Porter’s Five Forces is a model for analyzing its proposed five competitive forces prevalent in all industries. It simplifies the process of recognizing industry weaknesses and strengths to gain competitive advantage from them. In a procurement context, it can be used to determine a procurement category’s forces. Therefore, it can be a vital tool in the formation of a category strategy, sourcing plans, negotiation plans and supplier management strategy.
Created by Harvard Business School professor, Michael E. Porter, the Five Forces examine an industry’s attractiveness. Since its 1979 publication, the tool has been widely used to understand why several industries can sustain varying levels of profitability. Now, it is among the most well-known and popular business strategy tools.
Porter urged organizations to analyze the dominant forces in their wider business environment, not just their competitors’ moves. From a procurement perspective, it is important to consider both the supplier and its operating enviroment to get a better understanding of the current forces acting upon it. It is also important to understand the broader category forces that could affect future category strategy and planning and inform negotiation plans.
Porter's Five Forces
Porter’s Five Forces model has long been used to analyze a company’s industry structure and corporate strategy. Procurement too can use the model to assess category forces to inform many steps of the procurement process.
These five forces play a role in measuring industry attractiveness, profitability, and competition level. They are:
- Competitive Rivalry
The first among Porter’s Five Forces examines the number of competitors in an industry. It also analyzes their strength or ability to undermine a company. A high number of competitors with comparable products and services normally reduces a company’s power. Industries with a low number of competitors would normally increase a company’s power. When competition is high a buyer would normally be able to secure a deal that is beneficial to them, when competition is low a supplier would push for deals that suit them.
- Supplier Power
The number of suppliers of vital inputs, the uniqueness of these inputs, and the cost of switching suppliers affect the supplier power factor.
A company’s dependency on a supplier is directly proportional to the number of suppliers in the industry. The fewer the suppliers, the more dependency. Thus, giving suppliers more ability power to increase input costs or demand other trade benefits. Conversely, more suppliers or low supplier switching costs help companies minimize input costs and potentially increase organizational profits.
- Buyer Power
A company’s total number of customers or buyers, the significance of each buyer, and the cost of finding new markets or customers for outputs impact the amount of buyer power there is in a market.
Smaller numbers of buyers in a market usually command more power. Each buyer can bargain for better deals and lower prices within such a base. On the other hand, companies with a larger number of buyers will find it easier to charge higher prices.
- Threat of New Entrants
Established companies could find their position weakened if new rivals enter the market at less time and expense. Similarly, if protection for a company’s key technologies is low, new entrants could easily establish themselves as key competitors.
The ideal environment for existing companies is in an industry with strong entry barriers. Such an environment will provide them with a fair advantage in charging higher prices and negotiating better deals due to a lower number of competitors.
In procurement, it is important to assess potential new entrants to create more competition in the category or with the supplier to improve the negotiation power of an organization.
- Threat of Substitutes
A good or service that can replace a company’s products or services is an obvious threat.
Companies offering goods or services that are hard to substitute are more likely to find a favorable position. They will hold power to raise prices and settle for favorable terms. However, if close substitutes for a product are available, customers may choose to forgo purchase from the company. Thus, the company’s power weakens.
In procurement, this is also a vital aspect to improve a buying position. Having alternatives to a solution will increase the power in negotiations with suppliers.
Conclusion
Porter’s Five Forces is a crucial business strategy tool for analyzing an industry’s primary competitive forces. This information helps in assessing industry attractiveness. Also, it zeroes in on the areas that require strategic adjustments to enhance profitability.
The Five Forces model is especially beneficial when entering a new industry or starting a new business. The tool can also be put to effective use by entrepreneurs, marketers, and managers in determining product profitability.
For procurement, it is helpful in assessing category dynamics or reviewing a supplier’s operating market to identify opportunities or weaknesses that could create negotiating power or organizational competitive advantage.
Key Takeaways
The Porter’s Five Forces model is a great tool for the procurement professional to use when assessing both a category and a supplier. The key things to remember are:
- Only assess an individual category or supplier at a time.
- The tool can be used in many parts of the procurement process, not just in market assessment. It can be used during sourcing, market research, negation planning, supplier management and category strategies.
- The tool should be used regularly when being applied in management processes like category planning and supplier management. Reviewing each 12 months to ensure any new developments are understood and applied.
