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| Define Porter's Five Forces Analysis |
Define Porter's Five Forces Analysis
The five forces were originally identified and developed by Michael E. Porter while working for the Harvard Business School and the Boston Consulting group. Both were looking for a new and updated version for developing strategies in the area of competitive advantage. He applied the principles of microeconomics and business strategy to analyze requirements in individual sectors. Developing the five forces in line with the business goals of utilizing an organizations projects limited resources on its greatest potential opportunities. The Five Forces Model is a tool that can be used to analyze the opportunities and overall competitive advantage of you, your organization, or your project. It is comprised of five forces that can assist in determining the competitive intensity and potential attractiveness within a specific area. This can be developed to assist in analyzing a specific project and the strategic opportunities for this project, as well as the strategic opportunities, effectiveness and profitability of your organization as a whole.
Five Forces Analysis assumes that there are five important forces that determine competitive power in a business situation. These are:
- Supplier Power: Here you assess how easy it is for suppliers to drive up prices. This is driven by the number of suppliers of each key input, the uniqueness of their product or service, their strength and control over you, the cost of switching from one to another, and so on. The fewer the supplier choices you have, and the more you need suppliers' help, the more powerful your suppliers are.
- Buyer Power: Here you ask yourself how easy it is for buyers to drive prices down. Again, this is driven by the number of buyers, the importance of each individual buyer to your business, the cost to them of switching from your products and services to those of someone else, and so on. If you deal with few, powerful buyers, then they are often able to dictate terms to you.
- Competitive Rivalry: What is important here is the number and capability of your competitors. If you have many competitors, and they offer equally attractive products and services, then you'll most likely have little power in the situation, because suppliers and buyers will go elsewhere if they don't get a good deal from you. On the other hand, if no-one else can do what you do, then you can often have tremendous strength.
- Threat of Substitution: This is affected by the ability of your customers to find a different way of doing what you do – for example, if you supply a unique software product that automates an important process, people may substitute by doing the process manually or by outsourcing it. If substitution is easy and substitution is viable, then this weakens your power.
- Threat of New Entry: Power is also affected by the ability of people to enter your market. If it costs little in time or money to enter your market and compete effectively, if there are few economies of scale in place, or if you have little protection for your key technologies, then new competitors can quickly enter your market and weaken your position. If you have strong and durable barriers to entry, then you can preserve a favorable position and take fair advantage of it.
When and how to use Porter's Five Forces model
Risk of entry by potential competitors Bargaining power of suppliers Bargaining power of buyers Intensity of Rivalry among established firms Threat of substitutes His model focuses on five forces that shape competition within an Industry.
Porter argues that the stronger each of these forces is the more limited is the ability of established companies to raise prices and earn greater profits. Within porter’s framework, a strong competitive force can be regarded as a threat because it depresses profits. A weak competitive force can be viewed as an opportunity because it allows a company to earn greater profits. The task facing managers is to recognize how changes in the five forces give rise to new opportunities and threats and to formulate appropriate strategic responses.
When to use Porter's Five Forces model
The Five Forces Model is important for organizations to develop concise evaluations within a specific area. This will allow you to analyze your organization or project by looking at the specific internal and external forces and how they can potentially affect effectiveness and attractiveness.
How to use Porter's Five Forces model
The first three of the forces are external factors while the last two are internal factors that could affect you, your organization and /or project. For each factor you must look at exactly who, what, why and how these factors could potentially affect you, your organization and/or your project.
1. Competition
- Who is the current competition?
- What is the possibility of new competitors in your sector field?
- What are the abilities that they posses?
- How could this affect you, your project and/or your
- Are there any barriers that you and/or they must overcome?
2. New entrants
- Is there any potential threat of substitution?
- What are the factors that make them superior if any?
- Is there any fear of them replacing existing product(s) or service(s)?
3. End users/Buyers
- Determine who your organizations/ projects potential buyer could be.
- How many potential buyers could there be (Internally Externally)?
4. Suppliers
- Determine who your organizations/ projects potential suppliers could be.
- How many potential suppliers could there be (Internally Externally)?
5. Substitutes
- Is there any rivalry internally or externally regarding your organization or project?
- How can you increase your strengths while diminishing theirs?
- Aim to minimize the relative competitive strength of rivals.
