Question:? Generate a response to each peer discussion. Each response may include information from the text, handouts (attach

Awareness of the fi ve forces can help a company understand the structure of its industry and stake out a position that is more profi table and less vulnerable to attack.

78 Harvard Business Review | January 2008 | hbr.org

1808 Porter.indd 781808 Porter.indd 78 12/5/07 5:33:57 PM12/5/07 5:33:57 PM

P e

te r

C ro

w th

e r

Editor’s Note: In 1979, Harvard Business Review published “How Competitive Forces Shape Strat-

egy” by a young economist and associate professor,

Michael E. Porter. It was his fi rst HBR article, and it

started a revolution in the strategy fi eld. In subsequent

decades, Porter has brought his signature economic

rigor to the study of competitive strategy for corpora-

tions, regions, nations, and, more recently, health care

and philanthropy. “Porter’s fi ve forces” have shaped a

generation of academic research and business practice.

With prodding and assistance from Harvard Business

School Professor Jan Rivkin and longtime colleague

Joan Magretta, Porter here reaffi rms, updates, and

extends the classic work. He also addresses common

misunderstandings, provides practical guidance for

users of the framework, and offers a deeper view of

its implications for strategy today.

THE FIVE COMPETITIVE FORCES THAT

by Michael E. Porter

hbr.org | January 2008 | Harvard Business Review 79

SHAPE

IN ESSENCE, the job of the strategist is to under-

STRATEGYSTRATEGY stand and cope with competition. Often, however,

managers defi ne competition too narrowly, as if

it occurred only among today’s direct competi-

tors. Yet competition for profi ts goes beyond es-

tablished industry rivals to include four other

competitive forces as well: customers, suppliers,

potential entrants, and substitute products. The

extended rivalry that results from all fi ve forces

defi nes an industry’s structure and shapes the

nature of competitive interaction within an

industry.

As different from one another as industries

might appear on the surface, the underlying driv-

ers of profi tability are the same. The global auto

industry, for instance, appears to have nothing

in common with the worldwide market for art

masterpieces or the heavily regulated health-care

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LEADERSHIP AND STRATEGY | The Five Competitive Forces That Shape Strategy

80 Harvard Business Review | January 2008 | hbr.org

delivery industry in Europe. But to under-

stand industry competition and profi tabil-

ity in each of those three cases, one must

analyze the industry’s underlying struc-

ture in terms of the fi ve forces. (See the ex-

hibit “The Five Forces That Shape Industry

Competition.”)

If the forces are intense, as they are in

such industries as airlines, textiles, and ho-

tels, almost no company earns attractive re-

turns on investment. If the forces are benign,

as they are in industries such as software,

soft drinks, and toiletries, many companies

are profi table. Industry structure drives

competition and profi tability, not whether

an industry produces a product or service, is

emerging or mature, high tech or low tech,

regulated or unregulated. While a myriad

of factors can affect industry profi tability

in the short run – including the weather

and the business cycle – industry structure,

manifested in the competitive forces, sets

industry profi tability in the medium and

long run. (See the exhibit “Differences in

Industry Profi tability.”)

Understanding the competitive forces, and their under-

lying causes, reveals the roots of an industry’s current profi t-

ability while providing a framework for anticipating and

infl uencing competition (and profi tability) over time. A

healthy industry structure should be as much a competitive

concern to strategists as their company’s own position. Un-

derstanding industry structure is also essential to effective

strategic positioning. As we will see, defending against the

competitive forces and shaping them in a company’s favor

are crucial to strategy.

Forces That Shape Competition The confi guration of the fi ve forces differs by industry. In

the market for commercial aircraft, fi erce rivalry between

dominant producers Airbus and Boeing and the bargain-

ing power of the airlines that place huge orders for aircraft

are strong, while the threat of entry, the threat of substi-

tutes, and the power of suppliers are more benign. In the

movie theater industry, the proliferation of substitute forms

of entertainment and the power of the movie producers

and distributors who supply movies, the critical input, are

important.

The strongest competitive force or forces determine the

profi tability of an industry and become the most important

to strategy formulation. The most salient force, however, is

not always obvious.

For example, even though rivalry is often fi erce in com-

modity industries, it may not be the factor limiting profi t-

ability. Low returns in the photographic fi lm industry, for

instance, are the result of a superior substitute product – as

Kodak and Fuji, the world’s leading producers of photo-

graphic fi lm, learned with the advent of digital photography.

In such a situation, coping with the substitute product be-

comes the number one strategic priority.

