Porter’s Five Forces – Your route to competitive advantage
18/01/2012 Leave a comment
Sound more like an Alien invasion …or a Star Wars sequel?
Well, if 1979 was the year in which the sci-fi cult got a fix with block buster movie “Alien” then strategy fundi’s got their own fix when Harvard Business school guru (Michael Porter) created this framework for analysing industry profitability and competitive advantage.
Its’ also useful for understanding ‘market power’ and market dynamics.
Supplier power – can suppliers of raw materials, labour and expertise drive up the price of your inputs, and if so, how easily? The fewer alternatives you have the greater the power of your suppliers. Other factors to consider are: how easy is it to switch between suppliers, are their offerings really differentiated, will switching mean the loss of key product features, how strong is the distribution channel and can they cut you out through vertical integration? Also consider the power of employees and the impact of labour unions?
Customer power – how easy is it for your customers to get critical information, then ask for and demand discounts or lower pricing? How sensitive are they to pricing generally? How many customers do you have, are there concentrations of buying power (i.e. customers who you are overly reliant on for volumes or revenues?), what is the typical order size, have your customers got other options in terms of suppliers like you, and is your business dependant on one or more distribution channels?
Competitive rivalry – how competitive is/are the market/s you’re in?
The key is to assess who your competitors are, what they offer and how that is different to your own offering, how numerous they are, how well resourced and how well known they are? Furthermore are their customers loyal, and are there switching costs if their customers chose an alternative supplier? The likelihood is that the larger and more profitable the industry is – the more competition there is likely to be…!
The Threat/s of Substitution – this force covers the likelihood of you getting ‘bumped’ in favour of another supplier because of the existence of products outside your industry’s typical product offering. This factor should not be confused with your competitors’ (similar) products… as it focuses on products outside your direct market e.g. Nestle Iced Tea is not considered a substitute for Lipton’s Iced tea…but coconut water, vitamin water, iced-coffee and sparkling mineral water might be?
The Threat of New Entrants – the ease, and thus likelihood, that competitors can rush into the market because of the profits being made?
Said another way – what “barriers to entry” are there in your industry in terms of (1) economies of scale (2) capital requirements (3) ease and access to distribution channels (4) market experience or cost competitiveness (5) technology and Intellectual Property protection (6) the likelihood of ‘retaliation’ from those entrenched in the market and (7) the degree of legislation and / or government regulation, to keep competitors out?
Porter considers the 5-Forces determine “competitive intensity” and the relative “attractiveness” of a market i.e. the profitability of the industry you’re in.
We regularly use 5-Forces to assess that and the qualitative elements of client businesses (provided they operate in one market where similar or closely related products are sold…otherwise more than one analysis maybe needed).
Using the framework:
- Consider each of the 5-Forces individually, and summarise the key factors, which emerge.
- Allocate a rudimentary weighting e.g. “A,B,C“ to indicate the scale of importance to each factor. Consider which way that force might operate.
- Assess various scenarios, and how such might change or impact your business and other market players.
- Consider how elements of that force might be leveraged for your business?
- Many consider it not practicable to evaluate industry attractiveness without considering the resources that a firm can harness. A resource-based analysis should also be considered before reaching conclusions.
- Some criticism has been levelled at Porter’s assumptions and some commentators feel that there is an additional, 6th force which has been ignored, which variously includes “complementors” (the rationale behind strategic alliances), Government (national and regional) and Pressure Groups. Think about those elements too.
“You can’t fatten the pig on market day” (John Howard) – reminds us that it requires careful preparation and execution to achieve success.
Understanding ‘who’s who in the zoo’ gives you a clearer picture of where the market power lies and properly used, 5-Forces will clarify your strategic options for:
- leveraging position/s of strength
- avoiding introducing new products/services (or building a business) in markets which aren’t likely to be profitable
- improving market position – where your position is relatively weak.
Like SWOT and the other models discussed, 5-Forces is not all encompassing and it should ideally form but one element of a ‘suite’ of strategic models.
Have you used porter’s 5 forces in your business and what insights did it provide you? More importantly what did you do about it?
Join us next week when we’ll take a look at one more well known strategy tool in the armoury, PEST analysis.
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