Porter’s 5 forces model is an analytical methodology to investigate opportunities and threats in a given industry.
In other words, this model investigates whether it is profitable to create a company in a certain sector. This, depending on the structure of the market.
Each of the 5 Porter’s forces is a factor that influences the ability to profit and they are as follows:
- Current competition intensity.
- Potential competitors.
- Substitute products.
- Bargaining power of suppliers.
- Bargaining power of customers.
All of this is developed in the book “Competitive Strategy: Techniques for Analyzing Industries and Competitors” by Michael E. Porter, published in 1982. porter’s 5 forces
The main objective of this analysis is to look for opportunities and identify threats for companies already located in an industry and for those that plan to enter. Thus, your ability to make a profit is determined.
According to this model, the degree of attractiveness of an industry is determined by the action of these five basic competitive forces that, taken together, define the possibility of obtaining higher returns.
In this sense, Porter’s analysis can be performed for any market with the idea of improving long-term profitability. In addition, it allows increasing resistance to unforeseen situations. An example of the above would be that our company is affected as little as possible when an economic recession occurs .
1. Intensity of current competition
It refers to the performance of existing competitors in the industry, and is decisive to know if the rivalry is high or low. For this, each of the following points must be studied: porter’s 5 forces
- Number of competitors and balance between them: Concentrated industries (few companies and a lot of market share) have a lower level of competition, compared to fragmented ones (many companies with a homogeneous market share).
- Industry growth rate: As the expansion of an industry increases, so does the intensity of competition.
- Mobility barriers: These are those obstacles that prevent companies from moving from one segment to another, within the same market. We refer, for example, to moving from one customer niche to one with higher income.
- Exit barriers : These are factors that prevent the abandonment of a sector.
- Product differentiation: To the extent that an industry has a higher level of product differentiation (marketing strategy based on creating a perception of the product by the consumer that clearly differentiates it from others), the intensity of competition is reduced.
- Diversity of competitors: When competitors have different strategies (see business strategies ), the level of competition intensifies, as it is more difficult to predict their behavior.
2. Potential competitors
It refers to companies that want to compete in an industry. The more attractive a sector is, the more potential participants there will be. This depends on the following factors: porter’s 5 forces
- Entry barriers : We can define them as those factors that make it difficult for new companies to enter the industry.
For example, economies of scale represent a barrier to entry because they require the new competitor to make a high initial investment. Then, a reduction in unit costs will be observed only as the volume of business increases.
- Product differentiation: Established companies may have patents or a client portfolio. This forces new competitors to make large investments to retain new buyers.
- Other reasons: Situations may be observed that make it difficult for new competitors to enter. These are, for example, lack of financing or difficult access to distribution channels.
3. Substitute products
They are defined as those goods or services that satisfy the same needs. As more substitute products appear, the attractiveness of the industry begins to decrease. porter’s 5 forces
The threat of the emergence of these substitute goods depends on the degree to which they satisfy the needs of consumers. In addition, it influences the price and costs of exchanging one merchandise for another.
4 and 5. Bargaining power of suppliers and customers
Porter’s strength 4 is the power of negotiation with suppliers and 5, the power of negotiation with customers . However, as the analysis of both forces is very similar, they are often studied together.
The bargaining power is the ability to impose conditions on transactions. Thus, as this dominance is greater on the part of buyers, the attractiveness of the industry decreases. porter’s 5 forces
According to Porter, the most important factors affecting bargaining power are the following:
- Degree of concentration in the industry.
- Volume of transactions between customer and supplier.
- Degree of differentiation of products or services.
- Provider change costs.
- Level of benefits obtained by the customer from the supplier.
- Real threat of vertical integration forwards or backwards.
- Importance of the product or service sold.
- Possibility of storing the merchandise.
- Level of information that one of the parties has in relation to the other.