The Porter Five Forces model was developed by Michael Porter in 1980 in his work titled “Competitive Strategy: Techniques for Analyzing Industries and Competitors”. Since its conception, the idea has been widely used for the evaluation of an industry’s structure for any company and the company’s corporate strategy.
In his work, Porter described the five forces that outline the structure of almost all the industries and also establish the main factors of profitability and the set of rules of competition in an industry (Porter, 2008). This framework has become the most applied and widely accepted analytical framework as a part of strategic management. This structure describes how both the level of competition in an industry and the levels of profitability in that particular industry are determined by the structure of the industry. This analysis is used by companies to make decisions such as most attractive market or industry for a company to enter, the distribution of resources amongst the company’s various businesses, strategies to influence the structure of the industry, and the competitive position the company holds within the industry. Hence this framework can be related to both corporate strategies as well as the business strategy of a company.
Porter Five Forces Model is based on industrial economics; more precisely the microeconomic factors such as the theories of oligopoly, monopoly, and level of ideal competition forecast how the industry structure influences both the competition in the industry and the profit margins.
The five forces include competitive rivalry, the buyers bargaining power, the suppliers bargaining power, the potential of new entrants into an industry and threat of substitutes. These are described briefly below:
Competitive Rivalry
In almost every industry, the main determinant of the overall competition and the profit margins is the competition amongst the firms within that industry. In many cases, the firms within an industry compete aggressively. Sometimes the competition is on pricing such that even firms are willing to incur losses for the time being to gain market share, sometimes the competition is based on innovation, advertising or other non-pricing factors. The factors that determine this level of intensity of competition amongst firms are product differentiation, concentration, diversity of competitors, exit barriers, surplus capacity and the cost circumstances.
Buyers Bargaining Power:
Powerful and influential buyers are able to apply down pressure on profits and prices. Factors affecting the strength of a buyer are how few their number is, how big they are and their price-sensitivity.
Suppliers Bargaining Power
Analogous to buyers, this refers to the influence of suppliers on profits and prices. The factors include the number of suppliers, exclusivity of the supplied product or service and supplier switching cost.
Potential of new Entrants:
Greater profits attract new entrants into the industry. They, in turn, can directly impact prices and profits. The entry barriers that can make it difficult for new entrants are financial requirements, economies of scale, differentiation of the product, contact to distribution channels and legal barriers.
Threat of Substitutes:
The value customers are ready to pay for any particular product or service depends directly on price and availability of the substitute services or products. Lack of substitutes decreases price sensitivity and presence increases price sensitivity of buyers (Grant, n.d.).
Thus Porter’s model is a very useful analytical tool for industrial analysis.
References
Grant, R.M., n.d. Five Forces of Competition. [Online] Available at: http://onlinelibrary.wiley.com/store/10.1002/9781118785317/asset/homepages/weom120173.pdf;jsessionid=055D5EEAD5F78852FFC5CE06EED3D466.f01t01?v=1&s=f38efd0c2a9f3d5ab513e2b4cf59412e1f8a23d8 [Accessed 5 June 2017].
Porter, M.E., 2008. The Five Competitive Forces That Shape Strategy. Harvard Business Review, 57(1), pp.57-71.