Porter’s Five Forces: Definition, Model & Analysis

This is a Valuation Master Class student essay by Lim Lee Bin from May 20, 2018. Lee Bin wrote this essay in Module 4 and has since completed all five modules of the Valuation Master Class.

Porter’s Five Forces is a framework developed by Harvard Business School professor Michael Porter that identifies five competitive forces shaping every industry’s profitability: the threat of new entrants, the threat of substitutes, competitive rivalry, the bargaining power of suppliers, and the bargaining power of buyers. First published in 1979 and refined in his landmark 2008 Harvard Business Review article, this model remains the most widely used tool for industry analysis in business strategy, investment research, and company valuation.

Understanding these five forces helps analysts and investors determine whether an industry is structurally attractive, meaning companies within it can earn sustained returns above their cost of capital, or structurally challenged, where competition erodes profitability over time.

In this guide, you will learn what each of the five forces means, how they interact, how to apply the framework in a practical industry analysis, and how Porter’s Five Forces connects to stock valuation and investment decision-making.=

Why Is Porter’s Five Forces Important for Strategy?

The real point of the competition is not to beat your rivals, but to earn profits. To produce better P&L, an organization needs to have a well-thought-out strategy in place, so when facing competition, they will be able to achieve superior performance.  A popular starting point to formulate a strategy is by using Porter’s five forces analysis.

Porter’s five forces are based on the insight that a corporate strategy should meet the opportunities and threats in the organization’s external environment. Porter has identified five competitive forces that shape every industry and every market. These forces determine the intensity of competition and hence the profitability and the attractiveness of an industry. Understanding these five forces, it allows the organization to reshape itself to beat the average industry profit. In order to do that, Porter suggests the following:

1. Position the company where the forces are the weakest.
2. Exploit changes in the forces.
3. Reshape the forces in your favor.

For investors and analysts, Porter’s Five Forces serves a dual purpose. Beyond informing corporate strategy, it provides a systematic way to evaluate industry attractiveness before committing capital. An analyst performing a DCF valuation needs to make assumptions about future revenue growth, profit margins, and reinvestment requirements, all of which depend heavily on the competitive dynamics Porter’s framework reveals.

For example, an industry where all five forces are weak (high barriers to entry, few substitutes, mild rivalry, fragmented suppliers, dispersed buyers) tends to generate above-average returns on invested capital. Think of enterprise software, credit rating agencies, or defense contractors. Conversely, an industry where multiple forces are strong, such as airlines or commodity chemicals, typically destroys shareholder value over time, regardless of management quality.

What Are Porter’s Five Forces?

1. Threat of Entry
2. Threat of Substitutes
3. Rivalry Among Existing Competitors
4. Power of Suppliers
5. Power of Buyers

Force	What It Measures	Impact When Strong
Threat of New Entrants	How easily new competitors can enter the industry	Caps prices and increases costs for incumbents
Threat of Substitutes	Availability of alternative products or services	Limits pricing power and compresses margins
Competitive Rivalry	Intensity of competition among existing firms	Drives down prices and increases marketing/R&D spend
Bargaining Power of Suppliers	Leverage suppliers have over industry participants	Increases input costs and reduces industry margins
Bargaining Power of Buyers	Leverage customers have over industry participants	Forces prices down or demands more value

Each force has a clear, direct, and predictable relationship to industry profitability. The general rule is: the more powerful the forces, the more pressure on prices and costs, and the lower the industry’s profit potential.

1. Threat of Entry

The threat of entry dampens profitability in two ways. It caps prices because higher industry prices would make entry more attractive to newcomers. At the same time, incumbents typically have to spend more to satisfy their customers. Furthermore, new entries to an industry often bring new capacity and the desire to gain market share, often with substantial resources. Sometimes this might cause a shakeup in the industry, especially from those entrants who have enormous resources. The gravity of the threat of entry depends on the current barriers to entry and the reaction from existing competitors that the entrants can expect. If the threat of entry is high, profitability will drop because prices are lower and costs go up.

With reference to “The five competitive forces that shape strategy,” Porter states that there are seven major sources of barriers to entry, namely:

1. Supply-side economies of scale
2. Demand-side benefits of scale
3. Customer switching costs
4. Capital requirements
5. Incumbency advantages are independent of size
6. Unequal access to distribution channels
7. Restrictive government policy

To scare off new entrants, the industry can elevate the fixed costs of competing; for instance, by escalating the R&D expenditures.

