Threat of new entrants
New players bring capacity and push prices and costs.
- Strong when
- Barriers to entry are low
- Barriers
- Scale, brand, distribution, regulation
Porter's five forces, explained and worked
Porter's five forces is Michael Porter's framework for judging how much profit an industry leaves for the companies in it. The five forces are the threat of new entrants, the bargaining power of suppliers, the bargaining power of buyers, the threat of substitutes and rivalry among existing competitors. The stronger the forces, the less profit is left. Porter first described it in Harvard Business Review in 1979. Soreno, an AI voice interview practice app for consulting, investment banking and other finance candidates, runs a free market entry case with no sign-up, where you judge whether a market is worth entering, and full mock cases with scored feedback.
Updated
- What it judges
- An industry, not a company
- How much profit the industry's structure leaves
- Origin
- Michael Porter, 1979
- Revisited by Porter in HBR in 2008
- Worked case
- Home espresso machines
- Invented by us, every number shown
- Free practice
- No sign-up
- A full market entry case with a timer
What are Porter's five forces?
Harvard Business School's Institute for Strategy and Competitiveness describes the five forces as a framework for understanding the competitive forces at work in an industry, and how they drive the way economic value is divided among industry players. In Porter's 2008 HBR article, the point is that competition for profits goes beyond today's rivals to customers, suppliers, potential entrants and substitutes. Each card below is one force, with what makes it strong according to the Institute.
Bargaining power of suppliers
Strong suppliers charge more or demand better terms.
- Strong when
- Only one or two supply a key input
- Also
- Switching suppliers is costly or slow
Bargaining power of buyers
Strong customers force prices down or ask for more.
- Strong when
- Few large buyers, similar products
- Also
- Switching is cheap for them
Threat of substitutes
Another way to meet the same need.
- Strong when
- Better price for the performance
- Example
- Videoconferencing for travel
Rivalry among existing competitors
Intense rivalry cuts prices or raises the cost of competing.
- Strong when
- Many rivals or equal rivals, slow growth
- Also
- High fixed costs, high exit barriers
How the forces set profit3 ideas
From the Institute for Strategy and Competitiveness page.
Structure
Industry structure is half the story
The Institute says industry structure, together with a company's position within the industry, are the two basic drivers of company profitability. Five forces covers the first.
Same drivers
Every industry is different, the drivers are not
The Institute says every industry is different, but the underlying drivers of profitability are the same in every industry.
Change
Structure moves over time
Buyers and suppliers gain or lose power, new technology makes entry or substitution more or less likely, and regulation changes rivalry or barriers to entry. The Institute calls the analysis essential to anticipate and exploit those shifts.
Worked example: Ridgeline and home espresso (ours)6 steps
Ridgeline, an invented US maker of kitchen appliances, is thinking about entering the $2 billion US market for home espresso machines. Its goal is 5% of the market in five years. Should it enter? This case and every number in it are invented by Soreno for practice. The ratings are our judgment from the case data.
New entrants
Medium
Shelf space and brand are the barriers, and Ridgeline already sells to the same retailers. That cuts both ways: if Ridgeline can get in, so can other appliance makers. Smaller brands still hold 35% of sales, so the top three do not lock the market up.
Suppliers
High
Only 2 companies make the high-pressure pump every machine needs, and it is 15% of a machine's cost. With so few suppliers of an essential part, they set the terms.
Buyers
High
The two largest retailers sell 55% of all units. Retailers this large can push prices down and ask for more support. Shoppers who buy online are a second, weaker buyer group.
Substitutes
High
Pod machines and the coffee shop down the street meet the same need. Pods are cheaper to buy and easier to use, so the price for the performance is attractive for many shoppers.
Rivalry
Medium
The top three brands hold 65% and the market grows 4% a year. Slow growth makes every share point a fight, but the leaders compete more on features than on price.
Verdict
3 of 5 forces high: enter premium only
The whole market is a hard place to make money. The premium segment (machines over $700) is 30% of sales, about $600 million, and grows 9% a year, where buyers trade up and pods are a weaker substitute. At today's market size, Ridgeline's $100 million goal would be about 17% of premium sales, a big share for a new brand. Recommend entering premium only, with contracts from both pump makers signed before launch. Next, check whether Ridgeline can win there and what a launch costs.
From Harvard Business School, Institute for Strategy and Competitiveness: The Five Forces, Harvard Business Review (hbr.org): The Five Competitive Forces That Shape Strategy and Harvard Business School: The Five Competitive Forces That Shape Strategy.
How do you use the five forces in a market entry or industry case?
In our experience, it answers one question: is this industry worth being in? Use it early in a market entry, an acquisition or an industry decline case, then move on to whether the client can win. Here is what we listen for.
Draw the industry first
Say which product, which customers and which country you mean. Home espresso machines in the US is an industry. Coffee is not. The ratings change with the line you draw.
Start from the decision
Say why the industry matters for this client: to enter, to buy a company in it or to explain falling profits. Then use only the forces that bear on that.
