How do you Analyse threat of new entrants?

To defend against the threat of new competitors, companies depend on barriers to entry within an industry such as customer loyalty, product differentiation, market share, and cost advantage.

Questions to ask include:

• How easy is it for new companies to enter the market?
• Do incumbents have advantages? in price? brand loyalty? materials? location? experience?
• Are there technological barriers to entry?
• Are size and economies of scale important?
• How do capital requirements & switching costs influence market entry?
• Does government policy play a role?
• Are distribution channels open or closed?

Porter's Five Forces is a simple but powerful tool that you can use to identify the main sources of competition in your industry or sector.

When you understand the forces affecting your industry, you'll be able to adjust your strategy, boost your profitability, and stay ahead of the competition. For example, you could take fair advantage of a strong position or improve a weak one, and avoid taking wrong steps in the future.

In this article and video, we explore each of Porter's Five Forces and show you how to use them to analyze your organization's strengths and weaknesses, and how to identify critical factors that may affect your profitability.

Who Created the Porter's Five Forces Model?

The tool was created by Harvard Business School professor Michael Porter, to analyze an industry's attractiveness and its potential profitability. Since its publication in 1979, it has become one of the most popular and highly regarded business strategy tools.

Porter recognized that organizations like to keep a close watch on their rivals, but, in his Harvard Business Review article, 'How Competitive Forces Shape Strategy,' he encouraged them to look beyond the actions of their competitors and examine the forces at work in their wider business environment. [1]

What Are Porter's Five Forces?

According to Porter, there are five forces that represent the key sources of competitive pressure within an industry. They are:

1. Competitive Rivalry.
2. Supplier Power.
3. Buyer Power.
4. Threat of Substitution.
5. Threat of New Entry.

And he described them in his later article, 'The Five Competitive Forces That Shape Strategy.' [2]

He stressed that it's important not to confuse these five forces with more fleeting factors, such as industry growth rates, government interventions, and technological innovations. According to Porter, the latter are examples of temporary factors, while the Five Forces are permanent parts of an industry's structure.

Let's take a look at Porter's Five Forces in more detail:

1. Competitive Rivalry

The first of Porter's Five Forces looks at the number and strength of your competitors. How many rivals do you have? Who are they, and how does the quality of their products and services compare with yours?

In an industry where rivalry is intense, companies attract customers by aggressively cutting prices and launching high-impact marketing campaigns. However, this can make it easy for suppliers and buyers to go elsewhere if they feel that they're not getting a good deal from you.

On the other hand, where competitive rivalry is minimal, and no one else is doing what you do, then you'll likely have tremendous competitor power, as well as healthy profits.

Note that Michael Porter developed his Four Corners Model all about competitor behavior, and you can find out more about that in our related article.

2. Supplier Power

Supplier power is determined by how easy it is for your suppliers to increase their prices. How many potential suppliers do you have? How unique is the product or service that they provide? And how expensive would it be to switch from one supplier to another?

The more suppliers you have to choose from, the easier it will be to switch to a cheaper alternative. Conversely, the fewer suppliers there are and the more you rely on them for help, the stronger their position and their ability to charge you more is. This can impact your profitability, for example, if you're forced into expensive contracts.

3. Buyer Power

If the number of buyers is low compared to the number of suppliers in an industry, then they have what's known as "buyer power." This means they likely find it easy to switch to new, cheaper competitors, which can ultimately drive down prices.

Think about how many buyers you have. How big are their orders? How much would it cost them to switch from your products and services to those of a rival? Are your buyers strong enough to dictate terms to you?

When you deal with only a few savvy customers, they have more power. However, your power increases if you have many customers and little competition.

Judging how to price your product to attract the customers you want, and to protect your brand, requires great skill. Find out more in our article about Kotler's Pricing Strategies.

4. Threat of Substitution

This refers to the likelihood of your customers finding a different way of doing what you do. For example, if you supply a unique software product that automates an important process, people may substitute it by doing the process manually or by outsourcing it.

A substitution that's easy and cheap to make can weaken your position and threaten your profitability.

5. Threat of New Entry

Your position can be affected by people's ability to enter your market. If it takes little money and effort to enter your market and compete effectively, or if you have little protection for your key technologies, then rivals can quickly enter your market and weaken your position.

However, if you have strong and durable barriers to entry, then you can preserve a favorable position and take fair advantage of it.

Is it relatively easy for a new competitor to gain a foothold in your industry or market? How much would it cost, and how tightly is your sector regulated? Do new entrants come and go regularly? Or is the industry dominated by a few, big players?

