Michael Porter’s 5 Forces breaks the nebulous idea of business competition down into specific components that can be leveraged in marketing strategy. In this guide, we will explain the forces that make up Porter’s model, before moving on to giving examples of how Porter’s 5 Forces analysis can be used in strategy formulation.
What is Porter’s 5 Forces model?
Porter’s 5 Forces model breaks down the components of competition in a business environment. Marketers can use the model to assess the nature of competition facing their brand or product. This process generates insights which can help marketers formulate effective strategy, based on detailed and specific facts about their competitive context.
The 5 forces that make up Porter’s model are:
- Supplier power
- Buyer power
- Threat of substitution
- Threat of new entry
- Competitive rivalry
Marketers who can understand and formulate strategy around these five forces should be able, in theory, to improve the profitability of their brands and/or products.
Who created the 5 Forces model?
The 5 Forces model was put forward in the 1970s by Michael E. Porter, an economics theorist who was working as a Harvard Business School associate professor at that time.
Porter is among the world’s leading theorists on competition. He explained his approach to business theory in a 2010 interview:
“What I’ve come to see as probably my greatest gift is the ability to take an extraordinarily complex, integrated, multidimensional problem and get arms around it conceptually in a way that helps, that informs and empowers practitioners to actually do things.”
This is precisely what Porter’s 5 Forces model achieves.
Let’s go through each of the five forces in detail.
About the 5 Forces
Suppliers to an industry can influence its competitive nature by changing the prices of their goods and services, or by altering their quality. One contemporary example is Google Ads, which changes the cost-per-click (CPC) its advertisers pay on their ads based on the level of competition for visibility in search results. This creates a market in which clients understand they will often have to pay a premium for the best product: top-ranking ads on valuable SERPs.
Porter identifies several factors determining the power of an industry’s suppliers:
- The concentration of suppliers – how does the number of powerful suppliers compare to the size of the industry?
- Uniqueness of the product supplied.
- Switching costs – how much does it cost industry players to change from one supplier to another?
- Competition with alternative products – how able are industry players to use a different type of product?
- Threat of integrating forward – what is the potential for suppliers to integrate forward into the industry’s business? Suppliers have often used this option when businesses buy at unacceptable prices, as has sometimes been the case with farmers opening farm shops to achieve better profitability than was possible through selling to supermarkets.
- Importance of the industry to the supplier – the more heavily the supplier relies on the industry, the less bargaining power the supplier has.
These factors combine to determine the extent of supplier power in an industry.
How much buying power exists among the customers/clients of an industry? According to Porter, we can work this out by considering the following:
- Purchase volume – at what volumes can buyers purchase the industry’s products? Are multiple buyers able to increase their bartering power by purchasing as a collective? The higher the purchasing volume, the greater the buyer’s bargaining power.
- Differentiation of product – to what extent can the industry’s products be differentiated from one another? If a company sells ‘standard’ products, buyers could easily purchase from another company instead.
- Product involvement in buyers’ products – if the buyer uses the industry’s products as a significant component of their own product, they will likely be relatively sensitive to price. The is especially true when the industry’s product makes up a lot of the cost in the buyer’s product.
- Buyer’s own profitability – buyers with highly profitable products tend to be less sensitive to price than buyers with narrow profit margins.
- Importance of industry product to buyer’s goods and services – most buyers will be less sensitive to price when a product is highly important to their goods and services.
- Potential to save money – most buyers will be less sensitive to price when a product could save them money in some way.
- Threat of integrating backward – what is the potential for buyers to integrate backward into the industry’s business? One example of this would be a chain of bars setting up a factory to make their own post-mix syrup for soft drinks.
We can gauge the buyer power in an industry by considering the combined strength of these factors.
Bargaining power will likely vary among the buyers a company could sell to. The same applies to the suppliers a company could use. By targeting buyers and suppliers with relatively low bargaining power, based on the factors we’ve discussed, companies can cultivate a relatively mild competitive environment.
Threat of substitution
To what extent could an industry’s products be substituted for an alternative product by the buyer?
Many industries’ buyers have options to turn to a substitute product to fulfil their wants and needs. For instance, train travellers may choose to travel by coach instead, if they have encountered problems such as excessive train fares or inadequate service. Similarly, a buyer that manufactures ready meals might cease ordering from a nut producer and turn to an alternative protein such as tofu, if nut prices were to grow too high for the buyer to maintain the required profit margin.
The harder an industry’s products are to replace, the milder the effect this force will have on competition in that industry.
