Five forces analysis

Five forces analysis explains how an industry’s structure influences the average profitability available to competitors. It broadens attention beyond direct rivals to entrants, substitutes, buyers and suppliers, then helps a firm consider how to position itself against those pressures.

When to use it

• To understand why an existing industry is more or less profitable than relevant alternatives.

• To identify structural pressures and strategic moves that may improve the firm’s position.

Origins

Michael Porter developed the framework from industrial-organisation economics while teaching at Harvard Business School. That field had often examined how market structure could allow firms to exercise excessive power; Porter reframed the logic for strategists seeking to understand persistent differences in industry profitability. His 1979 Harvard Business Review article, “How Competitive Forces Shape Strategy,” introduced the model to a broad management audience, and Competitive Strategy developed it further. Unlike an open-ended SWOT list, five forces provides a defined economic structure for analysing the immediate competitive environment.

What it is

The framework evaluates five forces that shape the share of value retained by firms in an industry. “Attractive” means structurally capable of supporting stronger average returns; it does not mean socially desirable, fast-growing or suitable for every company.

1. Threat of new entrants: Attractive returns invite entry, but barriers such as scale economies, capital requirements, regulation, customer switching costs, access to distribution, proprietary capability and incumbent response can slow it. High barriers protect incumbents only when they are durable and lawful.

1. Threat of substitute products or services: A substitute meets a similar customer need through a different solution. Bottled water may substitute for a soft drink, while another cola is a direct rival. Accessible substitutes cap price and can redefine what customers consider valuable.

1. Bargaining power of customers: Buyers gain leverage when they purchase large volumes, can switch cheaply, have credible alternatives, possess good price information or could integrate backwards. Powerful retailers, procurement bodies or platforms may capture a greater share of the industry’s value.

1. Bargaining power of suppliers: Suppliers gain leverage when their input is differentiated, scarce, difficult to replace, important to quality or supported by high switching costs. A recognised component brand can also influence end-customer demand and strengthen the supplier’s position.

1. Intensity of competitive rivalry: Rivalry becomes more destructive when competitors are numerous or evenly matched, growth is slow, fixed costs are high, offerings are hard to differentiate, exit barriers are substantial or capacity expands in large increments. Competition need not centre on price; service, innovation and brand may alter its effect on returns.

The forces interact. A platform may be both a buyer and a route to market, while a substitute may later become a direct competitor. Define the unit of analysis before rating any force.

How to use it

First define the industry by customer need, geography, product scope and value-chain stage. Too broad a boundary hides differences; too narrow a boundary excludes real substitutes and entrants.

Gather evidence for each force: concentration, switching costs, entry barriers, economics of substitutes, supplier dependence, capacity, growth, margins and observed behaviour. Rate the direction and strength of each force and record the evidence and uncertainty behind the rating.

Use the result in two ways. Descriptively, explain the industry’s average economics and identify which force constrains returns most. Strategically, consider how the firm can differentiate, reduce switching, redesign its value chain, secure critical inputs, serve a less contested segment or otherwise improve its position without relying on anticompetitive conduct.

In pharmaceuticals, for example, government purchasing power may be a major pressure. Responses could include a demonstrably differentiated therapy, better evidence of outcomes or a portfolio that changes negotiating dependence. Pfizer’s attempted acquisition of AstraZeneca in 2014 illustrates a scale-based response, although a transaction’s merits require analysis beyond five forces.

Revisit the model when technology, regulation, customer behaviour or industry boundaries change. Complement it with analysis of company-specific capabilities, cooperation, ecosystem dynamics and the macro-environment.

Top practical tip

Calibrate the story against economics. Compare industry returns with a relevant baseline; average return on invested capital across US industries during 2000–2008 was 12.4 per cent in the cited example. Then concentrate strategy discussion on the one or two forces that most affect future value, while documenting why the others are secondary.

Top pitfall

A completed diagram is not a strategy. The analysis must lead to choices about positioning and activity. The most common error is an ill-defined industry boundary—for example, treating all banking as one market when retail banking in a particular country has different buyers, substitutes and rules from commercial banking elsewhere.

Further reading

• Porter, M.E. (nineteen seventy-nine). “How Competitive Forces Shape Strategy.” Harvard Business Review.
• Porter, M.E. (nineteen eighty). Competitive Strategy. Free Press.