The Five Forces

Threat of New Entrants

The threat of new entrants into an industry can force current players to keep prices down and spend more to retain customers. Actually, entry brings new capacity and pressure on prices and costs. The threat of entry, therefore, puts a cap on the profit potential of an industry. This threat depends on the size of a series of barriers to entry, including economies of scale, to the cost of building brand awareness, to accessing distribution channels, to government restrictions.

The threat of entry also depends on the capabilities of the likely potential entrants. If there are well established companies in the industry operating in other geographic regions, for example, the threat of entry rises.

Bargaining Power of Suppliers

Companies in every industry purchase various inputs from suppliers, which account for differing proportions of cost. Powerful suppliers can use their negotiating leverage to charge higher prices or demand more favorable terms from industry competitors, which lowers industry profitability. If there are only one or two suppliers of an essential input product, for example, or if switching suppliers is expensive or time consuming, a supplier group wields more power.

Bargaining Power of Buyers

Powerful customers can use their clout to force prices down or demand more service at existing prices, thus capturing more value for themselves. Buyer power is highest when buyers are large relative to the competitors serving them, products are undifferentiated and represent a significant cost for the buyer, and there are few switching costs to shifting business from one competitor to another. They can play rivals against each other—especially if an industry’s products are undifferentiated, it’s inexpensive to switch loyalties, and price trumps quality.

There may be multiple buyer segments in a given industry with different levels of power.

Threat of Substitute Products
or Services

A substitute is another product or service that meets the same underlying need that the industry’s product meets in a different way. Videoconferencing is a substitute for travel. Email is a substitute for express mail.

The threat of a substitute is high if it offers an attractive price-performance trade-off versus the industry’s product, especially if the buyer’s cost of switching to the substitute is low.

Rivalry Among Existing Competitors

If rivalry is intense, it drives down prices or dissipates profits by raising the cost of competing. Companies compete away the value they create. Rivalry tends to be especially fierce if: