How to understand industry profitability with Porter’s five forces

How to understand industry profitability with Porter’s five forces

Updated: May 17

Let’s say you are doing the #MarketingPlan for your new business and need to evaluate and select the market’s segment you want to serve, how can you do it? Or maybe you have an already operating business and want to catch an opportunity by expanding or switching your target market. How can you measure the profitability of this maneuver?


Keep reading to discover how Porter’s five forces help marketers in strategic management.



Table of contents

  1. What Porter’s five forces are;

  2. How to do Porter’s five forces analysis.






WHAT ARE PORTER’S FIVE FORCES




In March 1979, Harvard Business Review published How Competitive Forces Shape Strategy, an issue featured by the professor of Harvard University, Michael E. Porter, who shook up marketers with his new framework for analyzing industry attractiveness.


In 2002, The Academy of Management Executive released An Interview with Michael Porter by Nicholas Argyres and Anita M. McGahan, where the professor claimed to struggle teaching the SWOT analysis model at Harvard Business School: he believed it lacked rigor. That’s why he started seeking a new framework based on statistical tests and case studies:


The prevailing SWOT model of strengths/weaknesses/opportunities/threats was based on the idea that every case is different and that the relevant considerations are company-specific. As I was struggling to teach using the SWOT framework at HBS, I set out to add more rigor.

Portrait of Michael Eugene Porter, a professor at the Harvard Business School (HBS) and author of the Porter's five forces.


The five forces framework

Porter’s five forces is an amazing tool enabling organizations to evaluate the profitability of a market or industry.


It is based on five forces that affect attractiveness: competitive rivalry, supplier power, buyer power, threat of substitution and threat of new entry.


This framework lays on the structure-conduct-performance (SCP) paradigm which considers the market an ecosystem where everything is connected.


This paradigm, first published by Edward Chamberlin and Joan Robinson in 1933, was further developed by Joe S. Bain, an economist who greatly influenced Porter’s work.


Market environment has a direct and short-term impact on the market structure. There are mainly two types of structures: a market without any interference and limitation from governments (Adam Smith’s laissez-faire model) or with the presence of a controlled economy (Karl Marx’s model).


Anyway, a market structure directly affects companies’ economic behavior (conduct) which in turn determines market performance.


All of these elements are interconnected and influence each other.



Competitive rivalry

How many rivals do you have? Who are they and how does the quality of their products and services compare with yours?


Knowing the level of competitiveness in the target industry is fundamental to market a product or service. Studying rivals allow marketers to figure out the right positioning and eventual competitive advantages that can make a difference for the audience.


Alert points:

  • Too many or aggressive competitors;

  • War of price;

  • Market’s competition expectation: is it flat or in decline?



Supplier power

How many potential suppliers do you have? How unique is the product or service that they provide and how expensive would it be to switch from one supplier to another?


Supplier’s bargaining power can become a real headache for a company. If you run short on raw material and only have a few providers, you need to play their game. For instance, if they decide to raise the price, you can’t do anything: you’ll be forced to keep buying from them and review your pricing for the final consumer.


Alert points:

  • They can decrease the quantity provided or change the delivery time (think of an e-commerce with a drop-shipping model: can you imagine how many complaints?);

  • They have power on price.



Buyer power

How many buyers are there and how big are their orders? How much would it cost them to switch from your products and services to those of a rival? Are your buyers strong enough to dictate terms to you?


When I was working as an E-commerce Manager in San Marino, I was in between the devil and the deep blue sea.


Cutting a long story short, we had two main buyers: pharmacies and Amazon. Pharmacies weren’t happy that we were selling to Amazon, because customers started preferring buy cheap online rather than in the physical stores. Amazon was able to make better offers, because it had almost total control on the sales price and lower operational costs than a pharmacy.


What happened next is that pharmacies started threatening us: they didn’t want to buy our products anymore!


So, how would you solve this dilemma?


This is an actual marketing problem for many sellers. Let me know your strategy in the comments below and let’s see if it corresponds with what I really did at that time.



Threat of substitution

A substitution that is easy and cheap to make, can weaken your position and threaten your profitability.


Substitutes are products or services that use different technologies to supply the same demand. For instance, a bicycle is the substitute of a scooter. Also meat, poultry and fish are substitutes. But Coke is not a substitute of Pepsi: they are just competitors.



Threat of new entry

How easy is it to get a foothold in your industry or market? How much would it cost, and how tightly is your sector regulated?


Organizations should establish their presence in a profitable market segment. If they enter into your industry, they can get in the way and decrease the overall profitability till it reaches zero (perfect competition: minimum requirement for an industry to stay in business; companies are not encouraged to enter or leave the industry).


Alert points:

  • Low entry barriers;

  • High exit barriers.




HOW TO DO PORTER’S FIVE FORCES ANALYSIS




From theory to action. Let’s see the steps to perform Porter’s five forces analysis.



Prepare the matrix

Get a piece of paper and visualize a cross. In the center, position the “competitive rivalry” and, along the axis, draw four arrows which point to the center. Place the other forces on the external axis’ vertices. In this way, it’ll be clear that competitiveness is affected by all forces. Place “threat of new entry” to the North, “buyer power” to the East, “supplier power” to the West and “threat of substitution” to the South.


You should get my free Porter’s five forces worksheet here. You’ll save time!


Porter's five forces framework: competitive rivalry, threat of new entry, buyer power, threat of substitution and supplier power.


Brainstorming

Work in a team, set a timer and start brainstorming relevant factors of the matrix. Do it individually and write every input in the right section.



Group ideas

Time’s up. Everyone’s input is on the sheet. Proceed by grouping ideas and eliminating duplicates.



Rate the forces

Rate ideas according to how they affect the company. Set a timer and discuss every idea separately. Once everyone is aligned, use a “+” or “-” to mark moderate forces; use two “++” or ”--” to point out strong forces. If the force results neutral, use an “O”.


Check the example below to see how you can rate Porter’s five forces.



Share results

Time’s up. Last step. Your Porter’s five forces analysis is now complete. Grab your intel and share it with the relevant stakeholders. The next step in your marketing strategy is market segmentation.


Now, you have a lookout of the improvements you need to make profits in the target industry.



Example of Porter’s 5 forces analysis

I’ve prepared for you an example of Porter's 5 forces analysis by reviewing a template of MindTools.


In this example, you want to purchase a farm and decide whether to enter the market or not.


Example of Porter's five forces analysis: buying a farm. The outcome is negative, so purchasing a farm is not profitable unless marketing countermeasures are undertaken.

The outcome of this analysis is negative, but what does it mean? Can’t you enter the farm industry?


Of course not. Porter’s 5 forces analysis highlights the challenges to overcome to become competitive and, in this case, there are plenty leverages that you can develop.


For instance, you can specialize the farm in a niche with more cover from competition or embrace digital marketing and sell directly to customers by dodging big supermarkets.


Just squeeze your brain, solutions are always around the corner.




CONCLUSIONS




Porter’s five forces analysis is a tool that allows entrepreneurs and marketers to get to know the forces that shape competition within a market segment.


Has your company ever done this evaluation? If not, how can you be sure whether the marketing strategy is right? Drop a comment below and share your thoughts with me, it can help other readers like you!



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