The Five Competitive Forces That Shape Strategy
Authors: Michael E. Porter, Michael E. Porter
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Overview
In this article, I update and extend my classic work on the five competitive forces that shape strategy. The five forces are: 1. Threat of new entrants, 2. Bargaining power of buyers, 3. Bargaining power of suppliers, 4. Threat of substitutes and 5. Rivalry among existing competitors. This framework remains highly relevant for understanding industry dynamics and developing effective strategies in today’s business environment. My target audience is business leaders and strategists seeking to enhance their company’s competitive advantage. This framework helps companies understand why some industries are inherently more profitable than others, and how they can position themselves for success. The article begins by outlining the five forces, explaining how each force influences industry profitability. I discuss various factors that strengthen or weaken each force, giving examples. The framework helps companies assess the overall competitive landscape and develop robust strategies. I emphasize the dynamic nature of industry structure and discuss how changes in technology, consumer behavior, regulation, and other factors can alter the competitive landscape. By analyzing these trends, companies can anticipate potential opportunities and threats and adapt their strategies accordingly. I encourage readers to move beyond simply identifying the five forces and instead focus on understanding their underlying causes. It’s important to quantify each force whenever possible, using metrics such as market share concentration, buyer switching costs, or substitute product performance. A robust framework is presented for conducting industry analysis, which includes defining the relevant industry, identifying participants, assessing the drivers of each force, determining overall industry structure, and analyzing potential changes in the future. The insights gained from this analysis can then be used to develop strategies for improving the company’s competitive position. I offer guidance on how to shape industry structure to be more favorable to a company’s position. Three key approaches are highlighted: 1. Positioning the company where the forces are weakest. 2. Exploiting industry change. 3. Shaping the balance of forces to create a new industry structure more favorable to the company. I also emphasize the importance of complements. Finally, I explain the relevance of this analysis for investors. This helps assess the long-term prospects of an industry and identify attractive investment opportunities. In the current competitive climate, Five Forces analysis remains as essential as ever for developing effective business strategies. My work provides a holistic view of competition, enabling companies to develop more robust strategies that create sustainable competitive advantages.
Book Outline
1. Introduction: The Five Forces
I introduce a holistic framework for understanding and analyzing the competitive dynamics of any industry. I argue that competition is broader than just direct rivals and includes four other key forces: the threat of new entrants, the bargaining power of buyers, the bargaining power of suppliers, and the threat of substitute products or services. These five forces, collectively, shape the industry’s structure and ultimately determine its profitability.
Key concept: “The job of the strategist is to understand and cope with competition.”
2. Threat of Entry
I explain how the threat of new entrants limits an industry’s profit potential. New players bring new capacity and want market share, which often leads to price wars or increased investment by incumbents to deter entry. Seven major barriers to entry are discussed: supply-side economies of scale, demand-side benefits of scale (network effects), customer switching costs, capital requirements, incumbency advantages independent of size, unequal access to distribution channels, and restrictive government policy.
Key concept: “New entrants to an industry bring new capacity and a desire to gain market share that puts pressure on prices, costs, and the rate of investment necessary to compete.”
3. Power of Suppliers
This section explains how the bargaining power of suppliers affects industry profitability. Suppliers with significant leverage can charge higher prices, limit quality or services, or pass costs on to their customers (the industry players). This power is heightened under certain conditions, such as supplier concentration, low dependence on a single industry, high switching costs for industry participants, differentiated products, lack of substitutes, and the credible threat of forward integration.
Key concept: “Powerful suppliers capture more of the value for themselves by charging higher prices, limiting quality or services, or shifting costs to industry participants.”
4. The Power of Buyers
I discuss how strong buyers can exert pressure to lower prices, improve quality, or demand more services, all of which impact industry profitability. Factors increasing buyer power include buyer concentration, low switching costs for buyers, standardized or undifferentiated products, the threat of backward integration by buyers, and price sensitivity, particularly where the product purchased represents a significant portion of the buyer’s cost structure or budget.
Key concept: “Powerful customers – the flip side of powerful suppliers – can capture more value by forcing down prices, demanding better quality or more service (thereby driving up costs), and generally playing industry participants off against one another, all at the expense of industry profitability.”
