What is Michael Porter’s 5 Competitive Forces Model? Applications & Strategies

 

The Five Forces Model was developed by Michael E. Porter in his book “Competitive Strategy: Techniques for Analyzing Industries and Competitors” in 1980. Since then, the model has become an important tool for analyzing an organization’s industry structure in strategic processes.

1. What is the 5 competitive forces model?

Michael Porter’s 5 competitive forces, also known as “5 competitive forces”, is a model based on the insight that a company’s strategy must respond to the opportunities and threats in the organization’s external environment. In particular, competitive strategy needs to be based on an understanding of industry structure and how it changes.

Michael Porter identifies five competitive forces that shape every industry and every market: industry competitors, potential entrants, suppliers, customers, and substitute products. These forces determine the intensity of competition and, therefore, the profitability and attractiveness of an industry. The goal of corporate strategy is to manage these competitive forces in a way that improves the organization’s position.

The Michael Porter model aids in analyzing the forces within an industry. Based on the information gained from the Five Forces Analysis, management can decide how to influence or exploit the specific characteristics within their industry.

2. Factors affecting the 5 competitive forces

“Suppliers” include all the sources of inputs needed to provide a good or service. Suppliers of raw materials, components, labor, and services (such as expertise) to a company can be a source of pressure for a company when there are few substitutes. If you are making cookies and only one person has flour, you have no choice but to buy flour from them. Suppliers may refuse to do business with a company or charge too much for unique resources.

A supplier’s bargaining power is likely to be

 

 

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high when:

• The market is dominated by a few large suppliers.
• There is no substitution for specific input.
• Suppliers’ customers are fragmented, so suppliers’ bargaining power is high.
• The cost of switching from one supplier to another is high.
• There is a possibility that suppliers will consolidate terms to achieve higher prices and profit margins. This threat is particularly high when:

• Purchasing industry is more profitable than supply industry.
• The future of integration brings economies of scale to suppliers, and the ability to eliminate buyers.
• Purchasing industry hinders the development of supply industry (e.g., reluctance to accept new product launches).
• The procurement industry has low barriers to entry.

In such situations, purchasing departments often face high pressure on their suppliers for profits. Relationships with powerful suppliers can reduce the strategic options available to the organization.

2.2. Customer bargaining power

Customer bargaining power is also described as output market: the ability of customers to put pressure on the company.

A customer’s bargaining power is likely to be high when:

• They buy in bulk, concentrating buyers.
• The industry consists of a large number of small businesses.
• Negotiation leverage, especially in industries with high fixed costs.
• The product is not differentiated and can be replaced by similar products.
• Switching to substitute products is relatively simple (availability of existing substitutes).
• Customers are low margin and price sensitive.
• Customers can produce products themselves.
• The product is not of strategic importance to the customer.
• Customers know about the cost of producing the product.

2.3. Threat of potential competitors

The more competition in an industry, the easier it is for other companies to enter the industry. In such a situation, new entrants can change the key factors that determine the market environment (e.g. market share, price, customer loyalty) at any time. There is always a potential pressure for reaction and adjustment on the existing players in the industry.

The threat of new entrants will depend on the level of barriers to entry. These are typically:

• Economies of scale (Refers to the spreading of  b to c database production costs over the number of units produced. The cost of a product per unit decreases as the absolute volume per period increases. This discourages entry by forcing new entrants to enter on a large scale and risk being aggressively countered by existing players, or to enter on a small scale and accept a cost disadvantage).
• High capital requirements and fixed costs.
• Cost advantage of existing entrants due to the experience curve effect of operating with fully depreciated assets.
• Customer brand loyalty.
• Intellectual property is protected by patents, licenses, etc.
• The economics of product differentiation.
• Scarcity of key resources, e.g. qualified professionals.
• Access to raw materials is controlled by existing “players”.
• The distribution channel is controlled by the existing “players”.
• Existing “players” have close customer relationships, e.g. from long-term service contracts.
• High switching costs for customers.
• Government laws and policies.
• Industry profitability (the more profitable an industry is, the more attractive it is to new competitors).

2.4. Threat of substitute products

The threat of substitute products exists if there are lower priced substitute products with better performance specifications for the same purpose. They this marketing database have the potential to capture a significant share of the market and thus reduce the potential sales volume of existing “players”. This category also includes complementary products.

Similar to the threat of new entrants, threats to substitutes are determined by factors such as:

• Customer brand loyalty.
• Close relationship with customers.
• Buyer’s shipping costs.
• Relative price performance of substitute products.
• Number of substitute products available on the market.
• Buyer substitution trends (e.g., increasing mineral water and decreasing soft drinks).

2.5. Threats from competitors in the industry

This factor describes the level of rivalry among existing players (firms) in an industry. High competitive pressure leads to pressure on prices, profit margins and thus affects the profitability of each firm in the industry.

Rivalry among existing competitors can be high when:

• There are many “players” of the same size.
• Competitors have similar strategies.
• There is not much differentiation between competitors and their products so there is a lot of price competition.
• Low market growth rate (growth of a particular company can only be achieved at the expense of competitors).
• The industry has low barriers to entry.
• High exit barriers (e.g. expensive and highly specialized equipment).

3. Benefits of the 5 competitive forces model

Awareness of Michael Porter’s five forces facilitates and benefits companies in understanding industry structure and helps to position themselves more profitably with less risk of attack.

Five Forces analysis can provide valuable information for three aspects of business planning.

