How to understand industry profitability with Porter’s five forces

Let’s say you’re working on the #MarketingPlan for a new business and you need to evaluate (and select) the market segment you want to serve.

Or maybe you already have an operating business and you’re considering an expansion—or a full switch—toward a new target market.

How can you measure the profitability of that move without relying on vibes, gut feelings, or your cousin’s “trust me bro” analysis?

Keep reading to discover how Porter’s five forces help marketers in strategic management.

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Table of contents

1. What Porter’s five forces are;

2. How to do Porter’s five forces analysis.

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WHAT ARE PORTER’S FIVE FORCES

In March 1979, Harvard Business Review published How Competitive Forces Shape Strategy, featuring Harvard University professor Michael E. Porter, who shook up marketers with a new framework to analyze industry attractiveness.

In 2002, The Academy of Management Executive published An Interview with Michael Porter (Nicholas Argyres and Anita M. McGahan), where Porter explained that he struggled teaching the SWOT model at Harvard Business School: he believed it lacked rigor.

That’s why he started seeking a new framework based on statistical tests and case studies:

“The prevailing SWOT model of strengths/weaknesses/opportunities/threats was based on the idea that every case is different and that the relevant considerations are company-specific. As I was struggling to teach using the SWOT framework at HBS, I set out to add more rigor.” — Professor Michael E. Porter, Harvard Business School.

Portrait of Michael Eugene Porter, a professor at the Harvard Business School (HBS) and author of Porter’s five forces.

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The five forces framework

Porter’s five forces is a powerful tool that enables organizations to evaluate the profitability of a market or industry.

It’s based on five forces that influence attractiveness:

• Competitive rivalry

• Supplier power

• Buyer power

• Threat of substitution

• Threat of new entry

This framework is rooted in the structure–conduct–performance (SCP) paradigm, which sees the market as an ecosystem where everything is connected.

The paradigm, first published by Edward Chamberlin and Joan Robinson in 1933, was later developed by Joe S. Bain, an economist who greatly influenced Porter’s work.

Market environment has a direct (and short-term) impact on market structure.

There are mainly two types of structures:

• A market without interference/limitations from governments (Adam Smith’s laissez-faire model), or

• A market with a controlled economy (Karl Marx’s model).

Anyway, market structure affects companies’ economic behavior (conduct), which in turn determines market performance.

All of these elements influence each other.

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Competitive rivalry

How many rivals do you have?

Who are they?

And how does the quality of their products and services compare with yours?

Knowing the level of competitiveness in the target industry is fundamental to market a product or service.

Studying rivals allows marketers to figure out the right positioning and identify competitive advantages that can actually make a difference for the audience.

Alert points:

• Too many or aggressive competitors;

• War of price;

• Market’s competition expectation: is it flat or in decline?

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Supplier power

How many potential suppliers do you have?

How unique is the product or service they provide?

And how expensive would it be to switch from one supplier to another?

Supplier bargaining power can become a real headache for a company.

If you run short on raw material and only have a few providers, you need to play their game.

If they raise the price, you may be forced to keep buying from them—and then review your pricing for the final consumer.

Alert points:

• They can decrease the quantity provided or change the delivery time (think of an e-commerce business with a drop-shipping model: can you imagine how many complaints?);

• They have power on price.

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Buyer power

How many buyers are there?

How big are their orders?

How much would it cost them to switch from your products and services to those of a rival?

Are your buyers strong enough to dictate terms to you?

When I was working as an E-commerce Manager in San Marino, I was in between the devil and the deep blue sea.

Cutting a long story short, we had two main buyers: pharmacies and Amazon.

Pharmacies weren’t happy that we were selling to Amazon, because customers started preferring buying cheap online rather than in physical stores.

Amazon was able to make better offers because it had almost total control over the sales price and lower operational costs than a pharmacy.

What happened next?

Pharmacies started threatening us: they didn’t want to buy our products anymore.

So, how would you solve this dilemma?

This is a real marketing problem for many sellers.

Let me know your strategy in the comments below and let’s see if it corresponds with what I really did at that time.

