Business Strategy
Porter's Five Forces
A classic framework for understanding why some industries are highly profitable and others are not, by looking at five competitive pressures.
Why are some industries, such as software, often very profitable, while others, such as airlines, struggle? In 1979, Michael Porter proposed a framework to answer this: the five forces.
The five forces
- Rivalry among existing competitors: many similar firms competing fiercely on price reduces profits.
- Threat of new entrants: if it is easy to enter an industry, new firms will compete away profits. Barriers to entry, such as high capital costs, licences, patents or strong brands, protect incumbents.
- Bargaining power of suppliers: powerful suppliers, such as a sole provider of a key component, can raise prices and squeeze profits.
- Bargaining power of buyers: large or well-informed buyers can push prices down. A company selling to a few big retailers has less power than one selling to millions of individuals.
- Threat of substitutes: products from other industries that meet the same need limit how much a firm can charge. Video calls are a substitute for business travel.
Using the framework
The stronger these forces, the harder it is for firms in an industry to earn high profits. Companies can use the framework to:
- Decide which industries to enter.
- Find positions within an industry where forces are weaker.
- Shape the forces, for example by building a brand to reduce buyer power.
An example: airlines
Airlines face intense rivalry, powerful suppliers such as aircraft makers and airports, price-sensitive buyers who compare fares online, and substitutes such as trains. Around the world, airlines have often struggled to earn steady profits.
Criticism
Critics say the framework is static and does not fully capture fast-changing digital industries, cooperation between firms, or network effects. Still, it remains widely taught.
Global soft drink companies face few strong suppliers, since sugar, water and bottles are widely available, and millions of individual buyers with little bargaining power. Their strong brands and distribution networks deter new entrants. This helps explain their consistent profitability.
Industry structure matters a lot. A well-run firm in a harsh industry may earn less than an average firm in a favourable one.
- Porter's five forces are rivalry, new entrants, supplier power, buyer power and substitutes.
- Stronger forces mean lower industry profits.
- Firms use the framework to choose industries and positions.
- Critics say it can miss digital dynamics and network effects.
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