Studying an Industry

Porter’s 5 Forces

For a lot of people, their dream is to open up their own shop or business. Wanting that chance to be your own boss, to call all the shots and keeping all the profits for yourself. However, if you check the statistics on how many businesses survive after a year since they’ve opened; there are more failures than successes. One of the many reasons why this happens is the lack of study or knowledge one has for that industry. Because they are so overexcited about starting their own business, they forget all about understanding the industry and knowing the shortcomings of that industry.

This is where Porter’s 5 Forces Model comes in. One can think of it as a road map to studying an industry. It contains five factors that one should analyze to determine their chances of success in that industry. These five factors are:

1. Entry Barriers – This takes into consideration of the difficulty of entering into an industry, for you and for potential competitors. For this factor, one would have to analyze capital requirements, brand loyalty, government regulations affecting the industry, customer switching cost and access to key suppliers.

2. Rivalry – This is a measure of the competition within the industry. Are the competitors in this industry aggressive or passive? Do they react to price change immediately? Is it easy to leave this market?

3. Supplier Power – A measure of how much dependence does an industry have on their suppliers. Do suppliers have control of the industry through price and quantity of supplies? Can one easily switch between suppliers to take advantage of them?

4. Buyer Power – How much do buyers depend on your product? Can they easily switch to your competitor? How price sensitive are the buyers?

5. Substitutes – Can consumers easily switch to a product that is outside of your industry if your price or supply does not fit their demand?

After attaining enough research on these five factors of an industry. One will then have to evaluate the factors by determining if they are strong or weak. The weaker each factor is, the more attractive the industry becomes since there is a better chance to raise profit and succeed in the industry. While the stronger each factor is, the less attractive the industry becomes due to the small chances of success in it. Now that we have a gist of Porter’s 5 Forces Model, let’s try it out on an example.

Restaurant Industry

1. Entry Barrier
- Capital Requirements – Start up cost for a restaurant depends on what type of restaurant one is going for, but on the average the cost is around $ 250,000 to start. This is taking into consideration of leasing, fixtures, equipment and employment.
- Brand Loyalty – Consumers’ loyalty to a restaurant depends on the good food they produce, the service they provide and the memories they create there.

- Government Regulations – There are several licenses and permits one has to acquire. This goes from food handling license, heath department permit, fire department permit, liquor license. These things can be pros and cons to a restaurant. To attain these licenses and permits, one must play by the government’s rules in running a restaurant. As long as they accommodate to that, the licenses and permits are pretty easy to attain.

- Switching Cost – The thing about restaurants is there isn’t any security, since there isn’t much of a cost for consumers to go to this restaurant instead of another. This opens up a risk of not getting enough customers going to your restaurant if you fail to provide good food, service or environment.

- Access to Key Suppliers – There are plenty of suppliers in the food industry making access to suppliers to be quite easy.

Evaluation: Medium to High

2. Rivalry – With the restaurant industry, competition may not only be the price one charges for their food. Competition can be measured in different ways pending on if one wants to compete with local restaurants or just with their type of restaurant only. But most importantly restaurants compete through what they offer. Do they provide the better food, service and environment? Rivalry usually isn’t as intense because sometimes the restaurants may be catering to different groups and can even coexist in the same area.

Evaluation: Low to Medium

3. Supplier Power – Suppliers have a relatively weak control over the restaurant industry because of the vast amount of suppliers offering their products to restaurants. The industry in restaurant suppliers might even be more competitive themselves, because they want to offer the lowest price and quantity for the many restaurants out there.

Evaluation: Low

4. Buyer Power – Restaurants are customer sensitive because their success or failure relies on customers coming in to eat. Thus, in many ways, buyers have a strong influence in what a restaurant must offer. Buyers can easily decide to eat in the restaurant across the street from yours. Take hamburgers for example, if you make the best tasting hamburger in town but you charge too hefty of a price for it. Customers may either go somewhere else for it, leaving you without any sales, unless you decide to lower the price. This also goes for the service and environment you provide.

Evaluation: Medium to High

5. Substitutes – There are quite a lot of substitutes for eating out at a restaurants. Some include cooking at home, buying from a stand outside or buying from a deli. However, if there are so many substitutes, why are there still so many restaurants? Because going out to a restaurant is a culture, a convenience and maybe even entertainment. Thus making restaurants irreplaceable.

Evaluation: Medium

Personally, I always thought about opening a restaurant sometime in the future because I love food. Being able to analyze the industry for a bit was actually quite interesting. Let’s look at our results. From the evaluation of the five factors, it seems to be somewhat attractive to get into the restaurant industry. Breaking into the industry doesn’t seem to be hard, but seems to be more about sustaining it over the years. There seem to be relatively average competition in this industry because restaurants can appeal to different types of people at the same time. Suppliers don’t really have that strong of an influence in this industry because restaurants have so many suppliers to choose from. A key factor of this industry is the buyers and is the factor that many should look at when opening a restaurant, while substitutes may also be another factor to keep restaurant owners in line with their prices. All in all, the reason why we always see new restaurants opening up all the time is because it is a pretty attractive industry. One must keep in mind though, whichever business one goes into, there will always be risks, success and failure.