If you’re setting up a business or diversifying into a new market you’ll doubtless do research to establish the commercial viability of this. Michael Porter, Professor at Harvard Business School, author of 20 books and the most cited on the subjects of business and economics, developed a framework known as the Five Forces. It’s a really useful analysis tool, used to determine the competitive intensity and the corresponding attractiveness of a market. Ultimately, it’s a means of assessing risk versus reward and the likely level of profitability. Detailed below are the five individual forces within the framework.
The competitive rivalry relates to the supply and demand for products and services. Being first to market sounds like a good situation to be in, with just one supplier and plenty of potential interest. However, there could be a good deal of marketing and awareness raising required to really educate people about your value proposition and build traction. This could be costly and time consuming but with clear differentiation, profits could be maximised with no perceived alternatives. Recognising the profit potential, other businesses might enter the market providing unwanted competition. Profitability may be eroded if they attempt to gain share through an aggressive pricing strategy. Less skilled players, selling on price rather than value, will continually lower prices and encourage a “race to the bottom”. The most successful businesses in this scenario will maintain share and profitability by continually iterating, adding value and developing their key differentiators. Amazon is a particularly good example of a business that has continually improved every aspect of its e-commerce customer experience, from increasing its product range to offering alternative payment methods, comprehensive reviews, support for sellers, delivery arrangements and complaint handling. Its diversified into cloud computing, digital streaming and artificial intelligence and is considered to be one of the Big Five companies in the US alongside Apple, Microsoft, Facebook and Google.
Ease of Market Entry
The ease of market entry determines how many suppliers will be competing with you to offer similar products or services. High initial startup costs, specialist training and certification, technical expertise and regulatory compliance will all discourage new entrants and at the same time protect incumbents. Owning intellectual property, including patents, protects your competitive advantage. Economies of scale, highly developed sales channels and any secured exclusivity deals will also act as barriers to entry by companies wanting market share.
Ease of Substitution
How easily people can substitute your product or service with another will also influence the attractiveness of the market. Does your company have any direct or indirect competition? – are your competitors able to offer identical or similar products and services? Companies are becoming much better at influencing the ease of substitution using a “carrot or stick approach”, the former rewarding loyalty and encouraging retention while the latter penalising customers financially or making it very inconvenient for them to leave. Broadband providers, for example, offer an introductory price to attract new customers but then lock them into lengthy contracts with early termination charges. A customer relationship management (CRM) software company might not be particularly helpful if you wanted to migrate your data to another provider, potentially causing a real operational headache.
Suppliers will be wanting to increase their prices. The fewer suppliers there are and the more specialised or niche their products and services, the more control over pricing they will have. You need to, wherever possible, have access to a number of suppliers to reduce this dependency. Being reliant on a small number of suppliers can have both financial and operational consequences. For many years Apple has relied on external suppliers for its CPUs and this will likely have increased costs and affected the timeframe for new product launches. From late 2020 they’re planning to remove this supply chain problem with the introduction of Apple Silicon where their CPUs are designed and manufactured in-house, reducing their cost base and accelerating the time to market. Operating a franchise will usually involve you buying centrally from a strictly controlled product range and adhering to internal procedures. Are your suppliers’ prices creeping upwards and you’re unable to pass on these costs to your own customers? Taking into account the cost and inconvenience of moving, what can you do to mitigate this?
Buyers will try to reduce your prices and the fewer you have, the more they’re able to negotiate strongly and drive them down. The greater the amount they spend with you, the more price becomes an issue unless you’re able to demonstrate that the value you add exceeds this. You can influence this in many ways such as effective differentiation, developing greater customer loyalty through improved customer service, building strong personal relationships and becoming a “one stop shop” where people benefit from the convenience of using you for all their requirements. Brand loyalty is hugely important in this too and companies are becoming much better at using influencer marketing and other forms of social proof to grow it to the point that price is far less of a consideration.
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