Important business decisions such as entering a new category or market segment require in-depth strategic analysis. Some of the more important questions that need an answer are:
How attractive and profitable is the category I plan to penetrate?
Is it feasible for my company to enter this category?
What are my chances of successfully compete in the category?
Porter’s Five Forces is a industry analysis framework that helps business executives assess the attractiveness and profitability of a specific category or industry.
According to the famous business strategist and Harvard professor Michael Porter the five factors below impact the strategic decision making process:
Barriers to Entry
Entering a new industry or product category poses some obstacles, or challenges, to new entrants.
Barriers to entry include:
-the cost of entering a new market (financial and non-financial)
– the size of the players currently operating in that market
-the legal requirements required to become a player in the category
-the level of difficulty in building brand acceptance with consumers
Generally speaking the higher the entry barriers, the less attractive the segment or category.
The computer microprocessor market is dominated by Intel, and, to a lesser extent, AMD. No other company has managed to pose a real threat in this category, in part because the entry barriers are very high.
Financial costs aside, gathering the knowledge, creating manufacturing capabilities, and building acceptance among consumers keeps competition away.
Suppliers can greatly influence the attractiveness of a specific category. Hence, supplier power needs to be taken into account when performing an industry analysis. Some things to look at include:
-the number of suppliers in the category
-the difficulty in switching from one supplier to another
-the ability of suppliers to integrate vertically and manufacture the product themselves
-the criteria suppliers impose on new customers
Usually an industry dominated by only a few suppliers means less bargaining power for your firm.
In this situation suppliers are able to raise prices, reduce the quality or availability of products, with direct negative impact on your firm’s performance.
Buyers in a specific category could have a great impact on a new entrant’s profitability. The more bargaining power buyers have, the less attractive the market segment.
Some factors that influence buyers’ power are:
-the number of buyers in the category
-a buyer’s ability to choose from multiple offerings
-the availability of substitute products
-a price driven category
Let’s say you decided to become a real estate agent. With the slowdown in real estate activity in most parts of the world, pursuing a career in real estate is a tough decision to make.
The number of potential buyers is relatively low, while competition from other agents is fierce.
A home buyer can choose to be represented by a real estate agent or look for a house on his/her own (availability of alternative options). As a result of buyers’ power, many real estate agents are willing to work on very low commissions.
The level of competition is usually a very good indicator of a segment’s profitability. A market is less attractive if:
-there are many competitors available to service a stagnant or shrinking market segment
-the barriers to entry are low
-substitute products are readily available
-competition is very price-driven
-there are strong rivalries among competitors
The level of competition in the higher education market has been greatly impacted by technology. No too long ago the classic method of getting an education or learning a new skill was to attend a local college or university.
Today, local colleges and universities face strong competition from many directions: international institutions (via distance learning), independent websites that offer online courses (such as Coursera and Udemy), and private businesses and individual consultants who are experts in a particular field.
Threat of Substitute Products
The attractiveness of a market segment is in part dictated by consumers’ ability to choose from alternative products.
Let’s take the hotel industry as an example. When looking for a place to stay, consumers have many options: hotels, bed and breakfasts, private accommodation, camping, etc. The threat of substitute products in the hotel industry is very real.
Porter’s Five Forces could be used as part of an effective SWOT analysis, to highlight the external Opportunities and Threats a firm is facing. In order to have a complete picture, another industry framework, such as Resource Based View, has to be used to analyse Internal Strength and Weaknesses a firm could use to its advantage.