Michael Porter says you can assess the profitability and attractiveness of a business by assessing five forces: supplier power, purchaser power, substitute products, new entrants to the market and existing industry rivals.Summary by The World of Work Project
Porter’s Five Forces
Michael Porter’s classic model assesses the competitive landscape that a business operates within. It does this by capturing the main market factors that affect the ability of a business to generate profit. It considers both how many units a business will sell (substitute products, new competitors and existing competitors) and how much profit a business makes from each item it does sell (sales price and cost of production).
Porter’s model focuses on what he calls the “micro-environment”, the factors close to the company, and he makes clear that other macro factors exist that affect profitability but which he has chosen to ignore such as socio-political and regulatory changes (to assess macro factors you might consider using the PEST or PESTLE models (which we’ve yet to write about)).
Porter’s five forces are supplier power, purchaser power, substitute products, new entrants to the market and existing industry rivals. These forces can be considered to operate across two dimensions, horizontal competition factors and vertical supply chain factors.
To use Porter’s five forces as an analysis tool you need to consider each of the five forces in turn for the specific business, division or product that you’re assessing. We explore some of the factors that you might consider below.
When considering supplier power, what you’re really looking to do is to understand how much risk and control there is in relation to both the volume and cost of the inputs the business needs to produce its products or services. Generally speaking, the more power that suppliers have, the harder it will be for a business to prosper.
Factors to consider when assessing supplier power could include:
- Supplier competition
- Switching costs
- Supply volumes
- Input substitutes
- Labor solidarity
- Supplier channels
- Input costs
- Input volumes
When you’re looking to assess purchaser power, what you’re really trying to do is to understand how much control you have over the price and sales volumes for the product that you’re looking to sell. Generally speaking the more control you have over these factors, the more prosperous your business is likely to be.
The best case scenario from a business prosperity perspective would be to produce a product that’s habit forming, consumed frequently, hard to move away from, price insensitive, difficult to understand the true cost of and that there are few substitutes for. Some industries like tobacco, alcohol and pharma have managed to do this to some extent. Of course, responsible businesses should asses their impact much more broadly than simply whether their ability to make sustainable returns.
Some factors to consider in relation to purchasing power could include:
- Buyer concentration
- Bargaining leverage
- Switching costs
- Price sensitivity
- Price transparency
- Customer information
When you’re assessing substitute products, what you’re really trying to understand is how likely consumers are to buy specifically your product, as opposed to other things that may meet their needs instead. You’re also looking to understand your ability to eliminate or reduce the believe that there are suitable substitutes for your products. Generally speaking, the fewer substitutes your product has, the more likely you will be to prosper through your product.
Some factors to consider in relation to substitute products could include:
- Substitute availability
- Cost of switching
- Product differentiation
- Innovation and technology substitutes
- Customer loyalty
- Existing substitutes
New market entrants
When assessing new market entrants, what you’re really trying to do is to understand how easy it would be for another business to come along and start to sustainably produce and profitably sell the same products you’re looking to prosper from. Generally speaking, the harder it is for other businesses to compete with you, the more prosperous you will be.
Some factors to consider in relation to new market entrants could include:
- Labor supply
- Capital requirements
- IP requirements
- Brand value
- Switching costs
- Distribution channels
- Network effect (digital)
- Customer loyalty
- Economies of scale
Existing industry rivals
When assessing existing industry rivals, what you’re essentially doing is understanding the strengths and weaknesses of your immediate competitors, and any risks or opportunities that these may lead to. Generally speaking, the weaker your competition is across a wide range of factors, the more likely you will be to prosper.
Factors to consider in relation to existing industry rivals could include:
- Competitor volume
- R&D spending
- Advertising spending
- Digital capabilities
- Distribution networks
- Marketing strategy
- Multi-brand strategies
- Regulatory / political influence
- Order books / existing pipelines
- Balance sheet size
The World of Work Project View
Porter’s five forces model is a simple and comprehensive way to consider the attractiveness of a business, and it’s a good way to get people thinking about the impact of rate and volume of sales. It is a bit limited in that it doesn’t consider macro factors but, if you combine it with something like PESTLE, you’ll get a good high level view of your total environment.
Overall we think this model is a good and insightful tool and we totally understand why it is including in many business courses as a fairly introductory tool.
Sources and further reading
Where possible we always recommend that people read up on the original sources of information and ideas.
This post is based on original work by Michael Porter as published in his book “Competitive Strategy“.
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