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Porter's Five Forces

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Business Studies

The Porter's Five Forces analysis was created by Michael Porter, a professor at Harvard Business School in 1979. Since its publication, it has become one of the most popular and highly regarded business strategy tools. Let's take a look at what it is exactly and how businesses can use this tool to guide their strategy.

Porter's Five Forces Framework

Porter's Five Forces is a method for analysing a company's competitive environment. It identifies and analyses five competitive forces that shape the industry.

The purpose of Porter's Five Forces is to determine the profit potential of a market. It helps business people understand the relative attractiveness of an industry and the industry's competitive pressure. Each business sector is influenced by the five factors and therefore understanding them and how they apply to an industry can enable a company to implement a suitable business strategy. It can help to make decisions relating to whether to enter a specific industry, increase capacity in a specific industry and develop competitive strategies.

Porter's Five Forces Model

The five main forces that make up this model are:

Competitive rivalry
New entrants
Power of Buyers
Power of Suppliers
Threat of Substitutes

Competitive Rivalry

The type of competition can vary depending on the balance of the competitive relationship. The competitive rivalry is high when there are numerous competitors because then consumers can easily switch to competitors offering similar products or services. Similar size companies are likely to be more fierce than when there are large and small companies. It is also worth keeping an eye on the market growth as a growing market allows both companies to grow in sales and a stagnant market means that a market steal is required.

Therefore, it is important to know your competitors:

  • Number of competitors,

  • Quality differences,

  • Concentration of industry,

  • Brand loyalty,

  • Market growth.

New Entrants

New entrants to the market can threaten your own sales volume and market share. Therefore, think about how easily this could be done.

Entry barriers:

  • Economies of scale,

  • Capital cost of entry,

  • Expected retaliation,

  • Brand loyalty,

  • Government policies,

  • Specialist knowledge.

Power of Buyers

Power of buyers is an ability that customers have to drive prices lower or higher.

Buyers' power is high when there are few large players and proportionally many suppliers. If many sources are available, buyers may shop around for other materials or supplies which may include a risk of losing a key client.

Factors determining the power of buyers:

  • Number of customers,

  • Order size,

  • Differences between competitors,

  • Buyers' ability to substitute,

  • Price sensitivity,

  • Information availability.

Power of Suppliers

Power of suppliers is an ability that suppliers have to drive up the cost of inputs.

Opposite to the power of buyers, power of suppliers is high when there are few suppliers. When there are few suppliers, a product is new or specific, it might be difficult and expensive for a company to switch suppliers.

Factors determining the power of suppliers:

  • Number of suppliers,

  • Size of suppliers,

  • Uniqueness of the product or service,

  • Suppliers' ability to substitute,

  • Switching costs.

Threat of Substitutes

Most products can be substituted for other offerings, not necessarily in the same category. This is known as the threat of substitutes.

There are several types of substitution:

  • Product-for-product.

    A camera can be replaced with a smartphone.

  • Need-based. The same product, but better, improved.

    A computer with better software.

  • Generic substitution. There is no competitive product. It is just a decision on what to buy.

    A new car, new kitchen or holiday.

  • Go without.

    Give up smoking, alcohol, or meat.

Porter's Five Forces in Practice with Example

Let's take a look at Porter's Five Forces in action with a detailed example of the airline industry.

Competitive Rivalry

Characteristics:

  • Numerous airlines,

  • Two categories regarding quality: low fare airlines and regular airlines,

  • Concentrated mostly in North America, Europe and Asia,

  • No matter how big they are, some of them have built trust among customers,

  • The industry is very stagnant in terms of growth.

The airline industry is very competitive. No matter where a company is based, how big it is and what types of services it offers, the competitive rivalry among existing competitors is high.

New Entrants

Entry barriers:

  • Inability to procure cheap equipment since there are many established companies with significant customer base,

  • High cost of entry (cost of planes and airport spots),

  • High risk of retaliation,

  • Difficulties in building brand loyalty,

  • Many Government policies,

  • Need for specialist knowledge.

New entrants would face many difficulties when entering the market. Therefore, you should not worry about new competitors.

Power of Buyers

Characteristics:

  • High number of customers all over the world,

  • Different order sizes (individual and corporate flights),

  • Large differences between competitors (low fare, regular and more exclusive flight offers),

  • Small ability to substitute (many destinations are reachable by plane only),

  • Relatively big price differences (prices change continually),

  • Large information availability.

Power of buyers seems to be very high. There are many customers who are able to choose from many different services at different prices.

Power of Suppliers

Characteristics:

  • Low number of suppliers,

  • Big-sized suppliers,

  • Low uniqueness of products or services (there are that many types of planes),

  • Moderate ability to substitute,

  • High switching costs.

Power of suppliers appears as moderate. They are able to raise prices since there are few suppliers and it is tough to change a supplier. However, there are not many competitive suppliers and it might be difficult for them to offer a new, unique product.

Threat of Substitutes

It is hard to substitute a plane with any other type of transport since many destinations are reachable this way only. In the future there might be some inventions which will substitute planes, but for now you should not worry about them.

Limitations of the Porter's Five Forces

  • It is just a starting point for a deeper investigation. The framework is very general and does not assess whether the factors are advantageous or not.

  • There is no quantitative analysis involved.

  • It tends to be very subjective.

Porter's Five Forces - Key Takeaways

  • Porter's Five Forces is a tool for understanding the competitiveness of your business environment.

