The Five Forces Model

The Five Forces Model
                    The five forces model is a framework for understanding the structure of an
industry and was developed by Harvard professor Michael Porter. Shown in
Figure 5.1, the framework is comprised of the forces that determine industry
profitability.6 These forces—the threat of substitutes, the entry of new competitors,
rivalry among existing firms, the bargaining power of suppliers, and the
bargaining power of buyers—determine the average rate of return for the firms
competing in a particular industry (e.g., the insurance industry) or a particular
segment of an industry (e.g., health insurance only).
                    Each of Porter’s five forces impacts the average rate of return for the firms in an industry by applying pressure on industry profitability. Well-managed companies try to position their firms in a way that avoids or diminishes these forces—in an attempt to beat the average rate of return for the industry. For example, the rivalry among existing firms in the energy bar industry is high. Element Bars has diminished the impact of this threat to its profitability by selling customized energy bars online and through special arrangements with businesses like spas and fitness centers that want to brand their own specialty energy bars.
                    In his book Competitive Advantage, Porter points out that industry profitability is not a function of only a product’s features. Although the book was published in 1980 and the dynamics of the industries mentioned have changed, Porter’s essential point still offers important insights for entrepreneurs such as the insight suggested by the following quote:
                   Industry profitability is not a function of what the product looks like or whether it embodies high or low technology but of industry structure. Some very mundane industries such as postage meters and grain trading are extremely profitable, while some more glamorous, high-technology industries such as personal computers and cable television are not profitable for many participants.7
                    The five competitive forces that determine industry profitability are described next. As mentioned in previous chapters, industry reports, produced by companies like Mintel, IBISWorld, and Standard & Poor’s NetAdvantage, provide substantive information for analyzing the impact of the five forces on specific industries. All three of these resources are available free through many university library Web
sites and are highlighted in the Internet Resources Table in Appendix 3.2.