Michael E. Porter, the son of an Army officer, is the Bishop William Lawrence University Professor at Harvard University and the author of “The Five Competitive Forces That Shape Strategy.” Porter’s five forces are instrumental in business strategy development, influencing a generation of academic research and business practice across industries and governments.
Porter’s tool is a step-up from the popular SWOT analysis pushing companies to look beyond competition and examine what other factors could impact the business landscape. He identified five forces that make up the competitive environment that can eat into your profitability: buyer power, supplier power, competitive rivalry, the threat of substitution, and the threat of new entrants.
According to Porter, if the forces are intense, almost no company earns attractive returns on investment, as they are in the airline industry. If the forces are benign, many companies are profitable, as they are in software and soft drinks. This framework encourages you to learn your industry’s structure and position your company where forces are weakest. Porter stated:
“Industry structure drives competition and profitability, not whether an industry is emerging or mature, high-tech or low-tech, regulated or unregulated.”
Understanding the competitive forces can help you establish a defense against rivals and maximize your profitability. Below are factors and tips for using to reshape the forces of an industry in your company’s favor:
Buyer power is the strength of your customers to drive down your prices.
- Number of customers
- Size of each order
- Differences between competitors
- Price sensitivity
- Ability to substitute
- Cost of changing
Tip: To counter customer power, expand your services, so it’s harder for customers to leave you for a rival.
Supplier power is the ability of suppliers to drive up the prices of your inputs.
- Number of suppliers
- Size of suppliers
- Uniqueness of service
- Cost of changing
Tip: To neutralize supplier power, standardize specifications for parts so your company can switch more easily among vendors.
Competitive rivalry is the strength of competition in the industry.
- Number of competitors
- Quality differences
- Switching costs
- Customer loyalty
Tip: To temper price wars initiated by established rivals, invest more heavily in products that differ significantly from competitors’ offerings.
Threat Of Substitution
The threat of substitution is the extent to which different products and services can be used in place of your own.
- Substitute performance
- Cost of change
Tip: To limit the threat of substitutes, offer better value through wider product accessibility. Soft drink producers did this by introducing vending machines and convenience store channels, which dramatically improved soft drinks availability relative to other beverages.
Threat Of New Entry
The threat of new entry is the ease with which new competitors can enter the market if they see that you are making good profits.
- Time and cost of entry
- Specialist knowledge
- Economies of scale
- Cost advantage
- Technology IP
- Barriers to entry
Tip: To scare off new entrants, elevate the fixed costs of competing by escalating your R&D expenditures.
Awareness of the five forces can help your company understand its industry structure and stake out a more profitable position and less vulnerable to attack. If you’re brainstorming ideas, this analysis tool can also help you determine an industry’s attractiveness. This strategy is a starting point; not suitable for all businesses, can be viewed as outdated, presents bias, and emphasizes macro-environment over customers. To learn more, I recommend listening to Porter describe it himself in a 2008 interview and mapping out the five competitive forces to select an industry in which your company will compete today.