Porter's Five Forces
Porter's Five Forces of Competitive Position Analysis were developed in 1979 by Michael E Porter of Harvard Business School as a simple framework for assessing and evaluating the competitive strength and position of a business organization.
This theory is based on the concept that there are five forces that determine the competitive intensity and attractiveness of a market. These help to identify where power lies in a business situation. It is useful to both understand the strength of an organization’s current competitive position, and the strength of a position that an organization may look to move into.
Strategic analysts often use this analysis to understand whether new products or services are potentially profitable. By understanding where power lies, the theory can also be used to identify areas of strength, to improve weaknesses and to avoid mistakes.
The five forces are:
1. Supplier power. How easy it is for suppliers to drive up prices? This is driven by the: number of suppliers of each essential input; uniqueness of their product or service; relative size and strength of the supplier; and cost of switching from one supplier to another.
2. Buyer power. How easy it is for buyers to drive prices down? Assess: number of buyers in the market; importance of each individual buyer to the organization; and cost to the buyer of switching from one supplier to another. If a business has just a few powerful buyers, they are often able to dictate terms.
3. Competitive rivalry. Understand the number and capability of competitors in the market. Many competitors, offering undifferentiated products and services, will reduce market attractiveness.
4. Threat of substitution. Where close substitute products exist in a market, it increases the likelihood of customers switching to alternatives in response to price increases. This reduces both the power of suppliers and the attractiveness of the market.
5. Threat of new entry. Profitable markets attract new entrants, which erodes profitability. Unless incumbents have strong and durable barriers to entry, for example, patents, economies of scale, capital requirements or government policies, then profitability will decline to a competitive rate.
When to use this model:
Where there are at least three competitors in the market
Desire to understand impact that government has or may have on the industry
Assessing the industry lifecycle stage – earlier stages will be more turbulent
Considering the dynamic/changing characteristics of the industry
NOTE: This model is not appropriate for an individual firm; it is designed for use on an industry basis