You can pretty much control what’s going on inside your businesses but not the environment its operating in. However you don’t have to resign yourself to being at the mercy of economic or competitive winds. If you want to be proactive rather than reactive when it comes to responding to the competitiveness of your business environment, you should start with an environmental scan. This will help you understand the forces outside your business that can impact your success so you can adjust your strategy accordingly. Here’s one way to do it.
Porter’s Five Forces is helpful way to understand the competitiveness of your business environment and for clarifying the potential profitability of your business strategy. It was created by Harvard Business School professor Michael Porter to analyse an industry’s attractiveness and likely profitability and has become one of the most popular and highly regarded business strategy tools because it helps to answer two questions:
What are the best things my business can do to respond to changes in the competitive environment?
Or, in a volatile or uncertain economy, should I even be in this industry or providing this particular product or service?
The five forces are:
- Competitive Rivalry. This looks at the number and strength of your competitors. How many rivals do you have? Who are they, and how does the quality of their products and services compare with yours?
Where rivalry is intense, businesses can attract customers with aggressive price cuts and high-impact marketing campaigns. Also, in markets with lots of rivals, your suppliers and buyers can go elsewhere if they feel that they’re not getting a good deal from you.
On the other hand, where competitive rivalry is minimal, and no one else is doing what you do, then you should be in a position to generate healthy profits and cashflow.
- Supplier Power. This is determined by how easy it is for your suppliers (including your staff who supply skills and knowledge) to increase their prices. How many potential suppliers do you have? How unique is the product or service that they provide, and how costly would it be to switch from one supplier to another?
The more suppliers you have to choose from, the easier it will be to choose a better alternative. The fewer suppliers there are, and the more you need their help, the stronger their position and their ability to dictate terms, charge you more and potentially impact your profit.
- Buyer Power. Now ask yourself how easy it is for buyers to drive down your prices. How many buyers are there, and how big are their orders? How much would it cost them to switch from your products and services to those of a rival? Are your buyers strong enough to dictate terms to you or do they need to be informed about their choices and can you help them achieve this?
When you deal with only a few savvy customers, they have more power, but your power increases if you have a larger customer base.
- Threat of Substitution. This refers to the likelihood of your customers finding a different way of doing what you do. For example, sales of Coca Cola and Pepsi are both declining because, in part, buyers are substituting their products for bottled water. A substitution that is easy and cheap to make has weakened their position within their markets.
- Threat of New Entry. Finally, your position can be affected by people’s ability to enter your market. How easy is it to get a foothold in your industry or market? How much would it cost, and how tightly is your sector regulated? If it takes little money and effort to enter your market and compete effectively, or if you have little protection for your key technologies, then new rivals can quickly enter your market and weaken your position. If you have strong and durable barriers to entry, you are better able to preserve a favourable position and take fair advantage of it.
Brainstorm the relevant factors for your market or situation, and then check against the factors listed for the forces in the diagram below.
To take this to a really strategic level, especially if there is volatility or change in your market, you can do this exercise in three steps:
Brainstorm the five forces for your market as it has been over the past two to three years (Now).
Brainstorm the five forces to reflect the changes you think your market will experience over the next three to five years (Where).
Develop some strategies to retain or improve your competitiveness into the future (How).
While you can’t control your competitive environment, Porters Five Forces can help you proactively react to it and make better decisions about the products and services you provide and the way you go to market.