Porters Five Forces is a topic that came up in my recent CIMA E2 studies and it was a model I was not that familiar with. Maybe it came up in my E1 exam but that seems a long time ago now.
PESTEL analysis (Policital, Environmental, Social, Technology, Economical, Law) is used to understand the global business environment from an external point of view but to really get to grips with the position of a business we need to understand industry factors like;
- Who are our competitors?
- Do we have a diverse customer base?
- Will our suppliers start charging more?
- Are there lots of suppliers to choose from in our market?
This is where Porter’s Five Forces can be applied to analyse these industry factors and help the business make better business decisions.
This model has become one of the most important business strategy models ever developed so CIMA students need to know it inside out – especially with the E2 exam.
It’s used to understand how profitable an specific industry is, so companies who are considering entering the market will now whether or not it’s worth doing. Alternatively, it can be used for companies operating in a specific industry to understand if they need to adapt their business model to remain profitable or perhaps even consider leaving the market they are operating in.
If all of the factors are considered to be HIGH – then the market will be considered LESS profitable to enter OR the company will need to find additional ways to remain competitive in the current climate.
Here is a run through all five of the forces and what they mean.
This factor is considered high when they are lots of competitors out there currently on the market or there is little different between the products on offer – giving the customer more choice and more of a chance to shop around.
There also maybe exit barriers in the market meaning it’s not financially feasible for your competitors to leave the market. Likewise, you could be facing a competitors that has big financial backing and a strong reputation making it an unattractive proposition to enter the marker.
Threat of New Entrants
Is it easy for new businesses to enter the market?
i.e. There are no significant start up costs or highly technical skills required to produce the products or services. If this is the case, it’s likely that you will face a lot of competition in the market place and the prospect of new entrants entering the market on a frequent basis could affect your sales and profitability.
However, if you currently operate in a market that is difficult to enter then it’s wise to start thinking about how you can harness your current position and dominate the market without danger of new competition.
Does the balance of power lie with the customer?
And can customers switch between the competition easily?
If so, then the market is considered less profitable and steps will need to be taken to address that if you already operate in the market – alternatively it is seen as negative point for businesses who want to enter the industry.
Consideration has to be given to your supplier (or potential suppliers) also – if you are tied down to just one supplier for the raw materials or goods you require then you will be at the mercy of their pricing/delivery times.
The cost of changing suppliers might also be a complication and of additional cost of the business. If the supplier power is high then industry is seen to be less profitable.
If your product is easily replaces by an alternative then it’s a risky industry to enter or operate it. For example; your supplier may increase prices of materials which means your prices will also raise to remain profitable – but if the customer can easily replace your product with a substitute for a lower price than you are charging it will impact the profitability of the company.
If this factor is HIGH the market is seen to be LESS profitable.
This makes Porters Five Forces an invaluable tool for evaluating the industry you are operating or wish to operate in. If you find most of the forces are LOW then it’s a perfect market that operate in.
However, even when you’ve done the full analysis of the industry in relation to Porters Five Forces, and the majority are HIGH, it still maybe a profitable market to enter if you can negate all of the risks that have been identified.