Porter's 5 Forces Explained and How to Use the Model

These forces include the number and power of a company's competitive rivals, potential new market entrants, suppliers, customers, and substitute products that ... TableofContents Expand TableofContents WhatArePorter'sFiveForces? UnderstandingPorter'sFiveForces 1.CompetitionintheIndustry 2.PotentialofNewEntrants 3.PowerofSuppliers 4.PowerofCustomers 5.ThreatofSubstitutes Porter'sFiveForcesFAQs TheBottomLine Investing FundamentalAnalysis Investopedia/XiaojieLiu WhatArePorter'sFiveForces? Porter'sFiveForcesisamodelthatidentifiesandanalyzesfivecompetitiveforcesthatshapeeveryindustryandhelpsdetermineanindustry'sweaknessesandstrengths.FiveForcesanalysisisfrequentlyusedtoidentifyanindustry'sstructuretodeterminecorporatestrategy. Porter'smodelcanbeappliedtoanysegmentoftheeconomytounderstandthelevelofcompetitionwithintheindustryandenhanceacompany'slong-termprofitability.TheFiveForcesmodelisnamedafterHarvardBusinessSchoolprofessor,MichaelE.Porter. Porter's5forcesare: CompetitionintheindustryPotentialofnewentrantsintotheindustryPowerofsuppliersPowerofcustomersThreatofsubstituteproducts KeyTakeaways Porter'sFiveForcesisaframeworkforanalyzingacompany'scompetitiveenvironment.Porter'sFiveForcesisafrequentlyusedguidelineforevaluatingthecompetitiveforcesthatinfluenceavarietyofbusinesssectors.ItwascreatedbyHarvardBusinessSchoolprofessorMichaelE.Porterin1979andhassincebecomeanimportanttoolformanagers.Theseforcesincludethenumberandpowerofacompany'scompetitiverivals,potentialnewmarketentrants,suppliers,customers,andsubstituteproductsthatinfluenceacompany'sprofitability.FiveForcesanalysiscanbeusedtoguidebusinessstrategytoincreasecompetitiveadvantage. 1:44 Porter'sFiveForces UnderstandingPorter'sFiveForces Porter'sFiveForcesisabusinessanalysismodelthathelpstoexplainwhyvariousindustriesareabletosustaindifferentlevelsofprofitability.ThemodelwaspublishedinMichaelE.Porter'sbook,CompetitiveStrategy:TechniquesforAnalyzingIndustriesandCompetitorsin1979. TheFiveForcesmodeliswidelyusedtoanalyzetheindustrystructureofacompanyaswellasitscorporatestrategy.Porteridentifiedfiveundeniableforcesthatplayapartinshapingeverymarketandindustryintheworld,withsomecaveats.TheFiveForcesarefrequentlyusedtomeasurecompetitionintensity,attractiveness,andprofitabilityofanindustryormarket. 1.CompetitionintheIndustry ThefirstoftheFiveForcesreferstothenumberofcompetitorsandtheirabilitytoundercutacompany.Thelargerthenumberofcompetitors,alongwiththenumberofequivalentproductsandservicestheyoffer,thelesserthepowerofacompany. Suppliersandbuyersseekoutacompany'scompetitioniftheyareabletoofferabetterdealorlowerprices.Conversely,whencompetitiverivalryislow,acompanyhasgreaterpowertochargehigherpricesandsetthetermsofdealstoachievehighersalesandprofits. 2.PotentialofNewEntrantsIntoanIndustry Acompany'spowerisalsoaffectedbytheforceofnewentrantsintoitsmarket.Thelesstimeandmoneyitcostsforacompetitortoenteracompany'smarketandbeaneffectivecompetitor,themoreanestablishedcompany'spositioncouldbesignificantlyweakened. Anindustrywithstrongbarrierstoentryisidealforexistingcompanieswithinthatindustrysincethecompanywouldbeabletochargehigherpricesandnegotiatebetterterms. 3.PowerofSuppliers ThenextfactorinthePortermodeladdresseshoweasilysupplierscandriveupthecostofinputs.Itisaffectedbythenumberofsuppliersofkeyinputsofagoodorservice,howuniquetheseinputsare,andhowmuchitwouldcostacompanytoswitchtoanothersupplier.Thefewersupplierstoanindustry,themoreacompanywoulddependonasupplier. Asaresult,thesupplierhasmorepowerandcandriveupinputcostsandpushforotheradvantagesintrade.Ontheotherhand,whentherearemanysuppliersorlowswitchingcostsbetweenrivalsuppliers,acompanycankeepitsinputcostslowerandenhanceitsprofits. 4.PowerofCustomers TheabilitythatcustomershavetodrivepriceslowerortheirlevelofpowerisoneoftheFiveForces.Itisaffectedbyhowmanybuyersorcustomersacompanyhas,howsignificanteachcustomeris,andhowmuchitwouldcostacompanytofindnewcustomersormarketsforitsoutput. Asmallerandmorepowerfulclientbasemeansthateachcustomerhasmorepowertonegotiateforlowerpricesandbetterdeals.Acompanythathasmany,smaller,independentcustomerswillhaveaneasiertimecharginghigherpricestoincreaseprofitability. TheFiveForcesmodelcanhelpbusinessesboostprofits,buttheymustcontinuouslymonitoranychangesintheFiveForcesandadjusttheirbusinessstrategy. 