Porter's five forces

The Porter model of competitive industry structure, developed by Harvard Business School professor, Michael E. Porter and commonly known as Porter's five forces is a framework for assessing and evaluating the competitive strength of an organisation within an industry.

An industry is a group of companies that develop and market similar products. Some industries have historically been highly profitable, such as car, coal and textiles but more recently have struggled. In more recent years industries such as pharmaceuticals, soft drinks and creative industries such as television and web have enjoyed high profits.

Porter's fives forces is based on the concept that there are five forces that determine the competitiveness and viability of a market. Porter’s five forces help to identify where power lies in a business situation. This is useful both in understanding the strength of an organisation’s current competitive position, and the strength of an industry that an organisation may look to move into.

The five forces are:

Supplier bargaining power
Buyer bargaining power
Competitive rivalry
Threat of substitutes
Threat of new entrants

Porter’s Five Forces of Competitive Position Analysis (cgma.org)

1. Supplier bargaining power

An assessment of how easy it is for suppliers to drive up prices. This is driven by the cost of raw materials, the number of suppliers; uniqueness of their product or service; relative size and strength of the supplier; and cost of switching from one supplier to another. These costs can have a huge bearing on a company's profitability.

A company can reduce the bargaining power of suppliers by seeking new sources or designing standardised components for their products, so many suppliers can produce them.

Example: Apple adopted Intel processors, but found the bargaining power of Intel to be strong as they are the dominant supplier of processors. Apple have therefore started to develop their own processing chips in their latest machines. This meant Apple had to reprogram some of its most popular apps such as iTues and Garageband.

2. Buyer bargaining power

On the contrary, this is an assessment of how easy it is for buyers to drive prices down from suppliers. This is driven by the:

Number of buyers in the market - The power is greater if there are few buyers and many sellers.
Products are standardised - available from other suppliers so the buyer can just go elsewhere.
Importance of product to the buyer - If it's not a core trading product the buyer can stop purchasing.
Cost of switching from one supplier to another. If a business has just a few powerful buyers, they are often able to dictate terms.

A supplier can attempt to lower buyer power by increasing their number of buyers, moving into the buyer's industry and producing high-valued specialist products.

Example: Dixons Carphone (who own Currys) buy from many different technology companies and are the dominant tech retailer on the high street. They have a lot of buying power. Wilko sold bicycles online for a while, but with many buyers in that market and poor sales, it was deemed a non-essential product and were discontinued.

3. Competitive rivalry

A key driver is the number of & capability of competitors and the intensity of rivalry between them. Many competitors offering the same or similar products will reduce market attractiveness.

Less rivalry when there is a clear market leader (Google) who can dictate a cost advantage but more competitive when there is equally balanced competitors (wilko, B&M, Dunelm) (Pepsi, Coca Cola)
Differentiation of product. A business with a unique product that's hard to copy will have less rivals than a common product which will have many 'copycat' models. (iPhone runs own its own Apple software whilst the rest of the market run on Android where the competition is fierce from Samsung, Huawei, Sony)
Switching costs - Rivalry is reduced when switching costs are high due to the uniqueness of product and the business is invested in that product. (It's easy for an individual to switch bank or ISP these days, but may find it hard to switch to Android from iPhone if all of their digital life and app purchases are through Apple Store, they are invested in that universe)
Exit barriers - Rivalry will be more intense if it is easy to switch markets. Less so when the costs of leaving an industry are too high due to lack of opportunities elsewhere, or costs of closing down a manufacturing plant are too great to consider.

4. Threat of substitutes

Where close substitute products exist in a market, it increases the likelihood of customers switching to alternatives in response to price increases. This reduces both the power of suppliers and the attractiveness of the market and put a restraint on price levels. For example if Coca Cola raised the price of their product too highly, customers may switch to Pepsi. The threat of substitution depends on:

Customer's willingness to swap. (You see on many consumer programmes how members of the public choose to, or refuse to swap a branded product to a supermarket brand.)
Relative price and performance of substitutes
Costs of switching to substitutes

The threat of substituting can be lowered by discounting branded products, or on the contrary building up a strong brand and price in line with perceived values. Another tactic is to copy the substitute, form a partnership with the brand, buy the brand or move to a new market.

Example: Aldi produces many own brand products that mimic brands at a lower price. Nestle sells it's coffee exclusively in Starbucks (not Costa etc).

4. Threat of new entry

Profitable markets attract new entrants, which increases competition and erodes the profitability & attractiveness of the market. Unless incumbents have strong barriers to entry, for example, patents or economies of scale, then profitability will decline to a competitive rate.

The threat of new entrants depends on the barriers of entry. Pharmaceuticals is an industry with high barriers (highly regulated) whereas the restaurant industry is much easier to enter.

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