Porter's Five Forces

Goal

Porter's Five Forces breaks competition in an industry into five pressures and assesses the intensity of each one separately. Two factors explain a company's profitability in Porter's account: the structure of the industry it operates in and its relative position within that industry. The model handles the first. It holds that competition reaches beyond existing competitors: a buyer able to dictate terms, a supplier in a monopoly position or a cheaper substitute captures the same value as a price war.

The technique answers a framing question: in this industry, who captures the value created. The answer steers expensive decisions, among them whether a pricing advantage will hold or be taken back by a supplier at the next contract renewal. It also feeds other techniques: a SWOT analysis takes up the threats and opportunities it has characterised; the business model canvas builds on the buyer and supplier power it has measured.

The deliverable is an assessment force by force: for each one, an intensity of low, moderate or high, the factors that drive it, the facts that support it and the direction it is moving in. It closes with the dominant force, the one most of the industry's profitability hangs on.

Usage

When to use it

• Entry or exit decision: measure what an industry allows a company to earn before committing capital to it.
• Choosing between business areas: compare the structure of two markets that revenue alone does not separate.
• Early framing of a transformation programme: name the pressures the solution will have to ease.
• Persistently weak profitability: look in the industry structure for what internal analysis does not explain.
• A player arriving from another industry: classify the threat as entry or as substitution, which call for two different responses.

When not to use it

• The organisation's own position is what needs assessing: the model describes the industry, so follow it with a SWOT analysis for the company sitting in it or with benchmarking if the question is a performance gap.
• An emerging industry with no settled structure: boundaries and players move too fast for an intensity to hold, so track the market through market analysis until it settles.

Description

Draw the industry boundary first

The analysis starts by saying what the word "industry" covers. Porter gives it two dimensions: the range of products or services included and the geographic reach. The choice decides everything that follows, since it assigns every player to a force. An insurer that grants mortgages is an established competitor when the industry is taken to be mortgage lending. It becomes a new entrant when the industry covers retail financial services as a whole.

A boundary drawn too wide blurs structural differences: "banking" as a single industry mixes wealth management with the payments business, whose economics have nothing in common. A boundary drawn too narrow blinds the model to the pressures that count: analysing fixed-rate mortgage lending alone leaves out variable-rate mortgages and renting a home. The test: check that the players included face the same forces at the same intensity; if two groups of players react differently to the same pressure, there are two industries. The table below compares two possible boundaries, force by force.

The five forces, one by one

Rivalry among existing competitors sits at the centre of the model. Its form counts as much as its intensity: rivalry fought on price transfers value to the buyer and destroys the profitability of the whole industry, while rivalry fought on lead time, service or attributes that different buyers value differently can leave profitability intact.

The threat of new entrants weighs on an industry even when nobody enters. The possibility of entry caps prices, since established players forgo the increases that would make the industry attractive. Porter lists seven sources of barriers to entry, plus the retaliation an entrant expects from the incumbents.

The bargaining power of suppliers captures value through the price of inputs, their quality or the terms imposed. A powerful supplier is one more concentrated than the industry it serves, dependent on that industry for little of its revenue, hard to replace without cost or able to integrate forward into its customer's business.

The bargaining power of buyers is the same mechanism seen from the other side, and Porter distinguishes two components in it. The balance of power rests on the number of buyers, the volume they handle, how standardised the product is and their switching costs. Price sensitivity rests on the weight of the purchase in the buyer's costs, on its own margins and on the effect of the purchased product on the quality of what it sells. A powerful buyer that is insensitive to price does not apply the pressure its size would suggest.

The threat of substitute products or services is the one teams see last, because a substitute comes from another industry and meets the same need by another means. It is also the force that moves fastest: a technological shift in a neighbouring industry is enough to create a substitute.

The factors to weigh are gathered in the table below.

Running the analysis

1. Set the boundary
   Write in one sentence the products or services included and the geographic area.
2. Name the players behind each force
   A list of proper names: a label such as "IT suppliers" cannot be weighed; three named vendors can.
3. Assess each force through its factors
   Take the factors from the table above one by one and back every judgement with a dated fact: a market share, a contract term, a regulatory requirement, an observed price.
4. Name the dominant force
   Rank the five intensities and name the one that governs the industry's profitability. Two forces can dominate together; the decision is then judged on each. Beyond two, the ranking is still to be done.
5. Establish the direction of travel
   For each force, say which way it is moving and under what influence: a regulatory change, a technology, consolidation among suppliers, a shift in demand.
6. Draw a decision from it
   Three uses, depending on the company's room for manoeuvre: position it where the forces weigh least, exploit a change of structure before competitors do or act on the structure itself by raising a barrier or reducing a dependency.

What distorts the analysis?

A badly drawn boundary is the most serious trap. It stays invisible in the deliverable: the assessment is filled in, the five forces carry text and the error sits in the title of the document. The remedy: write the boundary at the head of the document, have someone from the business read it back and assess the first force only after that.

The list standing in for an analysis comes next. A box filled with six bullets carrying neither an intensity nor a supporting fact produces a document that settles nothing. The discipline is to close each force with an intensity and with the sentence that justifies it, which forces the analyst to find the missing fact instead of adding a bullet.

Attention spread evenly across the five forces is the third trap. The model exists to find what governs profitability, and five analyses of equal depth leave the question open. A weak force deserves a paragraph and the dominant force deserves the rest of the work.

