The Five Hidden Forces That Help Determine a Worker’s Value
How Michael E. Porter’s seminal model can help us plan for the future of work
Michael E. Porter’s Five Forces has been an influential framework to model business strategy since its original publication in 1979. Porter, an influential economist and Harvard Business School professor, developed the Five Forces as a tool through which to assess the competition within an industry. The premise is simple: business leaders can analyze their industry through five lenses — threat of new entrants, threat of substitutes, bargaining power of suppliers, bargaining power of buyers, and rivalry among competitors — to better understand the attractiveness of that industry and the restrictions on profitability for companies within it. With this information, it becomes easier to determine where to focus your company’s resources and attention.
When I first learned the model, I couldn’t help but wonder if it could be applied to a different economic perspective. And as an advocate for worker empowerment, of course I had to find out if it could help illustrate the dynamics of a labor market in a new way. Instead of looking at the environment of competition between firms selling products, I decided to use the model to look at the environment of competition between workers selling their labor.
The ultimate goal was to better understand the economic outcomes and potential for competitive wages within various professions, thus providing a new tool to help the workforce develop strategies to support wage growth. This same tool can also help leaders and founders to develop a strategy specific to their industry’s workforce, allowing them to attract and retain talent in a changing world.
How to Use Porter’s Five Forces
We use the Five Forces model by looking at the effect of each of the five forces using industry factors, like barriers to entry, barriers to exit, switching costs, and incumbency advantages, among others. The greater a certain force, the more likely a firm will have to make strategic decisions that ultimately reduce its profit margins.
I’ll walk through this model using the airline industry (notorious for its low-profit margins) as an example:
- Threat of New Entrants: Low threat due to high capital requirements, many safety and regulatory requirements, and restricted access to airport gates.
- Threat of Substitutes: High threat for local flights, where buyers may choose to take a train or drive; Low threat for international flights, where flying is the sole means of transportation.
- Bargaining Power of Buyers: High buyer-power due to low switching-costs for customers, who are price sensitive and have access to information on the costs of competitors.
- Bargaining Power of Suppliers: High supplier-power, due to low number of airplane manufacturers and reliance on long-term contracts.
- Rivalry Among Competitors: High rivalry due to slow industry-growth, high exit-barriers among existing players, and “perishability” of the product (seats that are not sold cannot be recovered).
Simple enough, right? These forces limit the ability of individual companies in the airline industry to make decisions, like raising prices for consumers or bargaining for their equipment, resulting in smaller profit margins on their services across the industry.
The Five Forces of the Labor Market
Now, what if we viewed each individual worker as their own business? They have competition with other qualified candidates, have to worry about the threat of younger workers coming into the market, and may have limited bargaining power with those that buy their labor. Before we look at the specific industries, let’s redefine the five forces in the context of labor.
Threat of New Entrants
Let’s refer to this as the threat of new workers entering the job market. The threat may be a factor of population dynamics, such as a growing population of young, educated workers. We can also look at immigration policies, such as a restriction on the number of work visas in that country.
Threat of Substitutes
A “substitute” for labor is any alternative way that the company can perform the same function. This may be the result of changes in technology and the potential for automation. It could also be a result of the attractiveness to outsource the role, or feasibility of replacing an in-house role with an independent contractor.
Bargaining Power of Buyers
In this case, the buyers of labor are the companies that hire the workforce, so let’s call this the bargaining power of employers. This is where the more traditional supply and demand for labor comes into play. If there are many people looking for work, and only a few companies hiring, companies can more easily justify offering lower wages. This force may also be influenced by the power of institutions, like labor unions, to elevate the needs of individuals through collective bargaining and organized strikes.
Bargaining Power of Suppliers
We can see the power of suppliers in the labor market as the bargaining power of jobs gatekeepers. In other words, the supply of jobs may be controlled by a platform that uses algorithms to assign buyers to service providers. In other industries, it could be the hiring portals that provide information on what jobs are available, recruiters, and A.I.-enabled resume screening tools.
Rivalry Among Competitors
Lastly, the competitors in this case are the workers themselves, or the rivalry among qualified candidates. This is a factor of number of workers and their ability to differentiate themselves from the competition, perhaps due to their experience, skills, or strength of their network.
