Knowledge Resource Centre

Porter's Five Forces and Profitability

M.E. Porter, "How Competitive Forces Shape Strategy", Harvard Business Review, 1980. This diagram has been recreated by LMC.

LMC explains Porter's Five Forces and Profitability

A business strategy tool designed to analyse a strategic business unit and its relationship with and competition within the industry. Using five key areas affecting profitability, the results give a company insight into its industry attractiveness. The five forces are identified as: bargaining power of suppliers, bargaining power of buyers, threat of new entrants, threats from substitute products and competitive rivalry. Each force is analysed in terms of whether it will produce higher or lower profitability if its effects are felt.

1. Bargaining power of suppliers

This will be high or strong where there are relatively few individuals holding the power, where the costs of changing suppliers are high, or if the supplier has a strong brand.

2. Bargaining power of buyers

This will be strong where market share is controlled by few buyers, for example large supermarket chains in the groceries market, or if the costs of switching supplier are low.

3. Threat of new entrants

There can be various barriers to new entrants and if these are present then the threat from the entrant will be low. They include upfront capital investment, the time it takes to establish in the market, government legislation and hostile reactions from existing market players.

4. Threats from substitute product

New products can negate the need for or replace an existing product or service.

5. Competitive rivalry

The level of competition in the marketplace has a great effect on industry attractiveness. This can be determined by the following factors: the maturity of the market, the relative size of competitors, any high-fixed industry costs and barriers to industry withdrawal (e.g. non transferable staff competencies and expensive plant and machinery that cannot be used elsewhere).

The analysis of the five forces is carried out at the strategic business unit (SBU) level, by the highest level executives and business decision makers, for example to analyse existing or new products. The results of the process are used to make strategic business decisions on the future of that product or venture and to understand and take advantage of key market relationships.