Understanding Porter’s five forces model
At some point in life, there can be situations that we have to decide whether to invest effort into a product/service that we will bring to a market to sell. Michael E. Porter came up with a framework in 1979 that helps us analyse the market situation so that we can decide whether it is worthwhile for us to enter the market with a product/service that we have in mind. This post documents my understanding of Porter's five forces for my future references.
What does Porter's Five Forces model examines?
The Porter's Five Forces model examines the following forces that shapes every industry:
- Buyers' bargaining power
- Suppliers' bargaining power
- Competitive rivalry
- Threat of new entrants
- Threat of substitutions
With these powers, we can then analyse the strengths and weaknesses of the industry that the market that we wish to enter belongs to.
Buyers' bargaining power
Without buyers, the product/service that we are bringing to the marketplace will not have any value. The buyers' bargaining power help us look into whether our potential buyers have the ability to drive our prices down.
The buyer usually have a higher bargaining power when:
- he/she buys a large quantity of our product/service within a short time frame.
- we only sell to a few of these buyers and they know it.
- there are no incentives given by a third party on condition that he/she buys from us.
- there are many other companies like us that they can buy from.
Suppliers' bargaining power
Unless we fully integrate our product/service, we will need to look at the bargaining power of our suppliers. Suppliers are people who we buy from in order to produce what we sell.
The supplier usually have a higher bargaining power when:
- there are few other suppliers that we can buy from.
- we buy little from him/her within a short time frame.
- there are many other buyers which they can sell to.
Competitive rivalry helps us look at whether the market that we are entering is crowded. When there are more competitors that provide products/services like us, the buyers' bargaining power and suppliers' bargaining power will increase as buyers and suppliers have more options to get better deals.
However competitive rivalry is not always bad. If the product/service that we are offering is new in the market, high competitive rivalry can help us:
- educate and bring in new customers, thereby enlarging the original customer base.
- attract more suppliers into the ecosystem to lower suppliers' bargaining power.
- reduce the effort needed to mature our product/service when there are many whom we can learn from to improve our product/service.
Threat of new entrants
The threat of new entrants helps us see whether it is easy for new players to enter the market to compete directly with us. The less time and money needed for these players to be effective in our market, the easier it is for our position in our market to be weakened. The threat of new entrants also relates to competitive rivalry in terms of the advantages and disadvantages that competitive rivalry brings about.
Threat of substitutions
The threat of substitutions helps us be aware of products/services that are different to what we are going to offer but can provide the same value to our buyers. In such a case, buyers' bargaining power will increase and we may not able able to price our product/service in a profitable way.
The threat of substitutions is strong if:
- it is as easy to access and use substitutions of our product/service.
- it is cheaper for our buyers to use substitutions of our product/service.
- it is regulatory for our buyers to use the substitutions of our product/service.