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. 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. 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 it 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. 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 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
which 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. 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. 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. 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.