Porter’s Five Forces is a business strategy framework developed by Michael E. Porter, a Harvard Business School professor. It is a valuable model for understanding the competitive landscape within an industry. It can also help to discover the big wide MOAT that surrounds and protects the castle.

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What is Porter’s Five Forces?

Business leaders and managers use this framework to create long-term strategies around the competitive environment they operate in.

Investors can also utilise the model to study companies and industries to identify sources of competition in a potential investment. I believe it is a helpful way to analyse companies that investors are looking to invest in and hold long-term.

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Strategy is about setting yourself apart from the competition. It’s not a matter of being better at what you do – it’s a matter of being different at what you do

Michael Porter

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This level of due diligence and analysis can provide valuable insights into the Investment Thesis if you’ve studied the forces that may make or break the business. Identifying downside risk and creating bear cases is an underutilised approach to investing, and these business models can help during the research and analysis process.

When investors think about competitive advantage or MOATs, they consider factors such as sustained return on invested capital (ROC), network effects, and a strong brand that sets the company apart from its closest competitors. The Five Forces model helps to assess how long this advantage will last, the potential disruptors, and the forces that could impact it. Investors can look beyond and examine the broader business environment using similar strategies and considerations as management.

How is Porter’s Five Forces different to MOATs?

Porter’s Five Forces provides a framework for analysing the competitive forces within an industry. MOATs help companies identify and leverage their unique competitive advantages to stay ahead of the competition.

Both Porter’s Five Forces and MOATs are used to assess the competitive landscape of an industry. They serve different purposes and offer different insights.

Porter’s Five Forces analyses the competitive forces that influence an industry and consists of five components:

1. Threat of New Entrants: The ease with which new companies can enter the market.
2. Bargaining Power of Suppliers: The ability of suppliers to impact prices and terms.
3. Bargaining Power of Buyers: The influence of customers on prices and terms.
4. Threat of Substitute Products or Services: The likelihood of customers switching.
5. Rivalry Among Existing Competitors: The level of competition among existing companies.

On the other hand, MOATs represent a sustainable competitive advantage that distinguishes a company from its competitors, making it challenging for others to replicate or overcome. MOATs can be based on various factors, such as unique technology or intellectual property, strong brand recognition and customer loyalty, economies of scale, network effects, regulatory advantages, and high switching costs.

The key differences between Porter’s Five Forces and MOATs are:

1. Focus: Porter’s Five Forces concentrates on the competitive forces shaping an industry, while MOATs focus on a company’s unique competitive advantages.
2. Scope: Porter’s Five Forces is a broader framework that analyses the overall industry, while MOATs are typically applied to individual companies.
3. Purpose: Porter’s Five Forces helps companies understand the competitive landscape and make strategic decisions, while MOATs assist companies in identifying and capitalizing on their unique strengths to maintain a competitive edge.

The Five Forces laid out.

Porter’s Five Forces consist of various segments, each offering unique insights into competition. Investors can use these areas as a checklist when assessing whether a company has a competitive advantage (MOAT) and the potential to maintain it over the long term.

This framework can also be applied to analyse industries that have the potential to establish dominant players. By understanding industries and how businesses can compete and gain market share, investors can evaluate companies with the best chance of success in that sector.

Competitive Rivalry

The first force looks at the existing competitors within an industry. How many rivals are competing for market share? By studying the competition, it can help achieve two things: First, it can help in assessing and analysing a business to reinforce why it is the better choice. Secondly, it may reveal that a competitor is a far better investment candidate.

Investors should first use this force to establish who the competitors are, how many there are, and the quality of not only the product or service but the business.

Understanding how the competitors compete can also provide insights into certain strategies that need to be played out that can impact the entire industry. If it is an intense sector, then it may result in a pricing war, driving down profits across the whole industry. This results in companies losing their MOAT as customers start shopping around with no minimal customer retention.