Industry structure grows out of a set of economic and

technical characteristics that determine the strength of

each competitive force. We will examine these drivers in the

pages that follow, taking the perspective of an incumbent,

or a company already present in the industry. The analysis

can be readily extended to understand the challenges facing

a potential entrant.

THREAT OF ENTRY. New entrants to an industry bring new capacity and a desire to gain market share that puts

pressure on prices, costs, and the rate of investment nec-

essary to compete. Particularly when new entrants are

diversifying from other markets, they can leverage exist-

ing capabilities and cash fl ows to shake up competition, as

Pepsi did when it entered the bottled water industry, Micro-

soft did when it began to offer internet browsers, and Apple

did when it entered the music distribution business.

Michael E. Porter is the Bishop William Lawrence University Pro-

fessor at Harvard University, based at Harvard Business School in

Boston. He is a six-time McKinsey Award winner, including for his

most recent HBR article, “Strategy and Society,” coauthored with

Mark R. Kramer (December 2006).

The Five Forces That Shape Industry Competition

Bargaining Power of Suppliers

Threat of New

Entrants

Bargaining Power of Buyers

Threat of Substitute Products or

Services

Rivalry Among Existing

Competitors

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hbr.org | January 2008 | Harvard Business Review 81

The threat of entry, therefore, puts a cap on the profi t po-

tential of an industry. When the threat is high, incumbents

must hold down their prices or boost investment to deter

new competitors. In specialty coffee retailing, for example,

relatively low entry barriers mean that Starbucks must in-

vest aggressively in modernizing stores and menus.

The threat of entry in an industry depends on the height

of entry barriers that are present and on the reaction en-

trants can expect from incumbents. If entry barriers are low

and newcomers expect little retaliation from the entrenched

competitors, the threat of entry is high and industry profi t-

ability is moderated. It is the threat of entry, not whether

entry actually occurs, that holds down profi tability.

Barriers to entry. Entry barriers are advantages that incum- bents have relative to new entrants. There are seven major

sources:

1. Supply-side economies of scale. These economies arise

when fi rms that produce at larger volumes enjoy lower costs

per unit because they can spread fi xed costs over more units,

employ more effi cient technology, or command better terms

from suppliers. Supply-side scale economies deter entry by

forcing the aspiring entrant either to come into the industry

on a large scale, which requires dislodging entrenched com-

petitors, or to accept a cost disadvantage.

Scale economies can be found in virtually every activity

in the value chain; which ones are most important varies

by industry. 1 In microprocessors, incumbents such as Intel

are protected by scale economies in research, chip fabrica-

tion, and consumer marketing. For lawn care companies like

Scotts Miracle-Gro, the most important scale economies are

found in the supply chain and media advertising. In small-

package delivery, economies of scale arise in national logisti-

cal systems and information technology.

2. Demand-side benefi ts of scale. These benefi ts, also known

as network effects, arise in industries where a buyer’s willing-

ness to pay for a company’s product increases with the num-

ber of other buyers who also patronize the company. Buyers

may trust larger companies more for a crucial product: Re-

call the old adage that no one ever got fi red for buying from

IBM (when it was the dominant computer maker). Buyers

may also value being in a “network” with a larger number of

fellow customers. For instance, online auction participants

are attracted to eBay because it offers the most potential

trading partners. Demand-side benefi ts of scale discourage

entry by limiting the willingness of customers to buy from a

newcomer and by reducing the price the newcomer can com-

mand until it builds up a large base of customers.

3. Customer switching costs. Switching costs are fi xed costs

that buyers face when they change suppliers. Such costs may

arise because a buyer who switches vendors must, for ex-

ample, alter product specifi cations, retrain employees to use

a new product, or modify processes or information systems.

The larger the switching costs, the harder it will be for an en-

trant to gain customers. Enterprise resource planning (ERP)

software is an example of a product with very high switching

costs. Once a company has installed SAP’s ERP system, for ex-

ample, the costs of moving to a new vendor are astronomical

because of embedded data, the fact that internal processes

have been adapted to SAP, major retraining needs, and the

mission-critical nature of the applications.

4. Capital requirements. The need to invest large fi nan-

cial resources in order to compete can deter new entrants.

Capital may be necessary not only for fi xed facilities but also

to extend customer credit, build inventories, and fund start-

up losses. The barrier is particularly great if the capital is

required for unrecoverable and therefore harder-to-fi nance

expenditures, such as up-front advertising or research and

development. While major corporations have the fi nancial

resources to invade almost any industry, the huge capital

requirements in certain fi elds limit the pool of likely en-

trants. Conversely, in such fi elds as tax preparation services

or short-haul trucking, capital requirements are minimal

and potential entrants plentiful.

