Five Forces Analysis

Porter’s Five-Forces Analysis

Porter's 5 Forces is a simple but powerful tool for evaluating the attractiveness, or profit potential, of an industry. It is based on an industrial organization perspective which posits that the external environment is the primary determinant of firm success.  An unattractive industry is one in which the five-forces act to drive down profitability. An attractive industry is one in which the five-forces permit the potential for high profits. Five-forces analysis may be used evaluate to whether products, services or businesses are likely to be profitable based on the attractiveness of the industry environment.

Five Forces Analysis assumes that there are five important forces, or tensions, that determine the profit potential in the business environment :

1. Supplier Power: addresses how easy it is for suppliers to force- up prices. This is driven by the number of suppliers of each key input, the uniqueness of their product or service, and the cost of switching from one to supplier to another. The fewer the supplier choices you have, and the more you need suppliers' help, the more power suppliers have when negotiating prices and terms.
2. Buyer Power:  addresses how easy it is for buyers to force-down prices. This is the flip-side of supplier power. Again, this is driven by the number of buyers, the importance of each individual buyer to your business, the availability of alternate products, and the cost to them of switching from your products and services to those of someone else. If you deal with few, powerful buyers (if, for example, Wal-Mart were your customer), then they are often able to dictate prices and terms to you.
3. Competitive Rivalry: addresses the intensity and nature of competition between companies in an industry. What is important here is the number and capability of the other companies. If there are many competitors, and they offer equally attractive products and services, then there is often intense rivalry for both suppliers and customers. Customers and suppliers can easily switch to other companies, so companies must fight to attract and protect market share.  On the other hand, if no-one else can do what you do, then you can often have tremendous strength when negotiating with your suppliers and customers.
4. Threat of Substitution: addresses how easily your customers can find other ways to satisfy the need you satisfy if your terms become unattractive – for example, someone may switch from playing golf to playing tennis if the golf course becomes too crowded or too expensive. Note that there is a distinction between competitors and substitutes. Competitors and usually in the same industry and satisfy a need in basically the same way; substitutes are usually in different industries and address the same need in a different way. What is important here is the availability of substitutes and the cost of switching from your product to an alternative. If substitution is easy and viable, it reduces your strength when negotiating with your customers.
5. Threat of New Entry: addresses how easily new competitors can enter your markets. What is important here are barriers to entry – conditions that are difficult for new entrants to overcome. If it costs little in time or money to enter your market and compete effectively, if there are few economies of scale in place, or if you have little protection for your key technologies, then new competitors can quickly enter your market and weaken your position. When barriers are low, companies are forced to keep profits low to avoid attracting new competitors.

Doing a Five-forces analysis involves systematically examining each of the forces using the factors that drive the force. Grant has a very thorough discussion of these factors and I have included a brief summary. You must use these factors in your assessment. You don’t need to include all of them, but you must support your assessment of the force (high/medium/low) by using them.  It is important that you specifically state your assessment of the level of each force – high (poor for profit potential), medium (not a significant force in determining profit potential), or low (good for profit potential).