Five Forces Model by Michael Porter

Five Forces model of Michael Porter is a very elaborate concept for evaluating
company's competitive position. Michael Porter provided a framework that models an
industry and therefore implicitly also businesses as being influenced by five
forces. Michael Porter's Five Forces model is often used in strategic planning.

Porter's competitive five forces model is probably one of the most commonly used
business strategy tools and has proven its usefulness in numerous situations. When
exploring strategic management models, you also might want to check out the BCG
matrix, SWOT analysis, IFE matrix, and SPACE matrix models.

Why would I need to use Porter's Five Forces model?

In general, any CEO or a strategic business manager is trying to steer his or her business
in a direction where the business will develop an edge over rival firms. Michael Porter's
model of Five Forces can be used to better understand the industry context in which the
firm operates. Porter's Five Forces model is a strategy tool that is used to analyze
attractiveness of an industry structure.

What is good about Porter's Five Forces model?

Porter has the ability to represent complex concepts in relatively easily accessible
formats. His book about the Five Forces model is written in a very easy and
understandable language. Even though his model is backed up by some complex model,
the model itself is simple and easily comprehensible at all levels.

Porter's Five Forces model provides suggested points under each main heading, by
which you can develop a broad and sophisticated analysis of competitive position. This
can be then used when creating strategy, plans, or making investment decisions
about your business or organization.

Does Porter's Five Forces model really work?

Theoreticians have different view on this. While some agree that Porter's Five Forces
model is the ultimate explanation of how world works, others disagree. It depends in
what time frame we judge the state of the facts. Even Michael Porter himself
acknowledges that time is of essence when it comes to how his forces interact with each
other.

Numerous economic studies have shown that different industries can sustain different
levels of profitability. This can be attributed to differences in industry structures.
What is the basic idea behind Porter's Five Forces model?

Porter's Five Forces model is made up by identification of 5 fundamental competitive

forces:

• Barriers to entry
• Threat of substitutes
• Bargaining power of buyers
• Bargaining power of suppliers
• Rivalry among the existing players

Some later economists also consider government as the sixth force in this model.

When putting all these points together in a graphical representation, we get Porter's Five
Forces model which looks like this:
Force 1: Barriers to entry

Barriers to entry measure how easy or difficult it is for new entrants to enter into the
industry. This can involve for example:

• Cost advantages (economies of scale, economies of scope)

• Access to production inputs and financing,
• Government policies and taxation
• Production cycle and learning curve
• Capital requirements
• Access to distribution channels

Patents, branding, and image also fall into this category.

Force 2: Threat of substitutes

Every top decision makes has to ask: How easy can our product or service be
substituted? The following needs to be analyzed:

• How much does it cost the customer to switch to competing products or services?
• How likely are customers to switch?
• What is the price-performance trade-off of substitutes?

If a product can be easily substituted, then it is a threat to the company because it can
compete with price only.

Force 3: Bargaining power of buyers

Now the question is how strong the position of buyers is. For example, can your
customers work together to order large volumes to squeeze your profit margins? The
following is a list of other examples:

• Buyer volume and concentration

• What information buyers have
• Can buyers corner you in negotiations about price
• How loyal are customers to your brand
• Price sensitivity
• Threat of backward integration
• How well differentiated your product is
• Availability of substitutes

Having a customer that has the leverage to dictate your prices is not a good position.
Force 4: Bargaining power of suppliers

This relates to what your suppliers can do in relationship with you.

• How strong is the position of sellers?

• Are there many or only few potential suppliers?
• Is there a monopoly?
• Do you take inputs from a single supplier or from a group? (concentration)
• How much do you take from each of your suppliers?
• Can you easily switch from one supplier to another one? (switching costs)
• If you switch to another supplier, will it affect the cost and differentiation of your
product?
• Are there other suppliers with the same inputs available? (substitute inputs)

The threat of forward integration is also an important factor here.

Force 5: Rivalry among the existing players

Finally, we have to analyze the level of competition between existing players in the
industry.

• Is one player very dominant or all equal in strength/size?

• Are there exit barriers?
• How fast does the industry grow?
• Does the industry operate at surplus or shortage?
• How is the industry concentrated?
• How do customers identify themselves with your brand?
• Is the product differentiated?
• How well are rivals diversified?

Rivalry is the fifth factor in the Five Forces model but probably the one with the most
attention.

What are the assumptions behind the Five Forces model?

From the risk-return perspective, Five Forces model indirectly implies that risk-adjusted
rates of return should be constant across firms and industries.

How can I analyze my business from inside?

Porter's Five Forces model views the business from outside. It focuses on assessing
competitive position within industry. If you wanted to analyze your firm from within, you
might want to consider the SWOT model. The SWOT model has some aspects of
external view as well but complements Porter's Five Forces model in the internal view.
Another model that you might want to consider is the Balanced Scorecard and IFE/EFE
matrix.

Who is Michael Porter?

Michael Porter is a professor at Harvard Business School and is a leading authority on

competitive strategy and international competitiveness. Michael Porter was born in Ann
Arbor, Michigan.

I like Porter's Five Forces model -- where can I read about it?

Michael Porter published his work in his book called Competitive Strategy:
Techniques for Analyzing Industries and Competitors. This book
has been translated into 19 languages and has been named a best-seller many times.

