Porter’s Five Forces is a framework for industry analysis and business strategy development formed by Michael E. Porter of Harvard Business School in 1979.
It draws upon Industrial Organisation (IO) economics to derive five forces that determine the competitive forces and intensity and therefore attractiveness of a market. Attractiveness in this context refers to the overall industry profitability.
An "unattractive" industry is one in which the combination of these five forces acts to drive down overall profitability. A very unattractive industry would be one approaching "pure competition", in which available profits for all firms are driven to normal profit.
The underlying theory is that there are five forces that determine industry profitability. The collective strength of these forces determines the ultimate profit potential in an industry.
The more attractive an industry is, the more profitable it will be for firms already competing in it and the more likely it will attract new firms, provided there are no entry barriers such as government regulation preventing this activity.
Want to learn more about the landscape of your current market?
Looking to enter a new country?
Need to see how your strategy fits in the marketplace?
Porter’s Five Forces is a great model to help you evaluate the different external factors that will impact your competitive position in the long term.
If you’ve not heard of it before, check out our introduction to Porter’s Five Forces.
A detailed Porter’s Five Forces analysis can provide clarity and help you plan what you need to do in order to continue to be successful. The basic underlying structure of the model looks at five different factors that are external and impact your business:
- Threat of New Entry
- Supplier Power
- Buyer Power
- Threat of Substitution
- Competitive Rivalry
We’re going to walk through how to establish each force and give it a High, Medium or Low value, before summarising how you compete within the environment.
Step 1 – Preparation is Key
Five Forces is a framework that requires a more detailed knowledge of the market than ones such as SWOT analysis and PESTLE. You need to prepare for Five Forces as most of the insight being documented is external. The best Five Forces is done in a group where you have experts from Customer Service, Company’s Products, Sales and Marketing all in the room.
Ideally be equipped with the following information:
- Sales and performance of competitors
- Any information on reasons behind customer churn
- Intelligence on why you have acquired or won certain clients
- Detail on what suppliers you use to provide the product/service
- An understanding of who your clients are and what is impacting them
Step 2 – Threat of New Entry
This section is designed to map out how easy it is for a new player to enter the market. It might be an established business like Google or it could be a brand new start-up. In either scenario, how easy would it be to enter your space and make some progress? New entrants put pressure on current organizations within an industry through their desire to gain market share. On the other hand, existing large organizations may be able to use economies of scale to drive their costs down, and maintain competitive advantage over newcomers.
- Is there regulation in the market?
- How complicated is the product or service?
- Are there legal barriers such as IP?
- What budget would be required?
- What would the existing players response be?
- What are the barriers to entry?
- Have new players arrived recently? If so, how did they do?
Bullet point out a few of your conclusions and decide if the threat is High, Medium or Low.
Step 3 – Threat of Substitution
It’s now time to step outside of your product or service and see how easy it would be to replace it with an entirely new service. Keep in mind this isn’t substituting your product with a competitor’s product, this is about the industry’s product being substituted. Similar to how in the 1980s everyone hand landlines, now everyone has mobile phones.
In many cases you’ll already have substitute products that compete against your industry profitability, meaning this section should evaluate their potential, cost, ease and quality. If you’re lucky enough to be in a market where there is no substitute then consider what it would take for one to appear.
- Are there already substitute products or services?
- Is the cost for a customer to switch low?
- What is the brand loyalty and strength like in the marketplace?
- How does the product or service compete?
Once done, summarise your conclusions in a bullet point list and label the threat to be High, Medium or Low.
Step 4 – Supplier Power
Your business uses suppliers to provide your products or services, for example, you may be in manufacturing clothing and have a supplier of cotton, or you may be a SaaS business that hosts their software on Azure. List out all the suppliers you use that enable you to provide your product or service to your customers.
Once done, consider how powerful they are, what could they do to your business? What pressure can they put on your business?
- How many suppliers of the product or service you use are there?
- What are the switching costs?
- Is what they supply unique or special?
- How big a customer are you to your supplier?
Once you’ve evaluated how much competitive pressure your suppliers can place on your business it’s time to bullet point out the conclusions and give a rating of High, Medium or Low to the bargaining power of suppliers.
Step 5 – Buyer Power
We’re now at the stage where the power of customers is analysed. This is a crucial part as it determines how much pressure a customer can place on you for price, for your product development or customer service.
At this point consider the customers you have lost, the sales you have won, and your customer survey feedback.
- How many alternative options are there in the market for customers?
- What would the cost of switching be?
- How long are your contracts on average?
- Are customers well educated about the product?
- Are they price sensitive?
- How much of your product or service do customers purchase?
- How strong is your brand value and loyalty?
As with the other sections your next step is to bullet point your conclusions before labelling the Buyer Power as High, Medium or Low.
Step 6 – Competitive Rivalry
You’re now in a position where you know the power of both buyers and suppliers and the threat of substitute products or threat of new entrants, so it’s time for the final section which establishes the competitive rivalry within your marketplace
- How many direct competitors are in this space?
- How big is the marketplace, can it sustain multiple successful companies?
- What is the industry growth looking like?
- What is the M&A news in this space?
- What are the exit barriers?
- Have you lost to competitors and, if so, why?
For the final time, summarise your findings in bullet points and decide on a High, Medium or Low label for Competitive Rivalry. Remember this section is influenced by the other factors, so take a look at how you’ve labelled the previous areas and consider them in your decision.
And if it’s still not clear, watch this video walkthrough:
Bonus Step – Placing Your Current Strategy
You’ve now got a completed Five Forces analysis, well done! It’s helpful to position your current competitive strategy on the diagram, so underneath write a few points about how you’re currently positioning yourself and competing within the marketplace you’ve just detailed.
Now you’ve completed your analysis, you’re ready to make use of it. Look out for any quick wins, flag internally any concerns, and consider what it teaches you about your future direction.
We hope you found this guide helpful! If you want to go further, check out how to complete a Six Forces model.