Learn how to use the Five Forces Model to analyze industries and companies with an example
Michael Porter is considered one of the most influential scholars in business. He has written extensively on competitive strategy and has helped numerous companies formulate their strategies. Over years, companies and academics have used the five forces model to analyze the industry attractiveness and to understand the forces that shape competition within an industry.
Porter’s Five Forces model provides an in-depth understanding of a firm’s current competitiveness and highlights ways to improve competitiveness.
Michael Porter outlines five forces for competitive analysis:
1) Threat of New Entrants
Consider the ease with which new companies can enter the market. Many factors need to be considered, such as barriers to entry (patents and high set-up costs), the profitability of the business, and the brand's reputation.
2) Threat of Substitute products
Analyze how easily your products can be substituted with others. It will depend on factors such as its relative price, accessibility, and quality. All alternatives should be considered, not just similar products. As an example, airlines compete not just with other airlines, but with train and bus operators as well.
3) Bargaining Power of Buyers
Analyze your buyers' strengths. Do buyers have the upper hand in this market? Can buyers easily switch brands? Could some of your customers be in such a strong position to make you vulnerable? What impact will it have on your company if you're dealing with businesses with low-profit margins?
4) Bargaining Power of Suppliers
Know how strong your suppliers are. Is there a supplier you are dependent upon? Is there anything you can do to reduce this? What are the chances that the supplier would be able to sell directly to your customers if it did not depend on your business? Is there an alternative product or method you could use to reduce your vulnerability?
5) Rivalry among Existing Competitors.
In industry analysis, it is important to understand who your competitors are and how you compare to them. From the outside looking in, it may seem that everyone is a competitor. However, take a closer look and you will find that there are both direct and indirect competitors depending on the industry. For example, the direct competitor for Netflix is Amazon Prime, Disney+, Hulu, etc but its indirect competition in games such as PUBG, Fortnite, etc.
Ask these questions to understand the competition:
Do they pose a threat?
How do they compare in terms of strengths and weaknesses?
Would you be able to survive a price war or other aggressive strategies?
Do they demonstrate innovation?
Is it easy for customers to switch companies?
What is the number of competitors?
Are there any strong companies?
Are there any newcomers in your market that will take your products by storm or replace them with others?
Analysis of the airline industry
It's no secret that the airline industry has been one of the least profitable over the past decade. Airlines have been struggling with various challenges such as fluctuating fuel prices, inexpensive tickets, high maintenance, terrorism, taxes, and an unfavorable exchange rate. Although there have been some short-term profits, most airlines have been losing money for a long time.
According to the author Joan Magretta, despite having billions in revenue, these companies are chronically bad businesses. Understanding Porter's five forces will help you understand why major airlines are consistently unprofitable. The five forces analysis is a framework for industry analysis and business strategy development.
Michael Porter explained the model using the airline industry. This article discusses how Michael Porter’s Five Forces model is used to analyze the global airline industry.
1) Bargaining power of Suppliers:
A handful of aircraft manufacturers. The airplane manufacturing industry is very different from other industries because the majority of aircraft are made by just three companies.
The labor union, which can take on many different forms, bargains for the rights of its workers. As the union works to improve the employment situation for its workers, it often negotiates with airline companies to make sure that they are paid handsomely.
2) Bargaining power of Buyers:
A study revealed that buyers are price sensitive and will jump on the opportunity to buy a ticket at a lower cost. Also, buyers have low switching costs and search for better prices on the internet. This means that if a company wants to keep customers, they need to offer competitive prices.
In general, buyers aren't interested in high-end features such as more comfortable seating or a better customer experience.
Partly, this was caused by the airline industry - they practice yield management i.e. determining the price of the same seat dependent on when a ticket was bought. Although this may have seemed like an effective way to segment prices, it actually taught customers to shop around.
3) Rivalry among Competitors
There is fierce competition among airlines and it has resulted in lower prices and lower profits. In the airline industry, every seat that is vacant is like a perishable item. Thus, competitive pricing ensures maximum occupied seats on planes.
4) Threat of New Entrants
In the past, it was very complicated and expensive to start an airline. One had to buy a plane, get approval from the authorities, hire pilots and crew members. However, new entrants into the market can now start an airline by simply leasing a plane from a major airline for a lower cost. Leasing is a business arrangement between two parties in which one party, the lessor, transfers ownership of an asset (for a specific period), such as an aircraft, to another party, the lessee. Failed airlines have extra planes leading to excess capacity.
5) Threat of Substitutes
Air travel has become more expensive in recent years, especially for short trips. On the other hand, technology is making it easier to substitute air travel for other forms of transportation. This causes prices for tickets to either go down or stay the same. For example, train tickets are more affordable than they have been in years because trains are cheaper to operate than airplanes.
By reviewing all five factors, you can determine the company's strengths and weaknesses as well as its direction in terms of competitiveness. However, one of the weaknesses of the five forces model is that it only focuses on external issues, so his approach is often used alongside complementary models that produce better insights into the internal factors that affect a company's competitiveness.