What hinders companies from growing? A refusal to individually identify the forces that make up and shake up their competitive environments, according to Harvard Business School’s Professor Michael Porter.
“Competitive advantage cannot be understood by looking at a business as a whole. It stems from the many discrete activities a company performs in designing, producing, marketing, delivering and supporting its product. Each of these activities can contribute to your business’s relative cost position and create a basis for differentiation,” according to Professor Michael Porter, Harvard Business School.
Who is Michael Porter?
The Economist magazine calls Michael Porter a guru. Born in 1947, he’s seen his fair share of tumultuous economic cycles and today he is deemed a doyen amongst business management experts – lauded for his creation of the Five Forces business strategy framework.
“Porter effectively redefined the way that businessmen think about competition, largely by introducing the language and concepts of economics into corporate strategy. He began by simplifying the notion of competitive advantage and then created a new framework for companies to think about how to achieve it,” the magazine explains.
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What are Porter’s Five Forces?
In 1979, Porter originally described five ‘forces’ that can govern the profit structure of a company by determining how the economic value it creates in a competitive environment.
“Economic value may be drained away through rivalry among existing competitors, and it can also be bargained away through the power of suppliers or the power of customers, or be constrained by the threat of new entrants, or the threat of substitutes,” he says.
To analyse a business’s likely profitability, he identified these five forces that make up the competitive environment for companies, regardless of the sectors in which they operate:
- Competitive rivalry
- Supplier power
- Buyer power
- Threat of substitution
- Threat of new entry.
The 6th Force arrives
In the mid-1990s, Porter reviewed his business strategy framework and added a sixth force – complementary products. He believes that the sixth force can be used to evaluate your company’s strategic position in a marketplace.
Together, the six forces model has helped some of the world’s biggest businesses achieve further growth in challenging economic circumstances. The forces can also be used by you to determine a market's overall attractiveness in relation to profitability and competition.
Why is Porter’s business strategy framework important?
Business News Daily’s associate editor, Marci Martin helps unpack Porter’s forces and their influence on companies in more detail:
Force 1 – Competitive rivalry
Porter’s first force centres on critically assessing how intense the competition currently is in a marketplace. This can be determined by the number of existing competitors and what each is capable of doing.
“Rivalry competition is high when there are just a few businesses equally selling a product or service, when the industry is growing and when consumers can easily switch to a competitor's offering for little cost. When rivalry competition is high, advertising and price wars can ensue, which can hurt a business's bottom line,” Martin says.
Force 2 – Supplier power
Here, Porter suggests analysing how much power your business’s main suppliers might have and how much control they have over the potential to raise cost prices. Should a supplier opt to raise prices it would lower your business's profitability.
“In addition, force two looks at the number of suppliers available. The fewer there are, the more power they will have. Businesses can achieve a better platform for growth by opting for a multitude of suppliers,” adds Martin.
Force 3 – Buying power
Force three focuses on assessing the power of the consumer in your growth strategy.
“Consumers have power when there aren’t many of them but lots of sellers, as well as when it is easy to switch from one company’s products or services to another,” says Martin. “Buying power is low when consumers purchase products in small amounts and the seller’s product is very different from any of its competitors.”
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Here is an example of Porter’s business strategy model that assesses The Coca-Cola Company in relationship to its Coca-Cola brand’s success:
1. THREAT OF NEW ENTRANTS: MEDIUM PRESSURE
Entry barriers are relatively low for the beverage industry and there is an increasing number of new brands entering the market with similar prices to Coke products. Coca-Cola is seen not only as a beverage but also as a brand. It has held a very significant market share for a long time and loyal customers are not very likely to try a new brand.
2. THREAT OF SUBSTITUTE PRODUCTS: MEDIUM TO HIGH PRESSURE
There are several types of energy drinks, sodas and juices in the market. Coca-cola doesn’t really have an entirely unique flavour. In a blind taste test, people can’t tell the difference between Coca-Cola and Pepsi.
3.THE BARGAINING POWER OF BUYERS: LOW PRESSURE
The individual consumer places no pressure on Coca-Cola. It’s the larger international retailers such as Wal-Mart that have bargaining power because of their bigger order quantities. The retailers’ bargaining power is lessened though, due to the end consumer’s brand loyalty to Coke.
4.THE BARGAINING POWER OF SUPPLIERS: LOW PRESSURE
The key components for a soft drink include carbonated water, phosphoric acid, sweetener, and caffeine. These suppliers are not concentrated, nor are they differentiated. Coca-Cola is likely a large, or the largest, customer of any of these suppliers.
5. RIVALRY AMONG EXISTING FIRMS: HIGH PRESSURE
Currently, Coca-Cola’s main competitor is Pepsi, which also produces a range of drinks under its brand. Coca-Cola and Pepsi both remain preeminent carbonated beverages and are committed heavily to sponsoring outdoor events and activities to maintain growth of their market share.
6. COMPLEMENTARY PRODUCTS: LOW PRESSURE
When there are other soft-drink brands to work with internally that can offer potential to grow market share, like Dr Pepper, Coca-Cola can market complementary products to bolster or grow sales. If there’s an up-and-coming brand that can be acquired, Coca-Cola is in the fortunate position to offer a buy-out.
Force 4 – Threat of substitution
The fourth force to consider as part of Porter’s strategy is the potential to be usurped by substitute products or businesses. The threat of substitution is about how easy it is for consumers to switch from your product or service to that of a competitor.
“It looks at how many competitors there are, how their prices and quality compare to the business being examined and how much of a profit those competitors are earning, which would determine if they can lower their costs even more. The threat of substitutes is informed by switching costs, both immediate and long-term, as well as a buyer’s inclination to change,” Martin describes.
Force 5 – Threat of new entry
“This force examines how easy or difficult it is for competitors to join the marketplace in the industry being examined,” says Martin.
She explains that the easier it is for a competitor to join the playing field, the greater the chances of your market share being depleted. “Barriers to entry include absolute cost advantages, access to inputs, economies of scale and well-recognised brands.
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Force 6 – Complementary products
The latest addition to Porter’s forces strategy looks at ‘complementors’. These can be companies or entities that sell or offer goods or services that are compatible with, or complementary to, the goods or services you produce or sell.
Do you partner with these complementors? Do you acquire them? By assessing their impact in your sector, you can decide on how to approach their presence in the market. Associate editor ofThe Strategic CFO, James Wilkinson says that complementary goods offer more value to the consumer together than apart.
“When one product or service complements another, there exists this condition called complementarity; a sort of commercial symbiosis,” he says. “Complementors are often considered the sixth force of Porter’s industry analysis framework. The presence of complementors can heavily influence the competitive nature of an industry.”
Porter stands by his forces resolutely, despite arguments that his thinking is outdated.
“These forces are the key sources of competitive pressure within an industry. Sure, it’s important to strategise on more fleeting factors that might grab your attention – such as industry growth rates, government interventions, and technological innovations – but these are temporary factors while the ‘forces’ are permanent influencers,” Porter says.
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