What Are Porter's Five Forces?

The framework comes from Michael E. Porter, a professor at Harvard Business School. He introduced it in the article "How Competitive Forces Shape Strategy", published in the March–April 1979 issue of Harvard Business Review. In January 2008 he published a revised version in the same journal, "The Five Competitive Forces That Shape Strategy".

According to Porter's institute at Harvard, the framework is for understanding the competitive forces at work in an industry and how they drive the way economic value is divided among its players. The five forces, with what strengthens each one according to the same source: - Rivalry among existing competitors: when it is intense, it drives prices down or eats up profit through the cost of competing. It is fiercer when there are many competitors or competitors of similar size, the industry grows slowly, fixed costs are high or exit barriers are high. - Threat of new entrants: it forces existing players to keep prices down and spend more to retain customers. It depends on barriers to entry such as economies of scale, the cost of building brand awareness, access to distribution channels or government restrictions. - Threat of substitutes: a substitute meets the same underlying need in a different way. Harvard's examples are videoconferencing as a substitute for travel and email as a substitute for express mail. The threat rises when the substitute offers a better price-performance trade-off and switching to it costs little. - Bargaining power of buyers: powerful customers force prices down or demand more service at the same price. Their power is highest when they are large relative to the companies serving them, the product is undifferentiated and switching costs little. - Bargaining power of suppliers: powerful suppliers charge higher prices or demand better terms, which lowers the industry's profitability. This happens, for instance, when there are only one or two suppliers of an essential input or switching suppliers is expensive.

The five forces determine the competitive structure of an industry and its profitability. According to the same source, industry structure and a company's relative position within the industry are the two basic drivers of its profitability.

The first step is to define the industry: which products belong to it and in which geographic area. If the definition is too broad or too narrow, the forces are measured on a market that is not the company's own.

The second step is to analyse each force with data: who exerts it, how strongly and why. For buyers, for example, how much the largest ones account for in industry sales and what it costs them to switch suppliers.

The mistake in use is filling in the analysis as a list of direct competitors. Porter described it in 2008: managers often define competition too narrowly, as if it occurred only among today's direct competitors. Customers, suppliers, potential entrants and substitutes also compete for profit. An invented example: an online coffee shop puts other coffee shops in all five boxes. It misses the power of the marketplaces it sells on, that of the roasters who supply it, and coffee capsules as a substitute.

The third step is the conclusion: which forces limit the industry's profit, and why. A list of five ratings is not yet an analysis. That leads to the fourth step, positioning: where can the company defend itself against the strongest forces, or which force can it weaken?

The five forces explain why some industries are more profitable than others. That is a different question from who sells the most within the industry. For entering a market, setting prices or negotiating with suppliers, the structure of the industry matters as well as the rivals.

The structure changes. According to Porter's institute, buyers or suppliers can gain or lose power, an innovation can make entry or substitution easier, and a change in regulation can alter rivalry or barriers to entry. That is why the analysis carries a date and is repeated.

Other tools share the work. A PESTEL analysis looks at the macro environment, which affects every industry; the five forces look at one industry, and a PESTEL factor such as a new law can change one of them. A SWOT analysis takes the result into its opportunities and threats columns. Before following a path of the Ansoff matrix that leads into a new market, the five forces show whether that market leaves any profit.

For the company's position within the industry, Porter proposed a second tool: the value chain, which looks for the source of a cost or differentiation advantage in the company's own activities.

• Define the industry by product and geography and write that definition next to the analysis.
• Analyse all five forces, not only rivalry.
• Back every rating with data: share of the largest buyers, number of suppliers, switching costs.
• End with a conclusion about the industry's profitability and the forces that limit it.
• Date the analysis and repeat it when regulation, technology or a large competitor changes.
• Use the result in decisions on market entry, pricing and purchasing, not only in a presentation.

• Filling the five boxes with the names of direct competitors.
• Missing substitutes because they do not look like the company's own product.
• Analysing the company instead of the industry.
• Defining the industry so broadly that the forces say nothing about the real market.
• Stopping at a list of ratings without a conclusion on profitability.
• Treating the analysis as permanent when the industry structure changes.