Porter’s Five Forces is a model that identifies and describes the five economic forces that shape each industry. More specifically, it explains how these forces dictate each industry’s competitive intensity, potential for profitability and attractiveness.
Porter’s Five Forces has become a fundamental model that most businesses use to understand the dynamics of their industry and in turn drive their business strategy. And it can also help you do the same.
To help illustrate this, we’ve outlined the five fundamental economic forces at play in each market and provided an example analysis in each section so you can see how each of these forces may play out in your particular industry.
What are Porter’s five powers?
- Competition in industry
- Potential for new entrants to the industry
- Power of Suppliers
- Power of customers
- Threat of substitute products
The way you apply this model to your own business depends entirely on the nature of your industry. Once you understand the forces that influence your industry, you can extract better insights that are relevant to your business.
Let’s break down each economic power and look at some examples:
Porter’s five forces model
1. Competition in Industry
Competition plays a big role in your industry’s profitability – the potential to deliver a high return on investment – and in turn its ability to attract new entrants.
When there is a lot of competition in your industry, it is harder to make a profit. Customers have a rich number of options to choose from, so if your prices are too high, they can enter into an agreement with a supplier who will sell to them at a lower price.
In other words, customers typically have more power than suppliers in competitive industries. This usually results in suppliers undermining each other until their revenues barely exceed their costs – which in turn lowers their profits and discourages new players from entering the market.
When there is less competition in your industry, it is easier to make a profit. Customers have fewer suppliers to choose from, so if they want to buy your market’s product or service, they have to accept the higher price.
To help you explore the competition in your own industry, let’s see it in action in the aluminum baseball bat industry.
From small league to college, baseball players across the country mainly use aluminum baseball bats to train and compete.
Louisville Slugger, Rawlings, Marucci, DeMarini and AxBat are the leaders in the high-end of this market. Their target customers are travel or college baseball players who are willing to pay a premium price for the best bats that can perform at a high level and stay durable for multiple seasons.
Easton, Mizuno and Adidas serve the middle of the market, and Anderson, Combat and Dirty South serve the low end of the market. Their target customers are less competitive players who probably only play baseball for fun and friendships.
2. Potential of new entrants to the industry
If new players can enter your market quickly and cheaply, they can sell their minimum viable product. It is a product with just enough features to satisfy early customers.
The frequency of new players entering your market depends on your industry’s barriers to entry. If it costs a lot of money and time to build a viable product and cover overhead expenses, beginners will not be able to enter or compete in your market.
To help you explore the potential of new entrants into your own industry, here’s an analysis of the potential of new entrants into the aluminum baseball bat industry.
Example of new entrants
The barriers to entry into the aluminum baseball bat industry are very high. You will have to spend a lot of money on research and development to figure out how to differentiate your product in a saturated market, purchase a lot of raw materials to manufacture the bats, and build expensive facilities and machines to really make it produce.
This start-up business will have to ask close to an industry average price to cover the initial overhead to create a minimum viable product, create an enjoyable branding experience and generate revenue. You will also need to hire a product, marketing and sales team to manage this day-to-day business operations.
3. Power of suppliers
The number of suppliers or competitors in your market directly affects your company’s ability to control prices. When there is little to no competition, suppliers keep the price power. If a consumer does not accept your prices, you and your co-suppliers can easily find someone else who will do it.
When there are many suppliers in your industry, each supplier has less price power. Your market’s customers have a rich pool of options to choose from, so if your prices are too high, they may just enter into an agreement with another supplier.
Example of power of suppliers
With 11 major suppliers in an extremely popular industry – and five or fewer brands competing in each segment of the market – the suppliers have a lot of price power. Almost every baseball player, from small league to college, needs an aluminum baseball bat to practice and compete, so they are very dependent on these providers, giving them even more price power.
4. Power of customers
The number of customers in your industry affects their ability to control prices directly. If there are only a few customers in your industry, they like most of the power.
Because suppliers depend on customers to generate revenue, suppliers must meet their customers’ pricing requirements – or run the risk of customers doing business with other suppliers.
On the other hand, if there are a ton of customers in your industry, those customers have significantly less power. They must accept the prices set by suppliers, otherwise they will not be able to buy any of the products or services.
Example of customer power
Every single baseball player needs an aluminum baseball to train and compete, so every supplier in the aluminum baseball bat industry has a huge potential customer base to market and sell. Since there are few suppliers and so many customers in this market, the customers do not have enough power to bring the prices down.
5. Threat of substitute products
Substitutes are products from different industries that consumers can use interchangeably, such as coffee and tea, and this can significantly shape your industry.
If your product has cheaper or better substitutes, you should not only compete with other role players in your industry, but you should also compete with businesses in other industries
However, if your product does not have cheaper or better substitutes, the businesses that manufacture these substitutes do not pose as much of a threat to you or your immediate competitors. This low multi-market competition might just lower your prices and profits slightly.
Example of threat of substitute products
Instead of buying aluminum baseball bats, players can buy bats from suppliers that only manufacture wooden bats, such as Baum Bats, Old Hickory and Sam Bat. But the chances of that happening are extremely low. Even though individual wood bats cost less than individual aluminum bats, wood bats break much more frequently.
For example, one $ 250 aluminum bat may last longer than five $ 100 wooden bats, so replacing aluminum bats with wooden bats will actually cost more money. Players can also hit the ball further with aluminum bats, making it the superior product.
In addition, wood batting manufacturers make the most money by focusing on a specific market of baseball players who only use wooden batsmen, such as professional baseball players, summer college league players and top-flight baseball players. In short, there is a low threat of substitutes in this industry.
Porter’s Five Forces Analysis
To perform a Five Forces analysis, start by reflecting on how each force is affecting your business. Then identify the strength and direction of each force – which also assesses your competitive position.
To get the ball rolling, ask yourself these questions:
- Are there many suppliers in my industry?
- Is my purchasing power high or low?
- Is there a replacement for my product or service?
- Is it easy or difficult for new competitors to enter my market?
- Is competition high or low in my industry?
Then write down each of the five forces, noting the size and scale of each, using your answers to guide you. You can also do this by downloading our Five Forces Model Template below.
Porter’s Five Forces Model Template
Download this template for free
Competition is a natural part of business. By analyzing your industry using Porter’s Five Forces, you can identify strategies to improve your competitive position, potential for long-term profitability and overall attractiveness.