Michael E. Porter, a well-known economist and professor at Harvard Business School, came up with Porter’s Five Forces framework in 1979. It is now widely used as a tool for market research and business strategy.
One of the reasons for this is the fact that it can be applied to any sector of the economy.
As an entrepreneur or business leader, understanding Porter’s Five Forces can help you come up with a smart plan for growth that will give you a big edge over your competitors. [Click to tweet]
You can empirically ascertain the potential profitability of your company in relation to the competitive environment of your industry by posing pertinent questions and reviewing the resulting data.
Understanding Porter’s Five Forces
Let us take a look at the five forces and how you can apply this framework to grow your business.
1. Competitive rivalry
Assess the degree of competition in your industry. How many competitors do you have and how powerful are they? Are their products and services quite similar or very different?
Having lots of competitors is not necessarily a bad thing; it shows that the market is viable. However, it could force companies to drive down prices. You may also need to incur huge marketing costs so that you can stand out.
Having a lot of competitors also means that your suppliers and customers have a lot of choices. All of the aforementioned factors are likely to reduce your profit margin.
On the other hand, when you are in an industry with only a few competitors, you have more freedom to set your prices and make a good profit. You can also win significant market share before new entrants arrive. However, having a few players in a space could also mean that demand is low and the market may not survive for long.
2. Buyer power
Buyers are powerful and can exert significant influence on the industry. This becomes even more significant if you only serve a few customers who purchase in large volumes. Their bargaining power can greatly affect the price at which you can sell.
On the other hand, having a large number of customers shifts the power equation in your favor. You can determine your own terms, set your prices, and increase profitability.
What does your customer base look like? Do they have many options to choose from? How easy is it to switch from one seller or service provider to another? Are they looking for the cheapest products or is quality more important to them?
3. Supplier power
To what extent does your business depend on suppliers? How easy is it for you to switch from one supplier to another, and what is the attendant cost? How will it affect your business if your suppliers raise the price of inputs while lowering their quality?
When there are fewer suppliers in your industry, they have more control over your business and, as a result, your profit margin. On the other hand, having more suppliers gives you more options. This could help to reduce your costs and increase your profits.
4. Threat of substitution
What products and services, besides those of your direct competitors, can meet your customers’ needs? If buyers can easily substitute another product or service for yours, your business may not be as profitable as you would like it to be.
For instance, if you work in the entertainment sector and produce stage plays, alternatives include movies, comedy shows, Netflix, YouTube, TV programs, and even online forums like WhatsApp groups.
When figuring out how much of a threat substitution is, it’s important to look outside of your industry. Think about other products and services from different industries that could meet your customers’ needs.
5. New entrants
What does it take for newcomers to have a stake in your industry? If you work in an industry with low overhead costs and don’t need to be an expert, make your product stand out, or follow any special policies, then the entry barrier is low. The threat of new entrants in such an industry is high. Competitors can easily get in and change the business environment.
10 steps to create your growth plan using Porter’s Five Forces
If you are looking to apply Porter’s Five Forces to grow your business, start by thinking through each of the five forces and writing out what you find. Once you have developed lists for each of the five categories, you can then proceed to create your growth plan by taking the following steps.
1. Carry out in-depth research.
2. Examine the information gleaned from your research.
3. Determine the industry’s long-term profit levers. Focus on these fundamentals.
4. Identify patterns and trends that the game-changers in your industry have in common.
5. Figure out where you stand in the industry based on the things you’ve found.
6. Build long-term partnerships with low-cost suppliers.
7. Choose a market segment where you’ll have a greater bargaining advantage over the buyers.
8. Embrace innovation to develop products and services that outperform their competitors in terms of value for money.
9. Keenly monitor the evolution of the industry. The business environment is constantly changing, and so are the five forces.
10. Instead of making small changes to simply help your business survive, think about how you can change direction or start over to take advantage of gaps in the market.
Conclusion
In the words of Michael E. Porter, “The key to growth—even survival—is to stake out a position that is less vulnerable to attack from head-to-head opponents, whether established or new, and less vulnerable to erosion from the direction of buyers, suppliers, and substitute goods. Establishing such a position can take many forms—solidifying relationships with favourable customers, differentiating the product either substantively or psychologically through marketing, integrating forward or backwards, establishing technological leadership.”
Porter’s Five Forces is a powerful framework that offers useful insights to strengthen your position in your industry and reduce your vulnerability to factors that can take you out of business. However, you must recognize that conducting this analysis not a one-off affair; plan to do it regularly. This will enable you to monitor changes in your industry and see how you measure up.