Sachin Rekhi

When I mention Porter's Five Forces Analysis, which is one of Michael Porter's most famous strategy frameworks, some product managers remember learning about it during business school, but most haven't used it since. Given this, I wanted to provide a refresher on the framework and when its most useful, as I do think it continues to have application to today's product managers.

Porter's core thesis behind his Five Forces Analysis is that an industry's structure will determine how the economic value created by an industry is divided amongst the companies in the industry versus it's customers, suppliers, substitutes, and potential new entrants. Understanding an industry's structure will help you understand the average profitability of firm's in the industry and therefore its attractiveness.

The Five Forces
Five unique forces determine each industry's structure. The more powerful each force is, the more pressure it will put on prices or costs or both, thereby reducing average profitability.

1) Rivalry amongst existing competitors - Competitors are always eager to try to steal market share from other players. The greater the number of industry competitors as well as the greater the intensity of rivalry amongst competitors, the more the value the company generates gets competed away, either passed to buyers in lower prices or dissipated away in higher costs of competing. When there is high rivalry amongst competitors, profitability is lower as prices fall and costs increase. Price wars in particular tend to be the most value destructive and quickly become a race to the bottom.

2) Bargaining power of buyers - Customers are always happier to pay less for products and get more for their money. When buyers are powerful, they will force prices down or demand more value in the product, thus capturing more of the value for themselves. If buyer power is high, profitability is lower because prices are lower and costs are driven up. Buyers are powerful if they are large and concentrated relative to a fragmented industry.

3) Bargaining power of suppliers - Suppliers are always happier to be paid more or to deliver less. Therefore powerful suppliers will charge higher prices or insist on more favorable terms. If supplier power is high, profitability will be lower due to the increased cost of suppliers. If switching cost is high for a supplier or if there are few alternative suppliers, supplier power will be high.

4) Threat of substitution - Substitutes, which are products that meet the same basic need as the industry's product but in a different way, limit how much you can charge. If substitutes are high, profitability is lower because prices are lower and costs are higher. To asses the threat of substitutes, it's helpful to investigate whether they offer an attractive price-performance trade-off relative to the industry's product.

5) Threat of new entrants - Threat of new entrants ultimately limits how much you can charge for your product. Entry barriers protect an industry from newcomers who would add new capacity. If threat of entry is high, profitability is lower because prices are lower and costs are higher. The most common entry barriers in an industry are economies of scale, switching costs, network effects, capital investments, proprietary technology, well-established brands, prime locations, access to distribution channels, or government regulation.

Applying Five Forces
There a two primary ways to apply Five Forces Analysis. The first is to use it as a tool to understand a given industry's attractiveness. For example, companies and investors deciding whether to exit, enter, or invest in an industry find the tool hugely valuable. For product managers, this use case might apply when you are working on new product innovation and trying to decide if a potential market for a new product is worth pursuing. Similarly, when you are looking to expand your existing product into a new market or new use case, this analysis can also help you asses the attractiveness of those options.

To use the framework for this purpose, follow these steps:

1) Define the relevant industry for analysis. This isn't as simple as it seems because you'll need to decide what products & services are in scope as well as what geographies are within the relevant market. You don't want to define the market too broadly as you'll typically find that the forces differ substantially in different markets, limiting the value of the analysis.

2) Identify the players constituting each of the five forces. You may ultimately divide those players into sub-segments if the industry is large enough.

3) Assess the power of each of the five forces. Here you're looking to understand the strength of each force relative to the industry incumbents.

4) Step back and assess which forces ultimately control profitability. You'll typically find an overarching force that is driving the lion share of profitability in the industry.

The second use of Five Forces Analysis for product managers is to brainstorm a host of potential actions you can take to improve your own product strategy within the industry. While the industry structure determines the profitability of the average firm in the industry, your own relative profitability in the industry will depend on your your own strategic positioning and competitive advantage.

To leverage Five Forces Analysis to help improve your strategy, you are looking to build defenses against the competitive forces or find a position in the industry where the forces are weakest. To find these opportunities, you would ask yourself the following questions after you've conducted the basis analysis.

1) What limiting factors must be overcome to capture more of the value you create?

2) Can you position your company where the forces are weakest?

3) What's changing in the industry structure and how can you take advantage of that change?

Next time you find yourself looking to improve your product's strategic position or are putting together a strategy for a new market opportunity, I'd encourage you to take advantage of Porter's Five Forces Analysis.