Every business strives to prevent its competitors from stealing its profits. With today's fierce competition in almost every industry, it's not a question of if, but it’s a matter of how...
Before you make any strategic decisions, you need to take a step back, analyze and answer these questions:
- What forces beyond direct competitors shape your industry?
- What makes your industry profitable?
- Where can you find a position amongst your competitors that is profitable and difficult to attack?
Porter’s 5 Forces is a straightforward strategic framework that can help you answer these questions and reduce the share of profit leaking to your rivals.
In this article, we will give you an overview of Porter’s Five Forces, explain key pitfalls you need to avoid during industry analysis, give you two examples of the model in real-world, and show you three possible strategies you can undertake to create a winning position in your industry and among your competition.
- Porter’s Five Forces are Threat of new entrants, Bargaining power of buyers, Bargaining power of suppliers, Threat of new substitutes, and Competitive rivalry.
- This framework helps strategists understand what makes an industry profitable and provides insights needed to make strategic choices.
- It’s applicable to any industry and company size.
- Pros: A strategic tool that gives you a complete picture of what drives profitability and helps you identify disruptive trends early on.
- Cons: This tool is outside-in and requires a great deal of research and analysis to uncover new information.
What Are Porter's Five Forces?
Porter's Five Forces model is a strategic framework that helps to identify and analyze five forces that affect a company’s profitability in any given industry. These five forces are:
- Threat of new entrants
- Bargaining power of suppliers
- Bargaining power of buyers (customers)
- Threat of substitutes
- Competitive rivalry
Porter’s Five Forces model is a critical element of strategic analysis that helps companies decide how to shape the balance of competitive forces to maximize profitability.
Based on the framework, companies should position themselves where forces are weakest, exploit changes in the forces, and design those forces to their advantage (Porter, 2008).
Advantages Of Porter’s 5 Forces Model
The advantages of Porter’s 5 Forces model are:
- Organizations can learn how profit is divided among the five forces.
- It enables organizations to identify which players are in control and set rules.
- It provides company strategists with insight and a baseline to evaluate the company's strengths and weaknesses.
- It provides a holistic overview of any industry and helps strategists identify the most important factors that can affect their position in the industry.
- It helps strategists to think more comprehensively about the industry and discover non-obvious opportunities that can also attract higher investments and affect the company’s future growth.
Porter's 5 Forces: In-Depth Overview
An analysis of all five competitive forces gives you a comprehensive view of the factors affecting profitability in your industry. When you understand each force, you can formulate a strategy that will allow the company to better cope with competitive forces and increase profit potential. Let's take a closer look at each force:
1. Threat of New Entrants
When an industry starts becoming profitable, it will entice new entrants. If the barriers to entry are low, new entrants can easily capture market share and threaten profitability.
New entrants undercut prices and offer valuable alternatives to what your industry currently provides.
A practical example of a new entry and high threat to existing players is Apple’s entrance into the music distribution industry with the iPod. They entered into a new market, stole market share from existing players, and completely changed the way we consume music and audio content today.
On the other hand, if barriers to entry are high, it’s much harder for new entrants to threaten your industry’s profitability.
According to Porter, there are 7 main sources that influence the height of entry barriers:
- Supply-side economies of scale: Production at higher volumes and lower costs per unit force new entrants to come in on a large scale or at a cost disadvantage.
- Network effect: Buyer’s willingness to pay increases as the number of buyers or sellers for the business grows. Customer loyalty or a buyer's preference for a bigger "network" discourages new entrants by limiting buyers’ willingness to buy from someone new.
- Switching costs: The more a customer has to pay to switch from one supplier to another, the higher the entry barrier will be.
- Capital requirement: The entry barrier can be significant for new entrants on account of the hefty financial investment required. However, investors can provide new entrants with the required capital if the industry returns are high and lower the entry barrier.
- Unfair advantage: Industry leaders have cost or quality advantages derived from resources that are hard to copy. An example would be patent technology, exclusive access to raw materials sources, a strong brand identity, or a favorable geographical location.
- Unequal access to distribution channels: Considering the power of existing players, it might be difficult for newcomers to break into existing distribution channels. As an alternative, companies typically bypass traditional distribution channels or create new ones. An example are low-cost airlines that started selling tickets on their own websites.
- Government policy: Government policy can lower or increase entry barriers for new entrants. Licensing requirements, for example, can increase entry barriers. In contrast, subsidies can make entry easier.
Questions you can use during analysis:
- How expensive would it be and how long would it take someone to enter your market?
- Is there strong customer loyalty in your industry? Would it be difficult for a new entrant to woo customers away from your products or services?
- Are there any additional barriers to entry a new player could encounter (e.g. regulation, intellectual property, access to distribution channels, etc.)?
- How strictly is your industry regulated?
- Is your key technology protected?
2. Bargaining Power of Suppliers
Suppliers offer your industry the needed inputs to operate (e.g. components, materials, and services). When the bargaining power of suppliers is high, there’s a strong chance your suppliers could raise prices or reduce quality without retaliation.
