Porter’s Five Forces Model

Porter’s 5 Forces Model is a business model and a tool which helps in identifying main competitive forces of an industry or a sector. The 5 Forces Model is mainly used to create a corporate strategy which will help a company to enhance its long- term profitability.

Understanding Porter’s Five Forces Model

The 5 Forces Model was created by Harvard Business School’s Professor Michael E. Porter and was published in his book “Competitive Strategy: Techniques for Analyzing Industries and Competitors” in 1980. The model was created to explain why various industries are able to maintain varying level of profitability. Porter’s 5 Forces helps in analyzing the industry of the company so that a company can adjust their corporate strategy, boost their profitability and beat their competition.

What are the five forces of the Porter’s Model?

• Competition in the industry
• Potential of new entrants into the industry
• Power of Suppliers
• Power of Customers
• Threat of substitute products

Competition in the Industry

For most industry, the level of competition in the industry determines the positioning of the product in the market. The intense the competition in the market, the more the company has to focus on innovation, marketing, price, etc. of the product. When the competition is less, a company has more authority to charge higher prices and establish the terms of deals in order to increase sales and profits.

Potential of New Entrants into the Industry

A company’s positioning is also affected by the new entrants in the market.  This in turn puts pressure on prices, costs, and the rate of investment needed to sustain a business within the industry. The less the time, money and effort it takes for a competitor to enter the market, more is the threat for a company to lose its market share. On the contrary, if there are strong barriers to entry in the industry, companies more secure about their market share.

Power of Suppliers

Power of suppliers in a market means how easily suppliers can increase the cost of the inputs. The suppliers’ power in the market is determined by the factors like number of suppliers in the market, uniqueness of the inputs they provide, cost of switching a supplier for a company. If the number of suppliers in an industry is less, a company would depend more on its current supplier, thus giving more power to supplier in terms of cost of inputs and other advantages in trade. However, if the suppliers are more in the market, then company has the advantage of switching the supplier in case the supplier increases the price or if a company finds a cheap supplier, thus keeping their input costs low and increasing their profitability.

Power of Customers

Customers are more powerful in an industry when there are less number of customers in an industry and more number of suppliers. Because the client base for a company is smaller and more strong, each customer has greater negotiating leverage to get better rates and deals. A company with a large number of smaller, independent consumers will find it easier to raise prices and increase profits.

Threat of Substitute Products

A substitute is a product or service that can be easily replaced with another by consumers. In economics, products are often substitutes if the demand for one product increases when the price of the other goes up. When there are no close substitutes in the market, a company can take advantage of charging higher prices. However, if there is availability of close substitutes, customers will switch to substitutes in case of increase of the prices of the products of a company.

Understanding Porter’s Five Forces and how they apply to a particular industry can help a company change its business plan to make better use of its resources and generate more profits for its shareholders.