Have you come across Michael Porter while creating your business strategy? No wonder. It became almost synonymous with business strategy after this gentleman created a tool for analysing a company’s competition – Porter’s Five Forces Model. What is the idea behind this strategy and how is it used?
What does Porter’s five force analysis determine?
We can think about corporate strategy in several different ways, so there is no one clear definition. But Porter tried to define it – as a competitive position. According to him, you need to understand your competitors and the market in order to determine the ideal reaction of your company.
Porter’s five forces model is especially useful when starting a new business or entering a new market. According to the model, the state of competition depends on five basic forces:
- threat of new entrants into the market
- bargaining power of suppliers
- bargaining power of buyers
- the threat of substitute products or services
- existing competition in the sector
These five forces determine the profit potential of the industry. If they are intense (for example in the aviation industry), almost no company achieves attractive return on investment. However, if the forces are moderate (for example in the soft drinks sector), there is room for higher yields.
How to analyse a company according to Porter’s model
Let’s figure out your competitive position in the market. First, we develop the individual forces:
1. Threat of new entrants into the market
New market players bring new capacities and an effort to gain market share. The severity of the threat depends on entry barriers in a particular sector. The higher these barriers, the smaller the threat to existing companies.
Examples of entry barriers are the need for economies of scale, customer loyalty to existing brands (for example through quality customer service), large capital requirements (such as large investments in marketing or research and development), government policy or limited access to distribution channels. Answer the following questions:
- How much does it cost to enter the market and how long does it take?
- What are the entry barriers? Do you need licenses, patents, rights or anytings else?
- Do you protect your key technologies?
- How strictly is the market regulated?
The harder the obstacles to overcome, the better for you – new competition is unlikely to appear.
2. Bargaining power of suppliers
This power analyses how much power and control your supplier has over profitability. It examines how easily suppliers could increase their prices and thus affect your economic result.
The concentration of suppliers is therefore an important factor – the fewer there are, the more power they have. The best option, of course, is if there are a large number of them. This also includes the costs of changing suppliers for companies in the sector, the presence of available substitutes and their uniqueness.
It examines how easily suppliers could increase their prices and thus affect your financial results. Remember that your supplier thinks strategically just like you. If he understands that few companies can meet the same need as he can, he could charge more for his service.
- How many suppliers does your company have?
- How unique is the product or service provided by the suppliers?
- How many alternative suppliers can you find? What are their prices compared to the current supplier?
- How costly would it be to switch from one supplier to another?
3. Bargaining power of buyers
The strength of buyers is greatly influenced by the sensitivity of customers to price changes. Customers have great power when there are not many of them and when they have a lot of alternatives to choose from. When it’s easy for them to move from one company to another. On the contrary, low purchasing power means that customers buy in small quantities, so it doens’t hurt to lose one, or that your product is different from the competition, so customers can’t switch to it.
Purchasing power is multiplied by access to the Internet, where the customer can obtain information on a wide range of products, and immediate access to other offers. It is necessary to find out what power buyers have to reduce your prices – in other words, if they have a “leverage” on you to dictate costs. The more customers you have, the more strength you will retain.
- How many buyers control your sales?
- How big are the orders you get?
- Could your customers change suppliers? How much would it cost them?
- How important is your product to your customers?
- What is the return on investment for your product or service?
Tip: Read our 15 tips on how to perfectly manage customer care.
4. Threat of substitution products or services
In this section, you determine the likelihood if your customers will exchange your product or service for an alternative that addresses the same need. A satisfied customer is the foundation. Remember what happened when the iPod entered the portable music market, which had been ruled by CDs. The price is not always the reason why the customer switches to another product – the iPod was, after all, much more expensive.
Answer these questions:
- What are the differences between your product or service and their alternative?
- How many substitute products are on the market?
- What are the customer’s costs for switching to a substitute product?
- How difficult is it to switch to another product or service?
- What products or services could you offer to replace the market leader?
Example: If you are an aircraft manufacturer, it is not very realistic for your clients to suddenly switch to an airship. The threat of substitution is therefore low. But if you sell coffee, customers can very easily switch to tea or matcha.
5. Existing competition in the industry
This last force is largely influenced by the previous four. Let’s take Apple as an example. Remember Microsoft Zune? Probably not. It was a product that Microsoft wanted to beat the iPod with. It was cheaper, offered music subscriptions long before Apple Music, and was regularly updated with updates. But it didn’t break through, it couldn’t beat the brand that the iPod had on the market.
Take a look at the number and strength of your existing competitors and answer these questions:
- How many competitors do you have?
- Who are your biggest competitors?
- What is the quality of their products and services compared to yours?
- How is your company different from the competition?
Now that we are done examining Porter’s model, do you have a better idea of how you stand in the market compared to your competition? Let’s look at how you can tailor your strategy to attract the right target audience.
What to take away from Porter’s five forces analysis
The whole model revolves around two ideas: to do what everyone else does, but cheaper. Or do something no one has done before.
As an existing business, you can build on what you already do and look for ways to maximize efficiency or look for new opportunities and trends. An example is Facebook, which is a leading social media platform, and as new markets gradually emerge, it expands into them – messengers, chatbots, online marketplaces and many others.
Find something that makes you unique and unrivalled. Or follow industry leaders and look for the missing pieces. Find a way to do it better, cheaper or otherwise – brand positioning will help with all this. And don’t forget your customers either. What is their unique need? Do they need a specific product that they can’t get elsewhere? Give it to them.
How to plan a successful corporate strategy
With Porter’s analysis, you can find your competitive advantage and create a strategy that takes your business to the next level. If you are not sure how to do it, contact us. We will help you create a business strategy or dive into the marketing one.