What are Porter’s Five Forces?

//What are Porter’s Five Forces?
What are Porter’s Five Forces? 2017-10-09T05:36:45+00:00

Definition: The Porter’s five forces is a broadly used model in business that refers to the five important factors that drive a firm’s competitive position within an industry.

What Does Porter’s Five Forces Mean?

What is the definition of Porter’s five forces? The Porter’s five forces include the following components:

The threat of new entrants: when the barriers to entry into an industry are high, new businesses can hardly enter the market due to high costs and strong competition. Highly concentrated industries, like the automobile or the health insurance, can claim a competitive advantage because their products are not homogeneous, and they can sustain a favorable position. On the other hand, when the barriers to entry into an industry are low, new businesses can take advantage of the economies of scale or key technologies.

The bargaining power of buyers: it represents the extent to which the buyers can influence the prices of the goods or services. When there is a large number of buyers, the costs of switching to competition and the customer loyalty are both low. Buyers can go with the business that meets their needs at the lowest cost. On the other hand, when the number of buyers is small, they can push the prices of the goods or services down because the business cannot easily find new customers.

The bargaining power of suppliers: it represents the extent to which the suppliers can influence the prices. When there are a lot of suppliers, buyers can easily switch to competition because no supplier can, actually, influence the prices and exercise control in the industry. On the contrary, when the number of suppliers is relatively small, they can push the prices up and be powerful.

The threat of substitutes: when customers can choose between a lot of substitute products or services, businesses are price takers, i.e. buyers determine the prices, thereby lessening the power of businesses. On the contrary, when a business follows a product differentiation strategy, it can determine the ability of buyers to switch to the competition.

Competitive rivalry: in highly competitive industries, firms can exercise little or no control on the prices of the goods and services. In contrast, when the industry is a monopolistic competition or monopoly, businesses can fully control the prices of goods and services.

Let’s look at an example.

Example

Company A is a leading athletic footwear company that operates in the athletic apparel industry.

Based on Porter’s Five Forces model the threat of new entrants is moderate as there are high capital costs, mostly related to advertising and promotion, especially when a new product line is launched. On the other hand, company A can expand in the performance apparel industry and cross-sell its products.

The bargaining power of buyers is higher in the wholesale customers as they can switch at a low cost to the competition, thereby gaining a higher margin. With respect to the retail customers, the bargaining power is lower as customers are loyal to the brand.

The bargaining power of suppliers is relatively low because the company has many different suppliers both in the US and abroad.

The threat of substitute products is relatively low because brand loyalty is high. Hence, the demand for the company’s products is expected to continue in the long-term.

Finally, the competitive rivalry in the industry is high as there are a lot of well-established companies with significantly larger resources and process patents.

Summary Definition

Define Porter’s Five Forces: Porter’s five forces means a business model that identifies the main factors contributing to a company’s completive edge over its competitors.