How to Use Porter's Five Forces Model

Porter's Five Forces Model can help you to analyze the attractiveness of a particularly industry, assess investment options, and measure competition intensity.

To use the model, start by looking at each of the five forces in turn, and how they apply in your industry. Ask yourself the following questions:

• Is rivalry between competitors intense or do you tend to retain customers relatively easily?
• Do you have lots of suppliers to choose from or do you rely heavily on a small group of suppliers?
• Is buyer power high or low?
• Would buyers find it easy to substitute your product or service?
• Do new competitors find it easy to enter the market or is it difficult?

After you've considered these questions, write down each of the five forces, and summarize the size and scale of each using your findings. An easy way of doing this is to use a single "+" sign for a force that's moderately in your favor, or a "-" sign for a force that's moderately against you. Use "++" for a force that's strongly in your favor, or "--" for one that's strongly against. For a neutral force, you can use "o."

Finally, think about how your analysis will likely impact you. Bear in mind that few situations are perfect – but analyzing your industry using Porter's Five Forces can help you to think through what you could change to improve your competitive position and increase your profitability.

What's more, if you find yourself in a structurally weak position, the model can help you to think about what you can do to move into a stronger one.

Video of How to Use Porter's Five Forces. Click here to view a transcript.

Porter's Five Forces Template and Example

Subscribed members of the Mind Tools Club and enterprise licensees of Mind Tools for Business can access our downloadable template and worked example by logging in to their account and reloading this page.

The template helps makes it easier to visualize the five forces and how they act, positively or negatively, and to record your research findings and analysis. Laying out your thinking in this way can clarify decisions and suggest where you need to invest more time and effort.

Our worked example is based around a fictitious business owner called Martin. He is deciding whether to switch his focus to something in agriculture – he likes the idea of hands-on work, in a rural environment, supplying people with something they really need. He carries out a Five Forces analysis to help him decide whether to buy a farm and start a new enterprise. And meets some surprises!

(With thanks to Harvard Business Review for permission to adapt the relevant diagram, copyright © 1979 by the Harvard Business School Publishing Corporation; all rights reserved.)

Criticism of Porter's Five Forces Model

Despite its enduring popularity, Porter's Five Forces Model has come in for considerable criticism in recent years. You can read more about this is in Isabelle et al's 2020 article, 'Is Porter's Five Forces Still Relevant?' [3] but the main argument is as follows.

Michael Porter's model was devised during the 1980s which was largely a period of:

• Strong competition.
• Relative market stability.
• Steady technological change.

Today, however, technological advances have revolutionized the way in which we do business – and the speed at which we do it. Indeed, according to business academic and consultant, Richard D'aveni, many organizations now operate in a "hypercompetitive" environment, where they need to be consistently dynamic, relentless and aggressive in order to stay on top.[4] This can lead to a constant state of flux and market instability.

In an ever-shifting business environment such as this, many believe that the rather inflexible Five Forces Model is of little help in anticipating what lies ahead or where competitive advantage can be gained.

There are also economists and strategists who believe that the attractiveness of an industry cannot be assessed without considering the resources that the organization brings to that industry as well. This would suggest that it's best to use the Five Forces approach alongside an "inside out" or "resource-based" view of the organization, where competitive advantage is derived from leveraging resources and competences within the organization.

You could do this by assessing the strengths and weaknesses of your own business, using tools such as USP Analysis, Core Competencies Analysis or VRIO Analysis.

For even more information on this tool, and on Michael Porter's approaches to competitive analysis, read his book, "Competitive Strategy: Techniques for Analyzing Industries and Competitors." [5]

Michael Porter's Five Forces model is an important tool for understanding the main competitive forces at work in an industry. This can help you to assess the attractiveness of an industry, and pinpoint areas where you can adjust your strategy to improve profitability.

According to Porter, the five permanent forces that can impact the competitiveness of an industry are:

1. Competitive Rivalry: the strength of competition in the industry.
2. Supplier Power: the ability of suppliers to drive up the prices of your inputs or raw materials.
3. Buyer Power: the strength of your customers to drive down your prices.
4. Threat of Substitution: the extent to which different products and services can be used in place of your own.
5. Threat of New Entry: the ease with which new competitors can enter the market (and potentially drive down your prices).

By thinking about how each force affects your organization, and by identifying the strength and direction of each force, you can quickly assess your competitive position.

You can then look at what strategic changes you need to make to deliver long-term profit.