Porter’s 5 Forces Analysis Guide: Methodology in 5 Easy Steps with Example
Updated: Oct 14, 2022
The Porter’s 5 Forces model of competition was developed by Michael Porter of Harvard Business School in 1979 to understand how industry competition affects profitability and attractiveness. The model helps organizations understand what drives a specific industry and how they can best compete within that industry. It is also useful for helping business strategists to determine their competitive advantage over others.
Table of Contents
What are Porter’s 5 Forces?
Porter's five forces model helps marketers and business managers to look at the 'balance of power' in a market between different types of organizations, and to analyze the attractiveness and potential profitability of an industry sector.
It analyzes an industry by looking at five key areas:
1. Rivalry among competitors.
2. Threat of new entrants into the market.
3. Threat of substitute products or services offered by other companies.
4. Power of suppliers within an industry.
For example, raw material suppliers.
5. Bargaining power of customers within an industry.
For example, retail buyers.
Understanding with Example
1. Rivalry among competitors:
Competition in an industry affects the behavior of firms within that industry. Competition forces firms to continuously improve their products and services, develop innovations, and push down prices. If a firm fails to do so, it risks losing market share and profits to other firms in the industry. The intensity of competition within an industry depends on a variety of factors, such as
- Number of competitors
- Competitors' capacity
- Competitors' pricing strategy
- Competitors' marketing strategy
- Competitors' innovation strategy
The greater the number of rivals in an industry, the more intense the rivalry is. This is because rival companies compete over customers, raw materials, and talent.
They also compete for funding and venture capital, space in stores and online shopping portals, media coverage, etc.
When only two or three companies are competing within a niche, they often become more cautious about how they compete. This sometimes results in collusion—companies agreeing not to compete too vigorously with each other.
For example, for years UPS and FedEx cooperated to keep shipping prices high for customers by coordinating their price hikes at the same time. However, when DHL entered the market with low shipping costs and aggressive pricing strategies, it had to lower its prices to compete with DHL.
Another example, consider the online travel industry. This industry has many competitors like Expedia, Priceline, Orbitz, etc. Each company has a significant market share, and they compete against each other on price and quality of services provided (e.g., number of flights and hotels listed). It would be very difficult for a new online travel firm to enter this industry and compete effectively with these companies. As a result, competitive rivalry within this industry is very high.
2. Threat of New Entrants –
The threat of new entrants is one of the forces that shape the competitive structure of an industry. The threat of new entrants is influenced by certain factors, such as barriers to entry, the reaction from existing competitors, the cost required to enter the market, and the expected retaliation from existing competitors. This framework is used by organizations for developing an effective business strategy to face the new players who are willing to enter their business areas of interest.
For example, the entry of Reliance Jio into the telecommunication market in India changed the entire game of the pricing system and the quality of the high-speed network given to the customers. Within a short period, they captured the market to become the largest telecommunication company.
Another example is Airlines are a very good example to explain this force. It is a capital-intensive industry and requires huge investment to establish an airline company. As one can see below, there are not many players in this industry.
Not many new airline companies are coming up because of the high barrier to entry in this industry. It requires a huge investment and a lot of people working together to run this complex operation successfully. In addition, those who are already established have established themselves due to customer loyalty and brand value that they have built over time. Therefore, it is difficult for any new player to break into this industry without spending a lot of money on marketing and promotions which would be less profitable initially.
3. The Threat of Substitute Products or Services:
It measures how likely it is that customers will switch from your product or service to a competitor's product or service.
The greater the threat, there more incentive you must fight back by offering lower prices, better features or benefits, new features, etc. So, if you have a high threat from substitute products then you need to offer something different from what they offer!
For example, if you are selling computers then there are other products such as tablets, smartphones, and laptops that could be used as substitutes for your product.
4. The bargaining power of buyers:
The bargaining power of buyers refers to how well-organized buyers are in terms of willingness and ability to negotiate prices with the company.
Buyers have stronger bargaining power when there is only one buyer in the marketplace (for example when they represent a large portion of sales) or when they can easily switch between suppliers (e.g., if there are many suppliers in one industry). This may mean that they can force down prices or demand better terms from suppliers.
The more intense the buyer pressure, the more likely it is that an industry will be profitable. This happens when customers are locked in by switching costs and have no alternatives to using your product or service. This can happen when you are selling commodities, such as corn or oil, where there are no close substitutes available for purchase.
For example, buyers having power over the industry is the emergence of online retailers such as Amazon.com. Their ability to offer lower prices has forced other retailers to adapt their business models, either through improving efficiencies, offering additional services, or lowering prices. If a large enough percentage of people start shopping online for electronic goods, then brick-and-mortar stores will be unable to compete and go out of business.
5. Power of Suppliers:
Suppliers have high bargaining power when they supply products that are difficult to replicate or replace.
For example, if there are only two suppliers of a product, they will have more leverage than if there were 20. The lesser number would mean they could charge more per unit sold and remain competitive with other companies.
Another example, is if there were only two companies manufacturing a specific component for cars or computers, then they would have more bargaining power than if thousands were making that same part.
Conducting Porter’s 5 Forces Analysis with Example of Tesla
1. Threat of New Entrants:
For TESLA, this threat is coming from different sectors like car manufacturers, battery manufacturers, electronics, etc. Many other companies are working on electric cars like BMW, Nissan, Tata Motors, etc.
Tesla has increased entry barriers due to expensive capital investments required in manufacturing facilities and R&D expenditures required for developing electric cars.
Tesla has built strong brand loyalty, differentiated products and offerings, and enhanced manufacturing to improve costs, reliability, and timely deliveries.
2. Bargaining Power of Suppliers:
Supplier bargaining power is high if the industry is reliant on a few key suppliers. Tesla manufactures its parts in-house which substantially reduces supplier bargaining power.
Giga factories in the United States, Asia, and Europe are built by Tesla to lower suppliers' bargaining power. As a result, the supply chain network is shortened, production and market are coming closer together and shipping costs are reduced.
Computer chip shortages have disrupted major US manufacturers, including GM and Ford. To keep production going, Tesla has rewritten the software codes to support different chip suppliers.
3. Bargaining Power of Buyers:
Tesla has been able to differentiate its product by offering unique features like self-driving technology combined with electric car usage, thereby reducing buyer bargaining power.
Electric carmaker Tesla is currently ranked among the leaders in speed, safety, battery life, and autopilot systems. It’s offering products that are unique in the high-end market.
4. Threat of Substitutes:
There are many products available to fulfill the needs of customers like cars for transportation and batteries for power supply etc. As TESLA is offering a complete package so it does not have much threat from substitutes.
Stores and showrooms under company management are creating an interactive technology hub, where customers can experience Tesla's latest technology, like Apple Stores and Starbucks Reserve.
5. Industry Rivalry Among Competitors:
Tesla has immense competition from different startups, and big automakers switching to electric cars. There is competition from BMW, Tata Motors, and Volkswagen Group who have started on the journey same as Tesla.
Big automakers are responding with price cuts and marketing campaigns to attract more customers.
Conclusion
In conclusion, Porter’s 5 forces analysis is a wonderful tool to help investors determine the potential of an industry. It is always better to know before investing where you stand and who your competitors are. Startups should do a complete analysis to plan their strategy for how to enter the market.
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