To describe a competitive environment in a business sphere specialists use Porter's five forces analysis. Read what it is, its advantages and disadvantages.
Porter’s Five Forces is a fundamental framework that describes the competitive environment. Which competitive environment? Actually, all of them. The basic simplicity of the Five Forces Analysis is what makes it so useful, and why it has become a staple of business and management studies over the past 30 years. If done properly, the Five Forces Analysis can accurately describe any competitive environment at any level.
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What Are the Five Forces?
The visual representation of the Five Forces is most likely familiar to most management students.The degree of competition in a particular market or industry is determined by four primary forces, which are described in relative terms such as strong or weak, or low-medium-high. One thing that may be misleading about the Five Forces framework is that in its familiar form as shown here, it gives the impression that the four forces that affect the intensity of competition act separately when in fact they are all interconnected in sometimes complex ways. In fact, the intensity of competition itself has an effect on the strength of the four forces that define it, which is why the analysis is called the Five Forces.
Defining the Five Forces
The easiest way to understand what each of the Five Forces is describing is to think of them in the simple context of what would make each of them “strong” or “weak”:
||Factors Contributing to Strength
||Factors Contributing to Weakness
|Power of Buyers
- Fewer buyers
- Few buyers who purchase a large part of the firm’s output
- Buyers can easily switch to different product
- Many buyers
- Buyers do not have great influence on product or price
- Buyers cannot easily switch to different product
|Power of Suppliers
- Fewer suppliers
- High cost to change suppliers
- Strength of buyers can increase power of suppliers over distributors
- Product is very common or standardized
- Low cost to change suppliers
- Weak buyers can decrease power of suppliers over distributors
|Threat of Substitutions
- Product is a commodity
- Weak brand loyalty
- Few suppliers
- Product is unique or specialized
- Strong brand loyalty
- Many suppliers
|Threat of New Entrants
- Common technology
- Weak brand strength
- Distribution channels are easily accessible
- Difficult or proprietary technology required
- Strong existing brand identification
- High scale needed
|Intensity of Competition
- High costs to exit the industry or market
- High fixed costs
- Strong brands
- Low exit costs
- Low capital investment or fixed costs
- Weak brands
These factors are simple examples and are certainly not the only ones that play a role, but should illustrate, at least, how the strengths and weaknesses can affect one another.
Application of the Five Forces Analysis
The Five Forces analysis is most often used as a tool for external, i.e., third-party analysis of a competitive environment, which is not surprising as it was developed from a thoroughly academic perspective – Michael Porter first devised the Five Forces analysis during his work at the Harvard Business School in the early 1980’s, and despite his characterizing it as a “strategic management tool”, the methodology has never quite shaken off its textbook charm. In actual practice, the Five Forces analysis is too basic for use as a strategic planning aid for established companies; to put it rather indelicately, if a company is lacking the information a Five Forces analysis provides about its current industry or market, the company probably has more problems than can be solved by the analysis. The Five Forces analysis is, however, a very good assessment to conduct when considering entry into a new market, and is usually included in properly-written business cases.
Shortcomings of the Five Forces Analysis
The most important thing missing from the Five Forces analysis is any sort of internal perspective, which other assessment tools such as the SWOT analysis do take into consideration. That is not necessarily an oversight – Professor Porter’s focus was on the competitive environment, and from that perspective the Five Forces analysis is set in the proper context – but one criticism that has sometimes been raised in the years since it was first developed is that the Five Forces analysis provides only vague and weak links between the external and internal environments. That can be a problem because the internal environment and activities of the firm do have an impact on competitive forces; without the use of a complementary analysis tool, the Five Forces analysis by itself does not identify or assess what that impact may be.
Another potential difficulty in making productive use of the Five Forces analysis is that its conclusions are qualitative; the strength of the various forces can only be described in a relative way, and are subject to interpretation. For example, a relationship between an auto manufacturer and a tire maker that supplies the tires for all the automaker’s new cars could be described in a couple different ways in a Five Forces analysis:
- The power of the buyer (the automaker) could be described as high because it purchases a large part of the tire manufacturer’s output.
- The power of the supplier (the tire maker) could alternatively be described as high, depending on how specialized their tire is.
- The power of both the supplier and buyer could be affected one way or the other by the brand loyalty of consumers to the tire brand or the auto marque.
For the student researcher or market analyst, then, the challenge is to fully investigate the underlying conditions that make a particular force “strong” or “weak”, and justify a conclusion that does not contradict a conclusion about one or more of the other forces. On the other hand, when one of these contradictions cannot be resolved even after a thorough investigation and analysis, it reveals a critical issue for the firm or market in question, and this can be an opportunity – for the academic researcher, it is likely that the problem will be a solid new area for study, and for businesses, it is likely a problem whose solution will give them a strong competitive advantage.
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