2. Threat of Substitutes

Investopedia.com defines substitutes as a product or service that a consumer sees as the same or similar to another product, and also defines price elasticity as the percentage change in quantity demanded divided by the percentage change in price. Substitutes impact the product’s price elasticity. When more substitutes become available, demand becomes more elastic as customers have more alternatives. This places a limit on the industry’s profitability. If the threat of substitutes is high, profitability will be lower because costs have gone up.

In reference to “The five competitive forces that shape strategy,” Porter states that the threat of a substitute is high if:

1. It offers an attractive price-performance trade-off for the industry’s product.
2. The buyer’s costs of switching to the substitute are low.

If an industry did not differentiate itself from the substitute, it would suffer in terms of profitability and often also growth potential. To limit the threat of substitutes, the industry should offer better value through wider product accessibility.

3. Rivalry Among Existing Competitors

In the traditional economic model, competition among rival firms drives profit to zero. The degree to which rivalry drives down an industry’s profit depends, first, on the intensity with which companies compete and, second, on the basis on which they compete. It will be destructive to profitability if the competition is solely focusing on price because price competition transfers profits directly from an industry to its customers. If the rivalry among existing competitors is intense, profitability will drop because prices will be lower and costs will go up.

With reference to “The five competitive forces that shape strategy,” Porter states that the intensity of rivalry is greatest if:

1. Competitors are numerous or are roughly equal in size and power.
2. Industry growth is slow.
3. Exit barriers are high.
4. Rivals are highly committed to the business and have aspirations for leadership.

To temper price wars initiated by established rivals, invest more heavily in products that differ significantly from competitors’ offerings.

4. Power of Suppliers

A producing industry requires raw materials, e.g., labor, components, and other supplies. Powerful suppliers will use their negotiating leverage to charge higher prices or insist on more favorable terms. In either case, it will lower industry profitability.

In reference to “The five competitive forces that shape strategy,” Porter states that a supplier group is powerful if:

1. It is more concentrated than the industry it sells to.
2. The supplier group does not depend heavily on the industry for its revenues.
3. Industry participants face switching costs when changing suppliers.
4. Suppliers offer products that are differentiated.
5. There is no substitute for what the supplier group provides.
6. The supplier group can credibly threaten to integrate forward into the industry.

To neutralize supplier power, standardize specifications for parts so that the company can switch more easily among vendors.

5. Power of Buyers

When the buyer power is strong, the industry is nearing what economist defines as a monopsony, a market situation in which there is only one buyer. Under such market conditions, the buyer sets the price and has the negotiating leverage relative to industry participants. A powerful buyer will force prices down or demand more value in the product, thus capturing more of the value for themselves.

With reference to “The five competitive forces that shape strategy,” Porter states that buyers are powerful if:

1. There are a few buyers, each of whom purchases in volumes that are large relative to the size of a single vendor.
2. The industry’s products are standardized or undifferentiated.
3. Buyers face few switching costs in changing vendors.
4. Buyers can credibly threaten to integrate backward and produce the industry’s product themselves if vendors are too profitable.

To counter buyer power, expand the services so that it will be harder for customers to leave for a rival.

Porter’s Five Forces Are Not Static but Dynamic

In this fast-changing world, industry structures keep changing, causing all the forces to shift over time, impacting industry profitability. Over time, buyers or suppliers can become more or less powerful. Managerial or technological innovations can cause new entry or substitution to increase or decrease. The choices managers make, or regulation changes, can influence the intensity of rivalry. Industry forces are not static but dynamic. Changes will happen in every industry; the better the understanding of the industry structure, the easier it is for one to identify changes and to exploit new strategic opportunities.

How to Conduct a Porter’s Five Forces Analysis: Step by Step

Whether you are an equity research analyst evaluating a new coverage universe, a finance student preparing for a case competition, or a corporate strategist assessing your competitive position, following a structured process ensures your Porter’s analysis is rigorous and actionable.

Step 1: Define the Industry Boundaries

Before analyzing forces, clearly define the industry you are assessing. This is more nuanced than it appears. “Technology” is too broad; “enterprise cloud infrastructure” is specific enough to produce meaningful conclusions. The right level of granularity matches the scope of your investment or strategic decision.

Ask yourself: which companies compete directly for the same customer dollar? That is your industry boundary.

Step 2: Assess Each Force Systematically

Work through all five forces one at a time. For each force, gather evidence:

• Threat of entry: What are the capital requirements? Are there regulatory barriers? How strong are brand advantages? Rate the force as low, moderate, or high.
• Threat of substitutes: What alternatives exist? How do they compare on price and performance? Is switching easy?
• Competitive rivalry: How many direct competitors exist? Is the market growing or stagnant? Is competition primarily on price or differentiation?
• Supplier power: How concentrated is the supply base? Are inputs commoditized or specialized? Can suppliers forward-integrate?
• Buyer power: How concentrated are customers? Is the product differentiated? Can buyers backward-integrate?

Step 3: Rate the Overall Industry Attractiveness

After assessing each force individually, synthesize your findings. An industry with mostly weak forces is structurally attractive; companies within it can generate strong returns over time. An industry with mostly strong forces will be structurally challenging.

Create a simple summary table:

Force	Rating	Key Evidence
Threat of Entry	Low / Moderate / High	[Your reasoning]
Threat of Substitutes	Low / Moderate / High	[Your reasoning]
Competitive Rivalry	Low / Moderate / High	[Your reasoning]
Supplier Power	Low / Moderate / High	[Your reasoning]
Buyer Power	Low / Moderate / High	[Your reasoning]
Overall Attractiveness	Attractive / Neutral / Unattractive

Step 4: Connect to Valuation Assumptions

This is the step most analysts skip, and it is the most valuable. Your Porter’s analysis should directly inform the financial assumptions in your valuation model.

Five Forces Finding	Valuation Impact
High barriers to entry	Supports higher long-term margins in your forecast
Intense rivalry	Compress margin assumptions; increase marketing cost estimates
Powerful suppliers	Higher cost of goods sold assumptions
Powerful buyers	Lower pricing growth; potential margin squeeze
High substitution threat	More conservative revenue growth rate

If you are building a DCF valuation, these findings affect your revenue growth rate, operating margin assumptions, reinvestment needs, and even the terminal growth rate. Understanding which valuation method is most suitable for a given company also depends on the competitive dynamics you uncover through Porter’s framework.

Step 5: Monitor for Structural Changes

As noted earlier, industry forces are dynamic. Aswath Damodaran’s approach to equity valuation emphasizes that competitive advantages erode over time. Set a schedule to revisit your five forces analysis, at a minimum annually, or whenever a major industry event occurs (new regulation, technological disruption, major M&A activity).

Porter’s Five Forces in Action: Real-World Example

To see how Porter’s Five Forces works in practice, consider the global beverage industry, a sector VMC has analyzed in depth through case studies of companies like Coca-Cola and PepsiCo.

Force	Beverage Industry Assessment
Threat of Entry	Low — enormous capital requirements for distribution, bottling, and brand building create high barriers
Threat of Substitutes	Moderate — water, coffee, energy drinks, and health beverages offer alternatives, but brand loyalty is strong
Competitive Rivalry	High — Coca-Cola and PepsiCo compete intensely on marketing but avoid destructive price wars in most markets
Supplier Power	Low — inputs (sugar, water, packaging) are commoditized with many suppliers
Buyer Power	Moderate — large retailers (Walmart, Costco) have negotiating leverage, but end consumers have limited power
Overall	Attractive — strong barriers to entry and weak supplier power offset moderate-to-high rivalry

This structural analysis explains why Coca-Cola and PepsiCo have maintained high returns on invested capital for decades. An analyst building a valuation model for either company can confidently assume durable margins, a conclusion that flows directly from the five forces analysis.

Common Mistakes When Using Porter’s Five Forces

Even experienced analysts make errors when applying the five forces framework. Avoid these pitfalls to produce more reliable industry assessments.

Mistake 1: Confusing Industry Analysis with Company Analysis

Porter’s Five Forces analyzes an industry, not a single company. A common error is evaluating whether a specific firm is strong or weak rather than assessing the structural forces acting on all participants. The framework tells you about the playing field, not who is winning on it.

Mistake 2: Treating the Analysis as Static

Running a five forces analysis once and never updating it defeats the purpose. Industry structures evolve as technology changes, regulation shifts, and new business models emerge. The airline industry looked very different before deregulation; the media industry transformed with the rise of streaming. Regular reassessment is essential.

Mistake 3: Ignoring Force Interactions

The five forces do not operate in isolation. Strong buyer power can amplify the effects of intense rivalry; if customers can easily compare prices and switch providers, competitors are incentivized to undercut each other. Analyzing forces independently without considering their interactions produces an incomplete picture.

Mistake 4: Defining the Industry Too Broadly or Too Narrowly

If your industry definition is too broad (“financial services”), the analysis becomes meaningless because the forces differ dramatically across sub-sectors. If it is too narrow (“artisanal ice cream in Brooklyn”), the analysis lacks strategic utility. The right scope matches the competitive arena in which your company actually operates.