Confusing a factor with a force is the mistake Porter warns against explicitly in 2008. Industry growth, technology, government intervention and complementary products act on the forces without being forces. A fast-growing industry is not an attractive industry if that growth draws entrants and strengthens suppliers. The question to ask of any factor is always the same: which of the five forces does it act on and in which direction.

An analysis done once and never revisited loses its value. An industry structure often shifts within three to five years, under the effect of a regulation, a consolidation or a new substitute. An assessment that is dated and filed with a note of what would change it can be taken up again in a few hours; an undated assessment has to be redone from scratch.

AI considerations

Gathering the facts is the surest gain. A language model collects the public material force by force and puts it into one format: competitors' annual reports, regulator publications, market-entry announcements, published pricing terms. In a body of documents it spots mentions of a sole supplier or an exclusivity clause, the raw material of supplier power, which nobody rereads contract by contract.

Its second use is the industry boundary. Asking it to list the players that come in and go out under two competing definitions, then comparing the two lists, shows where the classification tips and which boundary choice is being made. The same exercise applied to substitutes reaches further than a team's own thinking, since a team knows its competitors and rarely looks at neighbouring industries.

What the language model handles poorly is the assessment itself. Asked about an industry, it produces a plausible and generic intensity, "buyer power is high", without the fact that would establish it. A judgement of that kind then propagates through the document with nobody knowing where it came from. It has no sight of the terms negotiated with a supplier, the prices charged or the margins by product line, the data the decision rests on. It is also trained on earlier texts, so the direction of travel, the point that gives the analysis its value, is what it handles least well. Contract terms and margins by product are confidential as well: passing them to an external service is decided before the analysis starts.

Examples

A Swiss regional retail bank assesses its industry, defined as retail banking services in Switzerland, before deciding on a multi-year investment in its digital platform.

Threat of new entrants: moderate, rising. A FINMA banking licence and the capital requirements rule out entering head-on as a bank in its own right, but neobanks operate under a partner institution's licence or from abroad, which lowers the barrier on the payment account alone.

Bargaining power of buyers: high, rising. Comparison sites make terms public and immediately comparable, opening an account with a competitor takes a few minutes and new players lead with free account maintenance.

Bargaining power of suppliers: high. The Swiss core banking software market rests on a handful of vendors, Avaloq, Finnova and Temenos. Changing platform is measured in years and a mid-sized institution does not have the IT scale to bring the function in-house.

Threat of substitutes: moderate. Robo-advisers replace investment advice on small portfolios, where the margin on traditional advice was already thin.

Rivalry: high. Cantonal banks, Raiffeisen, PostFinance and the large banks offer savings and mortgage products with little differentiation, which brings the comparison back to the rate.

Two forces dominate: the power of the software vendors and that of the buyers. The investment is therefore judged on those two. Reducing dependence on the vendor's platform acts on the first; raising the customer's switching cost through a service the comparison sites do not measure acts on the second. A redesign of the mobile app that touches neither of them restores parity with competitors without changing the structure of the industry.

Visualisations

The layout of the five forces carries the model's thesis. Four forces placed around a central box and linked to it by inward-pointing arrows show that the observable rivalry is the product of outside pressures, which a list of five bullets of equal weight does not say. The diagram is read twice: empty, to understand the structure of the model, then filled with the players and intensities of a given industry, to read an assessment at a glance and see which force dominates.

The factors that drive each force belong in a table instead. They are a taxonomy, a column of criteria set against a column of forces, with no spatial relation to show. Rendering them as a diagram would add boxes without adding sense, and a reader preparing a session needs to run through them line by line. The same logic applies to the comparison of two industry boundaries, where the content of each cell changes while the structure stays identical.

Cost

Tooling

The technique needs no software. The diagram is drawn on a whiteboard during the session and the five assessments fit in a structured document or a spreadsheet, one row per factor, with a column for the fact and its source. The spreadsheet becomes useful as soon as several industries are compared, since it lines the intensities up side by side. For a distributed team, a shared canvas (Miro, Mural or a slide edited simultaneously) does the same job.

Most of the tooling question sits on the source side. In Switzerland, competitors' annual reports and press releases, the statistics of the Federal Statistical Office and the Swiss National Bank, the publications of the sector regulators, the cantonal commercial registers and the professional associations supply the dated facts that separate an assessment from an opinion. The comparison sites and marketplaces of the industry under analysis speak directly to buyer power, since they lower the search costs those buyers bear. Market monitoring organised by force rather than by competitor keeps the analysis alive between revisions.

Sources

• Porter, M. E., The Five Competitive Forces That Shape Strategy, Harvard Business Review, January 2008: the author returning to his own model thirty years on, with the seven sources of barriers to entry, the distinction between the balance of power and price sensitivity on the buyer side, the common application traps and the warning against mistaking a factor for a force.
• Porter, M. E., How Competitive Forces Shape Strategy, Harvard Business Review, 57(2), March-April 1979, pp. 137-145: the original article, which sets out the five forces and the thesis that the structure of an industry determines its average profitability.
• Porter, M. E., Competitive Strategy: Techniques for Analyzing Industries and Competitors, The Free Press, New York, 1980: the full treatment of the model and of the factors that drive each force, together with the generic strategies that follow from it.
• Institute for Strategy and Competitiveness, Harvard Business School, The Five Forces: the institutional presentation of the model, which fixes the canonical labels of the five forces and the formula linking industry structure with the company's relative position.