Porter's five forces: how to use it

Porter's five forces are the pressures that decide how much profit an industry can earn. They are rivalry, new entrants, substitutes, buyers and suppliers. When a force is strong, it takes profit out of the industry.

What it is

Michael Porter set out the five forces in the Harvard Business Review in 1979. Each force describes who can take a share of the value an industry creates. Rivals take it through price cuts and spare capacity. Buyers and suppliers take it by bargaining. New entrants and substitutes cap what anyone can charge.

Rivalry among existing firms How hard they fight on price and capacity

• New entrants
  • Economies of scale
  • Brands and product differences
  • Access to channels
  • Capital needed to start
  • Rules and licences
• Suppliers
  • How concentrated suppliers are
  • Inputs with no substitute
  • Cost of changing supplier
  • Whether suppliers could do your part of the chain themselves
• Buyers
  • How concentrated buyers are
  • How much each buys
  • Cost of changing supplier
  • How much buyers know about price
  • Whether buyers could make it themselves
• Substitutes
  • Price and performance of the alternatives
  • Cost of switching to them
  • How ready buyers are to switch

Each force pushes the industry's profit down when it is strong.

The forces explain why two industries, or two segments of one industry, earn such different returns. A segment where all five are weak can earn well for years. A segment with strong buyers and strong rivals struggles to earn a good return, however well it is run.

When to use it

Use the five forces when you need to explain why one segment earns more than another. They help most before a decision that ties up money for years, such as a new plant, a new market or a purchase. They also help when margins have slipped and the team disagrees about why.

The forces describe an industry. They say little about one business's place within it. For that, the value chain and customers' purchase criteria do the work.

How to run it

1. Define the segment narrowly. Group the customers and products that compete with each other. Boxes for food producers in one region is a segment. "Packaging" is too broad to rate.
2. Rate each force as weak, medium or strong. Write one line of evidence beside each rating.
3. Note which forces are growing stronger. A medium force that is rising can matter more than a strong one that is fading.
4. Say what it means for profit. Name the one or two forces that explain most of what the segment earns. Then say what that means for the decision in front of you.

Record it on the market-granularity worksheet.

How to rate each force

Rate each force for the segment as strong, medium or weak. A strong force takes profit out of the segment. Write one line of evidence beside each rating, and note whether the force is growing.

• Rivalry is strong when rivals are many and of similar size, growth is slow, fixed costs are high or leaving is costly.
• New entrants are a strong threat when a newcomer needs little capital, no licence and no special access to customers.
• Substitutes are strong when another product does the same job at a similar price, and buyers can switch easily.
• Buyers are strong when a few of them take most of the output, can switch at little cost, or could make it themselves.
• Suppliers are strong when a few of them sell an input with no substitute, or when changing supplier is costly.

Medium means the evidence points both ways. Where you have no evidence, mark the force unknown and go and find it.

The standard shape is only a start. In practice you rename its parts for the business at hand. A business in a regulated financial market recast the five forces as its own five pressures. They were how its products reached customers, regulation, changing customers and risks, a shifting set of competitors, and the economy.

A worked example: a regional box maker

Illustrative: an invented business, to show the method.

A family-owned firm makes cardboard boxes for food producers in one region. Its margins have slipped for several years. The owners want to know whether to invest in a faster production line.

Two forces explain most of the squeeze. They are the large buyers, and rivals with plants to fill. A faster line would add capacity to a segment that already has too much. The better move is to grow with smaller food producers, who value short runs and quick delivery. Rate the forces again for that segment before you commit.

Common mistakes

• Running it once for the whole industry. The forces differ by segment, and an average of them tells you little.
• Listing factors without rating them. A page of factors under each heading looks thorough and decides nothing. Each force needs a rating and its evidence.
• Treating it as a snapshot. Industries move. Note which forces are getting stronger, and rate them again before a large commitment.
• Using it to judge one business. The forces show what the segment can earn. Whether your business earns more than its rivals is a separate question.

Frequently asked questions

Is the five forces model still useful? Yes, for the question it answers: why a segment earns what it does. It is harder to use where the segment changes shape every year. Rate those segments more often.

How does it differ from a SWOT? The five forces describe an industry's structure. A SWOT looks at one business, inside and outside. Many reviews use the five forces to fill in a SWOT's opportunities and threats.

Who should take part? People who sell to the customers and buy from the suppliers. They hold most of the evidence. A rating that nobody can back with a fact should read unknown.

Where to go next

• The strategy health check, about ten minutes.
• The five forces in the frameworks library, beside the other industry frameworks.
• The move guide on your numbers and your market.