Is it true that you can crack every market case with a Porter’s five forces model? Is it so easy to break into management consulting and to convince BCG, McKinsey and Bain of your skills? No, unfortunately it is not!
While Porter’s five forces model covers important factors such as supplier landscape, customer landscape, substitution products, threat of new entrants, and competitive rivalry, it does not cover everything and additional considerations may also be necessary in business cases.
The first segment of Porter's five forces model focuses on the bargaining power of suppliers. Factors such as supplier landscape, switching cost, and level of differentiation are important to consider. An example would be industries with different levels of supplier bargaining power.
The second aspect of the model is the bargaining power of customers, which is similar to supplier bargaining power. Factors such as customer landscape, switching cost, and differentiation level play a role, for example industries with different levels of customer bargaining power.
The third aspect is the threat of new market entrants. Factors such as IP protection, capital requirements, access to knowledge or resources, and brand loyalty are important in assessing the threat of new entrants.
The fourth aspect of Porter’s five forces model is the threat of substitutes, where switching cost and properties/prices of substitution products are important considerations, for example of a bus line and its alternatives, showing how different factors influence the threat of substitution products.
The final aspect is competitive rivalry, which involves analyzing the number of competitors, market shares, market entry barriers, market segments, unique selling propositions, and cost structures. The more competitors and less differentiation, the more intense the competition. It is essential to note the importance of market share, market entry barriers, market segments and economies of scale.
Additionally, we suggest considering two additional forces, namely the regulatory force and the political force. The regulatory force includes regulatory changes, subsidies, and preferences, while the political force involves political interests and reputation management.
In summary, Gabriel Goldbrain highlights the key aspects covered by the Porter's five forces model in analyzing markets and emphasizes the need to consider additional factors in specific business cases. He also suggests including the regulatory force and the political force in the analysis.
Video transcript:
Is it true that you can crack every market case with a Porter's Five Forces model? Is it so easy to break into management consulting and to convince BCG, McKinsey, and Bain of your skills? No, unfortunately, it's not.
I'm Gabriel Goldbrain, and I invented the GoldBrain Success Training. This is the training you take when you're really dedicated to becoming a tier one or tier two management consultant. Apply under www.GabrielGoldBrain.com, with sending your CV. I'll check if you've got what it takes, and I'll get back to you when I think you're the right person to be trained by myself.
Now let's look into the Porter's Five Forces model and what it is good for. The Porter's 5 Forces model is a structured tool to analyze the key aspects of markets. So, whatever market cases you have during your case interviews, use Porter's Five Forces to cover all relevant aspects. You may focus on parts of the model depending on what the case asks from you, but this is situation-dependent, and you will have to develop a feeling for when to focus on what aspects or if you need the whole framework to kind of, to find out what matters in the business case.Porter's 5 Forces model covers five aspects of a market. It also does not cover everything. So once we talked about what Porter's 5 Forces model covers, we will also discuss what it not covers and what you may also consider when you're doing business cases.So, what does the Porter's Five Forces model cover? It covers the suppliers that you find in an industry. It covers the customers you will find in an industry. It covers substitution products that are relevant to an industry, and it covers also the threat of new entrants and the entry barriers that an industry has. Most importantly, it looks at the competitive landscape and the competitive rivalry that exists in a market.