5. The Threat of Substitutes
Here, I explain how substitute products or services limit an industry’s profit potential. Substitutes often place a ceiling on prices, and if an industry does not sufficiently differentiate itself through product performance, marketing, or other means, it risks losing profitability and growth potential. Factors that increase the threat of substitutes include attractive price-performance trade-offs and low switching costs for buyers.
Key concept: “A substitute performs the same or a similar function as an industry’s product by a different means.”
6. Rivalry Among Existing Competitors
This section describes how intense rivalry among existing competitors creates pressure to lower prices, increase marketing spending, or enhance product features, all of which can negatively impact profitability. Rivalry is most intense when there are numerous or equally balanced competitors, industry growth is slow, exit barriers are high, rivals are highly committed to the business, and firms cannot read each other’s signals well.
Key concept: “Rivalry is especially destructive to profitability if it gravitates solely to price because price competition transfers profits directly from an industry to its customers.”
7. Industry Analysis in Practice
In this section, I discuss how to use the Five Forces framework for industry analysis. I highlight common pitfalls to avoid, like defining the industry too broadly or too narrowly, focusing on short-term factors rather than structural underpinnings, and mistaking effects for causes. I emphasize the importance of using a proper time horizon, quantifying factors where possible, and considering the interrelationships between the forces.
Key concept: “By considering all five forces, a strategist keeps overall structure in mind instead of gravitating to any one element.”
8. Implications for Strategy
This section illustrates how understanding industry structure can inform strategic action. I outline three primary approaches: positioning the company to best defend against the competitive forces, anticipating and exploiting shifts in the forces, and shaping the balance of forces to create a new industry structure that is more favorable. I provide examples of companies that have successfully employed these strategies.
Key concept: “The best strategies exploit more than one of these possibilities.”
9. Competition and Value
I broaden the perspective to show how a deep understanding of industry structure and competition, using the Five Forces, can be crucial for investment decisions. I argue that by using this framework investors can better assess long-term industry attractiveness, distinguish between short-term fluctuations and structural changes, and identify companies with strong strategic potential.
Key concept: “Understanding industry structure is equally important for investors as for managers.”
Essential Questions
1. Why are some industries inherently more profitable than others?
The Five Forces framework explains why some industries are inherently more profitable. By analyzing the threat of new entrants, the bargaining power of buyers and suppliers, the threat of substitutes, and rivalry among existing competitors, we can understand the underlying structure that determines how value is created and distributed within an industry. Intense forces constrain profitability, while benign forces allow companies to earn higher returns.
2. How can companies anticipate and exploit shifts in industry structure?
Industry structure is dynamic and can be reshaped. While analyzing the current structure is crucial, strategists must also anticipate changes in each force, whether triggered by technological advancements, changing consumer preferences, or government regulations. These shifts can create opportunities for new entrants, strengthen or weaken the power of buyers or suppliers, introduce new substitutes, or intensify rivalry. Successfully anticipating and responding to these changes is vital for sustained competitive advantage.
3. How can a firm proactively shape the structure of its industry to its advantage?
Beyond adapting, firms can shape the structure. Companies, especially industry leaders, can influence the five forces to their advantage. They can standardize parts to reduce supplier power, build switching costs to increase customer loyalty, invest heavily to deter new entrants, differentiate their products to limit substitute threat, or find ways to compete on dimensions other than price to reduce rivalry. This shaping is often an industry leader’s most profitable strategic opportunity.
4. How do complementary products and services affect industry profitability?
Complements add value by enhancing the overall offering to customers. They influence industry profitability indirectly, by their effect on the five forces. Complements can raise switching costs (making buyers less sensitive to price), enhance product differentiation, or make an industry more attractive to new entrants. Strategists should consider both the existing and potential role of complements in their industry.
1. Why are some industries inherently more profitable than others?
The Five Forces framework explains why some industries are inherently more profitable. By analyzing the threat of new entrants, the bargaining power of buyers and suppliers, the threat of substitutes, and rivalry among existing competitors, we can understand the underlying structure that determines how value is created and distributed within an industry. Intense forces constrain profitability, while benign forces allow companies to earn higher returns.
