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Academic Insight: Understanding Industry Structure Using Porter’s Five Forces

Shontarius D. Aikens

How well do you understand the structure of the industry you work in? This question should be of central importance to managers when it comes to business strategy and identifying opportunities and threats to a company’s bottom line. At the heart of business strategy is a framework developed by Harvard Business Professor Michael Porter that helps managers understand and evaluate five major forces that shape the structure and landscape of an industry: 1) Competitive Rivalry, 2) Threat of New Entrants, 3) Threat of Substitutes, 4) Supplier Power, and 5) Buyer Power (Dyer et al., 2018)

Understanding the basics of Porter’s Five Forces is beneficial to managers in four ways. First, it provides managers with a mental model for deepening their understanding of any industry. Second, it can be used to evaluate any shifts and/or trends within an industry due to external changes in the general environment (e.g., economic conditions, technological changes, etc.). Third, managers could determine ways to make internal changes to the organization to better position themselves within the industry in response to each market force. Fourth, when considering the combined effects of all five forces, managers can make strategic decisions about the attractiveness of their current industry or perhaps the attractiveness of a different industry. Thus, my purpose for this month’s article is to provide a brief and easy-to-understand overview of Porter’s Five Forces along with things for managers to consider as it pertains to their organization.

Understanding the basics of Porter’s Five Forces is beneficial to managers in four ways. First, it provides managers with a mental model for deepening their understanding of any industry. Second, it can be used to evaluate any shifts and/or trends within an industry due to external changes in the general environment (e.g., economic conditions, technological changes, etc.). Third, managers could determine ways to make internal changes to the organization to better position themselves within the industry in response to each market force. Fourth, when considering the combined effects of all five forces, managers can make strategic decisions about the attractiveness of their current industry or perhaps the attractiveness of a different industry. Thus, my purpose for this month’s article is to provide a brief and easy-to-understand overview of Porter’s Five Forces along with things for managers to consider as it pertains to their organization.

Force #1: Competitive Rivalry

Competitive Rivalry refers to “the intensity with which companies compete with each other for customers” (Dyer et al, 2018, p. 22). The main implication in this area is for managers to clearly identify those companies that are their real competitors. Consider the needs of your customers and all products or services that can meet those needs. If another company offers a product or service that can meet those needs as well, then that company should be viewed as a direct competitor.

Force #2: Threat of New Entrants

The Threat of New Entrants refers to the difficulty for a new firm to enter an industry. In some industries, there are significant barriers to entry (e.g., government policy, large capital requirements, etc.). In other industries, those barriers are relatively small. When evaluating this force, the main implication is to identify the likelihood of new competitors in relation to the requirements to enter the industry. Then, managers should determine ways to increase those barriers to discourage new competitors from entering the industry.

Force #3: Threat of Substitutes

The Threat of Substitutes refers to the availability and awareness of alternative products or services that can meet or exceed the purpose of original products or services. For example, consider beverages that are consumed in the morning. For some people, coffee is their go-to beverage every morning, and no other beverage will suffice. But for others, they may choose to switch and to consume a different beverage (e.g., orange juice, milk, etc.). The main implication for managers is to be on the lookout for emerging substitutes that could potentially catch the eye of their existing customers and incentivize them to switch to a different product/service.

Force #4: Supplier Power

A supplier is defined as “a firm that provides products that are inputs to another firm’s production process” (Dyer et al, 2018, p. 24). In this regard, Supplier Power refers to the bargaining power that suppliers have over the companies in an industry. If a company is limited to inputs from only a few suppliers, suppliers typically have more power in the bargaining relationship. Managers should evaluate this force as it relates to their organization to determine ways to make themselves less vulnerable to changes in prices and/ or the availability of inputs needed to operate.

Force #5: Buyer Power

After a company receives its inputs from suppliers, it converts them to outputs, or finished goods and services, to be sold to customers (buyers). In this regard, Buyer Power refers to the bargaining power that customers have over the companies in the industry. When customers have lots of choices of companies to buy from, customers typically have more power in this relationship. The main implication in this area is for managers to continuously examine their product/service to develop the proper balance and mix of price (lowest possible price) and quality (highest possible quality) by continuously listening and responding to the needs of their customers or buyers.

In Summary

As I mentioned at the beginning of this article, my purpose was to provide a basic understanding of the principles and assumptions of Porter’s Five Forces model. For a more in-depth explanation of each force, there are plenty of available resources that can be retrieved through internet searches. Given the changes in business over the last several years, a refreshed and revised understanding of the current state, condition and trajectory of one’s industry is recommended. It is my hope that the information in this article will be a good starting point to help managers deepen their understanding of the structure and landscape of their industry and to develop ways to better position themselves to compete within their industry going forward.

Dr. Aikens can be reached at: [email protected]

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