The Five Forces framework was developed by Michael Porter, who argued that industry profitability was the most important factor in defining business success.
Porter reasoned that profitability within an industry is determined by the intensity of five underlying competitive forces:
Existing / established rivals - who compete with you directly
Buyers / customers - who could drive down prices by playing you and your competitors against each other
Suppliers - who could charge higher prices, constraining your profits
Substitutes - who reach your customers in an alternative way
New entrants - who may challenge your market share
Each exerts different forces affecting the profitability of an industry.
The Five Forces framework is an important tool for revealing an industry’s underlying structure and competitive intensity, enabling a company to design a strategy that maximises profits.
When & Why to Use Five Forces Analysis
Five Forces analysis is most commonly used when analysing the profitability of an industry.
It’s useful for helping you look beyond your direct competitors to identify the areas where your organisation is most at risk.
It can also be used within a strategic planning process to determine the viability of launching a new product or service in a new market.
IN A NUTSHELL: The Five Forces framework reveals an industry’s underlying structure and competitive intensity.
The Five Forces in Detail
The Five Forces framework is most commonly illustrated using a diagram like this:
Combined, the four surrounding forces determine the level of competitive rivalry in an industry, hence its position in the middle.
Let’s look an example of each of the five forces in turn:
As with a few of the examples above, a popular way of illustrating the Five Forces in action is to look at the airline industry.
As Porter says: “It’s one of the least profitable industries because all five forces are strong. Established rivals compete intensely on price. Customers are fickle, searching for the best deal regardless of carrier. Suppliers - plane and engine manufacturers, along with unionised labour forces - bargain away the lion’s share of airlines’ profits. New players enter the industry in a constant stream. And substitutes are readily available - such as train or car travel.”
A quick summary of each force in action can be seen in the table below.
Some have suggested extra forces should be added, as follows:
Porter acknowledges these two forces, however because neither are necessarily good or bad for industry profitability, argues that they should fall within the original framework.
As Porter says: “The best way to understand the influence of government is to analyse how specific government policies affect the five competitive forces.” Likewise: “Complements affect profitability through the way they influence the five forces.”
Here is a summary of some of the factors commonly affecting an industry’s competitive intensity:
KEY POINT: “A quick summary is that a terrible industry looks like this: the product is an undifferentiated commodity; everyone has the same costs and access to the same technology; and buyers are price sensitive, knowledgeable, and willing to switch suppliers at a moment’s notice to get a better deal.” - Richard Rumelt, Good Strategy / Bad Strategy
Running the Process
Make a copy of the below diagram and put it on a wall or a flipchart.
Invite your team to fill in the various elements, discussing their thoughts and ideas along the way. Use examples of each force to help people understand and identify the forces and factors relevant to your organisation and industry.
You could tackle each element in turn as a group, or if you have enough participants, you could split up into breakout groups and take one element each.
Once you have populated the diagram, you can discuss the results. However just because the diagram is full, you don’t necessarily need to stop - create more space if there are additional points to make. It’s important to do the exercise thoroughly so you have everything out in the open ready for you to consider your strategy.
As part of the exercise, try to identify why a particular force is increasing or decreasing. Ask questions like:
Is the market growing or shrinking?
Can your customers force you to lower your prices?
Is it easy for customers to use substitute products or services?
Is it easy for competitors to copy your products or services?
How is supply relative to demand at the moment?
Do you have a choice of suppliers to enable you to drive down costs?
How do your competitors’ products or services compare with yours?
Five Forces Example
An example for a hypothetical construction company can be seen below:
As a result of their analysis this construction company could look for substitutes to the unique product provided by the powerful supplier, and could increase their pool of suppliers to drive down costs.
They could also work on making their output more unique and specialist, to lessen the threat of substitutes and step away from the price wars being conducted by buyers and participated in by rivals and entrants.
Finally they could make proactive efforts to retain valuable talent by introducing relevant HR initiatives.
Pitfalls to Avoid
As with PEST and SWOT analyses, it’s important to focus on each of the elements to form a comprehensive picture. However it’s then important to spend time digging more deeply into the most important ones. All elements will likely not be equal for your organisation.
Make sure you define the edges of your industry correctly - this will clarify the causes of profitability for your organisation and help you set a strategy for each industry.
As Porter explains: “If industry structure for two products is the same or very similar (that is, if they have the same buyers, suppliers, barriers to entry and so forth), then the products are best treated as part of the same industry. If industry structure differs markedly, however, the two products may be best understood as different industries.”
TOP TIP: If your organisation offers a range of products and services, it may be useful to consider each within its own distinct industry.
Using Your Five Forces Results
The Five Forces reveal why industry profitability is what it is, and enable you to incorporate industry conditions into your strategy. You can do this in several ways, including positioning your organisation to better cope with competitive forces; anticipating and exploiting shifts; and even shaping the balance of the forces to your benefit.
Use the analysis to pose and answer questions like these:
Which forces are shifting or predicted to shift in the future?
Are more competitors likely to enter the market?
Are buyers or suppliers becoming more influential?
How could you change a force in your favour?
Could you work more closely with suppliers to reduce the risk of increased bargaining power?
Could you add new features to your product or service to deter substitutes from entering the market?
How can you position your organisation where the forces are weakest?
For more in-depth insights, you could combine your results with a Value Chain Analysis. You could also use the results to inform a strategic planning exercise, for example creating a Strategy Cascade, or considering how to create a Blue Ocean Strategy.
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