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Porter's Five Forces: Definition & Examples

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Lesson Transcript
Instructor: Beth Loy

Dr. Loy has a Ph.D. in Resource Economics; master's degrees in economics, human resources, and safety; and has taught masters and doctorate level courses in statistics, research methods, economics, and management.

There are many factors to consider when creating a business. One of the most important is the competitiveness of the industry. In this lesson, we look at Porter's Five Forces to analyze an industry's competitive forces.

Porter's Five Forces in Business

There are many factors to consider when creating a business. One of the most important is the competitiveness of the industry. Michael E. Porter, a Harvard professor known as a leader in competitive and strategic management, created a well-known model for determining the profitability of an industry. The framework is known as Porter's Five Forces and is based on the competitive forces that influence an industry the most. These five forces include:

  1. Competitive rivalry
  2. Threat of new entrants
  3. Bargaining power of suppliers
  4. Bargaining power of customers
  5. Threat of substitute products

Using Porter's Five Forces Model

Using these five forces will help a firm determine whether to enter an industry and how shape its competitive strategy. The model is extremely flexible and can be used to determine strengths and weaknesses in industries like healthcare, government, finance, education, and manufacturing.

Let's delve into how a strategic company can use Porter's model to determine whether to enter the industry. Would a company be able to create a competitive advantage over industry rivals? To demonstrate Porter's Five Forces, let's say we are an investment firm called Cross Investments, and we are looking for entrepreneurship ventures.

Force #1: Competitive Rivalry

Of Porter's Five Forces, competitive rivalry has the strongest influence on whether entering an industry would be profitable. When rivalry is high, there are many competitors, and those competitors have a high cost associated with exiting the industry. Typically, the industry grows slowly, has little customer loyalty, and products and competitors are very similar.

Before the owners of Cross Industries created their company, they looked at the investment industry. They were trying to determine whether the industry had enough room for another profitable company. What they found was that the industry contained very few competitors. As the industry developed, though, the capital needed to enter the market increased. There really weren't any services that were unique from what Cross Industries could provide. It also didn't seem like many companies would have the money readily available to enter the market. The owners decided to create Cross Industries because there was little competitive rivalry in the industry. They had the capital so they pushed forward.

Force #2: Threat of New Entrants

The threat of new entrants is the force that tells us how easy or difficult it is for competitors to enter an industry. The goal of those who are already in the industry is to make it difficult to enter. Government regulations, established brands, high capital investment, unique products, and high customer loyalty all decrease the threat of new entrants.

Cross Investments was researching whether to invest in a company that makes footballs. This market is difficult to enter. It has established brands like Nike, Wilson, and Under Armour. After researching the market, Cross Investments determined that with the high level of existing brand loyalty and the patents and trademarks needed to be successful, the investment was too risky.

Force #3: Bargaining Power of Suppliers

When suppliers are limited or inputs are scarce, the bargaining power of suppliers is high. They can then raise their prices and limit their negotiations. This affects buyers because they have to either absorb these costs or raise their own prices. Furthermore, they may not even be able to get the supplies when they need them.

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