Where Do You Fit Within Porter’s Five Forces?

A key problem for all business owners is how to deal with the competition. Perhaps you suffer from intense competition from a rival, or maybe you’re worried about competition coming from new sources as technology advances.

A question that you probably often ask yourself is: How can I get – or stay – ahead of the rest?

The first step to answering this question is to analyse your competitive environment. This allows you to see where you currently fit in the marketplace so that you can then find ways to improve your position.

A great analysis method is to use Porter’s Five Forces.

Porter’s Five Forces…

Michael Porter, born in 1947, is a highly respected economist who has had much influence in business thinking on strategy and competitiveness.

His book, Competitive Strategy, first published in 1980 became a corporate Bible for many in the early 1980s. Times of course change and academic thinking updates – including Porter’s own – but Porter’s Five Forces continue to be relevant and are taught as standard in business courses.

Porter’s Five Forces are a framework that you can use to analyse your competition position. By considering them you can develop a strategy to take advantage of opportunities or limit exposure to threats.

The Five Forces are…

  1. Bargaining power of customers

This is where your customers are powerful in relation to you meaning that their actions can have a significant impact on you.

Your customers gain power if:

  • There are only a few buyers and they have a significant share of the market. For example, Transport Infrastructure Ireland (TII) will have a lot of negotiating power in purchases made from contractors.
  • The customer buys a significant proportion of your output, such as a supermarket supplier buying much of what a farm produces.
  • The customer is in a position where they could buy or set up a rival to you.

Your customers lose power relative to you when:

  • It’s difficult, or will cause them significant cost, to switch to another product or service provided.
  • You have many, different customers so that no individual customer has a particular influence. This is the case with almost all consumer products.
  • You’re supplying the customer with something that’s critical to what they do.
  1. Bargaining power of suppliers

Basically this is the reverse position of customer power as this time you’re standing in the place of the customer.

Suppliers are powerful when:

  • It’s difficult for you to switch to another product or service provider.
  • There are only a few of them supplying your market.
  • They supply you with something that’s critical to what you do.

On the other hand, suppliers are weak when:

  • There are many competitive suppliers for the same standardised product or service.
  • You buy a significant proportion of their output.
  1. Threat of substitutes

Substitutes are products or services that aren’t directly the same as yours, but could be used in place of yours.

For example, the aluminium cans used for drinks can be substituted by glass and plastic bottles. This means that the demand for aluminium cans will be affected by the prices of glass and plastic bottles.

The more alternatives that your customers have, the more pressure you will feel in terms of the price you can charge, the amount of customers you win and so forth.

  1. Industry rivalry

Of course a similar thing applies when you look at competition from rival businesses that supply the same product or service.

The more direct competitors you have – and everything else being equal – the more price-sensitive your customer becomes. If they can buy the same item cheaper elsewhere then they probably will.

  1. Threat of new entrants

This is to do with how easy or difficult it is for a new business to set up in your chosen market.

There are usually characteristics in a particular industry that create some sort of difficulties for new businesses. These are called barriers to entry.

You’ll often be able to identify these barriers from your own experience of how easy or difficult it was to start your business.

It may be that a high amount of capital is needed, or certain qualifications and licensing. Perhaps patents and proprietary knowledge are a barrier.

The more difficult it is to start a new business in your industry the less threat you will face in winning customers.

What next?

Having analysed your competitive environment in these 5 areas, you’ll see where your biggest pressures are. For instance, are you heavily reliant on one big customer or one big supplier? Do you find new businesses continually starting up in your sector?

Once you’ve done the analysis and got a clear picture of your current situation, you need to form a strategy for improving your situation.

Porter himself identified 3 basic strategies that a business could employ.

  1. Cost leadership
  2. Differentiation
  3. Focus

The idea is that picking the right strategy will help give you a competitive advantage.

Look out for a future post in which we examine the three strategies and how you might use them.

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