The Five Forces of the Labor Market, Applied to Industry-Specific Jobs
Please note that I will be generalizing the industries in the examples that follow. The goal is to illustrate the use of the model, and the outcomes on individual wage-earning potential, which means I’ll be taking some liberties with the specific outcomes that I describe.
Example One: Software Engineer
The dynamics of an individual seeking a job as a software engineer are outlined below, using the Five Forces model. Beyond supply of labor and demand for skills, there are many other forces at play that can explain the relatively high expected earnings of an engineer.
An interesting force to note for a software engineer is the low threat of substitution. We know that technological advances are creating greater market value on non-routine tasks that require cognitive judgement, meaning that we can expect the market to develop in a way that places value on the work of engineers for the time being. There is still a risk of substitution in the way that companies can access engineering talent. Due to costs and other incentives, companies may choose to outsource their engineers, or hire them on short-term contracts using platforms such as Upwork or Fiverr.
The threat of new entrants might pose more of a risk for engineers in the market today. Although expertise is of high-value, the rapid advances in the field might mean that certain skills and techniques lose their relevance at a rapid pace. As a result, it is especially important for someone in this profession to continue to develop their skills in a variety of programming languages and to follow developments in the field, in order to maintain their competitive advantage over new talent.
Another interesting lesson comes from the low bargaining power of buyers. Because the skills of engineers are in demand and there are few substitutes, employers are incentivized to pay good wages to attract talent to their firm. There are also high “switching costs” of turnover, including the high monetary cost of finding talent and high cultural costs of eroding team collaboration and trust.
Example Two: Rideshare Driver
Let’s contrast the last example with that of a rideshare driver. The current setup of ride-sharing platforms provide an interesting differentiator for this model, because drivers are typically classified as independent contractors rather than full-time employees. Using Grab as an example (a popular ridesharing app in Southeast Asia), we can see the platform itself as a supplier because they control the availability of jobs. The riders are therefore the buyers because they purchase the services of the driver. Grab has incredibly high bargaining-power because there are few alternatives for drivers. This means drivers have little power to push back on prices or policies. Drivers are caught between a powerful supplier of jobs and a price-sensitive rider, who expects low rates and fast pick-up times.
Looking again at the types of jobs that have a high threat of technological substitution, we can see a potential threat for the ridesharing drivers. Although their tasks do require customer service along with non-routine tasks, ridesharing companies are actively developing substitutes for the labor cost of a driver through self-driving technology and multi-modal options.
All of the above forces create an environment where the rideshare driver has very little power to sell their labor at a rate that supports a good quality of life. Their classification as independent contractors, which could be changing starting in California, also reduces their power to bargain collectively and receive regulatory guarantees for health care and a minimum wage.
Why We Need to Think About Labor Strategy
There are different dynamics in every industry that result in different outcomes for the employees who work within those systems. I’ve attempted to use the Porter Five Forces model to unlock the effect that industry dynamics have on the earning potential of the workforce. These aren’t novel ideas, just a connection of existing insights portrayed in a new way.
We can look to the decline of wages and benefits in the U.S. auto manufacturing industry as an important example of why this model matters. Factory workers at GM saw their wages rise in the ’50s and ’60s, thanks to the low bargaining power of buyers. GM relied on its domestic workforce, and had to make concessions to the influential United Auto Workers Union.
So what changed? Most notably, the threat of new entrants and threat of substitution. Changes in immigration policy in the 1980s brought more workers into the labor pool. Trade policies enabled companies to offshore their factories in an increasingly globalized world. New machinery changed the type of tasks that made up individual jobs. Temporary workers were brought in to both perform work at a lower price, and also reduce the disruption caused by strikes. Policies like the Right-To-Work laws reduced the ability for unions to sustain their membership.
The lesson here is that as we look to the future of the workforce and of good jobs with livable wages, we have to look beyond the bargaining power of individuals and the companies that buy their labor. We may not be able to predict what the future economy will look like, but we need to recognize that the change will come from all sides. Think about your industry: Whether you’re a member of the workforce, or a business leader with the power to set standards, your strategy for sustainable and attractive jobs must include a dynamic understanding of the pressures within individual industries, and also account for all future threats.