What is the Porter's 5 Forces?
Porter’s 5 Forces is an analysis tool that studies the main factors determining any market in order to help establishing proper strategies.
- Its name comes from its creator: Michael Porter.
These main factors proposed by Porter are 5:
- Entry Barriers.
- Substitute Products.
Porter’s 5 Forces diagram
When should be used?
- Mandatory: when you are entering in a market you don’t know perfectly.
- Highly recommendable: when you are launching a new product-line within an existing market.
- Recommendable: although you were well established within a certain market, you should do a Porter’s 5 Forces once a year in order to check everything has not moved from its previous position.
As you can see, we highly recommend developing this analysis anyway, since it always highlights new aspects you may have not seen in previous analysis or Market changes that may eventually happen.
* In some Markets, an Additional Force is added.
- If you want to know this 6th Force, visit our “Porter 6th Force” Page.
Porter 5 Forces
Now we’ll explain how developing this analysis and which factors Porter recommend us taking into account:
Studying the suppliers is not just listing them. It is analyzing the “force” they have and how would it affect our relations.
Gas Station Example
If you owned a Gas station, your suppliers would be among the largest and more powerful companies in the world: Exxon Mobile or Aramco, for example.
Your “bargaining power” would be zero. So it would be really important to take this into account before making any “number”.
- Bargaining power:
- How difficult would it be to negotiate price variations, contract modifications…
- Number of Suppliers:
- How many available suppliers there are.
- If you had and urgency: would it be easy to find a new supplier?
- Supplier substitution difficulty:
- Would it be easy to substitute your current suppliers?
- Depends highly on your product: if it is a customized product or a “commodity”.
- The Supplier impact in the final product:
- Does the supplier quality impact a lot on the final product or not?
2. Entry Barriers
It consists on answering the question: How difficult would it be for a new company to enter in this Market?
In this section you must study potential new competitors that may want a piece of cake in the future. The more competitive a Market is, the fewer entry Barriers it has.
Energy & Blogging Example
- Blogging Market: Maybe the easiest market to enter.
You just need Internet a host and nothing else. Technically you could become a blogger for free (although it would be difficult to success): zero Entry Barriers.
- Energy Market: The completely opposite situation.
If you wanted to found an Energy company you would need billions of dollars, public investments and government permits.
That is why there are so few energy companies: the Entry Barriers are huge.
Entry Barriers Factors
- Legal requirements:
- If there is any legal issue you may worry about.
- Technological barriers:
- All the technological patents that would make it difficult to success.
- Example: Google’s search algorithm.
- Investment Required:
- Which is the average amount of investment needed to become a Market player.
- Learning Curve:
- Time is usually required for “earning a name”.
- For example: in customization or crafted products.
- Geographical barriers:
- If it is a market strongly marked by its location.
- Example: ski station.
3. Substitutive Products
Usually, companies focus strongly on their current competitor’s product, but forget about new tendencies, new substitutive products are about to come… and fail miserably.
- Think about the example we explained of “Olivetty” in the “PESTEL” unit: They focused on the typewriters but forgot completely about what was about to come: the PCs.
Nowadays, is more important than ever to be always open and updated regarding tendencies, variations in consumption habits and technological innovations.
Instagram and Facebook Example
When Facebook was founded on 2004, nobody had cameras on their mobile phones, so the picture-attachment interface was logically thought for people that went party with their cameras and the next morning prepared and uploaded as many compromising photos as they could.
Only 6 years later, another company was founded: Instagram.
They were born among 5 Megapixel-camera mobile phones with instant access to Internet everywhere. So they built the interface, completely different:
- They saved the tedious task of editing and uploading the photos to the customer.
- Also, you didn’t need your camera any longer with you, just the mobile phone.
The success was immediate
In 2012, Facebook acquired the company for 1 billion dollars, what may have been a good decision in order to guarantee its long-term position.
This example reflects perfectly how should you always be concerned about Market substitutive product, not being just focused on your current competitors since only few years can make the difference.
Substitutive Products Factors
- New technologies:
- If there are new technological improvements in the market.
- Consumption habits’ variations:
- For example: many years ago, the Japanese food started to be a new “healthy” alternative in Western countries.
- New regulations:
- For example: Different government regulations that may benefit other different products.
- Cheaper alternatives:
- If the prices rise due to an overall raw materials prices increase, the customers may choose other cheaper option.
- New versions of the old product:
- Not due to technological improvements but alternative marketing approaches.
