The Five Competitive Forces That Shape Strategy
Awareness of the five forces can help a company understand the structure of its industry
and stake out a position that is more
profitable and less vulnerable to attack.
by Michael E. Porter
Harvard Business Review (HBR), January 2008.
Editors Note: In 1979, Harvard Business Review published “How Competitive Forces
Shape Strategy” by a young economist
and associate professor, Michael E. Porter. It was his first HBR article, and it started a
revolution in the strategy field. In
subsequent decades, Porter has brought his signature economic rigor to the study of
competitive strategy for corporations,
regions, nations, and, more recently, health care and philanthropy. “Porters five forces”
have shaped a generation of academic
research and business practice. With prodding and assistance from Harvard Business
School Professor Jan Rivkin and
longtime colleague Joan Magretta, Porter here reaffirms, updates, and extends the classic
work. He also addresses common
misunderstandings, provides practical guidance for users of the framework, and offers a
deeper view of its implications for strategy today.
In essence, the job of the strategist is to understand and cope with competition. Often,
however, managers define competition too narrowly, as if it occurred only among todays
direct competitors. Yet competition for profits goes beyond established industry rivals to
include four other competitive forces as well: customers, suppliers, potential entrants, and
substitute products. The extended rivalry that results from all five forces defines an
industrys structure and shapes the nature of
competitive interaction within an industry.
As different from one another as industries might appear on the surface, the underlying
drivers of profitability are the same.
The global auto industry, for instance, appears to have nothing in common with the
worldwide market for art masterpieces or
the heavily regulated health-care delivery industry in Europe. But to understand industry
competition and profitability in each
of those three cases, one must analyze the industrys underlying structure in terms of the
five forces. (See the exhibit “The Five
Forces That Shape Industry Competition.”)
If the forces are intense, as they are in such industries as airlines, textiles, and hotels,
almost no company earns attractive
returns on investment. If the forces are benign, as they are in industries such as software,
soft drinks, and toiletries, many
companies are profitable. Industry structure drives competition and profitability, not
whether an industry produces a product or
service, is emerging or mature, high tech or low tech, regulated or unregulated. While a
myriad of factors can affect industry
profitability in the short runincluding the weather and the business cycleindustry structure,
manifested in the competitive
forces, sets industry profitability in the medium and long run. (See the exhibit “Differences
in Industry Profitability.”)
Exhibit: Differences in Industry Profitability
The average return on invested capital varies markedly from industry to industry. Between
1992 and 2006, for example,
average return on invested capital in U.S. industries ranged as low as zero or even negative
to more than 50%. At the high end
are industries like soft drinks and prepackaged software, which have been almost six times
more profitable than the airline
industry over the period.
Understanding the competitive forces, and their underlying causes, reveals the roots of an
industrys current profitability while
providing a framework for anticipating and influencing competition (and profitability)
over time. A healthy industry structure
should be as much a competitive concern to strategists as their companys own position.
Understanding industry structure is
also essential to effective strategic positioning. As we will see, defending against the
competitive forces and shaping them in a
companys favor are crucial to strategy.
Forces That Shape Competition
The configuration of the five forces differs by industry. In the market for commercial
aircraft, fierce rivalry between dominant
producers Airbus and Boeing and the bargaining power of the airlines that place huge
orders for aircraft are strong, while the
threat of entry, the threat of substitutes, and the power of suppliers are more benign. In the
movie theater industry, the
proliferation of substitute forms of entertainment and the power of the movie producers
and distributors who supply movies,
the critical input, are important.
The strongest competitive force or forces determine the profitability of an industry and
become the most important to strategy
formulation. The most salient force, however, is not always obvious.
For example, even though rivalry is often fierce in commodity industries, it may not be the
factor limiting profitability. Low
returns in the photographic film industry, for instance, are the result of a superior substitute
productas Kodak and Fuji, the
worlds leading producers of photographic film, learned with the advent of digital
photography. In such a situation, coping
with the substitute product becomes the number one strategic priority.
