Porter's Five Forces - Still a useful tool
Michael Porter's work, deeply based in economics as it was, has come under criticism in recent years. He was once the pin up boy (figuratively) of strategic management but the world is moving away from rationale economics and generic strategies (not fast enough for my liking) and Porter's theories don't dominate like they did through the 80s, 90s' and even the 00's. Not helped was when his own consulting company, in November 2012, was unable to pay its bills and was forced to file for bankruptcy protection.
However let's not throw the baby out with the bath water as many aspects of his thinking and work remain fundamental to understanding what is going on around us as we consider our strategic options. In particular, organisations don't operate in a vacuum and so it is important to always take a good honest look at the industry(s) in which they operate.
Porter outlined a technique for industry analysis in his 1985 book Competitive Advantage which was developed into the model - Porter's 5 forces. It provides a nice, simple way to look at the prospects of profitability in an industry and can be done over dinner on the back of an envelope (in true entrepreneurial style).
Porter’s 5 forces model is a tool for analysing an industry or market to gain an indication of the likely future profitability. If you are operating in a dog of an industry, no matter how strategically well positioned you are, it will be difficult to deliver consistent bottom line profitability.
The model looks at five areas in an industry and you have to use your judgement to assess the relative strength of those areas:
- Threat of new entrants – how easily can a new organisation enter the market?
- Rivalry of existing competitors – how strong is competition for market share?
- Pressure from substitutes – how many viable substitutes are available?
- Bargaining power of buyers – how much leverage does the buyer have to affect the price?
- Bargaining power of suppliers – how much leverage do suppliers have on the market?
The following model displays Porter’s model as a worked example and the strengths in relation to the New Zealand petrol retailing industry.
A quick look at the forces reveals that apart from oil suppliers who have the power to set whatever price they collectively feel like, there are no strong forces able to impact on the profitability of the industry. This indicates that the industry should be, and is, highly profitable and it will remain that way until something in the industry changes.
Porter's 5 forces remains a simple and effective way to get a feeling for industry profitability. As a manager, executive or consultant, it should always be nestled in your strategic management toolkit.