Understanding Michael E. Porter’s Five Forces in market analysis
One of the greatest concerns of private sector is profit opportunity. Which factors determine the level of profit that a private company can have?
In the book Competitive Advantage Creating and Sustaining Superior Performance, M. E. Porter gives 2 central questions relating this above issue:
- Question 1: What are the determinants of industries’ attractiveness for long-term profitability?
Not all industries have the equal opportunities for gaining profitability. The inherent profitability of each industry is one of the most important influencing factors of the profitability of a firm.
- Question 2: M. E. Porter gives other question in competitive strategy of a firm. Competitive strategy is the search for a favourable competitive position in an industry. The aim of competitive strategy is to establish a profitable and sustainable position against the forces that determine the industry competition. What is the determinants of a company’s relative competitive position within an industry?
A firm in a very attractive industry may not gain large profits because they choose the competitive strategy that force them to the poor competitive position. Conversely, a firm may get much profit in an unattractive industry due to their efforts in implementing their competitive strategy
Both questions are dynamic. Industry attractiveness and competitive position change. Industries become more or less attractive over time and competitive position reflects an unending battle among competitors. Both industry attractiveness and competitive position can be shaped by a firm. This is what makes the choice of competitive strategy become more challenging and exciting. While industry attractiveness is partly a reflection of factors over which a firm has little influence, competitive strategy has considerable power to make an industry more or less attractive. Simultaneously, the firm can improve or erode their competition position within its industry. Competitive strategy is not only the response to the market environment in which a firm operates but also influence on that environment.
Porter describes 5 competitive forces that determine the industry attractiveness and how these forces change over time and can be influenced by firm’s competitive strategy. This is mentioned in Figure 2.5 in L4M2 Study Guide – Defining Business Needs.
It highlights all the elements of industry structure that may drive competition in an industry. Not all of the five forces will be equally important in any particular industry. Every industry is unique and has its own unique structure. The five forces framework help a firm to outline the holistic picture of their industry and then pinpoint those factors that are critical to competition in its industry. Based on the understanding of the market, the company makes decision on the type of competitive strategy such as cost leadership, differentiation or focus strategy.