What is Porter’s five Forces model?
This model helps marketers and business managers to look at the ‘balance of power’ in a market between different types of organisations, and to analyse the attractiveness and potential profitability of an industry sector.
It’s a strategic tool designed to give a global overview, rather than a detailed business analysis technique. It helps review the strengths of a market position, based on five key forces.
Porter’s Five Forces works best when looking at an entire market sector, rather than your own business and a few competitors.
How can I use Porters five Forces?
To apply Porter’s Five Forces, you need to work through these questions for each area:
- Force 1: Threat of New Entry?
- Force 2: Buyer Power?
- Force 3: Threat of Substitution?
- Force 4: Supplier Power?
- Force 5: Competitive Rivalry?
Threat of New Entry
If a new businesses can be easily started up in your sector without substantial investment - then this is a threat. The Internet has made this a reality in many sectors, especially publishing! So ask yourself the questions:
- What’s the threat of new businesses starting in this sector?
- How easy is it to start up in this business?
- What are the rules and regulations?
- What finance would be needed to start-up?
- Are there barriers to entry which give you greater power?
Where there are fewer buyers, they often control the market. Questions here include:
- How powerful are the buyers?
- How many are there?
- Can the buyers get costs down?
- Do they have the power to dictate terms?
Threat of Substitution
If there are available alternatives then the threat of substitution increases.
- How easy is it to find an alternative to this product or service?
- Can it be outsourced? Or automated?
Markets where there are few suppliers means the suppliers retain the power
- Examine how many suppliers are in the market?
- Are there a few who control prices?
- Or many so prices are lower?
- Do your suppliers hold the power?
- How easy is it to switch, what’s the cost?
Markets where there are few competitors are attractive but can be short-lived. These are highly competitive markets with many companies chasing the same work reduce your power in the market.
- What’s the level of competition in this sector?
- What’s the competitor situation? Many competitors and you’re all in a commodity situation or a few?
Examples of how Porter's five Forces can be applied to a business?
If your business is thinking about moving into new sectors or markets, or if your business is stuck in a commodity situation, then Porter’s Five Forces enables you to see the issues clearly.
Work through each of the forces to identify in your current sector and your potential sectors, to see who has the power.
Here are some examples of where the balance of power lies in different markets
- 1. Threat of New Entrants
An example is web design, as there are independents in every location. This is an easy market to enter with few requirements, other than skills, initiative and relevant hardware and software. This does mean there are many new entrants!
An example is the grocery sector since supermarkets tend to retain power over suppliers due to volume and price of contracts. They dictate terms, set prices and can possibly end agreements at any time.
- 3. Threat of Substitution
The substitute to all services is DIY. For example hairdressing or writing a will. Focus is on expertise, customer service or added value.
Some sectors have monopolistic (one) or oligopolistic (few) suppliers, such as utility companies. Sometimes customers have little choice i.e. where to buy domestic water suppliers though this is changing.
In the jewellery sector, diamond suppliers often hold the power and can set prices, withhold supply and restrict sales.
These include Estate agents, web design and office stationary. Many competitors often buy on price.
What to watch for?
Sometimes not all the information is available and you may need to make assumptions, which should be shared. For example it’s difficult getting specific market information on parts of the Middle East and China.
Our free models guide gives more details on how the Internet has affected this balance of power.
Porter, M. (1979). How Competitive Forces Shape Strategy. Harvard Business Review. (Vol 57, March – April). p.86-93.
Recommended Guide: Essential Marketing Models
In our free, illustrated guide to 15 classic planning models diagrams we explain what they are and give examples of why and how to apply them in business.
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Since its introduction in 1979, Michael Porter’s Five Forces has become the de facto framework for industry analysis. The five forces measure the competitiveness of the market deriving its attractiveness. The analyst uses conclusions derived from the analysis to determine the company’s risk from in its industry (current or potential). The five forces are (1) Threat of New Entrants, (2) Threat of Substitute Products or Services, (3) Bargaining Power of Buyers, (4) Bargaining Power of Suppliers, (5) Competitive Rivalry Among Existing Firms. The following is a Five Forces analysis of The Coca-Cola Company in relationship to its Coca-Cola brand.
Threat of New Entrants/Potential Competitors: Medium Pressure
- Entry barriers are relatively low for the beverage industry: there is no consumer switching cost and zero capital requirement. There is an increasing amount of new brands appearing in the market with similar prices than Coke products
- Coca-Cola is seen not only as a beverage but also as a brand. It has held a very significant market share for a long time and loyal customers are not very likely to try a new brand.
Threat of Substitute Products: Medium to High pressure
- There are many kinds of energy drink s/soda/juice products in the market. Coca-cola doesn’t really have an entirely unique flavor. In a blind taste test, people can’t tell the difference between Coca-Cola and Pepsi.
The Bargaining Power of Buyers: Low pressure
- The individual buyer no pressure on Coca-Cola
- Large retailers, like Wal-Mart, have bargaining power because of the large order quantity, but the bargaining power is lessened because of the end consumer brand loyalty.
The Bargaining Power of Suppliers: Low pressure
- The main ingredients for soft drink include carbonated water, phosphoric acid, sweetener, and caffeine. The suppliers are not concentrated or differentiated.
- Coca-Cola is likely a large, or the largest customer of any of these suppliers.
Rivalry Among Existing Firms: High Pressure
- Currently, the main competitor is Pepsi which also has a wide range of beverage products under its brand. Both Coca-Cola and Pepsi are the predominant carbonated beverages and committed heavily to sponsoring outdoor events and activities.
- There are other soda brands in the market that become popular, like Dr. Pepper, because of their unique flavors. These other brands have failed to reach the success that Pepsi or Coke have enjoyed.
Valuation Academy is proud to present our meticulously researched and in-depth analysis of Coca-Cola using Porter’s Five Forces and a SWOT analysis avaialble for just $4. This 2,500 word, (fully editable) 10 page word document will be available for download after checking out through the link below.
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