  • The five forces are: competitive rivalry, new entrants, power of buyers, power of suppliers and threat of substitutes.

  • Its purpose is to identify a company's potential profitability and adjust its strategy.

  • The forces should be continuously monitored as they may change frequently.

Porter's Five Forces

Porter's Five Forces is a method for analysing a company's competitive environment.

To determine the profit potential of a market. It helps business people understand the relative attractiveness of an industry and the industry's competitive pressure.

Determine the five forces: competitive rivalry, new entrants, power of buyers, power of suppliers, threat of substitutes and assess their impact.

The Porter's Five Forces framework can be used to assess the competitive environment. It takes competitive rivalry, the threat of new entrants, the power of buyers and suppliers, and the threat of substitutes into consideration for the analysis.

An example of Porter's Five Forces can be outlined by looking at Apple Inc. In its competitive environment, there is high rivalry present due to the number of competitors. The bargaining power of suppliers is low, but the power of buyers is high. The threat of substitutes for Apple products is particularly low due to the limited capabilities of said substitutes, whereas the threat of new entrants is high, as large companies may have the investment necessary to establish a competitor brand.

Final Porter's Five Forces Quiz

Question

What is Porter’s Five Forces?

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Answer

Porter’s Five Forces is a method for analyzing a company's competitive environment.

Show question

Question

What is the purpose of the Porter’s Five Forces?


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Answer

The purpose of the Porter’s Five Forces is to determine the profit potential of a market. It helps business people understand the relative attractiveness of an industry and the industry's competitive pressure.

Show question

Question

What are the five forces?


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Answer

Competitive rivalry, new entrants, power of buyers, power of suppliers, threat of substitutes.

Show question

Question

What is meant by new entrants?


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Answer

New entrants are enterprises entering the market which can pose a potential threat to the already existing businesses.

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Question

What are the limitations of the Porter’s Five Forces?


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Answer

It is very general and tends to be subjective.

Show question

Question

What is the competitive rivalry high?

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Answer

The competitive rivalry is high when there are numerous competitors because then consumers can easily switch to competitors offering similar products or services.

Show question

Question

What is the power of buyers?

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Answer

Power of buyers is an ability that customers have to drive prices lower or higher.

Show question

Question

Give an example of a factor deremining the power of buyers.

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Answer

Any of:

  • Number of customers,
  • Order size,
  • Differences between competitors,
  • Buyers' ability to substitute,
  • Price sensitivity,
  • Information availability.

Show question

Question

What is the power of suppliers?

Show answer

Answer

Power of suppliers is an ability that suppliers have to drive up the cost of inputs.

Show question

Question

Give an example of a factor determining the power of suppliers.

Show answer

Answer

Any of:

  • Number of suppliers,
  • Size of suppliers,
  • Uniqueness of the product or service,
  • Suppliers' ability to substitute,
  • Switching costs.

Show question

Question

What is meant by the threat of substitutes?

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Answer

Most products can be substituted for other offerings, not necessarily in the same category. 

Show question

Question

Give an example of a type of substitution.

Show answer

Answer

Any of:

  • Product-for-product,
  • Need-based,
  • Generic substitution,
  • Go without.

Show question

Question

What is a need-based substitution?

Show answer

Answer

The same product, but better, improved. 

Show question

Question

Give two examples of entry barriers for new entrants.

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Answer

Any two of:

  • Economies of scale,
  • Capital cost of entry,
  • Expected retaliation,
  • Brand loyalty,
  • Government policies,
  • Specialist knowledge.

Show question

Question

Give two examples of things to know about competitiors.

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Answer

Any two of:

  • Number of competitors,
  • Quality differences,
  • Concentration of industry,
  • Brand loyalty,
  • Market growth.

Show question

Question

Porter's Five Forces is a method for analysing a company's...

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Answer

competitive environment. 

Show question

Question

Economies of scale, capital cost of entry, expected retaliation, brand loyalty, government policies and specialist knowledge are ___ for new entrants.

Show answer

Answer

entry barriers

Show question

Question

One of Porter's Five Forces is threat of ___ . 

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Answer

substitutes

Show question

Question

Power of buyers is an ability that customers have to drive ___ lower or higher.


Show answer

Answer

prices

Show question

Question

Number of suppliers, size of suppliers, uniqueness of the product or service, suppliers' ability to substitute and switching costs are factors determining...

Show answer

Answer

the power of suppliers.

Show question

Question

A camera can be replaced with a smartphone. What type of substitution is it?

Show answer

Answer

Product-for-product

Show question

Question

Competitive rivalry is high when there are only few competitors.


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Answer

False

Show question

Question

An ability that suppliers have to drive up the cost of inputs is called...


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Answer

power of suppliers.

Show question

Question

Similar size companies are likely to be more fierce than when there are large and small companies. 


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Answer

True

Show question

Question

Most products can be substituted for other offerings, not necessarily in the same category. 


Show answer

Answer

True

Show question

Question

Imagine that you have decided to buy a holiday. What type of substitution is it?

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Answer

Generic substitution

Show question

Question

When there are few suppliers, a product is new or specific, it should be easy and cheap for a company to switch suppliers.

Show answer

Answer

False

Show question

Question

Some of Porter's Five Forces are Power of Suppliers and Power of ___ .

Show answer

Answer

Buyers

Show question

Question

In the case of the airline industry, why is the threat of substitutes low?

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Answer

Because it is hard to substitute a plane with any other type of transport since many destinations are reachable this way only.

Show question

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