Porter’s 5 Forces: what they are, how they work and how to analyse competition

Porter’s 5 Forces are a competitive analysis model that helps to assess how attractive an industry is and which pressures may reduce a company’s profitability. The framework developed by Michael E. Porter examines five dynamics: rivalry among existing competitors, the threat of new entrants, the bargaining power of customers, the bargaining power of suppliers and the threat of substitute products or services.

Harvard Business School’s Institute for Strategy and Competitiveness describes the Five Forces as a framework for understanding the competitive pressures present in an industry and how economic value is distributed among the different players.

For a CEO, the model’s value emerges when the analysis clarifies where economic power is shifting. A shrinking margin may stem from a price war, from customers able to impose better terms, from suppliers that are hard to replace, from new players with lower costs or from alternatives that make the existing offer less relevant.

Industry structure genuinely matters to performance. Bart Vanneste, in a meta-analysis published in Strategy Science built on 18 samples from 16 studies with more than 225,000 observations, found a measurable industry effect, alongside even stronger effects linked to the individual business and to the corporate parent.

The five forces therefore become a basis for decision-making when they show which pressures are growing, what evidence demonstrates this and what effect they may have on prices, costs, investment and margins.

 

 

What Porter’s five forces are

The model starts from a precise principle: a company’s competition involves more players than just the competitors selling similar products. Profitability also depends on who can enter the market, who controls the inputs, the bargaining power of customers and the alternative solutions that can meet the same need.

1. Rivalry among existing competitors
2. Threat of new entrants
3. Bargaining power of customers
4. Bargaining power of suppliers
5. Threat of substitute products or services

The combined intensity of these forces helps determine the industry’s profit potential and shows where a company can seek a more defensible position.

How the five competitive forces work

1. Rivalry among existing competitors

Rivalry tends to intensify when competitors are numerous or similar in size, demand slows, fixed costs are high or exit barriers make it difficult to reduce capacity. Prices, market shares, industry growth, unused capacity and the intensity of commercial investment are useful signals.

2. Threat of new entrants

It depends on barriers to entry: capital requirements, economies of scale, regulation, patents, reputation, access to channels, proprietary data and switching costs. Technology and new distribution models can lower these barriers and make contestable a market that had remained relatively protected for years.

3. Bargaining power of customers

It increases when a few customers account for a significant share of revenue, can switch supplier easily or perceive little differentiation between the alternatives. Revenue concentration, average discount, churn, tender frequency and contract length help to measure this pressure.

4. Bargaining power of suppliers

It grows when inputs are critical, alternatives are limited or switching requires time and investment. Purchasing concentration, lead times, cost volatility, availability of alternatives and dependence on single suppliers therefore become strategic indicators.

5. Threat of substitutes

A substitute may belong to a different category and offer the customer another way of achieving the same result. Pressure grows when the price-performance ratio of alternatives improves or when habits and technologies change. That is why the analysis must start from the customer’s need and the result they are seeking.

 

How the 5 forces affect profitability and margins

The five forces affect above all price, volume, cost and the capital required to compete. Intense rivalry can squeeze prices and increase commercial investment; strong customers can secure better terms; concentrated suppliers can pass cost increases downstream; new entrants and substitutes can require fresh investment to defend demand.

McGahan and Porter, analysing US public companies, estimated that industry effects explained around 19% of the aggregate variance in the sample’s profitability. The 1997 study is one of the classic references on the weight of industry structure. Subsequent research has confirmed a significant role for the industry and an even greater weight for firm-specific factors.

OECD data also show why it pays to track how market power evolves. Across 15 European countries and 127 industries, average markups rose by around 7% between 2000 and 2019, with sharper increases in digital-intensive sectors. The OECD recommends reading markups, concentration and dynamism together.

How to carry out a Porter’s 5 Forces analysis

The first decision concerns the boundaries of the industry. A very broad definition makes the analysis generic; boundaries that are too narrow can miss substitutes and players coming from adjacent markets.

For each force, it is worth gathering verifiable evidence and stating its intensity, trend and economic consequence.

The decisive step comes after classification. For each force, management should state the trend, the economic impact, the company’s specific vulnerability, the possible responses and the person responsible for the decision.

Competitive Intelligence adds depth to this work when it is necessary to verify individual competitors’ moves, investments, products, hires and signals. Porter remains useful for reading the overall structure of the industry.

The same logic feeds into a Brand Audit, where market data, benchmarks, perception and competitive position are read together before a direction is set.

The most common mistake: treating Porter as a snapshot

Competitive structure changes. Technology, regulation, distribution models, acquisitions and buying behaviour can alter the relative power of customers, suppliers, competitors, substitutes and potential entrants within a few years.

Harvard explicitly stresses that industry structure is dynamic. The analysis also serves to anticipate how the forces are shifting.

A review should therefore be triggered when structural signals emerge: new players entering, acquisitions, regulatory changes, rising critical costs, technologies that lower barriers, the loss of strategic customers or the acceleration of substitutes.

A 2024 study published in the Journal of Management Control, based on responses from 505 US financial managers, also found that the use of management accounting practices can alter the relationship between the intensity of competitive forces, competitive advantage and performance. Baird, Nuhu and Jiao thus link competitive analysis to the systems through which an organisation measures and governs what happens.

This is why it can be useful to link the analysis to company KPIs as well: a force that is intensifying should leave observable signals in the measurement system, otherwise it risks remaining an isolated qualitative assessment.