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Whether for the purpose of examining an industry or determining how a new business would fit in with its competitors, many turn to Porter's Five Forces.
Originally developed by Harvard Business School's Michael E. Porter in 1979, the five forces model is a tool many businesses and companies use to figure out how well they can compete in the current marketplace. The model looks at five specific factors that help determine whether or not a business can be profitable, based on other businesses that are already in their industry.
"Understanding the competitive forces, and their underlying causes, reveals the roots of an industry’s current profitability while providing a framework for anticipating and influencing competition (and profitability) over time," Porter wrote in a Harvard Business Review article. "A healthy industry structure should be as much a competitive concern to strategists as their company’s own position."
According to Porter, industry structure is what drives competition and profitability — not whether an industry produces a product or service, is emerging or mature, high-tech or low-tech, regulated or unregulated.
"If the forces are intense, as they are in such industries as airlines, textiles, and hotels, almost no company earns attractive returns on investment," Porter wrote. "If the forces are benign, as they are in industries such as software, soft drinks, and toiletries, many companies are profitable."
Five forces model
To use this tool, it is critical that businesses understand each of the five forces. Porter's five forces that shape industry competition are:
Threat of new entrants: This force examines how easy or difficult it is for competitors to join the marketplace in the industry being examined. The easier it is for a competitor to join the marketplace, the greater the risk of a businesses market share being depleted.
Bargaining power of supplies: This force analyzes how much power a businesses supplier has and how much control it has over the potential to raise its prices, which in turn would lower a business's profitability. In addition, it looks at the number of suppliers available: the fewer there are, the more power they have. Businesses are in a better position when there are a multitude of suppliers.
Threat of substitute products or services: This force studies how easy it is for consumers to switch from a businesses product or service to that of a competitor. It looks at how many competitors there are, how their prices and quality compare to the business being examined and how much of a profit those competitors are earning, which would determine if they have the ability to lower their costs even more.
Bargaining power of buyers: This force looks at the power of the consumer to affect pricing and quality. Consumers have power when there aren't many of them, but lots of sellers, as well as when it is easy to switch from one businesses products or services to another. Buying power is low when consumers purchase products in small amounts and the seller's product is very different from any of its competitors.
Rivalry among existing competitors: This force examines how intense the competition currently is in the marketplace, which is determined by the number of existing competitors and what each is capable of. Rivalry competition is high when there are just a few businesses equally selling a product or service, when the industry is growing and when consumers can easily switch to a competitors offering for little cost. When rivalry competition is high, advertising and price wars can ensue, which can hurt a business's bottom line.
Example of Porter's Five Forces
There are numerous examples of how Porter's five forces can be applied to various industries online. One analysis is of Under Armour and how it fits into the athletic footwear and apparel industry by the stock-analyzing firm Trefis. Part of the analysis includes:
- Under Armour faces intense competition from the likes of Nike and Adidas, as well as newer players.
- Nike and Adidas, which have considerably larger resources at their disposal, are making a play within the performance apparel market to gain market share in this up and coming product category.
- Under Armour does not hold any fabric or process patents, and hence its product portfolio could be copied in the future.
Bargaining power of suppliers:
- A diverse supplier base limits their bargaining power
- In 2012, Under Armour’s products were produced by 27 manufacturers located across 14 countries. Of these, the top 10 accounted for 49 percent of the products manufactured.
Bargaining power of customers:
- Under Armour’s customers include both wholesale customers as well as end-customers.
- Wholesale customers, like Dick's Sporting Goods and the Sports Authority, hold a certain degree of bargaining leverage, as they could substitute Under Armour's products with other competitors' to gain higher margins.
- Bargaining power of end customers is lower as Under Armour enjoys strong brand recognition.
Threat of new entrants
- Large capital costs are required for branding, advertising and creating product demand, and hence this limits the entry of newer players in the sports apparel market.
- However, existing companies in the sports apparel industry could enter the performance apparel market in the future.
Threat of substitute products
- The demand for performance apparel, sports footwear and accessories is expected to continue, and hence we think this force does not threaten Under Armour in the foreseeable future.
Five forces templates
Businesses looking to complete a five forces analysis can find templates online to guide the process. Template sites include: