What Is Five Forces Analysis? The Concept and How to Use It, Explained Simply

Five Forces analysis is a framework for analyzing the five competitive forces that determine an industry’s profitability, in order to clarify a company’s competitive advantages and its future strategy. This analysis makes the structure of the entire industry and the “threats” surrounding the company visible. In this article, we explain what the Five Forces model is in plain terms — from its basic ideas to concrete usage, and even how it can be combined with other related frameworks — with practical information you can use.

Overview of Five Forces Analysis

The Five Forces model is a framework in management studies and marketing proposed by the American management scholar Michael E. Porter.
It is used to understand an industry’s profitability and the intensity of competition within it. By analyzing five key “threats,” it evaluates the attractiveness of an industry and the profitability of a company within it.

The originator of Five Forces analysis and its basic idea

Five Forces analysis was proposed by Michael E. Porter, a professor at Harvard Business School.

Introduced in his book Competitive Strategy, this framework is based on the fundamental idea that an industry’s profitability is determined by five competitive forces: “rivalry among existing competitors,” “threat of new entrants,” “threat of substitutes,” “bargaining power of buyers (customers),” and “bargaining power of suppliers.”

By analyzing these forces, a company can objectively grasp the competitive environment it faces. It is also useful for strategic decision-making.

The five threats that make up Five Forces analysis

Five Forces analysis evaluates the five “threats” that determine an industry’s profitability.

If these threats are strong, earning profits in the industry is judged to be difficult; if they are weak, there is an opportunity to improve profitability.

Let’s look at each threat in detail.

[Threat 1] Rivalry among existing competitors

Rivalry among existing competitors refers to the intensity of competition among existing firms in the industry your company belongs to.

A large number of competitors, the presence of many large firms, or difficulty in differentiating products and services (which easily leads to price competition) all act as major threats that lower profitability.

It is important for a company to objectively grasp its own position by analyzing competitors’ financial strength, technical capability, sales capability, brand power, market share, and so on.
In a highly competitive industry, even just maintaining market share involves significant costs. To secure profit in such an environment, a more differentiated strategy is required.

[Threat 2] Threat of new entrants

The threat of new entrants refers to the possibility of new firms entering the industry your company belongs to, and the impact this would have on existing companies.

In industries where the barrier to entry is low, an increase in new entrants intensifies competition, and price competition or loss of market share threatens to reduce the profitability of existing firms.

For example, industries with low initial investment requirements and no need for special technology or licenses tend to be easy to enter.

Conversely, industries that require government regulation or large capital investment have high entry barriers, so the threat of new entrants is small.

It is important to analyze this threat by also considering market size, the brand power of incumbents, and the technical level of potential entrants.

[Threat 3] Threat of substitutes

The threat of substitutes refers to the possibility that products or services that meet customers’ needs in a different way from your own will appear on the market.

For example, just as the rise of smartphones significantly reduced demand for landline phones, digital cameras, and portable music players, technological innovation can produce substitutes that come from outside your traditional competitors.

As substitutes improve in performance and decrease in price, the risk of customers switching to them grows.

Because the emergence of such substitutes can fundamentally change the profit structure of incumbents, it is important to constantly watch market changes, identify potential substitutes early, and develop strategies to deal with them.

[Threat 4] Bargaining power of buyers (customers)

The bargaining power of buyers refers to the degree of influence customers (buyers) have over your company in terms of price, quality, and conditions of the products or services you provide.

When the number of buyers is small but their purchase volume is large, buyers gain a strong position in price negotiation and can easily demand discounts — a clear threat.

In addition, when there is no clear differentiation between your product and competitors’ products, or when buyers’ switching costs (the cost or hassle of moving to other products or services) are low, buyers’ bargaining power increases.

When buyer bargaining power is high, firms are forced to lower prices to maintain profitability, which puts pressure on profit margins. It is therefore critical to accurately understand customer needs and continue to provide value.

[Threat 5] Bargaining power of suppliers

Bargaining power of suppliers refers to the degree of influence that suppliers (those who provide raw materials, parts, services, etc.) have over your company in terms of price, quality, and supply conditions.

When suppliers are few in number and your company depends on a specific supplier, or when a supplier provides scarce raw materials or parts with advanced technology, suppliers’ bargaining power increases.

As a result, suppliers may raise prices or restrict supply, threatening to drive up your production costs and worsen your profitability.

To weaken supplier bargaining power, you should consider building relationships with multiple suppliers, securing substitutable procurement sources, or even bringing production in-house.

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Three purposes of conducting a Five Forces analysis

The main purpose of conducting a Five Forces analysis is to understand the competitive environment your company faces from multiple angles, and to use that understanding in strategic decision-making.
Specifically, the following three purposes are notable.

To accurately grasp the profit structure of the industry

Five Forces analysis is an effective analytical method for accurately grasping the profit structure of an industry.

By examining the five competitive forces in detail, you can objectively evaluate how easy or difficult it is to generate profit in that industry.

For example, industries with a high threat of new entrants tend to experience intense price competition, which lowers profitability.

Through this analysis, you can understand the overall attractiveness of the industry and judge whether your business is in an environment that can secure stable profits over the long term.

To discover your own competitive advantages and challenges

Five Forces analysis is an important analytical tool for discovering your own competitive advantages and challenges. By analyzing the five threats surrounding the industry, you can objectively grasp the strengths your company has against competitors and the weaknesses you carry.

The results of this analysis give concrete clues for formulating strategies to establish a competitive advantage and clarifying the challenges that must be overcome. It is useful for decisions such as where to concentrate the company’s resources or what differentiation strategy to pursue.

To decide whether to enter or exit a business

Five Forces analysis is also a very effective analytical method when deciding whether to enter a new business or exit an existing one.

It allows you to evaluate the profitability and intensity of competition of the industry you are considering entering, in advance.

For example, if entry barriers are high or the threat of substitutes is small, you can judge that the probability of success for a new business is high.

On the other hand, when considering exit from an existing business, analyzing the latent threats the industry holds and its future profitability provides material for an objective and reasonable judgment.

How to conduct a Five Forces analysis [3 steps]

Five Forces analysis is generally conducted in several steps. By going through these steps in order, you can understand the structure of an industry and use it to formulate your strategy.

Step 1: Define the industry to be analyzed

The first step in starting a Five Forces analysis is to clearly define the industry being analyzed.

The results of the analysis vary significantly depending on how broadly you scope the industry.

For example, in the case of a home-appliance manufacturer, you need to carefully set the scope according to your concrete analysis purpose — whether to limit it to the TV industry, include white goods, or capture home appliances as a whole.

If this definition is vague, the information you need to collect becomes unclear, and the results of the analysis may miss the mark.

Step 2: Gather information on the five threats

Next, gather information on the five threats that make up the Five Forces (rivalry within the industry, threat of new entrants, threat of substitutes, bargaining power of buyers, and bargaining power of suppliers) for the defined industry.

At this stage, it is important to collect information based on objective data and facts.

For example, gather information from multiple angles — the number of competitors in the industry, market share, each firm’s strengths and weaknesses, movements of potential new entrants, the state of technical innovation in substitutes, buyer purchasing behavior and bargaining power, and supplier supply structures and pricing power — and use it in your analysis.

Step 3: Derive your strategy from the analysis results

Finally, based on the information gathered, analyze the five threats and derive your company’s strategy from the results. Evaluate how each threat affects your profitability and competitiveness, and understand the profit structure of the industry as a whole.

Based on these analysis results, consider differentiation strategies that leverage your strengths, measures to reinforce your weaknesses, and directions for finding new business opportunities. Rather than stopping at the analysis itself, you can maximize the effect of Five Forces analysis by translating the results into specific action plans and putting them into practice.

Benefits and cautions of Five Forces analysis

Five Forces analysis is a highly effective framework for understanding an industry’s competitive environment and formulating strategy, but its use comes with both benefits and cautions.

Benefits of Five Forces analysis

The benefits of Five Forces analysis are wide-ranging.

First, it makes it possible to clearly grasp the competitive situation and profitability of the industry. This lets you objectively understand how much profit your company could realistically generate and what kinds of risks it bears.

It is also useful for forecasting market risks and opportunities and for setting future business directions.

Another major benefit is that it clarifies your strengths and weaknesses, helping you allocate management resources optimally.

It can also serve as the basis for entry/exit decisions for new businesses, helping to avoid vague management judgments.

Cautions for Five Forces analysis

Five Forces analysis has several cautions.

First, this analysis is a framework used not for analyzing a single “company” but for analyzing the “industry as a whole.”

Also, because analysis results tend to become subjective, it is important to use objective data and to have multiple people work on the analysis.

Ambiguity in the analytical scope can also be a problem, so you must clearly set the scope in advance — for example, how substitutes are defined.

Furthermore, Five Forces analysis is ultimately a tool for organizing the current situation, not something that directly produces a strategy. Keep in mind that you must separately design concrete measures based on the analysis results.

Related frameworks for deeper analysis

Five Forces analysis is effective on its own, but combining it with other frameworks enables deeper, multi-faceted analysis and leads to more accurate strategy formulation.

In particular, by linking it with external- and internal-environment analysis frameworks, you can grasp the current situation from a comprehensive viewpoint and develop concrete strategies for establishing a competitive advantage.

Combination with SWOT analysis

SWOT analysis is a framework that organizes a company’s Strengths, Weaknesses, Opportunities, and Threats.

The “threats” identified through Five Forces analysis can be directly linked to the “Threats” element of SWOT analysis.

In addition, opportunities and risks in the industry that surface through Five Forces analysis can be explored in greater depth as “Opportunities” or “Threats” in the SWOT analysis. This makes it possible to comprehensively evaluate your situation from both external and internal perspectives, and to set a more concrete strategic direction.

Combination with PEST analysis

PEST analysis is a framework for analyzing the macro environment from four perspectives: Politics, Economy, Society, and Technology.

While Five Forces analysis focuses on the micro environment — the factors that directly affect a specific industry or market — PEST analysis captures broader changes in the external environment.

The macro trends and changes identified by PEST analysis may indirectly affect the five threats of Five Forces analysis.

For instance, technological innovation (Technology) can give rise to new substitutes (threat of substitutes).

Combining the two lets you comprehensively analyze the industry environment from both micro and macro perspectives, and build a more robust strategy.

Combination with 3C analysis

3C analysis is a framework that analyzes three elements: Customer, Competitor, and Company.

Information clarified by Five Forces analysis — such as “rivalry among existing competitors,” “bargaining power of buyers,” and “bargaining power of suppliers” — is very helpful when going deeper into the “Customer” and “Competitor” elements of 3C analysis.

For example, if buyer bargaining power turns out to be high, that directly connects to customer understanding in 3C analysis, prompting more detailed analysis of customer needs and purchasing behavior.

Understanding threats from competitors likewise feeds into the competitor side of 3C analysis.

By combining these frameworks, you can derive your strategy from a multi-faceted perspective that covers not only the competitive structure of the industry but also relationships with customers and competitors.

Frequently asked questions

I can’t quite picture the “threat of substitutes.” Are there any examples?

One example is how the rise of smartphones reduced demand for digital cameras and portable music players. These belong to different product categories, but they are “substitutes” that meet customer needs such as “taking photos” and “listening to music” in a different way.

Are there any cautions when conducting Five Forces analysis?

You should mainly be careful about the following points.

• It is an analysis of the “industry as a whole,” not of an individual company.
• To avoid subjective results, use objective data.
• It is only a tool for organizing the current situation; specific action plans must be considered separately.

Summary

Five Forces analysis is a powerful framework for understanding the profit structure and competitive environment of an industry.

Through this analysis, you can objectively evaluate the five threats — rivalry within the industry, new entrants, substitutes, bargaining power of buyers, and bargaining power of suppliers — and clarify your competitive advantages and challenges.

This analysis, which is useful for entry/exit decisions on new and existing businesses, enables deeper insight and more comprehensive strategy formulation when combined with other frameworks such as SWOT analysis, PEST analysis, and 3C analysis.

Please make use of Five Forces analysis in your company’s business strategy, referring to the ideas and concrete steps explained in this article.