Threat of new entry
New entrants can transform the nature of competition in an industry. Think of the late 2000s, when a social media market dominated by Myspace was transformed as Facebook entered the industry; or looking back a little further, consider the change in the airline industry when EasyJet entered the market in 1995. Most new entrants will have a milder effect on competition than these cases did. However, the desire, resources and fresh approach of a new entrant will almost always have some effect on the established players in an industry.
Porter identifies two key factors which affect the strength of this force: barriers to entry and retaliation from established players. The higher an industry’s barriers to entry are, and/or the more fiercely established players retaliate to new entrants, the weaker the threat of new entry will be.
Potential barriers to entry include:
- Economies of scale – businesses need to work with high volumes in order to compete.
- Product differentiation – significant marketing investment is required to familiarise consumers with a new product or service.
- Capital requirements – significant financial resources are required to enter an industry, e.g. investment in R&D and testing is required for a brand to enter the pharma industry.
- Cost disadvantages independent of size – established players have cost advantages over new entrants, e.g. a long-established, well-known performing arts college will typically have a lower customer acquisition cost than a new player in that field would.
- Access to distribution channels – in certain industries such as fast-moving consumer goods (FMCG), established players have a powerful hold on the existing distribution channels, such as wholesale and retail channels, by means of contracts and agreements. This presents a severe challenge to new entrants seeking to distribute their products.
- Government policy – government regulations can limit or ban the entry of new players into certain industries.
The other key influence on the likelihood of new players entering an industry is the level of retaliation from established players. Retaliation can take lots of different forms, including tying up exclusive deals with distributors, cutting prices, and buying up intellectual property (IP) such as patents and brand names. Retaliation by established players can seem harsh on new entrants, but it’s sometimes the best way for established companies to safeguard their position.
This force, which Porter refers to as ‘jockeying among current contestants’, describes the competition for strategic positions that occurs among the existing companies in an industry. Competitive rivalry is influenced by the four forces we’ve discussed previously, and for this reason, diagrams of Porter’s 5 forces model often depict this force as lying at the centre of the other four (see above).
Porter identifies the following components of competitive rivalry:
- Number and equivalence of rivals – how many rival companies are there in the industry, and how do these companies compare in terms of size and power?
- Industry growth rate – the slower the rate of growth, the more intense competition between players will be.
- Differentiation of products or services – lack of differentiation can leave a company vulnerable to its rivals.
- Product shelf-life – in industries where products are perishable or time-sensitive, competition between rivals can intensify at times when sales are low or stocks are too high.
- Nature of changes in capacity – in some industries, such as shipbuilding and the chemical industry, increasing a business’s production capacity may need to be done in large increments. When businesses in such industries increase their capacity, this can cause overcapacity and price cutting across the whole industry.
- Exit barriers – high exit barriers, such as highly specialised assets or a management team’s dedication to a business, can lead failing businesses to carry on trading, even though they may be unprofitable. Measures taken by such businesses – cutting prices, for example – can inflate the competition within an industry.
- Diversity – where the rivals within an industry have diverse ideas, strategies and brands, competition between those businesses will tend to be intense and complex.
You can read Porter’s own description of the 5 Forces in his 1979 Harvard Business Review article, How competitive forces shape strategy.
Porter’s 5 Forces examples: how to use the 5 Forces model
The first step to using Porter’s 5 Forces is analysing the state of the forces in your own business’s competitive environment.
We recommend doing this at one of two levels: the macro environment of the business, meaning its industry; or the task environment, meaning the immediate context of a project, such as rival sellers of a specific kind of product or service.
There are lots of ways to gauge the strength of the forces in a competitive environment. We recommend using a mix of primary and secondary research methods, such as:
|Primary research methods||Secondary research methods|
|Questionnaires||Trade magazine and newspaper articles|
|Focus groups||Case studies|
|Data analysis||Purchasing financial data from liquidated companies|
The depth of your analysis should befit the gravity of the decisions you are going to make. If you simply wish to compare a few different industries that you might consider entering, using high/medium/low etc. ratings for each force might suffice – at least while you’re still at the “ideas” stage. On the other hand, if you are going to use a 5 Forces analysis to formulate detailed business strategy, your analysis should use industry data to arrive at an accurate summary of each force within the relevant industry.
Once you have analysed the extent of Porter’s 5 Forces within the relevant competitive environment, you can progress to strategy formulation. Porter identifies three strategic uses for the 5 Forces model:
The 5 Forces can be used as a tool for positioning a company to use its strengths as a defence against the most threatening competitive forces.
There are three key steps to this process:
- Identify the most powerful competitive forces in the competitive environment.
- Identify the strengths of the business, e.g. unusually high product differentiation.
- Create a plan for how the strengths identified can nullify competitive forces.
