Being able to understand the underlying forces of competitors in an industry is an important factor for many different reasons. Primarily, it can help measure all the possibilities/opportunities for your firm, especially if you are going to compete as a new start-up firm. Also, it is a critical step because it helps you differentiate yourself better from others competing in the market with a similar set of products or services. Although the pure competition model is not a practical tool to assess an industry, Michael Porter’s Five Forces framework helps to truthfully measure all the potential profitability, risk and opportunity. With the help of these five forces, managers can develop and be in a strategic advantage compared to the other companies competing in the industry.
The five forces framework:
- Rivalry
- Threat of entry/ Barriers to entry
- Buyer Power
- Supplier Power
- Threat of substitutes

Companies strive for a competitive advantage over their competitors. The amount of rivalry differs within every industry and these differences can be critical for developing a strategy. Concentrated industries usually present high levels of rivalry. Many companies are conscious about industry concentration and in order to measure it, they use the “concentration ratio” (CR). The CR which has been reported by SIC (Standard Industrial Classification code) shows the percentage of the market share seized by the top 4 companies in the industry. If the industry has a high concentration ratio, this means that these firms are controlling the market by holding a big percentage of the market share. With only a few firms holding large amounts of shares, the industry becomes less competitive and becomes more of a monopoly. On the other hand, with a low concentration ratio, we are likely to see more of a competitive landscape. This shows that the industry is filled with many rivals that don’t necessarily have a significant share in the market. These fragmented markets are very competitive. There are other available measures other than the concentration ratio, for example, defining markets in terms that express more information than distribution of market shares. An industry is considered to be “disciplined” if rivalry between the competitors is low. This could be due to the history of competition in that specific industry and/or due to an informal agreement between the firms with an understood code of conduct. These firms usually do not consider it an option to make a competitive move trying to gain an advantage in the market. However, if any of these firms tries to go against the informal agreement and seek competitive advantage, this firm can displace the disciplined market and create weak to intense rivalry depending on how serious the attempt to gain advantage is.

It is not only the unavoidable rivals that pose threats to firms in the market. The likelihood that new start-ups might come into the industry also impacts competition. The key is to measure how easy it is for new companies to make a move into the industry. You can say that any new firm can enter and exit the market when it wants, but depending on the industry, the level of difficulty to enter varies. Usually, the more popular market segments have a high entry barrier with a low exit barrier and this is determined by economics. Manufacturing-based industries are more difficult to enter than many service-based industries. The definable characteristics of each industry protect profitable areas for firms and inhibit additional rivals from entering the market. These inhibitive characteristics are referred to as barriers to entry. When the profit levels increase in an industry, it is expected for firms to enter the market and take advantage of the situation which would result in reducing profits in the long run. On the other hand, decreasing profits in the industry would result in firms exiting the market. Other elements that will prevent new entrants are falling prices, actions that keep prices artificially low, expectations that future prices will fall, large or unpredictable start-up expenditures, and other extreme uncertainties. Patents and proprietary knowledge, specialized technology/assets, economies of scale and the government are different sources from which barriers to entry can arise. Barriers to exit are similar to barriers to entry. Exit barriers intensify competition since a firm’s ability to leave the market is limited. Being unable to leave the industry, a firm must compete. Some of an industry’s entry and exit barriers can be summarized as follows: Potential for profitability soars when both entry and exit barriers are high. In this situation, firms face more risk because poorer performing ones tend to continue to produce regardless of profitability and therefore, continue to add to the supply.

The power of buyers describes the impact customers have on an industry. When buyer power is strong, the relationship to the producing industry becomes closer to what economists term a monopsony. A Monopsony is a market where there are many suppliers and one buyer. Under these market conditions, the buyer has the most influence in determining the price. Few pure monopsonies actually exist, but there is often a connection between an industry and buyers that determines where power lies.
The bargaining power of buyers increases when they have the ability to:
- Be “organized” in some form with others providing similar products and services
- Purchase a product that represents a significant fraction of the buyer’s costs
- Buy a product that is undifferentiated
- Incur low switching costs when they change vendors
- Be price sensitive, with other options available
- Integrate upstream, to purchase the providers of the goods.
To mitigate the power of buyers, sellers can seek to select buyers with less power to negotiate, switch suppliers, or develop superior offers that strong buyers cannot refuse.
A producing industry requires raw materials, labour, components, and other supplies. This requirement leads to buyer-supplier relationships between the industry and the firms that provide it the raw materials used to create products. Suppliers, if powerful, can exert an influence on the producing industry, such as selling raw materials at a high price to capture some of the industry's profits. The following tables outline some factors that determine supplier power.

Porter’s Five Forces model refers to “substitute products” as those products that are available in other industries that meet an identical or similar need for the end user. As more substitutes become available and affordable, the demand becomes more elastic since customers have more alternatives. Substitute products may limit the ability of firms within an industry to raise prices and improve margins.
For example, the price of aluminum cans is constrained by the price of glass bottles, steel cans, and plastic containers. These containers are substitutes, yet they are not rivals in the same industries. A substitute product to the services offered by a CPA firm is accounting or tax-based software – two very different industries that offer some of the same consumer benefits.
The treat of substitutes often impacts price-based competition. There are other concerns in assessing the threat of substitutes relating to technology. New technologies contribute to competition though substitute products and services. Think of the impact wireless technologies have had on traditional telephone service. Except in remote areas it is unlikely that cable TV could compete with free broadcast TV from an antenna without the greater diversity of entertainment that it affords the customer.
Again, a segment is unattractive when there are actual or potential substitutes for a product