Porter's Five Forces explained so you can understand the underlying business principles. The Porter's Five Forces framework isn't a framework that is required or used in the consulting case interview. But you should understand the individual components and they may be items that you would use to look at a business problem. Consultant's should be familiar with each of Porter's Five Forces, and understand how they may effect a business, or create opportunities for a business. Listen to Jenny Rae La Roux, Managing Director of Management Consulted, as she gives a point by point explanation of Porter's Five Forces.
Porter's Five Forces Explained- YouTube Transcription
Porter's Five Forces. It's a concept that every consultant vaguely feels like they should understand, but many don't. And as you're starting your case interview preparation process, or if you're working on the job, and you haven't engaged with Porter's Five Forces, it's an important tool to help you understand how to look at a market or an industry and identify potential problems. That either your company that you're working for, or a client could have.
I'm Jenny Rae La Roux the Managing Director of Management Consulted. And I'm excited to walk you through what Porter's Five Forces are and how you use them as a diagnostic tool to identify how businesses can improve.
Force 1: Competition In An Industry
The first cornerstone idea of Porter's Five Forces is the central force. Which is competition in an industry. Porter's Five Forces by nature is not extremely quantitative, it's a qualitative idea. But if you were to make it consulting quantitative, if you were to drive home metrics, this would be the idea that there are percentages or distributions of the number of players that offer the same or similar products and services inside an industry. And here's the fundamental take away from it. The more players there are, the more difficult it is to protect yourself as an existing player from new entrants or from disruptive entrants in the market.
Think of this as the difference in a curve between a monopoly, a single player that has a complete lockdown on the market. Maybe it's through government regulation, maybe it's through scale, maybe it's through network effects, but the single monopoly player has a lock down. All the way to a completely fragmented market. A market where you have no brand loyalty, the ability to switch at a very low switching cost, and thousands of suppliers. Let's call it restaurants for example. So monopoly versus restaurants. The two of those are totally different industries, and success in those industries have very different dynamics. Associated with this core idea of competition in an industry, are the four other pieces of Porter's Five Forces.
Force 2: Potential Of New Entrants Into An Industry
Step number two, or force number two is: the potential of new entrants into an industry. What does this mean? It means that sometimes in industries especially industries where you see those more monopolies like characteristics, there are hindrances to new entrants getting in. One of the terms that consultants use as "barriers to entry". It makes it so that there's a very high investment cost, or regulation cost, in order to get into an industry. And you'll see industries that are characterized by this.
Pharmaceuticals are both highly regulated and also require high investments. So the threat of new entrants in pharmaceuticals is not severe. But let's say that you're interested in creating I don't know, an apron for a local market. And you want to sell that apron at a farmers market. It's very easy for the next person to build an apron that's just like yours. So a threat of entering that business is incredibly high. That's force number two, the potential of new entrants in an industry.
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Force 3: Power Of Customers
Force number three, again associated with this concept of competition, or the intensity of the rivalry, is the power of customers. In a market where there are few players but a lot of customers, the customers don't have a lot of power. They can't consolidate. But in a market where there are many players, and a few customers, that is a tricky market. And this is one of the ways that a company like Walmart, has succeeded in its business. They've identified themselves as one of the main consolidated retail customers for many different large brands. So they are an essential partner and that gives them power and leverage. The power of the customer to drive down prices from those that are supplying to them.
Force 4: Threat Of Substitutes
Force number four, again associated with the intensity of the rivalry, are the threat of substitutes. If it's very easy to switch one product for another, the threat of substitutes is high. And we've seen this in examples like Dollar Shave Club versus Gillette. It wasn't actually very hard, not as hard is everyone thought, to disrupt Gillette. And Gillette was a huge company with major spend behind it, with a relatively rambunctious start-up. Because it's not that hard for somebody to switch their razor. It's not something that is incredibly tailored. It's definitely not regulated, and it's something that somebody would be willing to try once, and then if they didn't like it they could easily go back to the initial product.
But think about something like a part for a car. There aren't a lot of substitutes for a part for a car. Especially if you have a car where the supply chain is very controlled, like a Tesla. You can't just go walk into any WalMart and grab a part for that car. You have to have THE specific part, that fits THAT specific car. So those kinds of differences create threats of substitutes, or no threat of substitutes in a market.
Force 5: Supplier Power In A Market
And then Porter's Five Forces 5, is supplier power in a market. Once again, if there are many people that are playing in a market that are buying services, but only a few suppliers, that creates power on behalf of the suppliers. So let's say that you were interested in starting a company. And there were only three developers in the entire world that could build a website for you. It would be relatively impossible for you to negotiate with them, on their price or to play them off one another in terms of their quality or their service. You would pick off of a menu of three.
But in reality there's not a lot of supplier power in the developer market because there are so many developers that are available out there. Look there are differences between great ones and good ones and everything else, but if you want to build a website you can build it and you can find a developer to do that for you. So understanding the threat or the challenge or the importance of supplier power is Porter's fifth force.
Summary Thoughts
Those five forces for Porter's, can help companies identify where threats and challenges present themselves inside their industry. It can help understand how to invest for the future, and also how to fix problems that exists inside a business, based on playbooks from similar companies in similar or peer type industries. If you don't understand Porter's Five Forces for the case interview, that's okay. You don't have to understand a hundred percent of it. And you're not going to use it as one of your structures. But these ideas underneath here, are incredibly important from a strategic toolkit perspective.
Porter's Five Forces Corporate Training
If you want to know more about Porter's Five Forces, we do corporate training, as well as training for case interviews, on structures and strategies in competition and we would love to help you. You can find more information at www.managementconsulted.com.
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