Porter’s Five Forces analysis of the IT industry

Porter’s Five Forces is a business framework that helps entrepreneurs shape their strategy to drive profitability. The framework is a holistic way of looking at any industry and understanding the structural underlining drivers of profitability and competition.

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The IT industry in 2021

According to the research consultancy IDC, the technology industry is expected to reach $5 trillion in 2021 which represents 4.2% growth, signalling a return to the trend line that the industry was on prior to the pandemic.

The three major industry groups within the IT sector:

1. software and services: companies that provide internet services, software and IT services, search engines or social networks, software for business or consumer use (Google, eBay, Facebook, Accenture, PayPal, Adobe, Microsoft and Electronic Arts (EA);
2. technology hardware and equipment: companies that produce routers, telephones and switchboards, computers, printers and cell phones (Apple, HP, Dell, Motorola, Cisco Systems, SanDisk and Western Digital);
3. semiconductors and semiconductor equipment: companies that produce semiconductor equipment (Intel, Microchip Technology, Nvidia, QUALCOMM and Texas Instruments).

4 IT industry trends according to CompTIA, a leading tech association

The Cloud-first mentality

With flexibility and resilience as the guiding principles for future success, organizations will adopt a cloud-first mentality when it comes to building or upgrading IT infrastructure.

Technology as a driver for business objectives

Businesses are placing much more emphasis on strategic IT as opposed to the tactical mindset of previous decades. This means that technology is a driver for business objectives rather than simply playing a supporting role. 

Increased need for cybersecurity solutions

The complexity of new IT solutions creates a world of new opportunities. Unfortunately, it also creates a nasty problem for cybersecurity. (…) As companies become more comfortable with a zero-trust framework, they will also gain an appreciation for the new investments they have to make, the new processes they have to build, and the new skills they need to acquire.

Regulation is not avoidable

Whether it’s the debate over breaking up the largest tech companies, establishing clear legal ramifications and penalties for the exposure of sensitive user data, or figuring out how to thwart foreign countries from using social media to meddle in elections, the topic of regulation is front and center. […] the government is taking a closer look at all types of tech companies in an effort to rein in abuse and potential harm to the public – and assign accountability. [..] Regulation is not avoidable in the tech industry anymore.

Porter’s Five Forces Analysis of the IT industry

BUYERS – How much influence do buyers have on the IT industry?

Is there a large number of buyers relative to the number of IT companies? YES / NO
The IT industry is expected to reach $5 trillion in 2021 which represents 4.2% growth compared to last year. Digital transformation and technology have contributed to this growth.

Are buyers both B2C and B2B? YES / NO
The IT industry caters to the needs of individuals and enterprises. According to this December 2020 report, the number of smartphone users in the world today is 3.5 billion, which translates to 44.69% of the world’s population. In 2019, there were over 2 billion computers in the world, including servers, desktops, and laptops. Although at home, we may prefer our smartphone, in the workplace, we do our work on PCs.

Do buyers face significant costs in switching suppliers? YES / NO

Do buyers need a lot of important information with regards to using the products? YES / NO

Does the product or service drive the buyer’s performance? YES / NO

Are buyers able to manufacture the product/service in-house? YES / NO

Are buyers highly sensitive to price? YES / NO

Are products unique to some degree? YES / NO

SUPPLIERS – How much influence do suppliers have on the IT industry?

Are inputs (material, labour, services) standard rather than differentiated? YES / NO

Can companies switch suppliers quickly and easily? YES / NO

Do suppliers find it difficult to enter the IT industry? YES / NO

Is there a large number of current suppliers in the IT industry? YES / NO

Is the IT industry important to the suppliers? YES / NO

Is the supplier’s product indispensable to IT companies? YES / NO

Microsoft has 13,000 U.S. suppliers. If you’ve made the list, it’s a great accomplishment. But keep in mind that every couple of years, Microsoft goes out to market and does a request for proposal or RFP. This means that depending on its current needs, Microsoft will look for fresh suppliers with innovative products or services.

Is an IT company important as a customer to the supplier? YES / NO
Becoming a supplier for Microsoft means taking a slice of a $14.5 billion-worth budget pie that the software giant spends every year.

