Porter’s five forces

Porter’s five forces is a model used to assess a company in its business environment to see if the likelihood of it generating a profit is high or low.

Marie-Claude Michaud, Senior Consultant, BDC Advisory Services, regularly uses this model with her clients. She explains why it’s useful and what its limits are.

What is Porter’s five forces model?

Porter’s five forces model was developed in 1979 by Michael Porter, a Harvard Business School professor in strategy. It identifies the forces present in an industry.

The five forces are as follows:

• competitive intensity
• suppliers’ bargaining power
• threat of new entry
• buyers’ bargaining power
• threat of substitution

Why is Porter’s five forces model used?

“Porter’s five forces model evaluates the various elements of the business environment in a company’s industry and its ability to generate a profit,” says Michaud. “The more the company faces large forces, the less likely it is to be profitable, and the less its industry is attractive.”

It can be used to assess whether investing in a company is a good idea, or for someone starting their own company or setting up a new business branch.

How to apply Porter’s five forces model to my company?

According to Michaud, “you analyze each force in turn and answer a number of questions to have a clear picture of the situation. Anyone who wants to go into business should be able to provide these details easily, as they form the backbone of the business plan.”

The following example below provides sample questions.

Porter’s five forces model

Our free supply and demand analysis tool includes a model for analyzing Porter’s five forces.

Sample analysis of a company using Porter’s five forces

Michaud gives the example of a microbrewery in Quebec that has its own pub and also distributes its beers at points of sale.

Competitive intensity

• How many competitors do you have?
  Over 300.
• What are the differences in terms of quality?
  There are few differences.
• Do they have other significant differences?
  No.
• What are the costs of changing suppliers for a customer?
  Minimal.
• What is the level of customer loyalty?
  Variable.

The result? The microbrewery’s competitive intensity is high.

Suppliers’ bargaining power

• How many suppliers do you have?
  Those for inputs, such as hops, for packaging, like cans and bottles, and for distribution.
• What is the size of your suppliers?
  Those for inputs, such as hops, may be small, but those for packaging and distribution are large.
• How specific is the service they provide?
  Those for inputs are less specific, but those for packaging and distribution are highly specific.
• What is your ability to substitute?
  Very low.
• What is the cost of changing suppliers?
  Modest.

The result? The bargaining power of suppliers is generally high.

Threat of new entry

• What are the time and entry costs of entering the market?
  Moderate.
• Do you need specialized knowledge to enter the market?
  Yes.
• Do you have economies of scale?
  No.
• Do you have any advantages over your competitors in terms of costs?
  No.
• Is your technology protected?
  No.
• Are there barriers to entry?
  No.

The result? The threat of new entries is high.

Buyers’ bargaining power

• How many customers do you have?
  Those from direct selling at the pub, those from food service and hospitality, and retail customers. There are many, but the large commercial players dominate the market.
• What is the size of each order?
  Modest, whereas beers from certain microbreweries bought by large commercial players are part of large orders.
• Are your products and services very different from those of your competitors?
  No.
• Are your customers very sensitive to the price of your products or services?
  Yes.
• Do your customers have access to many competitors’ products?
  Yes.
• What is the cost for your customers to switch to one of your competitors?
  Low.

The result? Buyers have a lot of bargaining power.

Threat of substitution

• What is the performance of substitutes?
  Moderate.
• What is the cost of change for a customer to switch to a substitute?
  Low.

The result? The threat of substitution is moderate.

“For a microbrewery in Quebec whose beers are also distributed at points of sale, Porter’s five forces are quite strong,” says Michaud. “The company, facing these major forces, is therefore less likely to be profitable. This can explain why we”ve seeen a lot of microbreweries struggling in the past few years.”

Porter’s five forces model to analyze an industry

“Porter’s five forces model is useful to see which key success factors are required to succeed in an industry,” says Michaud. “We can guide the company’s strategy based on these factors.”

While you can’t change the business environment, you can adapt the business strategy so that the company will do well despite the forces. Let’s take the example of highly price-sensitive customers.

“The company can choose to reduce its costs to a minimum, by investing in automation, for instance,” says Michaud. “Or it can invest in innovation to develop a unique product that will differentiate it from the competition, and thus shift focus away from price. The company could therefore be attractive even if Porter’s five forces are very present.”

Porter’s five forces and marketing

According to Michaud, Porter’s five forces model is useful in strategic marketing. “It shows the key factors for succeeding in an industry, and accordingly how the company can position itself to stand out from the competition,” she says. “For example, the first microbrewery that came out with a gluten-free beer, or a good no-alcohol beer, showcased this element.”

What are the weaknesses of Porter’s five forces model?

The model focuses only on external forces, without considering the company’s resources, competencies or internal capabilities.

“To assess a company’s chances for success, you need to look at factors other than threats,” says Michaud. “In addition to internal forces, you need to assess opportunities.”

Porter’s five forces also focus on the competition, but ignore cooperative dynamics (strategic alliances, partnerships, innovation ecosystems), which are increasingly frequent.

Lastly, the model assumes that industrial structures are relatively stable, which doesn’t necessarily reflect the current reality of quickly evolving markets, in particular with the digital transformation.

How to choose the right model for a strategic analysis?

According to Michaud, you have to use several models to carry out a good strategic analysis. In addition to Porter’s five forces, she mentions the SWOT model, which analyzes a company’s strengths, weaknesses, opportunities and threats. Then there is the PESTEL model, which examines the political, economic, social, technological, environmental and legal factors that impact an organization.

“It’s really when you look at all these factors together that you have a good idea of the company’s situation,” she says.

Next steps

Download the free BDC guide The Foundations of Strategic Planning and, using the model, discover how to set measurable targets for your business, create an action plan and ensure you have the capabilities to succeed.