The five forces model is an industry and business analysis development strategy. This framework was created by Michael E. Porter, a professor at Harvard Business School in 1979. His method determined that every industry and business is affected by five forces: barriers to entry, supplier power, threat of substitutes, buy power and rivalry. This model attempts to explain the different situations businesses may experience when operating in the economic market place. Each force includes specific elements companies must overcome or prepare for when conducting business operations.
The first force in Porter’s five forces model is barriers to entry. These are the initial obstructions companies need to overcome when starting operations or entering new economic markets. Common barriers include high operating or materials costs, limited access to business inputs, government regulations or high capital requirements. Overcoming the barriers to entry leads companies to the force of supplier power.
Supplier power is the ability of companies supplying inputs to hold a competitive advantage over production companies needing these inputs to produce goods. Suppliers may concentrate their power by requiring high volume orders of inputs, force out cheaper substitute inputs, withhold access to inputs or supply inputs to select production companies. Porter dovetails supplier power force with the threat of substitute in his model.
The threat of substitutes represents the competition of companies selling high quality inputs or consumer goods with companies selling cheaper or inferior inputs and consumer goods. Substitute goods are the items businesses and consumers purchase when the original good is no longer available or too expensive to purchase. Cost of inputs and consumer response to price are the main threats against high quality, top-notch goods. The ability of consumers to purchase substitute goods leads to the buyer power force of the five forces model.
All businesses are subject to the purchasing power of consumers and other businesses. Porter notes in his five forces model that buyer information, price sensitivity, brand identity and bargaining leverage are all important parts of the buyer power force. Many consumers are unaware of the power they have against companies in a free market economic system. Businesses will make choices based on the response from consumer buying power and response to changes in the company products or services. This force leads to the final part of Porter’s five forces model: rivalry.
Rivalry is the competition among businesses for consumer dollars. Companies compete against each other to earn the highest profits and earn the highest market share possible. Porter has said that this is the driving force behind his model since companies must compete in the free market to earn profits. Without competition, companies may earn profits or they may not, depending on the response of consumers to the company’s goods and services.