Knowing who your competition is and how their products, services and marketing strategies affect you is critical to your survival. Whether you are a Fortune 500 company or a small, local business, competition has a direct influence on your success.
One way to analyze your competition – and understand your standing in your industry – is using Porter's Five Forces model. Originally developed by Harvard Business School's Michael E. Porter in 1979, the five forces model looks at five specific factors that determine whether or not a business can be profitable in relation to other businesses in the industry. Using Porter's Five Forces in conjunction with a SWOT analysis will help you understand where your company or business fits in the industry landscape.
Porter's Five Forces is considered a macro tool in business analytics – it looks at the industry's economy as whole, while a SWOT analysis is a microanalytical tool, focusing 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 Harvard Business Review article. "A healthy industry structure should be as much a competitive concern to strategists as their company's own position."
Understanding Porter's Five Forces
Porter theorized that understanding both the competitive forces at play and the overall industry structure are crucial for effective, strategic decision-making, and developing a compelling competitive strategy for the future.
In Porter's model, the five forces that shape industry competition are
1. Competitive rivalry
This force examines how intense the competition is in the marketplace. It considers the number of existing competitors and what each one can do. Rivalry competition is high when there are just a few businesses selling a product or service, when the industry is growing and when consumers can easily switch to a competitor's offering for little cost. When rivalry competition is high, advertising and price wars ensue, which can hurt a business's bottom line.
2. The bargaining power of suppliers
This force analyzes how much power a business's supplier has and how much control it has over the potential to raise its prices, which, in turn, lowers a business's profitability. It also assesses the number of suppliers of raw materials and other resources that are available. The fewer supplier there are, the more power they have. Businesses are in a better position when there are multiple suppliers.
3. The bargaining power of customers
This force examines the power of the consumer, and their effect on pricing and quality. Consumers have power when they are fewer in number but there are plentiful sellers and it's easy for consumers to switch. Conversely, buying power is low when consumers purchase products in small amounts and the seller's product is very different from that of its competitors.
4. The threat of new entrants
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 is of an established business's market share being depleted. Barriers to entry include absolute cost advantages, access to inputs, economies of scale and strong brand identity.
5. The threat of substitute products or services
This force studies how easy it is for consumers to switch from a business's product or service to that of a competitor. It examines the number of competitors, 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 can lower their costs even more. The threat of substitutes is informed by switching costs, both immediate and long-term, as well as consumers' inclination to change.
Example of Porter's Five Forces
There are several 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 impact a business. As an example, stock analysis firm Trefis looked at how Under Armour fits into the athletic footwear and apparel industry.
- Competitive rivalry: Under Armour faces intense competition from Nike, Adidas and 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, hence its product portfolio could be copied in the future.
- Bargaining power of suppliers: A diverse supplier base limits supplier bargaining power. Under Armour's products are produced by dozens of manufacturers based in multiple countries. This provides an advantage to Under Armour by diminishing suppliers' leverage.
- Bargaining power of customers: Under Armour's customers include wholesale customers and end-user customers. Wholesale customers, like Dick's Sporting Goods, hold a certain degree of bargaining leverage, as they could substitute Under Armour's products with those of Under Armour's competitors to gain higher margins. The bargaining power of end-user 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, which 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 to grow. Therefore, this force does not threaten Under Armour in the foreseeable future.
Trefis has completed a similar analysis of Facebook, Nike, Coach and Ralph Lauren. Another example of the application of Porter's Five Forces on a familiar brand is the one recently done by Lawrence Gregory for McDonald's.
Strategies for success
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 need to be significantly better than the competition's, 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 their goods. It requires an intense understanding of the marketplace, its sellers, buyers and competitors. More information about the generic strategies is available in Porter's 1985 book, Competitive Advantage (Free Press).
Alternatives to Porter's Five Forces
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, Yale School of Management professors Adam Brandenburger and Barry Nalebuff created the idea of a sixth force, "complementors," using the tools of game theory.
In Brandenburger's and Nalebuff's model, complementors sell products and services that are best used in conjunction with a product or service from a competitor. Intel, which manufactures processors, and computer manufacturer Apple could be considered complementors.
Additional modeling tools are likely to help round out your understanding of your business and its potential. A value chain analysis helps companies understand where their best productive advantage lies, while the BCG matrix helps companies identify which products are likely to benefit the most from increased investment.
Additional reporting by Katherine Arline and Chad Brooks. Some source interviews were conducted for a previous version of this article.