Porter’s Five Forces
The five forces that influence a company’s ability to serve its customers and profit are:
- The threat of substitute products or services
- The threat of established rivals
- The threat of new entrants
- The suppliers’ bargaining power
- The customers’ bargaining power
Any change in those forces often demands a business to reassess its position in its industry’s landscape.
Why Use It
It’s a valuable tool to assess how each force affects the industry you’re in and utilize that information to determine how strong a company’s position is short and long-term.
As a result, you’ll have a solid understanding of businesses with good and bad economics.
When to Use It
Before entering a new industry or defining a company strategy, use this framework to pick apart the problem set. It can help you understand the foundations of competition and profitability.
To start, identify a business with a structural advantage by asking yourself these questions: Are there profitable businesses in the industry? Is this an exceptional organization in a mediocre industry? What drives growth in the industry? And conversely, what are some of the challenges? Finally, what factors will influence the industry’s future?
How to Use It
Utilize the five forces to form a clear picture of an industry and the opportunity within it:
- First is the threat of substitute products or services. These are not direct competitors but rather organizations from other industries. If several comparable options exist, then it will be challenging to raise prices and make a profit.
- The second is a competitive rivalry. These are the incumbents who already have significant market share or organizations vying for the same customers.
- The third is the threat of new entrants. New companies could enter the industry and compete for the customer.
- The fourth is the suppliers’ bargaining power. These companies, especially larger ones, can demand you create higher quality products, ask you to deliver better customer service, and require your products to sell at lower prices.
- The fifth is the customers’ bargaining power. Their power is high if alternatives exist and, as such, are more likely to be price sensitive.
How to Misuse It
While it is a valuable tool to illuminate gaps or potential weaknesses, it should not define how an organization operates. Ultimately, building a strategy utilizing this framework is one of looking over your shoulder at what everyone else is doing rather than focusing on creating customer value.
Try jotting down some notes on a piece of paper to understand how these forces are interrelated.
Where it Came From
The framework, developed by Michael E. Porter in 1979, was a reaction to the popular SWOT analysis, which he believed lacked rigor.
What Are Mental Models?
Mental models are thinking tools that help guide and shape our perceptions of the world. They simplify complexity so we can understand life better, make decisions confidently, and solve problems.