Customers are one of the competitive forces that affect an organizations ability to compete

Competitive forces are the factors and variables that threaten a company’s profitability and prevent its growth. They are generally grouped into two categories:

Direct forces that determine how low the floor can go for price competition. They include:

  • Intensity of direct competition measured by number of competitors, degree of product standardization, amount of excess production capacity
  • Customer negotiating power, which is influenced by customer expectations towards product quality and price

Indirect forces that place a ceiling on a market’s prices and profits. They include:

  • The threat of indirect competition—the availability of products that offer similar performance
  • The possibility of new entrants into the marketplace
  • Supplier pressure—where demand for inputs is high, suppliers can raise their prices
  • Regulatory pressure—laws and regulations affecting customer and supplier behaviour and the availability of substitute products and services

Companies use the insights from their SWOT analysis to address these forces. In addressing them, the objective is not only to counter these forces but also to state how a company can get a competitive advantage. These insights are refreshed annually as part of the strategic planning process and a company’s responses are stated in its strategic plan.

  • Differentiation (def.)
  • Offer advantage (def.)

Find out more in our glossary

Understand the six competitive forces

The Competitive Forces Model is an important tool used in strategic analysis to analyze the competitiveness in an industry. The model is more commonly referred to as the Porter’s Five Forces Model, which includes the following five forces: intensity of rivalry, threat of potential new entrants, bargaining power of buyers, bargaining power of suppliers, and threat of substitute goods and/or services.

In our competitive forces model, we include a sixth force, the power of complementary goods and/or services providers. The model helps a company understand the risks in the industry it is operating in and decide how it wants to execute its strategies in response to competition.

Customers are one of the competitive forces that affect an organizations ability to compete

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There are multiple factors that can impact the intensity of rivalry within an industry.

  • Concentration of rivals – the more competitors, the more intense the rivalry
  • Product homogeneity – industries selling very similar products are likely to be more competitive
  • Consumer switching costs – if it costs consumers a lot to switch from one company’s product to a competitor’s, the company is likely to face less competition
  • Excess production capacity – when there is excess production capacity available in an industry, there is a higher chance of increased rivalry as companies find the industry more attractive to enter
  • Brand loyalty – rivalry is high when customers have low brand loyalty
  • Network effects – refers to the positive effect on the value of a product when there is an additional user of the product. When a network effect exists, the value of a product or service increases as more people are using it.

Threat of Potential Entrants

The threat of potential entrants is impacted by things such as:

  • Brand loyalty
  • Cost advantage or economies of scale – The threat of potential entrants tends to be higher when companies can realize economies of scale by mass production
  • Switching costs
  • Network effects
  • Excess production capacity
  • Government regulation – industries with strict government regulation pose a higher barrier to potential new entrants
  • Barriers to exit – when exiting an industry requires high costs, companies are less likely to enter the industry in the first place
  • Investment in specialist equipment – companies also consider the amount of capital that needs to be invested in specialist equipment when entering an industry
  • High fixed costs – things such as specialist equipment, properties, and land are examples of high fixed costs
  • Specialized skills – when entering an industry requiring specialized skills or techniques, there is a higher barrier to entry for potential entrants

Bargaining Power of Buyers

The bargaining power of buyers is high when:

  • Buyers are large or concentrated, so their decisions to purchase a product/service have bigger impacts on the company
  • Buyers purchase a large percentage of volume
  • Buyers have good information about the product, such as product pricing and demand

Buyers are price-sensitive when:

  • There are many industry competitors, giving the buyers more choices with lower prices and better product attributes
  • There are many substitutes available
  • Switching costs are low, so buyers are indifferent between purchasing products from a company or its rivals
  • Product homogeneity is high

Bargaining Power of Suppliers

The bargaining power of suppliers is high when:

  • Suppliers are large or concentrated
  • Suppliers can credibly threaten forward integration in the industry
  • Rivals purchase a small percentage of the suppliers’ products

Purchasers’ price elasticity is high when:

  • There are few alternative suppliers available
  • There are few substitute inputs available
  • Switching costs are high for purchasers

Threat of Substitute Goods/Services

Companies are likely to experience a high threat of substitute goods/services when:

  • Switching costs are low for customers
  • Substitutes have superior pricing relative to the current products
  • Substitutes have better attributes or performance characteristics

Power of Complementary Good/Service Providers

Complementary goods or services can add value to the existing products in an industry. However, when complements have unattractive features or do not provide any value to consumers, they can actually become an issue for the industry by slowing growth and limiting profitability.

When developing strategies for a business, decision-makers should consider how they can potentially encourage complement providers to integrate and become a part of the business. Successful integration with complement providers is likely to expand market opportunities and bring profit-enhancing benefits to the business.

More Resources

Thank you for reading CFI’s guide to the Competitive Forces Model. Additional relevant CFI resources include:

Porter's Five Forces is a model that identifies and analyzes five competitive forces that shape every industry and helps determine an industry's weaknesses and strengths. Five Forces analysis is frequently used to identify an industry's structure to determine corporate strategy.

