In March of 1979, Harvard Business Review published an article about a business analysis model that countless MBA students still study to this day.
Coined by Michael Porter, a professor at Harvard Business SchooI, Porter’s Five Forces is a model that draws from industrial organization economics to identify and describe the fundamental economic forces that shape every industry. More specifically, it explains how these forces dictate every industry’s competitive intensity, potential for profitability, and attractiveness to other entrants.
Porter’s Five Forces has become a fundamental model that most businesses use to grasp the dynamics of their industry and, in turn, drive their business strategy. And it can help you do the same, too.
But the way you apply this model to your own business is totally dependent on the nature of your industry. Once you understand these economic fundamentals, though, you'll be able to extract insights from the model that are specific to your unique situation and apply them to your business.
To help illustrate this, we've fleshed out the five fundamental economic forces at play in every market and provided an example analysis in each section, so you can see how each of these forces might play out in your specific industry.
Porter's Five Forces Model
Porter’s Five Forces is a business analysis model that identifies and describes the economic forces that shape an industry’s competitive intensity, potential for profitability, and attractiveness. The five forces are competition in the industry, potential of new entrants into the industry, power of suppliers, power of customers, and threat of substitute products.
Porter's Five Forces Examples
Competition in the Industry
Competition plays a huge role in your industry’s profitability -- the potential to produce a high return on investment -- and, in turn, its ability to attract new entrants. If there’s a lot of competition in your industry, it’s harder to turn a profit. Customers have a rich pool of options to choose from, so if your prices are too high, they can just strike a deal with a supplier who will sell to them at their preferred price.
In other words, customers typically wield more power than suppliers in competitive industries. This usually leads suppliers to undercut each other’s prices until their revenue barely exceeds their costs, plummeting their profits and discouraging new players from entering the market.
If there’s less competition in your industry, it’s easier to turn a profit. Customers can only choose from so many suppliers, so if they want to buy your market’s product or service, they must accept the higher prices or else they won’t be able to buy it. This potential for high profitability encourages new players to enter your market.
To help you examine the competition in your own industry, here’s an analysis of the competition in the aluminum baseball bat industry.
From little league to college, baseball players all around the country primarily use aluminum baseball bats to train and compete. Louisville Slugger, Rawlings, Marucci, DeMarini, and AxeBat 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 just play baseball for fun and friendships.
Potential of New Entrants into the Industry
If new players can enter your market quickly and cheaply, they can sell their minimum viable product, which is a product with just enough features to satisfy early customers, at a much lower price than you and your competitors can while still covering their product development, marketing, and sales costs. As a result, they can snatch established player’s market share and threaten incumbents’ position in the industry more easily.
The frequency of new players entering your market hinges on your industry’s barriers to entry. If it costs a lot of money and time to build a minimum viable product and cover essential overhead expenses, startups can only afford to build an unsophisticated product that’s sole differentiating factor is a slightly cheaper price. With these high barriers to entry, they wouldn’t be able to compete, discouraging them from entering your market.
However, if building a minimum viable product and covering essential overhead expenses don’t cost that much money or time, your market’s low barriers to entry will encourage most start-ups to enter.
To help you examine the potential of new entrants in your own industry, here’s an analysis of the potential of new entrants in the aluminum baseball bat industry.
The barriers to entry of the aluminum baseball bat industry are very high. You would 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 bunch of raw materials to manufacture the bats, and build expensive facilities and machines to actually produce them.
You would also, at the least, have to hire a product, marketing, and sales team to run this startup’s daily business operations. This startup would have to charge close to an industry-average price to cover the initial overhead of creating a minimum viable product, crafting an enjoyable brand experience, and generating revenue. And since each incumbent in this industry would have a better, more trusted product than this start-up’s simple product, there’s no way they could compete with a slightly cheaper price as their only selling point.
Power of Suppliers
The number of suppliers or competitors in your market directly affects your company’s ability to control prices. When there are only a few suppliers in your industry, each supplier holds a ton of pricing power because if a consumer doesn’t accept your prices, you and your fellow suppliers can easily find someone else who will.
When there are a lot of suppliers in your industry, each supplier holds less pricing power. Your market’s customers have a rich pool of options to choose from, so if your prices are too high, they can just strike a deal with a supplier who will sell to them at their preferred price.
To help you examine the power of suppliers in your own industry, here’s an analysis of the power of suppliers in the aluminum baseball bat industry.
With 11 major suppliers in a massively popular industry -- and five or less brands competing in each segment of the market -- the suppliers hold a lot of pricing power. Almost every baseball player, from little league to college, needs an aluminum baseball bat to train and compete, so they’re very dependent on these suppliers, which gives them even more pricing power.
Power of Customers
The number of customers in your industry directly affects their ability to control prices. If there are only a few customers in your industry, they hold most of the power. Since suppliers depend on customers to generate revenue, suppliers must adhere to their customers’ pricing demands or their customers will just do business with one of the many other suppliers who are willing sell their product or service at a generous price.
On the flip side, if there are a ton of customers in your industry, the customers hold significantly less power. Since customers depend on suppliers to purchase necessary products or services, they must accept the prices suppliers set or else they won’t be able to buy any of the market’s products or services -- the suppliers can sell to plenty of customers who are willing to pay a prettier penny.
To help you examine the power of customers in your own industry, here’s an analysis of the power of customers in the aluminum baseball bat industry.
Every single baseball player, from little league to college, needs an aluminum baseball to train and compete, so each supplier in the aluminum baseball bat industry has a huge potential customer base to market and sell to. Since there are such few suppliers and so many customers in this market, the customers don’t hold enough power to drive the prices down.
Threat of Substitute Products
Substitutes are products from different industries that consumers can use interchangeably, like coffee and tea, and they can significantly shape your industry. If your product has cheaper or superior substitutes, you not only have to compete with other players in your industry, but you also have to compete with businesses in other industries. This high multi-market competition can plummet your prices and profit.
If your product doesn’t have cheaper or superior substitutes, though, the businesses who produce these substitutes don’t pose as much of a threat to you or your direct competitors. This low multi-market competition might only drop your prices and profits slightly.
To help you examine the threat of substitute products in your own industry, here’s an analysis of the threat of substitute products in the aluminum baseball bat industry.
Instead of buying aluminum baseball bats, players could buy wood bats from suppliers who only manufacture wood bats, like Baum Bats, Old Hickory, and Sam Bat. But the odds of this happening are extremely low. Even though individual wood bats cost less than individual aluminum bats, wood bats break much more frequently.
For instance, one $250 aluminum bat can last longer than five $100 wood bats, so replacing aluminum bats with wood bats would actually cost more money. Players can also hit the ball farther with aluminum bats, which makes it the superior product. Additionally, wood bat manufacturers make the most money by focusing on a specific market of baseball players who only use wood bats, like professional baseball players, summer college league players, and top-flight travel baseball players. In sum, there’s a low threat of substitutes in this industry.
Originally published Dec 17, 2018 7:00:00 AM, updated March 08 2019