What is Porter’s Five Forces Model? A Comprehensive Guide (2021)

Introduction

First developed by Michael E Porter of Harvard Business School in his book “Competitive Strategy: Techniques for Analyzing Industries and Competitors“, the Five Forces Model is currently used as a key indicator of competition intensity in industrial economics. To simplify, Porter’s five forces model aims to analyze the level of competition in the market, and to what extent competition will affect a firm’s profitability. It’s common knowledge that if the competition is imminent, then the price of the products would be tighter, reducing the profit margin. 

But is it as simple as that, or is there something deeper to gain from industry-level competition analysis? Read this article to find what key insights Porter’s Five Forces analysis can provide!

In this article let us look at:

1. Understanding the basics: What is Porter’s Five Forces model?
2. When to use Porter’s 5 Forces template for competition analysis?
3. Can we extrapolate Porter’s five Forces Model in strategic management?
4. How to use Porter’s Five Forces Model of the competition effectively?
5. An Example of Porter’s Five Forces Model

1. Understanding the Basics: What is Porter’s Five Forces Model?

Porter’s five forces theory is based on the concept that five major factors determine the competitive intensity and attractiveness of a market. The five competitive forces are:

1. Consumer Power: This is an indicator of how easy it is for buyers to bring prices down. In a niche market with few buyers, they are easily able to control the value proposition. The ease of switching to a competitor is also a factor to be considered.

2. Supplier Power: Assessing how easy it is for suppliers to spike prices on commodities or raw materials is vital in determining the fluctuations in profit margin, and consequently, the average margins over a while. It is also an important indicator of how stable the cash flow is. This is determined by the number of suppliers, quality vs quantity considerations, and how much time and money it would cost to switch suppliers.

3. The threat of new entrants: In Porter’s five forces framework, this particular indicator is considered a double-edged sword. Profitable markets attract new entrants quickly and easily, thereby reducing profitability. In profitable markets, rookies may be deterred by formidable barriers of entry like the need for a patent.

4. The threat of substitutes: Churn rate (the percentage of consumers who switch to a competitor) is primarily determined by how closely competition is placed. If the threat of substitutes is high, the market’s attractiveness is quite low, and price increases very quickly affect profitability. An excellent example of such a market is the airline industry.

5. Competitive Rivalry: If there is no defining difference in the USPs of competitive sellers, then the only determinant is the price – which will ultimately etch profits out.

2. When to use Porter’s 5 Forces template for Competition Analysis?

Michael Porter’s Five Forces model is best suited for market sector/segment analysis. It is not the right template to use for individual firms within an industry. But Porter’s 5 forces analysis gives optimum results only when there are three more competitors in the market.

What questions do Porter’s 5 forces model answer?

Michael Porter’s 5 forces model can help individuals help achieve concrete answers to the following questions:

• Should I set-up a new firm in the XYZ industry? Is it possible to enter the XYZ industry at this market stage, or is it not the right time?
• Should I increase the production capacity of my existing business? Will scaling up or scaling down affect my profitability?
• Should my investment portfolio include the XYZ industry?

3. Can we extrapolate Porter’s five Forces Model in Strategic Management?

While it is true that Porter’s Five Forces definition revolves around industry analysis, it also forms an important component in building competitive business strategies. The theory forms a crucial function in answering overall industrial weakness and how to tackle or work around the issue. It is also an important indicator of how mature a market – for example, if a company is at the top of its game but isn’t expanding it’s consumer-base, Porter’s 5 forces analysis can potentially hold the key to how profitability can be increased in a saturated market, i.e. applying new verticals or engage in investments in new technology that improve product competitiveness? 

4. How to use Porter’s Five Forces Model of the competition effectively?

Strategizing using Michael Porter’s Five Forces Analysis can be broken down into 3 key steps:

• Gather data: As with any analysis, strong data equals informed decision-making. The below table gives you examples of what data should be collected about each of Michael Porter’s 5 Forces.

Supplier Power	Consumer Power	The threat of new entrants	Threat of substitutes	Competition rivalry
Number of suppliers	Number of buyers	Capital costs	Number of substitutes	Number of competitors
Number & pricing of substitute materials	Number & pricing of alternates in the market	Legal barriers like patents	Performance of substitutes	Competitor size and performance
Average lead time, seasonal availability, stocking difficulties	The sensitivity of pricing and demand fluctuations	Access to suppliers and distributors	Ease of churn	Average and projected industry growth rates
Cost of switching suppliers	Ease of churn	Strength of USP		Cost of closure
The threat of suppliers becoming manufacturers	The threat of buyers preferring raw materials to finished goods (e.g. preference to buy fruits instead of milkshake)	Economies of scale		Threat/potential of buyouts & acquisitions

• Analyze: Once the information is collected, mapping using graphs, pie-charts, and other data visualization tools can help bring the feasibility of existing strategies to a consensus.
• Formulate strategies based on conclusion: Data-mapping usually provides solutions to irking fallacies in strategies. It exposes loopholes and closes bridges. Use the data-maps to concertize market-strategies.

5. An Example of Porter’s Five Forces Model

To understand how useful Porter’s 5 forces can be, let us take the classic Porter’s Five Forces example – Starbucks.

A leader in the coffee shop chain business, Starbucks has successfully leveraged the worldwide demand for wake-up beverages. Unlike other chain stores, Starbucks faces competition from smaller bistros and cuppas and fast food outlets with significantly higher scaling potential. Extending the analysis for Porter’s Five Forces Analysis Example gives the following picture:

• Supplier power – Weak Force
• Consumer power – Strong Force
• The threat of new entrants – Moderate Force
• The threat of substitutes – Strong Force
• Competitive rivalry – Strong Force

Among the five forces, consumer power is strong, and on occasion, Starbucks has had to swallow bitter coffee because it underestimated this force. The chain suffered a major failure in Australia and had to shut down operations because of the country’s innate love for small mom-and-pop coffee shops; this became one of the best Porter’s five forces model examples of how it can expose loopholes.

On the other hand, Starbucks has managed to succeed in combating competition rivalry elsewhere by setting itself up as a niche market. For example, it has a strong presence in Canada despite the popularity of homegrown Tim Horton’s. It also made a dent in the Indian coffee chain business even though much cheaper rivals like CCD have existed for longer. 

Conclusion

If you are still wondering what is so special about Michael Porter’s five forces, hear it from the man himself. Michael believed that the ad hoc nature of the existing SWOT analysis method for competition analysis meant no strong base to build new companies. So he developed the more potent Porter’s five forces model. 

On the contrary, a failing of Porter’s 5 forces example is that while it does cover many bases, many would suggest that ease-of-doing-business factors related to government regulations form a crucial sixth force. This is especially true when companies are considering expansion to new geographies. Still, the study of Porter’s 5 forces model examples remains one of the best ways to analyze how to structure pricing for new businesses, and how to strategize growth for an existing business. 
To get a holistic understanding of Product Development and Management, check out our 6-month online Product Management Course, in collaboration with IIM Indore. The is a unique program that offers Bring Your Own Product for a hands-on learning experience!

Also, Read

Buyer Persona: Why Is It Important in Product Management?

Consumer Research: A Beginner’s Guide in 4 Important Points