Purpose
If you’re thinking of entering a new market, you need to research it first. You want to know as much as possible about competitiveness, customers, suppliers and rival products.
This is where Michael Porter’s Five Forces can help. They give you a framework to find out just how profitable a market is likely to be.
How To Use Porter’s Five Forces
To establish this profitability, you must apply the Five Forces to an industry at its simplest level. This is the level at which consumers or business buyers are purchasing a product or service.
The first three of the Five Forces are threats:
- Threat of Rivalry. In most areas of business, rivalry determines the strength of competition. You must decide whether you have a competitive advantage thanks to innovation. You must consider what advertising you need to do to promote your product. You must look at the competitive effect of online companies. And you must think about the way rivals may react if you enter the market.
- Threat of New Entrants. You should consider whether other companies would follow you into the market. If they do, you need to judge how their presence may affect profits. You must also look at whether there are ways of discouraging new entrants by using such means as patents and intellectual property rights. If you can enter a market that others may have difficulty joining, you can benefit from higher profits.
- Threat of Substitute Products. Substitute products or services may prompt consumers to abandon what you can offer in favour of something cheaper. You need to analyse what substitutes may become available. You must work out when these substitutes may appear and whether or not they will match the quality of your product.
The other two of the Five Forces relate to competition:
- Bargaining Power of Customers. You need to establish the extent to which customers can determine your selling price. You must also examine customer sensitivity to any change in price.
- Bargaining Power of Suppliers. The suppliers of your essential materials or services can exert power over you. Find out how many suppliers are available, and what they will charge if you switch to them at short notice.
Limitations
The Five Forces provide a framework that doesn’t go into detail about a specific industry. The Five Forces are therefore options rather than confirmed strategy.
This limitation is not particularly important if you use the Five Forces purely for strategy and analysis. This is where their strength lies.
Related Subjects
- Porter’s Generic Strategies. Porter links his Five Forces with three Generic Strategies. They are Cost Leadership, Differentiation Strategy and Segmentation Strategy. These in turn work within two dimensions: strategic strength and strategic scope. The purpose of using the Generic Strategies is to create and maintain commercial advantage.
- Porter’s Value Chain. The Value Chain is a series of activities within a business. As a product passes through each activity it acquires value. This value is the product’s commercial worth. It does not refer to the actual cost of the activities.
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