Rate each force, with a reason
High, medium or low, with the one fact behind it: how many suppliers, how big the buyers are, how cheap the substitute is.
Ask for numbers you can use
Share held by the top three players, share of sales through the largest buyers, the input's share of cost, market growth. These turn opinions into ratings.
End with a verdict
Attractive or not, and for which segment. Then the next step: can the client win there, and what would entry cost?
7 case questions where the five forces help
Each of these turns on how attractive an industry is. Under each is what a strong answer does.
Market entry
Is the market worth entering?
A European e-bike maker is thinking about entering the US market. How would you structure the decision?
Checks the US industry first, from retailer power to cheap imports, then whether the maker can win and how to enter. Practice it, see a model answer
A US coffee chain is considering opening in India. How would you approach it?
Weighs local rivals, landlords as suppliers of prime sites and tea as a substitute before sizing the opportunity. Practice it, see a model answer
A consumer goods company is deciding whether to launch a premium pet food line. How would you structure the decision?
Asks how strong the retailers and the premium brands already are, then whether the segment's growth makes up for it. Practice it, see a model answer
Buying into an industry
Is the industry a good place to own a company?
A private equity firm is considering buying a regional chain of dental clinics. How would you assess the deal?
Rates insurer power as buyers, the pull of dentists as suppliers and the threat of new clinics, before the deal math. Practice it, see a model answer
A large food company wants to acquire a plant-based snack startup. Should it?
Checks how easy it is for new brands to enter and how much power grocers hold, since both set the startup's future margins. Practice it, see a model answer
Rivalry and industry profits
When the industry, not the company, explains the numbers.
An airline's profits are falling even though it is carrying more passengers. What is going on?
Tests whether rivalry has cut fares across the industry before looking at the airline's own costs. Practice it, see a model answer
Your client's main competitor has just cut prices by 20%. How should the client respond?
Reads the cut against the industry's fixed costs and exit barriers, which say whether a price war will last. Practice it, see a model answer
Common mistakes with Porter's five forces
The mistakes we hear most in practice cases.
Listing the forces without a verdict
Five paragraphs and no answer. Every force needs a rating, and the set needs a conclusion about the industry.
Using it on a company
The forces judge the industry. A company's own costs or brand belong to the second driver the Institute names, its position within the industry.
Calling a rival a substitute
The Institute defines a substitute as a product that meets the same need in a different way, like email for express mail. Another espresso machine brand is a rival, not a substitute.
Treating buyers as one group
The Institute notes an industry may have several buyer groups with different power. Large retailers and online shoppers bargain very differently.
A snapshot of a moving industry
New technology, new ways of managing, new regulation and rivals' new pricing or distribution change the forces. Say which way each force is heading, not only where it is today.
Calling a fast growing market attractive
Growth alone doesn't make an industry profitable. Harvard Business School's summary of Porter's 2008 article makes the same point. Check the forces before you size the prize.
Opening every case with it
In our experience, interviewers notice when a framework is forced onto a case. A profit decline at one company usually starts with its profit tree, not the industry.
Judge an industry out loud
Soreno's AI interviewer gives you a market entry case, asks how attractive the industry is, pushes back on your ratings and scores the session. Start your free week.
Questions people ask
What are Porter's five forces?
The threat of new entrants, the bargaining power of suppliers, the bargaining power of buyers, the threat of substitute products or services, and rivalry among existing competitors. Together they decide how much profit an industry leaves for the companies in it.
Who created the five forces?
Michael Porter of Harvard Business School. Harvard's Institute for Strategy and Competitiveness says he first described it in a 1979 Harvard Business Review article. He returned to it in HBR in January 2008 with The Five Competitive Forces That Shape Strategy.
What is the difference between a substitute and a competitor?
A competitor sells the same kind of product. A substitute meets the same need in a different way. Another espresso machine is a competitor. A pod machine is a substitute.
When should I use the five forces in a case interview?
When the question is whether an industry is worth being in: entering a market, buying a company in it, or explaining why a whole industry's profits fell. For one company's falling profit, start with its profit tree.
Is it the same as a market entry framework?
No. Five forces is one part of a market entry case, the part that judges the industry. A full market entry answer also asks whether the client can win, how it would enter and whether the numbers work.
Do the five forces change over time?
Yes. Harvard's Institute says industry structure is dynamic: buyers and suppliers gain or lose power, technology changes entry and substitution, and regulation changes rivalry. Say which way each force is moving.
Is there a sixth force?
Some guides add government or complements as a sixth. Harvard Business School's summary of Porter's 2008 article says he shows how government policy changes the relative strength of the five forces, and how to use the forces to understand complements. In a case, work them in through the five.
Is the five forces the same as SWOT?
No. Five forces looks at an industry from the outside. SWOT lists one company's strengths, weaknesses, opportunities and threats. Use five forces to decide if an industry is worth entering, and SWOT, if at all, to test one company's plan.