2. How can companies anticipate and exploit shifts in industry structure?
Industry structure is dynamic and can be reshaped. While analyzing the current structure is crucial, strategists must also anticipate changes in each force, whether triggered by technological advancements, changing consumer preferences, or government regulations. These shifts can create opportunities for new entrants, strengthen or weaken the power of buyers or suppliers, introduce new substitutes, or intensify rivalry. Successfully anticipating and responding to these changes is vital for sustained competitive advantage.
3. How can a firm proactively shape the structure of its industry to its advantage?
Beyond adapting, firms can shape the structure. Companies, especially industry leaders, can influence the five forces to their advantage. They can standardize parts to reduce supplier power, build switching costs to increase customer loyalty, invest heavily to deter new entrants, differentiate their products to limit substitute threat, or find ways to compete on dimensions other than price to reduce rivalry. This shaping is often an industry leader’s most profitable strategic opportunity.
4. How do complementary products and services affect industry profitability?
Complements add value by enhancing the overall offering to customers. They influence industry profitability indirectly, by their effect on the five forces. Complements can raise switching costs (making buyers less sensitive to price), enhance product differentiation, or make an industry more attractive to new entrants. Strategists should consider both the existing and potential role of complements in their industry.
Key Takeaways
1. Competition Is Broader Than You Think
Don’t define competition too narrowly. A company faces competition not only from its direct rivals but also from potential new entrants, substitute products or services, powerful suppliers, and demanding customers. Analyzing all five forces provides a broader picture of the true competitive threats a company faces and enables better strategic decisions.
Practical Application:
A software company can analyze its industry’s competitive forces, such as the threat of open-source alternatives or the bargaining power of cloud providers, to develop a robust strategy focused on differentiation and customer lock-in through platform integration.
2. Industry Structure Trumps Industry Attractiveness
Industry structure drives competition and profitability in the medium to long run, regardless of the industry’s stage of development or technological sophistication. Don’t mistake a hot industry for a structurally attractive one. Sustainable profitability hinges on favorable industry structure.
Practical Application:
An AI startup developing cutting-edge algorithms for image recognition needs to analyze the threat of larger tech companies entering the market, the bargaining power of clients, the availability of open-source alternatives, and the pace of technological change. This analysis informs decisions on IP protection, pricing, partnerships, and talent acquisition.
3. Strategy Is About Shaping Industry Structure
Companies can create superior performance by positioning themselves where competitive forces are weakest, exploiting industry change to their advantage, or proactively shaping the balance of forces to create a more favorable structure. Successful strategies typically involve a combination of these approaches.
Practical Application:
An online education platform could form partnerships with educational institutions to expand its reach and build stronger relationships with learners. It could also invest in personalized learning features and high-quality content to enhance its value proposition and reduce the attractiveness of substitutes, like traditional classroom learning.
1. Competition Is Broader Than You Think
Don’t define competition too narrowly. A company faces competition not only from its direct rivals but also from potential new entrants, substitute products or services, powerful suppliers, and demanding customers. Analyzing all five forces provides a broader picture of the true competitive threats a company faces and enables better strategic decisions.
Practical Application:
A software company can analyze its industry’s competitive forces, such as the threat of open-source alternatives or the bargaining power of cloud providers, to develop a robust strategy focused on differentiation and customer lock-in through platform integration.
2. Industry Structure Trumps Industry Attractiveness
Industry structure drives competition and profitability in the medium to long run, regardless of the industry’s stage of development or technological sophistication. Don’t mistake a hot industry for a structurally attractive one. Sustainable profitability hinges on favorable industry structure.
Practical Application:
An AI startup developing cutting-edge algorithms for image recognition needs to analyze the threat of larger tech companies entering the market, the bargaining power of clients, the availability of open-source alternatives, and the pace of technological change. This analysis informs decisions on IP protection, pricing, partnerships, and talent acquisition.
3. Strategy Is About Shaping Industry Structure
Companies can create superior performance by positioning themselves where competitive forces are weakest, exploiting industry change to their advantage, or proactively shaping the balance of forces to create a more favorable structure. Successful strategies typically involve a combination of these approaches.
Practical Application:
An online education platform could form partnerships with educational institutions to expand its reach and build stronger relationships with learners. It could also invest in personalized learning features and high-quality content to enhance its value proposition and reduce the attractiveness of substitutes, like traditional classroom learning.
