What are Porter’s Five Forces?
Porter’s Five Forces is a framework that is used to identify and analyze five separate competitive influences that impact businesses and industries. Through these five forces, you can understand the strengths and weaknesses of that business. The model was named after its creator - Michael E. Porter, who created it during his time as a Harvard business professor. It was first published in 1980, in his book “Competitive Strategy: Techniques for Analyzing Industries and Competitors.”
Many businesses utilize this model to act as a foundation for their corporate strategy and build on their strengths. It can be used from an economic perspective to understand the impact of competition (or lack thereof) in the industry and to predict and improve profitability.
What are the five forces?
The five forces are as follows:
1. Competition in the industry
2. Potential for new entrants into the industry
3. Power of suppliers
4. Power of customers
5. Threat of substitute products
Competition in the industry
This force pertains to the amount of competition that already exists in the industry, which will have an impact on your business. If there is little to no competition, this is a strength for you. There is some freedom to be able to charge prices that you want and generate greater profits for your business through more sales. If there are large amounts of competitors or competitors that are larger in size and offer more products and services, this can have a severe impact on your business. It can reduce the market power of your own company - you will have to work hard to ensure that your products are of a higher quality and your prices are lower, cutting your profit margins.
Potential for new entrants into the industry
Is there a high cost of entry into your market? This could be in the form of time or resources. This will dissuade potential competition from entering, which works in favor of your business. It also means that even if competitors are able to enter the market, they may not enter strongly, allowing you to maintain your share of the market. Conversely, if there is very little capital or time needed to enter a market, it makes it easier for new competitors to establish themselves. In turn, this reduces the market position of your own company and removes some of the freedom to charge your ideal prices for products and services.
Power of suppliers
Your business is going to be heavily dependent on your supplier and their ability to provide you with what you need at a low price. The more suppliers there are, the more power you have to negotiate and move around to find an option that works for you in terms of cost and quality. If there are a limited number of suppliers in your industry, they have a lot of power to drive up the costs of their goods, reducing the power of your own company. It’s also important to factor in the ability to switch providers - even if there is a surplus of providers, they may not be willing or able to take your business. You would still be stuck struggling to keep your costs low and have limited power within the market.
Power of customers
Similar to suppliers, customers also have a lot of power over businesses. One of their strongest methods of control is forcing prices lower. If they do not purchase a product or service at a given price, the company must lower it. There are specific components to the customer market that dictate how powerful it is: the number of customers a business has and how unique the customer base is (e.g., how easy would it be for the business to pivot slightly to cater to a new audience). If the customer base is small, it means that each individual sale becomes more important, and their power to demand lower prices increases. If the company base is larger, individual sales have less power, and although a business may lose a few customers due to higher prices, it can still function. If the business caters to a small, niche audience, the customer has greater power, as the business may struggle to find other consumers to take their place, reducing their opportunities for profitability.
Threat of substitute products
If the market is wide enough to contain substitutes for the product or service that your business sells, you have limited power. Consumers can easily switch to a substitute if they feel it is cheaper or offers favorable extras. Businesses have more power when they offer something unique that consumers cannot access elsewhere. This creates further opportunities to set your own prices without strong market forces demanding you lower them.
When should Porter’s 5 forces analysis be used?
This framework should be used whenever a business is trying to understand its market, usually because they want to introduce a new product or service. The analysis can be used to develop educated predictions about how well that new product or service might perform and what market tensions it is likely to face.
It’s important to remember that markets are fluid, not static. All aspects are currently changing, from consumer demand and supply to existing competition. Therefore this framework is designed to be used more than once, and can be revised every time significant market change occurs.
Porter’s 5 forces business examples in the industry:
Here are some links to real and hypothetical examples of Porter’s 5 forces framework being applied to businesses. These examples highlight the flexibility of the framework, which can be adapted to suit different industries and businesses of different sizes. Some of these examples also offer suggestions for continued success based on the major forces impacting the companies.
Apparel company and eBanking company examples
- The apparel company example highlights the risks associated with entering a market such as sports apparel, which is already highly competitive with big, key businesses. However, there are still some ways to hold on to power, through creating unique garments, and the supplier base is varied, so there is value in moving forward with the business decision.
- The eBanking example has slightly less competition, but their existing competitors still hold great power - the world of eBanking is still relatively new, and services are limited, so there are not many ways to differentiate between companies. Similarly, their entire service is run through technological suppliers, giving their suppliers very high levels of power.
Under Armor example
- This example utilizes a real brand - Under Armor - as its example. Similar to the previous example, Under Armor is a sports clothing brand. The brand has significant competition from brands like Adidas and Nike, and there is always a threat of new brands entering the market. However, their business model has been designed to reduce all other forces as much as possible by seeking multiple suppliers to reduce the bargaining power of one, building a successful brand that sells direct to consumers, not just wholesale retailers, and maintains unique, high-quality products to avoid the risk of substitutes.
Airline industry example
- This example is about the airline industry. Although they do not use a specific brand as an example, it illustrates how the industry forces impact existing airlines, and the difficulties a new brand may face when they enter the market. This example was pre-covid, but serves as an excellent reminder that market conditions change - Porter’s analysis of this industry would look significantly different at the height of all of the global lockdowns, when flights were being grounded and nobody could travel.
Uber example
- This is another transport example, although this one focuses on rideshare service Uber. There is significant competition from Lyft, as well as more local, smaller businesses operating the same. There is also a high threat of new competitors entering the market as more and more consumers demand the service, driving prices down. Most consumers will happily switch brands if they can find the same driver service for cheaper on another app - there is very little brand loyalty. The suppliers (drivers) also have very high bargaining power, as the qualifications to be a driver are similar across the different competitors, so they will transfer to the company that offers better money and protection. Uber is an interesting example as there are very significant market forces operating against them from all 5 forces.
Starbucks example
- Starbucks is a well-known coffee chain that has expanded globally. Just like Uber, Starbucks has a number of market forces upon them, from the competition, their customers, substitutions, and new entrants to the market. The only thing they are secure in is their suppliers as they have many and can afford to negotiate their terms for purchase. This is another good example that highlights the potential for a business to grow, despite negative market effects working against them.