If competition is only around a few key players (think monopolies), the profits can remain strong as minimal choice and rivalry means the profits remain higher for longer. Understanding the rivalry landscape helps paint a picture of profit margins, returns on capital, and the durability of these metrics.

Areas of analysis:

• Number of competitors.
• Diversity of the competitors.
• Concentration of the industry.
• Growth of the industry.
• What sets each apart quality wise.
• Barriers to exit.
• MOAT’s within each business.

Supplier Power

This force focuses on the bargaining power of suppliers. Understanding how suppliers can impact the business is crucial, as it can ultimately affect profitability and the business model. Having reliable suppliers is essential to ensure consistent operations. There is an old saying in product-based businesses: “You are only as strong as your supplier.” This means that a company can have all the demand in the world and be scaling rapidly, but if a supplier fails to deliver, the entire business can come to a standstill.

Understanding the power of suppliers and the terms of the arrangement is important. Is the company in a position to demand advantageous terms and deals with suppliers?

If a supplier can increase costs, knowing that a company cannot simply “shop around,” it gains a lot more power. If a supplier is one of the few who can provide that service or product, then the company becomes incredibly dependent on that supplier.

For a company to continue to thrive and not be brought to its knees by a supplier, it needs to increase its selection of suppliers. A business can improve its buying power with a larger supplier pool.

Investors should pay close attention to the dependability of suppliers, the terms they have, and how the supplier could impact business profitability if it raises prices. Many companies are held to ransom by suppliers who control the market. Sometimes, these suppliers may be the better investment choice, if you can find them.

Areas of analysis:

• How many suppliers are there?
• How Big are the suppliers?
• Does the company have other options?

Buyer Power

The bargaining power of buyers is stronger in some industries where there are more suppliers than buyers, giving buyers plenty of options. To stand out, a company needs to excel in areas such as customer service, operations, and overall customer experience compared to its competitors.

Buyers can easily switch to cheaper alternatives, so retaining clients is crucial for businesses. Companies in industries with low buying power can control their profitability. Understanding buying power involves knowing the number of buyers, their spending, and how easily they can switch between providers.

Companies that can create strong brands and other competitive advantages can attract new buyers in a highly competitive market without getting into price wars.

Areas of analysis:

• How many buyers are there?
• What is the size of each customers order?
• Competitor differences.
• Price sensitivity.
• Can buyers substitute easily?
• Switching costs?

Threat of Substitution

This force focuses on customers finding alternative options to what the company provides. It could be a different way to shop, a different product at a cheaper price, or when a newer, better product enters the market. Entire industries have been disrupted and destroyed by changes in consumer habits. Understanding the likelihood that an industry will be disrupted by customers finding different ways to do what you do can be an important consideration. This can be an area where having a competitive advantage with switching costs means customers may not be able to change to substitutes easily.

The threat of substitution is especially important when looking at a long-term investment opportunity. We can analyse a business with a stellar track record and a healthy balance sheet that may not have planned for a disruptive substitute entering the market. This has ended many strong runs for companies. Think about e-commerce changing the way customers shop in brick-and-mortar stores, or travel agencies that were disrupted by online travel companies, and streaming services that now offer multiple options for customers with no switching costs.

Areas of analysis:

• How many substitutes exist?
• Chances customers will substitute?
• The price difference of substitutes.
• What is the product differentiation?
• Switching costs involved.

Threat of New Entrants

The last force looks to understand the barriers to entry for an industry. Fewer barriers mean more competitors can enter, while more barriers provide more protection for established companies. If it takes minimal capital to enter a market, then these barriers mean more rivals can enter at any stage.

High barriers to entry provide a competitive advantage for a business. If it takes too much capital to compete, it discourages companies looking to enter a market. Barriers to entry can be anything from supplier relationships, capital required to start, a complex network of supply and value chains, and even regulations. Each makes it challenging for a business to enter unless it has a long time horizon and a lot of cash to invest.

If an industry requires economies of scale to achieve meaningful margins, this also keeps away a lot of competitors. Consider the cost to compete with an established telecommunications or infrastructure business as opposed to a new e-commerce dropshipping business. Anyone can start an online store with minimal upfront investment and start marketing. Not everyone can establish a national network of towers.

