As a young manager, i was occasionally asked to set up a strategic discussion, or a review of our strategy and really struggled about how to arrange my thoughts and hence the presentation.
I’m an academic by training and would always go back to the books when ever I became stuck. When I trained at INSEAD i was introduced to a useful and simple tool for arranging any strategic discussion,
The Porter’s Five Forces tool is simple but powerful means to understand where power lies in any business situation and hence a great means t arrange your strategic thinking. This is useful, because it helps you understand both the strength of your current competitive position, and as you consider your strategy the strength of a position you’re considering moving into.
Conventionally, the tool is used to identify whether new products, services or businesses have the potential to be profitable. However it can be very illuminating when used to understand the balance of power and hence business strategy in other situations.
Understanding the Tool:
Five Forces Analysis assumes that there are five important forces that determine competitive power in a business situation and which impacts on your strategic decision making. These are:
- Supplier Power: Here you assess how easy it is for suppliers to increase their prices. This is driven by the number of suppliers of each key input, the uniqueness of their supplied product or service, their strength and control over you, the cost of switching from one to another supplier, and so on. The fewer the supplier choices you have, and the more you need suppliers’ help, the more powerful your suppliers are.
- Buyer Power: Here you ask yourself how easy it is for buyers to force price decreases (through discounts, rebates, playing producers off). Again, this is driven by the number of buyers, the importance of each individual buyer to your business, the cost to them of switching from your products and services to those of someone else, and so on. If you deal with few, powerful buyers, then they are often able to dictate terms to you.
- Competitive Rivalry: What is important here is the number and capability of your competitors. If you have many competitors, and they offer equally attractive products and services, then you’ll most likely have little power in the situation, because suppliers and buyers will go elsewhere if they don’t get a good deal from you. On the other hand, if no-one else can do what you do, then you can often have tremendous strength.
- Threat of Substitution: This is affected by the ability of your customers to find a different way of doing what you currently do – for example, if you supply a unique software product that automates an important process, people may substitute by doing the process manually or by outsourcing it. If substitution is easy and substitution is viable, then this weakens your power.
- Threat of New Entry: Power is also affected by the ability of people to enter your market. If it costs little in time or money to enter your market and compete effectively, if there are few economies of scale in place, or if you have little protection for your key technologies, then new competitors can quickly enter your market and weaken your position. If you have strong and durable barriers to entry, then you can preserve a favorable position and take fair advantage of it.
This tool was created by Harvard Business School professor, Michael Porter, to analyse the attractiveness and likely-profitability of an industry. Since publication, it has become one of the most important business strategy tools. The classic article which introduces it is “How Competitive Forces Shape Strategy” in Harvard Business Review 57, March – April 1979, pages 86-93.
To use this tool, think about how each force affects your business, and by identifying the strength and direction (in your favour, against you) of each force, you can quickly assess the strength of your position and your ability to make a sustained profit in the industry. By analysing these movements your strategy can be developed by assessing what you need to do to sustainably change the power force in each area to your benefit. You can then rank each action in a simple matrix on two axes
– how easy is it to do; easy ——> tough
– what’s the impact Significant —-> insignificant
By doing this you have a simple way of assessing what you should do first. But also on balance whether this is a strategy, overall, to pursue or a business to develop.
The internet is full of case studies that apply this model
– here is a more detailed review of each element of the 5 Forces