Porter's 5 Forces Analysis

Porter's 5 Forces

Porter's Five Forces of Competitive Position Analysis were developed in 1979 by Michael E Porter of Harvard Business School as a simple framework for assessing and evaluating the competitive strength and position of a business organisation.

This theory is based on the concept that there are five forces that determine the competitive intensity and attractiveness of a market. Porter’s five forces help to identify where power lies in a business situation. This is useful both in understanding the strength of an organisation’s current competitive position, and the strength of a position that an organisation may look to move into.

The five forces are:

1. Supplier power. An assessment of how easy it is for suppliers to drive up prices. This is driven by the: number of suppliers of each essential input; uniqueness of their product or service; relative size and strength of the supplier; and cost of switching from one supplier to another.

2. Buyer power. An assessment of how easy it is for buyers to drive prices down. This is driven by the: number of buyers in the market; importance of each individual buyer to the organisation; and cost to the buyer of switching from one supplier to another. If a business has just a few powerful buyers, they are often able to dictate terms.

3. Competitive rivalry. The main driver is the number and capability of competitors in the market. Many competitors, offering undifferentiated products and services, will reduce market attractiveness.

4. Threat of substitution. Where close substitute products exist in a market, it increases the likelihood of customers switching to alternatives in response to price increases. This reduces both the power of suppliers and the attractiveness of the market.

5. Threat of new entry. Profitable markets attract new entrants, which erodes profitability. Unless incumbents have strong and durable barriers to entry, for example, patents, economies of scale, capital requirements or government policies, then profitability will decline to a competitive rate.

Example

Martin Johnson is deciding whether to switch career and become a farmer – he's always loved the countryside, and wants to switch to a career where he's his own boss. He creates the following Five Forces Analysis as he thinks the situation through:

The threat of new entry is quite high: if anyone looks as if they're making a sustained profit, new competitors can come into the industry easily, reducing profits. 

Competitive rivalry is extremely high: if someone raises prices, they'll be quickly undercut. 

Intense competition puts strong downward pressure on prices. 

Buyer Power is strong, again implying strong downward pressure on prices. 

There is some threat of substitution. 

Key Points

Porter's Five Forces Analysis is an important tool for assessing the potential for profitability in an industry. With a little adaptation, it is also useful as a way of assessing the balance of power in more general situations. 

It works by looking at the strength of five important forces that affect competition: 

Supplier Power: The power of suppliers to drive up the prices of your inputs. 

Buyer Power: The power of your customers to drive down your prices. 

Competitive Rivalry: The strength of competition in the industry. 

The Threat of Substitution: The extent to which different products and services can be used in place of your own. 

The Threat of New Entry: The ease with which new competitors can enter the market if they see that you are making good profits (and then drive your prices down).