Porter’s 5 Forces were first published in 1979 by Michael Porter, a professor of business strategy at Harvard. It is a model used as a strategic analysis tool that allows an entrepreneur to assess the competitive intensity in a market. It aims to precisely define what opportunities and what threats are inherent in the market in which the future company will evolve. How To Bargain Like a Pro?
As its name suggests, it analyzes 5 key elements to determine the viability of an entrepreneurial project:
- Competition in a market
- Bargaining power on the customer side
- Bargaining power on the supplier side
- The threat of new entrants
- The threat of substitute products
Learn more about Porter’s Five Forces Method and how to use each Porter Force for your own business venture.
Why use Porter’s 5 forces model?
Porter’s 5 forces model is a tool that entrepreneurs considering entering a new market may find interesting; whether as part of business creation, or in that of a range extension, the launch of a new product, or a new service.
The five forces method can be used as part of a business, product, or service creation, but it is also an excellent strategic intelligence tool to keep abreast of a market. Indeed, finding new opportunities and detecting potential threats is a job that takes place throughout the life of a company, and not just at the time of its creation.
It may be interesting to resume a Porter analysis in an existing company if the following elements are likely to change:
- New competitors have launched their activity
- A new product comes to compete with the company’s established offer
- The number of suppliers has decreased
How to implement a Porter 5 forces analysis?
To use this strategic tool, it is important to list the five key points of the study and to carry out an in-depth analysis of each of them. 7 ways to increase lead generation on social media
Then, the information gathered can be grouped into a strategy map that the entrepreneur can use to make strategic decisions about their products or services. For example, Porter’s Five Forces analysis can be used to define:
- How to create products or services that offer a competitive advantage over other players: your differentiation strategy
- What levers to activate to settle in new markets
- Which markets are opportunities due to low competition
- What positioning or what specialization to adopt to create a niche within a market
- Which price segment to adopt for your product or service: should cost domination be considered?
Explanation of Porter’s 5 forces step by step
The threat of new entrants
This element refers to new companies that could enter and threaten the current market. To determine the threat of new entrants, it is essential to analyze the barriers to entry into a market. The greater the barriers to entry, the lower the threat of new entrants. Among the barriers to entry, we can note:
- The amount of investment required to enter this market;
- The regulations and legislation in force (licenses, norms and safety standards, approvals, authorization from public authorities, etc.);
- Expertise (patents, R&D, diplomas);
- The size to be reached for the company to become profitable.
The bargaining power of customers
This element aims to shed light on the extent to which customers have the power to influence the prices or terms of sale of a company. Among the elements to take into account to study the bargaining power of customers, it is necessary to look in particular at:
- The number of potential customers
- The customer profile
- Their geographic location
This analysis is highly correlated to supply and demand. If demand is less than supply, customers have great bargaining power; in other words, they can easily look elsewhere. It may therefore be interesting to consider other areas of differentiation, such as technological innovation so as not to find yourself mixed up with the competition, and therefore forced to submit to a price war. What is the difference between tourmaline and rubellite?
The threat of substitute products
Substitute products or services are simply products and services that already exist or are likely to be launched on the market as an alternative to the company’s offer. They are generally innovative products that offer even greater added value than the current market offer.
When evaluating substitute products, it is important to ask the following questions:
- What are the advantages and disadvantages of said substitute products
- How easy is it for a customer to switch providers
- What is the price of substitute products and the price vs. added value of these products
The greater the ratio between the price and the added value of a substitute product, the more likely customers are to opt for this product, and therefore the greater the competitive risk for the company.
To mitigate this risk, it is important to develop its products and services to bring even more added value to customers.
The bargaining power of suppliers
Suppliers can also exert pressure on the company and its services. If competition is non-existent, suppliers have the power to impose their own conditions and negotiate to their advantage. This can have a direct impact on prices and therefore on the profitability of the company.
To assess supplier risk, it is important to ask the following questions:
- How many suppliers are available, and what is their size?
- Are the raw materials sold by suppliers difficult to obtain?
- Is the price of these raw materials likely to experience strong variations for macro-economic reasons?
- What would be the supplier transfer cost?
This element is essential to take into account when the number of suppliers is few and the number of customers is high. In this case, the suppliers can completely dictate the terms of the market.
This part of Porter’s 5 forces model aims to analyze the company’s competition according to several elements. For instance :
- The number of competitors the business has to face
- The size and diversity of competitors
- Market size and growth
In highly competitive markets, the tendency is usually for price wars to stand out from competitors. This can have a significant impact on the company’s margins. To overcome this, the company must opt for a volume activity; and the larger the competitors, the greater the cost dominance can be, as they are able to negotiate better contracts and minimize the cost per unit for their products and/or services. What Is Data Analysis? Methods, Techniques, Types & How To
The limits of Porter’s 5 forces
This tool is excellent for anticipating potential threats and seizing existing opportunities: it allows you to act rather than react to a state of affairs. However, it is sometimes difficult to prioritize the different elements that emerge from Porter’s five forces in order to make effective strategic decisions.
Moreover, Porter’s model only takes into account factors external to the company without analyzing the impact of certain internal key success factors such as a company’s resources or skills, which can really have a decisive impact on the success of a business model.
To overcome these limitations, it may therefore be interesting to combine Porter’s analysis with other strategic analysis tools such as PESTEL analysis and the SWOT matrix, which also takes internal factors into account.
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In summary: Porter’s strengths
Porter’s 5 forces model is an excellent tool for strategic analysis that allows you to study in detail and in a systematic way several market elements. It allows the establishment of a system that provides detailed knowledge of the limits and potential threats before launching a product or service. It is even more effective when used in conjunction with other strategic analysis tools like SWOT. What is Competitive Analysis? How To Do Competitive Analysis? Why is it Important?