Training course (PT)

“Second sailing”, meaning the next best way to achieve something

Plato, “Phaedo of Elis”

Description

Michael E. Porter has developed the Five Forces model in 1979 while being an associate professor at Harvard Business School. This model identifies five forces in the microeconomic environment that drive competition and can affect a company’s ability to serve its customers and make profits. The purpose of developing a model of the five forces was to aid managers in evaluating these threats so they can become more successful in creating strategies to neutralize them.

Porter's five forces include three forces from 'horizontal' competition--the threat of substitute products or services, the threat of established rivals, and the threat of new entrants--and two others from 'vertical' competition--the bargaining power of suppliers and the bargaining power of customers.

 Figure: Competitive Forces Model (Porter, 1980, p.4)

 Although developed forty years ago, the Five Forces model of Porter is still applicable for the analysis of the profitability of an industry. It is a fact that the Internet has changed the nature of competition in the sense that many companies today think and act globally in terms of collaboration and best price-performance ratios. However, all companies are still operating in a micro-network of buyers, suppliers, substitutes, competitors, and new market actors and this idea is valid for each competition-based economy. Today, as in the past, companies are required to offer products and services that are competitive enough concerning price, quality, and ‘after-sales service’.

The Five Competitive Forces that shape strategy

1. Potential new entries

There are some important structural components that can facilitate and ease the entrance of new competitors. The major components are the advantages of experience and learning, the brand differentiation of product or service, the fulfillment of capital advantages, the access to better distribution channels and other cost advantages like the the closest location of an enterprise to its customers’ needs and the customers’ loyalty to established brands.

2. Power suppliers

Suppliers can exert their bargaining power by threatening to raise prices or to reduce the quality of services and products. A supplier group is powerful if it has taking into consideration the switching costs of the customers, if its’ offered product or service constitutes a unique input and if it poses a threat. For example, if a company is baking bread and there is only one supplier that sells flour the company has no alternative but to buy from this supplier. Therefore, the presence of substitute inputs is very essential.

3. Rivalry competitors

In most industries, especially when there are only a few major competitors, competition will very closely match the offering of others. Aggressiveness will depend mainly on factors like the number of competitors, the industry growth, the level of fixed costs, the type of differentiation, the capacity to correspond to large increments, diversity in type of competitors and the strategic importance of the business unit.

4. Pressure of substitutes

A substitute product uses a different technology to try to solve the same economic need. These are products or services that basically perform the same function but are often based on a different technology. In general, the major factors that usually matter is the shift in better technology, the relative price performance of the substitute and the buyers’ propensity to substitute.

5. Power of customers

Customers’ power is high if customers have many alternatives. It is low if they have few choices. Through their bargaining power customers can force the competitors to lower their prices or to provide better services or products of better quality. The major factors that can determine the bargaining power of buyers are their level of knowledge and information of the actual market prices, the industry demand, and the suppliers’ cost.

Guidelines for applying Porter’s five forces framework

The practical application of the five forces frameworks entails the existence of certain challenges that entrepreneurs need to confront in order to avoid misapplications of the framework (Dobbs, 2014):

1.  Lack of depth: It is the misanalysis of the framework that can lead to misanalyses, poor decision making and disastrous organizational outcomes.

2.  Lack of structured analysis: It is the frequent arbitrary nature of the five forces’ analyses that may be significantly diminished through a more structured approach once the framework is implemented.

3.  Lack of strategic insight: It is the perception that the framework is primarily a tool to assess the attractiveness levels of industries rather than gain strategic insight as to how a firm can compete more effectively within its industry. The primary purpose of the framework is the latter; however, tying the analysis to specific strategic action items are challenging.

4.  Millennial generation preferences: Another factor affecting entrepreneurs process and apply the five forces framework may be the generation to which they belong. While people of the Millennial generation are very media-conscious and familiar with how technology contributes to an increasingly complex environment, they also long for the stability that authority and structure bring. In addition, they expect high levels of service, low levels of “busy work,” and will not hesitate to voice their frustrations or dissatisfaction when those expectations are not met.

The concept of the five forces framework is that choice of entrepreneurs depend on the external environment and this requires a significant understanding of a business’s surrounding environment. Through the application of this framework entrepreneurs begin to understand their perspective in the business activity can better serve customers while simultaneously increasing prices for increasingly valuable products, practice the decisions that business owners, as strategists, make every day in a low-risk setting. The major advantage of applying the five forces framework is that entrepreneurs can understand how to exhibit significant competitiveness by taking into consideration the existing environment.

Sources:

1.     Dälken, F., 2014. Are Porter’s five competitive forces still applicable? A critical examination concerning the relevance for today’s business (Bachelor's thesis, University of Twente).

 2.     Dobbs, M., 2014. Guidelines for applying Porter's five forces framework: a set of industry analysis templates. Competitiveness Review, 24(1), pp.32-45.

 3.     Grundy, T., 2006. Rethinking and reinventing Michael Porter's five forces model. Strategic Change, 15(5), pp.213-229.

 4.     Karagiannopoulos, G.D., Georgopoulos, N. and Nikolopoulos, K., 2005. Fathoming Porter's five forces model in the internet era. Info, 7(6), pp.66-76.

 5.     Swaans, A.H. and Waalewijn, P., 1998. A Knowledge Base Representing Porter's Five Forces Model'. Proceedings of the IEEE, 83(8), pp.1114-1123.

 6.     Porter, M.E., 2008. The five competitive forces that shape strategy. Harvard business review, 86(1), pp.25-40.

 7.     Porter, M.E., 1997. Competitive strategy. Measuring Business Excellence, 1(2), pp.12-17.

 8.     Ural, O., 2014. Uncovering Porter’s Five Forces Framework’s status in today’s disruptive business context (Bachelor's thesis, University of Twente).

 9.     Wilson, R.C., 2015. Mayhem: A hands-on case playing activity for teaching Porter’s five forces to undergraduate business students. Small Business Institute Journal, 11(2), pp.48-59.