Porters Five Forces - Who Holds the Power?
July 23, 2019 at 3:30 PM
DaltonPlan® Business Information Newsletter
Setting the Benchmark for Business Performance ● Issue 135 - 2019
Porters Five Forces - Who Holds the Power?
This article is about understanding competitive forces, enabling you to maximise profitability. I studied Michael Porter’s Five Forces model at university and have used it ever since in my own businesses and as part of my DaltonPlan® business planning model for my clients.
Porter recognised that organisations keep a close eye on their competitors, but he also realised that there are other forces at play in the market place. He encouraged business owners to look beyond the actions of their competitors and examine what other factors could impact their business environment.
He worked out that “differentiation” is the key to higher profits. That is, offering something different to what is available in the market place from competitors.
He identified five forces that make up the competitive environment, and which can erode your profitability. These 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 in order that you might discover points of difference to promote? Where rivalry is intense in an undifferentiated market, companies can attract customers with aggressive price cuts and high-impact marketing campaigns. Also, in markets with lots of rivals, suppliers and buyers can go elsewhere if they feel that they're not getting a good deal from you.On the other hand in a differentiated market, where competitive rivalry is minimal, and no one else is doing what you do, then you'll likely “hold the power” having tremendous strength and healthy profits.
- Supplier Power. This is determined by how easy it is for your suppliers to increase their prices. How many potential suppliers do you have? How unique is the product or service that they provide, and how expensive would it be to switch from one supplier to another?The more suppliers you have to choose from, the easier it is to switch to a cheaper alternative. However, the fewer suppliers there are, and the more you need their help, the stronger their position becomes along with their ability to charge you more. They hold the power. That can impact negatively on your profit.
- Buyer Power. Who holds the power here? You ask yourself how easy it is for buyers to drive your prices down. 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 their terms to you? When you deal with only a few savvy customers, they have more power, but your power increases if you have many customers who want your products and services due to their high level of differentiation.
- Threat of Substitution. This refers to the likelihood of your customers finding a different way of doing what you do. For example, if you supply a unique software product that automates an important process, people may substitute it by doing the process manually or by outsourcing it. A substitution that is easy and cheap to make can weaken your position and threaten your profitability, that’s why you need to find a major point of difference to what substitutes have to offer, in order to maintain your price.
- Threat of New Entrants. Your position can be affected by the ease with which a potential competitor can enter your market. So, think about how easily this could be done. 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 intellectual protection for your key technologies (patents or wordmarks), then rivals can quickly enter your market and weaken your position. If you have strong and durable “barriers to entry”, then you can preserve a favourable position and take fair advantage of it by maintaining or even increasing your price.
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By Dean Dalton DBA
Director, DaltonPlan® Business Action Planning Limited