Your Five Forces

Michael Porter’s framework is a darling amongst Business School faculty.

While being both concise and thorough, it can sum up how attractive/profitable a particular industry is for investors or entrepreneurs.

The forces are: 

• Competitive Rivalry

  • If rivalry is intense, profits will be lower.

• Threat of New Entrants

  • If it’s easier for people to enter this industry, profits will be lower.

• Bargaining Power of Suppliers

  • If the firms providing inputs have high demand, and there is low overall supply for their goods, profits will be lower.

• Bargaining Power of Buyers

  • If the firms buying inputs have low demand, and there is high overall supply, industry profits will be lower.

• Threat of Substitutes

  • If there are a lot of alternatives to products and services provided by the industry, profits will be lower.

In sum, the higher the industry scores on each of Porter’s forces, the lower the profits will be. 

Let’s look at a famously profitable industry: Digital Advertising.

• Competitive Rivalry

  • Between Google and Meta, who collectively own +65% of the market, there is some rivalry but not a ton. The firms typically compete on different behaviors. Google competes on Search Intent and Meta competes on a Social Graph. Between smaller players, especially on the social front, there is more rivalry.

    • MEDIUM

• Threat of New Entrants

  • In the last 15 years, we have seen only a handful of viable entrants: Amazon, Snap, Pinterest, Reddit, TikTok. It’s not easy to grow a base of users and collect enough data to create an advertising engine capable of helping advertisers find the right person at the right time in their purchase journey.

    • LOW

• Bargaining Power of Suppliers

  • Thinking back to the Value Chain, we can reverse engineer the process by which an ad is served. Before it’s served, a pre-requisite is data (which both firms own), and before data can be saved, the company needs large server capacity (which both firms owned). Therefore, neither company is subject to supply issues.

    • LOW

• Bargaining Power of Buyers

  • Advertisers need to deliver on their objectives, and Google/Meta make it extremely easy. Buyers can, however, test into new platforms who can provide differentiation on buyer behavior (Amazon) or access to a very engaged audience base (TikTok). By shifting advertising dollars away from the big firms, they will not be able to charge higher CPMs and thus relative profitability will decline.

    • MEDIUM

• Threat of Substitutes

  • Because of the immense amounts of data and reach large platforms have, there are few places Advertisers can go to effectively reach customers. TV/Linear advertising has fallen out of favor, and Out of Home is effective but geographically locked.

    • LOW

As an investor, Digital Advertising remains an attractive place to allocate resources. As an entrepreneur, it will be difficult to break into given that there are numerous economic moats to contend with: large data sets, large user bases, and vertically integrated incumbents. 

You too can use Porters 5 Forces in your personal life:

• Competitive Rivalry

  • Consider your peer group. Are you all in the same industry or do you work across industries?

• Threat of New Entrants

  • How niche or technical is your industry?

  • Can anyone join or does it require specific knowledge/skillset about esoteric subject matter?

• Bargaining Power of Suppliers

  • Suppliers to credentials will be higher education institutions, your past employers, and the open internet.

• Bargaining Power of Buyers

  • Buyers are future employers if you choose the corporate route, and customers if you choose the entrepreneurial route.

• Threat of Substitutes

  • How difficult is it for external people to gain the same credentials you have?

  • Consider your undergraduate/graduate education, your years of experience in a particular industry, and your hard and soft skills.

As you go through your professional and entrepreneurial life, remember to choose which industries you interact with wisely.

PK