Porter's Five Forces

Porter's Five Forces explains why some industries are consistently more profitable than others. Michael Porter of Harvard Business School argued that an industry's profits are not decided mainly by how fast it grows or how advanced its technology is, but by its structure: how much power customers and suppliers hold, how easily newcomers can enter, how readily customers can turn to substitutes and how hard existing competitors fight. He introduced the framework in a 1979 Harvard Business Review article, "How Competitive Forces Shape Strategy," developed it in his 1980 book Competitive Strategy and restated it in a 2008 HBR article, "The Five Competitive Forces That Shape Strategy."

It remains one of the most widely taught tools in strategy. Teams use it to judge whether a market is worth entering, to understand what is squeezing margins in their current industry and to find positions where the pressure is weaker. It answers a question that comes before most strategic choices: what kind of competitive environment are we actually in?

The Five Forces

Each force is a source of pressure on prices, costs or the investment needed to compete. The stronger a force, the more of the value an industry creates is captured by someone other than the companies in it.

1. Threat of New Entrants

New entrants bring extra capacity and a drive to win share, which pushes prices down or the cost of competing up. What matters is the threat, not the number of companies that actually enter: incumbents in an industry that is easy to enter have to keep prices low to discourage newcomers. The threat depends on barriers to entry, which Porter grouped as:

• Supply-side economies of scale, where larger producers have lower unit costs.
• Demand-side benefits of scale, or network effects, where a product is worth more to each buyer as more people use it.
• Switching costs that customers would face in changing suppliers.
• The capital required to compete.
• Advantages incumbents hold regardless of size, such as proprietary technology, strong brands or the best locations.
• Unequal access to distribution channels.
• Restrictive government policy, such as licensing requirements.

Expected retaliation matters too. Entrants think twice when incumbents have a record of fighting back hard.

2. Bargaining Power of Suppliers

Powerful suppliers capture value by charging more, limiting quality or service, or shifting costs onto the industry. Suppliers tend to be powerful when they are more concentrated than the industry they sell to, when they do not depend heavily on it for revenue, when changing suppliers is costly, when their products are differentiated or have no substitute and when they could credibly enter the industry themselves. Labor counts as a supplier, so scarce skills or strong unions can be a powerful force.

3. Bargaining Power of Buyers

Powerful buyers capture value by forcing prices down, demanding more quality or service and playing competitors off against each other. Buyers have leverage when there are few of them or they buy in large volumes, when products are standardized, when switching is cheap and when they could make the product themselves. They are also more sensitive to price when the product is a large share of their costs, when their own profits are thin and when the product makes little difference to the quality of what they sell.

4. Threat of Substitutes

A substitute meets the same need in a different way, as videoconferencing does for some business travel or a spreadsheet does for specialized planning software. Substitutes put a ceiling on what an industry can charge. The threat is high when a substitute offers an attractive trade-off between price and performance and when switching to it is cheap. Because substitutes come from outside the industry, they are the force most easily overlooked.

5. Rivalry Among Existing Competitors

Rivalry shows up as price cuts, new products, advertising campaigns and service improvements. It does the most damage when it centers on price, because price competition hands profit directly to customers. Rivalry tends to be intense when competitors are numerous or similar in size, when the industry is growing slowly, when exit barriers are high, when products are hard to tell apart and when high fixed costs push companies to fill capacity at almost any price.

What the Five Forces Are Not

In his 2008 article, Porter addressed several factors that are often mistaken for additional forces: the industry's growth rate, technology and innovation, government, and complementary products and services. All of them matter, but they affect profitability through the five forces rather than alongside them. Government licensing, for example, raises a barrier to entry, and rapid growth can soften rivalry for a while without making an industry structurally attractive.

The framework also analyzes an industry, not a company. It describes the conditions every competitor faces. A company's own strengths, weaknesses and capabilities are assessed with other tools, such as a SWOT analysis, and the two are most useful together.