What Porters Five Forces are Used For: Business Basics

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If you have graduated or are currently in business school you defiantly have heard the term porters five forces over and over again. Here is the simplest way to understand the 5 forces.


Threat of New Entry

New entrants increase competitive pressure by implementing new production capacity into play and also through actions to gain market share; the seriousness of the threat of entry depends on the barriers to entry and the expected result of existing firms to new entry; barriers to entry exist when it is difficult for newcomers to enter the market and/or a new entrant’s small sales volume put it at a price/cost disadvantage

Threat of Substitutes:

Comes into play when products made by firms in another industry enter the market picture; substitutes can place a ceiling on prices, ceiling prices then can place a lid on the profits industry members can earn, availability of substitute invites customers to make quality, performance, and price comparisons, and lastly it lowers the costs of switching to substitutes

  • Common Barrier to Entry: economies of scale, inability to gain access to technology and specialized know-how, existence of learning and experience curve effects, brand preferences and customer loyalty, capital requirements, access to distribution channels, regulatory policies, and tariffs and international trade restrictions   

Threat of Rivalry:

Usually the most powerful of the five competitive forces. Intensity of rivalry is seen by how vigorously competing sellers try to attract customers on the basis of lower prices, higher quality, performance functions, increased customer service, better warranties and guarantees, smart advertising and promotions, larger or more robust dealer networks and new product innovations.

Threat of Buyers:

They have more bargaining power and leverage and can exert strong competitive advantage when: They are large and purchase a large % of the industry’s product, they buy in volume quantities, they incur lowers costs in switching to competing brands or competing substitutes, they have the flexibility to purchase from many sellers instead of just one, the selling industry’s product is standardized, they can integrate backward, the product being purchased does NOT save the buyer money or else has low value to the buyer

Industry Attractiveness Factors to Consider:

Industry size and growth potential, potential for entry/exit of major firms, stability/dependability of demand, whether competitive forces will become stronger or weaker, severity of problems/issues confronting industry, degree of risk and uncertainty in industry’s future, whether competitive conditions and driving forces are conducive to rising or falling industry profitability