Michael Porter’s five forces is a model used to explore the environment in

which a product or company (or business unit) operates.

Five forces analysis looks at five key areas mainly the threat of entry, the
power of buyers, the power of suppliers, the threat of substitutes, and
competitive rivalry.

New Entrants
   

Industry competitors
Suppliers Buyers
and extent of rivalry

Substitutes
   

Introduction
The model of the Five Competitive Forces was developed by Michael E.
Porter in his book „Competitive Strategy: Techniques for Analysing Industries
and Competitors“ in 1980. Since that time the ‘five forces tool’ has become an
important method for analysing an organizations industry structure in strategic
processes.
Porters model is based on the insight that a corporate strategy should meet
the opportunities and threats in the organizations external environment.
Especially, competitive strategy should based on an understanding of industry
structures and the way they change.
Porter has identified five competitive forces that shape every industry and
every market. These forces determine the intensity of competition and hence
the profitability and attractiveness of an industry. The objective of corporate
strategy should be to modify these competitive forces in a way that improves
the position of the organization. Porters model supports analysis of the driving
forces in an industry. Based on the information derived from the Five Forces
Analysis, management can decide how to influence or to exploit particular
characteristics of their industry.

Overview
The Five Forces model of Porter is an ‘outside looking in’ business
unit strategy tool that is used to make an analysis of the
attractiveness or value of an industry structure.
The Competitive Forces analysis is made by the identification of 5
fundamental competitive forces:

 The entry of competitors (how easy or difficult is it for new entrants to

start to compete, which barriers do exist)
 The threat of substitutes (how easy can our product or service be
substituted, especially cheaper)
 The bargaining power of buyers (how strong is the position of buyers,
can they work together to order large volumes)
 The bargaining power of suppliers (how strong is the position of sellers,
are there many or only few potential suppliers, is there a monopoly)
 The rivalry among the existing players (is there a strong competition
between the existing players, is one player very dominant or all all equal in
strength/size)
Some academics believe that a sixth force could be included – government.
The Original Five Factors:
1) Threat of New Entrants –

The easier it is for new companies to enter the industry, the more cut-throat
competition there will be. Factors that can limit the threat of new entrants are
known as barriers to entry. Some examples include:
 Existing loyalty to major brands
 Incentives for using a particular buyer (such as frequent shopper
programs)
 High fixed costs
 Scarcity of resources
 Government restrictions or legislation
 Entry protection (patents, rights, etc.)
 Economies of product differences
 Brand equity
 Switching costs or sunk costs
 Capital requirements
 Access to distribution
 Absolute cost advantages
 Learning curve advantages
 Expected retaliation by incumbents
2) Power of Suppliers
This is how much pressure suppliers can place on a business. If one supplier
has a large enough impact to affect a company’s margins and volumes, then
they hold substantial power. Here are a few reasons that suppliers might have
power:
 There are very few suppliers of a particular product
 There are no substitutes
 The product is extremely important to the buyer, they cannot do without
it
 The supplying industry has a higher profitability than the buying industry
 Supplier switching costs relative to firm switching costs
 Degree of differentiation of inputs
 Presence of substitute inputs
 Supplier concentration to firm concentration ratio
 Threat of forward integration by suppliers relative to the threat of
backward integration by firms
 Cost of inputs relative to selling price of the product

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3) Power of Buyers/ Customers

