As a business leader, knowing your industry inside and out is critical to finding ways to dominate the market. Fortunately, there are a few strategies that can help you perform this type of in-depth analysis.
One that is relatively well-known is the SWOT analysis. This acronym stands for strengths, weaknesses, opportunities, and threats – four areas that, when analyzed in greater detail, provide a clearer view of the obstacles faced within a specific market, as well as where companies can stand out.
Another is the PEST analysis, which helps business leaders learn more about the political, economic, sociodemographic, and technological variables within their industry. Sometimes this analysis method is also referred to as the Broad Factors Analysis.
There is also a third analytical method that some business owners use to gain a better understanding of the factors most impactful within their respective markets. It is the Porter’s Five Forces model.
What Porter’s Five Forces Model Is
Developed by Michael Porter, who published this strategy in 1979 in the Harvard Business Review, Porter’s Five Forces is a model designed to provide business owners and managers greater insight into an industry’s strengths and weaknesses.
“This framework was popularized at and by Harvard Business School and subsequently adopted by other business schools,” explains Mac Fadra, CEO of National Stem Cell Centers. Stem cell therapy falls within the regenerative medicine industry, a market that includes therapies for chronic medical conditions such as neurological disorders, diabetes, cancers, and cardiovascular diseases. In 2019, the regenerative medicine market is $21.8 billion according to data collected by BCC Research, with an anticipated CAGR of 20.4 percent.
The way Porter’s model works is by drawing company leaders’ attention to the top five competitive forces that exist within all industries. These forces are:
- Competitive rivalry within the industry – the number of competitors you are actively competing against for business; the more you have, the tougher it is to grow your business
- Threat of new entrants – how difficult or easy it is to gain entry into your particular industry considering factors such as capital and time; if your industry is easy to access by new competitors, the lower your pricing and the more you’ll pay to gain and retain new customers
- Bargaining power of suppliers – whether suppliers can easily inflate the costs of goods, driving up your costs as well; this factor is further impacted by how many supplier options exist and how much it would cost (both in money and time) should you want to make a switch
- Bargaining power of customers – how many customers exist within your market and how much it costs to acquire new ones; the more customers within your industry, the greater their bargaining power, especially if there is nothing that sets your products or services apart from those offered by your competitors
- Threat of substitute products – if there are other products on the market similar to yours, or that solve the same problem in a different way, this poses a threat to your current and future profitability
The Purpose Behind Porter’s Five Forces
The Porter industry analysis model is a traditional and fundamental analytical framework that is generally taught to business school students to lend structure to industry/sector analysis,”
says Fadra. “Porter’s model enables a company to take a strategic and broad look at where it stands vis-a-vis competitors, suppliers, and customers while possibly identifying industry dynamics and sector trends.”
In other words, when you use Porter’s Five Forces to analyze your market, it provides a snapshot image of the most imminent threats existing against your company’s profitability, as well as where you have clear advantages. But it serves other purposes as well.
The framework can also help companies identify threats of vertical integration, price-driven competition, customer trends, barriers to entry, and innovation that could result in product obsolescence, among other threats,”
says Fadra. “It can also form merger/acquisition strategy, whether horizontal or vertical and lay the foundation for strategic planning.”
“More importantly, it enables senior management to assess the company—as well as the industry and market—in a structured manner and support strategy formulation and planning process,” adds Fadra. So, not only is this tool helpful to assess where your company stands today, but it can also provide a path for future growth.
A Practical Example: The Fast Food Industry
To give you a better idea of how these five forces could be used in your market, let’s apply the model to an industry we all know on some level: fast food.
Within the U.S. alone, the ‘quick service restaurant’ industry is an estimated $256 billion. As the name suggests, included in this category is all food establishments that serve patrons quickly but also do not offer at-the-table service.
When considering rivalry within the industry—one of Porter’s Five Forces—the amount of competition is likely to be high since there are approximately 247,000 fast-food establishments in the U.S. Conversely, if you intend to build in an area that has extremely limited quick service options, this may be a strength versus a weakness.