Michael Porter has been active not only in competitive strategy theories but in other
fields, most notably in health care. Michael Porter's key books include the following:

Competitive Strategy: Techniques for Analyzing Industries

and Competitors, 1980
Competitive Advantage: Creating and Sustaining Superior
Performance, 1985
Competition in Global Industries, 1986
The Competitive Advantage of Nations, 1990

The Five forces of Porter

To perform the Industry Analysis it is better to follow Michael Porter's five forces model.
This analysis framework was created so that it helps managers in their task to analyze
competitive forces to the company. (Hill & Jones 80) This model is only one of the models
that can be used for this task but it is one of the more popular models. The five forces that we
will have to look at for this model are (1) the risk of new and potential competitors; (2) the
bargaining power of suppliers; (3) the threat of substitute products; (4) the bargaining power
of buyers; and (5) the degree of rivalry among established companies within an industry.
(Hill & Jones 80) The first force in Porter's Five Forces Model is Entry Barriers. These
factors are those that make it harder or easier for another company to enter into the industry.
High barriers to entry will keep potential competitors out of the industry and low barriers to
entry will give an opening for competitors to enter into the industry if the industry returns are
high enough. (Hill & Jones 82) The fewer competitors in an industry the more the existing
companies can take advantage of higher prices and better returns.

Hewlett Packard and Compaq, revenues have increased by 107% and 714% respectfully over
the past ten years. When IBM and Apple were the only computer systems to choose from
people had to make a choice. Depending on the program and the equipment in use, word
processors can display documents either in text mode using highlighting, underlining, and
color to represent italics, or boldfacing and other such formatting. There have been several
companies that have entered the notebook computer business by offering custom-built
computers over the Internet. (Hill & Jones 207) This in turn caused IBM to loose their
advantage over new competitors. The forms exchange service translates web data into
standard EDI format and transfers these messages to and from IBM Information Exchange
mailbox. These companies offer that they will make a custom computer to the specifics that
you need. For Apple computer industry it's gross profit has declined form 3. Its Design is to
be used by a single person; a PC is smaller, less expensive and easier to use than other classes
of computers, such as supercomputers, mainframe computers, or workstations.

The Five forces of Porter

To perform the Industry Analysis it is better to follow Michael Porter's five forces model.
This analysis framework was created so that it helps managers in their task to analyze
competitive forces to the company. (Hill & Jones 80) This model is only one of the
models that can be used for this task but it is one of the more popular models. The five
forces that we will have to look at for this model are (1) the risk of new and potential
competitors; (2) the bargaining power of suppliers; (3) the threat of substitute products;
(4) the bargaining power of buyers; and (5) the degree of rivalry among established
companies within an industry. (Hill & Jones 80)

The first force in Porter's Five Forces Model is Entry Barriers. These factors are those
that make it harder or easier for another company to enter into the industry. High barriers
to entry will keep potential competitors out of the industry and low barriers to entry will
give an opening for competitors to enter into the industry if the industry returns are high
enough. (Hill & Jones 82) The fewer competitors in an industry the more the existing
companies can take advantage of higher prices and better returns.

IBM does set some standards for its suppliers however. Once suppliers enter into a
contract with IBM, they must follow specific instructions given to them. These
instructions include document requirements (eg: packaging list, billing invoices, etc.),
packaging and labeling requirements, shipping instructions, and even country of origin
marking (See Appendix A). IBM also has instructions for exports to IBM corporations in
the United States (www.ibm.com).

As we have looked into the Laptop industry we have noticed that IBM's competitors have
somewhat taken market share away from IBM due to an increase in the compatibility
among its products. Whether you want a laptop with mega memory and great graphics or
high power and good Business programs, you must make a choice between many offers
in your laptop selection. Because of the dramatic increases in the laptop market IBM has
seen some declines in sales yet they haven't taken as hard of a hit over the past ten years
as Apple computers have. Because of IBM's high ratings in the computer production
market, their competition has had a battle in itself to make up for losses in sales and
production due to the current success level of IBM. (Research Insight) From our research
we have found that IBM and Apple, who were once the leaders in the computer industries
have taken pretty sharp cutbacks in production and prices to stay in competition with the
rest of their competitors.

The Personal Computer (PC) or desktop, is a machine capable of repetitively and quickly
performing calculations and instructions. Its Design is to be used by a single person; a PC
is smaller, less expensive and easier to use than other classes of computers, such as
supercomputers, mainframe computers, or workstations. However, it usually has less
computational power (www.msn.encarta.com). PC's can most likely be found within
office environments, schools, and homes. Along with typewriters and word processors,
their prices are far less than laptops as well.

Each of these forces in Porter's Five Forces model are all connected in some way. The
stronger each force is the more the industry in which the company is in is competitive.
When an industry is more competitive this leads to lower prices due to price wars and
ultimately lower rate of return. One of the limitations to this way of looking at industry
analysis is that the Five Forces model looks at an industry as a whole instead of each
individual company.

The second of Porter's competitive forces is the bargaining power of suppliers. Suppliers
can become severe threats to any company when the business depends on them for their
products, but the supplier does not depend on the company for business. Suppliers are a
threat when "they are able to force up the price that a company must pay for its inputs or
reduce the quality of inputs they supply, therefore depressing the company's profitability.
If suppliers are weak, this gives a company the opportunity to force down prices and
demand higher input quality" (Hill & Jones, 2001).