Porter's Five Forces
Ever since its publication (1979), Harvard University faculty Michael Porter’s tool has been very popular in the domain of business strategy.
Porter’s tool is primarily used for understanding the competitiveness of your business environment and for identifying your strategy's potential profitability.
There are 5 forces that are part of this toolbox.
Competitive Rivalry
Supplier Power
Buyer Power
Threat of Substitution
Threat of New Entry
(Sort-of) Deep Dive
Let us examine what each of these forces deal with and the possible questions you need to ask yourself about what they mean to your business’s profitability.
Competitive Rivalry - Number and strength of your competitors
Questions to ask yourself:
How many competitors are in the market?
How many of my competitors are direct competitors?
Which of my competitors are the most competent?
How does my product compare with my competition?
Is my challenge to the competition realistic and achievable?
Naturally, if your competition is high then your costs of marketing and production are going to be high and your profit margins will be lower. The opposite is also true.
Supplier Power - How easily can your suppliers drive up the cost of inputs?
Questions to ask yourself:
How many suppliers are there in the market?
How is the competition among suppliers in the market?
What is unique about the suppliers output?
What is the cost of switching from one supplier to another?
If you have few suppliers with low market competition and a unique output, then the power they wield to drive up the price of your materials is really high. But, if there are plenty of suppliers in a high competition market selling a generic good, then their ability to drive up the price is really low.
Buyer Power - How easily can buyers drive the prices down?
Questions to ask yourself:
How big is the market for my product?
What is the cost of switching products for the buyer?
Do the buyers hold leverage to dictate prices to you?
What is the level of brand loyalty in the market?
If you’ve got buyers with high brand loyalty and higher switching costs, your profitability will be higher. But if the buyers have no brand allegiance and can switch between your product and your rivals’ without cost, then your profitability will be lower.
Threat of Substitution -Likelihood of your customers finding a different way of doing what you do.
Questions to ask yourself:
Is your product features easy to replicate?
What is the cost of doing things by themselves?
What is the monetary value derived by using your product in particular?
What is the nearest alternative to your product apart from rival products?
If your customers can easily do what you do for them, you’ll have no leverage in the market. This will lead to your prices being low since the real value it provides to your customers is low.
Threat of New Entry: How easy is it for new entrants to get into your market.
Questions to ask yourself:
Is there any gatekeeping in the industry?
What is the startup cost for someone to compete with you?
What ways can you impact new entrants trying to break into the market?
If there are barriers to entry, then your market position and profitability is safe from being eroded rapidly. But if there are no barriers, then anyone can get in with superior technology or reduced costs and take your business away from you.
So those are Porter’s Five Forces that can help you ascertain competition and profitability in any market.
Let me know your thoughts on this by replying to this email.
Thanks for reading.