What is Porter’s 5 Forces Model?
Porter’s 5 Forces Model provides a structured framework for industry analysis and the competitive dynamics impacting an industry’s profitability.
Table of Contents
- How the Porter’s 5 Forces Model Works
- Industry Analysis of Competitive Dynamics
- How to Interpret Porter’s 5 Forces Model
- Factor 1. Threat of New Entrants
- Factor 2. Bargaining Power of Buyers
- Factor 3. Bargaining Power of Suppliers
- Factor 4. Threat of Substitute Products or Services
- Factor 5. Rivalry Among Existing Competitors
- Five Forces Model: Attractive vs. Unattractive Industries
How the Porter’s 5 Forces Model Works
The originator of the 5 Forces Model is Michael Porter, a Harvard Business School (HBS) professor whose theories remain instrumental to business strategy even today.
Porter’s 5 forces model framework is utilized for strategic industry analysis, and focuses on the following:
- Barriers to Entry – The difficulty in partaking in the industry as a seller.
- Buyer Power – The leverage held by buyers in being able to negotiate lower prices.
- Supplier Power – The ability of a company’s suppliers to increase the prices of its inputs (e.g. raw materials for inventory).
- Threat of Substitutes – The ease at which a certain product/service can be replaced, typically with a cheaper variation.
- Competitive Rivalry – The intensity of the competition within the industry – i.e. number of participants and the types of each.
Competitive industry structures can be analyzed utilizing Porter’s five forces model, as each factor influences the profit potential within the industry.
Moreover, for companies that are considering whether to enter a particular industry, a five forces analysis can help determine whether the profit opportunity exists.
If there are substantial risks making the industry unattractive from a profitability perspective and negative industry trends (i.e. “headwinds”), it may be better for the company to forgo entering a given new industry.
Industry Analysis of Competitive Dynamics
“Understanding the competitive forces, and their underlying causes, reveals the roots of an industry’s current profitability while providing a framework for anticipating and influencing competition (and profitability) over time.”
– Michael Porter
How to Interpret Porter’s 5 Forces Model
The premise of the 5 forces model is that for a company to obtain a sustainable, long-term competitive advantage, i.e. “moat“, the profitability potential within the industry must be identified.
However, identification is not sufficient, as it must be followed up with the right decisions to capitalize on the proper growth and margin expansion opportunities.
By analyzing the prevailing competitive environment, a company can objectively recognize where it currently stands within an industry, which can help shape corporate strategy going forward.
Certain companies will identify their competitive advantages and attempt to extract as much value as possible from them, whereas other companies might focus more on their weaknesses – and neither approach is right or wrong as it depends on each company’s particular circumstances.