It is important not to overstate the degree to which capital

requirements alone deter entry. If industry returns are at-

tractive and are expected to remain so, and if capital markets

are effi cient, investors will provide entrants with the funds

they need. For aspiring air carriers, for instance, fi nancing

is available to purchase expensive aircraft because of their

high resale value, one reason why there have been numer-

ous new airlines in almost every region.

5. Incumbency advantages independent of size. No matter

what their size, incumbents may have cost or quality advan-

tages not available to potential rivals. These advantages can

stem from such sources as proprietary technology, preferen-

tial access to the best raw material sources, preemption of

the most favorable geographic locations, established brand

identities, or cumulative experience that has allowed incum-

Industry structure drives competition and profi tability, not whether an industry is emerging or mature, high tech or low tech, regulated or unregulated.

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LEADERSHIP AND STRATEGY | The Five Competitive Forces That Shape Strategy

82 Harvard Business Review | January 2008 | hbr.org

bents to learn how to produce more effi ciently. Entrants try

to bypass such advantages. Upstart discounters such as Tar-

get and Wal-Mart, for example, have located stores in free-

standing sites rather than regional shopping centers where

established department stores were well entrenched.

6. Unequal access to distribution channels. The new en-

trant must, of course, secure distribution of its product or

service. A new food item, for example, must displace others

from the supermarket shelf via price breaks, promotions,

intense selling efforts, or some other means. The more lim-

ited the wholesale or retail channels are and the more that

existing competitors have tied them up, the tougher entry

into an industry will be. Sometimes access to distribution

is so high a barrier that new entrants must bypass distribu-

tion channels altogether or create their own. Thus, upstart

low-cost airlines have avoided distribution through travel

agents (who tend to favor established higher-fare carriers)

and have encouraged passengers to book their own fl ights

on the internet.

7. Restrictive government policy. Government policy can

hinder or aid new entry directly, as well as amplify (or nul-

lify) the other entry barriers. Government directly limits or

even forecloses entry into industries through, for instance,

licensing requirements and restrictions on foreign invest-

ment. Regulated industries like liquor retailing, taxi services,

and airlines are visible examples. Government policy can

heighten other entry barriers through such means as ex-

pansive patenting rules that protect proprietary technol-

ogy from imitation or environmental or safety regulations

that raise scale economies facing newcomers. Of course,

government policies may also make entry easier – directly

through subsidies, for instance, or indirectly by funding ba-

sic research and making it available to all fi rms, new and old,

reducing scale economies.

Entry barriers should be assessed relative to the capa-

bilities of potential entrants, which may be start-ups, foreign

fi rms, or companies in related industries. And, as some of

our examples illustrate, the strategist must be mindful of the

creative ways newcomers might fi nd to circumvent appar-

ent barriers.

Expected retaliation. How potential entrants believe in- cumbents may react will also infl uence their decision to

enter or stay out of an industry. If reaction is vigorous and

protracted enough, the profi t potential of participating in

the industry can fall below the cost of capital. Incumbents

often use public statements and responses to one entrant

to send a message to other prospective entrants about their

commitment to defending market share.

Newcomers are likely to fear expected retaliation if:

Incumbents have previously responded vigorously to

new entrants.

Incumbents possess substantial resources to fi ght back,

including excess cash and unused borrowing power, avail-

•

•

able productive capacity, or clout with distribution channels

and customers.

Incumbents seem likely to cut prices because they are

committed to retaining market share at all costs or because

the industry has high fi xed costs, which create a strong mo-

tivation to drop prices to fi ll excess capacity.

Industry growth is slow so newcomers can gain volume

only by taking it from incumbents.

An analysis of barriers to entry and expected retaliation is

obviously crucial for any company contemplating entry into

a new industry. The challenge is to fi nd ways to surmount

the entry barriers without nullifying, through heavy invest-

ment, the profi tability of participating in the industry.

THE POWER OF SUPPLIERS. Powerful suppliers capture more of the value for themselves by charging higher prices,

limiting quality or services, or shifting costs to industry par-

ticipants. Powerful suppliers, including suppliers of labor,

can squeeze profi tability out of an industry that is unable

to pass on cost increases in its own prices. Microsoft, for in-

stance, has contributed to the erosion of profi tability among

personal computer makers by raising prices on operating

systems. PC makers, competing fi ercely for customers who

can easily switch among them, have limited freedom to raise

their prices accordingly.

Companies depend on a wide range of different supplier

groups for inputs. A supplier group is powerful if:

It is more concentrated than the industry it sells to.

Microsoft’s near monopoly in operating systems, coupled

with the fragmentation of PC assemblers, exemplifi es this

situation.

