How Porter’s Five Forces Can Help Small Businesses Analyze the Competition

Understanding Porter’s Five Forces model

Porter’s Five Forces model is a competitive analysis method that’s considered a macro tool in business analytics. It looks at the industry’s economy as a whole; in contrast, a SWOT analysis is a microanalytical tool that focuses on a specific company’s data and analysis.

“Understanding the competitive forces, and their underlying causes, reveals the roots of an industry’s current profitability while providing a framework for anticipating and influencing competition (and profitability) over time,” Porter wrote in a 2008 Harvard Business Review article. “A healthy industry structure should be as much a competitive concern to strategists as their company’s own position.” 

Porter theorized that understanding the competitive forces at play and the overall industry structure is crucial for effective, strategic decision-making and the development of a compelling competitive strategy for the future.

Here are the five forces in Porter’s model:

1. Competitive rivalry

This force examines marketplace competition intensity. It considers the number of existing competitors and what each one can do. Rivalry competition is high when these conditions are met:

• Only a few businesses sell a product or service.
• The industry is growing.
• Consumers can easily switch to a competitor’s offering for little cost. 

When rivalry competition is high, advertising and price wars ensue, which can hurt a business’s bottom line.

2. The bargaining power of suppliers

This force analyzes a supplier’s power and control over price increases. When a B2B vendor has extensive control over pricing, their client business’s profit margins can suffer. 

This force also assesses the available number of suppliers of raw materials and other resources. The fewer suppliers in the supply chain there are, the more power they have. Businesses are in a better position when there are many suppliers. 

3. The bargaining power of customers

This force examines consumer power and its effect on pricing and quality. Consumers have power when there are fewer sellers because they can easily switch to another seller. Conversely, buying power is low when consumers depend heavily on a single seller. When a business has more customers, the buying power of each individual customer is low.

4. The threat of new entrants

This force considers how easy or difficult it is for competitors to join the marketplace. The easier it is for a new competitor to gain entry, the greater the risk that an established business’s market share will be depleted. Barriers to entry include absolute cost advantages, access to inputs, economies of scale, and strong brand identity.

5. The threat of substitute products or services

This force studies how easy it is for consumers to switch from a business’s product or service to a competitor’s offering. It examines the number of competitors, how their prices and quality compare with the business being examined, and how much of a profit those competitors are earning — which, in turn, would determine if they can lower their costs even more. The threat of substitutes is informed by switching costs, both immediately and in the long term, as well as consumers’ inclination to change. 

Example of Porter’s Five Forces

There are many examples of how Porter’s Five Forces can be applied to various industries. 

The ultimate goal is to identify the opportunities and threats that could affect a business. 

In this example, the financial education company 365 Financial Analyst looked at the competitive position of retail giant Walmart. Here’s how it breaks down:

• Competitive rivalry: Walmart has a significant reach, a strong brand identity, a physical and online presence, and low prices that make it difficult for small challengers in the retail space to compete. However, Walmart does face sustained challenges from large, established competitors such as Target, Costco and Amazon. Overall, Walmart faces a moderately competitive rivalry space.
• Bargaining power of suppliers: A diverse supplier base limits supplier bargaining power. Additionally, due to Walmart’s size, purchasing power and consumer reach, each individual supplier exerts very little influence on the company.
• Bargaining power of customers: Walmart has a massive customer base of small buyers, weakening the power of any single customer and granting the company significant leverage. The company’s low prices, established locations and online presence further reduce the power of any single customer. However, customers can switch to other retailers at little or no cost, affording them some power. Overall, buyer bargaining power is medium to low.
• Threat of new entrants: Walmart maintains a substantial edge in sales, marketing, distribution and established business locations. It also has a highly developed and deployed online presence to complement its physical locations. Due to its size and established network, Walmart also has the advantage of selling to multiple customers while being able to purchase at scale from various suppliers. All of these factors, as well as the established nature of large rivals such as Amazon, make the threat of new entrants low.
• Threat of substitute products: Walmart’s economies of scale, reach and size ensure it carries almost all brands and products a customer would like, with the exception of specific in-house brands that its rivals offer. Even then, Walmart can leverage economies of scale to offer products and a range of substitutes at low costs. As such, the threat of substitute products is low.

Strategies for success

Once your analysis is complete, it’s time to implement a strategy to expand your competitive advantage. To that end, Porter identified three generic strategies that can be implemented in any industry and by companies of any size.

Cost leadership

Your goal is to increase profits by reducing costs while charging industry-standard prices, or to increase market share by reducing the sales price while retaining profits.

Differentiation

To implement this strategy, your company’s products must be significantly better than the competition’s, thereby improving their competitiveness and value to the public. It requires thorough research and development, plus effective sales and marketing.

Focus

Successful implementation entails the company selecting niche markets in which to sell its goods. It requires an intense understanding of the marketplace, as well as deep knowledge of the business’s sellers, buyers and competitors. (Consult Porter’s 1985 book Competitive Advantage for more information.)

Alternatives to Porter’s Five Forces

While Porter’s Five Forces is an effective and time-tested model, it has been criticized for failing to explain strategic alliances. In the 1990s, professors Adam Brandenburger, then at Harvard Business School and now at New York University’s Stern School of Business, and Barry Nalebuff, of the Yale School of Management, created the idea of a sixth force, “complementors,” using game theory insights. (Consult their book, Co-Opetition, for more information.)

In this model, complementors sell products and services that are best used in conjunction with a competitor’s product or service. For example, Intel, which manufactures processors, and Lenovo, a computer manufacturer, could be considered complementors.

These additional modeling tools can inform your understanding of your business and its potential:

• Value chain analysis: A value chain analysis helps companies understand where their best productive advantage lies.
• BCG matrix: The BCG matrix helps companies identify which products will likely benefit most from increased investment.
• PEST analysis: Businesses should also consider conducting either a PEST analysis or a PESTLE analysis. These analyses take into account how external political, economic, sociocultural and technological forces — as well as legal and environmental forces, in a PESTLE analysis — can affect the business environment. This analysis should be conducted alongside Porter’s Five Forces to provide a thorough overview of factors and challenges that influence a business and its industry. 

Navigating the economic environment

All business decisions contain elements of risk and uncertainty. Conducting routine analyses of the business, industry and overall economic environment is vital to the success of any company, regardless of its size. Porter’s Five Forces model provides a clear framework that business leaders can employ to understand how their business fits into the larger industry. 

Using Porter’s Five Forces alongside additional analytical tools and models — like a SWOT analysis, a BCG matrix and a PEST(LE) analysis — can help business leaders navigate the broader economic environment with greater confidence and, ultimately, reap increased odds of success. 

Jeremy Bender and Katherine Arline contributed to this article.