What is Porter’s Approach to Industry Analysis?
Every person in business usually does a lot of research and makes a lot of plans before starting a business. One of the most important among such aspects is to conduct an industry analysis. It can provide the entrepreneur with an idea regarding the growth of his products or services and the amount of competition he has to face from others.
Michael Porter’s Five Forces is one such tool which can be used to evaluate the five important factors regarding the growth of the industry. It helps the entrepreneur to get to know about the environment surrounding the industry and the necessary steps to be taken to get success in this market.
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Porter’s Five Forces Analysis
It is important to have firm knowledge regarding the industry before making the investments and Porter’s 5 Forces is the most effective tool for this purpose. The five forces model plays an important role to identify and analyse the primary five competitions in any industry and also provides a clear picture regarding the strengths and the weaknesses of the industry.
This can prove to be a huge difference for someone new in this sector and can help him find his feet. He can use these factors to his advantage so that he can maximise his profit.
Porter’s Five Forces Model Consists of the Following Sections:
1. Power of Supplier
It is the power which lay in the hands of suppliers to increase or decrease the prices of certain commodities. It depends on a large number of factors like the number of suppliers present in the market, the quality of the products and if they stand out from the quality of other suppliers, etc. If the number of suppliers in that particular sector is less, then the power of the suppliers tend to increase. Then the entrepreneur has to take into account the idea of alternative suppliers, but that may be difficult due to budget constraints.
2. Power of Buyer
Buyers love to bargain and are more often successful in reducing the prices of products in the market. It also depends on a large number of factors like the number of buyers, size order, the demand of new products among buyers, prices of other alternative products and quality of the products. If the number of buyers is less, they have more control over the prices.
3. Competition with Others
It is one of the most important factors in the Porter analysis. In the industry market, the number of competitors, as well as their potential, has a major impact. If a newly launched product has a lot of competition, then it might be a problem as the buyers will have a lot of options for purchasing. But this is not the case if there are fewer options in the market.
To get the upper hand in a competitive market, a firm opts for several methods to increase their profit-
Changing the prices according to the competition
Improving the quality of the products to attract more buyers
Innovatively using channels of distribution to grab a new area
Using the relationship with customers to good effect by satisfying their demands
4. Threat of Getting Substituted
Often customers may find an alternative way to fulfil their demands and they no longer have the necessity to buy these products or services. This can prove to be a major threat to the company. More the number of substitute products available in the market, lesser is the demand for the products. The threat of getting substituted can not only cause an impact on the prices of the products but can also raise the question of sustainability in some cases.
5. Threat Due to New Entry
Not only there is the threat of the direct rivals, but there is also the threat of new firms entering into the picture and causing a major craze in the market. This can harm the sales of products and weaken your position in the market. Free entry markets tend to suffer more in such situations and thus the need for a few entry barriers are a necessity to reduce competition with new firms.
Countering the Five Forces
A strategy can be made to counter Porter’s 5 forces model on three levels-
Corporate level
Business unit level
Departmental level
The business unit level acts as an immediate context to industry rivalry. Porter came up with three generic strategies - cost leadership, differentiation and focused on gaining an advantage over the rivals. With the help of a proper generic strategy, firms can enjoy a position where they can use their strengths to good effect and combat against the effects of five competitive forces on them.
FAQs on Porter's Industry Analysis Approach
1. What is Porter's Industry Analysis Approach?
Porter's Industry Analysis, also known as the Five Forces Model, is a framework developed by Michael Porter to evaluate the competitive intensity and, consequently, the attractiveness and long-term profitability of an industry. It helps businesses understand their competitive environment by analysing five key forces that shape every industry and market.
2. What are the five forces in Porter's model of industry analysis?
The five forces that determine the competitive structure of an industry are:
Threat of New Entrants: The likelihood of new companies entering the industry.
Bargaining Power of Buyers: The ability of customers to put the firm under pressure, which also affects the customer's sensitivity to price changes.
Bargaining Power of Suppliers: The ability of suppliers to control the prices of their inputs (like raw materials or services).
Threat of Substitute Products or Services: The extent to which different products or services can be used in place of a company's offerings.
Intensity of Rivalry among Existing Competitors: The degree of competition between existing firms in the industry.
3. What is the main purpose of using Porter's Five Forces analysis in business?
The primary purpose of Porter's Five Forces analysis is to help a business understand its position within its industry's competitive landscape. By identifying the strength and direction of these five forces, a company can develop strategies to increase its competitive advantage, improve profitability, and make informed decisions about entering new markets or launching new products.
4. What factors increase the intensity of rivalry among existing competitors?
The intensity of rivalry in an industry is heightened by several factors, including:
A large number of competitors of similar size.
Slow industry growth, which forces firms to fight for market share.
High exit barriers, making it difficult for companies to leave the industry.
Low product differentiation or low switching costs for customers.
High fixed costs, which push firms to produce at full capacity.
5. Can you provide a real-world example of applying Porter's Five Forces?
Consider the global smartphone industry. The rivalry is intense (Apple, Samsung, Google, etc.). The threat of new entrants is moderate due to high R&D costs and established brand loyalty (high barriers to entry). The bargaining power of buyers is high, as they can easily compare prices and features. The bargaining power of suppliers (like chip manufacturers or OS providers like Google's Android) is high. Finally, the threat of substitutes is low, as there are few true substitutes for a smartphone.
6. How does Porter's Five Forces model differ from a PESTEL analysis?
The key difference lies in their scope. Porter's Five Forces analyses the micro-environment, focusing on the competitive forces within a specific industry. In contrast, PESTEL (Political, Economic, Social, Technological, Environmental, Legal) analysis examines the broader macro-environment, assessing external factors that can impact all industries and businesses operating within a region or market.
7. How does a high threat of substitutes impact a company's strategy?
A high threat of substitutes forces a company to be more competitive in its pricing and innovation. If customers can easily switch to an alternative product or service that fulfils the same need, the company's pricing power is limited. To counter this, a firm might focus on differentiating its product, building strong brand loyalty, or ensuring its product offers superior performance or value compared to the substitutes.
8. What are some common barriers to entry that protect existing firms from new competitors?
Common barriers to entry include:
Economies of scale: Existing large firms have lower per-unit costs that new, smaller entrants cannot match.
Brand loyalty and product differentiation: Established brands have a loyal customer base that is expensive for new firms to capture.
Capital requirements: The high cost of investment needed to enter an industry, such as for machinery or facilities.
Access to distribution channels: Existing firms may have locked up key distribution channels, making it hard for newcomers to get their products to market.
Government policies and regulations: Licensing requirements, patents, and other regulations can restrict entry.
9. What are the main limitations or criticisms of Porter's Five Forces analysis?
While powerful, the model has some limitations. A major criticism is that it presents a static picture of an industry and may not adequately capture the dynamics of fast-changing, technology-driven markets. It also tends to focus on competition rather than collaboration (co-opetition), and it assumes that industry structures are relatively stable, which is not always the case in the modern economy.
10. How is Porter's Five Forces model applied in strategic management?
In strategic management, the model is used as a diagnostic tool. By understanding which of the five forces are most powerful, a management team can craft a strategy that:
Positions the company where the competitive forces are weakest.
Influences the forces to the company's advantage.
Anticipates and prepares for shifts in industry competition.
Identifies opportunities for strategic moves like vertical integration or product differentiation.
