Amongst the tools to evaluate the feasibility of a new project or business line, and to help to make the decision whether to go ahead, iterate or give up, the Porter’s Five Forces analysis (PFFA) focus on the industry in which we are going to operate.
In a nutshell, it allows us to assess the attractiveness of this industry in terms of its profitability. In contrast to PESTEL analysis, which refers to the macro environment, the PFFA sticks to the sector and the description and status of its main 5 driving forces:
- The Threat of New Entrants:
The most attractive segment is defined by high entry barriers and low exit barriers. We must answer the following questions regarding the particular market:
- Is it easy to enter into it or are there any entry barriers, as patents and contracts?
- How big are the capital requirements and the economies of scale?
- How are the existent competitors going to react when a new agent arises?
- Is there product differentiation and customer loyalty to established brands?
- Are there any sunk costs?
- Is it necessary any specific knowledge/contacts to access to distribution?
- The Bargaining Power of Suppliers
Suppliers represent the market of the company’s inputs, and the more bargaining power they have, the less attractive is the industry. Some factors that affect it are:
- Firm switching costs compared to supplier switching costs
- Degree of differentiation of the inputs
- Presence of substitute inputs
- Ability of the suppliers of vertical integration
- Importance of the input cost relatively to the final product cost
- The Threat of Substitutes
Substitutes are products and services than can be used to satisfy the same need as ours, but that are structurally and physically different (in contrast to a competitor’s similar product). Some factors that affect this force are:
- Ease of substitution
- Availability of substitution
- Buyer switching costs
- Elasticity of the demand
- The Bargaining Power of Buyers/customers
Buyers/consumers represent the market of the company’s outputs. Some factors that affect this force are:
- Buyer price sensitivity
- Buyer switching costs relative to firm switching costs
- Degree of differentiation of the company’s product and loyalty to it
- Availability of competitors’ products and substitute products
- Degree of access to information of the buyers
- The Industry Rivalry
At the end, competitors are the agents which you have to split the cake with, so they are usually the major determinant of the competitiveness of the industry . Some factors that affect this force are;
- Possession of a competitive advantage
- Firm concentration ratio
- Capacity of affecting other competitors’ price
- Level of advertising expense
Steps to perform the Porter’s Five Forces Analysis:
- Determine the concrete industry of interest.
- If your business steps into different industries, you must perform an individual Porter’s five forces analysis for each of them.
- Assess each one of the 5 forces in a qualitative way
- Taking into account all the factors and the available information, answer to the question “how is each forced perceived in this industry”?
- Give a score for each force
- 0 means no force and 10 maximum force. If you find difficult to concrete the numbers, think of other industries and compare with them.
- Get the average score for the five forces
- Write the final conclusions of the analysis
- Is it an attractive industry or not? It’s important to take into account that the PFFA tells the industry average profitability, but there can be one or more businesses that deviate, exceeding it (a successful business model) or being lower (for example, because of a lack of resources, a poor application of good practices or a bad economic model)
