Whether it motivates you to strive further or causes financial stress, competition is a defining element of running a business. It’s not the be-all, end-all of what your company does—you should always be focused first and foremost on creating value for your customers—but competitive forces shape strategy regardless. With the right mindset, it can even be a good thing. If you didn’t have anyone to compete with, you’d never need to improve.
To understand your industry competition, it may be useful to analyze it systematically and identify your place within it. To do that, try using Porter’s Five Forces model.
What is Porter’s Five Forces model?
The Five Forces model is a framework for analyzing an industry’s competitive environment, first laid out by Harvard Business School professor Michael Porter. In a seminal 1979 article in the Harvard Business Review, Porter proposes a broader understanding of competition. It’s tempting to think of competition as beginning and ending with the rival companies in your field. But the full scope of competition, Porter argues, factors in a much wider range of influences. By assessing the impact of the five forces, you can gauge the strength of competition within a given industry and determine the opportunity, i.e., potential profitability, in that market. The Five Forces are:
- Rivalry among existing competitors
- Threat of new entrants
- Supplier bargaining power
- Customer bargaining power
- Threat of substitute products or services
While Porter was mainly addressing competition on a macro scale, the framework holds for companies of any size. A sophisticated understanding of market forces and potential barriers to industry profitability is useful for small business owners and multinational players alike.
Porter’s Five Forces
- Rivalry among existing competitors
- Threat of new entrants
- Supplier bargaining power
- Customer bargaining power
- Threat of substitute products or services
Here’s a more detailed explanation of each of Porter’s five competitive forces:
1. Rivalry among existing competitors
The established rivals of a company are what most people think of when they hear “competition.” These are all the other businesses that produce similar goods to serve a similar base of consumers and thus compete with you directly. McDonald’s and Burger King both make burgers, nuggets, and fries. They have established a competitive rivalry.
The same tenets hold in the context of a small business. If you start making and selling candles at your local farmers market, your competitors may be other small candle makers. But they’re also larger companies like Yankee Candle and Bath & Body Works that have a presence, whether in retail stores or online. Ideally, you can then use that knowledge to identify where your established rivals are vulnerable and market your products to play to your comparative strengths.
2. Threat of new entrants
The threat of new entrants has to do with the rival companies in your industry that have yet to emerge. To gauge this factor, you essentially have to ask: How high is the barrier to entry for a new competitor to disrupt this market?
The barrier to entry depends on multiple factors, including capital required, regulations, and economies of scale (wherein per unit costs go down as production rises, making it easier for large companies to keep prices down). While an ideal market situation may be one where barriers to entry are high and barriers to exit are low, this is seldom the case in practice.
A low barrier doesn’t have to be a negative. It allows entrepreneurs to enter a field like ecommerce with relatively modest investment, meaning more small business owners get a chance to succeed in their market. Realize, too, though, that others can more easily follow you into your chosen market. As a solution, find ways to distinguish yourself and work on customer loyalty to give yourself a competitive edge.
3. Supplier bargaining power
While you typically won’t be competing with your own suppliers, they still play an outsize role in your industry’s competitive landscape. In fact, the competitive landscape among suppliers has a great deal of influence on the potential profitability of your market. In a more disaggregated market, where dozens of companies produce the inputs you use to make your products, those companies have less bargaining power over your own.
On the other hand, in a more concentrated market, you might have little choice but to rely on just a handful of suppliers. That would be a case where your suppliers’ bargaining power is high, allowing them to charge you more than they might be able to if they were facing more competition.
4. Customer bargaining power
Customers have bargaining power as well, and the strength of that bargaining power can vary widely by industry. In markets where customers have a lot of options for where to buy a certain product, and those products aren’t especially differentiated—take a grocery store in an area with plenty of varied options, for instance—customers’ bargaining power is high. It’s easy for them to compare prices across stores, just as it’s easy for them to take their business to another store.
As a result, grocery suppliers in that neighborhood have less power to raise the prices of their produce than they would in a less crowded market. Customers exercise their power to keep prices low and demand a certain level of service. Otherwise, they go elsewhere, and that phenomenon constrains the industry’s competitive landscape.
5. Threat of substitute products or services
While the threat of substitute products or services may seem closely related to the threat of new entrants, it’s more concerned with a wider view of your market and how it could be affected by the emergence of similar but different markets.
Take cable TV providers as an example. Where they once enjoyed a highly concentrated market in which their customers had very little bargaining power, the emergence of streaming platforms like Netflix quickly eroded that dominance by providing fundamentally similar products—movies and TV shows—with a substitute service. When that service appealed more to consumers, it ultimately disrupted the existing market to dramatic effect.
