Porter 5 Forces - Analysis

Created by Michael Porter, the Porter's 5 Forces is a simple yet powerful tool that models an industry being influenced by five forces which aids in the understanding of where power lies in a business situation. This allows a strategic business manager to take advantage of a situation by using his strengths to create opportunities as well as to know his weaknesses in order to blunt potential threats, avoiding the sticky situation of making a wrong move. Typically used to identify whether new businesses or products have the potential to be profitable, it can also be used to understand the balance of power in order for businesses to re-strategize. Let's take a quick look @ the following video for a brief understanding of the model.

1.) Competitive Rivalry

In a market with perfect competition, profits are driven to zero. However in most instances, competition is far from perfect and firms are not unsophisticated passive price takers. The degree of rivalry can be measured by indicators of industry concentration. High concentration indicates a large proportion of the market share is held by the largest firms, while low concentration translates into a market teeming with many rival firms, none of which holds a significant market share. The degree of rivalry is often influenced by the following characteristics:

- larger number of firms

- slow market growth

- high fixed cost

- highly perishable products

- low levels of product differentiation

- high exit barriers

2.) Threat of Substitution

A product's demand is often closely related to the price change of a substitute (or similar) product. The more substitutes are available, the customers will have more alternatives, subsequently it weakens your power to manipulate the price freely. Take note that substitutes may not necessarily be rival products, for example plastic containers versus glass containers.

3.) Buyer Power

This refers to the consumers' ability to dictate prices, the stronger the buying power, the easier it is for consumer's to dictate prices. Buyers are typically strong when: they are concentrated and/or purchase a significant proportion of the output. And they are weak when: they are fragmented and/or when there is significant buyer switching cost.

4.) Supplier Power

Typically, the fewer supplier choices there are, the more we'll need to rely on them, and the more powerful they are. Suppliers are strong when: suppliers are concentrated and there is significant cost incurred when switching suppliers. They are weak if: there are many competitive suppliers, customers are weak (no power to dictate price) and concentrated buyers.

5.) Barriers to Entry

These are characteristics industries possess to protect their profit levels and prevent new rivals from entering the market as that will corrode their profit margins. There are a few ways in which barriers to entry are created: government creates barriers to regulate industry, patent knowledge serves as restriction for entry into an industry and economies of scale.