- Cost Transformation
What is it?
Porter's Five Forces of Competitive Position Analysis was developed in 1979 by Michael E Porter of Harvard Business School. It's a simple framework for assessing and evaluating the competitive strength and position of a business organisation.
It promotes the concept that there are five forces which determine the competitive intensity and attractiveness of a market. Porter's Five Forces helps to identify where power lies in a business situation. This is useful both in understanding how strong an organisation's competitive position is currently, and how it can achieve competitive advantage. According to Porter, a business has competitive advantage if, compared with its rivals, it operates at a lower cost, commands a premium price, or both.
Strategic analysts often use Porter's Five Forces to understand whether new products or services are potentially profitable. By understanding where power lies, the theory can also be used to identify areas of strength, to improve weaknesses and to avoid mistakes.
The five forces are:
- Supplier power.
An assessment of how easy it is for suppliers to drive up prices. This is determined by: the number of suppliers for each essential element; the uniqueness of their product or service; the relative size and strength of the supplier; and the cost of switching from one supplier to another.
- Buyer power.
An assessment of how easy it is for buyers to drive prices down. This is determined by: the number of buyers in the market; the importance of each individual buyer to the business; and the cost to the buyer of switching from one supplier to another. If a business has just a few powerful buyers, they are often able to dictate terms.
- Competitive rivalry.
The main driver is the number and capability of competitors in the market. If there are many competitors offering undifferentiated products and services, this will reduce market attractiveness.
- Threat of substitution.
Where close substitute products exist in a market, it increases the likelihood of customers switching to alternatives in response to price increases. This reduces both the power of suppliers and the attractiveness of the market.
- Threat of new entry.
Profitable markets attract new entrants, which in turn reduces profitability. Unless incumbents have strong and durable barriers to entry – for example, patents, economies of scale, capital requirements or government policies – then profitability will decline to a competitive rate.
Arguably, the influence of regulation, taxation and trade policies makes government a sixth force for many industries.
What benefits does Porter's Five Forces analysis provide?
Five Forces analysis helps organisations understand the factors affecting profitability in a specific industry. This can help inform decisions about: whether to enter a specific industry; whether to increase capacity in an industry; and developing competitive strategies.
Implementing Porter's Five Forces analysis? Questions to consider
- Can we define our industry?
- Is our cost structure competitive?
- Does our value chain support a sustainable business model?
- Do we want bigger market share or bigger profits?
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