Let's have a look at the first segment of the Porter model, which is the bargaining power of the suppliers in a market. So, the first and most important piece of bargaining power of suppliers is the supplier concentration. That means how many suppliers do you have in a market. I mean, Porter talks about it in a qualitative way, but in a McKinsey interview, you may have to do quantitative calculations about the supplier concentration. You may get a list, and you may have to identify what are the top suppliers, what is their share, what is their accumulated share, and you may draw charts where you basically tell your interviewer what is the concentration level of the top five and the top 10 suppliers in an industry. And then you will have to draw conclusions. What does that mean, that there are dozens of suppliers? Usually that means, if there are hundreds of suppliers, they have no bargaining power because you can replace them. And on the other hand, if there are only very few suppliers, for instance, like in the airline industry where you have Boeing and Airbus as the two major suppliers of airplanes, then they have a lot of bargaining power, which is bad for you as a customer because they can squeeze you. You have to pay for the products whatever they charge you.Another aspect you have to look at when you're talking about suppliers is the switching cost and the level of differentiation that exists in an industry. If, for instance, you are talking about the software industry or ERP systems like SAP or Oracle offer it. So once you set up these systems in your company, it's pretty hard and pretty expensive and highly critical to switch the supplier. So, in that case, even though there may be several or a bigger number of suppliers, it may be quite difficult or quite expensive for a company to switch its supplier because there is a lock-in. And therefore, you have high switching costs, which makes it unlikely that customers easily switch to another supplier.When you look at the bargaining power of suppliers, the differentiation level can also play an important role, at least for some sub-segments of the suppliers. Think of a retail chain like supermarkets. Typically, they have thousands and thousands of customers, but you will find niches where there is not so much competition. So, you may have, like in the soft drink market, there is Coca-Cola, which has a very strong brand, and customers are demanding those products. So, you can't easily be substituted by a no-name drink. The same may be the case for Nestle products, which offer a broad range and have a good brand, and people demand these products, whereas other brands or other segments of the supplier landscape, like, for instance, flower.... flower, you can easily replace them by another manufacturer, or noodles, you can also exchange the suppliers rather easily. So, that means for some of your suppliers, there is not a lot of bargaining power, but some of them, they have, and so that you also need to be aware of that. The differentiation can play a crucial role in the market landscape of the suppliers.Another thing to consider is the threat of forward integration of a supplier. Let's assume you're an Amazon; you're running an Amazon shop, and then one day Amazon finds out, hey, this guy, he is doing really, really attractive margins with his products, and he's selling big numbers. So, Amazon may decide, hey, we're going to offer the same products because we want to take a share of the business because it's so attractive and it's so big. And so, in that case, you may run into serious problems because Amazon will take away your market share and enter your market because your margins are so attractive that they think that they can do it on their own and also earn some good margins from it.
The second important aspect of a market according to the Porter model is the bargaining power of customers. Similar to the bargaining power of the suppliers, we have to analyze the customer concentration level in an industry. If there are only one or two big customers, then this is a big risk because they can squeeze you. For example, if you're in the business of smartphone repairs and return handling, you're highly dependent on a very little number of smartphone manufacturers. So, they are able to squeeze your margins.Another aspect of the bargaining power of customers is the switching cost. For instance, if you're a tire manufacturer, there are virtually no switching costs for an automotive manufacturer that uses your tires. So, the switching costs are very low, and they have a very good bargaining power against you as a tire manufacturer. The same applies to the differentiation level in your industry. When you have a high level of differentiation, you will find market segments where customers have little bargaining power. You will also find segments where there is more bargaining power and also very competitive segments if you have no differentiation at all. For instance, if you're a manufacturer or a producer of corn, there is almost no differentiation, so customers have high bargaining power in such situations because you can easily be replaced by anyone else. So, your pricing must be competitive.Like with the supplier bargaining power, also for the customer bargaining power, an important aspect is the risk of backward integration. A good example for backward integration is Tesla building its own batteries for its vehicles. So, if you're a battery manufacturer, then you have to consider this risk that automotive suppliers, they may think backward integration is of strategic importance or it's financially beneficial. So, if you are in an industry where this threat exists, you also have to be careful with the pricing and not overdoing it because then your customer may backward integrate and drive you out of the market.
The third aspect that Porter's model looks into is the threat of new market entrance. Here, you partly focus on the market entry barriers. So, what keeps other competitors out of the market? How deep is the moat of the industry? Is there IP which protects you from new market entrance? Are there big capital requirements which keep competitors out of the market? Is there some knowledge which keeps competitors out of the market, knowledge that is not easily accessible? Are there any other things like resources or switching costs or a good brand loyalty of customers that keeps people out of the market? This is what you analyze when you look at entry barriers.Think of the operating system market; companies like Microsoft, Apple, and Google. They've built whole ecosystems around their operating systems. So, switching an operating system is very difficult for a customer, particularly because you have network effects, which means you have certain software that only runs on a certain operating system, and therefore you have a lock-in effect. You cannot easily open a file that you produced with an app or with software that only runs on one operating system because the software may not exist for the other operating system. And so, it's very hard for new competitors to enter this market because they will not have this ecosystem; they first have to build it, which is very, very expensive and takes a big effort to do so. And therefore, there is a big moat around the operating system market.Think of mining companies; it's difficult to gain access to a new property, to develop a new mine. You need a certain reputation that someone would even consider you for building a mine. You need to build trust over years to develop new mining projects. So, here, access to resources is critical and the high entry barriers for new entrance.Think of hard drive manufacturers; there are only a few competitors in that market, and they have big economies of scale and cost advantages, which will keep competitors out of this market. Think of the market for AI chips; there is a lot of knowledge that you require to build such chips. There is limited personnel who has that knowledge, and there are a lot of patents around to protect your IP. So, also, you find a big moat in the chip industry for AI chips.When you reason about the threat of new market entrance, you also have to think about the reaction, the expected reaction of the competitors in the market. Will they start a price war? Will they take legal action? Will they start innovating and copying the new market entrant? How heavily will they fight for their business? You have to assess all of these aspects to finally come to a conclusion about the threat of new market entrance.
