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Porter’s 5 Forces – The Explanation With Examples

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Published:
July 17, 2022
Reading Time:
11 minutes
Leo
Experienced copywriter who spends a lot of money at restaurants and regrets it later.

What are Porter’s 5 forces? That is probably the question that brought you to this article, right? This old and renowned business strategy model is used by companies to this day. So, whether you run a business or work for a business, this is one of the frameworks you should know.

The vast majority of articles on the internet give a surface-level gist of this decades-old strategy framework. However, in this article, you will learn each of Porter’s 5 forces with a practical example.

Whether you’re a consultant trying to refresh your memory, an entrepreneur working on a new strategy, or a student who is curious about this strategy framework, this article has something for everybody.

So, without further ado, let’s begin.

Porter’s 5 Forces With Examples

Porter’s 5 Forces is a time-tested strategy framework that takes into consideration the five competitive forces as defined by Michael Porter. He is an American academic who has written extensively on economic theories and business strategies. Educated at Harvard and Princeton, and currently a professor at Harvard Business School, he has authored many books on strategy. Now, let’s understand his model with practical examples.



Force #1: Competitors in the industry

The first of Porter’s 5 forces is the number of competitors in a particular industry. Competitors are the core of this specific strategy framework by Michael Porter. So important, that when Porter’s 5 Forces model is represented using a diagram, competitors are placed in the center and the rest of the four forces are placed around it (as shown in the infographic).

Now, when a company operates in an industry in which there are many competitors selling similar products, it’ll have lesser power. The reason is that there are many rivals trying to get a more significant share of the pie. This is a scenario in which a customer has many options to choose from. So, they will go for the best, the cheapest, the trendiest, and so on. On the other hand, if a company offers products in an industry that doesn’t have much competition, it can easily charge a premium price and dominate the market. This is because, in the absence of another alternative, the customers will have no choice but to depend on one company for a particular product.


Practical example:

Let’s consider the hospitality industry as an example. In every country, every city, and every neighborhood, there are many hotels for customers to select from. Customers make their decision by evaluating the price, ratings, reviews, and location of a hotel. With the advent of online bookings, the competition has become tougher. So, if there are two hotels in the same location with 4-star ratings, and one offers a room for a measly $30 less, then it’s very likely that customers will go for the cheaper one. From a strategy perspective, if one is thinking about getting into the hotel business, one must know that rivalry in this industry is intense.

KEY TAKEAWAYS

  • Porter’s 5 forces are as follows: Competitors in the industry; Threat of new entrants; Bargaining power of suppliers; Bargaining power of buyers; Threat of substitutes.
  • Competitors operating in the same industry may drive profit margins and revenue down for any given company.
  • If the barrier to entry in an industry is low, the threat of new entrants is high, and vice versa.
  • The lower the number of suppliers in an industry, the more power they’ll have, and vice versa.
  • If a company has a small customer base, customers may have higher bargaining power. In the case of a larger customer base, individual customers may have lesser power.
  • A new product that is better than an existing one can substitute the existing product and put a business in dire straits.

Force #2: The threat of new entrants

The second of Porter’s 5 forces is the threat of new entrants. Before partaking in a business venture, investors, and entrepreneurs should ask themselves: How easily can others do what we’re planning to do? The threat of new entrants can be divided into three categories: high, medium, and low. If an industry enables new competitors to enter quickly and without investing a lot of money, then the barrier to entry is low and the threat of new entrants is high. On the flip side, for industries like petroleum and pharmaceuticals, the barriers to entry are way too high for an average businessman or investor to cross. Part of the reason are the high investment costs. So, in such cases, the threat of new entrants is low and usually, only one or very few companies can ever operate in these industries.


Practical example:

What’s the first brand name that comes to your mind when you hear the term ‘electric vehicle’? That’s right—it is Tesla! This company is a great example of an industry in which the threat of new entrants is really, really low. Why? Well, it's one thing to design a prototype of an EV and show it off in trade shows, and it’s another thing to manufacture these cars on a mass scale and bring it to the customers. It’s hard to compete with Tesla, even for established car manufacturers. Thus, a new entrant is highly unlikely to be a threat.

Force #3: Bargaining power of suppliers

The third of Porter’s 5 forces is the power of suppliers. Maybe you didn’t think that suppliers would affect a business’s strategy? Well, they actually do. You see, as customers, most of us only see the finished product—a laptop, a car, a camera, and so on. However, Michael Porter mentions how suppliers of raw materials, equipment, etc. can drive the cost of a product and make businesses rethink their strategy. The lower the number of suppliers in an industry, the more power they’ll have, and vice versa. Let’s understand this using a real-life case.

Porter's 5 Forces, Porter’s 5 Forces – The Explanation With Examples

Practical example:

The restaurant industry is a great example of a supplier-dependent sector. Everything from cooking oil to flour comes from an external supplier. Restaurant owners are not farmers, so they can’t have any raw material for their business without external help. Thus, in a location where there is a lack of suppliers (for example, if there’s only one supplier for cooking oil), the restaurant may have to pay whatever price the supplier asks for to run their restaurant. On the other hand, in a place where there is an abundance of suppliers, restaurant owners can choose the best one from a pool of many suppliers.

Force #4: Bargaining power of buyers

The fourth of Porter’s 5 forces is the power of customers. Michael Porter, being a smart strategist, elaborated on the role of customers in this classic strategy framework. In any industry, if a company only serves a small number of customers, then customers have more power to negotiate lower prices. This is because the business doesn’t have too many options when it comes to customers. Therefore, it will have to customize itself based on customer demands. On the other hand, if a company has a very high number of customers, it can dictate the terms of engagement. For instance, it could charge a higher price for a product that is cheap to produce.


Practical example:

Let’s talk about Apple. According to many sources, an iPhone only costs around $500-$600 to produce. Still, the cost of iPhones can be around $1000—almost double the production cost. The reason is that Apple’s operating system and product are one of a kind. This means that currently there is only one competitor to Apple’s smartphones—Android phones (source). Hence, when it comes to Apple, the number of customers and loyal fans is high. Therefore, the bargaining power of customers is low, and the company can charge a premium price.



Force #5: The threat of substitutes

The fifth of Porter’s 5 forces is the threat of substitute products. A company can sell a very popular product that generates high profits. Still, if a substitute of that product seems more appealing, then customers may ditch the company’s products and go for the substitute. Now, you must understand what a substitute product really means. For instance, a substitute for a calculator is not necessarily a faster calculator. Rather, it could be a smartphone that has an in-built calculator. A substitute could be a completely different product type from the original one or a better, improved version of the same product.


Practical example:

Let’s start with the statistics. In 2016, the revenue of dairy-free frozen desserts in Europe was $123.02 million. In 2021, it was over $184 million, and in 2024, it’s expected to cross $230 million (source). Due to the prevalence of animal rights activism and a preference for vegan food, milk-based ice creams are being substituted with dairy-free versions that taste almost the same as milk-based ice creams. Two decades ago, no one would’ve imagined this. But now, it’s the reality.



Final Thoughts

Michael Porter gave this very important strategic tool to the world decades ago, and it’s still relevant to this day. In order to grow and sustain a business, all five forces must be given equal importance. It’s not that one can completely control any or all of these forces. However, applying this framework to a business and keeping an eye on all these factors can help business owners prepare themselves for a rainy day. Moreover, this framework can be used to tweak one’s business strategy in order to achieve desired outcomes. For instance, a business can switch to a cheaper supplier or acquire a company that can potentially become a competitor.

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