In this article, I would like to propose a methodology that can help any organization to articulate its own position in the competition and to develop effective strategies for successful competition. The methodology I would like to introduce to you was developed by the American economist Michael Eugene Porter and is generally known as Porter’s Five Forces, also known as industry structure analysis.
The idea behind Porter’s five forces is based on the insight that the factors influencing a company’s business model fall into five categories, the five forces.
Namely the influences through:
Porter’s five forces
Before I talk about the five forces in detail, I would like to discuss some basic assumptions about the framework and underlying terminology.
Porter assumes a closed environment in which the five forces can relate to each other. The corresponding overall framework is defined as industry level. For the factors influencing the conflict between buyers and sellers of products, the so-called market level is defined, which is an inherent part of the industry level.
An industry is a group of companies whose products are interchangeable and therefore potentially in competition with each other.
Examples are the automobile manufacturers or the pharmaceutical industry. The term industry is most likely to be compared to a business area of a company or a specific business model, but less so to complex companies with many business fields or different business models. Here, a separate analysis for each of the individual business models would be more appropriate than an attempt to analyze the entire company using the five forces.
A market is a group of potential or actual buyers and sellers of a product.
The distinction between industry and market is based on the assumption that an industry can combine different markets. Accordingly, the industry level is understood as the totality of all actors who have a potential or actual interest in the industry. The market level is understood as the totality of all actors who have a potential or actual interest in the market.
The idea of the competition analysis is to find a position within the industry from which an organization can best handle the influences caused by the 5 forces or influence these 5 forces in favor of the organization.
The knowledge of the various influencing factors helps to assess the critical strengths and weaknesses of a company and can help a company to understand its market position. One of the added value is identifying those strategic decisions that promise the biggest win, the highest pay-off. The corresponding structural analysis is the foundation in the development of a competitive strategy.
Each of the five forces features specific characteristics that describe their effects. I would like to discuss this in more detail below.
I would like to start with the market participants and the competitive pressure.
Competitive pressure and market participants
The extent of competition between market participants can be determined by various factors.
Taking into account these factors, companies must be careful not to bring a stable competitive situation into imbalance to their own disadvantage. This includes, in particular, the balance between a strong position within the market and the health of the entire industry. For example, entering into a price war or special discounts can lead to a company gaining market share in the short term. In the long term, however, the profitability of the business model may decline as competitors tend to respond to price wars and special discounts with lower prices and better discounts. Therefore, it is important for companies to recognize those situations in which the fundamental protection of the business model must be given priority over the pursuit of short-term benefits.
In the following I would like to consider the influences by suppliers.
Bargain of suppliers
The cost of materials and the cost of necessary components or external services can have a significant impact on the profitability of a business model. The higher the influence that suppliers can take the higher the corresponding costs. The negotiating position of suppliers is the higher, the stronger the following influencing factors are given.
However, a company can strengthen its negotiating position with suppliers,
These approaches correspond to the analysis of market participants and competitive pressure.
After the suppliers, I would like to examine the influences of buyers and customers of products and services.
Market power of customers
The negotiating position of buyers is the stronger, the more the following influencing factors are given.
A company can strengthen its bargaining position towards its customers
In the retail business the market leader’s products potentially have the highest margins. This is particularly because market leadership means that a retailer has to run the market leaders product in order to be attractive to its customers and thus weaken its own bargaining position towards the manufacturer.
Customers who buy a product and are not end users (such as OEMs or distributors) can be analyzed in the same way as all other buyers. However, they can achieve an enormously strong negotiating position if they manage to directly or indirectly influence the buying decisions of the end customers.
Over the years, for example, the chemical company DuPont has gained a tremendous influence on its suppliers and the retail sector by putting enormous marketing effort into its own brand “Teflon” and thus decisively controlling the buying behavior of end customers.
After considering the suppliers and the buyers, I would like to discuss the threat of the business model by alternative products.
Threat of alternative products
The availability of alternative products and the regarding impact on pricing can reduce the attractiveness and profitability of an industry.
If a business model is successful and generates high profits, it is likely that competitors will address the market with alternative products in order to secure a share of the potential profits. The threat of alternative products depends on the following factors.
The threat of replacement products can be reduced by high switching costs. These costs can also be psychological. Examples of this are the creation of strong and distinctive brands as well as the consideration of a price difference which corresponds to the perceived added value by the customers.
Finally, I would like to address the threats caused by new business models or new competitors.
Threat of disruptive business models
New business models and market participants can increase competition within an industry. Above all, the danger posed by new business models and market participants depends on the height of the entry barriers to the market.
However, market entry barriers can be influenced.
For example by:
Market entry barriers can make even a potentially attractive market unattractive or even unattainable for new competitors. Consequently it is all the more worthwhile not passively waiting for new competitors, but actively seeking opportunities to increase market entry barriers as much as (within the limits permitted by law) possible.
High marketing and research efforts as well as clearly communicated countermeasures, if a new competitor wants to enter the market, are proven ways to keep the market entry barriers high. However, some business decisions can also unintentionally lower the market entry barriers. For example, cost reductions in product design, production, or branding can make it possible for competitors to attack a previously well-secured business model.
In this article, I’ve suggested a method for competitive business model analysis with Porter’s five forces. The 5 forces consider the influences of competitors, suppliers, buyers, the threat management regarding new entrants and the threat management regarding replacements and alternative products. While the original idea behind the 5 forces was presumably the maximization of the competitive advantage of a company, the model can also be used to develop strategies for inter-firm collaboration.
I hope this article has helped you with your own business development and competitive analysis challenges and wish you every success in using Porter’s five Forces.