Porter’s Five Forces analysis is a framework that helps you analyze the level of competition within a specific industry. This analysis is especially useful when you want to start a new business or enter a new part of an industry. Based on this working model, competition does not come only from your competitors.
Competition in an industry depends on five basic forces; Threat of new entrants, bargaining power of suppliers, bargaining power of buyers, threat of substitute products or services, and current competition within the industry. The overall strength of these forces determines the potential profit from an industry and thus can determine how attractive the industry is to entry.
If these five forces are in great tension (as in the airline industry), almost no company in the industry will receive an attractive return on investment. If the forces are softer (such as the soft drinks industry) there is room for greater returns. In the rest of the article, we will discuss each of these forces separately with the help of examples from the aviation industry so that you can get a better picture of them.
Table of Contents
Analysis of Porter’s 5 competitive forces
1- The threat of new entries
New entrants into an industry create new capacity and demand for market share. The seriousness of the threat depends on the barriers to entry in a given industry. The higher the barriers to entry in an industry, the lower the threat to existing industry players. Examples of barriers to entry can be the need for economies of scale, high customer loyalty to existing brands, the need for large capital, accumulated experience, government policies, and limited access to distribution channels.
Example: The threat of new entrants to the airline industry can be considered low to moderate. Starting an airline company requires significant capital. In addition, new entrants require licenses, insurance, distribution channels, and other approvals that are not easy to obtain when you are a new entrant to the industry.
It can also be expected that the current players have built up a huge base of experience over the years to save costs and increase service levels. A new entrant usually does not have this level of expertise and therefore gets a negative competitive advantage score from the start.
However, due to the liberalization of market access the availability of leasing options, and foreign financial support from banks, investors, and aviation industry owners, new doors are opening for new possible entries.
Although entering the aviation industry is not very attractive for new companies, it is not impossible either. Many low-cost airlines, such as Southwest Airlines, RyanAir, and EasyJet, have successfully entered the industry over the past years by introducing innovative cost-saving business models, thereby displacing major players in the market such as American Airlines, Delta have shaken Air and KLM.
2- Bargaining power of suppliers
This force analyzes how much power and control a company’s suppliers have over increasing their prices or reducing the quality of purchased goods and services, which can reduce the profitability potential of an industry. Supplier concentration and availability of alternative suppliers are important factors to consider when determining supplier power.
The smaller their number, the more powerful they will be. Businesses have more control when there are many suppliers. Sources of supplier power include switching costs for firms within an industry, the presence of available substitutes, the strength of their distribution channels, and the specificity or level of differentiation in the products or services the supplier provides.
Example: The bargaining power of suppliers in the airline industry can be considered very high. When we look at the main inputs that airlines need, they are heavily dependent on gasoline and airplanes. But these inputs are very much influenced by the external environment, where airlines have very little control over them. The price of airplane gasoline is affected by the fluctuations of the global oil markets, which can change drastically due to geopolitical reasons and other factors. In the field of airplanes, there are only two major suppliers in the world, Boeing and Airbus. As a result, Boeing and Airbus have a lot of bargaining power in terms of the prices they set.
3- Bargaining power of buyers
The bargaining power of buyers is described as a market of results. This force determines how much buyers can pressure sellers, which also affects buyers’ sensitivity to price changes. Customers become very powerful when they are few or have many alternatives to purchase.
In addition, it is very easy for them to go from one business to another. Purchasing power is low when buyers buy products in small quantities, buy independently, or the product sold by the seller is very different from the product offered by other competitors. The Internet has given consumers the power to be more informed and thus more empowered. Customers can easily compare prices online, get information about different products, and have immediate access to offers from other companies. Companies can take steps to reduce buyer power, such as implementing loyalty programs or by differentiating their products or services.
Example: The bargaining power of buyers in the airline industry is high. Customers can quickly check the prices of different companies with online comparisons on sites such as Expedia or, in the case of our own country, Alibaba. In addition, there is no switching fee in this process. Today, customers can go to their desired destination very easily with different airlines if it costs less for them. Therefore, brand loyalty does not seem very high in this context. Some airlines are trying to change this issue with frequent flyer programs with the aim of rewarding customers who buy tickets from them once in a while.
