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Porter’s Five Forces

Porter’s Five Forces

What is this?

The five forces is a tool that that was designed by Michael Porter, a professor at Harvard Business School, to be used in the assessment of where the power lies in a business situation. Porter identified five factors that affect the competition within any industry. These are:

  • Supplier’s power; which is the bargaining power of the suppliers, and how they can manipulate the market prices

  • Buyer’s Power; which is the bargaining power of the customers, and how can they affect the selling prices.

  • Competitive Rivalry; reflects the number of competitor’s and how strong they are. It also analyzes how they can affect your business.

  • Threat of a new entry; the ability of people to enter your market and affect your overall profitability

  • Threat of substitution; the ability of customers or buyers to find an alternative for your product that is more convenient to them.

When and why is this tool used?

The technique can be used to understand the nature of competition within a certain industry, and/or to identify areas of strength and weakness. It is useful as it helps entrepreneurs analyze the market they want to join. It can help you assess your current position and the position you consider moving to. Additionally, the tool can identify whether a product, service or business can be profitable or not.

How is this tool used?

To start using this tool, download the five forces worksheet.

Step 1 (Assess the five forces):

Write down an assessment of each of the five forces:

  • Supplier Power: A supplier is the one who provides goods or services for your company. For example, the person who manufactures and sells wood is the supplier of a furniture company. You can understand your supplier's power by answering the following questions. How far do suppliers control prices in this market? Think of the number of supplier, how big their business is, how easy or difficult it is to switch to different suppliers. 

  • Buyer Power: A buyer is the person who buys or purchases your products or services. For example, a couple who is getting married wants to buy furniture so they are the buyer of a furniture company. Answer the coming questions to assess your buyer's power. How far do buyers control prices in this market? Again, think about their number and the importance of each buyer to your business. To some businesses, there are only few buyers who have much power and control.

  • Competitive Rivalry: A competitor is any entity that opposes your company in a competition. For example, for Mercedes, a car that runs on gasoline, BMW is considered competitor. How many competitors do you have? How strong are they? 

  • Threat of Substitution:  A substitute is any product or service that alternates or takes place of your product. Again, for Mercedes the substitute will be Tesla, a car that runs on electricity. How unique is your product compared to other ones available in the market? How many similar substitutes exist? Do they offer better quality or price? 

  • Threat of new entry: A new entry is a company beginning its business in the same market as yours. Try to answer the following: Are there any new businesses opening up in your market? How much does it cost to enter your market? 

  • Other factors to be considered include taxation, government policies that are concerned with trade and the industry’s life cycle.

Step 2 (Identify their scale force):

After listing all the five factors, mark the size and scale of every force in your worksheet. You start to determine how every factor affects you and whether this force is in your favor or against you.

Step 3 (Analyze how they affect you):
Now you can see the bigger picture. Look at the analysis you have just done and think of how it affects you. If you are in a weak position the tool gives you hints what you can do to move to a stronger one. Revising the forces, the tool helps you to think what you can change to increase your power with respect to each of the five forces.

Hints for using this tool

It is designed for the assessment of an industry where there are several competitors, not for an individual business.

Case Study
Karim is a software engineer who wants to make a career shift. He wants to start his own business. Being interested in green products, Karim thinks of starting a supermarket for organic products but he is worried about the competition.

Here is Karim’s five forces assessment:

Karim reached the conclusion that the new market he is trying to enter has some threat of substitution. The threat of new entry is quite high. Supplier’s power is very high. On the hand, Competitive rivalry is reasonable, he won’t suffer intense competition. The buyer power is moderate which he could make use of

Unless he finds a way to change his weaknesses, and come up with alternative ideas to improve his situation it will be hard for him to survive in the market. Ideas can include, specializing in one sector of organic products, being his own supplier, or find a related business where he can have a better position.

Pros and Cons

Very simple and easy as a starting point for further analysis. The model is industry-based, yet fails to take the rapid pace of change within the market in considerations. It considers the market static rather than dynamic. The tool also focuses on a single industry while some industries are codependent.

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