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Porter’s Five Forces

Model
 21 Apr 2018

Porter’s Five Forces is a business analysis

model that helps to explain why different
industries are able to sustain different levels
of profitability. The model was originally
published in Michael Porter’s book,
“Competitive Strategy: Techniques for
Analyzing Industries and Competitors” in
1980.

The model is widely used to analyze the

industry structure of a company as well as its
corporate strategy. Porter identified five
undeniable forces that play a part in shaping
every market and industry in the world. The
forces are frequently used to measure
competition intensity, attractiveness and
profitability of an industry or market.

These forces are:

1. Competition in the industry;

2. Potential of new entrants into the industry;

3. Power of suppliers;

4. Power of customers;

5. Threat of substitute products.

Threat of new entrants.

This force determines how easy (or not) it is

to enter a particular industry. If an industry is
profitable and there are few barriers to enter,
rivalry soon intensifies. When more
organizations compete for the same market
share, profits start to fall. It is essential for
existing organizations to create high barriers
to enter to deter new entrants. Threat of new
entrants is high when:

Low amount of capital is required to enter

a market;

Existing companies can do little to

retaliate;

Existing firms do not possess patents,

trademarks or do not have established
brand reputation;

There is no government regulation;

Customer switching costs are low (it

doesn’t cost a lot of money for a firm to
switch to other industries);

There is low customer loyalty;

Products are nearly identical;

Economies of scale can be easily

achieved.

Bargaining power of suppliers.

Strong bargaining power allows suppliers to

sell higher priced or low quality raw materials
to their buyers. This directly affects the buying
firms’ profits because it has to pay more for
materials. Suppliers have strong bargaining
power when:

There are few suppliers but many buyers;

Suppliers are large and threaten

to forward integrate;

Few substitute raw materials exist;

Suppliers hold scarce resources;

Cost of switching raw materials is

especially high.

Bargaining power of buyers.

Buyers have the power to demand lower price

or higher product quality from industry
producers when their bargaining power is
strong. Lower price means lower revenues for
the producer, while higher quality products
usually raise production costs. Both scenarios
result in lower profits for producers. Buyers
exert strong bargaining power when:

Buying in large quantities or control many

access points to the final customer;

Only few buyers exist;

Switching costs to other supplier are low;

They threaten to backward integrate;

There are many substitutes;

Buyers are price sensitive.

Threat of Substitutes.

This force is especially threatening when

buyers can easily find substitute products with
attractive prices or better quality and when
buyers can switch from one product or service
to another with little cost. For example, to
switch from coffee to tea doesn’t cost
anything, unlike switching from car to bicycle.

Rivalry among existing competitors.

This force is the major determinant on how

competitive and profitable an industry is. In
competitive industry, firms have to compete
aggressively for a market share, which results
in low profits. Rivalry among competitors is
intense when:

There are many competitors;

Exit barriers are high;

Industry of growth is slow or negative;

Products are not differentiated and can be

easily substituted;

Competitors are of equal size;

Low customer loyalty.

Although, Porter originally introduced five

forces affecting an industry, scholars have
suggested including the sixth
force: complements. Complements increase
the demand of the primary product with which
they are used, thus, increasing firm’s and
industry’s profit potential. For example, iTunes
was created to complement iPod and added
value for both products. As a result, both
iTunes and iPod sales increased, increasing
Apple’s profits.

Application of Porter’s Five Forces

Model

Competitive Analysis:

Companies use the model to assess the

competitive dynamics within their industry. By
evaluating the intensity of each force,
businesses can gain insights into the level of
rivalry, bargaining power of suppliers and
buyers, threat of substitutes, and barriers to
entry.

Learn more

Market Entry Strategy:

Before entering a new market, businesses

can apply the Five Forces Model to assess
the potential risks and opportunities. This
analysis helps in making informed decisions
about the feasibility and attractiveness of
entering a specific market.

Strategic Planning:

Companies use Porter’s model as a strategic

planning tool. It helps in formulating business
strategies that capitalize on industry strengths
and mitigate weaknesses. For example, a
company might focus on differentiation
strategies if there is high rivalry, or explore
cost leadership if there is significant supplier
power.

Mergers and Acquisitions (M&A):

When considering M&A activities, firms

evaluate the industry’s competitive forces to
understand how the acquisition target fits into
the broader competitive landscape. This
analysis informs decisions about potential
synergies and risks associated with the
acquisition.

Supplier and Buyer Negotiations:

Understanding the bargaining power of

suppliers and buyers allows companies to
negotiate more effectively. If suppliers have
high power, companies might seek alternative
sources or negotiate for better terms.
Similarly, if buyers have high power,
companies might focus on adding value to
their products or services.

Product Development and Innovation:

Companies use the model to identify

opportunities for innovation and new product
development. By assessing the threat of
substitutes and understanding customer
preferences, businesses can create products
that meet specific market demands.

Risk Assessment and Management:

The Five Forces Model helps companies

identify potential risks and vulnerabilities
within their industry. This includes risks
associated with intense competition, supplier
disruptions, changes in customer
preferences, and the emergence of new
substitutes.

Market Positioning and Differentiation:

The analysis of competitive forces informs

decisions about how a company positions
itself in the market. It helps in identifying
areas where differentiation can provide a
competitive advantage. For example, a
company facing high rivalry might focus on
unique value propositions to stand out.

Regulatory and Policy Impact

Assessment:

Changes in regulations and government

policies can have a significant impact on
industry dynamics. Companies use the model
to assess how regulatory changes might
influence the competitive forces in their
industry and adjust their strategies
accordingly.

Investment Decisions:

Investors utilize Porter’s Five Forces Model to

assess the attractiveness of an industry
before making investment decisions. By
evaluating the competitive forces, investors
can gauge the potential returns and risks
associated with investing in a particular
sector.

Scenario Planning:

Companies use the model for scenario

planning, evaluating how changes in
competitive forces might impact their
business in different future scenarios. This
helps in preparing for potential shifts in
industry dynamics.

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