The essence of having a business strategy is to help a company understand and stay ahead of the competition. In many cases, business managers restrict their definition of competition to perhaps industry rivals alone, leaving out other competitive forces that also play a role.
Michael Porter, a prominent name in the topic of business strategy, came up with five competitive forces that impact business: suppliers, potential entrants, customers, presence of substitute products, and competitors in the industry.
His analysis of these forces has helped shape how businesses define their strategies.
Briefly, the five forces can be described as follows:
- Suppliers’ Power: Where an industry has fewer suppliers, companies are more dependent on them, and therefore suppliers have more power to charge higher costs. On the other hand, where a company has several sources of supplies, it can maintain low input costs.
- Threat of New Entrants: An industry with strong barriers to entry for new players is ideal for existing businesses, which are able to operate on better terms.
- Customers’ Power: A smaller client base is more powerful when it comes to negotiating lower prices on products and services. Where clients are many and independent, a business can charge higher prices to boost its bottom line.
- The Threat of Substitutes: A business has to be wary of substitute goods and services that customers can resort to in place of its own offering. Where there is no threat of substitutes, companies have more power to raise prices.
- Industry Competition: A business with competitors in its industry must assess their ability to undercut it. Its power is reduced with the presence of a large number of rivals and the equivalent services and products that buyers can access from these competitors.
In a perfect industry, entry into the market is easy and companies don’t have to fight for position. However, this kind of environment has its downside as the prospects of long-term profitability are low. While every competitor might feel the pressure of these forces, a strategist has to dig deeper to analyse the source of each, with knowledge of the underlying sources of pressure forming the foundation of a strategy.
Nilesh Waghela, a retired independent business advisor, has worked with business clients to help them formulate their strategies. The use of Porter’s Five Forces was essential to his work, helping him to understand how to assess a company’s position in its industry and formulate a winning strategy.
Strategy Formulation
Having looked intently at the competitive forces and determined the underlying factors that apply to each, a business strategist can perform a strength and weakness analysis of a company to gauge how it stands against each element.
From there, a strategy is formulated based on the following aspects:
- Company Positioning: The business matches its strengths and weaknesses to the industry structure, taking care to position itself within the industry where the impact of the competitive forces is weak or where it can best defend itself. Doing this ensures the company knows where to confront competitors and where to adopt a different approach.
- Influence Over the Competitive Forces: A company can take the offensive position and come up with a strategy to influence the causes of the competitive forces. For example, investing in large-scale production facilities can raise the barriers to entry, while marketing innovations can lead to product differentiation.
- Anticipating Industry Shifts: As industries evolve, new trends emerge that have an impact on the competitive forces. A good strategist will not only consider the trends but anticipate how they affect the sources of competition and respond to them.
Recent Comments