08 Feb How to Use Porter’s Five Forces
Porter’s Five Forces is an economic model that identifies the five economic forces that influence every industry. It explains how these forces affect every industry’s competitiveness, profitability potential, and attractiveness.
Porter’s Five Forces is a fundamental model that businesses use to understand the industry dynamics and drive their business strategy. It can also help you do the exact same.
We’ve highlighted the five most important economic forces in every market, and provided examples in each section. This will help you to see how each force might work in your industry.
What are Porter’s Five Forces and How Do They Work?
- There is a lot of competition in the industry
- Potential for new entrants to the industry
- The power of suppliers
- The power of customers
- Substitute products are a threat
Your industry will determine how you apply this model to business. Understanding the forces that affect your industry will help you to find insights that are relevant for your business.
Let’s look at some examples of each economic force.
Porter’s Five Forces Model
1. There is a lot of competition in the industry
Your industry’s profitability is directly affected by the competition. This includes the potential to generate a high return-on-investment and its ability to attract new entrants.
It’s more difficult to make a profit if there is a lot of competition within your industry. Customers have many options, so if you charge too much, they may be able to find a supplier that will sell them at a lower cost.
In other words, customers are more powerful than suppliers in competitive industries. This often leads to suppliers cutting corners until their revenue barely exceeds the costs of their competitors. This can lead to a decline in profits and discourage new players from entering markets.
It’s easier to make a profit if there is less competition in your industry. Customers have fewer options than suppliers, so if they wish to purchase your market’s product/service, they will need to pay a higher price.
Let’s take a look at the aluminum baseball bat industry to help you see the competition in your industry.
Example of Competition
Baseball players from all walks of the game use aluminum bats for training and competition.
The leaders in this market’s high-end are Louisville Slugger and Rawlings as well as DeMarini, Marucci. Their customers are college and travel baseball players who are willing pay a premium for bats that perform well and last for many seasons.
Adidas, Mizuno and Easton serve the middle market. Anderson, Combat and Dirty South are the low-end. Their target market is less competitive players who play baseball for fun and friendship.
2. Potential for new entrants to the industry
It is possible to sell your minimum viable product if new players are able to enter your market quickly and cheaply. This product has just enough features to satisfy customers early on.
Your industry’s barriers to entry will determine how many new players enter your market. Startups wouldn’t be allowed to enter your market if it takes too much time and money to create a viable product.
Here’s a look at the potential for new entrants to your industry.
Example of New Entrants
There are many barriers to entry in the aluminum baseball bat market. To differentiate your product in a saturated market, you would need to invest a lot of money in research and development, purchase raw materials, and then build expensive facilities and machines to actually make them.
To cover the initial overheads of creating a minimum viable product, creating an enjoyable brand experience and generating revenue, this startup would need to charge close to the industry average price. To manage the startup’s daily operations, you would need to hire a product, sales, and marketing team.
3. The power of suppliers
Your company’s ability control prices directly depends on the number of competitors or suppliers in your market. Suppliers have the pricing power when there is little or no competition. If a customer doesn’t agree to your prices, you or your fellow suppliers can easily find someone who will.
Each supplier has less pricing power if there are many suppliers in your industry. Customers in your market have many options, so if you charge too much, they may be able to find a better deal with another supplier.
Example of Power of Suppliers
The suppliers have a lot of pricing power, with 11 major suppliers in a highly regarded industry and five or fewer brands competing in each market segment. Every baseball player, from the little league to college, requires an aluminum bat to train and compete. This makes them even more dependent on their suppliers.
4. The power of customers
Their ability to control prices directly depends on the number of customers they have. They hold the most power if there are just a few customers in your sector.
Suppliers rely on customers to generate revenue. Suppliers must comply with their customers’ pricing requirements or risk losing customers to other suppliers.
On the other hand, customers who have a lot of customers in their industry hold less power. They must accept the prices set by suppliers or they won’t be allowed to purchase any products or services.
Example of the power of customers
Each baseball player requires an aluminum baseball to play and train. Every supplier of aluminum baseball bats has a large potential customer base to market to and sell to. The market is small and there are not many suppliers. This means that customers can’t drive down prices.
5. Substitute products are a threat
Substitutes are products that consumers can use interchangeably from different industries, such as coffee and tea. They can also significantly impact your industry.
You must compete with other businesses in the industry if your product is cheaper or better than those of your competitors.
Your product may not have superior substitutes that are cheaper or more affordable than yours. However, these substitutes won’t pose a threat to your business or your direct competitors. Low multi-market competition may only cause a slight drop in your profits and prices.
Example of Substitute Products in Threat
Instead of buying aluminum bats for baseball, players could purchase bats from suppliers that only make wood bats like Baum Bats and Old Hickory. However, the chances of this happening are very low. Individual wood bats are less expensive than individual aluminum bats but wood bats tend to break more often.
One aluminum bat can last for $250 longer than five $100 wooden bats. Therefore, replacing aluminum bats with wooden bats will actually cost more. Aluminum bats are also more accurate and can be hit farther by players, making them the superior product.
Wood bat manufacturers also make the most of a niche market that only uses wood bats. This includes professional baseball players, top-flight baseball players, and summer college league players. This industry is safe because there are few substitutes.
Porter’s Five Forces Analysis
Start by examining how each force affects your company. Next, identify the strength of each force and their direction — this will help you assess your competitive position.
These questions will help you get started.
- Are there many suppliers in my industry sector?
- Is my purchasing power high or low?
- Is there a substitute product or service for my product?
- Is it difficult or easy for new competitors to enter my market
- Is there high or low competition in my industry?
Next, take a note of the five forces and make a list of their sizes and scales. Use your answers as a guide. You can also download our Five Forces Model Template.
Porter’s Five Forces Model Template
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Business is full of competition. Porter’s Five Forces analysis can help you identify strategies that will improve your industry’s competitive position, long-term profitability potential, and overall appeal.