In the HR world the importance of “being strategic,” “getting a seat at the table,” and “being part of the C-Suite” is constantly preached. While important, these catchphrases no longer have the same impact they once did. We should be assessing the threats that affect our organizations and human resources departments. If we did, we would be able to develop proactive plans that address both the risks and the competitive advantages that HR provides.
HR needs a framework to determine the competitive intensity and profitability of a market in order to identify potential threats, prioritize their impact, and develop a game plan to compete. This strategy model, known as the Five Forces Analysis, is widely used by business leaders. It’s time for HR to start using it as well.
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What Are Porter’s Five Forces?
Porter’s Five Forces is a model that identifies and analyzes five competitive forces that shape every industry and aids in determining an industry’s strengths and weaknesses. The Five Forces analysis is frequently used to determine corporate strategy by identifying the structure of an industry.
To better understand industry competition and increase a company’s long-term profitability, Porter’s model can be applied to any sector of the economy. The Five Forces model was developed by Harvard Business School professor Michael E. Porter.
Porter’s 5 forces are:
- Competition in the industry
- Potential of new entrants into the industry
- Power of suppliers
- Power of customers
- Threat of substitute products
Understanding Porter’s Five Forces
Porter’s Five Forces is a business analysis model that helps to explain why different industries can maintain varying levels of profitability. In 1979, Michael E. Porter’s book Competitive Strategy: Techniques for Analyzing Industries and Competitors published the model.
The Five Forces model is widely used to analyze a company’s industry structure as well as its corporate strategy. With some caveats, Porter identified five undeniable forces that shape every market and industry in the world. The Five Forces model is commonly used to assess the intensity, attractiveness, and profitability of an industry or market.
1. Competition in the Industry
The first of the Five Forces is the number of competitors and their ability to undercut a company. The more competitors there are, as well as the number of comparable products and services available, the less powerful a company becomes.
Suppliers and buyers look for a company’s competitors if they can provide a better deal or lower prices. When competitive rivalry is low, a company has more leverage to charge higher prices and negotiate better terms in order to increase sales and profits.
2. Potential of New Entrants Into an Industry
The power of a company is also affected by new entrants into its market. The less time and money it takes a competitor to enter and compete in a company’s market, the more an established company’s position may be significantly weakened.
An industry with high entry barriers is ideal for existing companies in that industry because the company can charge higher prices and negotiate better terms.
3. Power of Suppliers
The next factor in the Porter model considers how easily suppliers can raise input costs. It is influenced by the number of suppliers of a good or service’s key inputs, how unique these inputs are, and how much it would cost a company to switch to a different supplier. The more suppliers an industry has, the more a company depends on them.
As a result, the supplier has more bargaining power and can raise input costs and seek other trade advantages. When there are many suppliers or low switching costs between rival suppliers, a company can keep its input costs low and its profits high.
4. Power of Customers
Customers’ ability to drive down prices or their level of power is one of the Five Forces. It is influenced by the number of buyers or customers a company has, the importance of each customer, and the cost of finding new customers or markets for its output
A smaller and more powerful customer base means that each customer has more negotiating power to get lower prices and better deals. A company with a large number of smaller, independent customers will find it easier to charge higher prices in order to increase profitability.
5. Threat of Substitutes
The fifth and final force is concerned with substitutes. Threatened by substitute goods or services that can be used in place of a company’s products or services. Companies that manufacture goods or provide services for which there are no close substitutes will have more leverage to raise prices and secure favorable terms. Customers will have the option to forego purchasing a company’s product if close substitutes are available, and a company’s power will be weakened.
Understanding Porter’s Five Forces and how they apply to an industry can help a company adjust its business strategy to make better use of its resources and generate higher profits for its shareholders.
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What Are Some Drawbacks of Porter’s Five Forces?
Once you understand each Force, it is time to identify the threats and bargaining powers that surround you. We don’t usually think about competing for external forces in HR, but that doesn’t mean they don’t exist.
The Five Forces model has some limitations, including the fact that it is backward-looking. Thich means that its findings are mostly relevant only in the short term. This limitation is exacerbated by the impact of globalization.
Another significant disadvantage is the tendency to apply the five forces to an individual company rather than an entire industry, as the framework was designed to do.
Another issue is that the framework is designed in such a way that each company is assigned to a single industry group, even though some companies operate in more than one. Another issue is the requirement to evaluate all five forces equally when some industries are not as heavily influenced by all five.
The Bottom Line
Porter’s Five Forces framework defines the most important criteria to consider when examining a corporation’s competitive landscape. High threat levels usually indicate lower future profits, and vice versa. For example, if there are no entry barriers, an early startup in a rapidly growing industry may be quickly shut down. Similarly, a company selling products with numerous substitutes will be unable to use pricing power to improve margins, and it may even lose market share to competitors.
When making long-term plans, HR must look beyond their immediate business and to their industry as a whole, which is why Porter’s model has become so widely adopted. Porter’s still plays an important role in this, but it should not be the only tool in the toolbox when developing an HR strategy.
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