Investors should pay close attention to the threat of new entrants to understand how long a company can protect its margins.

Areas of analysis:

• Barriers to entry.
• Require economies of scale?
• Any brand loyalty?
• Capital intensity to enter.
• License required?

The key questions of each force.

Porter’s five forces sections and questions
Threat of New Entrants (Barrier to Entry):
How easy or difficult is it for new companies to enter the market?
What are the costs associated with entering the market?
Are there any regulatory barriers to entry?
Are there any patents or intellectual property rights that protect existing companies?
Threat of Substitute Products or Services:
How easily can customers switch to alternative products or services?
Are there alternative products or services that can satisfy the same needs?
How easily can customers switch to these alternatives?
Are there any barriers to switching, such as switching costs or lack of compatibility?
Bargaining Power of Suppliers:
How much influence do suppliers have over the company?
Are there few suppliers or many?
Are suppliers critical to the company’s operations?
Is there any alternative suppliers?
Bargaining Power of Buyers:
How much influence do customers have over the company?
Are there few buyers or many?
Are buyers price-sensitive?
What alternative products or services can buyers switch to?
Competitive Rivalry Among Existing Competitors:
How intense is the competition among existing companies?
Are there many companies competing in the market?
What differences between the products or services are offered by these companies?
Are there any barriers to entry or exit that affect the number of competitors?

How can Investors use Porter’s Five Forces?

The best way to use Porter’s Five Forces is to run potential investment ideas through a checklist of questions similar to the one above. We want to understand the likelihood of each outcome. This type of analysis is best suited for evaluating investments aimed at long-term holdings. Short-term opportunities do not warrant the level of analysis that this framework requires.

Long-term quality compounders often come down to the competitive landscape and the moat the business has built for itself. If investing in quality companies with durable competitive advantages is part of your strategy, then using this framework is essential in your due diligence and analysis work.

It can help answer questions about the time horizon of the moat and the possibility of it being “bridged”. It can highlight areas that warrant further research and analysis to keep a close eye on. If you identify an investment opportunity and pinpoint the areas in which a company can be disrupted, it can prepare you to pay attention to aspects that may contribute to the thesis breaking, and as a result, warrant a sell.

I use the five forces to evaluate if the chances are high or low for each category. The less each force impacts the business, the better. This can mean a company can remain profitable for a longer time. If your in-depth analysis reveals that a company operates within an industry highly susceptible to being impacted by many of the forces, it can indicate that the business may not be a strong long-term compounder.

In Summary…

I find Porter’s Five Forces to be a very helpful strategy to use when evaluating opportunities. To buy and hold long-term winners, it’s essential to consider all possible scenarios and the bigger picture that is crucial to the long-term execution of the business strategy.

Investors can use this model to gain strategic insights into an industry and all the players within it. This expertise is helpful when trying to invest in the best candidate within a sector. The best use of the framework is for risk mitigation. Identifying potential risks is a great technique to prepare investors for worst-case scenarios. They will be better prepared emotionally when a risk that has been identified earlier starts to play out.

This level of analysis allows investors to make more informed decisions based on research rather than emotions. Another benefit of using the framework is that it can help identify other opportunities that may normally be overlooked when focusing only on specific company criteria. By developing expertise and knowledge within an industry and the competitive landscape, we may uncover better opportunities or, better yet, understand that the entire landscape is up for disruption and avoid it entirely.

Another way to use the model is to align it with the company’s long-term strategy. By identifying all the risks and factors that contribute to a company’s success within an industry, you can understand the management’s thought process. Perhaps they are overlooking major risks or, better yet, noticing them and preparing to pivot and take advantage of them.

There are many useful business tools, such as Porter’s Five Forces, that help investors think more businesslike when evaluating opportunities. There are so many areas that contribute to the rise and fall of companies. The threat of competition is one of the most important.