Porter's Five Forces Framework is a method for analysing competition of a
business and determine the competitive intensity and, therefore, the
attractiveness of an industry in terms of its profitability. An "unattractive"
industry is one in which the effect of these five forces reduces overall
profitability.
This framework was developed by Michael E. Porter and includes
three forces from 'horizontal' competition, the threat of substitute products or
services, the threat of established rivals, and the threat of new entrants, and
two others from 'vertical' competition, the bargaining power of suppliers and
the bargaining power of customers.
Threat of new entrants:
Profitable industries that yield high returns will consequently attract new
entities. New entrants eventually will decrease profitability for other firms in
the industry. Unless the entry of new firms can be made more difficult,
profitability will fall towards zero. The most attractive markets are the ones
in which entry barriers are high and exit barriers are low; the less time and
money it costs for a competitor to enter a company's market and be an effective
competitor, the more an established company's position could be significantly
weakened.
Threat of substitutes:
Substitute goods or services can be used in place of a company's products or
services and pose a threat to the existing company. Companies that produce goods
or services for which there are no close substitutes will have more power to
increase prices.
Bargaining power of customers:
Defined as the ability of customers to put the firm under pressure and drive
prices low. Consumer’s power is high if they have many alternatives but it
weakens if they only have few choices. A smaller and more powerful client base
means that each customer has more power to negotiate for lower prices and better
deals, on the other hand a company that has many, smaller, independent customers
will have an easier time charging higher prices to increase profitability.
Bargaining power of suppliers:
Similarly to the consumers bargaining power, the fewer suppliers to an industry,
the more a company would depend on a supplier, and as a result, the supplier has
more power and can drive up prices. On the other hand, when there are many
suppliers a company can keep its costs lower and enhance its profits.
Competitive rivalry:
It refers to the number of competitors and it’s the biggest determinant of the
competitiveness of the industry. The larger the number of competitors, along
with the number of equivalent products and services they offer, the lesser the
power of a company. Conversely, when competitive rivalry is low, a company has
greater power to charge higher prices and achieve higher sales and profits.
