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Porter’s Five Forces

What are Porter’s Five Forces?

Porter’s Five Forces Model is a model that identifies and analyzes the five competitive forces that shape each industry and help identify industry weaknesses and strengths. Five Forces analysis is often used to identify industry structures to determine company strategy. The Porter model can be applied to any part of the economy to understand the level of competition within an industry and improve a company’s long-term profitability. The Five Forces Model is named after Harvard Business School professor Michael Porter.

Understanding Potter’s Five Forces

Porter’s Five Forces is a business analysis model that helps explain why different industries maintain different levels of profitability. The model was published in 1980 in Michael E. Porter’s book Competitive Strategy: Analyzing the Technology of the Industry and Competitors.The Five Forces Model is widely used to analyze a company’s industry structure as well as its corporate strategy. Porter identifies five undeniable forces that have played a role in shaping every market and industry in the world, with some caveats. These five forces are often used to measure the competitive intensity, attractiveness and profitability of an industry or market.

Potter’s five powers are:

1. Industry competition

2. Potential for new entrants

3. Powers of Suppliers

4. The power of customers

5. The threat of substitute products

key takeaways

  • Porter’s Five Forces is a framework for analyzing a company’s competitive environment.
  • The number and strength of a company’s competitors, potential new market entrants, suppliers, customers and substitute products affect a company’s profitability.
  • Five Forces Analysis can be used to guide business strategies to increase competitive advantage.

Industry competition

The first of the five forces refers to the number of competitors and their ability to weaken a company. The greater the number of competitors, and the greater the number of equivalent products and services they offer, the less power a company has. If suppliers and buyers can offer better deals or lower prices, they will seek competition from companies. Conversely, when competition is fierce, companies have greater power to charge higher prices and set the terms of deals to achieve higher sales and profits.

Potential for new entrants to enter the industry

The strength of a company is also affected by the power of new entrants to the market. The less time and money it takes for a competitor to enter a company’s market and become an effective competitor, the more likely the incumbent’s position is to be significantly weakened. An industry with strong barriers to entry is ideal for an existing company in the industry, as the company will be able to charge higher prices and negotiate better terms.

The power of suppliers

The next factor in the five forces model is the ease with which suppliers raise input costs. It is influenced by the number of suppliers of key inputs for a good or service, the uniqueness of those inputs, and the cost of a company switching to another supplier. The fewer suppliers an industry has, the more companies rely on suppliers. As a result, suppliers have more power to drive up input costs and drive other trade advantages. On the other hand, when the number of suppliers is large or the cost of switching between competing suppliers is low, companies can reduce input costs and increase profits.

The power of customers

The ability for customers to lower their prices or lower their power levels is one of the five forces. It is influenced by how many buyers or customers the company has, the importance of each customer, and the company’s cost of finding new customers or markets for its products. A smaller, stronger customer base means each customer has more power to negotiate lower prices and better deals. Companies with many smaller, independent customers will be more likely to charge higher prices to increase profitability.

The Five Forces Model can help companies improve profits, but they must continue to pay attention to changes in the Five Forces and adjust their business strategies.

The threat of substitutes

The last of the five forces focuses on the substitute. Substitutes or services that can be used in place of the company’s products or services pose a threat. Companies that produce goods or services for which there are no close substitutes will be better able to raise prices and lock in favorable terms. When there are close substitutes, customers can choose not to buy the company’s product, the company’s power may be weakened.

Understanding Porter’s five forces and how they apply to an industry can allow companies to adjust their business strategies to better utilize their resources to generate higher returns for investors.

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