In today’s blog post, I will share how to use Porter´s Five Forces for your strategic decision-making.
I will show how to deal with your competition and how to position your company strategically that benefits your long-term success.
If you analyze the company´s current competition advantage with these five forces, it will reveal where you´ll need to focus your efforts to get back to high performance and business success.
- ⇒ What are the five forces?
- ⇒ What is the best way to deal with competition?
- ⇒ What determines the profit margin of your industry?
- ⇒ What is the advantage of analyzing these forces?
- ⇒ What are the aspects you´ll need to analyze?
- ⇒ What are the strategic actions you should consider?
- ⇒ What is the best way to improve the positioning of your company?
- ⇒ Summary
What are the five forces to consider?
- Force #1: Threat of new entrants
- Force #2: Bargaining power of suppliers
- Force #3: Bargaining power of customers
- Force #4: Jockeying for position among current competitors
- Force #5: Threat of substitute products or services
What is the best way to deal with competition?
This model was developed by Harvard University Professor Michael E. Porter to support companies to deal better with competition. It is very easy to view your competition pessimistically and feel like a victim of these outer circumstances.
While competing for market shares in your industry, competition is rooted in its underlying economics. Customers, suppliers, potential entrants, and substitute products are all competitors that may be more or less prominent or active.
According to Michael E. Porter it is important to be aware of your competitors in your industry in order to stay competitive. It depends on five basic forces which is displayed below.
What determines the profit margin of your industry?
- The collective strength of these forces determines the ultimate profit potential of your industry.
- In the economists’ “perfectly competitive” industry, jockeying for position is unbridled and entry to the industry very easy.
- This kind of industry structure offers the worst prospect for long-run profitability.
- The weaker the forces collectively, the greater the opportunity for superior performance and profit.
- The company´s goal is to find a position in their industry where the company can best defend itself against these forces or can influence them in its favor.
While analyzing these five forces use questions, such as:
- What makes the industry vulnerable to entry?
- What determines the bargaining power of suppliers?
- How strong is the bargaining power of customers?
What is the advantage of analyzing these forces?
Knowledge of these underlying sources of competitive pressure:
- ⇒ Advantage #1: Helps in your strategic decision making.
- ⇒ Advantage #2: Highlight the critical strengths and weaknesses of your company.
- ⇒ Advantage #3: Supports the positioning of your company in your industry.
- ⇒ Advantage #4: Clarifies the areas where strategic changes may yield the greatest payoff.
- ⇒ Advantage #5: Where industry trends promise the greatest profit.
Understanding these sources helps to determine areas for diversification.
What are the aspects you´ll need to analyze?
⇒ What are the contending forces?
- The strongest competitive forces determine the profitability of your industry.
- For example, even if your company has a strong position in your industry unthreatened by potential entrants, your company will earn low returns if it faces a superior or a lower-cost substitute products.
⇒ Are new entrants a threat to your company?
- The seriousness of the threat of entry depends on the current barriers.
- If barriers to entry are high and newcomers can expect sharp retaliation from the entrenched competitors, they are not a serious threat to your company.
⇒ Are there powerful suppliers & buyers?
- Suppliers can exert bargaining power in your industry by raising prices or reducing the quality of purchased goods and services.
- Powerful suppliers can thereby squeeze profitability out of your industry.
- Customers can force down prices, demand higher quality or more service, and play competitors off against each other—all at the expense of companies and industry profits.
⇒ What is the best strategic action?
- Your company needs to choose the suppliers to buy from or buyer groups to sell to wisely. It is a crucial strategic decision you´ll have to make.
- Your company can improve its strategic position by finding suppliers or buyers who possess the least power to influence it adversely.
⇒ Are there substitute products?
- By placing a ceiling on prices it can charge, substitute products or services limit the potential of an industry.
- Unless it can upgrade the quality of the product or differentiate it somehow the industry will suffer in earnings and possibly in growth.
- Substitute products that deserve the most attention strategically are those that are subject to trends improving their price-performance trade-off.
- Substitutes often come rapidly into play if some development increases competition in their industries and causes price reduction or performance improvement.
⇒ Jockeying for your position
- Rivalry among existing competitors takes the familiar form of jockeying for position—using tactics like price competition, product introduction, and advertising.
⇒ Formulation of your strategy
- Once you´ve assessed the forces affecting competition in your industry and their underlying causes, the next step is to identify the company’s strengths and weaknesses (e.g. SWOT analysis) to formulate a powerful strategy for your company.
- While formulating your new strategy keep an eye on potential substitutes and how your company can stand against those substitutes.
What are the strategic actions you should consider?
- ⇒ Positioning your company so that it provides the best defense against competitive forces.
- ⇒ Influencing the balance of the forces through strategic moves, thereby improving the company’s position.
- ⇒ Anticipating shifts in the factors underlying the forces and responding to them.
- ⇒ Choosing a strategy appropriate for the new competitive balance before your competitors recognize it.
What is the best way to improve the positioning of your company?
- ⇒ Strategy #1: You take the structure of the industry as given and match the company’s strengths and weaknesses to it.
- ⇒ Strategy #2: You find out where the competitive forces in your industry are weakest. Use your knowledge of the company’s capabilities and of the causes of the competitive forces where your company should confront competition and where avoid it.
This framework for analyzing competition can also be used to predict the eventual profitability of your industry by constructing a composite picture of the likely profit potential of the industry.
The potential of your industry will…
- Depend largely on the shape of future barriers to entry
- Improvement of the industry’s position relative to substitutes
- Intensity of competition
- The power of buyers and suppliers
- The ultimate capital costs to compete
- ⇒ Key Point #1: Porter´s five forces provide a roadmap for your strategic decision-making.
- ⇒ Key Point #2: They supports the positioning of your company against competition.
- ⇒ Key Point #3: They answer the question on how to respond to competitive forces.
I´m available to support you through this difficult time by re-imagine your business. Porter´s five forces will help you in your strategic decision-making process and to spots the forces you´ll need to adapt your strategy too.
I will work with you and your leadership team to assess how these forces influence your company. We will develop a tailored strategy that takes into account these five forces. The goal is to get your business fast running at its peak performance.
Contact me for a complimentary 30-minute strategy session:
Coming up next month…
In my next blog post, I’ll share how to use the five WHY´s?.
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