This is how much pressure customers can place on a business. If one
customer has a large enough impact to affect a company’s margins and
volumes, then they hold substantial power. Here are a few reasons that
customers might have power
 Small number of buyers
 Purchases of large volumes
 Switching to another (competitive) product is simple
 The product is not extremely important to the buyer, they can do without
it for a period of time.
 Customers are price sensitive
 Buyer concentration to firm concentration ratio
 Bargaining leverage
 Buyer volume
 Buyer switching costs relative to firm switching costs
 Buyer information availability
 Ability to backward integrate
 Availability of existing substitute products
 Buyer price sensitivity
 Price of total purchase
4) Availability of Substitutes
What is the likelihood that someone will switch to a competitive product or
service? If the cost of switching is low, then this poses to be a serious threat.
Here are a few factors that can affect the threat of substitutes:
 Buyer propensity to substitute
 Relative price performance of substitutes
 Buyer switching costs
 Perceived level of product differentiation
 Fad and fashion
 Technology change and product innovation
The main issue is the similarity of substitutes. For example, if the price of
coffee rises substantially, a coffee drinker is likely to switch over to a beverage
like tea because the products are so similar.
 If substitutes are similar, then it can be viewed in the same light as a
new entrant.
 Consider technology substitutes (who would have thought that MP3
technology would replace tape & CD’s?)
5) Competitive Rivalry
And last but not least, this describes the intensity of competition between
existing firms in an industry. Highly competitive industries generally earn low
returns because the cost of competition is high. A highly competitive market
might result from:
 Many players of about the same size, no dominant firm.
 Little differentiation between competitors products and services.
 A mature industry with very little growth.
 Companies can only grow by stealing customers away from
competitors.
For many industries, this is the major determinant of the competitiveness of
the industry. Sometimes rivals compete aggressively and sometimes rivals
compete in non-price dimensions such as innovation, marketing, etc.
 Number of competitors
 Rate of industry growth
 Intermittent industry overcapacity
 Exit barriers
 Diversity of competitors
 Informational complexity and asymmetry
 Fixed cost allocation per value added
 Level of advertising expense
Use of the Information form Five Forces Analysis:
Five Forces Analysis can provide valuable information for three aspects of
corporate planning:
 Statistical Analysis:
The Five Forces Analysis allows determining the attractiveness of an
industry. It provides insights on profitability. Thus, it supports decisions
about entry to or exit from and industry or a market segment. Moreover,
the model can be used to compare the impact of competitive forces on the
own organization with their impact on competitors. Competitors may have
different options to react to changes in competitive forces from their
different resources and competence’s. This may influence the structure of
the whole industry.
 Dynamical Analysis:
In combination with a
PESTLE Analysis, which reveals drivers for change in an industry, Five
Forces Analysis can reveal insights about the potential future
attractiveness of the industry. Expected
Political, Economical, Socio demographical, Technological, Legal and
Environmental changes can influence the five competitive forces and thus
have impact on industry structures.
Useful tools to determine potential changes of competitive forces are
scenarios.
 Analysis of Options:
With the knowledge about intensity and power of competitive forces,
organizations can develop options to influence them in a way that
improves their own competitive position. The result could be a new
strategic direction, e.g. a new positioning, differentiation for competitive
products of strategic partnerships (see section 4).
Porters model of Five Competitive Forces allows a structured and
systematic analysis of market structure and competitive situation. The model
can be applied to particular companies, market segments, industries or
regions. Therefore, it is necessary to determine the scope of the market to be
analysed in a first step. Following, all relevant forces for this market are
identified and analysed Hence, it is not necessary to analyzer all elements of
all competitive forces with the same depth.

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The Five Forces Model is based on microeconomics. It takes into account

supply and demand, complementary products and substitutes, the relationship
between volume of production and cost of production, and market structures
like monopoly, oligopoly or perfect competition.

Influencing the Power of Five Forces

After the analysis of current and potential future state of the five competitive
forces, managers can search for options to influence these forces in their
organization’s interest. Although industry-specific business models will limit
options, the own strategy can change the impact of competitive forces on the
organisation. The objective is to reduce the power of competitive forces.

The following figure provides some examples. They are of general nature.
Hence, they have to be adjusted to each organization’s specific situation. The
options of an organization are determined not only by the external market
environment, but also by its own internal resources, competence’s and
objectives.

Reducing the Bargaining Power of Suppliers

Partnering
Supply chain management
Supply chain training
Increase dependency
Build knowledge of supplier costs and methods
Take over a supplier
Reducing the Treat of New Entrants

Increase minimum efficient scales of operations

Create a marketing / brand image (loyalty as a barrier)
Patents, protection of intellectual property
Alliances with linked products / services
Tie up with suppliers
Tie up with distributors
Retaliation tactics
Reducing the Competitive Rivalry between Existing Players

Avoid price competition

Differentiate your product
Buy out competition
Reduce industry over-capacity
Focus on different segments
Communicate with competitors
Reducing the Bargaining Power of Customers

Partnering
Supply chain management
Increase loyalty
Increase incentives and value added
Move purchase decision away from price
Cut put powerful intermediaries (go directly to customer)
Reducing the Threat of Substitutes

Legal actions
Increase switching costs
Alliances
Customer surveys to learn about their preferences
Enter substitute market and influence from within
Accentuate differences (real or perceived)
Generic Strategies to help counter the Five Forces
Strategy can be formulated on three levels:

 corporate level
 business unit level
 functional or departmental level.
The business unit level is the primary context of industry rivalry. Michael
Porter identified three generic strategies (cost leadership, differentiation, and
focus) that can be implemented at the business unit level to create a
competitive advantage. The proper generic strategy will position the firm to
leverage its strengths and defend against the adverse effects of the five
forces.