5.ThreatofSubstitutes ThelastoftheFiveForcesfocusesonsubstitutes.Substitutegoodsorservicesthatcanbeusedinplaceofacompany'sproductsorservicesposeathreat.Companiesthatproducegoodsorservicesforwhichtherearenoclosesubstituteswillhavemorepowertoincreasepricesandlockinfavorableterms.Whenclosesubstitutesareavailable,customerswillhavetheoptiontoforgobuyingacompany'sproduct,andacompany'spowercanbeweakened. UnderstandingPorter'sFiveForcesandhowtheyapplytoanindustry,canenableacompanytoadjustitsbusinessstrategytobetteruseitsresourcestogeneratehigherearningsforitsinvestors. WhatArePorter'sFiveForcesUsedfor? Porter'sFiveForcesModelhelpsmanagersandanalystsunderstandthecompetitivelandscapethatacompanyfacesandtounderstandhowacompanyispositionedwithinit. IsPorter'sFiveForcesModelStillRelevant? Yes,eventhoughitwascreatedmorethan40yearsago,theFiveForcesModelcontinuestobeausefultoolforunderstandinghowacompanyispositionedcompetitively. WhatAreSomeDrawbacksofPorter'sFiveForces? TheFiveForcesmodelhassomedrawbacks,includingthatitisbackward-looking,makingitsfindingsmostlyrelevantonlyintheshortterm;thatlimitationiscompoundedbytheimpactofglobalization.Anotherbigdrawbackisthetendencytotrytousethefiveforcestoanalyzeanindividualcompany,versusabroadindustry,whichishowtheframeworkwasintended.Alsoproblematicisthattheframeworkisstructuredsothateachcompanyisplacedinoneindustrygroupwhensomecompaniesstraddleseveral.Anotherissueincludestheneedtoassessallfiveforcesequallywhensomeindustriesaren'tasheavilyimpactedbyallfive. What'stheDifferenceBetweenPorter'sFiveForcesandSWOTAnalysis? Porter's5ForcesandSWOT(strengths,weaknesses,opportunities,&threats)analysisarebothtoolsusedtoanalyzeandmakestrategicdecisions.Companies,analysts,andinvestorsusePorter's5Forcestoanalyzethecompetitiveenvironmentwithinanindustry,whiletheytendtouseaSWOTanalysistolookmoredeeplywithinanorganizationtoanalyzeitsinternalpotential. TheBottomLine Porter'sFiveForcesframeworkdefinesthemostimportantcriteriatoconsiderwhenlookingatthecompetitivelandscapeofacorporation.Highthreatlevelstypicallysignalthatfutureprofitsmaydeteriorateandviceversa.Forexample,anearlystartupinafast-growingindustrymightquicklybecomeshutoutifbarrierstoentryarenotpresent.Likewise,acompanysellingproductsforwhichtherearenumerous substitutes willnotbeabletoexercise pricingpower toimproveitsmargins,anditmayevenlosemarketsharetoitscompetitors. ThereasonPorter'smodelbecamesowidelyadoptedisthatitforcescompaniestolookbeyondtheirownimmediatebusinessandtotheirindustryasawholewhenmakinglong-termplans.Porter'sstillplaysavitalroleinthat,butitshouldnotbethesoletoolinthetoolboxwhenitcomestobuildingabusinessstrategy. ArticleSources Investopediarequireswriterstouseprimarysourcestosupporttheirwork.Theseincludewhitepapers,governmentdata,originalreporting,andinterviewswithindustryexperts.Wealsoreferenceoriginalresearchfromotherreputablepublisherswhereappropriate.Youcanlearnmoreaboutthestandardswefollowinproducingaccurate,unbiasedcontentinour editorialpolicy. MichaelE.Porter."CompetitiveStrategy:TechniquesforAnalyzingIndustriesandCompetitors(Abstract)." CompareAccounts AdvertiserDisclosure × TheoffersthatappearinthistablearefrompartnershipsfromwhichInvestopediareceivescompensation.Thiscompensationmayimpacthowandwherelistingsappear.Investopediadoesnotincludealloffersavailableinthemarketplace. Provider Name Description RelatedTerms WhatIsHorizontalIntegration? Horizontalintegrationistheacquisition,merger,orexpansionofabusinessthatincreasesthemarketshareinitsexistingindustry. more UnderstandingtheSixForcesModel Thesixforcesmodelisastrategicbusinesstoolthathelpsbusinessesevaluatethecompetitivenessandattractivenessofamarket. more WhatIsthePorterDiamond? ThePorterDiamondisamodelthatattemptstoexplainthecompetitiveadvantagesomenationsorgroupshaveduetocertainfactorsavailabletothem. more WhatIstheNationalDiamond? TheNationalDiamondisatheoryofcompetitiveadvantage,representedvisuallywithadiamond-shapedgraphictoillustrateacountry'scompetitiveadvantages. more HowSubstitutesWork Asubstitute,orsubstitutegood,isaproductorservicethataconsumerseesasthesameorsimilartoanotherproduct. more Duopsony Duopsony,theoppositeofduopoly,isaneconomicconditioninwhichthereareonlytwolargebuyersforaspecificproductorservice. more PartnerLinks RelatedArticles FinancialAnalysis Porter's5Forcesvs.PESTLEAnalysis:What'stheDifference? FundamentalAnalysis Porter's5Forcesvs.SWOTAnalysis:What'stheDifference? TopStocks AnalyzingPorter's5ForcesonApple(AAPL) Stocks Porter's5ForcesonUnderArmour Tools AnalyzingPorter'sFiveForcesModelonDeltaAirlines BusinessEssentials ThePitfallsofPorter'sFiveForces