Reading: Porter’s Five Competitive Forces Model

Roy Larke

Porter’s Five Competitive Forces Model

To evaluate the state of competition in an industry or within a particular market, one possible sub-framework would be the Five Forces model introduced by Professor Michael Porter from Harvard University Business School.[1]

About the Five Forces model

  • Porter’s Five Forces is a framework for analyzing a company’s competitive environment.
  • It is a frequently used guideline for evaluating the competitive forces that influence a variety of business sectors.
  • Five Forces analysis can be used to guide business strategy to increase competitive advantage.
  • It is a largely qualitative tool that provides an overview, but companies need to undertake more detailed quantitative analysis to fully understand where their business stands in comparison with competitors.

For the purposes of a 101 course, the Five Forces model is used purely as a framework to help you think about the competition surrounding a company or brand.

1. Rivalry among Existing Competitors

First, you should consider all the major players within a particular market. Make a list and note any particular characteristics of each, being sure to include links and citations where needed. You should also evaluate just how intense the rivalry (competition) between these players is. Generally, there is more competition when there is a number of major players with similar levels of power or similar market attributes. Is the level of competition high, moderate or low?

Various factors affect how intense the rivalry is between players within an industry:

  • The number of competitors: when there are more competitors of similar size and power, competition becomes more intense. This is actually quite a rare situation in many single-country markets.
  • Industry growth rates: the slower the industry is growing, the higher the competition as companies fight for market share. This only occurs when competitors are roughly equal.
  • Exit barriers: companies can find it hard to exit an industry, and so create higher competition. Exit barriers exist because of ownership of specialised assets (e.g. owning land that can’t be used for other purposes) or possibly management’s love of the business (e.g. a long-standing family business).
  • Literal rivalry: in some cases, individuals or companies can create additional rivalry due to personalities and ambition. Individuals (e.g. Elon Musk) can be driven by personality or ideology to succeed and so create greater rivalry within an industry.

Rivalry within markets

  • High Competition: Automobiles (cars)
    Many competing brands with multiple different market positions from premium to low price, high function to low function.
  • Moderate Competition Ice Cream
    Multiple brands with different positions in terms of offer, including both local and international brands.
  • Low Competition: Supermarkets
    Despite a small number of independent stores, only two supermarket operators account for roughly 90% of all supermarket sales in New Zealand. Competition is very low and this is reflected in the relative lack of differentiation in terms of prices and variety of products. This is known by economists as an oligopoly.
  • No competition: Domestic Air Travel
    Air New Zealand is the only major carrier operating within the New Zealand market. There are only a handful of short, local routes that Air New Zealand does not control. This is known by economists as a monopoly.

Once you have defined the core market and the main players within that market, you can then consider the four other forces that will influence competition within the market.

2. Bargaining Power of Suppliers

Again, the bargaining power of suppliers (i.e. their ability to influence the players within the market) to the industry can be high, moderate or low, or some other more quantitative measure. Suppliers have relatively high bargaining power when:

  • The suppliers’ own industry is less competitive than the industry that it sells to. The uncompetitive nature of air travel in New Zealand means that, as a supplier of seats on airlines, Air New Zealand has high bargaining power over travel agents.
  • If suppliers serve many industries and do not rely heavily on one client industry, then they have more bargaining power.
  • Suppliers have more power if their customers face high switching costs to change between suppliers. For example, for a company that uses primarily the Google Workspace suit of tools, switching to Microsoft 365 represents a significant cost.
  • When suppliers provide unique products, they have more power. For example, drug companies make a range of unique pharmaceuticals with different properties, and these suppliers will have more power over hospitals and doctors than other drug companies that supply generic drugs.
  • Similarly, when the suppliers have unique skills, technology or other advantages that are difficult to replicate, they have more bargaining power because all clients must use the same company to access those skills. For example, there are only two medical schools in New Zealand at University of Auckland an University of Otago. The teaching and specialisms of these schools provide significant bargaining power against the government and medical employers. The supply of pilots and other highly skilled professions through highly specialised training programmes produces a similar situation.

Some important factors that determine supplier bargaining power are a dearth of substitute offerings, switching costs for buyers, and concentration of suppliers. Industries where supplier bargaining power is high limit the negotiating leverage of the companies within the industry.

Supplier Bargaining Power Examples

High Supplier Bargaining Power:

  • Pharmaceuticals – Brand drug suppliers usually have patent protections and few competitors for a specific drug type (e.g. cancer cures), enabling pricing setting power and buyer restrictions.[2]

Moderate Supplier Bargaining Power:

  • Automobile manufacturing – Companies like Toyota supply differentiated offerings but ample competing models constrain pricing power. [3]

Low Supplier Bargaining Power:

  • Agricultural Commodities (e.g. corn, beef, etc.): Individual farmers sell undifferentiated crop products, while these products are traded on huge commodity exchanges around the world, meaning that farmers have to accept the prices dictated to them and have very little power.[4].