Industry structure grows out of a set of economic and technical characteristics that
determine the strength of each competitive
force. We will examine these drivers in the pages that follow, taking the perspective of an
incumbent, or a company already
present in the industry. The analysis can be readily extended to understand the challenges
facing a potential entrant.
Sidebar: Industry Analysis in Practice
Good industry analysis looks rigorously at the structural underpinnings of profitability. A
first step is to understand
the appropriate time horizon. One of the essential tasks in industry analysis is to
distinguish temporary or cyclical changes
from structural changes. A good guideline for the appropriate time horizon is the full
business cycle for the particular industry.
For most industries, a three-to-five-year horizon is appropriate, although in some industries
with long lead times, such as
mining, the appropriate horizon might be a decade or more. It is average profitability over
this period, not profitability in any
particular year, that should be the focus of analysis.
The point of industry analysis is not to declare the industry attractive or unattractive but to
understand the
underpinnings of competition and the root causes of profitability. As much as possible,
analysts should look at industry
structure quantitatively, rather than be satisfied with lists of qualitative factors. Many
elements of the five forces can be
quantified: the percentage of the buyers total cost accounted for by the industrys product
(to understand buyer price
sensitivity); the percentage of industry sales required to fill a plant or operate a logistical
network of efficient scale (to help
assess barriers to entry); the buyers switching cost (determining the inducement an entrant
or rival must offer customers).
The strength of the competitive forces affects prices, costs, and the investment required to
compete; thus the forces are
directly tied to the income statements and balance sheets of industry participants. Industry
structure defines the gap
between revenues and costs. For example, intense rivalry drives down prices or elevates
the costs of marketing, R&D, or
customer service, reducing margins. How much? Strong suppliers drive up input costs.
How much? Buyer power lowers prices
or elevates the costs of meeting buyers demands, such as the requirement to hold more
inventory or provide financing. How
much? Low barriers to entry or close substitutes limit the level of sustainable prices. How
much? It is these economic
relationships that sharpen the strategists understanding of industry competition.
Finally, good industry analysis does not just list pluses and minuses but sees an industry in
overall, systemic terms.
Which forces are underpinning (or constraining) todays profitability? How might shifts in
one competitive force trigger
reactions in others? Answering such questions is often the source of true strategic insights.
Threat of entry.
New entrants to an industry bring new capacity and a desire to gain market share that puts
pressure on prices, costs, and the
rate of investment necessary to compete. Particularly when new entrants are diversifying
from other markets, they can leverage
existing capabilities and cash flows to shake up competition, as Pepsi did when it entered
the bottled water industry, Microsoft
did when it began to offer internet browsers, and Apple did when it entered the music
distribution business.
The threat of entry, therefore, puts a cap on the profit potential of an industry. When the
threat is high, incumbents must hold
down their prices or boost investment to deter new competitors. In specialty coffee
retailing, for example, relatively low entry
barriers mean that Starbucks must invest aggressively in modernizing stores and menus.
The threat of entry in an industry depends on the height of entry barriers that are present
and on the reaction entrants can
expect from incumbents. If entry barriers are low and newcomers expect little retaliation
from the entrenched competitors, the
threat of entry is high and industry profitability is moderated. It is the threat of entry, not
whether entry actually occurs, that
holds down profitability.
Barriers to entry.
Entry barriers are advantages that incumbents have relative to new entrants. There are
seven major sources:
1. Supply-side economies of scale. These economies arise when firms that produce at
larger volumes enjoy lower costs per unit
because they can spread fixed costs over more units, employ more efficient technology, or
command better terms from
suppliers. Supply-side scale economies deter entry by forcing the aspiring entrant either to
come into the industry on a large
scale, which requires dislodging entrenched competitors, or to accept a cost disadvantage.
Scale economies can be found in virtually every activity in the value chain; which ones are
most important varies by industry.1
In microprocessors, incumbents such as Intel are protected by scale economies in research,
chip fabrication, and consumer
marketing. For lawn care companies like Scotts Miracle-Gro, the most important scale
economies are found in the supply chain
and media advertising. In small-package delivery, economies of scale arise in national
logistical systems and information
technology.
2. Demand-side benefits of scale. These benefits, also known as network effects, arise in
