Porter 5 Forces

What is it?

The Classic Porter framework that was introduced in his book “Competitive Strategy” that describes the 5 forces that operate on an industry that explain much of the overall performance of an industry.

When is it useful?

Porters 5 forces is helpful whenever you want to analyse an industry, enabling you to step back from the details to see the big picture. It is most valuable when used dynamically – not a static picture of the attractiveness of the industry, but a dynamic one – how are the forces changing, and as a consequence will the industry becoming more or less attractive in future.

It is particularly valuable for market entry, to help understand the attractiveness of the potential market.  This framework enables the strategist to judge the long term profitability of the business if it is entered successfully.

It is helpful for resource allocation decisions in multi-business companies – can you shift discretionary resources to businesses that are more structurally attractive? You can use this framework to help decide which segments of your business to focus on. There will be some segments where the 5 forces are moving in your favour – you can expect a profitability tailwind in these segments. Equally, there may be some segments where the 5 forces are moving to eliminate profits.

It also helps existing businesses think through the strategic trends driving their future long term economics. How can they position themselves to take advantage of these trends?

An Example?

Lets look at the printer industry

Notes:

  • An overall conclusion – 4 out of the 5 forces are favourable to industry profit (green), so net net, this is an attractive industry. However, it is not necessarily attractive to new entrants, since barriers to entry are so high.
  • Printing is a classic Razor/Blade business model
  • The only potential cloud on the horizon is the threat of paperless technology. You would have thought that the invention of e-mail and photo/file sharing would reduce the amount of printing, but this has not happened yet. However, at some point in the future, it is bound to, right?

How do you do the analysis?

The underlying assumption is that average returns in a business or industry is driven by Structural Forces and Conduct of the participants.

How to fill it in the framework:
Map out each of the 5 industry forces in turn.
i) Competition. What is the competitive behaviour? Is it stable, with a couple of big players competing in ways that grow the pot (e.g. Pepsi vs Coke)? Or is it closer to perfect competition, with a large number of competitors prepared to compete on price (e.g. construction).
ii) Customers. How concentrated and sophisticated are customers? What is the balance of power? Who has an information advantage?
iii) Suppliers. How concentrated and sophisticated are suppliers? Who needs each other more? Who has an information advantage?
iv) New Entrants. How does government regulation impact the industry returns? When crafting your strategy, as well as positioning yourself to differentiate from current competition, you also need to ask yourself “What new competitors could enter? How can we pre-empt them?” Technology has reduced barriers between industries, making it easier for competition to come from adjacent industries, or even fast-moving start-ups. The threat of new entrants can depress industry profitability, as incumbents keep prices down to the point where entry is uneconomic.

v) Substitutes. What alternative products could the customer use?

Once you have a historical picture, think through how these forces will change over the next 5 to 10 years. Are Suppliers increasing or decreasing in relative power? What regulation changes would impact industry profit? How could competitive behaviour change for the better? The key insights will come from extrapolating these forces into the future.

Calculate the industry economic profit pool over time. Does the strength of the forces identified match the historic returns to competitors, suppliers and customers?

Limitations

The big challenge of this framework is the “So What”? If you are already in an industry, you are stuck with it’s 5 Forces – there is not much you can do as one company to affect these forces. And these forces do not dictate an individual companies profitability – research shows that there is more variation in average returns across companies within an industry than the variation across industries.
A second danger is that it presents a static view of the industry, not shedding enough light on how the forces are changing and what opportunities this creates.

I want to know more

Read Michael Porter’s “Competitive Strategy” and if that is not enough “Competitive Advantage” the follow-up

Michael Porter interviewed about on the 5 forces