The Porter’s five forces model is a powerful for understanding the market attractiveness of the industry and for identifying potential profitability of a strategy. It was created by professor Michael Porter from the Harvard Business School.
Porter recognized that organizations keep a close eye on their competitors and identified factors that could impact a business environment. He defined five forces that influence the competitive environment and that can affect the profitability of an organization. These forces are:
This force analyzes the power and control that a supplier has to (potentially) raise its prices or to reduce the quality of products or services. Important factors that play a role are: the availability of substitute and the concentration of suppliers. The less suppliers, the more power to control the market. Other factors include switching costs, the availability of substitutes, the strength of their distribution channels, and the differentiation in the product or service.
This force analyzes the power buyers have over suppliers and therefore the company to influence the market prices. When there are a limited number of buyers and many suppliers in the market, they will have more buying power. It means that the buyers can easily switch to an alternative. On the other hand, buying power is low when buyers purchase small amounts of products, act individually and when the seller differentiates its product offering from his competitors.
The digital revolution and globalized economy strengthened the position of the buyers because of their increased information position and ability to buy (mainly) products in larger geographical area.
This force analyzes the possibility of the replacement of a product or service in the market by an alternative that isn’t equal but fulfils the same function. For example, a car that using gasoline and is being substituted by an electrical car.
Substitution can have a big impact on a market and will have a huge profitability impact and should therefore be considered when evaluating the attractiveness of an industry.
This force analyzes the ability to enter a market by new entrants. They will add new capacity to market and therefore drive down prices. If it’s easy to enter a new market will depend on the market barriers, for example the need of “economies of scale”, brand loyalty by customers, or extensive knowledge on a product or service, but also capital requirements or government policies (like in the aerospace and defense markets).
The rivalry between existing competitors is examined by how many existing competitors there are in a market and what their capabilities are. Rivalry is high in a market with competitors that are approximately of the same size and their offering is roughly the same. For customers this means that they can easily switch to another competitor at a low cost. Sellers are forced to actively promote their product and need to accept lower margins, because of price wars. When barriers to exit a market are high will the rivalry be more intense. A barrier to exit could be a long-term loan or high fixed company costs. On the other hand, where competitive rivalry is low, and you have a unique offering then you'll likely have tremendous strength and good profits.