Porter's 5 Forces theory is a method with five main factors used to determine the competition of an industry or business. The purpose of this method is to identify the attractiveness of a company that can affect profits.
Talking about profits, you can implement the theory to map the business or business conditions. Based on the theory created by a Harvard Professor, Michael E. Porter in 1979, the following are the determining factors that can affect product profits in a business.
1. Threat of Substitutes
The threat of substitutes (products/services) cannot be underestimated. There are some companies that have the strongest position in their own market or even create a monopoly market. Even if a company has unmatched market power, it can still get a significant threat of replacement.
Coca-Cola once came under pressure from health-conscious consumers about consuming low-sugar beverages. The emergence of a variety of flavored waters and juices as substitute drinks has put pressure on Coca-Cola to innovate.
Although it still dominates the soft drink market, Coca-Cola is slowly starting to lose revenue. This is due to the choice of people who switch to consuming healthier soft drinks such as low sugar smoothies or juices.
In this case, Coca-Cola is not a monopoly and most other factors don't apply except the threat of substitutes being the main determining factor. This, of course, did not go unnoticed by the company, which expanded its range of Diet Coke or Zero Sugar products.
For companies with a strong market position, the threat of substitutes is perhaps one of the most important issues. Arguably, the other four forces tend to be less decisive in a market that has a dense concentration of competition.
2. Threat of New Entrants
The threat of new entrants refers to how easy it is to enter or leave a market, also known as barriers to entry and exit. The easier the barriers to a market, the easier it will be for entrants to enter and take advantage of new aspects.
This is not profitable for any company. However, this factor can help existing companies to ensure that they stay proactive with the latest product offerings or designs.
There are six main areas that reduce the threat of new entrants and create significant barriers to entry. There are many other contributing factors, but these are the main ones:
New firms do not have the same resources to compete on price as existing firms, presenting a major barrier to entry.
The image of a brand is another obstacle that is difficult for new entrants to overcome. After an image is formed and widely known, it will be difficult to beat the business of a trusted brand.
Some industries require significant capital, such as the oil, gas, or banking industries. Newcomers need millions if not billions to start a business in this field with uncertain success. Therefore, emerging new entrants are limited to businesses with large capital requirements.
Certain industry-specific technologies and expertise are invaluable to a business, but also an insurmountable barrier for new entrants.
Government policies can limit competition in the market, either by enacting new laws, or imposing tariffs/quotas on goods imported from abroad. Both limit competition by making it more technically difficult and expensive to enter the market.
In some industries, the first company to exist has a good image and a very advantageous position. However, existing companies can get rid of new companies easily by using ‘predatory pricing’ i.e. controlling the supply chain with the aim of lowering prices for consumers.
3. Bargaining Power of Buyers
Buyers have significant bargaining power when there are several other sellers, but only a handful of buyers. The buyer can refuse to buy, but the seller cannot refuse the sale. As a result, buyers have significant power to dictate the price they are willing to pay – otherwise they will take their offer to another seller.
4. Bargaining Power of Suppliers
Suppliers can exert their power by raising prices, reducing quality, or limiting supply in order to take advantage of buyers. They can become stronger if this bargaining power extends down the supply chain.
For example, manufacturers may have power over retailers who in their position have power over consumers. The results will be visible or have an impact on the costs that are passed through the supply chain.
5. Competitive Rivalry
Competitive competition is competition that uses methods such as price competition, product introduction, and advertising campaigns. This intense competition puts pressure on both new and existing companies to lower prices and compete more aggressively. As a result, existing firms may experience reduced profits due to possible price reductions in order to compete for the most superior position to attract customers.
The weaker these factors affect the company, the more opportunities to achieve high profits. That is, a product offered by your business has an appeal and is able to survive in the midst of a competitive market competition.
Porter's 5 Forces theory is a method with five main factors used to determine the competition of an industry or business. The purpose of this method is to identify the attractiveness of a company that can affect profits.
Talking about profits, you can implement the theory to map the business or business conditions. Based on the theory created by a Harvard Professor, Michael E. Porter in 1979, the following are the determining factors that can affect product profits in a business.
1. Threat of Substitutes
The threat of substitutes (products/services) cannot be underestimated. There are some companies that have the strongest position in their own market or even create a monopoly market. Even if a company has unmatched market power, it can still get a significant threat of replacement.
Coca-Cola once came under pressure from health-conscious consumers about consuming low-sugar beverages. The emergence of a variety of flavored waters and juices as substitute drinks has put pressure on Coca-Cola to innovate.
Although it still dominates the soft drink market, Coca-Cola is slowly starting to lose revenue. This is due to the choice of people who switch to consuming healthier soft drinks such as low sugar smoothies or juices.
In this case, Coca-Cola is not a monopoly and most other factors don't apply except the threat of substitutes being the main determining factor. This, of course, did not go unnoticed by the company, which expanded its range of Diet Coke or Zero Sugar products.
For companies with a strong market position, the threat of substitutes is perhaps one of the most important issues. Arguably, the other four forces tend to be less decisive in a market that has a dense concentration of competition.
2. Threat of New Entrants
The threat of new entrants refers to how easy it is to enter or leave a market, also known as barriers to entry and exit. The easier the barriers to a market, the easier it will be for entrants to enter and take advantage of new aspects.
This is not profitable for any company. However, this factor can help existing companies to ensure that they stay proactive with the latest product offerings or designs.
There are six main areas that reduce the threat of new entrants and create significant barriers to entry. There are many other contributing factors, but these are the main ones:
New firms do not have the same resources to compete on price as existing firms, presenting a major barrier to entry.
The image of a brand is another obstacle that is difficult for new entrants to overcome. After an image is formed and widely known, it will be difficult to beat the business of a trusted brand.
Some industries require significant capital, such as the oil, gas, or banking industries. Newcomers need millions if not billions to start a business in this field with uncertain success. Therefore, emerging new entrants are limited to businesses with large capital requirements.
Certain industry-specific technologies and expertise are invaluable to a business, but also an insurmountable barrier for new entrants.
Government policies can limit competition in the market, either by enacting new laws, or imposing tariffs/quotas on goods imported from abroad. Both limit competition by making it more technically difficult and expensive to enter the market.
In some industries, the first company to exist has a good image and a very advantageous position. However, existing companies can get rid of new companies easily by using ‘predatory pricing’ i.e. controlling the supply chain with the aim of lowering prices for consumers.
3. Bargaining Power of Buyers
Buyers have significant bargaining power when there are several other sellers, but only a handful of buyers. The buyer can refuse to buy, but the seller cannot refuse the sale. As a result, buyers have significant power to dictate the price they are willing to pay – otherwise they will take their offer to another seller.
4. Bargaining Power of Suppliers
Suppliers can exert their power by raising prices, reducing quality, or limiting supply in order to take advantage of buyers. They can become stronger if this bargaining power extends down the supply chain.
For example, manufacturers may have power over retailers who in their position have power over consumers. The results will be visible or have an impact on the costs that are passed through the supply chain.
5. Competitive Rivalry
Competitive competition is competition that uses methods such as price competition, product introduction, and advertising campaigns. This intense competition puts pressure on both new and existing companies to lower prices and compete more aggressively. As a result, existing firms may experience reduced profits due to possible price reductions in order to compete for the most superior position to attract customers.
The weaker these factors affect the company, the more opportunities to achieve high profits. That is, a product offered by your business has an appeal and is able to survive in the midst of a competitive market competition.