Technological disruption is a common corollary to this force. Spotify has done something similar to the music industry, which was disrupted many times over by previous shifts in technology, from the vinyl record to the cassette tape to the CD.
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How to use Porter’s Five Forces
- Identify key players in your industry
- Evaluate the strength of each force
- Develop a response to each force
- Regularly reassess your strategy
Now that we’ve established what they are, let’s get into how you can use Porter’s Five Forces to improve your business:
1. Identify key players in your industry
First, it’s helpful to set the stage with an understanding of the key players in your industry. Performing a competitive analysis can give you a clearer idea of how rival companies are behaving. Along similar lines, examining your supply chain analytics can help point out the strengths and weaknesses with suppliers, shipping providers, and your logistics technology, while building out an ideal customer profile can help clarify your marketing efforts and product roadmap.
2. Evaluate the strength of each force
The five forces are only helpful if you’re accurately gauging the strength of each force. If you make decisions for your business on the basis that customer bargaining power is low in your industry, and you then turn out to be mistaken, that could amount to serious losses. Ultimately, though, Porter’s Five Forces don’t have a numerical scale attached to them. They’re a qualitative analysis. While it isn’t exhaustive, here’s a quick checklist to help you evaluate whether the strength of each force is high, low, or somewhere in between:
- Rivalry among existing competitors. A crowded market, numerous rivals, a low-growth industry, and high fixed costs all signal a high barrier to entry. However, if you have only a few rivals, low fixed costs, and low exit barriers, this force is relatively weak.
- Threat of new entrants. Low barrier to entry, low customer loyalty, and little to no government regulation signal this force is strong. A high barrier to entry, high customer loyalty, and government regulation suggest the threat of new entrants is weak.
- Threat of substitute products or services. Low switching costs, low customer loyalty, and undifferentiated products all signal that the threat of substitutes is high. You need to be less concerned if there are high switching costs, high customer loyalty, and highly differentiated products.
- Supplier bargaining power. This force is strong if there are only a few suppliers, high switching costs, and differentiated products. It’s weaker if there are numerous suppliers to choose from, low switching costs, and undifferentiated products.
- Customer bargaining power. Buyer power is strong if there are numerous alternatives, high price sensitivity, and low switching costs. This force is weaker if there are few alternatives, low price sensitivity, and high switching costs.
3. Develop a response to each force
Once you’ve assessed each of Porter’s Five Forces, you’ll need to decide how to respond. If you’re just starting your business, you might use the analysis to decide whether you’ll enter a certain market segment or try to target another one.
If you’re already engaged in a certain industry, you can use your assessment to guide your decision-making to give yourself a competitive advantage. For example, if you’re in retail, selling a product like loose-leaf tea, then you would probably see a series of highs across the five forces—in customer bargaining power, threat of new entrants, rivalry among existing competitors, and threat of substitute products—and know that you’ll need to market your products aggressively and intelligently to succeed.
You might also note that there is one low-strength threat on the list that you could potentially play to your advantage: supplier bargaining power. If you can keep your input costs low as a result, then you could justify a higher customer acquisition cost and still come out ahead.
4. Regularly reassess your strategy
Finally, remember that none of these forces is necessarily static. Some are more fixed than others, and changes may happen slowly, but they can also shift dramatically, especially if a new entrant, technology, or regulation impacts your market. Be sure to regularly revisit your analysis and reassess where you stand, so you aren’t relying on years-old analysis to guide your present-day strategy.
Porter’s Five Forces FAQ
What are the Five Forces of Porter’s model?
The Five Forces model is a framework for analyzing an industry’s competitive environment. The Five Forces are: rivalry among existing competitors, the threat of new entrants, the threat of substitute products or services, supplier bargaining power, and customer bargaining power.
What is Porter’s Five Forces analysis with an example?
Porter’s Five Forces analyzes the five forces that impact your competitive landscape and assigns a rating of either high, low, or medium to each force, providing a business owner with a set of indicators on the industry’s potential profitability. Here’s an example of a hypothetical Five Forces analysis of the automotive industry:
- High rivalry among existing competitors.
- Low threat of new entrants.
- Low to medium threat of substitute products or services.
- High supplier bargaining power.
- Low to medium customer bargaining power.
How can I use Porter’s Five Forces?
You can apply your learnings from Porter’s Five Forces to give yourself a competitive advantage. For example, if you’re in an industry with a low barrier to entry and high buyer power, you may find that spending your marketing budget to boost brand loyalty helps you retain customers, even when new entrants come in, and to differentiate yourself from existing firms. Or you may assess that your industry has low supplier bargaining power and use that to negotiate better terms for your raw materials.
