Knowing who your competitors are and how their products, services and marketing strategies affect you is critical to your business’s survival. Whether you’re a Fortune 500 company or a small, local business, competition has a direct influence on your success.
One way to analyze your competition and determine your industry standing is to use Porter’s Five Forces model. Originally developed by Harvard Business School’s Michael E. Porter in 1979, the Five Forces model looks at five factors that determine whether a business can be profitable in relation to other businesses in the industry.
Using Porter’s Five Forces and other analytics models will help you understand where your company fits in the industry landscape.
Porter’s Five Forces model is a competitive analysis method that’s considered a macro tool in business analytics. It looks at the industry’s economy as a whole; in contrast, a SWOT analysis is a microanalytical tool that focuses on a specific company’s data and analysis.
“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 2008 Harvard Business Review article. “A healthy industry structure should be as much a competitive concern to strategists as their company’s own position.”
Porter theorized that understanding the competitive forces at play and the overall industry structure is crucial for effective, strategic decision-making and the development of a compelling competitive strategy for the future.
Here are the five forces in Porter’s model:
This force examines marketplace competition intensity. It considers the number of existing competitors and what each one can do. Rivalry competition is high when these conditions are met:
When rivalry competition is high, advertising and price wars ensue, which can hurt a business’s bottom line.
This force also assesses the available number of suppliers of raw materials and other resources. The fewer suppliers in the supply chain there are, the more power they have. Businesses are in a better position when there are many suppliers.
This force examines consumer power and its effect on pricing and quality. Consumers have power when there are fewer sellers because they can easily switch to another seller. Conversely, buying power is low when consumers depend heavily on a single seller. When a business has more customers, the buying power of each individual customer is low.
This force considers how easy or difficult it is for competitors to join the marketplace. The easier it is for a new competitor to gain entry, the greater the risk that an established business’s market share will be depleted. Barriers to entry include absolute cost advantages, access to inputs, economies of scale, and strong brand identity.
This force studies how easy it is for consumers to switch from a business’s product or service to a competitor’s offering. It examines the number of competitors, how their prices and quality compare with the business being examined, and how much of a profit those competitors are earning — which, in turn, would determine if they can lower their costs even more. The threat of substitutes is informed by switching costs, both immediately and in the long term, as well as consumers’ inclination to change.
There are many examples of how Porter’s Five Forces can be applied to various industries.
The ultimate goal is to identify the opportunities and threats that could affect a business.
In this example, the financial education company 365 Financial Analyst looked at the competitive position of retail giant Walmart. Here’s how it breaks down:
Walmart’s economic impact on the communities where it opens stores can be both positive and negative. It can serve as an anchor store that drives additional business, but it can also lower wages locally.
Once your analysis is complete, it’s time to implement a strategy to expand your competitive advantage. To that end, Porter identified three generic strategies that can be implemented in any industry and by companies of any size.
Your goal is to increase profits by reducing costs while charging industry-standard prices, or to increase market share by reducing the sales price while retaining profits.
To implement this strategy, your company’s products must be significantly better than the competition’s, thereby improving their competitiveness and value to the public. It requires thorough research and development, plus effective sales and marketing.
Successful implementation entails the company selecting niche markets in which to sell its goods. It requires an intense understanding of the marketplace, as well as deep knowledge of the business’s sellers, buyers and competitors. (Consult Porter’s 1985 book Competitive Advantage for more information.)
While Porter’s Five Forces model is helpful, it’s inherently backward-looking. Consider conducting modeling exercises regularly while accounting for business trends and marketplace shifts to keep models up to date.
While Porter’s Five Forces is an effective and time-tested model, it has been criticized for failing to explain strategic alliances. In the 1990s, professors Adam Brandenburger, then at Harvard Business School and now at New York University’s Stern School of Business, and Barry Nalebuff, of the Yale School of Management, created the idea of a sixth force, “complementors,” using game theory insights. (Consult their book, Co-Opetition, for more information.)
In this model, complementors sell products and services that are best used in conjunction with a competitor’s product or service. For example, Intel, which manufactures processors, and Lenovo, a computer manufacturer, could be considered complementors.
These additional modeling tools can inform your understanding of your business and its potential: