How to Use Porter’s Five Forces Analysis to Create a Business Strategy

Porter’s Five Forces analysis was designed to help businesses evaluate the competitive forces at play in their industry and engage in strategic planning that accounts for the specifics of their industry structure and the relative power of suppliers and buyers.

Harvard Business School professor Michael E. Porter devised his five forces analysis in 1979 and described the forces model in a Harvard Business Review article. Michael Porter encouraged businesses to look beyond their direct industry competition and conduct a comprehensive industry analysis to get a full picture of their growth capabilities. Porter named five forces that determined the competitive intensity of a given market, which are:

1. 1. Competitive rivalry: This category is where you evaluate the level of competition in your industry based on the number of competitors you have and their relative power. If you have a large number of direct competitors, there’s incentive for companies to lower prices and spend considerable amounts of money on marketing in order to maintain a competitive position. These tactics can affect your bottom line. A large number of direct competitors also gives your buyers and suppliers a large degree of choice in who they decide to work with. A small number of competitors means that you have more power in setting your prices and sustaining profits.
2. 2. Supplier power: What’s the bargaining power of suppliers in your industry? How easy is it for them to raise prices, and what is the cost of switching from one supplier to another? The more quality suppliers you have, the easier it is to keep your costs down. Conversely, having fewer suppliers to choose from takes your power away and decreases the likelihood of you finding a long-term low-cost supplier.
3. 3. Buyer power: How much power do your buyers have to dictate your price? How easy is it for them to switch from one company to another? The bargaining power of buyers has a massive effect on the prices at which you’re able to sell. If you only deal with a handful of buyers, the power of your customers increases. If you have a wealth of customers, you have greater power to set your own terms and maintain profits.
4. 4. Threat of substitution: The threat of substitution refers to the possible alternatives and workarounds that customers can use to replicate your services. Say you developed a new proprietary payroll software: How easy and cheap is it for customers to continue using existing methods or hire a different company to handle payroll for them? If it is easy to substitute another product or service for yours, your profitability might suffer.
5. 5. Threat of new entry: How easy is it for new competitors to enter your industry? If overhead costs are low and expertise is easy to come by, then the competitive environment of your industry can quickly be upended by a new entry.

Most business owners spend their whole careers learning about how competitive forces shape strategy. Markets and competitive forces are not static, and conducting regular reviews of your corporate strategy and the state of your industry are vital to your company’s success. Porter’s Five Forces analysis can make this process much easier and provide you with a consistent and uniform rubric for analyzing the changes in your market and evaluating your competitive advantage or lack thereof. Here are three ways Porter’s Five Forces can be particularly useful:

1. 1. When you’re starting a new business: Before you take the leap and decide to start a new business in an unfamiliar industry, conduct Porter’s Five Forces analysis to get the lay of the land. Understanding the potential for industry growth, the existing distribution channels, and relative price sensitivity will give you a full picture of the level of competition you can expect and the capital requirements you need to start a viable business. Be realistic about the amount of stability you require and factor in how the threat of new entrants can affect your market share and sustained profitability.
2. 2. When you’re evaluating profit potential for existing businesses: For an existing business, a five forces analysis can be used to get an accurate picture of what future growth might look like. As a business owner it’s important to stay up to date with changing dynamics within your industry, and Porter’s Five Forces analysis can help make sure you are basing business decisions on accurate and up-to-date information about your industry and competition.
3. 3. When you’re gauging the effectiveness of a competitive strategy: Conducting an analysis using Porter’s Five Forces after the implementation of a new business strategy can help you keep track of the effectiveness of that strategy over time.

A Porter’s Five Force analysis can take many forms, depending on the scale of your business and the time and money you have to devote to it, but the basic steps are the same. Here are some things to consider as you start a Porter’s Five Forces analysis:

• Brainstorm. Before you begin a five forces analysis, take some time to brainstorm and create lists for each of the five categories. You might only think of a few direct competitors or suppliers that you interact with, but it’s important to consider your entire industry and include companies outside of your general frame of reference.
• Research exhaustively. Don’t skip over details that you think might not affect you or that seem unimportant. The purpose of a five forces analysis is to give you a full and exhaustive picture of your industry and your company’s market share and competitive advantage within that industry. A Porter’s Five Forces analysis isn’t simply a place to list things you already know—it’s a process to uncover new information affecting your company’s future growth.
• Evaluate the data. Make sure you’re basing your analysis on hard numbers whenever possible. Some parts of a Porter’s Analysis require you to rely on conventional wisdom and industry insight, but as much as possible, base your evaluations of the bargaining power of customers or the threat of other products on historical data.
• Conduct regular analyses. Michael Porter designed an analysis that takes into account the five competitive forces that shape strategy, but Porter never postulated that these forces remain static. Porter’s Five Forces analyses should be conducted regularly in order to keep track of changes in your industry and take stock of the effectiveness of your business strategies.

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