4- The threat of substitute products
The presence of products outside the realm of common product boundaries increases the tendency of customers to switch to an alternative. To discover these alternatives one must look beyond similar products branded differently by competitors. Instead, any product that fulfills a similar need for customers should be considered.
Energy drinks like Red Bull, for example, are not usually considered a competitor to coffee brands like Nespresso and Starbucks. Although both coffee and energy drinks fulfill a similar need to stay awake and get energy, customers may switch if they feel the price of the coffee or energy drink is too high. This issue ultimately affects the profitability of an industry, and as a result, it should be considered when evaluating the attractiveness of an industry.
Example: In the context of the airline industry, it can be said that the general need of customers is to travel. There are many alternatives to travel other than flying. Depending on the urgency and the desired distance to travel, customers can use the train or even travel by car. Especially in Asia, more and more people are using high-speed trains. In addition, the aviation industry is likely to have to compete very hard in the near future with Elon Musk’s Hyperloop model, where passengers travel by capsule inside a vacuum tube at a speed of over 1,200 km/h. Taking all of these into consideration, the threat of substitutes in the airline industry can be considered at least moderate to high.
5- Competition between current competitors
The last of Porter’s five forces examines current market competition, which is characterized by the number of current competitors and the capabilities of each. Competition is when the number of businesses of roughly equal size and power is high, where the industry is growing slowly, and customers can easily choose a competitor that offers a lower cost.
A good indicator of stiff competition can be the rate of concentration in an industry. The lower this rate, the greater the competitive tension. When there is a lot of competition, the possibility of competitors engaging in advertising and price wars are more likely, which can harm the bottom line of businesses. In addition, competition will be more intense when exit barriers are high and compel companies to stay in the industry even if their profitability reaches negative limits. These exit barriers can be, for example, long-term loans and high fixed costs.
Example: When we look at the air transportation industry in America, we see that this industry is highly competitive for several reasons, including the entry of companies with low costs, the rigid regulations of this industry where security leads to high costs and high exit barriers, and the fact that the market is very stagnant in terms of growth at the moment. The switching cost for customers is also very low and many players in this industry are of the same size, which results in fiercer competition among these companies. Considering all these things, it can be said that the competition among the current competitors in the aviation industry is high.
By looking at each of the competitive forces separately, you can design a focal map of the industry and its attractiveness. Note that different industries differ in attractiveness depending on the country you are looking at. Government policies, for example, are different in each country, and the number of suppliers and buyers is also different from one country to another.
Porter’s five competitive forces are a good starting point for evaluating an industry, but they should not be looked at alone. For example, you can combine these forces with value chain analysis or the VRIO framework to gain a better understanding of where your company’s competitive advantage comes from and how you can improve your position among competitors.
In addition, Porter’s five competitive forces are usually combined with a PESTEL analysis to give you a good overview of the organization’s environment. Finally, it should be said that this work format has also faced various criticisms from several experts. For example, some experts have said that this model requires a sixth force called complementarity to explain the reason behind strategic alliances and joint ventures.
This extended model is also known as the Value Net Model. Despite the criticisms leveled at this model, Porter’s five competitive forces are still one of the most widely used frameworks for strategy development and will likely remain so for the foreseeable future.
A complete list of Porter’s five competitive forces factors
The threat of new entries
Economies of scale
Differentiation between products
Brand identity and loyalty
Access to distribution channels
capital required
Access to the latest technology
Access to essential inputs
Lower cost benefits
The impact of learning and experience
Government policies
Cost of change
Expected reciprocity from current actors
Bargaining power of suppliers
Number of suppliers
Size of suppliers
Concentration of suppliers
Alternative availability for suppliers’ products
Uniqueness of suppliers’ services or products
Replacement cost for suppliers’ products
The threat of integration in front of suppliers
The threat of backward integration of the industry
Commitment of suppliers to the quality or service of industry products
Importance of volume for suppliers
Total industry cost generated by suppliers
Importance of the industry in terms of profits earned by the supplier
Bargaining power of buyers
The volume of buyers
Order size per buyer
Buyer focus
Buyers’ ability to substitute
The cost of switching buyers
Availability of information for buyers
Threatening buyers for backward integration
Industry threats to forward integration
Price sensitivity