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Threat of substitution

A substitution that is easy and cheap to make can weaken your position and threaten profitability.

Substitutes are products or services that use different technologies to satisfy the same demand.

For instance:

• A bicycle is a substitute of a scooter;

• Meat, poultry, and fish are substitutes.

But Coke is not a substitute of Pepsi: they’re just competitors.

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Threat of new entry

How easy is it to get a foothold in your industry or market?

How much would it cost?

And how tightly is your sector regulated?

Organizations should establish their presence in a profitable market segment.

If competitors enter your industry, they can get in the way and reduce overall profitability—potentially all the way to zero.

That’s the logic behind perfect competition: the minimum requirement for an industry to stay in business, where companies aren’t encouraged to enter or leave the industry.

Alert points:

• Low entry barriers;

• High exit barriers.

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HOW TO DO PORTER’S FIVE FORCES ANALYSIS

From theory to action.

Here are the steps to perform Porter’s five forces analysis.

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Prepare the matrix

Get a piece of paper and visualize a cross.

In the center, position competitive rivalry.

Along the axis, draw four arrows pointing to the center.

Place the other forces on the external vertices.

This makes it visually clear that competitiveness is affected by all forces.

• Place threat of new entry to the North

• Buyer power to the East

• Supplier power to the West

• Threat of substitution to the South

You should get my free Porter’s five forces worksheet. You’ll save time!

Porter’s five forces framework: competitive rivalry, threat of new entry, buyer power, threat of substitution and supplier power.

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Brainstorming

Work in a team.

Set a timer and start brainstorming factors relevant to the matrix.

Do it individually first and write every input in the right section.

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Group ideas

Time’s up.

Everyone’s input is on the sheet.

Now group ideas and eliminate duplicates.

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Rate the forces

Rate ideas according to how they affect the company.

Set a timer and discuss every idea separately.

Once everyone is aligned:

• Use “+” or “-” for moderate forces

• Use “++” or “--” for strong forces

• If a force is neutral, use “O”

Check the example below to see how you can rate Porter’s five forces.

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Share results

Time’s up. Last step.

Your Porter’s five forces analysis is complete.

Grab your intel and share it with the relevant stakeholders.

The next step in your marketing strategy is market segmentation.

Now you have a clear lookout on what needs to improve to make profits in the target industry.

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Example of Porter’s 5 forces analysis

I’ve prepared an example of Porter’s five forces analysis by reviewing a template from MindTools.

In this scenario, you want to purchase a farm and decide whether to enter the market.

Example of Porter’s five forces analysis for buying a farm. The outcome is negative, so purchasing a farm is not profitable unless countermeasures are undertaken.

The outcome of this analysis is negative—but what does it mean?

Can’t you enter the farm industry?

Of course not.

Porter’s five forces highlights the challenges to overcome to become competitive.

And in this case, there are plenty of leverages you can develop.

For instance:

• Specialize the farm in a niche with more cover from competition, or

• Embrace digital marketing and sell directly to customers by dodging big supermarkets.

Just squeeze your brain.

Solutions are usually around the corner.

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CONCLUSIONS

Porter’s five forces analysis helps entrepreneurs and marketers understand the forces that shape competition within a market segment.

Has your company ever done this evaluation?

If not, how can you be sure your marketing strategy is right?

Drop a comment below and share your thoughts with me—your experience can help other readers too.

Do you want me to do an online competition analysis? Meet me in a free 15-min call!

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References

• Porter, M. E. (1979). How Competitive Forces Shape Strategy. Harvard Business Review.

• Argyres, N., & McGahan, A. M. (2002). An Interview with Michael Porter. The Academy of Management Executive.

• Chamberlin, E. H. (1933). The Theory of Monopolistic Competition. Harvard University Press.

• Robinson, J. (1933). The Economics of Imperfect Competition. Macmillan.

• Bain, J. S. (1956). Barriers to New Competition: Their Character and Consequences in Manufacturing Industries. Harvard University Press.

• MindTools. Porter’s Five Forces Analysis.