Learning Outcomes
After reading this article, you will be able to explain Porter’s five forces model and its application to industry competition and profitability for the ACCA exam. You will be able to identify and describe each force, analyse how barriers to entry, customer and supplier power, and substitutes influence profit potential, and apply the model to various market structures and scenarios.
ACCA Business and Technology (BT) Syllabus
For ACCA Business and Technology (BT), you are required to understand how the external environment shapes organisational strategy and competitiveness. In particular, focus on:
- The purpose and structure of Porter’s five forces model for analysing industry competition
- Factors affecting competitive rivalry and the power of buyers, suppliers, new entrants, and substitutes
- The impact of market structure and industry developments on competition
- How external industry analysis supports business strategic decisions
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- List the five forces in Porter’s model and state the business question each one helps answer.
- Describe two factors that can act as barriers to the entry of new firms into a market.
- In which type of market structure would supplier power usually be highest: monopoly, oligopoly, or perfect competition?
- True or false? A high threat of substitute products limits the maximum price firms can charge in an industry.
Introduction
Assessing the external environment is an essential part of business planning. Porter’s five forces model is a systematic way to analyse the competitiveness and profit potential of an industry by examining the forces that influence competition. This helps organisations judge how attractive or risky a sector might be for new investment or ongoing operations.
Key Term: Porter’s five forces
A framework for analysing the main competitive pressures in an industry: rivalry, threat of entry, buyer power, supplier power, and threat of substitutes.
Porter’s Five Forces Explained
Porter’s model breaks competition down into five distinct forces:
- Competitive rivalry
- Threat of new entrants
- Bargaining power of buyers
- Bargaining power of suppliers
- Threat of substitutes
Each force affects the ability of businesses in the industry to maintain high profit margins or earn only average returns.
Competitive Rivalry
The intensity of competition between existing firms is at the centre of the model. Rivalry increases when there are many similar-sized competitors, slow market growth, high fixed costs, little product differentiation, or high exit costs. Intense rivalry can lead to price cuts and lower profits.
Key Term: competitive rivalry
The degree of ongoing competition among firms already operating in an industry, which shapes prices and profit margins.
Threat of New Entrants
New companies entering a market increase capacity and competition. Entry is likely unless barriers are high, such as significant start-up costs, strict regulations, strong brands, or restrictive access to sales channels.
Key Term: barriers to entry
Factors that make it difficult or costly for new firms to enter an industry, protecting established firms from new competition.Key Term: threat of entry
The risk that potential new competitors can start to compete in the industry, impacting pricing and profitability.
Bargaining Power of Buyers
Buyers (customers) have power if they buy in bulk, the products are standardised, or switching to another supplier is easy. Powerful buyers can negotiate lower prices, demand higher quality, or push for additional services, reducing industry profitability.
Key Term: bargaining power of buyers
The ability of customers to influence the terms, price, or quality offered by suppliers in an industry.
Bargaining Power of Suppliers
Suppliers have power if there are few alternatives, their product is unique or essential, or switching cost is high. Powerful suppliers can demand higher prices or better terms, squeezing buyer margins.
Key Term: bargaining power of suppliers
The ability of input providers to influence price, terms, and availability of goods or services to industry firms.
Threat of Substitutes
Substitutes are products or services from outside the industry that satisfy the same customer need. If substitutes offer a better price-performance ratio, they can limit the price companies can charge and reduce industry profitability.
Key Term: threat of substitutes
The risk that customers may switch to alternative products or services that perform the same function.
Worked Example 1.1
A major airline faces several low-cost carriers offering domestic routes. Ticket prices have fallen, profit margins are tight, and customers now expect discounts and flexible terms.
Answer:
Competitive rivalry is high due to many competitors in the market with similar offerings. The threat of substitutes from train and bus travel also puts downward pressure on airline ticket prices.
Applying the Five Forces to Industry Analysis
A five forces analysis helps managers understand why some industries are more attractive than others and which forces are most significant in their sector.
Major Factors Influencing Each Force
- Rivalry: Number of direct competitors, market growth, product similarity, cost structure, and exit barriers.
- Threat of entry: Start-up costs, economies of scale, access to technology/distribution, regulation, customer loyalty.
- Buyer power: Size and concentration of buyers, product importance to buyer, ease of switching.
- Supplier power: Number of suppliers, uniqueness of input, ease of switching, supplier collaboration.
- Substitute threat: Availability, price, and performance comparison to industry’s products.
Worked Example 1.2
A new online grocery retailer plans to open in a market dominated by large supermarket chains with established supply agreements and extensive logistics.
Question: Which Porter’s forces will pose the greatest challenges for the new entrant?
Answer:
The new business will struggle with high barriers to entry (capital, logistics, and brand loyalty) and strong competitive rivalry from established supermarkets. Buyer power may also be high if customers can easily compare prices and switch suppliers.
Industry Developments and Market Structure
The strength of each of the five forces is shaped by broader industry developments and the fundamental market structure.
Market Types and Their Impact on the Forces
- Perfect competition: Many small competitors, easy entry and exit. Rivalry and threat of entry are very high; profits are limited.
- Monopoly: Single producer, high entry barriers. Rivalry is low; potential for new entry or substitutes remains important.
- Oligopoly: Few large firms dominate. Barriers to entry often high, but rivalry may be stable or, in some sectors, fierce. Collusion is more likely.
Changes such as new technology, regulatory shifts, or evolving consumer habits can alter the balance of the five forces over time.
Worked Example 1.3
A company in a mature, slow-growing market faces a decline in demand. A new technology is announced that lowers production costs for all competitors.
Question: What effect will this have on industry competition?
Answer:
Lower costs may lower barriers to entry, increasing the threat of new entrants. Existing competitors may intensify rivalry as they try to win market share by passing on cost savings or investing in product improvements.
Exam Warning
A common mistake is confusing the influence of buyers (customers) with that of suppliers (input providers). Always identify whether the question relates to power over final products/prices or over the key inputs required for production.
Summary
Porter’s five forces model provides a practical way to evaluate the pressures affecting industry competition and long-term profitability. Each force—rivalry, threat of entry, buyer power, supplier power, and substitutes—must be considered to judge industry attractiveness. Shifts in technology, consumer tastes, and regulation can quickly change the balance and require businesses to review their strategies regularly.
Key Point Checklist
This article has covered the following key knowledge points:
- Explain the purpose and application of Porter’s five forces model for industry analysis
- Identify each force and recognise what increases or decreases its strength
- Analyse how industry structure and developments influence competition and profitability
- Use the model to compare perfect competition, monopoly, and oligopoly environments
- Recognise common exam pitfalls, such as confusing buyer and supplier power
Key Terms and Concepts
- Porter’s five forces
- competitive rivalry
- barriers to entry
- threat of entry
- bargaining power of buyers
- bargaining power of suppliers
- threat of substitutes