The Porter’s Five Forces Model is a unique way of analyzing the competitive landscape of any company. It draws on industrial organization theory to derive five forces that determine the attractiveness and, thus, the competitive intensity of an industry. The framework stipulates that there are five key factors which drive industrial activity: suppliers, customers, executives, infrastructure, and competition. This framework has been adopted by many investment banks as a standard of assessing potential of any industry and has proved to be very helpful. However, it may not be a perfect model and even experts admit that there are still many limitations. Nevertheless, it is considered to be a helpful tool for managers to understand the competitive environment of their firms.
The importance of understanding competitive forces is often highlighted by investors as they try to make money out of the market. They try to capture the share of growing companies by capitalizing on their competitive advantage. It is believed that capturing the share of growing companies in a fast growing sector is a good idea for the investors. However, capturing such share requires a lot of hard work and good strategy, especially for start-ups. Therefore, it is important for managers to understand how they can apply the five forces to their own businesses so that they can take advantage of their competitive advantage and capitalize on the opportunities ahead.
Understanding the five forces first, we come to understand that they deal primarily with the behavior of competitors. The theory says that if you observe a competitor’s behavior, you can forecast his or her next action and use this information to exploit the weakness or strength of the competitors. It also says that there are barriers to profitability and these barriers are artificial in nature. They are imposed by the behavior of competitors and are called barriers of substitution. In other words, what substitutes the existing product in the market. Porter’s framework then suggests that managers should not only think about overcoming competitors’ substitutes but also consider ways of overcoming barriers of substitution.
Understanding the concept of substitution, let us now move on to the second part of the model, which is dealing with the use of potential factors. Potential factors refer to all factors that can change the existing prices and supply of the product. This includes factors like the opening and closing price, demand, availability, quality, geography, incentives, and competition. Potential factors can form the basis for competitive strategies but they cannot be used as a checklist to determine strategies.
One of the main reasons why competitors switch suppliers is because they face barriers of substitution. In cases where suppliers are already established, it becomes difficult for start-ups to compete with them. Start-ups have fewer resources and they usually need to spend a lot of money to enter the market. Therefore, they look for suppliers who can provide them with lower cost raw materials. Since there are a lot of potential factors, it becomes very difficult to identify which ones are relevant and significant. However, it is possible to find out how competitors are moving towards or away from certain industries using the Porter’s five forces model.
Once companies have identified all the factors that affect their business, they can start applying the five forces framework to identify which of them are important to their competitive success. First, companies should examine the direct effect of their competitors’ activities on their business. They should also take into consideration indirect effects of competition on their business, on its business model and its competitors. And finally, they should examine whether the competitors are taking any strategic or tactical actions that could reduce their competitive advantage.
Another important component of the five forces model is the value chain. The value chain refers to the process by which raw materials are acquired, converted into finished goods, marketed and consumed. Thus, the more profitable a commodity is at the beginning of the process, the more profitable it will be at the end of it. Value chains are crucial for competitive success because they help link different parts of the supply chain and identify bottlenecks that hinder profitability. This way, a company can identify the activities that lead to inefficiencies in its business processes. By analyzing these inefficiencies, a company can determine what actions to take to reduce or eliminate them so that it can improve overall profitability.
Finally, a company should also look into whether it needs new entrants to take over market shares. New entrants can either adopt the same five forces approach as the existing players or develop new strategies. In addition, new entrants can also bring with them the innovations and technologies that are essential to the application of five forces in a given industry. To take advantage of this, companies should first analyze the new entrants’ strengths and weaknesses, the quality of their products and services, the competitive position they have established in their respective industries, and other relevant information related to the competition.