Five Forces Analysis

Have you completed an effective Five Forces analysis?
A. No. How many analyses do we have to do?
B. We analysed some aspects of a Five Forces analysis.
C. We have completed a superficial Five Forces analysis.
D. We have completed a detailed and thorough Five Forces analysis.
E. We have completed a detailed, thorough and independently facilitated Five Forces analysis.
[Score:  A=0, B=1, C=2, D=3 and E=4]

Why is this question important?

Porter’s Five Forces Analysis tool is a simple but powerful tool for understanding where the market power axis lies in a business situation. This helps you understand both the strength of your current competitive position, and the strength of a position you’re considering moving into.

It works by looking at the strength of five important forces that affect competition:

  • Supplier Power:   The power of suppliers to drive up the prices.
  • Buyer Power:   The power of customers to drive down prices.
  • Competitive Rivalry:   The strength of competition in the industry.
  • The Threat of Substitution:   The extent to which different products and services can be used in place of your product or service.
  • The Threat of New Entrants:   The ease with which new competitors can enter the market if they see profit opportunities, and then drive down prices.

With a clear understanding of where power lies, you can position your business to take advantage of a condition of strength, improve a condition of weakness, and avoid taking wrong steps.  Thus this makes it an important part of your StrategyPal kit.

Five Forces Analysis assumes that there are five important forces that determine competitive power in a business situation.

Supplier Power.

This is how much pressure suppliers can place on your business.   Here you assess how easy it is for suppliers to drive up prices. This is driven by the number of suppliers of each key input, the uniqueness of their product or service, their strength and control over you, the cost of switching from one to another, and so on.  If one supplier has a large enough impact to affect a company’s margins and volumes, then it holds substantial power.  Here are some reasons that suppliers might have power:

  • There are very few suppliers of a particular product
  • There are no substitutes
  • Switching to another (competitive) product is very costly
  • The product is extremely important to buyers – can’t do without it
  • The supplying industry has a higher profitability than the buying industry

Buyer Power.

How easy it is for buyers / customers to drive prices down?

This is driven by the number of buyers, the importance of each individual buyer to your business, the cost to them of switching from your products and services to those of someone else, etc. If you deal with few, powerful buyers, then they are often able to dictate terms to you.

If one buyer / customer has a large enough impact to affect your margins and volumes, then the customer hold substantial power. Here are a few reasons that customers might have power:

  • Small number of buyers
  • Purchases large volumes
  • Switching to another (competitive) product is simple
  • The product is not extremely important to buyers; they can do without the product for a period of time
  • Customers are price sensitive

Competitive Rivalry

What is important here is the number and capability of your competitors. If you have many competitors, and they offer equally attractive products and services, then you’ll most likely have little power in the situation, because suppliers and buyers will go elsewhere if they don’t get a good deal from you. On the other hand, if no-one else can do what you do, then you can often have tremendous strength.

  • A highly competitive market might result from:
  • Many players of about the same size; there is no dominant firm
  • Little differentiation between competitors’ products and services
  • A mature industry with very little growth; companies can only grow by stealing customers away from competitors

Threat of Substitution.

What is the likelihood that someone will switch to a competitive product or service? If the cost of switching is low, then this poses a serious threat. Here are a few factors that can affect the threat of substitutes:

  • The main issue is the similarity of substitutes.
  • If substitutes are similar, it can be viewed in the same light as a new entrant.

Threat of New Entrants.

Power is also affected by the ability of people to enter your market.  If it costs little in time or money to enter your market and compete effectively, if there are few economies of scale in place, or if you have little protection for your key technologies, then new competitors can quickly enter your market and weaken your position.

The easier it is for new companies to enter the industry, the more price competition there will be. Factors that can limit the threat of new entrants are known as barriers to entry. Some examples include:

  • Existing loyalty to major brands
  • Incentives for using a particular buyer (such as frequent shopper programs)
  • High fixed costs
  • Scarcity of resources
  • High costs of switching companies
  • Government restrictions or legislation

These forces can be represented as follows: