The Flaws of Porter’s Five Forces

When analyzing industries, investors and analysts typically use Porter’s five forces, which refer to a widely used framework of industry analysis.

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This framework talks about the competitive influences that shape the corporate strategies that are likely to be successful.

What is Porter’s Five Forces?

Michael Porter first outlined these five forces in 1979 and later in 1980. The five forces are :

1. Threat of New Entrants. This force purports that companies in markets where there are high barriers to entry usually face less competition than companies within markets with lower barriers.
2. Power of Suppliers. If there is a limited number of suppliers in the market, then the power of those suppliers is high. This means that suppliers may sometimes fare better than buyers.
3. Power of Buyers. If the industry moves products through retailers or distributors, then the buyers can have the same type of pricing power to eat up profit margins.
4. Threats of Substitutes. Substitutes here refer to products or services a customer can use to fill the same need.
5. Threat of Competition. If there are too many players all trying to beat each other, profit margins will show that.

Flaws of the Five Forces

While the framework has a lot of benefits when seeking to analyze a company’s competitiveness in an industry, it also has some flaws.

Composition

The composition of the framework is a static model, meaning it offers a snapshot of the wider industry at some point in history.

Though it can be useful for the short term, the window of applicability for the information from the forces has been diminished by the rapidly evolving external factors.

The Role of Globalization

Those external factors include globalization and rapid tech advances that weren’t present when Porter outlined the framework.

For many industries, the domestic competition is less of a concern than the global competitors who can offer goods and services all over the world because of advances in tech and logistics.

People’s Usage

Another flaw of the framework is that people use it in ways that Porter never really intended. Most commonly, people apply the framework to a specific company instead of an industry as a whole.

While Porter’s five forces can offer information for strategic discussions, the framework isn’t a tool for analysis of individual companies.

For businesses, it might be better to stick with the SWOT (strengths, weaknesses, opportunities, and threats) analysis for specific business, and use Porter’s five forces for data input.

Meanwhile, for investors, Porter’s analysis can be used to look at the attractiveness of taking a position in an industry.

Defining the Industry

Another weakness of the framework has something to do with defining the industry clearly. Companies can belong to multiple industries, depending on their business lines.

It is difficult to group companies with similar business lines and think of them as belonging to the same industry.

Rather, Porter’s five forces would be done for each business line and then it will be consolidated. This is one of the reasons behind an investor’s frown when a company spreads itself widely. It’s a huge feat for a company to succeed in many different sectors at the same time.

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