Understanding Porter's Five Forces Model

Sep 4, 2024

Five Forces Analysis by Michael Porter

Michael Porter of Harvard Business School developed the Five Forces Model to analyze the competitive environment in industries, explaining why some industries are more profitable than others.

Purpose

  • To determine the attractiveness of an industry for companies.
  • Example: Airlines (unprofitable) vs. Soft Drink Companies (highly profitable).
  • The model helps explain these differences.

The Five Forces

  1. Level of Rivalry

    • High competition among many strong competitors can make an industry less attractive.
    • Example: Coffee shop industry has high rivalry due to many competitors.

  2. Customer Power

    • Customers have power if they can easily switch suppliers or negotiate prices.
    • In coffee shops, individual customers can't negotiate but can easily switch and influence through social media.

  3. Supplier Power

    • Industry is less attractive if suppliers offer unique products that are hard to substitute.
    • Coffee shop suppliers (coffee beans, milk, sugar) generally lack power due to many choices.

  4. Power of Substitutes

    • Competing against products in other industries that fulfill a similar need.
    • Coffee shops compete with home-brew or vending machine alternatives, but they offer unique social experiences.

  5. Threat of New Entrants

    • Low entry barriers can decrease industry attractiveness as new competitors can easily enter.
    • Coffee shops have low entry barriers compared to industries like car manufacturing.

Analyzing Industry Attractiveness

  • Consider all five forces to determine how attractive an industry is.
  • Identify barriers to profitability and create strategies to address them.
    • Example: Use loyalty cards to prevent customer switching.
    • Differentiate to reduce the impact of rivalry.

Steps for Five Forces Analysis

  1. Define the industry.
  2. Identify the current situation for each force.
    • Important competitors, customers, suppliers.
    • Substitutes and entry barriers.
  3. Analyze the attractiveness per force.
    • Determine factors making the industry easy or difficult.
  4. Look at the overall picture.
    • Conclude on the industry's attractiveness and competitive strategies.

Conclusion

  • Even in unattractive industries, originality and innovation can lead to profitability.
  • Examples exist of successful companies in tough industries.

This concludes the Five Forces Analysis. For further insights, see additional resources by Sim Institute.