Porter's 5 forces

What are Porter's 5 forces?

Porter's 5 Forces is a model of analysis of the competitive forces of the market, developed by the eminent and renowned North American economist Michael Porter.

This system became known as a result of the publication of the book Competitive Strategy, on 1980, which raises an analysis of industrial markets and the characteristics of the competitive struggle, in addition to techniques for practical application.

The framework developed by Porter, to assess the attractiveness of a business sector, identifies 5 sources of competitive pressure that determine the profitability of a sector: threat of potential new entrants, threat of substitution, intensity of rivalry between competitors, bargaining power of suppliers and bargaining power of buyers.

The 5 identified forces have a clear influence on costs, prices and investment needs, as they are essential elements in determining the profitability of a sector and its attractiveness. Porter's model identifies some key players (competitors, buyers, suppliers, entries of potential new entrants and substitutes), the interrelationships of these key actors (the 5 forces) and the factors that determine the intensity of these forces.

Porter's 5 forces

The best way to graph the 5 forces of the Porter model is through an image of it:

Potential inputs

The attractive sectors formed by companies that have a striking profitability, act as a hook for many organizations to see these businesses as new and good opportunities. The emergence of new entrants, however, is taken as bad news for companies already established in the sector.

Potential new business entries can take different forms: a new entrant can be a company that didn't exist before; an existing one that diversifies its activities or one that expands its operations to new geographic areas.

Theoretically, any entity could enter or leave a market, however the different sectors protect the companies established in it and seek to inhibit the entry of new rivals by placing entry barriers.

Some of these entry barriers include economies of scale, product differentiation, capital requirements, government policies, and access to distribution channels.

Competitors

Competition between entities that are part of a given sector sets the level of profitability of that sector and the general status of competitiveness.

The intensity of sectoral rivalry between firms can vary significantly from one sector to another, and qualifiers such as "fierce", "intense", "moderate" or "weak" are often used to identify competitive confrontations.

Among some of the factors that must be taken into account for the analysis of this force, the following can be identified:

• Concentration or fragmentation of the sector.
• Market growth.
• High fixed costs.
• Low degree of product differentiation.
• Strategic game.
• Exit barriers, such as specialized assets or socio-political restrictions.

Substitutes

Substitutes are those products from other sectors that can perform the same function as those of the sector under analysis. Substitute products essentially meet the needs of customers, therefore the companies that offer them are potential competitors and have to be seen as a threat to the organizations that make the original product.

The availability of like-minded substitutes can put pressure on a sector to keep prices competitive, thus limiting the profitability of the sector. The impact of substitutes on the profitability of a sector can be influenced by various factors, such as:

• The relative performance of substitutes with respect to price.
• The costs of the change for the buyer.
• The propensity of the buyer to change.

Providers

Companies in a sector buy and sell products and services to suppliers for production, trying to exert their power and influence to obtain better prices, the highest possible quality and the highest level of service, all of which have an impact on the level of profitability of the sector.

Industry providers will be powerful if they:

• They are concentrated, meaning that there are few suppliers with a significant market share.
• They supply vital components for production.
• They supply exclusive or differentiated components, the costs of which to change suppliers would be onerous.
• They pose a credible threat of forward integration.

Buyers

The bargaining power of buyers, that is, customers, will be greater the more organized and cohesive consumers are, which will allow them to demand more and better commercial conditions.

The improvement in supply and demand in the market largely depends on this force, and its influence is not only on sellers, but also on the demand that may exist for the products.

Buyers in a sector will be powerful if:

• They are concentrated, meaning that there are few with a significant market share.
• They buy a significant portion of the supplier's output.
• They buy a standard product, or the costs to switch suppliers are low.
• There is a credible danger of backward integration and they may threaten to buy the supplier company from a rival.

Porter 5 Forces Analysis Example

Below we propose an example within the mobile phone sector, in which Porter's 5 forces are analyzed:

• Potential inputs: In this era of hyper-connection at a global level, the cell phone niche is extremely attractive, and of course the sector is a magnet for a good number of companies to want to position themselves in this market, mainly existing companies that aspire to cover new geographical areas.
• Competitors: here the fight between competitors is very tough, taking place in multiple facets of the business such as prices, advertising, quality and innovation, among others.
• Substitutes: Regarding substitute products, although they exist, since competitive forces are settled in the dynamic area of ​​technology, personal mobile communication teams, at least for the moment, seem to reign.
• Providers: Regarding suppliers, as the technology sector is so dynamic and constantly evolving, it is necessary to be making constant improvements in the products offered so that they are not left behind.
• Buyers: Mobile buyers have significant power of influence, as the number of potential cell phone users and customers is represented by an immense number of millions of people across the globe. In this context, the premise "the customer is right" is applicable in all its dimensions.