The supplier group does not depend heavily on the in-

dustry for its revenues. Suppliers serving many industries

will not hesitate to extract maximum profi ts from each one.

If a particular industry accounts for a large portion of a sup-

plier group’s volume or profi t, however, suppliers will want

to protect the industry through reasonable pricing and as-

sist in activities such as R&D and lobbying.

Industry participants face switching costs in changing

suppliers. For example, shifting suppliers is diffi cult if com-

panies have invested heavily in specialized ancillary equip-

•

•

•

•

•

Differences in Industry Profi tability

The average return on invested capital varies markedly from industry to industry. Between 1992 and 2006, for example, average return on invested capital in U.S. industries ranged as low as zero or even negative to more than 50%. At the high end are industries like soft drinks and prepackaged software, which have been almost six times more profi table than the airline industry over the period.

1808 Porter.indd 821808 Porter.indd 82 12/5/07 5:34:24 PM12/5/07 5:34:24 PM

hbr.org | January 2008 | Harvard Business Review 83

ment or in learning how to operate a supplier’s equipment

(as with Bloomberg terminals used by fi nancial profession-

als). Or fi rms may have located their production lines adja-

cent to a supplier’s manufacturing facilities (as in the case

of some beverage companies and container manufacturers).

When switching costs are high, industry participants fi nd it

hard to play suppliers off against one another. (Note that

suppliers may have switching costs as well. This limits their

power.)

Suppliers offer products that are differentiated. Phar-

maceutical companies that offer patented drugs with dis-

tinctive medical benefi ts have more power over hospitals,

health maintenance organizations, and other drug buyers,

for example, than drug companies offering me-too or ge-

neric products.

There is no substitute for what the supplier group pro-

vides. Pilots’ unions, for example, exercise considerable sup-

plier power over airlines partly because there is no good

alternative to a well-trained pilot in the cockpit.

The supplier group can credibly threaten to integrate for-

ward into the industry. In that case, if industry participants

make too much money relative to suppliers, they will induce

suppliers to enter the market.

•

•

•

THE POWER OF BUYERS. Powerful customers – the fl ip side of powerful suppliers – can capture more value by forc-

ing down prices, demanding better quality or more service

(thereby driving up costs), and generally playing industry

participants off against one another, all at the expense of

industry profi tability. Buyers are powerful if they have nego-

tiating leverage relative to industry participants, especially

if they are price sensitive, using their clout primarily to pres-

sure price reductions.

As with suppliers, there may be distinct groups of custom-

ers who differ in bargaining power. A customer group has

negotiating leverage if:

There are few buyers, or each one purchases in volumes

that are large relative to the size of a single vendor. Large-

volume buyers are particularly powerful in industries with

high fi xed costs, such as telecommunications equipment, off-

shore drilling, and bulk chemicals. High fi xed costs and low

marginal costs amplify the pressure on rivals to keep capac-

ity fi lled through discounting.

The industry’s products are standardized or undifferenti-

ated. If buyers believe they can always fi nd an equivalent

product, they tend to play one vendor against another.

Buyers face few switching costs in changing vendors.

•

•

•

Profi tability of Selected U.S. Industries Average ROIC, 1992–2006

N u

m b

e r

o f

In d

u st

ri e

s

ROIC

0% 5% 10% 15% 20% 25% 30% 35%

40

50

30

20

10

0

10th percentile

7.0% 25th

percentile

10.9%

Median:

14.3% 75th percentile

18.6% 90th percentile

25.3%

or higheror lower

Average Return on Invested Capital in U.S. Industries, 1992–2006

Security Brokers and Dealers

Soft Drinks

Prepackaged Software

Pharmaceuticals

Perfume, Cosmetics, Toiletries

Advertising Agencies

Distilled Spirits

Semiconductors

Medical Instruments

Men’s and Boys’ Clothing

Tires

Household Appliances

Malt Beverages

Child Day Care Services

Household Furniture

Drug Stores

Grocery Stores

Iron and Steel Foundries

Cookies and Crackers

Mobile Homes

Wine and Brandy

Bakery Products

Engines and Turbines

Book Publishing

Laboratory Equipment

Oil and Gas Machinery

Soft Drink Bottling

Knitting Mills

Hotels

Catalog, Mail-Order Houses

Airlines

Return on invested capital (ROIC) is the appropriate measure of profi tability for strategy formulation, not to mention for equity investors. Return on sales or the growth rate of profi ts fail to account for the capital required to compete in the industry. Here, we utilize earnings before interest and taxes divided by average invested capital less excess cash as the measure of ROIC. This measure controls for idiosyncratic differences in capital structure and tax rates across companies and industries. Source: Standard & Poor’s, Compustat, and author’s calculations

