To run a business successfully, many factors must be taken into account that often elude the attention of entrepreneurs. However, if you study the economy more carefully and diligently, you will learn a lot of different approaches that allow you to competently and effectively analyze financial activities. One of the most interesting examples is the analysis of Porter's 5 forces, an example of which will be examined in detail in this article. But first of all, you need to understand what it is, what it is oriented to and what it will allow you to achieve. You can be sure that you will definitely need a tool such as the analysis of the 5 forces of Porter. Examples in the text will serve as a clear confirmation of this.
What it is?
This model was described in 1979 by the famous economist Michael Porter. He did this in order to create a full-fledged model that would allow the company to analyze its productivity and competitiveness, and in the future also maintain these indicators at a high level. After almost forty years, you can see how well the analysis of Porter's 5 forces works.
Examples of its use in life are very diverse. This analysis is used by factories, restaurants, banks, and other enterprises that have competition in the market. Accordingly, if you want your business to be successful, you need to think about exploring this model. And this article will help you understand what Porter’s 5 forces analysis is all about. Examples of its use will also be presented to your attention. The second half of the article will be devoted to the consideration of one large example step by step.
Model description
When Michael Porter created this model, he said that there are five different forces on the market, each of which determines the competitiveness of the product :
- the market power of buyers that they have in a particular segment;
- suppliers' market power, which affects the supply of raw materials to enterprises;
- the threat of market entry of new entrants capable of increasing competition;
- the danger of substitutes having the best price-quality ratio;
- level of competition within the selected market.
This is Porter’s 5 powers. An example of analysis will be described in the second part of the article, but for now it is necessary to focus directly on the consideration of each of the forces. At first glance, it might seem that no analysis can be done in these areas, but in fact, the result may surprise you. Using this approach, you can analyze the activities of your company and the competitiveness of its products on the market in order to make certain adjustments in the future that will allow you to increase some indicators in the long term. So, Porter’s 5 forces will be examined in detail later, an example of the analysis will also be given in detail, so that as a result you will know everything you need about this method.
Model use
How to use in the real world the analysis of 5 forces of Porter? Example: “Izbenka” - a Russian chain of stores. The purpose of such an event is to determine competition in a particular segment of the market, so that you can calculate how logical the introduction of the product will be, whether additional efforts will have to be made to achieve the desired result, and so on.
Thus, this model is used in the modern economy to compile a detailed competitive analysis of your company's products, as well as the selected market. Now you are sure that it is imperative that you use the Porter 5 Force Method. An example of an analysis of a bank or any other company can confirm this in the future, but now it is necessary to concentrate on considering each individual force.
The threat of invasion of new members
An analysis of Porter’s 5 forces using the example of a cafe can show in great detail what the first force represents, that is, the threat of an invasion of new participants. So, there is a certain market in which there are already operating companies with their goods and services. New participants increase competition, that is, if new cafes appear on the market, fewer customers may start going to your place. How to assess the level of threat? Here, Porter identifies several factors that affect the entry barrier. If it is high, then the threat will be lower, since not everyone wants to overcome it.
What are these factors? First, economies of scale. If the volume of production on the market is large, then the cost of one unit will be low, so it will be difficult for new participants to achieve positive profitability. Secondly, this is product differentiation - the more products or services available on the market, the more difficult it will be for a new participant to compete. Thirdly, this is the need for capital - the higher the initial threshold of investment, the less likely that new participants will enter the market. It is also worth noting the height of costs, access to distribution channels and government policies regarding production for a particular market. Naturally, the factors are not limited only to this - there are additional threats that depend directly on the sales market and current conditions.
Buyers Market Power
If we talk about the second force, then it is important to understand that it is best to choose the market where the buyer has the least power and the weakest influence. Why? The reason is that customers are consumers of your goods and services, which is why it is at the expense of them that the market exists. Influential customers with great power can directly influence your products, demanding higher quality, presenting their requirements and so on. So the lower the level of influence of buyers in the market, the better for you.
There are several conditions for increasing the influence of buyers: for example, the lack of uniqueness of goods (the buyer can choose any, not just your product), high sensitivity to the price (the buyer chooses not your product, but the cheapest option), and so on.