Next, let’s take a look at the threat of new entrants. In other words, how easy is it for individuals or companies to build and grow a new fast food restaurant in your area? The answer to this question will vary depending on a number of factors.
For example, some fast food businesses are regional. In-and-Out Burger is one as you can only buy its famous burgers and fries in five states: Arizona, California, Nevada, Oregon, and Texas. (Though, Taste of Home reports that this chain is planning to open up to 50 new locations in Colorado.) Therefore, if you want to open a burger joint on the East Coast, this chain isn’t likely to be a threat, where others would.
Another factor falling under the threat of new entrants is whether a new competitor could appear by way of franchising. This an essential consideration since 36 percent of fast-food restaurants are franchises. Additionally, the cost of a franchise varies wildly based on the brand, with Franchise Direct reporting that you can open a Subway with as little as $89,550, but if it’s a KFC, individuals must be prepared to spend at least $1.4 million.
What is the bargaining power of suppliers in fast food? If your restaurant is using average, everyday ingredients that you can purchase from virtually any vendor, their bargaining power will be relatively low. On the flip side, if you plan to serve harder-to-find or top-end menu options in your quick service restaurant, their power will rise.
The bargaining power of customers is another of Porter’s Five Forces. Maybe you plan to open a fast-food restaurant that serves southern fried food, for instance. In this case, you’re likely to have a bigger customer base in the south because that’s the people who are used to eating (and therefore crave) this type of food. Not that this type of restaurant wouldn’t be desired in the northern states, but the customer base may be smaller—thus, less powerful—in these areas.
The final factor to consider when using Porter’s Five Forces is the threat of substitute goods. If your food is just like everyone else’s in the area, this threat is high. But if you plan to serve something no one else offers, the threat would probably be fairly low.
Is Porter’s Model Still a Valuable Tool?
One factor that many find valuable today is advancement. In technology, we’re always looking for the latest gadgets, and when it comes to healthcare, we only want the newest, most innovative procedures. So, does this model created way back in 1979 still offer value today? Some business leaders say yes.
My company works in the travel sector,” says Galena Stavreva, CEO of SpareFare.net, “and the Porter’s Five Forces Model is very relevant to the travel industry.”
If you’ve never heard of SpareFare, Stavreva shares that it is “like eBay for travel” in that you can go to this site to purchase flights, hotels, and other vacation-based packages that people have bought but can no longer use.
“Travelers have a huge choice of offers,” says Stavreva, “and, consequently, significant bargaining power. Suppliers, on the other hand, compete on price, and margins in the sector are tight. Generally, barriers to entry are low, and substitutes are plentiful. Therefore, this model helps businesses in the travel sector to evaluate better the risks involved and how they can position themselves among their competitors.”
Stavreva shares that this model is actually a tool that has helped her from day one. “Before starting up, I used the Porter’s Five Forces Model to analyze the competitiveness of the sector and included the analysis in my business plan,” says Stavreva. “I used the model during the initial evaluation stage of the idea, to help me understand better how risky it is and whether we would need to compete on price with other similar businesses.”
Fadra adds that, though Porter’s Five Forces can still be a valuable tool, “the model could use some adjustment and adaptation to today’s digital age.” Advancements that Fadra feels would be helpful no—a whole 40 years after this model was first developed—include making room to analyze “technology trends, product/service positioning, global implications, digital applicability, scale, and other factors.”
“Regardless, it’s a useful starting point for a company in looking at where it is positioned in its industry and what it could possibly explore to survive, grow, and create/sustain competitive advantage,” says Fadra.
Putting Porter’s Five Forces Model into Action in Your Business
If you feel that Porter’s Five Forces is a model that can provide a clearer picture of the threats that exist in your market, which makes it easier to identify your potential strengths and weaknesses, simply go through each of the forces as we did with fast food. Research each one in your market and consider the impact it has on your business.
There are also some online tools and templates available if you need help putting all of your information together in an easy-to-read chart or infographic. A quick search will provide a list of your options.
“Each type of firm needs to identify its unique strengths and the target market and align its strategy to support their identity,” Stavreva says in conclusion. “Distinguishing yourself from the competition is vital.”