Porter's Five Forces - The Framework Explained

Introduction to Porter's Model

Porter's Five Forces is a simple but powerful tool that you can use to identify the main sources of competition in your industry or sector.

When you understand the forces affecting your industry, you can adjust your strategy, boost your profitability, and stay ahead of the competition. You can take fair advantage of a strong position or improve a weak one, and avoid taking wrong steps in the future.

In this article and video, we explore each of Porter's Five Forces and show you how to use them. This will help you to analyze your organization's strengths and weaknesses, and to identify critical factors that may affect your profitability.

Contents

• Introduction to Porter's Model
• Porter's Five Forces FAQs
• Who Created the Five Forces Model?
• What Are Porter's Five Forces?

1. Competitive Rivalry
2. Supplier Power
3. Buyer Power
4. Threat of Substitution
5. Threat of New Entry

• How to Use Porter's Five Forces Model
• Porter's Five Forces Example
• Criticism of Porter's Five Forces Model

Porter's Five Forces FAQs

What is the purpose of Porter's Five Forces?

Porter's Five Forces model can help you to analyze the attractiveness of a particular industry, evaluate investment options, and assess the competitive environment in your market.

How do you use Porter's Five Forces?

Think about each force in turn, and how it applies to your industry. Gather data on each force, and use it to help inform your future strategic decision making. Read more in the section How to Use Porter's Five Forces Model.

What are the benefits of using Porter's Five Forces?

Porter's Five Forces allows you to gain valuable insights into your current market, or one that you're considering moving into. This can help you to develop a strategy to succeed.

Who Created the Five Forces Model?

The tool was created by Harvard Business School professor Michael Porter. Since its publication in 1979, it has become one of the most popular and highly regarded business strategy tools.

Porter recognized that organizations like to keep a close watch on their rivals, but, in his Harvard Business Review article, 'How Competitive Forces Shape Strategy,' he encouraged business leaders to look beyond the actions of their competitors and examine the forces at work in their wider business environment. [1]

What Are Porter's Five Forces?

According to Porter, there are five forces that represent the key sources of competitive pressure within an industry They are:

1. Competitive Rivalry.
2. Supplier Power.
3. Buyer Power.
4. Threat of Substitution.
5. Threat of New Entry.

He described them further in his later article, "The Five Competitive Forces That Shape Strategy." [2]

Porter stressed that it's important not to confuse these five forces with more fleeting factors, such as industry growth rates and government interventions. According to Porter, those are examples of temporary factors, while the Five Forces are permanent parts of an industry's structure.

Let's take a look at Porter's Five Forces in more detail.

1. Competitive Rivalry

The first of Porter's Five Forces looks at the number and strength of your competitors. Consider how many rivals you have, who they are, and how the quality of their product compares with yours.

In an industry where rivalry is intense, companies attract customers by cutting prices aggressively and launching high-impact marketing campaigns. This can make it easy for suppliers and buyers to go elsewhere if they feel that they're not getting a good deal from you.

On the other hand, where competitive rivalry is minimal, and no one else is doing what you do, then you'll likely have tremendous competitor power, as well as healthy profits.

If you were setting up a haulage business, you'd likely be entering a crowded market. You'd have to consider many potential rivals, how much they charged, and whether they were able to discount deeply. You'd also need to think about their resources: you might be setting up to compete with international logistics companies, as well as local competitors

Remember that at this point the analysis should focus on your potential rivals. Only start thinking about your own offer when you've got your data together on the competition.

Note that Michael Porter developed his Four Corners Model   all about competitor behavior. You can find out more about that in our article.

2. Supplier Power

Suppliers   gain power if they can increase their prices easily, or reduce the quality of their product. If your suppliers are the only ones who can supply a particular service, then they have considerable supplier power. Even if you can switch suppliers, you need to consider how expensive it would be to do so.

The more suppliers you have to choose from, the easier it will be to switch to a cheaper alternative. But if there are fewer suppliers, and you rely heavily on them, the stronger their position – and their ability to charge you more. This can impact your profitability, for example, if you're forced into expensive contracts.

Let's say your business idea was to manufacture electronic devices. You'd have to assess your supply options for a range of specialist components. If one supplier dominated the components market, then they could raise their prices without worrying about their own competitors. This might affect the viability of your product.

3. Buyer Power

If the number of buyers is low compared to the number of suppliers in an industry, then they have what's known as "buyer power." This means they may find it easy to switch to new, cheaper competitors, which can ultimately drive down prices.

Think about how many buyers you have (that is, people who buy products or services from you). Consider the size of their orders, and how much it would cost them to switch to a rival.

When you deal with only a few savvy customers, they have more power. But if you have many customers and little competition, buyer power decreases.