Mistake 5: Not Connecting the Analysis to Financial Projections

The most impactful mistake for valuation professionals: conducting a thorough five forces analysis and then ignoring it when building the financial model. Every force should translate into a specific assumption about revenue growth, margins, capital expenditure, or risk. If your Porter’s analysis does not change a single number in your model, it was an academic exercise, not an analytical tool.

Why Does Porter’s Five Forces Matter for Investors?

Porter’s Five Forces is not just an academic framework studied in MBA classrooms; it is a practical analytical tool used daily by equity analysts, investment bankers, and portfolio managers to assess the fundamental attractiveness of industries and the companies within them.

For investors, the framework answers a critical question: can this company sustain its current profitability, or will competitive forces erode its margins over time? A company operating in an industry with weak competitive forces (high barriers, limited substitutes, fragmented buyers and suppliers) has structural protection for its margins. A company in an industry with strong forces must continuously out-execute competitors just to maintain its returns.

When valuing cyclical companies, Porter’s analysis is especially important. Cyclical industries often see competitive forces shift dramatically across the business cycle. Rivalry intensifies during downturns as firms fight for shrinking demand, while entry threats increase during boom periods as high profits attract newcomers.

The most effective analysts integrate Porter’s Five Forces analysis into every stage of their valuation work, from industry screening to financial modeling to investment recommendation. By mastering this framework alongside quantitative valuation methods, you build the complete toolkit that separates capable analysts from exceptional ones.

Frequently Asked Questions

What is Porter’s Five Forces model?

Porter’s Five Forces is a strategic analysis framework created by Harvard professor Michael Porter that evaluates five competitive forces shaping industry profitability: the threat of new entrants, the threat of substitutes, competitive rivalry among existing firms, the bargaining power of suppliers, and the bargaining power of buyers. Analysts, strategists, and investors use it to determine whether an industry is structurally attractive or unattractive for generating sustained returns.

What is the purpose of Porter’s Five Forces analysis?

The purpose of Porter’s Five Forces analysis is to understand the competitive structure of an industry and assess its long-term profit potential. Rather than focusing on individual competitors, the framework examines the underlying economic forces that determine whether companies in an industry can earn returns above their cost of capital. It helps strategists position their company advantageously and helps investors evaluate industry risk.

How do Porter’s Five Forces affect company valuation?

Porter’s Five Forces directly impact valuation assumptions in financial models. Industries with weak competitive forces (high barriers to entry, limited substitutes) support higher margin forecasts and growth projections. Industries with strong forces require more conservative assumptions. Specifically, an analyst might lower revenue growth estimates when buyer power is high, increase cost assumptions when supplier power is strong, or reduce terminal growth rates when rivalry is intense.

What are examples of Porter’s Five Forces in real industries?

The pharmaceutical industry demonstrates strong barriers to entry (patents, regulatory approval, R&D costs), making it structurally attractive despite moderate buyer power from insurance companies. The airline industry, by contrast, shows high rivalry, low switching costs for buyers, and moderate substitute threats (trains, video conferencing), explaining chronically low industry returns. The global beverage industry sits in between, with strong barriers protecting established players like Coca-Cola and PepsiCo.

How is Porter’s Five Forces different from SWOT analysis?

Porter’s Five Forces analyzes external industry structure, forces that affect all companies in an industry equally. SWOT analysis evaluates a single company’s internal strengths and weaknesses alongside external opportunities and threats. The two frameworks are complementary: use Porter’s Five Forces to understand the industry playing field, then use SWOT to assess how a specific company is positioned within that field. For valuation purposes, Porter’s framework is more directly useful because it informs industry-level assumptions in financial models.

Can Porter’s Five Forces change over time?

Yes, industry structures are dynamic, not static. Technology disruption, regulatory changes, and shifts in consumer behavior can strengthen or weaken any of the five forces. For example, the internet dramatically reduced barriers to entry in retail (weakening incumbents’ position) while also increasing buyer power by making price comparison effortless. Effective analysts reassess the five forces regularly, especially when building long-term valuation forecasts that depend on assumptions about competitive dynamics years into the future.

What is the best business valuation course to learn frameworks like Porter’s Five Forces?

Valuation Master Class is an online business valuation course designed by Dr. Andrew Stotz, a former top-ranked equity analyst. The program teaches practical valuation methods, including industry analysis frameworks like Porter’s Five Forces, through real company case studies. Whether you are a career starter, an experienced professional, or switching into finance, the course builds the skills analysts use in practice.