How Porters Five Forces Can Help Your Business
What are Porters Five Forces, and how can they help my business?
Originally devised back in 1979 by Harvard Business School academic Michael Porter, the ‘Five Forces’ theorem is a series of tools or tests for analysing the competitive intensity of a business and the marketplace in which it operates. From this, organisations can extrapolate the attractiveness of that specific industry, in relation to the profitability and competitive strength.
In essence, Porter theorised that there are five fundamental forces in operation which will determine in which direction power is focused in any given business scenario. This information and analysis will then enable the organisation to appraise whether – and to what degree – new products or services might be profitable. Hence, business can use this information to determine when, whether and, indeed, if to move into a new market or business opportunity.
1. Supplier Power
This ‘force’ assesses the relative ease or otherwise with which a supplier to a business (whether it be of goods, components or services) can make upward adjustments to the price it charges. The key determining factors here are:
- How many suppliers there are.
- How competitive they are between themselves.
- The individual uniqueness of the item that they are being asked to supply.
- How big or dominant in the marketplace that supplier is.
- The ease and associated costs of switching from one supplier to its competitor.
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2. Buyer Power.
This component of the Porters five forces examines the ease with which your organisation can influence the prices charged to it. This is primarily driven by your bargaining power.
The more the buyer-seller relationship is skewed in your favour, the more likely you will be able to influence the cost to you in a downward direction. This, in part at least, is determined by the cost and ease of switching between suppliers, as well as your dominant or otherwise position in the market segment. If you’re a ‘bigger player’, you’re more likely to be able to negotiate lower prices. Consider the example of supermarkets and their smaller supplier farm producers, for example.
3. Competitive Rivalry.
Within this particular ‘force’, Porter considered the number and skillset of the competitors existing in the market. If, for example, there are a large number of competitors in a particular market, each offering a generic or barely differentiated product or service, it makes the market a less attractive one into which to enter.
The classic example is one of the ‘widget’ producer, where any marginal price change will result in a significant change in demand for the item. This is, in essence, a sector where there would be a high price elasticity of demand, therefore.
4. Threat of Substitution.
In the ‘generic’ marketplace, where there is a high likelihood of closely similar or identical products or services being available, this will increase the probability of customers switching between suppliers, unless there is some sort of penalty in so doing. This means that the market becomes a less appealing one for new entrants, as well as eroding the suppliers’ bargaining power among customers.
5. Threat of New Entry.
A highly profitable market will, inevitably, attract new entrants. This will then result in customers within that market having greater supplier choice which, in turn, will erode profitability for those suppliers into the market. The main caveat to this is where there are barriers to entry, such as high set-up costs, regulation, taxation, trade and tariff barriers. Indeed, this final ‘force’ takes us onto the PEST analysis model – the external market influences over which a business has no direct input.
These Political, Economic, Sociological and Technical issues collectively form highly effective barriers to entry into a market. In addition, some business theories add an additional two factors to this list, namely Environmental and Legal, to form the acronym PESTEL.
Using Porters Five Forces is merely a framework to help you measure yourself against your competitors. When did you last perform this exercise and if it’s not recently, you might be missing an opportunity for business growth! Seek independent expert help to assist you with this and many other growth concepts that can help you accelerate your business performance.
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Now you’ve read our article on growing a business (and measuring your competitors) – have you any more questions?
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