Assumptions made about the Five Forces model:

 That buyers, competitors, and suppliers are unrelated and do not
interact and collude
 That the source of value is structural advantage (creating barriers to
entry)
 That uncertainty is low, allowing participants in a market to plan for and
respond to competitive behaviour.
Use of the Five Forces model

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The Five Forces tool is a simple but powerful tool for understanding where
power lies in a given business situation. This is important, as it helps you
understand both the strength of your current competitive position, and the
strength of a position you’re looking to move into.

With a clear understanding of where power lies, you can take fair advantage
of a situation of strength, improve a situation of weakness, and avoid taking
wrong steps. This makes it an important part of your business planning toolkit.

   
Supplier Power
Supplier
concentration

Importance of volume
to supplier

Differentiation of
inputs

Impact of inputs on
cost or differentiation

Switching costs of
firms in the industry

Presence of
substitute inputs

Threat of forward
integration

Cost relative to total

purchases in industry
 Barriers to Entry Degree of Rivalry Threat of Substitutes
Absolute cost Exit barriers Switching costs
advantages
Industry concentration Buyer inclination to
Proprietary learning
curve Fixed costs/Value substitute
added
Access to inputs Price-performance
Industry growth
Government policy trade-off of
Intermittent substitutes
Economies of scale overcapacity

Capital requirements Product differences

Brand identity Switching costs

Switching costs Brand identity

Access to distribution Diversity of rivals

Expected retaliation Corporate stakes

Proprietary products

   
Buyer Power Bargaining
leverage
Buyer volume

Buyer information

Brand identity

Price sensitivity

Threat of backward
 integration

Product differentiation

Buyer concentration
vs. industry

Substitutes available

Buyers’ incentives

Application with other tools

Porters five forces model works well in association with  a SWOT analysis and
a PESTLE analysis

About Michael Porter

American Michael Porter was born in 1947. After initially graduating in

engineering, Porter achieved an economics doctorate at Harvard, where he
was subsequently awarded university professorship, a position he continues
to fulfil at Harvard Business School. Porter’s research group is based at the
Harvard Business School, and separately he co-founded with Mark Kramer
the Foundation Strategy Group, ‘a mission-driven social enterprise, dedicated
to advancing the practice of philanthropy and corporate social investment,
through consulting to foundations and corporations’.

After his earlier work on corporate strategy Porter extended the application of
his ideas and theories to international economies and the competitive
positioning of nations, as featured in his later books. In fact in 1985 Porter was
appointed to President Ronald Reagan’s Commission on Industrial
Competitiveness, which marked the widening of his perspective to national
economies. By the 1990’s
Porter had established a reputation as a strategy guru on the international
speaking circuit second only to Tom Peters, and was
among the world’s highest earning academics.
Porter’s first book Competitive Strategy (1980), which he wrote in his thirties,
became an international best seller, and is considered by many to be a
seminal and definitive work on corporate strategy. The book, which has been
published in nineteen languages and re-printed approaching sixty times,
changed the way business leaders thought and remains a guide of choice for
strategic managers the world over.

References:
This tool was created by Harvard Business School professor, Michael Porter,
to analyze the attractiveness and likely-profitability of an industry. Since
publication, it has become one of the most important business strategy tools.
The classic article which introduces it is “How Competitive Forces Shape
Strategy” in Harvard Business Review 57, March – April 1979, pages 86-93
Michael Porter’s key books and publications:

 Competitive Strategy: Techniques for Analyzing Industries and

Competitors, 1980
 Competitive Advantage: Creating and Sustaining Superior Performance,
1985
 Competition in Global Industries, 1986
 The Competitive Advantage of Nations, 1990