Microsoft is one of the leading IT companies in the world. Working with Microsoft is an accomplishment for any software supplier. But not every supplier can become a partner for Microsoft. The software giant has rigorous standards and high expectations for its partners. And once they’ve made to the list, it’s not over. Each supplier must undergo an annual review, receiving ratings of 1 to 5 for delivery, innovation, organizational health, quality, service supply-chain management and value.

NEW ENTRANTS – Is the threat posed by new entrants high or low?

Are economies of scale important? YES / NO
Economies of scale is achieved when costs are lowered and production is increased. This happens because costs are spread over a larger number of goods.

Are economies of scope important? YES/NO
Economies of scope is a concept which states that the unit cost to produce a product will decline as the variety of products increases. Namely diversity of products lowers the costs of producing them. Apple has the manufacturing capacity to design, manufacture and launch other products besides smartphones.

Would a new entrant be competing with established brands? YES / NO
Any newcomer to, let’s say, the semiconductor industry would go against the market leaders Intel or AMD. They would need to spend significant amounts of money on advertising and promotions to attract customers.

Is a large amount of up-front capital required to enter the market? YES / NO
New entrants in the semiconductor industry must develop strong research & development departments and large amounts of capital in order to compete with the patents of established companies.

Are profit margins in this market currently high? YES / NO
A 2019 McKinsey report shows that profits in the semiconductor industry have been growing strong in recent years.

Are switching costs for customers high? YES / NO
Embedded switching costs make it difficult and costly for customers to move from one brand to another.

Are there other barriers to entry: patents, regulatory requirements, experienced workers etc? YES / NO

Is a new entrant expecting strong competition from the existing players? YES / NO

SUBSTITUTES – Is the threat posed by substitutes high or low?

Are there available substitutes? YES / NO

Do customers incur costs in switching to substitutes? YES / NO

Do available substitutes have performance limitations? YES / NO

Do available substitutes have high prices? YES / NO

Are customers likely to go for substitutes? YES / NO

Is it easy to replace one product with a substitute? YES / NO

EXISTING COMPETITORS – What advantages do competitors have?

Are there many similar competitors in the IT market? YES / NO

Are market shares equally distributed among competitors? YES / NO

Are costs high? YES / NO

Are the products being sold commodities, making it difficult to add value and have a high-margin? YES / NO

Are exit barriers high? YES / NO

Products on offer are highly complex and require significant customer-producer interaction. YES / NO

Is the industry growing rapidly? YES / NO

The IT industry is changing rapidly due to fast-evolving technology.

Conclusion

According to Porter’s Five Forces business framework, the IT industry landscape has the following features:

High competition

High bargaining power of buyers

Low threat of new entrants

Low bargaining power of suppliers

Low threat of substitutes

BUSINESS reSOURCES: Grow your business with Porter’s 5 Forces framework

On this page:

• What is Porter’s 5 Forces business framework?
• How to evaluate Porter’s 5 Forces (explained)
• 11 Benefits of applying Porter’s 5 Forces framework to grow your business
• 6 recommendations for a successful business strategy

What is Porter’s 5 Forces business framework?

Porter’s 5 forces is a holistic way of looking at any industry and understanding the structural underlining drivers of profitability and competition.

Porter’s 5 Forces framework is a valuable business tool that helps entrepreneurs shape their strategy to drive profitability.

The framework was created by Michael E. Porter, an economist, researcher, author and Harvard Business School professor. His expertise focuses on market competition and company strategy. His extensive research is widely recognized in governments, corporations, NGOs, and academic circles around the globe.

Strategy can be viewed as building defences against the competitive forces or as finding positions in the industry where the forces are weakest.

Michael E. Porter

How to evaluate Porter’s 5 Forces (explained)

1. Existing rivals

Evaluate the existing rivals by looking at the number of competitors. Are there many competitors? How do they rate in terms of size and power? Are they clearly differentiated or are their products almost identical?

What is the size of the competitors?

What is the industry growth rate: slow or fast?

Is product differentiation between competitors present?

What about exit barriers: are they high or low?

2. Buyers

The buyers are powerful and can influence the industry if they make purchases in large volumes.

Is the product undifferentiated? If that’s the case, the buyer will be price-sensitive and the digital environment allows the buyer to instantly compare prices and choose the cheapest.