Average industry ROIC in the U.S. 14.9%

40.9% 37.6% 37.6%

31.7% 28.6%

27.3% 26.4%

21.3% 21.0%

19.5% 19.5% 19.2% 19.0% 17.6%

17.0% 16.5%

16.0% 15.6%

15.4% 15.0% 13.9%

13.8% 13.7%

13.4% 13.4% 12.6%

11.7% 10.5% 10.4%

5.9% 5.9%

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LEADERSHIP AND STRATEGY | The Five Competitive Forces That Shape Strategy

84 Harvard Business Review | January 2008 | hbr.org

Buyers can credibly threaten to integrate backward and

produce the industry’s product themselves if vendors are

too profi table. Producers of soft drinks and beer have long

controlled the power of packaging manufacturers by threat-

ening to make, and at times actually making, packaging ma-

terials themselves.

A buyer group is price sensitive if:

The product it purchases from the industry represents

a signifi cant fraction of its cost structure or procurement

budget. Here buyers are likely to shop around and bargain

hard, as consumers do for home mortgages. Where the prod-

uct sold by an industry is a small fraction of buyers’ costs or

expenditures, buyers are usually less price sensitive.

The buyer group earns low profi ts, is strapped for cash,

or is otherwise under pressure to trim its purchasing costs.

Highly profi table or cash-rich customers, in contrast, are gen-

erally less price sensitive (that is, of course, if the item does

not represent a large fraction of their costs).

The quality of buyers’ products or services is little af-

fected by the industry’s product. Where quality is very much

affected by the industry’s product, buyers are generally less

price sensitive. When purchasing or renting production qual-

ity cameras, for instance, makers of major motion pictures

opt for highly reliable equipment with the latest features.

They pay limited attention to price.

The industry’s product has little effect on the buyer’s

other costs. Here, buyers focus on price. Conversely, where

an industry’s product or service can pay for itself many times

over by improving performance or reducing labor, material,

or other costs, buyers are usually more interested in quality

than in price. Examples include products and services like tax

accounting or well logging (which measures below-ground

conditions of oil wells) that can save or even make the buyer

money. Similarly, buyers tend not to be price sensitive in ser-

vices such as investment banking, where poor performance

can be costly and embarrassing.

Most sources of buyer power apply equally to consum-

ers and to business-to-business customers. Like industrial

customers, consumers tend to be more price sensitive if they

are purchasing products that are undifferentiated, expensive

relative to their incomes, and of a sort where product perfor-

mance has limited consequences. The major difference with

consumers is that their needs can be more intangible and

harder to quantify.

Intermediate customers, or customers who purchase the

product but are not the end user (such as assemblers or distri-

bution channels), can be analyzed the same way as other buy-

ers, with one important addition. Intermediate customers

gain signifi cant bargaining power when they can infl uence

the purchasing decisions of customers downstream. Con-

sumer electronics retailers, jewelry retailers, and agricultural-

equipment distributors are examples of distribution chan-

nels that exert a strong infl uence on end customers.

•

•

•

•

•

Producers often attempt to diminish channel clout

through exclusive arrangements with particular distributors

or retailers or by marketing directly to end users. Compo-

nent manufacturers seek to develop power over assemblers

by creating preferences for their components with down-

stream customers. Such is the case with bicycle parts and

with sweeteners. DuPont has created enormous clout by

advertising its Stainmaster brand of carpet fi bers not only

to the carpet manufacturers that actually buy them but

also to downstream consumers. Many consumers request

Stainmaster carpet even though DuPont is not a carpet

manufacturer.

THE THREAT OF SUBSTITUTES. A substitute performs the same or a similar function as an industry’s product by a

different means. Videoconferencing is a substitute for travel.

Plastic is a substitute for aluminum. E-mail is a substitute

for express mail. Sometimes, the threat of substitution is

downstream or indirect, when a substitute replaces a buyer

industry’s product. For example, lawn-care products and ser-

vices are threatened when multifamily homes in urban areas

substitute for single-family homes in the suburbs. Software

sold to agents is threatened when airline and travel websites

substitute for travel agents.

Substitutes are always present, but they are easy to over-

look because they may appear to be very different from the

industry’s product: To someone searching for a Father’s Day

gift, neckties and power tools may be substitutes. It is a sub-

stitute to do without, to purchase a used product rather than

a new one, or to do it yourself (bring the service or product

in-house).

When the threat of substitutes is high, industry profi tabil-

ity suffers. Substitute products or services limit an industry’s

profi t potential by placing a ceiling on prices. If a

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