The Client analysis is similar to that done before for the Suppliers: It mainly focuses on your Clients’ strength when they purchase.
It is not the same selling a product in retail shops, than in middle-big Industries.
If you had a Smartphone shop, your Clients would have zero bargaining power on your products’ prices.
However, if you distributed Oranges to big logistic companies, they would tell you the price you would charge them. If you didn’t like it, they would found another distributor in 5 minutes.
- Their size:
- It is not the same selling a single client in a retail shop than a huge corporation.
- Their Bargaining power:
- Not always the bigger the client is, the higher its bargaining power is.
- Sometimes, small but strong clients can be difficult to substitute.
- Price sensitivity:
- Whether they would assume an eventual price increase or not.
- Client Substitution difficulty:
- Some products are more customized and hence substituting their Clients is more difficult.
- Their willingness to buy from another supplier (you):
- Sometimes the Clients are used to a certain product that maybe is not technically the best but they are used to it.
- Imagine how difficult would it be to convince a Coke consumer to change Coca-Cola to Fritz-Kola (a German Coke drink).
- Geographical location:
- Depending on their location, it can increase the logistics difficulty.
- Example: sometimes you would rather have a medium profitability close Client than a higher profitability but far away one. In case there is any reclamation, or some meetings are needed, your margins would fall to the ground.
5. Current Competition
This is the first factor everybody looks into before entering in any market, but usually when analyzing the competitors, the conclusions obtained tend to be superficial and sterile.
It is not intended to be a Competitors list with a simple description of what they offer but a deep description of the different strategies within a certain Market, who is using them, etc.
Football Competition Example
Imagine you had to analyze a certain football league (soccer in USA).
You should not just describe the best teams of the moment but how the competition works, which are the main factors determining players’ transfers, how the money is made and many other things.
Of course you would analyze the best teams, as well as the best players, but the analysis should also include other important factors that are commonly forgotten when a Market is analyzed.
- Main competitor companies:
- Their size.
- Their profitability.
- Their market share.
- Their positioning and dominance within the market.
- Main strategies employed:
- Which are the main strategies employed by the competitors.
- Revenues’ streams, monetization, customer support strategies, etc.
- Exit Barriers:
- If there are any “exit barriers” within a market that may dissuade you from entering.
- For example: if you have big and strong Clients, they may have made you guarantee your supply for a long period of time by means of punishable contracts.
- Average market lifetime:
- Is it a market with old companies and stable revenues?
- Is it a Market with an obsolescence period of 6 months just like the high tech sector?
Using a Porter 5 Forces analysis
Of course, these lists shown are open to new and different items depending on the Market you are targeting.
Now; how can we use the conclusions obtained?
Evaluating Market attractiveness
After analyzing a certain Market with a proper 5 Forces analysis, imagine the conclusions obtained were:
- There are big and strong competitors in that Market.
- The opportunities are reduced.
- The Clients are exigent and not willing to try new alternatives.
- The margins are reduced.
- The investment necessary to enter this market is enormous.
If these were the conclusions obtained, you would easily state: we are in front of a “risky market”, not an attractive one.
This is the main purpose of the Porter’s 5 Forces: to establish if a certain Market is an attractive market worth investing into, or a risky “piranha pool”.
Amazon e-commerce market Example
Unless you have lived the last 15 years of your life in the dark side of the Moon, you surely know Amazon and its founder: Jeff Bezos.
- He worked in a hedge fund for years before creating Amazon. He knew “nothing” about books.
- He was not a passionate book seller that luckily was at the right place at the right time.
- He pro-actively analyzed the e-commerce incipient market in the early 90’s and discovered that book-sector was a niche full of opportunities.
- He saw future opportunities within on-line retail Market and particularly in the book sub-Market, and created Amazon without being from the sector.
There is no need to explain deeply what happened after since it is a well-known story: by using Amazon’s excellent position in online retailing he started to grow in all directions almost monopolizing the e-commerce Market.
This real example shows how a proper Market analysis can make you the richest person in the world (with some luck, of course).
Never forget: sometimes is better having a mediocre product in a good Market than a perfect product in the wrong one.
* Check the “Strategy Templates” section: you will find a useful and open Excel Template with a proposed Market Risk analysis based on a Porter 5 Forces study.
A proper market analysis can make the difference between success and failure.
Porter’s 5 Forces analysis is a useful tool that helps when analyzing the different factors determining a Market:
- Entry Barriers
- Substitutive Products.
By deeply analyzing these factors it is possible to evaluate the attractiveness of a certain market and start taking proper decisions.