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February 02, 2018

Porter's Five Forces

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At MyConsultingCoach we often emphasise the importance of avoiding relying on frameworks. And we are writing an article on the father of them all: Porter’s Five Forces! The reason why we would like to go over this topic is that even though the methodology is quite outdated and never used in consulting, it is useful for a consultant to know it as it can sometimes serve as a tool for more complex analyses. 

What are the five forces?

Porter’s five forces is a model of industrial competition and a way to analyse the market and specific sectors as well as the company that you are working for. That analysis helps your clients look at competition rivalry within a market which should paint a picture of how competitive the market is overall. 

The key and the central force of the 5 forces is ‘Competitive Rivalry’. Porter believes that the more competitive the market the higher the likelihood that a participant of that market will constantly try to improve it (for example by investment). The main idea rests on the point that competition drives down prices which will lower the unit cost (whether that is a good or a service). This usually leads to the development of new technology (as a result of an attempt to reduce unit prices for example) or platforms. Often, the need for new technology which will reduce the cost of the competitor will require the services of a consultant. So, it is vital that whilst you recognise the role that this analytical tool can play in your arsenal you also recognise that this process generates the need for consultancy in its own right. 

The consequences of Porter’s key force are presented in the next four forces which explain the impact that these have on the competitive rivalry. High levels of competition will lead to the ‘Power of Consumers’ and ‘Power of Suppliers’ rising and increase the ‘Threat of Substitutes’ and the ‘Threat of New Entrants’. 

One of the questions to ask is regarding the ‘Power of Suppliers’. How powerful are your suppliers? Can your suppliers singlehandedly dictate the prices that they charge you? The rising power of suppliers can be problematic for your client because of their growing power and ability to dictate prices comes an increased cost. This cost will then have to be passed to customers (which will decrease your client’s competitiveness) or it will hit your client’s profit. 

The opposite of this spectrum is the ‘Power of Customers’. Powerful customers can also have a knock-on effect on the prices according to Porter’s model. The company (your client) will be keen on being able to set the price rather than have it dictated to them by the customers. Michael Porter argues that a lot of companies will focus on addressing this as it is relatively simple. A very basic way of addressing this issue is to disallow the customers from negotiating a price. This, however, has an impact on the competitive rivalry of your client. As a consultant, you may be asked to look at other ways of reducing the power of customers. 

The theory of five forces also argues that every business seeks to eradicate the ‘Threat of New Entrants’. The reasons for that are quite simple. New entrants will compete with companies who are already a part of the market which can have a negative effect on the competitiveness of those companies.  A way of addressing that is by creating a barrier to entry. A key barrier which helps to stop new entrants is savings. This is easier for the existing companies as they will have had the time to do so. That money can then be used to drive down the prices to remain competitive or achieve a competitive edge on the new entrant. A good example of how stockpiling cash allows the existing players to remain competitive by eradicating the threat of new entrants is seen in large supermarkets which can offer hugely competitive prices thus, effectively, stopping new players from entering the market. 

Lastly, there is the ‘Threat of Substitute’ which is simply the danger that customers will choose a different product. The key and predominant strategy of dealing with this is for the company to have a Unique Selling Point (USP). This reduces the threat of customers being able to find the same product elsewhere and increases the competitiveness of the business. If you are a branding consultant, for example, a client may employ you to help identify the USP and then to brand it in the most effective way. Relying on the rest of this analysis may be very useful in that case. The further issue with substitute products or goods is that it will decrease the value of the goods or services that are sold or provided by your client. The effect of that is that more power is given to the customers. An effective strategy is to ensure that the product or service provided is ‘inelastic’ which is based largely on having a good USP. 

Putting Porter to Use

Porters 5 forces is an effective tool when analysing a company that employs you as a consultant. It will help you come up with strategies to put forward to your client which will improve their business. By assessing the five forces you will be able to determine how the attractiveness of the market or the industry that your client is in. In general, the stronger these forces the less attractive the market or industry as it is more competitive which means that in times of increased competition there is more strain on the company. The main focus in your role as a consultant will not only be to assess these for your client but also to consider and propose viable solutions for your client. 

For more free material on case interviews and business related concepts, visit the section on case interview.

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