What is Porter’s five Forces model?
This model helps marketers and business managers to look at the ‘balance of power’ in a market between different types of organisations, and to analyse the attractiveness and potential profitability of an industry sector.
It’s a strategic tool designed to give a global overview, rather than a detailed business analysis technique. It helps review the strengths of a market position, based on five key forces.
Porter’s Five Forces works best when looking at an entire market sector, rather than your own business and a few competitors.
How can I use Porters five Forces?
To apply Porter’s Five Forces, you need to work through these questions for each area:
- Force 1: Threat of New Entry?
- Force 2: Buyer Power?
- Force 3: Threat of Substitution?
- Force 4: Supplier Power?
- Force 5: Competitive Rivalry?
Threat of New Entry
If a new businesses can be easily started up in your sector without substantial investment - then this is a threat. The Internet has made this a reality in many sectors, especially publishing! So ask yourself the questions:
- What’s the threat of new businesses starting in this sector?
- How easy is it to start up in this business?
- What are the rules and regulations?
- What finance would be needed to start-up?
- Are there barriers to entry which give you greater power?
Where there are fewer buyers, they often control the market. Questions here include:
- How powerful are the buyers?
- How many are there?
- Can the buyers get costs down?
- Do they have the power to dictate terms?
Threat of Substitution
If there are available alternatives then the threat of substitution increases.
- How easy is it to find an alternative to this product or service?
- Can it be outsourced? Or automated?
Markets where there are few suppliers means the suppliers retain the power
- Examine how many suppliers are in the market?
- Are there a few who control prices?
- Or many so prices are lower?
- Do your suppliers hold the power?
- How easy is it to switch, what’s the cost?
Markets where there are few competitors are attractive but can be short-lived. These are highly competitive markets with many companies chasing the same work reduce your power in the market.
- What’s the level of competition in this sector?
- What’s the competitor situation? Many competitors and you’re all in a commodity situation or a few?
Examples of how Porter's five Forces can be applied to a business?
If your business is thinking about moving into new sectors or markets, or if your business is stuck in a commodity situation, then Porter’s Five Forces enables you to see the issues clearly.
Work through each of the forces to identify in your current sector and your potential sectors, to see who has the power.
Here are some examples of where the balance of power lies in different markets
- 1. Threat of New Entrants
An example is web design, as there are independents in every location. This is an easy market to enter with few requirements, other than skills, initiative and relevant hardware and software. This does mean there are many new entrants!
An example is the grocery sector since supermarkets tend to retain power over suppliers due to volume and price of contracts. They dictate terms, set prices and can possibly end agreements at any time.
- 3. Threat of Substitution
The substitute to all services is DIY. For example hairdressing or writing a will. Focus is on expertise, customer service or added value.
Some sectors have monopolistic (one) or oligopolistic (few) suppliers, such as utility companies. Sometimes customers have little choice i.e. where to buy domestic water suppliers though this is changing.
In the jewellery sector, diamond suppliers often hold the power and can set prices, withhold supply and restrict sales.
These include Estate agents, web design and office stationary. Many competitors often buy on price.
What to watch for?
Sometimes not all the information is available and you may need to make assumptions, which should be shared. For example it’s difficult getting specific market information on parts of the Middle East and China.
Our free models guide gives more details on how the Internet has affected this balance of power.
Porter, M. (1979). How Competitive Forces Shape Strategy. Harvard Business Review. (Vol 57, March – April). p.86-93.