Porter's 5 Forces | Sample Business Plan

Porter’s Five Forces


 

Porter’s five forces model is a managerial tool for decision makers to gain a better understanding of, and analyze, the competitive nature of the industry they are competing in, or intend to enter, with long term profitability being the focal point.

 

Porter's 5 Forces are:

1) Threat of New Entrants
2) Threat of Substitutes
3) Bargaining Power of Suppliers
4) Bargaining Power of Buyers
5) Industry Rivalry

 


Threat of New Entrants

 

As implied, this area of analysis evaluates the likelihood of new businesses entering a particular industry. New entrants raise the level of competition, reducing the attractiveness of that industry. One of the primary areas of consideration in this segment is barriers to entry. If an industry has high barriers, then it is difficult to enter, whereas low barriers means it is fairly easy to enter the market. An example of an industry with high barriers is manufacturing jets; this requires expensive equipment, tools, licensing, and highly skilled professionals. An example of an industry with low barriers is establishing a restaurant; this requires minimal investment (in contrast to building jets) and it is a fairly easy market to enter.

 

The following is a list of barriers to market entry:

 

1) Product Differentiation,

2) Economies of Scale,

3) Location Decisions,

4) Vertical Integration

5) Intellectual Property & Patents,

6) Brand Recognition.

7) Governmental Policy,

8) Capital Requirements, and

9) Supplier/Distributor Agreements

 

Threat of Substitutes

 

In this area the threat of substitute products is reviewed. If the industry you are analyzing has a large number of substitutes, then this lowers profit potential as a result of price competition. An example of an industry with numerous substitutes is coffee; i.e. Starbucks, Dunkin Donuts, Bess Eaton, convenience store brands, supermarket store brands, Folgers, etc. While each coffee focuses on a specific target within their respective market, if a Starbucks consumer doesn’t have the money for their coffee, they can go to a convenience store to get the same product (albeit it may not be as tasty).

 

A few areas to review when analyzing threat of substitutes are:

 

1) Switching Costs,

2) Comparable Price and Quality,

3) Buyer Willingness to Substitute, and

4) Price Performance Ratio

 

Bargaining Power of Suppliers

 

In this area you will analyze the businesses that provide the raw materials, or parts of the whole within your production process. If supplier bargaining power is high, this reduces the attractiveness of a particular industry. One way to overcome this particular “obstacle” is to vertically integrate. Vertical integration occurs when a company establishes additional production processes to complete the manufacturing of a product (for example, if Coke buys a bottling plant due to instability, or bargaining power of suppliers, they have vertically integrated by including this as part of their production process).

 

The following are areas of consideration when reviewing bargaining power of suppliers:

 

1) Many Buyers and Few Suppliers,

2) Can Suppliers Forward Integrate (produce the product buyers are making),

3) Supplier Product Differentiation, and

4) Supplier Switching Costs

 

Bargaining Power of Buyers

 

The bargaining power of buyers considers the consumers and companies that establish demand for a product within an industry. As with bargaining power of suppliers, if bargaining power of buyers is high, the industry attractiveness is lowered as a result of reduced profit potential. An example of bargaining power of buyers occurs when analyzing commercial real estate, the supplier is the property owner and the buyers are the retail establishments that rent the space within the facility (such as a mall) and the customers that buy those items. When the market is “bad,” the retailers are at an advantage in regards to bargaining because there is generally more supply (more shopping spaces) and less demand (less businesses starting up, expanding, etc.).

 

Areas to consider when analyzing bargaining power of buyers are as follows:

 

1) Few Buyers and Many Suppliers,

2) Can Suppliers Forward Integrate (produce the product buyers are making),

3) Can Buyers Integrate Backward (produce the product suppliers offer), and

4) Product Standardization

 

Industry Rivalry

 

Competition is the primary factor that contributes to this area of analysis. When there are a lot of companies within an industry, generally there is tremendous competition, which affects the industry attractiveness; conversely, if there are only a few companies competing within an industry, then competition tends to be low.

 

Factors that contribute to industry rivalry are the following:

 

1) The Number of Companies within an Industry,

2) Fixed Costs (high costs generally leads to price cutting to move product),

3) Product Differentiation (many companies with similar products leads to price cutting),

4) Switching Costs (rivalry tends to be higher when buyers can buy alternatives relatively easy),

5) Competitor Diversity,

6) Strategic Stakes (organizational determination to succeed in a particular effort), and

7) High Exit Barriers