Memorable Quotes
Introduction. 79
In essence, the job of the strategist is to understand and cope with competition.
Forces That Shape Competition. 80
Industry structure drives competition and profitability, not whether an industry produces a product or service, is emerging or mature, high tech or low tech, regulated or unregulated.
Rivalry Among Existing Competitors. 85
Rivalry is especially destructive to profitability if it gravitates solely to price because price competition transfers profits directly from an industry to its customers.
Factors, Not Forces. 86
Industry structure, as manifested in the strength of the five competitive forces, determines the industry’s long-run profit potential.
Implications for Strategy. 89
The five forces reveal why industry profitability is what it is.
Introduction. 79
In essence, the job of the strategist is to understand and cope with competition.
Forces That Shape Competition. 80
Industry structure drives competition and profitability, not whether an industry produces a product or service, is emerging or mature, high tech or low tech, regulated or unregulated.
Rivalry Among Existing Competitors. 85
Rivalry is especially destructive to profitability if it gravitates solely to price because price competition transfers profits directly from an industry to its customers.
Factors, Not Forces. 86
Industry structure, as manifested in the strength of the five competitive forces, determines the industry’s long-run profit potential.
Implications for Strategy. 89
The five forces reveal why industry profitability is what it is.
Comparative Analysis
My Five Forces framework stands apart from other competitive analysis models due to its holistic approach. While SWOT analysis focuses on internal strengths and weaknesses alongside external opportunities and threats, it lacks the structured approach of Five Forces to dissect the external landscape. Similarly, PESTLE analysis considers political, economic, social, technological, legal, and environmental factors but doesn’t provide a framework for understanding the competitive intensity within an industry. My work complements resource-based view theories, which emphasize internal capabilities, by adding a crucial external perspective. Unlike game theory, which focuses on individual competitive interactions, Five Forces examines the underlying structure of the industry as a whole.
Reflection
My Five Forces framework continues to be a powerful tool for understanding competition and developing effective strategies. While some have argued that the framework is too static in today’s rapidly changing environment, I maintain that the underlying principles remain valid. The framework’s strength lies in its focus on structural factors rather than transient trends. However, it’s crucial to understand that the framework is not a one-size-fits-all solution. Its application requires careful consideration of industry-specific contexts, including network effects, the role of platforms, and the increasing importance of data. Critics might argue that the framework is too focused on competition and neglects the potential for collaboration. While I acknowledge the importance of cooperative strategies, I believe a strong understanding of competitive dynamics is essential for any successful collaboration. The framework remains a valuable tool for achieving sustainable competitive advantage and should be a cornerstone of any strategy development process.
Flashcards
What are Porter’s Five Forces?
Threat of new entrants, bargaining power of buyers, bargaining power of suppliers, threat of substitutes, and rivalry among existing competitors.
When is buyer power high?
When the product represents a significant fraction of buyer costs, when buyers are price sensitive, and when switching costs are low.
How does the threat of substitutes affect profitability?
It limits industry profit potential by placing a ceiling on prices.
When is supplier power high?
When it is more concentrated than the industry it sells to, when industry participants face switching costs, and when there is no substitute for what the supplier group provides.
What factors intensify rivalry?
Numerous or equally balanced competitors, slow industry growth, high exit barriers, high commitment of rivals, and low differentiation.
What are three ways to use the Five Forces for strategic action?
Positioning the company, exploiting industry change, and shaping industry structure.
What are Porter’s Five Forces?
Threat of new entrants, bargaining power of buyers, bargaining power of suppliers, threat of substitutes, and rivalry among existing competitors.
When is buyer power high?
When the product represents a significant fraction of buyer costs, when buyers are price sensitive, and when switching costs are low.
How does the threat of substitutes affect profitability?
It limits industry profit potential by placing a ceiling on prices.
When is supplier power high?
When it is more concentrated than the industry it sells to, when industry participants face switching costs, and when there is no substitute for what the supplier group provides.
What factors intensify rivalry?
Numerous or equally balanced competitors, slow industry growth, high exit barriers, high commitment of rivals, and low differentiation.
What are three ways to use the Five Forces for strategic action?
Positioning the company, exploiting industry change, and shaping industry structure.