The fourth field of analysis in the Porter Five Forces framework is the threat of substitutes. Switching costs also play an important role when it comes to the threat of substitutes. The easier you can switch to a substitute, the more likely it's going to happen. Another important thing to analyze when it comes to the threat of substitutes are the properties of the substitutes and the price of the substitutes because customers will only switch if they have cheaper alternatives or alternatives that better suit their needs.Let's make an example here. Let's assume you're operating a bus line between Barcelona and Paris. So, what alternatives do exist? You can either drive by your own car; you can go by train, and you can go by airplane. All of these different transportation means have different price points and different benefits. The bus ride may be the cheapest, the train ride may be faster than the bus ride but more expensive, by airplane, you may be there the quickest, and by your own car, you maybe the most, you may have the most flexible option. So, if you factor all these in, you will see that probably there is a very fine line between those alternatives. So, when you overdo the pricing on your bus line, people will drive with their own car or they will take the train. And this could be a nice example of a McKinsey or BCG or Bain case because they might ask you to do some qualitative analysis using the Porter's 5 Forces framework and then do a deeper dive, analyze the substitutes, the potential substitutes along different dimensions like freight volume, transportation cost, duration of the trip, and then give you a task to find the optimal alternative or the next best alternative for an existing means of transportation like the bus ride. That's what you should expect in a McKinsey case, and that's why never the Porter's 5 Forces framework alone will do the job. There will also be some deep dive involved like just I what I mentioned substitutes, which result from new technologies are often over-discussed, although the threat usually is just of theoretical nature. People like to talk about it.For example, imagine the hyperloop. The bus operator, he might be afraid of Elon Musk announcing a hyperloop line from Paris to Madrid, although the likelihood of this happening is rather small. But besides all of that, you should not forget to discuss these threats of substitution which result out of new technologies or which may result out of new technologies.
Then the core piece of the Porter's 5 Forces framework is to analyze competitive rivalry. In this block, you look into how many competitors are there, in which segments do they operate, which market shares do they hold, and which unique selling propositions do they have? You also analyze the cost structures and derive a cost curve. Often the cost curve cannot be exactly determined, but you may find business cases where you're asked to develop a cost curve or you're given a cost curve, and then you will have certain discussions. What happens if you raise the price above a certain level? What will then happen to certain competitors?Some general statements you can make about the competitive rivalry is the more competitors, the more rivalry you will find in a market. The more differentiated a market is, the less intense is the competition. So, if everyone offers more or less the same product, which is pretty much undifferentiated, you will have a very strong competition. Then regarding market shares, the players with the biggest market share, they often also have the best economies of scale, which means they have the best cost structure. They can produce the products the cheapest, and when the markets go sour, they are the ones still making profit while the other players further up in the cost curve, they have to sell at losses. These guys will also be the ones who can fill up their capacities most easily because they can offer the best prices.In a case interview, you may be given a list of products from different manufacturers, and you may be asked to do a market segmentation and then to calculate market shares of the individual competitors and market shares in certain market segments. So never forget that the Porter framework is a general framework with which you should pretty quickly come to the pressing points in a market. And then this is where the McKinsey, BCG, and Bain interviews go to the next level. You usually are asked to do quantitative analysis, figure out things, optimize things, and the Porter's 5 Forces framework only is the entry point to see if you're generally aware of it and if you can nail down the most pressing issues quickly.
There are two forces which are not included in the Porter's 5 Forces framework, but which I would recommend to include today. The first of these forces I'd recommend is the regulatory force, and the second of these forces is the political force. What would the regulatory force be about? The regulatory force could be about regulatory changes which might happen during the next decade. It might be about subsidies for businesses which are preferred. It might be about disadvantages for non-preferred kinds of business. Your business may be highly affected by regulatory changes; as, for instance, the cruise ship industry was. They had to reduce the sulfur content of their fuel from 3% or 3.5% to 0.5%. That means, as such an operator, you have an increased cost base. And these kinds of things happen more and more today because there is more and more national and international regulatory action which I think should be taken into consideration in a sixth force.
The seventh force I propose may be the political force. Nowadays, businesses have to be highly aware of political interests. You should not operate in politically unwanted areas, or at least you should be aware of things happening like [__] storms which harm your business, kill your reputation, media campaigns, things that kill your reputation and are a threat to your business.
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