What is Porter's Five Forces Analysis?

Porter's five forces analysis is an industry analysis model developed by Michael E. Porter as a tool for developing corporate strategies to become or remain competitive in an industry. It helps a company exploit opportunities and overcome threats in the external environment of the business. According to Porter, there are five forces that affect the competitive environment of an industry. The five forces include rivalry among competitors, the threat of new players, bargaining power of consumers, bargaining power of suppliers, and the threat of substitute products.

The rivalry among competitors is considered the strongest among the five competitive forces that affect an industry. In a graphical representation, this force is often placed at the center, with the other four forces feeding into it. Fierce competition normally results in the decline of profitability in an industry.

A new business entrant or player is a threat to existing businesses in an industry, especially when the new player is able to hurdle difficult barriers to entry. A new business may be able to enter the industry with products that have better quality and lower prices. Corporate strategists of existing firms must, therefore, always keep their ears to the ground to detect any new players early and to quickly prepare a counter-offensive.

When there is little product differentiation and the features of the product are standard, buyers will have bargaining power. Consumers will be able to negotiate for discounts more easily and even ask for freebies. Companies, on the other hand, will be pitted more strongly against each other to get the sale and keep the customer from switching to another supplier or store. Marketing must play an aggressive role in coming up with promotional campaigns to establish customer loyalty.

The bargaining power of a supplier is high when there are a limited number of dominant suppliers that can dictate the price for their products and services. Conversely, suppliers will have a weak bargaining power when there are many competent suppliers servicing an industry. In times when suppliers control the market, a company must find a way to establish a good relationship with a supplier and negotiate a long-term supply contract. When the supply market has too many players, a company should exploit the situation by negotiating for an attractive discount and payment plan, as well as working for a just-in-time delivery arrangement.

According to Porter's five forces analysis, substitute products become a competitive pressure to a company when the cost of the substitute product is substantially lower and the customer's switching cost is also low. When it makes economic sense, customers will be encouraged to go for the substitute product. Corporate strategists may resort to product innovation to improve their offerings, and it may also be possible to lower production costs to reduce the price of the product to prevent customers from switching.

A company that employs Porter's five forces analysis may be able to get a good grasp of the competitive environment. Managers may be better able to prepare an effective strategy to achieve profitability and stay ahead of the competition. Porter's five forces analysis can also help in the planning of an optimized allocation of a company's resources. It could likewise paint a good picture of the industry that will allow shareholders to see where the industry is headed.