Are you looking to gain a competitive edge in your industry? One tool that can help you analyse the competitive forces in your market is Porter’s Five Forces.
Developed by Harvard Business School professor Michael Porter in the 1980s, Porter’s Five Forces is a framework used to evaluate the intensity of competition in an industry and the potential for profitability.
By understanding the five forces, businesses can identify the key drivers of competition and make informed decisions about positioning themselves in the market.
In this comprehensive guide, we’ll cover the basics of Porter’s Five Forces and how you can use them to analyse the competitive forces in your industry.
By the end of this article, you’ll have a solid understanding of the five forces and how to use them to develop a winning business strategy.
Threat Of New Entrants
One of the forces that can affect the intensity of competition in an industry is the threat of new entrants. New entrants can disrupt existing competitors by offering new products or services, entering the market with lower prices, or utilising innovative business models.
This can increase competition and pressure existing firms to adapt or lower their prices.
Several factors can make it difficult for new entrants to enter and compete successfully with established firms. These include:
- High barriers to entry: Some industries have high barriers to entry that make it difficult for new firms to enter the market. These barriers include regulatory barriers, such as licensing requirements or strict regulations, and economic barriers, such as high upfront costs or the need for specialised equipment or technology.
- Strong brand recognition: Established firms often have strong brand recognition and loyalty among customers, making it difficult for new entrants to gain a foothold in the market.
- Economies of scale: Firms that have already achieved economies of scale – the cost advantages that come with producing at a large scale – may have a cost advantage over new entrants, making it difficult for new firms to compete on price.
Threat Of Substitutes
Another force to consider when analysing the intensity of competition in an industry is the threat of substitutes. Substitutes are products or services used in place of a particular product or service. For example, bottled water is a substitute for tap water, and streaming services are a substitute for cable television.
The availability of substitutes can affect the demand for a particular product or service and pressure firms to lower their prices. Several factors can make it difficult for substitutes to enter the market:
- High switching costs: If customers face high costs to switch to a substitute product or service, such as purchasing new equipment or cancelling a subscription, they may be less likely to switch.
- Strong brand loyalty: If customers are loyal to a particular brand or product, they may be less likely to switch to a substitute.
Bargaining Power Of Buyers
The bargaining power of buyers, or the ability of customers to negotiate for lower prices or better terms, is another force to consider when evaluating the intensity of competition in an industry.
If buyers have a lot of bargaining power, they can pressure firms to lower their prices or offer additional benefits to win their business.
Several factors can give buyers more bargaining power:
- Availability of substitutes: If customers have several options, they may be more likely to negotiate for better terms or switch to a substitute product.
- Importance of the product to the buyer: If the product or service is essential to the buyer’s business or daily life, they may have more bargaining power.
- Number of buyers in the market: If there are many buyers in the market, firms may be more willing to negotiate to win their business.
Bargaining Power Of Suppliers
In addition to considering the bargaining power of buyers, businesses should also consider the bargaining power of suppliers.
Suppliers can affect the prices and terms of the products or services they provide, and if they have a lot of bargaining power, they can pressure firms to pay higher prices or accept less favourable terms.
Several factors can give suppliers more bargaining power:
- Availability of substitutes: If there are few substitutes for a supplier’s products or services, they may have more bargaining power.
- Importance of the supplier’s product to the buyer: If the supplier’s product is essential to the buyer’s business, the supplier may have more bargaining power.
- Concentration of suppliers in the market: If there are few suppliers in the market, they may have more bargaining power.
Rivalry Among Existing Competitors
The intensity of competition among existing competitors in an industry is another factor to consider when evaluating the potential for profitability.
If there is a lot of rivalry among competitors, firms may be pressured to lower their prices, increase their marketing efforts, or introduce new products to stay competitive.
There are several factors that can increase rivalry among existing competitors, including:
- Excess capacity: If there is more capacity in the market than in demand, firms may be more likely to compete aggressively to increase their market share.
- High fixed costs: If firms have high fixed costs, such as leasing a facility or purchasing equipment, they may be more likely to compete aggressively to recoup their costs.
- Intense price competition: If firms are competing primarily on price, they may be more likely to engage in price wars or other aggressive pricing strategies.
Porter’s Five Forces In Online Retailing
- Threat of new entrants: The threat of new entrants in the online retailing industry is moderate. While the barriers to entry are relatively low – any individual or company can set up an e-commerce website with relatively little upfront investment – there are still some barriers to consider. For example, new entrants may face challenges in establishing a strong brand recognition and building a customer base and competing with established firms that already have economies of scale and strong customer loyalty.
- Threat of substitutes: The threat of substitutes in the online retailing industry is low. While customers can purchase products from physical stores or other online retailers, the convenience and wide selection of products offered by online retailers make them a strong choice for many customers. In addition, the high switching costs associated with changing online retailers – such as updating payment information and shipping addresses – may discourage customers from switching to substitutes.
- Bargaining power of buyers: The bargaining power of buyers in the online retailing industry is high. With the abundance of options available, customers can shop around and compare prices and negotiate for discounts or promotions. In addition, using price comparison websites and quickly checking prices on multiple sites gives buyers more bargaining power.
- Bargaining power of suppliers: The bargaining power of suppliers in the online retailing industry is moderate. While online retailers do rely on suppliers for the products they sell, the large number of suppliers available and the ability to easily switch between them gives online retailers some bargaining power. However, suppliers that offer unique or in-demand products may have more bargaining power.
- Rivalry among existing competitors: The rivalry among competitors in the online retailing industry is intense. Competition is fierce with many market players, including large multinational corporations and small independent retailers. Firms may use price wars or other aggressive pricing strategies to win market share. They may also compete on product selection, convenience, and customer service.
Overall, the competitive forces in the online retailing industry are moderate to high, indicating that while there are opportunities for profitability, firms will need to consider their strategy to compete successfully.
Porter’s Five Forces is a valuable tool for analysing the competitive forces in an industry and developing a successful business strategy.
By understanding the threat of new entrants, the threat of substitutes, the bargaining power of buyers and suppliers, and the rivalry among existing competitors, businesses can identify the key drivers of competition and make informed decisions about positioning themselves in the market.
Whether you’re looking to enter a new market or strengthen your position in an existing one, Porter’s Five Forces can provide valuable insights into the competitive landscape and help you develop a winning strategy.
- Porter, M. E. (2008). The five competitive forces that shape strategy. Harvard Business Review, 86(1), 78-93. https://hbr.org/2008/01/the-five-competitive-forces-that-shape-strategy
- Porter, M. E. (1985). Competitive Advantage: Creating and Sustaining Superior Performance. New York, NY: Free Press. https://www.goodreads.com/book/show/494991.Competitive_Advantage?ac=1&from_search=true&qid=IhEGf8l7YB&rank=1
- Zott, C., Amit, R., & Massa, L. (2011). The business model: Recent developments and future research. Journal of Management, 37(4), 1019-1042. https://journals.sagepub.com/doi/abs/10.1177/0149206311406265