Porter's Five Forces Analysis
Porter’s Five Force Analysis
Five forces analysis is a set of ideas, a framework, a tool that states that there are five key competitive forces that serve to minimize the prospects for profitability in a particular industry. It is a method of analyzing the operating environment of competition of a business. It helps managers and analysts understand the competitive landscape that a company faces and to understand how a company is positioned within it.
1.??????Threat of Entry: Threat of entering is simply the threat of a new business entering your industry. Potential new entrants might want the threat to entry barriers to be low and therefore the threat of entry to be high, but those already in the industry want the threat to be low.
What can make threat of entry low?
a)??????High sunk costs: ?Sunk costs is simply the money that has already been spent and cannot be recovered. If the cost of capital is high, it won’t be much of a problem but if the sunk costs are high, potential new entrants might pause a bit. They represent risks to these potential new entrants that if things don’t work out in their attempt to enter the industry, they are going to have difficulty recovering those costs or investments. An example would be an amusement park and buying a roller coaster. If the business doesn’t succeed you can’t recover the capital invested in the business.
b)?????Incumbents have really dominant and competitive advantage:?If new entrants are going to be at a competitive disadvantage, compared to existing players, it just might not be profitable to enter. Things like intellectual property, patents, licenses. If to succeed in an industry requires you need a certain license or IP and someone already has it, it would be had for new entrants. Example would be if the government auctions three 5G licenses. If you want to enter the 5G market you would need to buy from an existing holder, which is almost nearly impossible. Also domineering brands is a competitive advantage. Example would be google being a household name for search. That could scare people who want to enter the search business.
c)??????If the new entrants are going to face serious retaliation from incumbent members of the industry. Example would be the social media industry; clubhouse & twitter spaces, snaps & Instagram stories, tiktok videos & Instagram reels
2.??????Threat of substitutes: Substitutes are products that are similar to other products or services, but not exactly the same. But in the eyes of some consumers or buyers, they might under certain conditions substitute in and out for another. The threat of substitute is taking away your sales.?The threat should be low from the perspective of those in the industry. An example would be blueband butter and golden penny margarine. If the price of butter rises, sales of margarine goes up because most consumers just switch from butter to margarine. Having switching costs can hedge against this threat.
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3.??????Bargaining power of buyers: If we are negotiating over a price for our goods or service in the industry, who gets to wield a little more power in negotiation? Do buyers set the price or sellers do? It’s better for businesses if the bargaining power is lower. Buyers would have less power if they are less concentrated. If you are selling to a variety of buyers, those buyers won’t have as much power. When buyers are many and suppliers are few, it’s called monopoly power (e.g.; cement business). When buyers are many and suppliers are many, you are in the competitive arena (e.g.; pure water and bakery business). When buyers and suppliers are few, it’s called mutual dependence (e.g.; luxury business). When buyers are few and suppliers are many, it’s called monopsony power. The best and worst spot to be in is monopoly and monopsony power, respectively. To hedge this; differentiate your product, carve a niche in an industry, make sure buyers are not concentrated, classify buyers according to segments.
4.??????Bargaining Power of Suppliers: Supplier bargaining power will be lower when sellers are not concentrated. If the sellers are not concentrated. If the sellers are few, they have a much greater ability to set price for the goods or services. If firms have other alternatives, the bargaining power of suppliers will be lower. If suppliers can’t forward integrate into your business, their bargaining power will be low. A typical example will be the PC business where the operating systems are supplied majorly by Microsoft. Microsoft has higher bargaining power, they can increase prices and PC manufacturers can’t do anything.
5.??????Intensity of Rivalry: This is about how intense is the rivalry among competitors in a particular industry. Those in the industry want the intensity to be low.
How can you tell the intensity?
a)??????Number of competitors: The smaller the number the lesser the rivalry. An example would be the cement manufacturing business in Nigeria.
b)?????Opportunities to differentiate in the industry.
So when trying to start a business in a particular industry, use this five forces to analyze how you are going to compete and be profitable in that industry.