3.1. Static analysis

Analyzing the five competitive forces helps determine the attractiveness of an industry. It provides insight into profitability.

Thus, it supports decisions about entering or exiting an industry or a market segment. Furthermore, the model can be used to compare the impact of competitive forces on your own organization with their impact on your competitors.

Competitors may have different options for responding to changes in competitive forces from their different resources and capabilities. This may affect the structure of the entire industry.

3.2. Dynamic analysis

Combined with the PEST Analysis , which shows the drivers of change within an industry, the Five Forces Analysis can reveal insights into the potential future attractiveness of an industry. Expected political, economic, demographic, and technological changes can influence the five competitive forces and thus impact industry structure.

3.3. Analysis of options

With knowledge of the intensity and strength of competitive forces, organizations can develop options to influence them in ways that improve their own competitive position. The result may be a new strategic direction, for example, a new, differentiated positioning for a competing product.

Thus, Michael Porter’s Five Forces model allows for a systematic and structured analysis of the market and competitive landscape. The model can be applied to specific companies, market segments, industries or regions. Therefore, the first step is to define the scope of the market to be analyzed. Next, all the forces relevant to this market are identified and analyzed. Therefore, you do not necessarily have to analyze all the elements of every competitive force in the same depth.

The Five Forces model of competition is based on microeconomics. It takes into account supply and demand, complements and substitutes, the relationship between production volume and production costs, and market structures (such as monopoly, oligopoly, or perfect competition).

4. How to apply Michael Porter’s 5 competitive forces model

4.1. Three basic steps of analysis

Collect data and information 

First, the company must gather industry-related information in applying the five forces to classify that information.

Analyze results and visualize with charts

After gathering all the information, we need to analyze and identify the factors that affect the industry, because there are different factors and issues that affect each industry. This requires not using data from other industries to compare, using data from other industries to “speculate” about our own industry.

Build and strategize based on conclusions

The factors generated from the analysis affecting the industries can be converted into suitable strategies to be applied to improve the company’s benefits.

Companies need to consider the application of Michael Porter’s Five Forces Model as a dynamic and continuous process. This process includes several stages:

• Before applying: Before applying the model, it is important to develop a clear understanding of the analytical framework and objectives. Identify what you want to achieve through the analysis and prepare by collecting relevant data.

• During Application: The analysis must be done with a focus on the industry’s unique characteristics and competitive dynamics. This includes delving into the Five Forces to assess their impact on the company.

• After Application

• : After analysis, the results should not be “static”. The company should periodically review the results and the strategies that were formed based on those results. The business environment is always changing, and strategies may need to be adjusted to adapt to changing circumstances.

In summary, the application of Michael Porter’s Five Forces Model involves a structured approach that begins with data collection, continues with thorough analysis, and ends with the development of customized strategies for the specific industry. This process is ongoing, requiring constant monitoring and adjustment to remain competitive in a changing business environment.

5. Michael Porter’s Competitive Strategy

Michael Porter has outlined three general business-level strategies that can be used to gain competitive advantage over other competitors operating in the same industry, which are cost leadership, differentiation, and focus.

Industry force	Overall strategy
	Cost leadership	Differentiation	Niche market
Threat from potential competitors (new entries)	Ability to reduce costs to create barriers to potential competitors.	Customer loyalty can be a barrier to potential competitors.	Focusing on developing core competencies can act as a barrier to entry.
Customer bargaining power	Ability to offer lower prices to “power buyers”.	Large buyers have less negotiating power because there are few suitable alternatives.	Large buyers have less negotiating power because there are fewer alternatives.
Supplier bargaining power	Less dependent on suppliers.	Ability to pass on supplier price increases to product prices.	Suppliers have power because there are few competitors in the supply market, but a company that focuses on differentiation in a niche market will be able to overcome supplier price increases.
Threat of substitute products	Low prices can be used to counter substitute products.	Customers become attached to distinctive attributes, reducing the threat of substitutes.	Specialized products and core competencies are protected from substitutes.
Threat from competitors	Has better price competitiveness.	Brand loyalty to keep customers from competitors.	Your competitors cannot meet the needs of customers in your niche as well as you can.

Michael Porter’s Grand Strategy

6. Minimize the pressure of the 5 competitive forces

After analyzing the current state and future potential of the five competitive forces, leaders can explore options for influencing these forces to the benefit of the organization. Although industry-specific business models will limit options, individual strategies can change the impact of competitive forces on the organization. The goal is to reduce the strength of competitive pressures.

Some examples are provided below. They are general in nature. Therefore, they must be adapted to the specific situation of each organization. An organization’s choices are determined not only by its external market but also by its internal resources, capabilities, and goals.

6.1. Reduce the bargaining power of suppliers

• Cooperate with suppliers
• Supply Chain Management
• Supply chain training
• Increased Dependence
• Build understanding of supplier costs and methods
• Take over a supplier

6.2. Reduced customer bargaining power

• Cooperate with customers
• Supply Chain Management
• Increase loyalty
• Increase incentives and added value
• Make purchasing decisions that are not based on price
• Eliminate powerful intermediaries (go direct to customers)

6.3. Reducing the threat of new entrants

As the industry shows profitability, it attracts new companies. Therefore, it is forced to improve with long-term business and marketing strategies, creating barriers to entry:

• Increase the minimum effective scale of operations
• Building brand image (loyalty is a barrier)
• Knowledge gained from patents and intellectual property protection
• Access to innovative infrastructure and technology
• Alliance with related products/services
• Links with suppliers
• Links with distributors