2. Bargaining Power of End Users

In this case, Porter uses the term. “End Users” or “Buyers” because he is referring to all types of customers and users of an industry’s output. These could be consumers, but equally, they could be other businesses, governments or organisations. There is also a difference between the customer (the person or business that makes the purchase decision) and the end user (the person or business that actually consumes the product or service). End User, therefore, provides a broad-based definition of the entities to which the industry players sell.

As with supplier bargaining power, the industry’s end users also have different levels of bargaining power depending on specific characteristics. The more power an End User has, the more likely that they can negotiate on price and reduce the prices they purchase at. End Users are powerful when:

  • There are relatively few buyers. In this case, the industry players have few options and must carefully meet the needs of the buyers.
  • The industry offers undifferentiated products or services. In this case, the buyer can easily switch to a different company, so they have more power.
  • There are fewer switching costs for buyers. A good example is an industry where there are many supermarkets. Supermarkets have many buyers, which would suggest low bargaining power for those buyers, but buyers can often easily switch to a competitor.
  • Buyers can threaten to taken on the same role as the industry players. This has happened in modern-day retailing, where retailers have used their access to customer data to develop their own production channels and brands, so increasing their buying power versus product manufacturers.

When end users have high price sensitivity, they also have higher buyer bargaining power. A buyer group is price-sensitive if:

  • When a product or service represents a significant cost to the buyer, the buyer is more likely to shop around for better deals.
  • When a buyer has relatively less money or a smaller budget, they are more likely to shop around for better deals. [5]
  • When buyers are less concerned about quality, they will be more price-sensitive.

Most aspect of buyers’ bargaining power apply to either consumers and industrial buyers. The only major difference is that while businesses spend the time and resources to plan major purchases (e.g. buying a new factory), consumers make more spur-of-the-moment purchases, meaning their decision-making is more opaque.

Buyer Bargaining Power Examples

High Buyer Bargaining Power:

  • Gig economy platforms (Uber, Fiverr): people selling their labour have very little bargaining power in these systems as the buyers (Uber etc.) can easily find alternative options.[6]

Moderate Buyer Bargaining Power:

  • Banking: Large customers have some negotiating leverage, smaller individual customers have very little. Products are differentiated between banks to a moderate degree, and switching is easy, but there are some costs to doing so.

Low Buyer Bargaining Power:

  • Supermarkets in New Zealand: although most consumers in NZ can switch easily between one supermarket and another, only two companies control some 90% of the market, so the choice is very limited. This leads to prices that are similar across stores, and various marketing techniques that are used to obscure the lack of price differentials. There is also a lack of variety in terms of the products available across different supermarkets.[7]

3. Threats of Substitutes

The third force influencing competition within an industry is the threat of substitute products or services. In Porter’s original article, he explained this as follows:

A substitute performs the same or a similar function as an industry’s product by a different means. Videoconferencing is a substitute for travel. Plastic is a substitute for aluminum. E-mail is a substitute for express mail. [8]

Substitution can be either direct (as in Zoom vs Travel) or indirect, where a change in the environment leads to buyer switching behaviour. For example, New Zealand is currently seeing multiple homes being built on single lots within cities. This means that consumers who might previously have had a need for lawn mowing services may now substitute those for other gardening products and services. There are always potential substitutes for any industry’s products or services, but they can be easily missed because they aren’t always obvious substitutes for what is available.

Industry profitability can suffer when the threat of substitutes is high, because the option to chose substitutes limits the prices that industry players can set. Very often, when the threat of substitutes is high (or when new entrants create more substitutes) industries will take steps to mitigate the attractiveness of buyers switching to those substitutes.

The threat of a substitute is high when:

  • The substitute offers better value (the price-performance trade off) compared to the industry’s product.
  • The cost of a buyer switching to a substitute is low.

Threat of Substitutes Examples

High Threat of Substitutes:

  • Traditional Taxis:  Ridesharing apps like Uber and Lyft now provide similar transport more conveniently.

Moderate Threat of Substitutes:

  • Hotels: While home and apartment rentals like Airbnb offer some alternatives, business travel and conferences support hotels, and brand loyalty persists. Some customers prefer the full-service aspect of hotels over the freedom of Airbnb.

Low Threat of Substitutes:

  • Sweet, carbonated drinks: although Coca Cola and Pepsi, as well as other brands of carbonated sweet drinks, face a lot of competition between brands and recipes,  consumers of these drinks show a very high level of brand loyalty. Of course, consumers can substitute other drinks (e.g. sparkling water, beer etc.), but often the consumption of sweet carbonated drinks is related to a different situation (e.g. everyday use, rather than party use for beer, etc.).

