Porter’s Five Force Analysis - Marketing and Management Models

Porter’s Five Force Analysis

Helen Strong

Five Forces: Purpose

This model is one of the most popular management models to be used in strategic planning. It would be applied when the organization is trying to analyze the attractiveness of a market and inherent risks, through understanding which entities hold the power. The model helps to identify competitive threats either through increased competition, price manipulation, or control of resources.

Five Forces: Structure and Description

Essentially the five forces model (Figure 25.1) points your attention to the players in the market, requiring an assessment of their nature and capabilities. The underlying hypothesis is that business operations are a power play, and that the one who holds the controls, or who has the means to prevent other players from either entering or participating, is the one who will succeed.

The model is intended to evaluate the attractiveness of a market for participation and entry. Do bear in mind that it mainly helps you evaluate the macroenvironment. For a full picture of attractiveness, you would also consider conducting a marketing audit^G on the microenvironment to check whether your product is aligned to market needs and preferences.

The graphic below from the Mindtools website raises some of the questions that need to be answered in order to use the model to evaluate the situation and risks associated with your marketplace.

Whilst the model includes the customer or buyers, a lot more emphasis is placed on the environment and factors affecting organizations manufacturing, supplying products, or both, rather than on the target market.

Figure 25.1 Porter’s five forces

Source: Reproduced by permission from Mindtools.com (n.d.).

Five Forces: Strategic Considerations

The model has tipped the scales at the top of the popularity polls since it was first released by Porter in 1979. If it is properly applied, the C-suite team has a comprehensive picture of the trends and risks in the market. Whilst the organizational vision may remain constant, it is possible to adjust the organization’s objectives and strategies to take account of the changing conditions in the market.

Decisions are based on the facts that have been gathered and analyzed. There is a conscious effort to understand the factors behind the trends. This deliberate unraveling and reintegration of the forces in the market enable the team to make decisions with insight into the risks and benefits of being in the chosen markets or segments.

Five Forces: Implementation

Competitive Rivalry

The expected degree of rivalry could be in proportion to the number of consumers in the target market, the number of companies operating in a market, and the ability of those companies to differentiate their products according to the consumer needs and wants; see Market Structures in Chapter 35.

To apply the five forces model and understand the risks faced by your organization, you need to have information about:

• The number of competitors, their structure, and geographical presence
• How the industry functions?
• What are the macrotrends affecting this industry? For example, the green movement
• Legislation and regulations affecting operations
• Understand the quality standards required by the market and how they are matched by you and your competition
• What are the key drivers and success factors in this industry?
• Identify using the Pareto principle the 20 percent of companies doing 80 percent of the business
• Identify their strategies, know their product ranges, and their other marketing mix factors
• Appreciate their research and development activity. How innovative are they?
• Finally, analyze how they are different to you. What markets do they serve? How are their products better than or not as good as yours?
• How strong is their brand? What image do they have?
• What do consumers like about them and their services? And how do you stack up in this assessment?

With this type of information, you are in a position to know which companies need to be on your radar. You will know which can be included or ignored in strengths, weaknesses, opportunities, and threats (SWOT) analyses in the future.

Buyer Power

It is totally possible for buyers to flex their muscles and influence the way in which the market operates. For example, in South Africa for a long time mining houses dictated terms to their suppliers. In the retail sector in South Africa, we have seen the likes of Woolworths and Pick ‘n Pay dictate delivery and pricing terms to their suppliers. To gain a listing, and the associated turnover, suppliers to these buyers go out of their way to meet the terms. In spite of the Competition Commission, these practices are still rife in our economy.

How can buyers gain their power?

First, if a buyer holds an enormous share of purchases, they will exercise a disproportionate influence on what they are prepared to pay. In this way, they protect their margins. They will also delay supplier payment to 90 or 120 days, putting smaller suppliers at risk of going out of business. Often they have a choice as to what they will buy, dictating, in a way what is made available to the final consumers.

When the balance of power could be in the hands of the buyers, you need to factor in lower prices and late payments into the cost. You need to calculate what these practices will do to your margins. The ultimate question is: Can you afford to do business with this type of customer?

Threat of Substitution

In the marketplace, you need to be aware of which products offer similar or better benefits than yours^G. This tied to the user’s buying criteria will inform you of the risk your products face of substitution. Protection can be found in the form of some unique feature of your product that is valued by the consumer. This differentiation is extremely difficult to achieve in view of all the modern manufacturing processes.

Where companies are often caught short is where they do not see the emergence of substitution products or services from what we could call nontraditional sources. For example, retailers now compete with banks for deposits by enabling payment of municipal bills through their tills. It is convenient for customers, but removes a substantial amount of business out of the traditional banking system.

It is hence incumbent on marketers and researchers to keep in touch with trends, to monitor innovation companies and websites. Consumers may express needs that are noticed and taken up by totally different industries. Companies also need to be alert to think out of the box, applying their own products and technologies across industry borders.

Supplier Power

Suppliers of specialist products and custom-made items are in a position to dictate their own terms. There are likely to be only a few who can meet stringent quality specifications, and they will have skilled personnel, advanced technology, or both, which needs to be rewarded.

Where relationships have been built up over time, it is also more difficult to change suppliers. The incumbents know your needs and are comfortable with your systems. Where change is instituted then there are likely to be errors and hitches that people do not want to have to deal with.

To level out the balance of power, a company need to conduct performance reviews at regular intervals so that suppliers’ service quality and levels can be monitored (and not allowed to deteriorate, even if they are preferred suppliers).

Here the researcher needs to know what levels are expected in contracts, and what the consequences are if those standards are not met.

Threat of New Entries

Many industries are protected via entry barriers being prohibitive. To minimize surprises from this factor, companies again need to be aware of trends and events within their industry. Which companies are gaining market share, which are losing, and are these companies likely to exit the market leaving space for another more imposing competitor.

As we mentioned in the section on substitution, new players can emerge from anywhere, so keeping in touch with the broader environment is important to be aware of what is happening throughout the business world, and who is changing strategies or technology or both. Monitor university theses and research projects. Maybe hidden amongst the many submissions is the next threat to your company and its products.

Five Forces: Conclusions

To be attractive, the risks that emerge from the analysis need to be manageable, and profit margins achievable within the parameters set by the organization. Ideally one would want a market where:

1. The threat of substitutes is low, that is, the product offering fulfills a particular need or want and there is a limited choice of alternatives.
2. Competitive activity is at a level that still allows a company to achieve a respectable market share, without having to do too much promotion and discounting to maintain that share.
3. The threat of new entrants is minimal, preferably coupled with a sustainable advantage or differentiation enjoyed by the organization.
4. There are sufficient suppliers of raw materials, equipment, and technology to prevent manipulation of the market price and supply, that is, to give the organization a choice of suppliers.
5. The buyers in a market are not able to organize themselves into pressure groups to influence the price and margins in the product (or function) category.

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