Consider the soft drinks market, where there are high barriers to entry in terms of access to distribution channels and economies of scale, and where the potential intensity of competitive rivalry is very high, due to the immense power of that industry’s leading players.
One way for a new soft drink business to nullify these competitive forces would be to develop a flavour of drink that is highly differentiated from other products currently available, and to focus entirely on selling that particular product. It tends to be far easier to compete with the likes of Coca-Cola and Pepsi if your brand is selling something quite different to them, as has been the case with challenger brands Irn-Bru and Mountain Dew. These differentiated products will typically experience milder competitive rivalry than products which are more alike to the products of established players – e.g. another cola priced similarly to the market leader.
Differentiation can make it easier for a brand to get products stocked in supermarkets and other key locations. Furthermore, differentiated products can have an elevated appeal to customers. This sometimes makes it feasible to charge a relatively high price, which can offset the cost disadvantage produced by rivals’ economies of scale.
2. Changing the balance of forces
A business may be able to strengthen its own position by influencing the balance of forces in a competitive environment.
Imagine a startup which has developed a new software, in an industry where the threat of new entrants is relatively low due to the capital requirements involved in entering that industry (specifically, development costs). That startup could change the balance of competitive forces in the industry by making its software open-source – a move which could weaken its more established rivals by increasing the threat of new entrants; while raising the profile of the startup itself.
Businesses that seek to change the balance of competitive forces in an industry are often described as ‘disruptive’. They would likely be unable to compete with an established player on its own playing field – so they change the playing field.
3. Anticipating change
Anticipating change in Porter’s 5 Forces and their underlying factors can provide excellent opportunities to steal a march on rival companies.
This relies on the capability to predict the future. Some businesses do this through statistical analysis; others rely on their leadership’s perceptiveness. In either case, this approach is a gamble.
Imagine a company that sells a range of power tools, gardening tools and other household appliances. All these tools run off rechargeable lithium-ion batteries, and the company predicts that those batteries will face a significant threat of substitution from new battery products in the coming years. That company could safeguard its products from this threat by selling them as a system, with separate batteries and chargers that can power any of the products in the range. Customers will be less likely to switch to a substitute product type in the near future, if they have already invested heavily in a range of products that depend upon each other to function.
Another use for Porter’s 5 Forces: gauging potential profit
Marketers who are aiming to launch businesses in new sectors can use Porter’s 5 Forces to compare the potential profitability of different industries or product types.
According to Porter, the collective strength of the five forces within an industry determines its ultimate profit potential. In an industry where the five forces are collectively intense, profit potential will be relatively low, whereas the opposite is true of industries where the five forces are collectively mild.
With this maxim in mind, we can assess the potential profitability of any type of brand or product, using the 5 Forces. The industries with the highest competition also likely have the highest potential profits.
Extra tips on using and interpreting Porter’s 5 Forces
Before we round up this guide to Porter’s 5 Forces, we’d like to go through a few points which are key to properly understanding the model.
Firstly, for most marketers using Porter’s 5 Forces for strategy formulation, it tends to be best to focus your attention on the one or two force you have identified as the strongest in the relevant competitive environment, as these will have the most influence on potential profitability. So, if you’ve identified threat of new entry as the strongest competitive force in an industry, your primary strategic focus should be on safeguarding your business against new rivals.
Another important consideration is that Porter’s definition of ‘competition’ goes beyond rival companies selling the same sort of goods as your own. It also includes customers, suppliers, and the potential new entrants and substitute products that may become involved in the business environment. Paying attention to this wider picture, rather than just what competing brands are doing, is crucial to good competitive strategy.
Why you should do Porter’s 5 Forces analysis regularly
Each of Porter’s 5 Forces is subject to change over time, within any given industry. For example, the expiration of a patent may make an industry more accessible to new entrants.
Regular Porter’s 5 Forces analyses will flag up significant shifts in the competitive nature of your brand’s business environment. Further, tracking your analyses over time can usefully illustrate the changing competition within your industry, which may point towards likely future developments.
In our view, there are two levels to the value Porter’s 5 Forces offers marketers.
First and foremost, the model brings clarity and specific detail to the idea of competition, which is sometimes discussed in vague terms by marketers and business leaders. It enables us to replace valid but unhelpful observations (“this industry is highly competitive”) with actionable insights (“the threat of substitution is the most intense competitive force in this industry”). If this sort of detailed perspective is all you take away from Porter’s 5 Forces, you’ve still gained something valuable.
The other level to the value of Porter’s 5 Forces is its usefulness in strategy formulation, as we’ve described in this guide. Through recognising and leveraging the fine detail of the competitive environment, we can identify strategic positions that play to the strengths of our own brands, and play on the weaknesses of our rivals.