The Five Forces – Michael Porter

Harvard Business School professor Michael Porter created one of the most famous models in business strategy with the Five Forces Industry Analysis which explains why some industries of much more profitable than others.

What Is Industry Analysis

Industry analysis is a structured process for reviewing the profitability of your industry at the moment and in the future to help you position your business in the most advantageous way.

Industry analysis explains why one industry is very profitable and all the competitors make good money while another industry has much lower profit and many businesses operate on a marginal basis.

I will use industry analysis and market analysis as the same basic concept so that there is some variety in the words I use. Strictly speaking, industry analysis looks from the supply side while market analysis looks from the demand side.

So you have the airline industry and the market for air travel.

Why is Industry Analysis Important?

There are only three alternatives:

  • You are thinking about starting a business in a particular industry.Industry analysis asks “Is this a sensible market for us to enter? Is this market a source of superior profits?”
  • You already have a business in an industry and you are committed to it.Industry analysis asks “How can we make sure that we perform better than our competitors?”
  • You have a business but you are considering selling it, either because it is struggling or because it is very successful and you will be paid a great price.In the disposal situation, industry analysis asks “How are the future prospects of the industry likely to be affected and how does that affect my decision to sell.?”

So industry analysis helps you to move from having a “gut feel” about the prospects for the market to having scenarios that you can explain to others and seek their feedback.

It is for the big strategic questions and not for the smaller tactical decisions that many businesses spend their time focusing on.

There Are Only Two Reasons For Superior Profits

Either :

  • You have a business which is in an attractive industry or
  • You have a competitive advantage which means that you can capture the majority of profits made in your immediate market.Some industries are very fragmented and localised.One shop for example may be in a city where there is no competition while an identical shop in a city 100 miles away, may have two hot competitors which severely ration profits available.

Michael Porter argues that the Five Forces model identifies the key factors which determine the average profitability of an industry.

Michael Porter Five Forces Model

The five forces are:

1. The threat of new entrants

2. The bargaining power of customers

3. The bargaining power of suppliers

4. The threat of substitutes

5. The rivalry among existing firms.

How The Five Forces Model Works

Customers, suppliers and competitors compete for value created by the industry which is limited by substitutes or alternative solutions to the underlying customer need.

The ideal industry is one where both suppliers and customers are weak, any new companies would find it very difficult to enter the market effectively and competitors focus on enlarging the total industry profits rather than competing away profits unnecessarily through crazy pricing because there are no viable substitutes.

When Is The Five Forces Model Most Effective

The Five Forces model often gives more insight when you are considering entering a new market than for small businesses already firmly entrenched in existing markets.

This is because it helps to identify the threats to making superior profits.

This problem of putting the Five Forces model to work has led to people struggling to gain much insight about what to do next in their current markets.

The options are limited:

  • Can the business influence the five forces? Most small businesses can’t.
  • Can the business protect itself from any damaging forces or take advantage of opportunities that come from favourable changes?
  • Can the business move to into an area of the market where the forces are less of an issue?
  • Should the business exit this market and move its attention and resources elsewhere?

Any business that has a significant position in its market should periodically work through the five forces model and see what new insights it brings.

Industry Evolution Is Monitored By The Five Forces Model

All industries and local economies are constantly evolving.

Michael Porter’s Five Forces model is a proven technique for analysing industries and markets so that you identify threats and opportunities early.

Without a framework like the Five Forces Model, it is very difficult to identify all the issues that are changing.

I will be looking at the threat of new entrants, buyer and supplier power, substitutes and competitive rivalry in more detail.

First let’s hear from Michael Porter himself.

More details on:
Buyer Power & Supplier Power
Threat Of New Entrants
Threat Of Substitutes
Rivalry Between Competitors

Return to P3M3 The Attractiveness Of Your Industry

Twitter Digg Delicious Stumbleupon Technorati Facebook Email

No comments yet... Be the first to leave a reply!

Leave a Reply