Five Force Analysis
Five Forces analysis is a framework for industry analysis and business strategy development developed by Michael Porter of Harvard Business School in 1979. It is a tool used to analyze the competitive environment in an industry, and it identifies five forces which are likely to have a major effect on how companies in an industry compete and the profitability of the industry. The five forces are: 1) buyers, 2) suppliers, 3) substitutes, 4) potential entrants, and 5) competitive rivalry.
Buyers
Buyers are the customers of an industry. They influence the profitability of the industry because they determine what they are willing and able to pay for the product. When buyers have more power, they are able to drive down the prices of the product and force the supplier to reduce their profits or exit the market. This is especially true when there are few buyers in the industry, when the buyers have much information about the product, or if the buyers purchase a large portion of the industry’s output.
Suppliers
Suppliers are the companies or individuals who provide inputs for an industry. They greatly influence the profitability of an industry because if the suppliers increase their prices, the cost of production goes up and the companies have to either raise their prices, reducing demand, or accept lower profits. This is especially true when suppliers have few competitors, when the input of the supplier represents a large portion of the company’s costs, or when the industry has to purchase specialized inputs.
Substitutes
Substitutes are products that may satisfy the same need as the product of a particular industry. They can take away potential demand because instead of purchasing the product of the industry, people can purchase the substitute which can be cheaper or more convenient. This can also drive down the prices of the product because if people are more likely to purchase the substitute, the companies have to lower their prices to remain competitive.
Potential Entrants
Potential entrants are companies that may enter a particular industry. If there are high barriers to entry, it may be difficult for companies to enter the industry and the businesses that are in the industry are able to maintain their profits. However, if the barriers to entry are low, it can be easy for new companies to enter the industry and this can lead to an increase in competition and a decrease in profits.
Competitive Rivalry
Competitive rivalry is the competition between existing companies in an industry. This competition can lead to aggressive pricing by the companies to gain market share and this can drive down profits for all of the companies in the industry. This is especially true when there are a small number of competitors, when the products in the industry are all similar, or when the companies are highly dependent on their customers.
Conclusion
The five forces analysis is a framework that helps businesses to analyze the competitive environment in their industry and the factors that influence the profitability of the industry. By understanding the five forces in their industry, companies can better structure their strategies to maximize their profits and stay competitive.
