Five forces analysis is a tool, used to audit and analyse the marketing environment of a business. This model was formed and popularized by Michael Porter. The tool aids the manager to analyse the forces in the industry which are acting on the business, to develop an edge over rivals.
Three of the forces in the model are reference to competition from external sources, while the remaining two are internal threats. Since the time it was first professed in the year 1979, the concept has been widely used and abused by marketing professionals and practitioners across the world. In 2008, Porter revisited the concept, a video of which you can find below.
According to porter, the following are the five forces acting on a business. A manager should be prudent to study, comprehend and act on changes in any/all of these forces, in order to establish a competitive edge.
- Threat of New Entrants;
- Threat of Substitute Products;
- Bargaining Power of customers;
- Bargaining Power of Suppliers; and
- Intense Rivalry among Existing Competitors
1. Threat of New Entrants
The number of players in the market, determine the strength of each such players. The number of players depends on the the attractiveness of the industry. It again depends on the industries entry/exit barriers. When both entry and exit barriers are high, the margins are high, as new players cannot enter easily, and old players cannot leave easily. The risk is more as non performing players stay and fight it out. When both the barriers are low, the profit margins are very low, as new players keep entering and exiting the business.
Threat of new entrants are high when
- The business is not very capital intensive
- Customers can easily switch (low cost of switching)
- The product is not very differentiated
- Technology is not hard to acquire
- Economies of scale are not present
2. Threat of Substitute ProductsThis is a measure of how easily customers can switch to other products(of competitors). This is an alarming factor when
- The number of substitute products are high
- Substitute products are from a high profit earning company, which can reduce prices to the lowest
- Quality of competitor's products are better
- Customers can easily find such substitutes
3. Bargaining Power of Customers
This is another critical factor which determines profitability. It depends on how much control the buyers have over the market. Buyers have more bargaining power when
- There are too many sellers and too few buyers
- Buyer purchases in bulk quantity
- Product is not differentiated
- Buyers are price sensitive
4. Bargaining Power of SuppliersPowerful suppliers with high bargaining power have a direct bearing on the costs of the business. Suppliers exert higher power when
- The suppliers are concentrated and well organized
- Few substitutes available for supplies
- The product of the supplier is very effective/efficient and unique
- You are not a very important customer to the supplier
5. Intense Rivalry among existing competitorsThe intensity of competition depends on the following factors
- There are a number of small or equal competitors, and less when there is a clear market leader
- Customers have low switching costs
- The industry is growing
- Exit barriers are high, and rivals stay and compete
- Fixed costs are high resulting in huge production and reduction in prices
Source: Harvard business Review.