When to apply Porter's Five Forces
Porter’s Five Forces is a framework for understanding industry structure. The approach is useful when you want to understand why certain industries are historically more profitable than others, or why in certain settings the buyers or suppliers are able to capture a high proportion of the overall industry value.
It is particularly useful when firms compete in similar ways to one another – the profits are largely determined by industry-level factors rather than differences between firms. By analyzing buyer power, supplier power, barriers to entry, substitute productions, and inter-industry rivalry, the framework helps illustrate why certain industries are able to capture a high proportion of the overall industry value, while others are not.
Situation 1: Understanding your industry
One application of Porter’s Five Forces is understanding your own industry. Porter’s Five Forces can help explain why your industry, and in turn, firm may only have relatively slim margins, or why you are able to push up prices.
This insight can be useful for potentially changing the industry structure. Your firm could, for example, look to backward vertically integrate so as to remove a powerful supplier that typically captures a high proportion of the overall value being created.
Situation 2: Considering entering a market
Another situation where Porter’s Five Forces can be useful is when considering entering a new market. The analysis may help illustrate the challenges that a company may have entering, with such entry barriers illustrating why the industry may historically be profitable – an attractive, although hard to enter the market. Alternatively, the insight may reveal that while the industry is currently profitable, the particularly low entry barriers are going to result in a rush of other firms entering, quickly pulling down industry profitability.
Porter’s Five Forces can also be useful when considering an alternative way of entering the market and competing. By identifying and analyzing traditional barriers to entry, it may be possible to identify alternative approaches for entering the market, sidestepping the barriers to entry to allow you to enter.
Situation 3: Before investing in a firm or industry
A final time when Porter’s Five Forces can be useful is before investing in a firm. The analysis may illustrate potential weaknesses in the industry – for example, that despite high profits, other firms can quickly enter. The approach may thus help identify key things to be aware of in the industry before investing.