Michael Porter’s Five Forces
Running a business is one of the most challenging journeys you can start. There might be things about a company that managers don’t know about.
Fortunately, experts have developed models to help analyze the competition and other factors that might impact the results owners get. Therefore, considering these theoretical aspects allows them to better understand what’s at play when they manage a company and how they can use that information to improve.
This article is about Michael Porter’s Five Forces Model. When owners and managers are done reading, they’ll know what it is, its characteristics, and how to use it for their business.
Who Created the Five Forces Model?
Professor Michael Porter of Harvard Business School created this model in 1979. Since he developed it, it has gained fame and become one of the most relevant business models of all time.
When he developed his model, he noticed a few things about organizations. On the one hand, he realized that most managers keep a close watch on their rivals.
However, he wrote an article called ‘How Competitive Forces Shape Their Strategy,’ in which he encouraged business leaders, managers, and owners, to look beyond what the competition does. Instead, Porter said, they should consider the inner forces that work in their business environment.
What Are Porter’s Five Forces?
According to Michael Porter, there are five forces people should consider when they’re developing an effective business strategy. The following sections include details to understand each of them:
1. Competitive Rivalry
When managers consider the first of the five forces, they must closely examine the strength and number of competitors they have around them.
Additionally, they must think about who they are, what they produce, and how the quality of their product compares with theirs.
If someone is in an industry with an intense rivalry, they must keep in mind that competitors attract customers by cutting prices and offering one-of-a-kind deals. However, if what they themselves offer is unique, they have better chances of earning more revenue because no one else can give people what they’re giving them.
2. Supplier Power
The second force that Michael Porter encourages you to consider is supplier power. In this case people must remember how suppliers work. Here are the basic principles:
- Suppliers gain power if they increase prices.
- They’ll gain power if they reduce the quality of the product they offer.
- When suppliers are the only ones available to give someone a particular service or product, they’re very powerful.
- Managers must consider the costs of switching suppliers.
When people take into account all the previously mentioned points, they have to gauge whether the suppliers they work with allow them to earn the profits they want.
The more suppliers managers have to choose from, the better chances they have at earning more money because they’ll have different alternatives to consider. People probably don’t want to be forced into signing expensive contracts. Therefore, they should make sure they’re aware of how this is impacting their business.
3. Buyer Power
In this case, owners must compare the number of buyers with the available suppliers in the industry. Doing this allows them to have an idea of whether their business is profitable or not.
If, for example, the number of buyers is low compared to the number of suppliers in an industry, then, according to Michael Porter, they have ‘buyer power.’
These buyers can quickly switch to cheaper alternatives, which will eventually cause the industry prices to drop.
To handle this situation, people have to consider how many buyers they have. Then, they should think about the size of their orders, and include how much they believe it would cost them to switch to one of their rivals.
Suppose someone deals with a small number of customers and also has to handle a lot of competition. In this case, their clients have buyer power. Alternatively, if they have numerous clients and little to no competition, buyer power decreases.
4. Threat of Substitution
This is the fourth force by Michael Porter, and it’s one of the essential factors people should keep in mind if they’re developing an effective business strategy to gain a competitive advantage.
The threat of substitution consists of the possibility of your clients or potential buyers finding a different way to get the product or service someone is offering them.
To put it differently, the threat of substitution rises in various situations. If a new competitor appears with a cheaper or more convenient option, for example, this could put a manager’s business at risk.
It also occurs when clients can quickly switch to another alternative. Thus, the idea is to ensure that competitors won’t be able to weaken a business’ profitability by offering more advantageous options to customers.
5. The Threat of a New Entry
If potential rivals are able to enter the market, then a manager’s position might be in danger. According to Michael Porter, this is the last force they should consider.
There are a few factors that mangers must keep in mind to handle this situation. Firstly, they must think about how easy it would be for a competitor to offer something similar to what they give their clients.
When rivals can easily weaken someone’s position by entering the market, they should make some adjustments to make sure their business is safe.
Businesses that have strong barriers that make them unique will last longer, and their owners will be able to earn more profits. Some of the mistakes managers could make at first are the following:
- High capital costs when getting started.
- Complex networks of distribution.
- Challenges when finding suppliers.
Advantages and Disadvantages of This Model
All theoretical models have both advantages and disadvantages, and this one is not the exception. The following sections include some things to consider when applying Porter’s Five Forces.
Undoubtedly, Michael Porter developed a one-of-a-kind model that many people apply to their business strategies. Here are its strongest points:
1. It Helps Gauge the Competition
The first advantage of using Porter’s Five Forces Model is that owners can take a close look at their competitors comparing them to what they already do.
