Porter’s Five Forces and SWOT Analysis: What’s the Difference?

When people begin to take an interest in their investments, most of them believe one of two things about stock analysis and selection; either that it is a kind of mystical art, best performed by those with some innate gift that they lack, or that it is an exact, mathematical science and that if they can just learn the formula, they will be fine. Neither of those things is completely true, and the truth lies somewhere in between the two extremes. The analysis of businesses, and therefore of stocks, involves both science and art. You gather data in a scientific manner but then you must interpret it, which is more of an art.

There is, however, not just one dataset to look at. Each individual company has hundreds of factors influencing its pricing at any given time. They might be macro like the global economy, or micro, such as who is the CEO, CFO or COO. They might be industry or company specific or based on consumer trends or sentiment. The possibilities are too vast for anyone to consider every factor. So over the years, various theories have been proposed as to which are the most influential to arrive at a manageable set of factors that can be observed in search of an informed opinion.

Two of the most popular strategic tools are the Porter’s Five Forces and SWOT analysis. Both offer a framework for analyzing a company’s competitive advantages and disadvantages, along with their prospects, but their approaches differ in some ways.

What are Porter’s Five Forces?

Named after the Harvard Business School Professor Michael E. Porter, the five forces model attempts to distill the complexity of competition down to five factors:

1. Existing Competition in the Industry: An obvious one, but the most important in some circumstances. It is a snapshot in time that doesn’t account for the future, but the existing level of competition can dictate the success or failure of a company in its early days. For example, when Tesla (TSLA) started making electric vehicles (EVs), they pretty much had the market to themselves. That enabled the company to focus on growth and establish a strong brand rather than worrying about beating off others and competitive pricing. Company’s entering the space now face a completely different landscape, having to differentiate themselves based on either their product or pricing.
2. Threat of New Entrants to the Market: The snapshot taken in force one is important, but so is what the future holds. Is the market potentially large enough to attract others? If so, would entry involve massive capital outlay or onerous regulatory compliance? How strong is a company’s existing brand? In other words, what are the chances of competitors arriving quickly and stealing the business?
3. Supplier Power: In 2022, we have all become aware of how important this is. If suppliers can increase prices readily, it will impact margins, and their inability or sometimes unwillingness to increase supply levels can hold back growth.
4. Buyer Power: Essentially, this is about what economists call price elasticity. Can a company raise prices without destroying demand for their products? There are multiple factors to consider here including: Can customers easily switch to a competitor’s product? How many customers are there? How strong is the brand? Does the product have unique features for which customers will pay a premium?
5. Threat of Substitution: What is the chance of “knock offs” emerging to steal business? Is the product and concept protected by patents and the legal framework in which the company operates? How easy would it be for substitutes to supply and distribute?

Take all five factors together, and you get a detailed picture of the competitive landscape in which a company operates. This is an important part of predicting future performance.

What is SWOT Analysis?

Like the five forces model, SWOT analysis is a way of simplifying the complex task of analyzing a business. SWOT stands for strengths, weaknesses, opportunities and threats.

The first two factors, strengths and weaknesses, are mainly internal: What is a company good or bad at and what competitive advantages and disadvantages does it have? How effective is its senior management?

On the other hand, the second two factors, opportunities and threats, are primarily external: Is the market for the company’s product growing? Are there other potential areas of expansion for the business? Are there competitors emerging and gaining ground? Is there a chance of a change to the regulatory environment?

What's the Difference?

Essentially, the Porter’s Five Forces and SWOT are two different ways of answering the same basic questions: How is a company situated now and what are its prospects for the future? These are useful internally, but they are also important questions for potential investors. So an understanding of this kind of analysis is at least useful for them and maybe even essential. Which strategy investors choose to use is partly a matter of personal choice, but it is also a function of where a company and the industry in which it operates sit in terms of development.

In relatively new industries and for young companies, the five factor approach is generally more useful and informative, whereas for mature companies, SWOT tells us more about where a company is at and where they are going.

It is often said that you should never invest in something you don’t understand and using either the Porter’s Five Forces or SWOT models will help you to appreciate the advantages and challenges of a corporation, and the opportunities and dangers that exist within the market it serves. Hopefully, if you have gotten this far, you now have a better understanding of both models and can use them to make better informed investment decisions in the future.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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