Porter's model can be applied to any segment of the economy to understand the level of competition within the industry and enhance a company's long-term profitability. The Five Forces model is named after Harvard Business School professor, Michael E. Porter.

Porter's 5 forces are:

  1. Competition in the industry
  2. Potential of new entrants into the industry
  3. Power of suppliers
  4. Power of customers
  5. Threat of substitute products

  • Porter's Five Forces is a framework for analyzing a company's competitive environment.
  • Porter's Five Forces is a frequently used guideline for evaluating the competitive forces that influence a variety of business sectors.
  • It was created by Harvard Business School professor Michael E. Porter in 1979 and has since become an important tool for managers.
  • These forces include the number and power of a company's competitive rivals, potential new market entrants, suppliers, customers, and substitute products that influence a company's profitability.
  • Five Forces analysis can be used to guide business strategy to increase competitive advantage.

Porter's Five Forces is a business analysis model that helps to explain why various industries are able to sustain different levels of profitability. The model was published in Michael E. Porter's book, Competitive Strategy: Techniques for Analyzing Industries and Competitors in 1979.

The Five Forces model is widely used to analyze the industry structure of a company as well as its corporate strategy. Porter identified five undeniable forces that play a part in shaping every market and industry in the world, with some caveats. The Five Forces are frequently used to measure competition intensity, attractiveness, and profitability of an industry or market.

The first of the Five Forces refers to the number of competitors and their ability to undercut a company. The larger the number of competitors, along with the number of equivalent products and services they offer, the lesser the power of a company.

Suppliers and buyers seek out a company's competition if they are able to offer a better deal or lower prices. Conversely, when competitive rivalry is low, a company has greater power to charge higher prices and set the terms of deals to achieve higher sales and profits.

A company's power is also affected by the force of new entrants into its market. The less time and money it costs for a competitor to enter a company's market and be an effective competitor, the more an established company's position could be significantly weakened.

An industry with strong barriers to entry is ideal for existing companies within that industry since the company would be able to charge higher prices and negotiate better terms.

The next factor in the Porter model addresses how easily suppliers can drive up the cost of inputs. It is affected by the number of suppliers of key inputs of a good or service, how unique these inputs are, and how much it would cost a company to switch to another supplier. The fewer suppliers to an industry, the more a company would depend on a supplier.

As a result, the supplier has more power and can drive up input costs and push for other advantages in trade. On the other hand, when there are many suppliers or low switching costs between rival suppliers, a company can keep its input costs lower and enhance its profits.

The ability that customers have to drive prices lower or their level of power is one of the Five Forces. It is affected by how many buyers or customers a company has, how significant each customer is, and how much it would cost a company to find new customers or markets for its output.

A smaller and more powerful client base means that each customer has more power to negotiate for lower prices and better deals. A company that has many, smaller, independent customers will have an easier time charging higher prices to increase profitability.

The Five Forces model can help businesses boost profits, but they must continuously monitor any changes in the Five Forces and adjust their business strategy.

The last of the Five Forces focuses on substitutes. Substitute goods or services that can be used in place of a company's products or services pose a threat. Companies that produce goods or services for which there are no close substitutes will have more power to increase prices and lock in favorable terms. When close substitutes are available, customers will have the option to forgo buying a company's product, and a company's power can be weakened.

Understanding Porter's Five Forces and how they apply to an industry, can enable a company to adjust its business strategy to better use its resources to generate higher earnings for its investors.

Porter's Five Forces Model helps managers and analysts understand the competitive landscape that a company faces and to understand how a company is positioned within it.

Yes, even though it was created more than 40 years ago, the Five Forces Model continues to be a useful tool for understanding how a company is positioned competitively.

The Five Forces model has some drawbacks, including that it is backward-looking, making its findings mostly relevant only in the short term; that limitation is compounded by the impact of globalization.

Another big drawback is the tendency to try to use the five forces to analyze an individual company, versus a broad industry, which is how the framework was intended.

Also problematic is that the framework is structured so that each company is placed in one industry group when some companies straddle several. Another issue includes the need to assess all five forces equally when some industries aren't as heavily impacted by all five.

Porter's 5 Forces and SWOT (strengths, weaknesses, opportunities, & threats) analysis are both tools used to analyze and make strategic decisions. Companies, analysts, and investors use Porter's 5 Forces to analyze the competitive environment within an industry, while they tend to use a SWOT analysis to look more deeply within an organization to analyze its internal potential.

Porter's Five Forces framework defines the most important criteria to consider when looking at the competitive landscape of a corporation. High threat levels typically signal that future profits may deteriorate and vice versa. For example, an early startup in a fast-growing industry might quickly become shut out if barriers to entry are not present. Likewise, a company selling products for which there are numerous substitutes will not be able to exercise pricing power to improve its margins, and it may even lose market share to its competitors.

The reason Porter's model became so widely adopted is that it forces companies to look beyond their own immediate business and to their industry as a whole when making long-term plans. Porter's still plays a vital role in that, but it should not be the sole tool in the toolbox when it comes to building a business strategy.