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In 1979, a young associate professor at Harvard Business School published his first article for HBR, “How Competitive Forces Shape Strategy.” In the years that followed, Michael Porter’s explication of the five forces that determine the long-run profitability of any industry has shaped a generation of academic research and business practice. In this article, Porter undertakes a thorough reaffirmation and extension of his classic work of strategy formulation, which includes substantial new sections showing how to put the five forces analysis into practice.
The five forces govern the profit structure of an industry by determining how the economic value it creates is apportioned. That value may be drained away through the rivalry among existing competitors, of course, but it can also be bargained away through the power of suppliers or the power of customers or be constrained by the threat of new entrants or the threat of substitutes. Strategy can be viewed as building defenses against the competitive forces or as finding a position in an industry where the forces are weaker. Changes in the strength of the forces signal changes in the competitive landscape critical to ongoing strategy formulation.
In exploring the implications of the five forces framework, Porter explains why a fast-growing industry is not always a profitable one, how eliminating today’s competitors through mergers and acquisitions can reduce an industry’s profit potential, how government policies play a role by changing the relative strength of the forces, and how to use the forces to understand complements. He then shows how a company can influence the key forces in its industry to create a more favorable structure for itself or to expand the pie altogether. The five forces reveal why industry profitability is what it is. Only by understanding them can a company incorporate industry conditions into strategy.
In essence, the job of the strategist is to understand and cope with competition. Often, however, managers define competition too narrowly, as if it occurred only among today’s direct competitors. Yet competition for profits goes beyond established industry rivals to include four other competitive forces as well: customers, suppliers, potential entrants, and substitute products. The extended rivalry that results from all five forces defines an industry’s structure and shapes the nature of competitive interaction within an industry.
A version of this article appeared in the January 2008 issue of Harvard Business Review.
What is it?
Framework/theory
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 organisation.
This theory is based on the concept that there are five forces that determine the competitive intensity and attractiveness of a market. Porter’s five forces help to identify where power lies in a business situation. This is useful both in understanding the strength of an organisation’s current competitive position, and the strength of a position that an organisation may look to move into.
Strategic analysts often use Porter’s five forces 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.
Porter’s five forces of competitive position analysis:
The five forces are:
1. Supplier power. An assessment of 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. An assessment of how easy it is for buyers to drive prices down. This is driven by the: number of buyers in the market; importance of each individual buyer to the organisation; 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. The main driver is 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.
Arguably, regulation, taxation and trade policies make government a sixth force for many industries.
What benefits does Porter’s Five Forces analysis provide?
Five forces analysis helps organisations to understand the factors affecting profitability in a specific industry, and can help to inform decisions relating to: whether to enter a specific industry; whether to increase capacity in a specific industry; and developing competitive strategies.
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Analysis of the Indian business environment Download full case study In the June 2010 issue of Financial Management magazine, the Five Forces model was applied to the emerging Indian business environment in comparison with more developed markets. The analysis found that factors such as state protectionism and a lack of infrastructure are greater barriers to entry in India than they are in more developed nations, where market forces are more powerful. The analysis highlighted many issues affecting competition in emerging economies and compared them to those that are more prevalent in more developed markets. One factor that could play a crucial role in India is public opinion, which exerts a considerable influence on the government. A good example of this is a campaign by local retailers against Walmart, who feel that the arrival of the US retail giant could put them out of business. Walmart has made huge investments in India, but is having to find ways around stringent regulations that prevent it from doing things as basic as putting its brand name on stores. |
Related and similar practices
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Industry analysis—also known as Porter’s Five Forces Analysis—is a very useful tool for business strategists. It is based on the observation that profit margins vary between industries, which can be explained by the structure of an industry.
The Five Forces primary purpose is to determine the attractiveness of an industry. However, the analysis also provides a starting point for formulating strategy and understanding the competitive landscape in which a company operates.
Porter’s Five Forces Analysis
The framework for the Five Forces Analysis consists of these competitive forces:
Industry analysis and competition
Competition within an industry is grounded in its underlying economic structure. It goes beyond the behaviour of current competitors.
The state of competition in an industry depends upon five basic competitive forces. The collective strength of these forces determines profit potential in the industry. Profit potential is measured
in terms of long-term return on invested capital. Different industries have different profit potential—just as the collective strength of the five forces differs between industries.
Industry analysis as a tool to develop a competitive strategy
Industry analysis enables a company to develop a competitive strategy that best defends against the competitive forces or influences them in its favour. The key to developing a competitive strategy is to understand the sources of the competitive forces. By developing an understanding of these competitive forces, the company can:
- Highlight the company’s critical strengths and weaknesses (SWOT analysis)
- Animate its position in the industry
- Clarify areas where strategic changes will result in the greatest payoffs
- Emphasize areas where industry trends indicate the greatest significance as either opportunities or threats
Industry analysis and structure
The five competitive forces reveal that competition extends beyond current competitors. Customers, suppliers, substitutes and potential entrants—collectively referred to as an extended rivalry—are competitors to companies within an industry.
The five competitive forces jointly determine the strength of industry competition and profitability. The strongest force (or forces) rules and should be the focal point of any industry analysis and resulting competitive strategy.
Short-term factors that affect competition and profitability should be distinguished from the competitive forces that form the underlying structure of an industry. Although these short-term factors may have some tactical significance, analysis should focus on the industry’s underlying characteristics.
Read next: Barriers to entry: Factors preventing startups from entering a market
References
Porter, M. (1998). Competitive Strategy. New York: Free Press, pp. 3-5.
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