Porter's 5-Forces Model

A means of providing corporations with an analysis of their competition and determining strategy, Porter's five-forces model looks at the strength of five distinct competitive forces, which, when taken together, determine long-term profitability and competition. Porter's work has had a greater influence on business strategy than any other theory in the last half of the twentieth century, and his more recent work may have a similar impact on global competition.

Michigan native Michael Porter was born in 1947, was educated at Princeton, and earned an MBA (1971) and Ph.D. (1973) from Harvard. He was promoted to full professor at Harvard at age 34 and is currently C. Roland Christensen Professor of Business Administration at the Harvard Business School. He has published numerous books and articles, the first Interbrand Choice, Strategy and Bilateral Market Power, appearing in 1976. His best known and most widely used and referenced books are Competitive Strategy (1980) and Competitive Advantage (1985). Competitive Strategy revolutionized contemporary approaches to business strategy through application of the five-forces model. In Competitive Advantage, Porter further developed his strategy concepts to include the creation of a sustainable advantage. His other model, the value chain model, centers on product added value. Porter's work is widely read by business strategists around the world as well as business students. Any MBA student recognizes his name as one of the icons of business literature. The Strategic Management Society named Porter the most important living strategist in 1998, and Kevin Coyne of the consulting firm McKinsey and Co. called Porter "the single most important strategist working today, and maybe of all time."

The five-forces model was developed in Porter's 1980 book, Competitive Strategy: Techniques for Analyzing Industries and Competitors. To Porter, the classic means of developing a strategy--a formula for competition, goals, and policies to achieve those goals--was antiquated and in need of revision. Porter was searching for a solution between the two schools of prevailing thought-the Harvard Business School's urging firms to adjust to a unique set of changing circumstances and that of the Boston Consulting Group, based on the experience curve, whereby the more a company knows about the existing market, the more its strategy can be directed to increase its share of the market.

Figure 1

Porter applied microeconomic principles to business strategy and analyzed the strategic requirements of industrial sectors, not just specific companies. The five forces are competitive factors which determine industry competition and include: suppliers, rivalry within an industry, substitute products, customers or buyers, and new entrants (see Figure 1).

Although the strength of each force can vary from industry to industry, the forces, when considered together, determine long-term profitability within the specific industrial sector. The strength of each force is a separate function of the industry structure, which Porter defines as "the underlying economic and technical characteristics of an industry." Collectively, the five forces affect prices, necessary investment for competitiveness, market share, potential profits, profit margins, and industry volume. The key to the success of an industry, and thus the key to the model, is analyzing the changing dynamics and continuous flux between and within the five forces. Porter's model depends on the concept of power within the relationships of the five forces.

THE FIVE FORCES

INDUSTRY COMPETITORS.

Rivalries naturally develop between companies competing in the same market. Competitors use means such as advertising, introducing new products, more attractive customer service and warranties, and price competition to enhance their standing and market share in a specific industry. To Porter, the intensity of this rivalry is the result of factors like equally balanced companies, slow growth within an industry, high fixed costs, lack of product differentiation, overcapacity and price-cutting, diverse competitors, high-stakes investment, and the high risk of industry exit. There are also market entry barriers.

PRESSURE FROM SUBSTITUTE PRODUCTS

Substitute products are the natural result of industry competition, but they place a limit on profitability within the industry. A substitute product involves the search for a product that can do the same function as the product the industry already produces. Porter uses the example of security brokers, who increasingly face substitutes in the form of real estate, money-market funds, and insurance. Substitute products take on added importance as their availability increases.

BARGAINING POWER OF SUPPLIERS

Suppliers have a great deal of influence over an industry as they affect price increases and product quality. A supplier group exerts even more power over an industry if it is dominated by a few companies, there are no substitute products, the industry is not an important consumer for the suppliers, their product is essential to the industry, the supplier differs costs, and forward integration potential of the supplier group exists. Labor supply can also influence the position of the suppliers. These factors are generally out of the control of the industry or company but strategy can alter the power of suppliers.

BARGAINING POWER OF BUYERS

The buyer's power is significant in that buyers can force prices down, demand higher quality products or services, and, in essence, play competitors against one another, all resulting in potential loss of industry profits. Buyers exercise more power when they are large-volume buyers, the product is a significant aspect of the buyer's costs or purchases, the products are standard within an industry, there are few changing or switching costs, the buyers earn low profits, potential for backward integration of the buyer group exists, the product is not essential to the buyer's product, and the buyer has full disclosure about supply, demand, prices, and costs. The bargaining position of buyers changes with time and a company's (and industry's) competitive strategy.

POTENTIAL ENTRANTS

Threats of new entrants into an industry depends largely on barriers to entry. Porter identifies six major barriers to entry:

* Economies of scale, or decline in unit costs of the product, which force the entrant to enter on a large scale and risk a strong reaction from firms already in