Bargaining power of suppliers
The market power of suppliers is not manifested as often as the power of buyers, but its influence can be very strong. The fact is that suppliers, in fact, are the owners of resources, without which the company cannot carry out its activities. And in some situations, suppliers receive a much higher level of power - for example, when there are not too many of them on the market (or when there is a monopoly on the market), when the resources used to produce the goods are limited, and the costs of switching to alternative raw materials will be too high. In such situations, suppliers gain more power than usual, and they can directly influence the market environment, and at the same time, competition.
The emergence of substitute products
Substitutes are those products that can offer a profitable alternative to your products. If you have quality analogues, your profit will be very limited. Serious threats are those substitutes that offer a more attractive ratio of quality and price. As long as the consumer can purchase lower-quality goods cheaper, he will not buy yours.
Also, substitute products from well-known brands that have already gained impressive popularity in other markets and are now planning to achieve the same result in the new one pose a threat. It is necessary to deal with substitutes by creating your own strong brand, increasing product differentiation, eliminating standardization, and so on.
Intra-industry competition
And, of course, do not forget that the participants in the market most of all influence the competition in the market. The level of competition in the market will be high if there are a large number of participants with approximately the same volume of production, low differentiation of goods, high barriers to entry and so on. High competition, of course, reduces the profitability of the industry, so you need to pay special attention to this item.
Assessment of product competitiveness and level of competition
Well, you already know everything about the forces that Michael Porter described in 1979; now you can safely analyze Porter's 5 forces using a café, restaurant, shop, or any other institution. But to increase the effectiveness of the analysis, you should standardize it. This is what will be discussed later.
Now in detail will be described an example of analysis, divided into four steps. The first one is to assess the competitiveness of your product and the level of competition in a particular market. As part of this step, you need to evaluate the substitute products on the market, giving them an estimate of one to three, where one is the absence of substitute products, two is the presence on the market with a low share, and three is the presence of high market share. If you get one point, then the threat level is low, if two - medium, and if three - high.
The next point is the analysis of intra-industry competition, one of the most important among Porter's 5 forces.
An example of a store analysis might look like this. There are four points in total: the number of participants in the market, the rate of market growth, the level of product differentiation, and the limitation on price increases. Naturally, each of these points also has its own criteria by which they can get from one to three points. If we are talking about an ordinary store, then the level of market saturation will be high (3 points), as well as the market growth rate (1 point), the products of companies will be very different from each other (1 point), and the possibility of increasing prices will be available only within cost coverage (2 points). The result is 7 points, which gives an average level of intra-industry competition.
As for the entry of new participants into the market, there are much more parameters: economies of scale, strong brands, product differentiation, as well as all the criteria that were described in the theoretical part. If we talk about a specific example of a store or cafe, we can assume that only a few participants will have economies of scale (2 points), product differentiation will be average, and the willingness of participants to lower prices will be high, except for large representatives. The remaining parameters will be at a high level, that is, they will receive three points.
As a result, we have a high level of threat of the emergence of new players. Now you can see which side there is the biggest threat to your business.
Buyer Market Power Rating
However, these are only three stages, and all 5 forces of Porter must be taken into account. An example of analysis in banks will allow you to understand how to analyze the power of buyers. Here the result will be expressed in high, medium or low probability of loss of customers. At the average bank, about half of the income comes from influential customers, while the second half falls to the rest (2 points). Also, two points are obtained when assessing the tendency of clients to switch to substitutes, since the services offered by the bank are only partially unique.
In addition, customers are highly sensitive to price, that is, they will always try to switch to the offer that is more profitable. Also, customer dissatisfaction can be estimated at two points. And in the end, it turns out that the probability of losing customers is high.
Assessing the market power of suppliers
So the analysis of Porter’s 5 competitive forces comes to an end. An example will tell about the last force concerning suppliers. Here the assessment should be given on a two-point, rather than a three-point scale. An analysis of Porter’s 5 forces on the example of a restaurant shows that everything is fine with suppliers on the market - there is a wide selection of options, there is no restriction in the volume of raw materials, if you need to switch to another supplier, the costs will not be too high, and for the supplier this industry has a high priority . As a result, it turns out that suppliers have practically no influence on the market.
Summarizing
We have studied in detail the 5 forces of Porter. An example of enterprise analysis ends with a debriefing. You need to analyze each of the five forces, determine whether it has a high, medium or low value for your company in a particular market, then describe in detail each of them and, if necessary, develop a direction for improving the situation for you.