Porter's Five Forces: A Strategic Management Tool - MGMT 449

Michael Porter, a celebrated academic, elaborates on the five fundamental forces that drive industry competition in his article “The Five Competitive Forces that Shape Strategy”. The basis of his theory is that competition runs far deeper than most strategists might believe. The threat of new entrants, bargaining power of suppliers, threat of substitutes, bargaining power of buyers, and rivalry among existing competitors are key elements in defining the structure and nature of an industry. These universal principles cohesively design the competition of any industry. Porter emphasizes the importance of understanding each of the forces for strategists and investors as this will allow companies to be more perceptive to fluctuations in the market and provide a comprehensive understanding of industry structure. The Five Forces have a paramount role in developing strategy. Only in acquiring a more comprehensive grasp of their reach can strategists, executives, and investors gain a competitive advantage. Porter’s theory covers how the Forces shape competition and how they can provide critical insight to changing industries. The most important takeaway from the article, however, might be the strategic implications of these Five Forces.

How the Five Forces Shape Competition:

Porter urges strategists to consider the strongest competitive force to understand industry profitability. For example, it is the threat of new entrants, not the entry itself, that limits profitability. High entry barriers such as large capital requirements and unequal access to distribution channels contribute the most to this element. Maintaining these barriers allows for incumbent businesses to perpetuate their advantages. Regarding suppliers, profitability becomes limited when industries are offered minimal resources or costs can’t be transferred to finished products or services. This is particularly defeating if the supplier does not depend on the specific industry for the majority of its revenues. Contrastingly, large buyers can leverage their power by threatening to buy products elsewhere or integrating backwards. The latter might reveal itself in ways such as soft drink distributors producing their own drinkware. This ties in loosely to the threat of substitutes. The largest concern industries face, in this regard, has to do with either a decent price-performance trade-off or that buyer’s cost of switching is low. Finally, existing rivalries can become apparent in several ways. However, as Porter emphasized, it is the strongest force that strategist need be most concerned about. This force is the most widely discussed but may also in turn be misunderstood. More intense rivalries might arise for many reasons, but it is important to distinguish these from healthy rivalries which are just as abundant and can result in profitable industries.

How the Five Forces Offer Insight in Changing Industries:

All strategists are aware that industries are fickle, but in approaching the system with a more trained eye one could gather information that can aid long-term decision-making processes. Keeping the different aspects of each force in mind, it is clear to see how in using Porter’s model, one can develop a more holistic view of an industry. Industries might notice that some threats of new entry are time sensitive; expiring patents or adopting new (and in turn, more expensive) activities that boost efficiency, all the while raising entry barriers and forcing smaller players out of business. Buyers and suppliers are also subject to such changes. As technologies become more advanced and easily accessible, certain industries fall. Porter exemplifies this relationship through travel agents whose commissions have significantly decreased since airline tickets have become directly available to consumers online. Similarly, technology plays a large role in the everchanging threat of substitutions. As new operations and methods are discovered, older products become obsolete. Rivalry is more constant than its brothers, but as industries mature, competitors distinctive features become blurred. Technology becomes more available and competitors begin to search for niche targets. This eliminates direct competition but is not a sound strategy according to Porter. The nature of this final force has revealed itself to be a critical element to profitability thus suggesting that diverse competition is necessary for industry growth.

Strategic Implications of the Five Forces:

Porter’s Five Forces can be used to analyze and determine new opportunities for potential entrants or within existing industries. Keen observation of the industry paired with a careful understanding of the competitive forces can help strategists outline the results of changing technology. Porter notes that the forces are synced with the development of technology. Therefore, in understanding that products and services will evolve, strategists can focus on how improvements will affect each of the forces. Firms can potentially employ the five forces to redistribute profits in an industry or expand the larger profit pool. Again, this requires an extensive grasp of the firm’s current standing and of its opportunities as illustrated by the Five Forces. Industry leaders have a responsibility to improve the industry structure by means of this comprehensive understanding. Improving the structure of an industry will provide opportunities for growth on both the buyer and supplier sides as well as push current technologies to become more efficient. This may lead to a larger profit pool. That said, leaders should not expect to reap the profits. The five forces determine which industries will excel and enjoy the largest market share. Further than this, the five forces are indispensable in defining industries. Illustrating where the true competition exists, the Five Forces allow strategists to make appropriate long-term decisions in simply understanding where relevant industries lie.

Porter’s revolutionary contribution to the realm of strategic management offers a valuable template for managers to use when analyzing their industries. Managers now have a series of avenues to explore prior to suggesting next steps for a firm’s improvement. Porter’s model forces strategists to consider all aspects of an industry before rushing into action. From simply understanding where an industry might sit in relation to its competitors or considering large-scale structural improvements, the Five Forces provide a comprehensive basis for strategy formulation and long-term decision-making processes. This implies more thoughtful consideration of both the market and the firm. The Five Forces encourage industry analysis from a structural perspective that inspires strategists to think more holistically.