Porter's five forces: a worked example and how to test each force wit...

Porter's five forces is a framework for judging how profitable an industry is likely to be, and why. It looks at five pressures on the profits of companies in an industry: rivalry among existing competitors, the bargaining power of buyers, the bargaining power of suppliers, the threat of new entrants, and the threat of substitute products or services.

Michael Porter first described the forces in a 1979 Harvard Business Review article, "How Competitive Forces Shape Strategy," and restated and extended them in the 2008 HBR article "The Five Competitive Forces That Shape Strategy". His argument is that managers often define competition too narrowly, as only today's direct rivals, when customers, suppliers, potential entrants and substitutes also compete for the value an industry creates. The article also explains why a fast-growing industry is not always a profitable one.

Below: what each force means, a hypothetical worked example, and how to test each force with interviews instead of guessing.

The five forces, briefly

Harvard Business School's Institute for Strategy and Competitiveness summarizes what drives each force:

Threat of new entrants. New entrants add capacity and push down prices, which caps an industry's profits. The threat depends on barriers to entry, such as economies of scale, the cost of building a brand, access to distribution and government restrictions. It rises if established companies in other regions could move in.
Bargaining power of suppliers. Suppliers are powerful when there are only one or two sources of an essential input, or when switching suppliers is expensive or slow.
Bargaining power of buyers. Buyers are powerful when they are large relative to the companies selling to them, when the products are undifferentiated and a significant cost, and when switching is cheap. Different buyer groups in one industry can have different power.
Threat of substitutes. A substitute meets the same need in a different way. The HBS examples are videoconferencing as a substitute for travel and email for express mail. The threat is high when the substitute offers an attractive price and performance trade-off and switching to it is cheap.
Rivalry among existing competitors. Rivalry is fiercest when competitors are numerous or similar in size, growth is slow, fixed costs are high, exit barriers are high, and rivals are committed to the business.

The same page stresses that industry structure changes over time, through new technology, regulation, or a competitor's new pricing or distribution approach. A five forces analysis is a snapshot you revisit.

A worked example: commercial recycling collection

Suppose you are considering starting, or investing in, a company that collects cardboard and mixed recycling from businesses in one mid-sized metro area. The industry, the numbers and the ratings below are hypothetical. Each rating is a hypothesis to test, not a finding.

Force	What to look at	Hypothesis for this example	Initial rating
Buyers	Size of customers, contract terms, switching cost	Grocery chains and property managers put contracts out to bid and switch at renewal	High
Suppliers	Number of processing facilities within driving distance, truck makers	Only one or two sorting facilities are within a practical haul, so they set the price paid per ton	High
New entrants	Truck and container costs, permits, haulers in nearby metros	A used truck and a permit get a small operator started; neighboring haulers could expand	Medium
Substitutes	Balers or compactors that let a business sell cardboard itself	Large grocery stores may bale cardboard on site and sell it directly	Medium for large accounts
Rivalry	Number and size of haulers, fixed costs	A few similar-sized haulers with expensive trucks that must stay busy, so price cuts are common	High

Some arithmetic helps show why buyer power matters here. Say a hauler has 200 business accounts and the three largest grocery chains together make up 40% of revenue. If one chain moves its contract to a rival at renewal, the hauler loses roughly 13% of revenue at once (40% ÷ 3, assuming the chains are similar in size). That loss lands on trucks and drivers that cost the same whether they are full or not. On this reading, the attractive part of the industry is probably the smaller accounts, which do not run formal bids, not the big ones.

How to test each force with interviews

Desk research gives you the questions. People who work in the industry tell you which answers are true in this market. Talk to each side of the force you are testing:

Force	Whom to ask	Questions to ask
Buyers	Facility managers at grocery stores, property managers	How did you choose your current hauler? When did you last change, and why? What would a new hauler have to offer to win your contract?
Suppliers	Sales or operations staff at sorting facilities	How is the price per ton set? Do all haulers get the same terms? How often does your capacity fill up?
New entrants	Owners of small haulers, people at haulers in neighboring metros	What did it take to start? How long did permits take? What would stop you expanding into this area?
Substitutes	Store operations managers	Have you looked at baling cardboard yourselves? What stopped you, or what made it worth it?
Rivalry	Former managers or sales reps at local haulers	How do haulers usually win business from each other? How often do price cuts start, and who starts them?

Three habits make these interviews useful:

Ask about recent events, not opinions. "When did you last change haulers?" gets a better answer than "Is switching easy?"
Count agreement. If four of five facility managers describe a formal bid at every renewal, buyer power is high. If one does, you may have found a single large account.
Stay clear of confidential information. Former employees of haulers can explain how the market works, but they owe their former employer confidentiality. The SCIP Code of Ethics says to disclose who you are before every interview and to tell former employees up front that you do not want confidential information. Competitive intelligence covers these rules in more detail.

After the interviews, go back to the table and change the ratings the evidence did not support. In the example, you might learn that the sorting facilities publish a price per ton tied to a commodity index, which makes supplier power high but predictable, and that small businesses rarely switch unless service fails. That would point the business toward small accounts and reliable service.

Common mistakes

Defining the industry wrongly. If the boundary is too wide or too narrow, every force is rated against the wrong set of companies. How to map a competitive landscape covers drawing the boundary by what buyers would switch to.
Filling the table from memory. Each rating should cite the evidence behind it: a filing, a price list, or a count of interviews.
Treating it as a score. The point is to see where the profit in an industry goes and where a company could position itself to face weaker pressure, not to add up five ratings.
Never revisiting it. A new regulation or a large entrant can change a force quickly. Put a date on the analysis.

Your next step

Pick the industry you are evaluating and write one line per force: your hypothesis and the evidence you have now. Circle the two forces with the least evidence, then schedule three interviews for each with people on that side of the market.

If you do not know those people, Instant Expert can find people who match a description you write, such as "facility managers at grocery chains" or "sales managers at recycling processors." You review who it finds, it sends your invitations, and you pay only for calls that get booked. The directory pages for procurement professionals in recycling and operations professionals in waste management are one place to start.