Porter's Five Forces: Sizing Up Your Industry as a Small Business

When small-business owners think about competition, they usually picture the business across the street or the brand that keeps showing up in search results. That is part of the picture, but only part.

Michael Porter's five forces framework widens the view. In his 2008 Harvard Business Review article "The Five Competitive Forces That Shape Strategy," Porter writes that managers often define competition too narrowly, and that competition for profits also includes customers, suppliers, potential entrants and substitute products. Together with rivalry among existing competitors, those make five forces.

This guide explains each force in plain terms, shows how to run a quick five-forces review for a small business, and covers how to use what you learn. It complements a SWOT: where SWOT looks at your business, five forces looks at the industry you are in.

Where the framework comes from

Harvard Business School's Institute for Strategy and Competitiveness describes the five forces as "a framework for understanding the competitive forces at work in an industry," first described in Porter's 1979 Harvard Business Review article. Porter revisited and extended it in the 2008 article.

The core idea, according to the Institute, is that industry structure and a company's relative position within the industry are the two basic drivers of company profitability. Some industries are simply harder places to make money than others, and knowing why helps you choose where and how to compete.

The five forces, one at a time

The descriptions below follow the Institute's explanations.

1. Threat of new entrants. When it is easy for new players to enter, current players have to keep prices down and spend more to keep customers. The threat depends on barriers to entry, which the Institute lists as including economies of scale, the cost of building brand awareness, access to distribution channels and government restrictions. It also rises when established companies in other regions could move in.
2. Bargaining power of suppliers. Powerful suppliers can charge higher prices or demand better terms. Supplier power is greater when there are only one or two sources of an essential input, or when switching suppliers is expensive or slow.
3. Bargaining power of buyers. Powerful customers can push prices down or demand more service at the same price. The Institute says buyer power is highest when buyers are large relative to the businesses serving them, when products are undifferentiated and a significant cost for the buyer, and when switching costs are low. It also notes that an industry may have several buyer segments with different levels of power.
4. Threat of substitutes. A substitute meets the same underlying need in a different way. The Institute's examples are videoconferencing as a substitute for travel and email as a substitute for express mail. The threat is high when the substitute offers an attractive price-performance trade-off and switching to it is cheap.
5. Rivalry among existing competitors. Intense rivalry drives down prices or raises the cost of competing. The Institute says rivalry tends to be especially fierce when competitors are numerous or roughly equal in size, industry growth is slow, fixed costs are high, exit barriers are high, rivals are highly committed to the business, or firms have differing goals and approaches.

The SBA's competitive analysis guidance touches the same ground for new owners, pointing to the level of competition, the threat of new competitors or services, and the effect of suppliers and customers on price.

Running a five-forces review for a small business

You can do a useful version in an afternoon.

1. Define the industry carefully. Be specific about the product or service and the geography that matter to your customers. "Restaurants" is too broad; "weekday lunch for office workers within a ten-minute drive" is closer to the market you actually compete in.
2. For each force, write down the evidence. Who are the realistic new entrants? Which suppliers could hurt you? How easily can customers switch? What else could solve the customer's problem?
3. Rate each force as low, medium or high, and note the one or two factors driving each rating.
4. Identify the forces that matter most. Porter's 2008 article says the strongest force or forces determine an industry's profitability, and the most important one is not always obvious.
5. Ask what could change. The Institute stresses that industry structure is not static: buyers or suppliers can gain or lose power, innovations can make entry or substitution easier, and regulation can change rivalry or entry barriers.

For example, imagine a hypothetical residential cleaning business in a mid-size town. Entry is easy, since the equipment is inexpensive and there is no storefront to build, so the threat of new entrants is high. Supplier power is low, because cleaning supplies are widely available. Buyer power is moderate: households are small buyers, but switching providers is easy. Substitutes include doing it yourself and booking through a gig app. Rivalry is high if many small operators compete on price. The review points to the real strategic problem: low barriers and easy switching. Possible responses include specializing in move-out cleaning for property managers, a customer group with recurring needs and higher switching costs once a trusted provider is in place.

Using the results

Porter's 2008 article summary describes two broad ways to respond: strategy can be viewed "as building defenses against the competitive forces or as finding a position in an industry where the forces are weaker." For a small business, that might mean:

• Raising switching costs in ways customers value, such as service records, scheduling convenience or training.
• Reducing dependence on a powerful supplier by qualifying a second source.
• Choosing customer segments with less buyer power or fewer substitutes.
• Differentiating so that rivalry is less about price.

The same summary notes that Porter explains "why a fast-growing industry is not always a profitable one." Growth in demand doesn't help much if it also attracts a flood of new entrants. Our guide Choosing Your Target Customers: Where to Compete and Where Not To can help you turn these findings into a choice of segment.

Common mistakes

• Looking only at direct rivals. Substitutes and buyer power can matter more.
• Defining the industry too broadly, which blurs every rating.
• Rating forces from gut feel instead of evidence.
• Treating the review as a one-time exercise. Revisit it when a new competitor, regulation or technology appears.
• Confusing it with SWOT. Five forces describes the industry; your strengths and weaknesses belong in a separate analysis, such as the one in our guide SWOT Analysis Done Well: From Four Lists to Real Choices.

Key takeaways

• Competition comes from five forces: new entrants, suppliers, buyers, substitutes and rivalry, not just from direct competitors.
• Industry structure and your position within it are the two basic drivers of profitability, according to Harvard's Institute for Strategy and Competitiveness.
• Define your industry narrowly and realistically, then rate each force with evidence.
• Use the results to build defenses or to find a position where the forces are weaker.
• Industry structure changes, so revisit your review when the market shifts.

Sources

• Harvard Business School Institute for Strategy and Competitiveness, The Five Forces
• Michael E. Porter, Harvard Business Review, The Five Competitive Forces That Shape Strategy (January 2008)
• U.S. Small Business Administration, Plan your business: Market research and competitive analysis