Buyer power is a significant factor in food retail. Think of large supermarkets that operate in a crowded, highly competitive market. This market has changed dramatically with the arrival of cheap, no-frills food discounters. Shoppers have strong buyer power here. That's why supermarkets have coupon schemes, loyalty cards, and aggressive discounting – to capture the largest share of buyers.

These organizations in turn have strong buyer power with their own suppliers, using their influence to drive down the cost of food at the manufacturing level.

4. Threat of Substitution

This refers to the likelihood of your customers finding a different way of doing what you do. It could be cheaper, or better, or both. The threat of substitution rises when customers find it easy to switch to another product, or when a new and desirable product enters the market unexpectedly.

If your organization makes medical instruments, you may find your position being threatened by the rise of 3D printing. This enables instruments to be made from a wide range of materials, sometimes at a fraction of the cost of traditional methods. If a competitor gets it right, it can weaken your position and threaten your profitability.

5. Threat of New Entry

Your position can be affected by potential rivals' ability to enter your market. If it takes little money and effort to enter your market and compete effectively, or if you have little protection for your key technologies, then rivals can quickly enter your market and weaken your position.

However, if you have strong and durable barriers to entry, then you can preserve a favorable position and take fair advantage of it. These barriers can include complex distribution networks, high starting capital costs, and difficulties in finding suppliers who are not already committed to competitors.

Existing large organizations may be able to use economies of scale to drive their costs down, and maintain competitive advantage over newcomers.

If it costs customers too much to switch between one supplier and another, this can also be a significant barrier to entry. So can extensive government regulation of an industry.

Even industries that seem to be well protected against new entry can prove to be vulnerable. For many years, high-volume air travel was in the hands of a relatively small number of established airlines. The barriers to entry were formidable. Start-up costs were high, routes and take-off slots were mostly grabbed by the big operators, and the industry was strictly regulated.

Even so, some small operators did manage to break into the market, mostly by offering no-frills, low-cost travel to popular destinations, and taking advantage of reduced regulation. These smaller, more agile operators now hold strong positions in the industry, particularly in short- to medium-haul travel.

How to Use Porter's Five Forces Model

To use the model, start by looking at each of the five forces in turn, and think about how they apply in your industry. (Mind Tools subscribers can see figure 1, above, and copy the subheadings. They can also download a handy template.)

Next, write down the forces that are at play in your industry, and summarize the size and scale of each on your diagram. An easy way to do this is to use a single "+" sign for a force that's moderately in your favor, or a "-" sign for a force that's moderately against you.

Use "++" for a force that's strongly in your favor, or "--" for one that's strongly against. For a neutral force, you can use "o." (An example of this method can be found in figure 2, below.)

Finally, think about how your analysis will likely impact you. Few situations are perfect. Nonetheless, analyzing your industry using Porter's Five Forces can help you to think through what you could change to improve your competitive position and increase your profitability.

What's more, if you find yourself in a structurally weak position, the model can help you to think about what you can do to move into a stronger one.

Porter's Five Forces Example

In this section, we'll look at a full worked example of Porter's Five Forces model to help you make effective business decisions. You'll also find short examples of applying each of the Forces separately in the sections above.

Our worked example is based on a fictitious business owner called Martin. He's deciding whether to switch his focus to something in agriculture, as he likes the idea of hands-on work, in a rural environment, supplying people with something they really need. He carries out a Five Forces analysis to help him decide whether to buy a farm and start a new enterprise – and meets some surprises!

Members of the Mind Tools Club can see the analysis in figure 2 (click on the image to view it full screen).

Martin's analysis has raised a number of "red flags" that previously he didn't know existed. For example:

• The threat of new entry is quite high. If anyone looks as if they're making a sustained profit, new competitors can come into the industry easily, reducing profits.
• Competitive rivalry is extremely high. If someone raises prices, they'll quickly be undercut. Intense competition puts strong downward pressure on prices.
• Buyer power is strong. Again this can put a strong downward pressure on prices.
• There is some threat of substitution. There's some cross-product substitution and ability to import food.

Unless Martin is able to find some way of changing this situation, it looks like the farming industry is a very tough market to compete and survive in. Maybe he'll need to specialize in a sector of the market that's protected from some of these forces, or find a related business that's in a stronger position.

Criticism of Porter's Five Forces Model

Despite its enduring popularity, Porter's Five Forces model has come in for considerable criticism in recent years. In particular, critics have pointed to its age, lack of flexibility, and the fact that it doesn't take account of new technology.

You can read more about this in our article Pitfalls of Porter's Five Forces   .

If you want to use the Porter's Five Forces model to analyze the competitive forces at work in your industry, and you're a Mind Tools subscriber, download our template worksheet here.