Porter's five forces analysis

Porter's Five Forces Framework is a method of analysing the competitive environment of a business. It is rooted in industrial organization economics and identifies five forces that determine the competitive intensity and, consequently, the attractiveness or unattractiveness of an industry with respect to its profitability. An "unattractive" industry is one in which these forces collectively limit the potential for above-normal profits. The most unattractive industry structure would approach that of pure competition, in which available profits for all firms are reduced to normal profit levels. The five-forces perspective is associated with its originator, Michael E. Porter of Harvard Business School. This framework was first published in Harvard Business Review in 1979.^[1]

Porter refers to these forces as the microenvironment, to contrast it with the more general term macroenvironment. They consist of those forces close to a company that affects its ability to serve its customers and make a profit. A change in any of the forces normally requires a business unit to re-assess the marketplace given the overall change in industry information. The overall industry attractiveness does not imply that every firm in the industry will return the same profitability. Firms are able to apply their core competencies, business model or network to achieve a profit above the industry average. A clear example of this is the airline industry. As an industry, profitability is low because the industry's underlying structure of high fixed costs and low variable costs afford enormous latitude in the price of airline travel. Airlines tend to compete on cost, and that drives down the profitability of individual carriers as well as the industry itself because it simplifies the decision by a customer to buy or not buy a ticket. This underscores the need for businesses to continuously evaluate their competitive landscape and adapt strategies in response to changes in industry dynamics, exemplified by the airline industry's struggle with profitability despite varying approaches to differentiation.^[2] A few carriers – such as Richard Branson's Virgin Atlantic – have tried, with limited success, to use sources of differentiation in order to increase profitability.^[3]

Porter's Five Forces include three sources of "horizontal competition"—the threat of substitute products or services, the threat posed by established industry rivals, and the threat of new entrants—and two sources of "vertical competition"— the bargaining power of suppliers and the bargaining power of buyers.

Porter developed his Five Forces Framework in response to the then-prevalent SWOT analysis, which he criticized for its lack of analytical rigor and its ad hoc application.^[4] The Five Forces model is grounded in the structure–conduct–performance paradigm of industrial organization economics. Other strategic tools developed by Porter include the value chain framework and the concept of generic competitive strategies.^[5]