How to use Porter’s five forces to understand industry attractiveness

How to use Porter’s five forces to understand industry attractiveness


Let’s say you are doing the marketing plan for a new business and you are evaluating the market segment that you are going to serve. So, how can you do it? Or maybe, you have already a business and you want to expand into another target market. So, how can you audit the profitability of that industry? Today, I’ll show you how to use Porter’s five forces to understand industry attractiveness. Before beginning, do you notice something different from my last video? It’s been a week that I skipped gym, so I had to cut my hair to stay big! Because I seem big, right? We will go through what Porter’s five forces are and we will see how to do a Porter’s five forces analysis. Michael Porter is a professor at Harvard Business School and, in May 1979, Harvard Business review published for the first time his new framework to analyze the attractiveness of an industry. In fact, during an interview for The Academy of Management Excellence, he revealed that: “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”. And actually, his new framework, based on the five forces, is based on statistical test and case studies. His five forces are a tool to evaluate the profitability of an industry or a market. And they are: competitive rivalry, supplier power, buyer power, threat of substitution and threat of new entry. His work was first influenced by Joe Bain, an economist who developed the structure-conduct-performance paradigm, that basically represents a market as a whole of forces interconnected to each other. First of all, the structure-conduct-performance paradigm says that a market environment has a short-term impact on the market structure. One follows the so called “laissez-faire” of Adam Smith, that says that a market shouldn’t have interference or limitations from governments. And the second is the “controlled economy” model of Karl Marx. But in any cases, the market structure affects company’s behavior or conduct. Company’s conduct in turn determines market performance. So, you understand that this is a loop where all elements influence each other. So, let’s start understanding the first force: competitive rivalry. How many rivals do you have? Who are they? And how does the quality of their services or products compare with yours? Studying competitiveness is fundamental for marketers, because they can understand the positioning and develop competitive advantages that can make a difference for the audience. If there are too many competitors or they are too aggressive, you don’t want to enter that industry. Or you have to develop strategies and take marketing actions to overcome them. The second alert point is war price, so before entering that industry, you want to develop strategies to avoid it. Finally, the third alert point is your expectations on market rivalry. The competition is flat or in decline? The second Porter’s force is supplier’s power. How many suppliers do you have? How unique is the product or service that they provide? And how expensive would it be to switch from one provider to another? Supplier’s bargaining power is a real headache for a marketer, because if you have only few suppliers and they start playing with their prices, you have to play their game. Otherwise you can quit your business. For instance, if they decide, for some reasons, to raise their price you have to keep buying from them and the result will negatively impact your final consumer. So, also here you have mainly two alert points. The first is made on purpose for e–commerce. Can they decrease the quantity provided or change the delivery time? Think, if you have an e-commerce and your clients don’t receive the goods right away, you are toast! Above all, nowadays with Amazon Prime and all the super fast delivery services, people want their products as soon as possible. The second alert point is that how much power do they have on the final price? The third force is buyer’s power. So, how many buyers are there? And how big are their orders? How much would it cost them to switch from your product or service 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, we had mainly two clients. Amazon and pharmacies. At a certain point, our clients started buying cheap online from Amazon, because Amazon was able to make better offers. It has lower operational costs than a pharmacy and it has almost the total control on the sales price. Cutting a long story short, pharmacies started threatening us. They didn’t want to buy our products anymore! So, the ball’s on you now marketers. How would you solve this problem if you were me? Amazon, pharmacies, both, how could you solve this strategic problem? Let me know in the comments below. The fourth force is the threat of substitution. A substitution that is cheap or easy to make can weaken your position and threaten your profitability. So, now the tricky question. What is a substitute? marketing and management of Kotler and Keller defines substitutes as products or services that use different technologies to supply the same demand. For instance, a bicycle is the substitute of a motor scooter. Also meat, poultry and fish are substitutes. But Coke and Pepsi are not. They are just competitors. Because they are using the same technology which is soda. Finally, the fifth force: 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? Every company should operate in a profitable industry. But profitable industries will attract new players. Every time that a new organization enters an industry, it decreases the overall profitability and, in an ideal market, this process will continue till profitability reaches zero. In this point, no business has interest in leaving or enter the market. This is called condition of “Perfect competition”. Also for this force, we have two main alert points. The first is low entry barriers. So, you have to pay attention if it is so easy to enter the market. The second is high exit barriers. It means that you have to consider also the possibility that you are not making profits and you want to exit the market. But if you have bought a lot of equipment, maybe a building or machines and stuff, it will be very expensive and you should consider the exit costs in your marketing strategy. Finally, from theory to action. How to do Porter’s five forces analysis. Take a piece of paper or if you are working in remote and using collaborative tools, you can just visualize a cross on the screen otherwise visualize a cross on a piece of paper. Write in the center “Competitive rivalry” and, along the four axis, draw four arrows that point towards the center. Now, write the other four forces on the external vertices of the axis. Place “Threat of new entry” in the North, “Buyer power” in the East, “Supplier power” in the West and “Threat of substitution” in the South. In this way, you can easily understand that all those four forces affect the competitiveness. I know that you are lazy, so I’ve already prepared for you my template! In the description below, I put the link where you can download my Porter’s five forces worksheet. You’ll save time! You should work in a team, because you will have a better result. So, set a timer and start brainstorming the relevant factors of the matrix. Do it individually, without influencing each other and put every input in the right section. Once the time is up, everyone’s input should be on that sheet. Group the ideas and eliminate duplicates. Then, rate ideas according to how much they affect the company. Set a timer. Discuss each idea till everyone is aligned. At the end, use the plus or minus sign to mark moderate forces or use two plus and two minus to point out strong forces. If the force results neutral, just use a zero or an “O”. This is just an example, so you can see how I did Porter’s five forces analysis. Now, your Porter’s five forces analysis is complete. You should take your intel and share it with the relevant stakeholders. The next step, in your marketing strategy, is market segmentation. Now, you should have a nice lookout of the improvements that you need to make profits in your target industry. At this point, I’m very curious. Has your company ever done Porter’s five forces analysis? If not, how can you be sure whether the marketing strategy is right or not? Drop a comment below and share your thoughts with me. If you liked this video, push that like button and subscribe to my channel. Every week, I come up with a digital marketing lesson. Thank you for watching and see you soon!

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