3/3/24
Porter's Five Forces
Author: David Sun
Editor: Kushagra Sadwal
As consumers, we’re constantly presented with options. We choose the search engine we use, the supermarket we buy our groceries from, the brand of clothing we wear, etc. Thus, the success of a company largely comes from its ability to persuade consumers to choose them over other suppliers.
However, it may be difficult to analyze this process within an industry. This is where Porter’s Five Forces comes in. Created by Professor Michael Porter at Harvard Business School, these five factors serve as a framework with which we may analyze competition within an industry. Let’s take a look at each of these forces.
Competitors
Let’s say I open up a lemonade stand in my neighborhood. If someone else decides to open up a lemonade stand, how will that affect my business? What if fifty people open up lemonade stands? As one may expect, it’s much harder to compete with fifty lemonade stands than to compete with one. This idea holds for all industries: it’s more difficult to compete with a lot of competitors than it is to compete with a few.
Another factor that makes the competition between my lemonade stand and the fifty other stands in my neighborhood intense is the fact that there isn’t much we can do to improve our lemonade stands. Perhaps we could offer different flavors or straws, but the quality of the product remains fairly static regardless of what we do. On the contrary, if we were offering twisted balloon animals, this competition would likely be less intense, since the person who can make the best product would have a competitive edge over the others. Competition is less fierce in industries where there is more room to improve.
Bargaining Power of Consumers
Going back to the lemonade stand example, imagine that there was someone who wanted to purchase ten cups of lemonade, but they wanted to have the lemonade immediately. Would it make sense for me to meet their demands, even if it meant allowing them to cut the eight people ahead of them in line? Probably. Customers who make larger purchases can make more demands on businesses.
Another way consumers may influence businesses is through their size. If there were three people at my lemonade stand, each one of them would likely be able to make more specific requests. Someone may ask for less ice or may want to receive the lemonade from the more full pitcher. Since there are only three people in line, I would probably fulfill each request. However, if there were fifty people in line, I may not grant this courtesy. In industries where there are fewer buyers, each buyer has more power.
Threat of Substitutes
Let’s say someone opens a juice stand right next to my lemonade stand. On a hot summer day, people are likely buying lemonade to cool off. So, since juice serves a very similar purpose, consumers will likely be open to purchasing either product, as it is of no cost to them to choose one or the other. Thus, if my competitor makes their juice 10¢ cheaper than my lemonade, their business will likely experience more success than mine. If two products offer similar experiences and there is little cost to the consumer to switch products, substitutes pose a high threat.
Bargaining Power of Suppliers
Suppose that I ran out of lemons to make lemonade at the hottest time of the day. Lemons are 20¢ each at the grocery store, but it takes thirty minutes to drive to the grocery store and I don’t want to miss out on potential sales. Knowing this, my neighbor makes an offer to sell me lemons for 30¢ each, which I accept, even though it lowers the profitability of my lemonade stand. Suppliers have more bargaining power over businesses when it is costly to switch suppliers.
The Threat of New Entrants to the Industry
It’s fairly easy for someone to open a lemonade stand to compete with my business. As a result, I would have to find a way to gain a competitive edge over them, perhaps by lowering costs or increasing the quality of my lemonade. But what if I had a smoothie stand? That would be more difficult to replicate, which would lower the need for me to account for competition. The easier it is for new businesses to enter an industry, the more necessary it is for existing businesses in that industry to account for potential competition.
One other factor that may influence the threat of new players in an industry is customer loyalty. If all my customers know me and get along with me, someone who isn’t well-connected with the neighborhood may have a hard time competing with my lemonade stand, even if their lemonade is slightly cheaper than mine. Customer loyalty may reduce the need for businesses to account for new entrants.
Source:
Porter, Michael. “The Five Forces.” Institute For Strategy And Competitiveness, https://www.isc.hbs.edu/strategy/business-strategy/Pages/the-five-forces.aspx. Accessed 3 March 2024.