What is Porter’s Five Forces model?

The Five Forces model breaks down the competitive forces within an industry. Once you know the forces at play, you and your leadership team can potentially make better decisions regarding your strategic business planning. For example, Porter’s Forces model can help you determine whether you should expand into a new industry or continue focusing on your current one.

An overview of the Porter Forces

The Five Porter Forces focus on the overall business environment instead of individual competitors. As a result, they can help you identify industry trends, the business potential within a particular industry or whether you should adjust your business model.

According to Porter’s model, five main forces affect how well a company performs in its industry. When you understand how each force works in your industry, you can potentially use them to increase profitability.

1. Competitive rivalry

This force refers to the number of companies competing in an industry and how their products or services compare to yours. The more competitors and valuable products, the more challenging it may be for your organization to be an industry leader. When there are more competitors and valuable products, it often takes more effort to become a leader. However, a unique product can help you stay competitive.

Customers tend to choose companies with the lowest prices. When your industry has less competition, you can typically sell your products for more. If you own a mortgage technology company, you may have an easier time negotiating prices with customers if there are few competitors.

2. Bargaining power of customers

Bargaining power is the ability a customer has to negotiate prices or influence your business to offer different products, features and services. Customer power can depend on the average purchase price, the size of the customer base and the price sensitivity of buyers.

For example, patrons of a brick-and-mortar bookstore may suggest titles to carry based on their interests and support for local writers. A larger chain or online business could have more customers who have less influence over inventory. Independent, or indie, bookstores, which operate independently of large or international chains, may also have a loyal customer base.

Depending on the retailer, brick-and-mortar or indie stores might be more willing to lower prices based on damages to a book’s cover or pages, while a chain retailer would likely be less willing to lower the price and instead return the damaged goods to the distributor.

3. Bargaining power of suppliers

Similar to your customers, your suppliers hold power over your organization. How much power they have depends on how many suppliers can make the product you need and the costs of switching suppliers.

If your industry has a large selection of companies that offer similar products, suppliers generally have less power. You can negotiate better prices or move to a different supplier. When fewer companies sell the products you need, the suppliers have more power.

4. Threat of substitutions

This model refers to how easily customers can replace your product or service with a competitor’s offerings. If your business offers a product or service that’s difficult for customers to replace, your company may have a competitive advantage, which typically helps retain customers. Substitution could also refer to a customer’s ability to make your product or perform your service themselves or function comfortably without it.

If your offering is difficult for customers to replace, your company has more power. It may be easier to retain customers, even when you increase prices.

5. Threat of new entrants

The threat of new entrants depends on how easy it is for individuals to start a business in your industry and reach your target market. Significant barriers to entry, such as high start-up costs, loyalty to existing brands or strict regulations, can reduce this threat. In these industries, your company can potentially charge higher prices or take risks on new products.

For instance, fast-fashion retailers can generally offer their services with low upfront costs, making it fairly easy for another company to enter the industry. In comparison, sustainable fashion companies typically have a lower threat of new entrants, since those brands have established loyalty and the high-quality materials cost more upfront.

How to use Porter’s Forces model in your business

Here are several ways to use the Porter Forces to strengthen your competitive position:

• Identify your industry’s competitors: Search for competing organizations in your industry. You might list them in a spreadsheet with columns detailing each company’s products, features, prices, customer service offerings and target market. Compare your business to competitors to identify its unique selling proposition (USP).
• Prepare for potential entrants into your industry: Determine how easy entry is for other companies within your industry. Identify potential barriers that could stand in their way, such as startup costs, patents and potential government regulations. If barriers are low, you can remain competitive by cutting costs, improving products or building brand loyalty.
• Assess the threat of substitutes: Find companies with products that could potentially replace yours. Then, determine if your customers can easily replace your service by doing it themselves. When the threat of substitution is high, reinforce your value by keeping prices competitive and maintaining quality.
• Determine suppliers’ power: Research suppliers in your industry, and note how many offer the products you need at acceptable prices. Consider how much it would cost to switch suppliers. Based on this information, determine your leverage to negotiate with current suppliers.
• Understand customers’ bargaining power: Examine the size of the market, your business model and the availability of competing products and services to determine how much power your customers have. Collect customer feedback, and build a strategy that resonates with buyers.

Careful research is the key to using the Five Forces model effectively. Once you understand potential obstacles, you can develop a business strategy to overcome them. You can also find ways to offer products or services unique to your company.

FAQs about Porter’s Five Forces

Is Porter’s Five Forces model still relevant?

Although Porter’s model was developed in the 1970s, it can still provide useful insights for your business. If your company operates in a rapidly changing industry or works across multiple industries, you may need to adapt the model accordingly. For example, if you’re competing with businesses across the globe, you may need to conduct a more detailed analysis of competitive rivalry.

When can you use Porter’s Five Forces model?

You can use Porter’s forces to analyze your industry any time your business is making a change. Whether you want to increase profitability or open a new location, understanding the industry can help you make smarter decisions.