5 Porter forces

The model of the 5 forces of Porter, constitutes a methodology of analysis to investigate the opportunities and threats in a certain industry. That is, it analyzes the structure of an industry.

The analysis of the 5 forces of Porter investigates if it is profitable to create a company in the industry or sector that we are analyzing. Each of the forces is a factor that influences the ability to obtain benefits. As we analyze below, Porter’s 5 strengths are the intensity of current competition, potential competitors, substitute products, bargaining power of suppliers and bargaining power of clients.

The main objective of the analysis of the industry is to seek opportunities and identify threats for companies already located in that industry or for the entry of new companies, which will determine their capabilities to obtain benefits.

According to this model, the degree of attractiveness of an industry is determined by the action of these five basic competitive forces that, together, define the possibility of obtaining higher returns.

1. The intensity of current competition

It refers to the performance of existing competitors in the industry and is crucial to know if the rivalry is high or low. For this, each of the following points in the industry must be studied:

• The number of competitors and balance among them: concentrated industries (few companies and a large market share) have a lower level of competition, compared to fragmented industries (many companies with a homogeneous market share), with a higher level of competition.
• The rhythm of growth of the industry: there are four phases through which an industry goes through its life – emerging, growing, mature or declining -, as the growth rate increases, thus also the intensity of the competition.
• Mobility barriers: those obstacles that prevent companies from moving from one segment to another within the same industry.
• Barriers of exit: They are factors that prevent the abandonment of an industry.
• Product differentiation: as in an industry there is a greater level of product differentiation (marketing strategy based on creating a perception of the product by the consumer that clearly differentiates it from the competition), the intensity of the competition is reduced.
• The diversity of competitors: when competitors have different strategies, the level of competition is intensified, as it is more difficult to predict their behaviour.

2. Potential competitors

It refers to companies that want to enter to compete in the industry. The more attractive an industry is, the more potential competitors there will be. The possibility that new companies enter to compete in an industry depends on the following factors:

• Barriers to entry: We can define them as those factors that hinder the entry of new companies in the industry.

For example, economies of scale and economies reach a barrier to entry, because the reduction of unit costs as business volume increases, slows the entry of new competitors. Another example may be the disadvantage in costs of another nature, such as the product technology that allows producing that company with lower costs.

• Product differentiation: in this case, established companies can have patents or a portfolio of clients that force new competitors to make large investments to retain new customers.
• Other reasons: for example, financing needs, exchange costs or difficult access to distribution channels.

3. Substitute products

They are defined as those products that meet the same needs of customers as the product offered by the industry. As more substitute products appear in the industry, the degree of attractiveness of the industry begins to decrease.

The threat of the appearance of these products depends on the degree to which they meet the needs of consumers, their price or the costs of switching to these alternative products.

4 and 5. Bargaining power of suppliers and customers

The strength 4 of Porter is the power of negotiation with suppliers and 5, is the power of negotiation with clients, but as the analysis of both forces is very similar, they are often analyzed jointly.

The bargaining power is the ability to impose conditions on the transactions that are made with the companies in the industry. Therefore, as the bargaining power between suppliers and customers is greater, the attractiveness of the industry decreases.

According to Porter, the most important factors that affect bargaining power are the following:

• The degree of concentration in relation to the industry.
• The volume of transactions made with the company.
• The degree of importance of purchases made in relation to customer costs.
• The degree of differentiation of products or services.
• Costs of change of provider.
• Level of benefits of the client in relation to the provider.
• The real threat of vertical integration forward or backwards.
• Importance of the product or service sold.
• The product is or is not storable.
• Level of information that one of the parties has in relation to the other.