4. Threat of New Entrants

A successful industry will always face the threat of new entrants coming in and taking market share. New entrants to an industry expand the scale and scope of an industry, but may also simple steal market share from existing players, so increasing the pressure on those existing firms.  There are many famous historical examples:

  • Apple entering the phone market with the iPhone
  • Microsoft entering the browser market with Internet Explorer
  • Tesla entering the car market with electric cars

There are also many cases of new entrants from overseas. Zara[9] and H&M[10] both entered New Zealand’s fashion retail market fairly recently, and IKEA will enter the New Zealand furniture market in 2025.[11]

When the threat of new entrants is high, incumbent players may seek ways to deter new competitors—creating barriers to entry. For example, it is fairly cheap and easy to open new coffee stores, so Starbucks invested in branding, new stores and store upgrades aggressively to stay ahead of potential new entrants. As such, the threat of new entrants can be assessed by how high the barriers to entry are. Barriers to entry arise from:

  1. Supply-side economies of scale: industries that require large capital investment, such as microchip manufacturing, are difficult to enter.
  2. Demand-side benefits of scale: where customers trust a company because of its size, it is harder for new entrants to establish a foothold. Social media presents an example of this as customers find little value in using smaller platforms.
  3. Customer switching costs: when it is expensive or difficult for a customer to switch to a new option, it is harder for that new entrant to establish market share. For example, a company that already uses Microsoft 365 would face high costs if it were to switch to new online platform.
  4. Capital requirements. Related to supply-side economies of scale, industries that require large amounts of financial capital to operate naturally have high barriers to entry. This factor would apply to any mass market production process but also to banking, insurance and many other industries.
  5. Incumbency advantages that are independent of size. Advantages such as proprietary technology, preferential access to buyers or raw materials, or simply dominance in a particular geographical location can all act as barriers to entry. The dominance of Coca-Cola is an example of this type of barrier to entry. Other companies could also produce cola, and many try, but getting customers to switch is hard because of high brand loyalty.
  6. Unequal access to distribution channels. A new entrant will require access to distribution channels and supply chains. Restricting distribution, both legally and less legally, is a common method to increase barriers to entry. The domination of Countdown and Food Stuffs in the New Zealand supermarket industry is an example of this type of barrier.
  7. Restrictive government policy. Government policy can hinder or aid new entry. Many countries make it difficult for international brands to operate in competition with domestic brands, for example. Government regulations also make it difficult for new companies to enter markets such as liquor production, taxi services, public transport, medical supplies and so on.

Threat of New Entrants

High Threat of New Entrants:

  • Retailing in New Zealand: New Zealand’s retail market has evolved to support only a small number of retailers as larger companies, many of them funded from overseas, have forced out smaller ones—a situation often blamed falsely on New Zealand’s small population. With so few companies operating, there is a high threat of new entrants that can offer distinct competitive advantages. Recent examples include Temu[12] and Chemist Warehouse[13], both of which newly entered the market from overseas.

Moderate Threat of New Entrants:

  • Brewing industry: Brewing requires some equipment, knowhow and access to distribution, but it is not a difficult process and can be set up on a relatively small scale to begin with. There is also high demand for microbreweries and craft beers.

Low Threat of New Entrants:

  • Pharmaceuticals:  Researching, creating, manufacturing and distributing drugs requires very large amounts of capital and expertise and, in most countries, pharmaceutical production and sales are highly regulated, making it difficult for new entrants.

 

  1. Porter, M. (2008) How Competitive Forces Shape Strategy, Harvard Business Review, January ↵
  2. U.S. new drug price exceeds $200,000 median in 2022 ↵
  3. Kanban – Toyota Production System guide ↵
  4. Ninan, K.N. (1988) Small Farmers and Commodity Market: An Analysis of Market Participation and Price Discrimination, Economic and Political Weekly, 23(52/53), pp. A163-A172. ↵
  5. However, you should note that a large body of research has shown that poorer consumers often pay more than wealthier consumers for basic needs such as groceries. This is because the option to shop around is reduced due to their poverty. Many companies, such as fast food chains, have targeted this particular type of low income consumer, knowing that it is hard for them to switch to other options. See: Kunreuther , H.(1972) ,"Why the Poor May Pay More For Food: Theoretical and Empirical Evidence", in SV - Proceedings of the Third Annual Conference of the Association for Consumer Research, eds. M. Venkatesan, Chicago, IL : Association for Consumer Research, Pages: 660-678. ↵
  6. The gig economy – a changing workforce ↵
  7. RNZ (2023) Supermarket pricing complaints continue despite Consumer NZ warning in March. Accessed 19 December 2023. ↵
  8. Porter (2008) ↵
  9. Ryan, H. (2016) World's largest fashion retailer Zara opens its doors in NZ, NZ Herald, 6 October. Accessed 19 December 2023. ↵
  10. H&M (2016) Press Release: H&M first store in New Zealand, 1 October. ↵
  11. IKEA (2023) Construction begins on first IKEA store for New Zealand. 2 June. Accessed 19 December 2023. ↵
  12. Turner, S. (2023) What you need to know about Temu, Reason. Accessed 20 December 2023. ↵
  13. Clayton, R. (2017) Chemist Warehouse to shake up New Zealand's pharmacy industry. Stuff. Accessed 20 December 2023. ↵

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