introduction. In such a situation customers move towards the competitors who offer low product prices.
But in some cases rivalry competition has not existed due to the unique quality of products or services, in such a situation, new competitors do not affect the positions of an existing company.
Threats of Substitute Products
The entry of new alternative products or services may substitute the need for existing products or services. The product which has more substitutes there is likely to decrease in product price and customers easily switch from one product to another where they find low cost, it also weakens the position of the company in the marketplace.
Similarly, the product which has fewer substitute products is more likely to maintain its position in the market for the long run.
For example, the advent of computers has reduced the demand for typewriters.
Bargaining Power of Customers
The power of buyers influences the market share of the manufacturers and suppliers. This force tests the bargaining power of customers in terms of price and quality of products. When the numbers of marketers are high there is high power of customers in drowning the price of products by bargaining and they switch between products easily.
When there are fewer sellers but high numbers of customers may price of products not be adjusted according to the expectations of customers.
Another example, considering the products or service price and quality. In Asian countries, most people are price sensitive and in Western countries, people are quality sensitive.
Bargaining Power of Suppliers
This force examines the power of suppliers that influence the company and the potential customers. In the context of the company, it assesses the power of suppliers to drive up the input costs. It is assessed by the number of suppliers of inputs, the uniqueness of their inputs, and the cost of switching between suppliers.
The fewer numbers of suppliers the company has, the more power suppliers have to control the input price, and the more numbers of suppliers the company has, the company has the power to reduce the input cost and easily switch from one supplier to another. When suppliers have the power they take other advantages by increasing the input costs and when the company has the power it reduces the input costs, saves them, and invests in profitable sectors.
In the context of customers, suppliers drive up their goods and services prices by supplying quality and the right quantity of goods to the right customers at the right time.
Examples of Porter’s Five Forces Model
Let’s look at some of the real-world examples of Porter’s five forces model. Porter has given an example of the airline in his concept, let’s take an example of a fast food company, McDonald’s, and know how each force has affected it.
The threat of new entrants
The fast food industry has relatively low barriers to entry, allowing new competitors to enter the market easily. However, McDonald’s, as an established player, has managed to build significant economies of scale and brand recognition. This makes it challenging for new entrants to compete effectively. McDonald’s has an extensive global presence and a well-established supply chain, giving it a cost advantage and making it difficult for newcomers to replicate its scale.
Bargaining power of suppliers
In the fast food industry, suppliers hold considerable bargaining power due to the reliance on key ingredients like meat, produce, and packaging materials. McDonald’s, being one of the largest purchasers of food products globally, has significant influence over its suppliers. This allows the company to negotiate favorable terms and pricing, reducing the impact of supplier power. Additionally, McDonald’s has implemented strategic supplier partnerships and strict quality control measures to ensure consistency across its vast network of restaurants.
Bargaining power of buyers
Fast food customers have a high degree of bargaining power as they can easily switch to alternatives or substitute products. McDonald’s recognizes the importance of customer satisfaction and has continuously adapted its menu to meet changing consumer preferences. In response to the demand for healthier options, McDonald’s has expanded its menu to include salads, wraps, and fruit options. The company has also embraced customization, offering a variety of choices to cater to individual tastes.
The threat of substitute products or services
The fast food industry faces competition from various substitutes, such as casual dining restaurants, fast-casual chains, and even home-cooked meals. McDonald’s has responded to this threat by enhancing its offerings and customer experience. It has invested in store renovations, technology integration, and digital ordering platforms to stay ahead of the evolving consumer preferences and compete effectively in the market.
The fast food industry is characterized by intense competition among players seeking to gain market share. McDonald’s faces strong rivalry from global competitors like Burger King, Wendy’s, and other fast-food chains. To maintain its competitive advantage, McDonald’s invests heavily in marketing and advertising campaigns, promoting its brand, value propositions, and limited-time offers. It also focuses on innovation and regularly introduces new menu items to attract customers and differentiate itself from competitors.
Overall, McDonald’s has successfully navigated the five forces in the fast food industry by leveraging its scale, brand recognition, and customer-centric approach. The company’s ability to adapt to changing consumer preferences, negotiate favorable supplier relationships, and effectively compete in a crowded market has contributed to its long-standing success in the industry.
Pros and Cons of the Five Forces of Model
The advantages and disadvantages of Porter’s five forces model can also be pointed out below:
- Comprehensive assessment: It evaluates the competitive dynamics of an industry, considering factors like suppliers, buyers, new entrants, and substitutes.
- Industry-specific insights: Tailors strategies to industry-specific characteristics and challenges.
- Power dynamics: Identifies who holds power in the industry, enabling businesses to leverage strengths and mitigate influential stakeholders.
- Opportunity identification: Uncovers potential industry opportunities for partnerships or innovation.
- Threat recognition: Helps identify and address potential risks and challenges.
- Strategic decision-making: Guides informed decisions on market entry, product launches, and competitive strategies.
- Adaptation to change: Enables agility and adjustment to evolving industry dynamics.
- Limited scope: Focuses on external factors, neglecting internal aspects like culture and resources.
- Static analysis: Snapshot in time, doesn’t consider industry or environmental changes.
- Subjectivity: Interpretation can be biased, leading to potential inaccuracies.
- Lack of quantification: This relies on qualitative assessments, and lacks quantitative analysis.
- Challenging for diversified businesses: Difficulty applying to companies with diverse portfolios or operating in multiple industries.
Porter’s Five Fores Model: Conclusion
Porter’s Five Forces Model is a powerful tool for understanding and evaluating the competitive forces that shape an industry. By analyzing the threats of new entrants, competitive rivalry, substitute products, bargaining power of buyers, and bargaining power of suppliers, businesses can make strategic decisions to position themselves for success. It helps identify industry trends, challenges, and opportunities, enabling companies to develop effective strategies that drive long-term profitability and sustainability.