The Five Forces Model

February 18th, 2009 by Sharon Larsen

Today we begin learning about Rich’s favorite power tool – Porter’s Five Forces Model.  We’ll walk through a hypothetical example to give you an idea of how the model is used in starting a business.

 

 

The Five Forces Model[1] is one of very few things I learned in MBA school that I still use frequently. Michael E. Porter is a professor at Harvard Business School, and is considered a leading authority on competitive strategy. His model can look a bit intimidating, but it is the first tool I use to do a quick evaluation of a business idea. It provides an overview of how viable and profitable the venture could be. Running this model should not be a laborious process. I will demonstrate how simple it is.

 

First, here’s a quick rating system that helps when using this tool. For each force, you will come up with several questions. The answer to each question will receive a positive (+), negative (-), or neutral (o) result, ending in a final, overall score for each force. To further clarify, I’ll create a fictional company, GRB—in honor of the gourmet root beer that I love!

 

Porter’s model include five forces:

·         Industry competitors

·         Suppliers

·         Buyers

·         Potential entrants

·         Substitutes 

 

#1—Industry Competitors

The first step is to ask some specific questions regarding the competition that occupy the space you want to enter. It’s important to remember that every venture will require different questions, but this will give you a good place to start.

 

        Q: Who is competing for market share in the Gourmet Root Beer space?

 

A: Four other companies, but they are all in geographies other than my target sales region. This results in a positive (+) score for this question. Place a plus on your diagram next to “Industry Competitors.”

 

Q: Is there a tenacious rivalry among competitors in the industry?

 

A: No. It seems to be a friendly and cooperative rivalry. No one is bristling at the mention of another company’s name, and the advertising hasn’t become intense. Place another + next to “Industry Competitors.”

 

As a side note, I find that too many people don’t really understand competition. At first glance, you might think two companies have a spiteful rivalry, but it’s actually friendly banter. Make sure you do your research here. Take a second look. Is the competition in your industry being fruitful or involving vicious catfights? Competition is good, as long as it isn’t so brutal as to squash your chances of entering the market. (See Chapter 18, “Dancing with the Devil” for more on quality competition.)

 

Q: How much will you need to spend on shelf space or advertising to differentiate your product?

 

A: Focused advertising within a target market will help the product take hold and gain popularity. (+)

 

Q: Is the market growing rapidly or is it dog-eat-dog?

 

A: A surge of interest in specialty drinks has provided more than enough market to go around. (+)

 

Four positive ratings result in an overall rating for this force of (+).

 

#2—Suppliers

In this category the model refers to the bargaining power of suppliers and how they will impact the cost of material required to develop your product. Put another way, how much power do I have over the suppliers?

 

Q: Are there multiple suppliers available?

 

A: Yes. (+)

 

Q: Can you exert influence over the sugar supplier to get a better price?

 

A: No. Sugar is a commodity: unless you are able to lock in a long-term contract for huge quantities, the price will remain the same. (-)

 

Q: Can you negotiate a better price than the competition for sugar?

 

A: No. You’re not going to buy enough product to get a better price. (-)

 

The overall score for this force is a (-).

 

#3—Buyers

Now analyze the bargaining power of the buyers. In this instance, the buyers are the stores and other vendors that will buy your root beer.

 

Q: Do your target buyers have the power to force the price of your product down?

 

A: Yes. If you don’t lower your price, they will likely buy a competitor’s product. (-)

 

                Q: Can you command a premium for your product?

 

                A: No. Buyers will take their business elsewhere.

 

The overall score for this force is a (-).

 

 

We’ll cover the remaining two forces tomorrow!

 


[1] Porter, M.E. “How Competitive Forces Shape Strategy,” Harvard Business Review, 57.2 (1979): 141.

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