Classic · Model
Porter's five forces.
Michael Porter set out in 1979 why some industries are profitable year after year and others are not, and the answer did not lie in how good the companies were. Five forces decide how much of the value stays with the one doing the delivering: the bargaining power of customers, that of suppliers, the threat from new entrants, the threat from substitutes, and the rivalry among those already there. The model is most often used to analyse a whole industry, whereas for a smaller company it is considerably more useful applied to a single customer relationship.
The model
Five forces that between them decide how much profitability an industry allows.
The bargaining power of customers. Strong when the customers are few and large, when they can switch easily, and when what you do is comparable to something else.
The bargaining power of suppliers. Strong when only one party can deliver what you need, which in a service business often means a handful of key people rather than a supplier.
The threat from new entrants. This is about how hard it is to get in. Low barriers mean that every good year draws somebody new in who pushes the price down.
The threat from substitutes. Something else that solves the same problem, meaning not the same thing more cheaply but a different sort of solution altogether.
Rivalry among the existing players. How hard those already there fight, which is decided by how many they are and how alike they are.
Porter published the model in Harvard Business Review in March 1979 and developed it in the book Competitive Strategy the following year.
How it’s used
Draw it on one customer at a time rather than on the whole industry. Take your five largest customers and go through how strong each one is in the negotiation, meaning how easily they could switch, how much of your revenue they account for, and how well they know what the alternatives cost.
The question after that is what would make you stronger in that particular relationship. It is rarely a lower price. More often it is about becoming harder to compare, which is the same thing Porter meant when he said that strategy is about being different rather than better.
The threat from substitutes is worth a session of its own, because it never shows up in a lost tender. The customer who solved the problem internally, or left it unsolved, never got in touch.
Where it’s usually misused
As a five-sided industry description in a business plan that nobody makes a decision from. The model is built to explain why the profitability looks the way it does, and used without anybody asking what the company intends to do about it, it becomes a report.
It is also misused when all five forces are treated as equally important. In practice one or two usually dominate, and those are the ones the work should be about.