Porter's Five Forces

What are Porter’s Five Forces?

Porter’s five forces is a fundamental, qualitative valuation framework to help evaluate an industry’s strengths and weaknesses through five competitive forces. It can also be applied to evaluate companies. The model is first developed by the Harvard Business School professor, Michael E. Porter in his book "Competitive Strategy: Techniques for Analyzing Industries and Competitors”. The five forces are:

• The threat of substitute products
• The threat of new entrant
• Bargaining power of suppliers
• Bargaining power of buyers
• Industry rivalry

It is worth noticing that the difference between “threat of substitute products” and “industry rivalry” can be tricky for new investors. The threat of substitute products represents products from another industry that can offer a similar benefit and user experience as the product produced by the companies within a selected industry. On the other hand, industry rivalry represents the direct competition within the selected industry.

Graph source: https://www.business-to-you.com/porters-five-forces/

Ideally, when the five forces are weak, a company has gained greater power to charge its customers a higher price to achieve more profits, creating a monopoly. When the forces are strong, the companies are forced to join the “price war” and lower its price to attract more customers. In this case, the industry will turn into a perfect competition market, with high rivalries.