Porter’s 5 Forces Model

Factor 1. Threat of New Entrants

Industries constantly undergo disruption or are prone to it, especially given the modern pace of technological growth.

Seemingly every year, new features or updates to existing technology are introduced to the market with claims of more efficiency and improved capabilities to accomplish difficult tasks.

No company is entirely protected from the threat of disruption, but differentiation from the market provides more control to the company.

Hence, many of the market leaders nowadays allocate a significant amount of capital each year into research and development (R&D), which makes it more challenging for others to compete while protecting themselves from being blindsided by new breakthrough technologies or trends.

Potential barriers to entry include:

• Economies of Scale – Upon achieving greater scale, the cost of producing one unit declines, which provides a competitive advantage to the company.
• Differentiation – By offering unique products/services to meet targeted customer needs, the greater the barrier to entry (i.e. higher customer retention, loyal customer base, more technical product development).
• Switching Costs – Even if a new competitor offers a better product/service, the cost of switching to a different provider can deter the customer from switching (e.g. monetary considerations, inconvenience).
• Patents / Intellectual Property (IP) – Proprietary technology can protect competitors from attempting to steal market share and customers.
• Initial Required Investment – If the upfront cost of entering the market is high (i.e. significant capital expenditures required), fewer companies will enter the market.

Factor 2. Bargaining Power of Buyers

On the topic of the bargaining power of buyers, the first question to ask is if the company is:

• B2B: Business-to-Business
• B2C: Business-to-Consumer
• Combination: B2B + B2C

In general, commercial customers (i.e. SMBs, enterprises) are more likely to have more bargaining power due to having more spending power, whereas everyday consumers typically have far less money to spend.

However, the universe of commercial clients is limited compared to that of consumers.

For reputable buyers with significant purchase volumes or order sizes, suppliers tend to be willing to accept lower offer prices to retain the customer.

By contrast, if a B2C company with millions of individual customers were to lose a single customer, the company would likely not even notice.

Factor 3. Bargaining Power of Suppliers

The bargaining power of suppliers stems from selling raw materials and products that other suppliers do not carry (i.e. more scarcity results in greater value).

If the items provided by the supplier constitute a significant proportion of the product as sold by the buyer, the bargaining power of the supplier directly increases, as the supplier is a major component of the buyer’s operations.

On the other hand, if the suppliers for a certain product are not differentiated, the competition will be more heavily based around pricing (i.e. a “race to the bottom” – which benefits the buyers, not the sellers).

Factor 4. Threat of Substitute Products or Services

Often, products or services can have substitutes that make them more vulnerable, as customers in these instances have more optionality.

More specifically, if a certain condition is met – e.g. an economic downturn – customers could opt for cheaper products despite lower quality and/or lower-tier branding.

Factor 5. Rivalry Among Existing Competitors

The degree of rivalry within an industry is a direct function of two factors:

1. Size of the Revenue Opportunity – i.e. Total Addressable Market (TAM)
2. Number of Industry Participants

The two are closely linked, as the greater the revenue opportunity, the more companies will enter the industry to grab a piece of the pie.

Furthermore, if the industry is growing, there are likely going to be more competitors (and vice versa for stagnant or negative growth industries).

Five Forces Model: Attractive vs. Unattractive Industries

Signs of a Profitable Industry

• (↓) Low Threat of Entrants
• (↓) Low Threat of Substitute Products
• (↓) Low Bargaining Power of Buyers
• (↓) Low Bargaining Power of Suppliers
• (↓) Low Rivalry Among Existing Competitors

Signs of an Unprofitable Industry

• (↑) High Threat of Entrants
• (↑) High Threat of Substitute Products
• (↑) High Bargaining Power of Buyers
• (↑) High Bargaining Power of Suppliers
• (↑) High Rivalry Among Existing Competitors