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Porter's Five Forces

 

Disciplines > MarketingUnderstanding Markets > Porter's Five Forces

Rivalry | Customers | Suppliers | Entrants | Substitutes | Discussion | See also

 

 

Porter (1979, 2008) described five forces that act a company within an industry. More generally, this applies to any market. Any industry can contain multiple markets. Markets can also reach across industries.

This model is commonly shown as in the diagram below:

 

 

 

1. Competitive rivalry among existing competitors

When you are selling something, there are others who want to sell something similar to the same customers. This leads to direct competition where multiple suppliers vie for the custom of each potential customer.

Competition can take many forms. In the first instance, it involves trying to persuade potential customers that you have a product that they need and that your offering is better than the other choices that the customer may perceive. The first form of competition is hence at the product level.

Beyond this, you may seek to show your company or brand as being superior in various ways, for example in having generally higher quality or being more stable and available into the future. The opposing brand or company may also be framed as being 'bad' in some way, from their ecological credentials to the reliability of their products. This is competing at the company or brand level.

Competition may hence focus on 'our product', 'their product', 'our brand' or 'their brand' (and usually a combination of all four).

Rivalry and competitive action increases with:

  • Numbers of competitors.
  • Oversupply of products as compared with demand.
  • Sharp increase in capacity.
  • Slow market growth that means business growth comes from stealing market share.
  • Dynamic, creative marketing in many competitors.
  • Emotional commitment to growth and leadership within competitors.
  • A blind commitment to strong competition even when it costs more than it gains.
  • High fixed costs and lower product costs that lead to temptations to cut product price.
  • Products that quickly date or are perishable that may also lead to price-cutting.
  • High exit barriers such as sunk costs that would be lost.
  • Dumping of products at bargain prices and other self-destructive actions.

Mature markets often stabilize into a dynamic equilibrium where, although there is competition, most competitors survive over the long term. To achieve this, tacit oligopolistic tactics may be used, such as price alignment and an avoidance by all of price wars.

2. Bargaining power of customers

Customers are not just passive recipients who pay whatever they are asked. If they think they can achieve it, then they will seek to bargain for a better deal.

Large customers can do this as an individual tactic, pressuring their suppliers into better deals. Customers often have the ultimate sanction of taking their business elsewhere, which gives them significant power.

Smaller customers have less ability to act this way, yet they may still band together into buying groups or may use the services of an aggregate purchaser.

3. Bargaining power of suppliers

Suppliers also may not be completely beholden to the company as they have something that the company needs. Their power is similar to employee power in that their ultimate sanction is withholding or total withdrawal. While few would do this, a degenerated relationship could lead to temptations to do so.

Suppliers are more powerful when:

  • What they supply is unique or difficult to find elsewhere.
  • They have fewer competitors for your custom.
  • You are a relatively minor customer for them.
  • You are unable to cope if you run out of supplied items.
  • They have viable alternatives if you remove your custom.
  • They have few serious competitors for your business.
  • There are high switching costs for you between suppliers.

On the other hand, buyers are more powerful when:

  • They buy in large volumes.
  • The items bought are relatively expensive.
  • Their profits are lower (so they work hard at finding supply).
  • Purchased items are standard and undifferentiated.
  • They use more than one supplier for the same item.
  • They represent a significant part of the supplier's business.
  • They have the capability to produce the items themselves.
  • Suppliers have spare capacity.
  • Quality requirements are high (leading to inspections, etc.)

If you can replace suppliers easily then this reduces their power. However, even if you can find other suppliers, it can take time to get this organized.

When suppliers have limited ability to deliver, for example when raw materials or a key part becomes scarce, then they have to choose which of their customers to supply. This gives them further power is another reason to sustain your relationship with them.

Suppliers may also act as a group, collaborating to get the best for those in their industry. This can be helpful but may also lead to actions that make things more difficult for you.

4. Threat of new entrants

At any time, new direct competitors may enter the market seeking to take customers away from both you and your current competitors.

The likelihood of there being new entrants into the market is affected by factors including:

  • The existence and severity of Barriers to Entry.
  • The market attractiveness, including potential profit or other benefits.
  • New entrants have better economies of scale, newer technology, lower cost structures, existing brand reputation or other differential advantages.
  • Low switching costs for customers to move to new entrants.
  • The lack of investment by current companies in the market.
  • Regulatory changes that give new entrants advantages, including de-regulation.

When a market has been stable for some time, existing market 'competitors' can become lazy and set in their ways. A new entrant may compete in new ways that could be considered 'unfair' even though these are legal and effective.

5. Threat of substitutes

One of the biggest sources of surprise in a marketplace is when a 'competitor' appears with a product so different they are not seen as real competitor until it is too late.

A classic example of this is where the typewriter was substituted by the wordprocessor. At first, the wordprocessor was a very expensive system attached to a big computer and available to only a few, but with the advent of personal computer, the now-established method quickly killed the whole typewriter industry.

Incumbents may well try to fight substitutes with the same technology, but if they lack the whole competence to produce and sell these new products, then they will still fail.

There are two different types of substitute. The full substitute completely replaces the current product, making it redundant (as the wordprocessor did to the typewriter). The partial substitute acts as a new competitor but does not fully replace the original product. A classic example of this is margarine and butter. Butter has retained many customers as it has qualities that margarine does not have. Butter marketing has emphasized this and positioned margarine as a lower-quality substitute.

Substitutes can come from a wide range of products. The critical aspect of a substitute is that it is paid for with the same money that would be used for the item being replaced. Substitutes hence compete for 'share of wallet'. In this way, all beverages may be considered substitutes for one another.

Shifts in the wider marketplace and customer needs can lead to substitutes appearing, for example a 'health' concern leads to fruit juices and bottled water becoming substitutes for colas.

Substitutes are more likely when:

  • Buyers are open to alternative solutions.
  • The substitute offers significant price benefits.
  • Substitutes are seen to offer similar or better features.
  • There are low switching costs for customers.
  • There are other substitutes already available.
  • Customers are dissatisfied with current offerings.
  • It is easy to learn and communicate about substitutes.

As with butter and margarine, substitutes may be of lower quality as long as they are good enough. In particular where price is important, a reduction in quality may be accepted when the reduction in price makes this worthwhile. Other disadvantages may also be acceptable, such as the delays in delivery associated with items source overseas.

Discussion

Porter's model was created of of his doctoral work. Since then it has become a standard framework that is taught at many business schools and on most marketing courses. The main innovations it encompasses is in showing that (a) non-competitors within the current marketplace have power, and (b) there are additional threats beyond the status quo.

Other forces have since been identified, in particular Nalebuff and Brandenburger's complementor. This is a product which does not compete. Instead it supports the company's offerings. Essential complementors are necessary additional products, for example paper is an essential complementor for printers. Non-essential complementors are helpful but not necessary, for example decorative 'skins' for personal devices.

See also

Market Players, Barriers to Entry

 

Nalebuff, B.J. and Brandenburger, A.M. (1996). Co-opetition, Doubleday Business

Porter, M.E. (1979). How Competitive Forces Shape Strategy, Harvard Business Review, Mar-Apr 1979

Porter, M.E. (2008). The Five Competitive Forces That Shape Strategy, Harvard Business Review, Jan 2008

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