If you have a number of suppliers to choose from, their bargaining power is likely low, so you will not have a problem switching suppliers if needed.
As an example, let's take a look at the automotive industry.
Volkswagen Group's suppliers have limited bargaining power due to VW's global presence with suppliers scattered around the globe. On top of that, Volkswagen has at least 1 or 2 backup suppliers for each part and can shift demand between them.
On the contrary, many automotive suppliers manufacture only a specific part and are heavily dependent on the industry. These dynamics of the automotive industry put Volkswagen in a superior position while its suppliers have relatively low bargaining power.
If you don’t have the option to choose between multiple suppliers, there is no substitute for what the supplier provides, or the cost of switching suppliers is high, the suppliers will have stronger bargaining power and you will have to rethink your strategy.
Questions you can use during analysis:
- Who are your key suppliers?
- How many competent suppliers does your company have to choose from?
- How many alternative suppliers can you find?
- How difficult or expensive would it be to change your suppliers?
3. Bargaining Power of Buyers
In Porter's 5 Forces model, buyers are your customers. At the expense of industry profitability, strong buyer power can lower prices, pit rivals against each other, and demand higher quality or service.
Buyers have power when they are few in number and have many sellers to choose from. Beyond this, if a large portion of a seller’s revenue is determined by a handful of buyers, those buyers will have more leverage.
Switching costs should also be considered when determining the buyers' bargaining power.
Questions you can use during analysis:
- How many potential buyers are in your industry compared to the number of sellers?
- Does a handful of buyers make up the majority of your revenue?
- What is the size of the orders you receive?
- How easy would it be for your buyer to switch from one seller to another?
4. Threat of Substitute Products or Services
All firms in an industry are competing with other industries that make substitute products or services. An example is a messaging app that is a substitute for e-mail. Or an airline website replacing travel agents with its own ticket booking system.
If buyers can satisfy their needs with a different product or service from an alternative industry, that will put a lid on how high your industry can set its price.
The more attractive a substitute, the firmer the lid on industry profits. If there are many substitutes that can perform a similar function as your product or service, then the threat of substitutes is high.
If there are few substitutes that provide the same function as your product or service the threat is low.
Questions you can use during analysis:
- How many substitute products/services are in your industry?
- How similar are those products/services from a functional standpoint?
- What differentiates your products/services from those substitutes?
- Are those products/services affordable?
- What is the buyer’s cost of switching to a substitute product? Low or high?
- Are you able to offer a new product or service that can become a substitute for a market leader? If so, what it is?
5. Competitive Rivalry
Although rivals are subject to the same industry forces as yourself, the force of competitive rivalry is often the largest determinant of an attractive industry since it is affected by the four previous forces. In order to capture their share of the market, rivals will compete on price, quality, service, marketing spends, etc.
Competitive intensity is the highest when your buyers have plenty of alternatives, there is little differentiation between rivals, and when industry growth is slowing. If the buyer can choose from multiple rivals, the buyer can start bidding wars and reduce profits.
When there is little differentiation between rivals, your product or service will be perceived as a commodity and the buyer will purchase solely on price.
If an industry’s growth is slowing, the existing firms will be in a fight to maintain their piece of the market share. We've written extensively about VRIO Analysis that can help you find your competitive advantage and then turn that into a sustainable competitive advantage.
Questions you can use during analysis:
- What is the number of competitors in your industry?
- Who is your biggest competition?
- What makes your product/service different from your rivals?
- Are there any barriers that would prevent your customers from switching providers? If so, what are they?
- Is your industry shrinking or growing?
Porter’s 5 Forces Examples
The following two examples illustrate how the Five Forces model might be applied in practice.
Five Forces analysis in higher education
The following is an example of Porter's Five Forces Analysis applied to higher education:
Under each force, you should evaluate the threat, ranging from low to high.
Five Forces analysis in the airline industry
Here’s an example of an analysis for the airline industry that was developed and framed for the International Air Transport Association (IATA) by Michael E. Porter himself:
Weaknesses Of Porter’s 5 Forces Model
These are some possible limitations and pitfalls, as noted by Porter himself and other experts:
- Not putting in enough effort to discover and understand the ‘why’ behind observations.
- Lack of engagement with stakeholders during analysis can result in obstacles that could be prevented from the get-go.
- Not understanding the goal of Porter’s Five Forces Framework. The goal is to use insights to formulate a business strategy, not to declare whether the industry is attractive or not.
- Strategies fail because managers and strategists define the industry in which the competition takes place too broadly or too narrowly. On top of that, strategists shouldn’t ignore the possibility of shifting industry boundaries.
- Some authors and sources say that innovation should be considered one of the forces that drive industry competition. However, Porter argues that technology and innovations are fleeting factors that are not enough to make an industry attractive or unattractive.
