Michael E. Porter’s Five Forces framework is one of the most widely regarded business strategy tools. Born out of his work in 1979, this framework offers organizations a systematic approach to assessing their competitive environment and making strategic decisions that can influence their long-term success.
The five forces include the factors that influence every industry. The five critical dimensions which shape the competitive business landscape are:
- Competitive Rivalry
- Supplier Power
- Buyer Power
- Threat of Substitution
- Threat of New Entrants
Competitive Rivalry
Competitive Rivalry evaluates the number of existing players and how established they are in the industry. How many competitors do you have? Are their products better than your own?
In industries with cutthroat competition, companies often lower prices and invest in expensive marketing campaigns to increase market share. That means suppliers and buyers can quickly move towards your competitors. Conversely, businesses in less competitive sectors enjoy more comfortable profit margins.
For example, the airline industry has intense competition. Major players such as American Airlines, Delta Air Lines and United Airlines often differentiate themselves by reducing costs, improving customer experience and launching new routes to attract passengers.
Supplier Power
Suppliers provide the essential ingredients for a business’s operations. How much influence does a supplier wield over a company’s profits?
When only a few suppliers can provide a product, they can dictate terms and pressure businesses to accept higher prices. Even if terms are unfavorable, some get pressured to take them because of the costs of moving to another supplier.
In an ideal scenario, companies must be able to diversify their supplier base. By reducing their dependency on a supplier, businesses can safeguard their supply chains, control costs and maintain a competitive edge.
For example, the automotive industry has many suppliers for engines, electronics and tires. However, a relatively small number of companies supply critical components such as semiconductor chips, which grants them substantial power.
Buyer Power
Buyer Power refers to the influence customers wield over a business. If an industry has strong buyer power, consumers can demand lower prices, higher quality or improved service, affecting a company’s profitability.
Buyers wield more power in a market with fewer customers and more sellers. In this scenario, businesses can differentiate themselves by formulating unique value propositions to justify their higher prices. Some examples include loyalty programs, excellent customer service and novel experiences.
The electronics industry provides a compelling example of buyer power within Porter’s Five Forces framework. Consumers can access various electronic products, from smartphones and laptops to smartwatches and home entertainment systems. Price comparisons are easily accessible online, so finding the best deals and discounts is easy.
For example, companies such as Apple let consumers customize their devices with various features, colors and accessories. They consistently upgrade their products with new features because it’s easy to transition to alternative brands or products.
Threat of Substitution
The Threat of Substitution refers to the likelihood that customers might switch to a different product or service. When substitution threats are high, businesses are vulnerable to sudden shifts in consumer preferences.
One notable example of the threat of substitution occurs in the beverage industry. Consumers can choose from many beverages including carbonated soft drinks, bottled water, juices, energy drinks, coffee, tea and alcoholic beverages. That’s why beverage companies must explore niche markets, introduce limited-edition flavors and change their packaging to differentiate themselves.
Threat of New Entrants
How easy is it for new competitors to enter the market and threaten existing players? Threat of New Entrants involves evaluating the barriers to entry in an industry.
High barriers such as high starting capital costs and a small pool of suppliers can deter new rivals from early success. For example, an established company with significant resources can lower prices to maintain a competitive edge over new entrants. However, new competitors can easily weaken your business’s position and quickly disrupt the status quo.