Therefore, they can draw conclusions on how they can improve their business or adjust some things to get more revenue.
2. It Allows Managers to Plan
Another immensely fantastic advantage of Porter’s model is that it helps owners see the bigger picture. Consequently, they can plan. They’re able to decide what they must do next to design an effective strategy or maintain their position in the industry.
3. This Model Helps Deal with Suppliers and Buyers
When operating a company, people have to deal with buyers and suppliers. Therefore, they must know how to handle the conversations with them to get the best deals.
As managers probably know by now, Porter’s model considers the position of suppliers in comparison to their business. Thus, it’s an effective way to broaden their perspective and use the available information to improve their strategy.
Even though Porter’s Five Forces Model has numerous advantages, it has some downsides as well. Here they are:
1. It Ignores Other Factors
No theory considers every single aspect that can impact a business, and Porter’s model is no exception. Therefore, if someone is using it, they should keep in mind that it ignores other factors that could influence the company, for example, recent trends.
When using Porter’s model, people should try to compare it to other theories as well. They mustn’t limit themselves to one view only. Instead, they must consider multiple theoretical approaches when developing a business strategy.
2. According to This Model, No Industry Is the Perfect Fit
There will always be flaws in a business according to this model. There is no perfect fit. Therefore, using it might discourage owners because they believe that there is too much to fix to get the results you want.
Nonetheless, they should remember that Michael Porter designed the model for them to be able to examine the forces that might be impacting a business. Thus, the company also has positive aspects that this theoretical approach might not allow them to recognize.
3. Unfortunately, It’s Not Useful for All Companies
Lastly, not all companies can rely on Porter’s Five Forces Model. Companies like technology or fashion might have to consider other factors when owners are analyzing them.
Therefore, using the Five Forces Model might not allow managers to see the bigger picture in these cases, and they might have to rely on other theoretical approaches to complement their view and create a strategy that works for them.
How to Use Porter’s Five Forces Model
Now that managers are aware of the basics of Michael Porter’s model, it’s time to learn how to use it to improve a business strategy. They can consider the next steps to get started:
Step One: Gathering Information
The first thing they should do is gather information on each of the five forces. Therefore, they have to get as much data as they can about their competition, suppliers, etc. Here are some questions they can try to answer:
- Who is your direct competition?
- How many competitors do you have?
- Who is your local competition?
- What do your competitors offer?
- Who supplies your products or services?
- How many suppliers do you have?
- Can you find substitute materials?
- Are your materials scarce?
- How much would it cost to switch to alternative materials?
- How many buyers are there?
- What is their average size order?
- How much would it cost them to switch suppliers?
Threat of Substitution
- How many substitutes are there?
- Would your customers have to pay too much to switch suppliers?
- Are there new competitors or products that you should consider?
The Threat of a New Entry
- Can rivals quickly enter your industry?
- Do competitors’ strategies affect your position?
- What’s the worst thing that a competitor could do to affect your business?
There are numerous questions managers must answer before actually implementing the theory. If they run a new business, for example, or haven’t been in the industry for long, they might not have all the information.
However, with time, they’ll get more data on their competition and how this can affect them in the long run. They must try to gather as much information as they can before proceeding to the next step.
Step Two: Analyzing the Results, then Displaying Them on a Diagram
Once they have the data, it’s time to analyze it and draw conclusions. They should prioritize the most essential forces that could impact the business on a short and long-term basis, and make sure they’re aware of how they can influence their revenue.
An illustrative example of this is to consider whether or not there are numerous slow-growing companies in the industry someone is in. If that’s the case, it means managers have a lot of competitors.
Step Three: Developing Strategies Based on the Conclusions
Lastly, depending on the analysis managers made, they have to develop an effective business strategy.
Clearly, if they want to gain a competitive advantage, they must create a strategy that works for their business. Therefore, they have to take a close look at their results and determine which techniques would work best for them.
If someone is in an industry with many competitors, for example, they might want to develop a unique product that no one else offers. At the same time, they have to remember that their business will probably grow very slowly because there are numerous rivals.
Michael Porter’s Five Forces Model is one of the most widely used theoretical approaches since the last century. Therefore, managers could take advantage of it as well.
Even though no model is perfect, this one offers a unique perspective on the factors that influence a business and what owners can do to get the best results possible. Therefore, they should consider it if they want to effectively manage their company, get top results, and improve their strategies every day.