Porter’s model: what it is and how to use it to evaluate one’s position with respect to competitors
Evaluating your company’s position relative to competitors and securing a lasting competitive advantage in your business environment is very important. To do this, you can use a valuable tool called Porter’s 5 Forces model.
As you can easily guess from the name, this particular model takes into consideration 5 specific aspects that help to better understand the structure of the sector in which a company operates and its profitability, so as to allow you to implement the best strategies to gain the maximum competitive advantage.
What is Porter’s model
The Porter’s model was first theorized by Michael Porter in 1979. It is generally called the “Porter’s 5 Forces model”, but you can also find references in the literature with the formulas “Porter’s 5 competitive forces model“, “Porter’s 5 forces analysis” or “analysis of extended competition“.
It is a marketing tool that, after identifying 5 forces operating within an economic environment, studies their intensity and importance, in order to determine the profitability of the sector in the long term and the attractiveness in the market.
In practical terms, Porter’s five forces model helps you to better understand the structure of the sector in which your company operates and its profitability in the medium to long term, and also allows you to understand how you can anticipate competition, thus ensuring a lasting competitive advantage.
Remember, in this regard, the maxim of Ryan Holday:
“You are not competing with what comes out today, but with everything that has come out in the past.”
The time has now come to finally understand what are the elements that make up the pattern of Porter’s 5 forces model, also called Porter’s matrix. They are:
- direct competitors;
- substitute products;
- new entrants.
Graphically, in the model it is possible to identify 1 central force (direct competitors), 2 horizontal forces (substitute products and new entrants) and 2 vertical forces (suppliers and buyers).
The 5 competitive forces
To really understand how Porter’s 5 Forces model works, it is necessary to better understand each single force and the threats associated with it. Keep in mind that the competitive structure of a sector depends on the interaction of these 5 forces, which act continuously. In more concrete terms, these forces, if not properly monitored and dealt with with effective strategies, risk leading you to the loss of competitiveness.
Direct competitors are companies that operate in the same industry as you, offering the same products or services. Various factors contribute to determining the intensity of this particular force, including:
- the concentration of businesses (i.e. the number of businesses within the sector);
- structural diversity (the more the firms are structurally similar, the more competition will affect the price of goods);
- the differentiation of the offer (similar offers lead the customer to choose based on the price and therefore push to further lower prices);
- production capacity (even excessive production capacity leads to lower prices).
Suppliers, that is the subjects from whom your company purchases raw materials or semi-finished products necessary for the production of your goods, exercise their bargaining power and influence the entire supply cycle. They can, for example, raise prices or reduce the quality of their services. It is evident that if you have a small number of suppliers, their power increases.
Your company’s customers can exercise their bargaining power, for example, by forcing you to reduce prices, requesting higher quality of services or vertically integrating into your industry (becoming manufacturers and, therefore, your potential competitors). A customer with a high volume of purchases also has a high bargaining power. If you have few customers, their bargaining power increases.
Replacement products are products that are different from yours but that satisfy, even if in a different way, the same need as your customer. The presence on the market of these goods clearly represents a threat to your product, precisely because they are able to satisfy the same need.
Another threat is the possibility that new potential competitors can enter the market. This depends on the barriers to entry of the market itself, which, in turn, depend on a set of factors, such as the need for a major initial investment, knowledge of the sector and Brand Reputation.
Some practical examples
Now that it is clearer to you what Porter’s 5 forces are and how they work, it may be helpful to translate this into practical terms.
One of the most classic examples of how Porter’s model works is Apple. The level of direct competition in the field of technology is very high. There are many large companies on the market and consumers can switch from one brand to another at relatively low cost. This strengthens the bargaining power of buyers but, to counter mass defections in its customers, Apple has invested significant resources in the field of research and development to continuously offer new and unique products, thus building a great loyalty to the brand.
The high barriers to entry into the technology sector make the threat of new market entrants relatively low to dent Apple’s position. The threat from suppliers is also low, due to the large number of potential suppliers for such a large company (for which, moreover, the cost of switching from one supplier to another is low) and the fact that hardly a supplier will give up working with it. Furthermore, given the multiple features of an iPhone, the threat from replacement products is also to be considered low.
Another possible practical example is that of Uber. The company is present in many countries and the level of direct competition on the market varies from country to country, although it can be considered generally high due to the many competitors. The barriers to entry for a company that wants to replicate Uber’s business model are low and this makes the threat of new entrants to the market very high.
For Uber replacement products, not only taxis or chauffeured rental should be considered, but also public transport and shared mobility services: the large number of replacement products makes this particular threat very high.
Due to the many options available on the market, the threat from customers is also particularly high. Not only that: Uber customers are very sensitive to the issue of prices and the competition risks playing everything on this aspect. Lastly, not having its own cars, the threat of suppliers, another decisive factor in Porter’s 5 Forces model, is also considered high for a company like Uber.