Michael E. Porter, a Harvard Business School professor, created the Five Forces model in 1979. It is a framework used to evaluate and assess the competitive environment and attractiveness of an industry. In this model, you gather information about 5 different ‘forces’ to gain a better understanding of your current (or future proposed) market. You will then be able to take better informed decisions and make strategic plans.
The five forces considered in this widely used model are:
- Competitive rivalry
- Threat of a new businesses entering into the market
- Bargaining power of suppliers
- Bargaining power of customers
- Threat of new substitutes
When assessing the market, you may first want to consider what competitors already exist within in it. Make a list of who they are, how their quality, pricing and product or service specifications compare with your current or potential offering. With higher rivalry, your market share becomes less secure as customers will more easily be drawn to other businesses. This is because high competitive rivalry is usually characterized by aggressive marketing and advertising campaigns, slashed prices, and the frequent introduction of new products or services. This could happen when:
- The industry has many competitors, or the competitors are approximately equal in strength (power) and size.
- The growth of the industry is slow, thus triggering fights to retain and grow market share.
- The product or service in question has no special or different features.
- The product has an expiry date or has high fixed costs, creating the impulse to slash prices.
- Barriers to exit the market are high (such as owning highly specialized equipment or having long-term contracts with employees or projects).
Threat of a new businesses entering into the market
When new competitors enter your industry, they often come prepared, having the resources to back them up and they will immediately want to gain market share. The threats of new entrants are based on the strength of barriers to entry into the market, such as:
- The presence of large organisations that can use their buying power to drive down their costs in order to remain competitive.
- Government policy.
- Access to tools, materials and other resources needed to enter the market.
- The cost of customers switching their business of choice within the industry.
Bargaining power of suppliers
Suppliers can exert bargaining power over your business by raising their prices or reducing the quality of their products or services. They will be most likely to have power when:
- Suppliers are few when compared to the businesses in the industry they sell to.
- They supply a unique product or service that is highly differentiated from other suppliers.
- There are no other products for sale that can be used interchangeably in the industry.
- There is the possibility that the supplier group is not interested in the industry anymore and will move out of the industry.
- The cost of switching supplier is high.
Bargaining power of customers
Customers can also exert influence over your industry through their bargaining power. There are several different market situations which make for powerful buyers, such as:
- There being few buyers in comparison with the number of suppliers offering the product or service, meaning that the buyer has power to negotiate better prices.
- When buyers purchase in large volumes.
- When the products that the buyers purchase are not differentiated and they know that they can easily find other suppliers.
- When selling to other businesses, buyers with low profits will try to negotiate on lowering their purchasing costs.
Threat of new substitutes
The availability of substitutes for the products or services offered by your industry can limit the profits of the industry as a whole. This means that your customers can find different, cheaper, or more efficient solutions to the need that they were fulfilling with what your industry offers. You can remain ahead of the game by keeping your mind open to developments that could act as substitutes and keeping an eye on:
- Emerging trends.
- Industries that earn high profits and produce/offer potential substitutes for what you offer.
After listing the factors at play within each force, you can assess its beneficial or detrimental strength by giving it a weighting with a number from 1 to 10 or giving it a positive, negative or neutral rating. You can then more easily identify your overall standpoint in order to make strategic plans for the future.
If you would like to learn more about Porter’s Five Forces, and about how a sixth force could come into play, consider joining our Level 6 Award in Strategy, forming part of our Level 6 Bachelor in Business and Management.
Various strategic tools and techniques, including this model, are also covered to greater depth in the Strategy module on the Henley Executive MBA.