Porter's Five Forces Analysis

Illustrative outline of the five forces identified by Porter

The 5 Porter Forces

The Porter's Five Forces Analysis is a strategic model developed by engineer and professor Michael Eugene Porter of the Harvard Business School in 1979. This model establishes a framework for analyzing the level of competition within an industry, in order to develop a business strategy. This analysis derives in the respective articulation of the 5 forces that determine the intensity of competition and rivalry in an industry, and therefore, how attractive this industry is in terms of investment opportunities and profitability.

He referred to these forces as microenvironmental, to contrast them with forces that affect the environment on a scale larger than industry, the macroenvironment. These five forces are those that operate in the immediate environment of an organization, and affect its ability to satisfy its customers and obtain profitability.

Since the model was developed in 1979, it is questionable whether the forces are still relevant today. It seems doubtful that Porter's model, which has been available for many decades, since 1979, without any changes, is still relevant for analyzing the balance of power within a particular industry. However, today, Each scholar or manager or executive can adapt it to their current situation and their current specific circumstance.

Porter's five forces include three forces of horizontal competition: Threat of substitute products, threat of new entrants or competitors in the industry, and rivalry among competitors, and also comprises 2 forces of vertical competition: The bargaining power of suppliers, and the bargaining power of customers.

Porter's 5 forces

(F1) Bargaining power of customers or buyers

If the customers are few or very well organized, they could agree on the prices they are willing to pay and they will be a threat to the company, since they will acquire the possibility of standing at a price that seems appropriate to them but that, generally, will be less than the company would be willing to accept.

In addition, if there are many suppliers, clients will not increase their bargaining power since they have less possibility of changing to a supplier of higher and better quality, for this reason things change for companies that give their clients bargaining power of their mechanical positions in order to worsen the services of a company.

Customer bargaining power is also described as product market: the ability of customers to put the company under pressure, which also affects customer sensitivity to price changes. Companies can take steps to reduce buyer power, such as implementing a loyalty program. Buyer power is high if buyers have many alternatives. It is low if they have few options.

Determining Factors

• Concentrations of the buyer to the firm concentration ratio.
• Grade of dependency on existing distribution channels.
• Negotiating, particularly in high-cost industries
• Buyer ' s exchange costs
• Availability of information for the buyer
• Availability of existing substitute products.
• Sensitivity to buyer price
• Differential Sales (singularity) of products of the industry.
• RFM Analysis.

(F2) Bargaining power of suppliers or vendors

This “bargaining power” refers to a threat imposed on the industry by suppliers, due to the power that these have either due to their degree of concentration, due to the characteristics of the inputs they provide, due to the impact of these inputs on the cost of the industry, etc. The ability of suppliers to negotiate is generally considered high, for example: the food market in supermarket chains, they can opt for a wide variety of suppliers, mostly undifferentiated.

Since suppliers want to charge the highest prices for their products, a power struggle naturally arises between companies and their suppliers. The advantage goes to the side that has more options and less to lose if the relationship ends. In this bargaining power, the company's customers want to lower prices or raise quality. Their ability to do so depends on how much they buy, how well informed they are, their willingness to experiment with alternatives, and so on.

Some factors associated with the second force are:

• Number of suppliers in the industry.
• Decision-making power on the supplier's price.
• Level of organization of suppliers
• Level of purchasing power.

(F3) Threat of new entrants

This point refers to the entry barriers of new products/competitors. The easier it is to get in, the greater the threat. In other words, if it is a question of setting up a small business, it will be very easy for new competitors to enter the market. It refers to the ease or difficulty that a new entrant may experience when they want to start operating in an industry.

Porter identified six barriers to entry that could be used to create a competitive advantage for the organization:

• Scale economies: The economies of scale in production, research, marketing and service are probably fundamental barriers in entering the IT industry sector.
• Product differentiation: Established companies have brands and have earned their customers' loyalty over time.
• Capital investments: When greater resources are needed to start a business, greater is the barrier to entering a sector.
• Disadvantage in costs regardless of scale: Established companies may have cost advantages for a number of reasons, including technology ownership, know-how of the product, favorable access to raw materials, favorable location, government aids, the experience of the workforce
• Access to distribution channels: When a company has several distribution channels it is complicated that competitors may appear and especially that suppliers accept the product.
• Government policy: The government may limit or prevent entry into certain sectors by requiring licences, limiting access to raw materials such as coal or public land, or other regulations.
• Vertical integration

(F4) Threat of substitute products

There's an old saying that no one is irreplaceable. Competition depends on the extent to which the products of an industry are substitutable for each other. Postal services compete with courier services, which compete with fax machines, which compete with email, and so on. When one industry innovates, another may suffer.

As in the case cited in the first force, pharmaceutical or technological patents that are very difficult to copy allow prices to be set alone and normally imply high profitability. On the other hand, markets in which there are several identical or similar products generally imply low profitability. We can cite the following factors:

• Propension of the buyer to replace.
• Relative prices of substitute products.
• Cost or ease of the buyer.
• Perceived level of product or service differentiation.
• Availability of nearby substitutes.
• Enough suppliers.

(F5) Rivalry between competitors

Rivalry between competitors is the result of the previous four. Rivalry defines the profitability of a sector: the fewer competitors there are in a sector, it will normally be more economically profitable and vice versa.

All of the above factors converge in rivalry, which for Porter is a cross between active warfare and peaceful diplomacy. They may attack each other, or tacitly agree to coexist, perhaps even form alliances.

Porter identified the following barriers that could be used:

• Large number of competitors
• Fixed costs
• Lack of differentiation
• Miscellaneous components
• Departure barriers

Criticism

The model does not take government into account, since as can be seen in the five forces, the actors that are mainly taken into account are customers (public), suppliers and competitors.

• The government can regulate price hikes in most cases.
• The model is proposed for the analysis of individual business strategies, not for corporate business portfolios.
• It does not take into account that an industry is more attractive by the companies that make up it.
• It does not raise flexibility and agility in the radical change of strategies in markets.
• There is no possibility of opening new markets that can replace existing ones.
• It does not reflect changes or trends in the future.
• It gives excessive importance to the structure of the industry to explain the profitability of the companies.

Application

Porter's Five Forces model proposes a framework for systematic strategic reflection to determine the profitability of a specific sector, normally in order to assess the value and future projection of companies or business units that operate in said sector. sector. Each model is structured under the effectiveness and efficiency of the five forces.