Is there a large customer base? Do they have many alternatives to buy from? When the buyers are interested in high quality, they are not price-sensitive.

3. Suppliers

How much control does a supplier have over your business?

Does it influence your business by raising the cost of their products and lowering quality?

How many suppliers are in the industry? The fewer they are, the more powerful they are to control the industry and influence your profit margin.

Factors in determining supplier power: number of suppliers and concentration, switching costs, availability of substitutes, uniqueness of product, whether or not the industry is an important customer of the supplier and its availability to cut out the middle man.

4. Substitutes

Substitutes are alternative products that fulfil the same need by different means. In the airline industry, the substitutes are trains and cars.

Rule of thumb: don’t limit your analysis to your industry. Expand your approach to products that meet the same need but are in different industries.

How many alternatives to your product are on the market?

How can you rate the buyers’ willingness to switch and choose a substitute instead of your product?

What is the price-performance ratio of the substitutes?

5. New rivals

Is the entry barrier low or high?

If the entry barrier is low, which means requirements to enter the industry are affordable or readily accessible, then there are increasing chances of new entrants in great numbers. In this case, the threat is high.

There are six major sources of barriers to entry: economies of scale, product differentiation, capital requirements, cost disadvantages independent of size, access to distribution channels and government policy.

In a future envisioned by Elon Musk, people will fly from New York to Shanghai in a rocket, not an airplane and it will take only 10 minutes instead of 24 hours. The downside of this type of futuristic fast-travel may prove to have a high price.

A different way of fast and affordable transportation shines brightly in the near future: the hyperloop. Read about the hyperloop.

11 Benefits of applying Porter’s 5 Forces Business Framework

If you have a great idea, the next step is not product development, logo design, or assembling the best team.

If you’re contemplating starting a business, the first thing you should do is industry analysis and look at the competitor environment before anything else.

And that’s why Porter’s 5 Forces framework is of paramount importance to any entrepreneur: it helps to design a successful business strategy that will support the business to achieve its goals.

11 benefits of applying Porter’s 5 Forces Business Framework

• Evaluate the roots of long-term profitability in your industry.
• Discover the trends that are most likely to be significant in changing the game in the industry.
• Where are the constraints which if you can relax, it might allow you to find a really strong competitive position?
• Avoid getting trapped or tricked by the latest trend or technological sensation.
• Focus on the underlying fundamentals.
• Analyze your competition and how it is affecting the profit.
• Learn how to approach competition in your industry.
• Identify the structure of the industry.
• Find answers to the question How is the industry changing?
• Get the tools to understand industry dynamics.
• Position your business to find that spot in the industry where you can have a really good profit.

6 Recommendations for a successful business strategy

The goal of Porter’s business framework is not to find the weaknesses of your competitors in order to drive them out of the market.

As Michael Porter says, it’s not a zero-sum game. By applying this framework, you get valuable insights which in turn can help you identify a specific and unique way in which to delight your customers.

Your business can delight your customers in one way, the competitors can delight their customers in another way.

It’s a better strategy rather than engaging in price wars which is not a long-term strategy.

When creating your strategy based on insights gained by applying Porter’s 5 Forces framework, take into account the following recommendations:

1. Choose a supplier group to buy from that exercises less power over your business;
2. Perform buyer selection i.e. choose a buyer group to sell to that leverages a low power over your business;
3. Your business can sell to powerful buyers if it partners with a low-cost supplier or the product is unique;
4. When creating your strategy, factor in the substitutes that are subject to trends improving their price-performance tradeoff with the industry’s product;
5. Devise a solution to not merely survive the forces, but change them;
6. Keep a close eye on industry evolution.

The key to growth—even survival—is to stake out a position that is less vulnerable to attack from head-to-head opponents, whether established or new, and less vulnerable to erosion from the direction of buyers, suppliers, and substitute goods. Establishing such a position can take many forms—solidifying relationships with favourable customers, differentiating the product either substantively or psychologically through marketing, integrating forward or backwards, establishing technological leadership.

Michael E Porter

Conclusion

Porter’s 5 Forces Framework is a very robust framework, easily applicable to all industries, allowing entrepreneurs to position the business so as to be least vulnerable to the industry’s competitive forces.

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Source: How Competitive Forces Shape Strategy by Michael E. Porter