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How Porter's Five Forces Can Help

Small Businesses Analyze the

Competition

Marci Martin

Business News Daily Contributing Writer

Dec 03, 2019

Porter's Five Forces offer businesses a way to analyzePorter's Five Forces offer businesses a way to analyze

and outmaneuver their competitors in theand outmaneuver their competitors in the

marketplace.marketplace.

Knowing who your competition is and how their products, services and

marketing strategies affect you is critical to your survival. Whether you are a

Fortune 500 company or a small, local business, competition has a direct

influence on your success.

One way to analyze your competition – and understand your standing in your

industry – is using Porter's Five Forces model. Originally developed by

Harvard Business School's Michael E. Porter in 1979, the five forces model

looks at five specific factors that determine whether or not a business can

be profitable in relation to other businesses in the industry. Using Porter's Five

Forces in conjunction with a SWOT analysis will help you understand where

your company or business fits in the industry landscape.

Porter's Five Forces is considered a macro tool in business analytics – it looks

at the industry's economy as whole, while a SWOT analysis is a

microanalytical tool, focusing on a specific company's data and analysis.

"Understanding the competitive forces, and their underlying causes, reveals

the roots of an industry's current profitability while providing a framework for

anticipating and influencing competition (and profitability) over time," Porter

wrote in a Harvard Business Review article. "A healthy industry structure

should be as much a competitive concern to strategists as their company's

own position."

Understanding Porter's Five Forces

Porter theorized that understanding both the competitive forces at play and

the overall industry structure are crucial for effective, strategic decision-

making, and developing a compelling competitive strategy for the future.

In Porter's model, the five forces that shape industry competition are

1. Competitive rivalry

This force examines how intense the competition is in the marketplace. It

considers the number of existing competitors and what each one can do.

Rivalry competition is high when there are just a few businesses selling a

product or service, when the industry is growing and when consumers can

easily switch to a competitor's offering for little cost. When rivalry

competition is high, advertising and price wars ensue, which can hurt a

business's bottom line.

2. The bargaining power of suppliers

This force analyzes how much power a business's supplier has and how much

control it has over the potential to raise its prices, which, in turn, lowers a

business's profitability. It also assesses the number of suppliers of raw

materials and other resources that are available. The fewer supplier there

are, the more power they have. Businesses are in a better position when

there are multiple suppliers.

3. The bargaining power of customers

This force examines the power of the consumer, and their effect on pricing

and quality. Consumers have power when they are fewer in number but there

are plentiful sellers and it's easy for consumers to switch. Conversely, buying

power is low when consumers purchase products in small amounts and the

seller's product is very different from that of its competitors.

4. The threat of new entrants

This force considers how easy or difficult it is for competitors to join the

marketplace. The easier it is for a new competitor to gain entry, the greater

the risk is of an established business's market share being depleted. Barriers

to entry include absolute cost advantages, access to inputs, economies of

scale and strong brand identity.

5. The threat of substitute products or services

This force studies how easy it is for consumers to switch from a business's

product or service to that of a competitor. It examines the number of

competitors, how their prices and quality compare to the business being

examined, and how much of a profit those competitors are earning, which

would determine if they can lower their costs even more. The threat of

substitutes is informed by switching costs, both immediate and long-term, as

well as consumers' inclination to change.

Example of Porter's Five Forces

There are several examples of how Porter's Five Forces can be applied to

various industries. The ultimate goal is to identify the opportunities and

threats that could impact a business. As an example, stock analysis firm

Trefis looked at how Under Armour fits into the athletic footwear and apparel

industry.

Competitive rivalry: Competitive rivalry: Under Armour faces intense competition from

Nike, Adidas and newer players. Nike and Adidas, which have

considerably larger resources at their disposal, are making a play within

the performance apparel market to gain market share in this up-and-

coming product category. Under Armour does not hold any fabric or

process patents, hence its product portfolio could be copied in the

future.

Bargaining power of suppliers: Bargaining power of suppliers: A diverse supplier base limits supplier

bargaining power. Under Armour's products are produced by dozens of

manufacturers based in multiple countries. This provides an advantage

to Under Armour by diminishing suppliers' leverage.

Bargaining power of customers: Bargaining power of customers: Under Armour's customers include

wholesale customers and end-user customers. Wholesale customers,

like Dick's Sporting Goods, hold a certain degree of bargaining leverage,

as they could substitute Under Armour's products with those of Under

Armour's competitors to gain higher margins. The bargaining power of

end-user customers is lower as Under Armour enjoys strong brand

recognition.

Threat of new entrants: Threat of new entrants: Large capital costs are required for branding,

advertising and creating product demand, which limits the entry of

newer players in the sports apparel market. However, existing

companies in the sports apparel industry could enter the performance

apparel market in the future.

Threat of substitute products: Threat of substitute products: The demand for performance

apparel, sports footwear and accessories is expected to continue to

grow. Therefore, this force does not threaten Under Armour in

the foreseeable future.

Trefis has completed a similar analysis of Facebook, Nike, Coach and Ralph

Lauren. Another example of the application of Porter's Five Forces on a

familiar brand is the one recently done by Lawrence Gregory for McDonald's.

Strategies for success

Once your analysis is complete, it's time to implement a strategy to expand

your competitive advantage. To that end, Porter identified three generic

strategies that can be implemented in any industry (and by companies of

any size.)

Cost leadership

Your goal is to increase profits by reducing costs while charging industry-

standard prices, or to increase market share by reducing the sales price

while retaining profits.

Differentiation

To implement this strategy, your company's products need to be significantly

better than the competition's, improving their competitiveness and value to

the public. It requires thorough research and development, plus effective

sales and marketing.

Focus

Successful implementation entails the company selecting niche markets in

which to sell their goods. It requires an intense understanding of the

marketplace, its sellers, buyers and competitors. More information about the

generic strategies is available in Porter's 1985 book, Competitive

Advantage (Free Press).

Alternatives to Porter's Five Forces

While Porter's Five Forces is an effective and time-tested model, it has been

criticized for failing to explain strategic alliances. In the 1990s, Yale School of

Management professors Adam Brandenburger and Barry Nalebuff created

the idea of a sixth force, "complementors," using the tools of game theory.

In Brandenburger's and Nalebuff's model, complementors sell products and

services that are best used in conjunction with a product or service from a

competitor. Intel, which manufactures processors, and computer

manufacturer Apple could be considered complementors.

Additional modeling tools are likely to help round out your understanding of

your business and its potential. A value chain analysis helps companies

understand where their best productive advantage lies, while the BCG

matrix helps companies identify which products are likely to benefit the most

from increased investment.

Additional reporting by Katherine Arline and Chad Brooks. Some source

interviews were conducted for a previous version of this article.

Image Credit: AnemStyle/Shutterstock

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With an associate's degree in business management

and nearly 20 years in senior management positions,

Marci brings a real-life perspective to her articles

about business and leadership. She began freelancing

in 2012 and became a contributing writer for Business

News Daily and business.com in 2015.

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Home > Lead Your Team > Strategy

Understanding Porter's

Five Forces

Example of Porter's

Five Forces

Strategies for success

Cost leadership

Differentiation

Focus

Alternatives to Porter's

Five Forces

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Marci Martin

Business News Daily Contributing Writer

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