There are also many resources criticizing that the 5 Forces model is a static tool. The main argument is that the framework gives a snapshot of competitive forces at a single point in time. However, Porter never stated that these five forces remain unchanged. Strategists have to periodically reassess five forces as well as keep an eye out for creative approaches taken by their competitors or newcomers.
TIP: Porter’s 5 Forces model is an outside-in facing tool that analyzes only external factors that impact a company’s profitability. You can do a comprehensive strategic analysis using additional tools and frameworks, like SWOT analysis, PESTLE analysis, Blue ocean strategy, or Value chain analysis.
How To Apply Porter’s 5 Forces Analysis?
Using Porter's 5 Forces, you should start to understand the forces that shape your industry. The next step is to identify how your company is going to compete and formulate a strategy.
Ideally, you want to sit in a position where you can balance the 5 Forces and maximize your profit. The key question to answer here is how are you going to achieve a competitive advantage that will put your organization in a winning position.
Porter developed three generic strategies that can be used to create a defendable position and outperform competitors. These strategies are cost leadership, differentiation, and focus on a particular niche.
Here’s a quick overview of each:
Cost Leadership Strategy
Cost leadership is a strategy that focuses on reducing the costs involved in providing a product or service. By running a lean operation and reducing costs across different departments, you’ll maintain healthy margins and profits.
A differentiation strategy focuses on providing a product or service that is perceived as being unique and hard to replicate. Buyers won’t find anything like your product or service in the market allowing you to charge a premium.
A focus strategy looks at serving a specific target market better than anyone else in this industry. By acquiring a deep understanding of your specific customer, you’ll be able to serve your customers more effectively and efficiently than the competitors who are working across the entire industry.
Don't Get Stuck In The Middle
Which strategy is your organization working towards? It’s not uncommon for organizations to successfully pursue more than one strategy, especially if your industry is growing and profitable.
However, as industries mature, the companies that are unclear about their strategy often see their profits dwindle. When companies fail to focus their efforts on any one of these 3 strategies they are, as Porter calls it, “stuck in the middle”.
Companies that are stuck in the middle lack the investment and resolve needed to be a cost leader, the unique product offering to pursue differentiation, and the attention required to pursue focus… in the long run, it’s a losing strategy.
If you are stuck in the middle, it’s important to start aligning your company with one of these strategies. Not sure which strategy to pick? Choose a strategy that is hardest to replicate and that is best suited for your company's strengths.
If you’re interested in easy-to-follow methods for identifying your strengths, check out our internal analysis article that covers different tools that can help you in the process.
Interestingly, the idea of focusing on a strategy is omnipresent in the realm of strategic planning.
Whether you’re reading Michael Porter’s Competitive Strategy, Stephen Covey’s 4 Disciplines of strategic execution (BHAG), or Jim Collins’ Good to Great (Hedgehog Concept), keeping an acute focus on one strategy is vital for success.
Focus + Strategy Execution = 🏆
If you’re looking to focus your company on a specific strategy, you should adopt a simple yet powerful strategy method. Our FREE strategic planning ebook can help you with this.
The eBook walks you through our proven method for crafting your strategy from the top down. To prevent being “stuck in the middle,” remember to keep your strategy top-of-mind as you work through the course.
For example, if you’re looking to pursue a cost leadership position, make sure you create goals focused on cost reduction and growing market share. In order to protect yourself successfully against the forces that shape your industry, you’ll need to identify the strength of each force and the underlying reason for its strength.
From there, create goals and procedures that, if achieved, place you in a position that protects you from whatever force you were looking to mitigate.
Lastly, know that you cannot do this alone. Change requires buy-in from your people. Aligning your strategy across your organization can be difficult - it’s even more difficult for everyone to keep strategy top-of-mind.
Make sure you have the systems in place that can help to align and facilitate your strategy, such as strategic planning and execution software.
FAQs About Porter’s Five Forces
What are the 5 elements in Porter’s 5 Forces?
The 5 elements in Porter’s 5 Forces are the Threat of new entrants, Bargaining power of buyers, Bargaining power of suppliers, Threat of new substitutes, and Competitive rivalry.
Is Porter’s Five Forces model still relevant today?
Porter’s Five Forces model remains relevant despite being on the scene for more than 40 years. It has its own limitations and can’t be used as a standalone tool but it’s an evergreen strategic tool that helps strategists make better decisions.
Who developed the model?
Porter’s 5 Forces model was developed and published by Michael E. Porter in 1979. The model was later updated by the author itself in 2008 and published in Harvard Business Review.
What is the difference between Porter's Five Forces and SWOT Analysis?
The main difference between Porter's Five Forces and SWOT Analysis is the fact that Porter's model analyzes only external forces, while SWOT Analysis takes into account both internal and external factors.
Porter, M. E. "How Competitive Forces Shape Strategy." Harvard Business Review 57, no. 2 (March–April 1979): 137–145.
Porter, Michael E. "The Five Competitive Forces That Shape Strategy." Special Issue on HBS Centennial. Harvard Business Review 86, no. 1 (January 2008): 78–93.