Tool Box Talks: Porter’s Five Forces

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Management tools are a dime a dozen. And yet, contrary to popular belief, most of them are good and helpful if used correctly and in an adequately defined context.

In “Tool Box Talks” we introduce you to common and less well-known tools and show you how you can exploit their potential for your enterprise, with today’s focus on Porter’s Five Forces.

What is the five forces analysis and when should it be used?

Porter’s Five Forces Framework is one of the best-known models of strategic analysis. It analyses the external environment of a company and provides valuable input for strategic planning.

This tool is used for various strategic questions, the answers helping companies to optimise their strategies for the portfolio business with a special focus on external conditions, forming a sound basis for decision-making when it comes to entering new markets, or becoming a focal point to systematic innovation processes.

How is the five forces analysis used?

The five forces model, just as its name suggests, investigates five aspects of a company’s environment that have different effects on businesses:

  1. the bargaining power of suppliers
  2. the bargaining power of customers
  3. the jockeying for position among current competitors
  4. the threat of new entrants
  5. the threat of substitute products or services.

For each aspect the current market situation is being assessed: what is the present state of affairs? What changes are to be expected within the next years? What opportunities or threats will follow, affecting one’s own business? The last two questions could be used as a direct input to a SWAT analysis.

Having evaluated the current situation, different measures of strategic action can be analysed and assessed. What is important here is that both all five aspects of the five forces framework and identified developments plus interrelations are taken into account.

Beware of pitfall!

A common pitfall is a biased analysis. Established companies in particular which have long been present in a market or market segment tend to look at their market environment from entrenched positions. This will result in a distorted image of the status quo and a misjudgement of current developments.

To avoid this, it makes sense to use diverse sources of data for the analysis or to have more or less independent external service providers, like a business consultant, make the analysis.

What is the benefit of using the five forces analysis?

The five forces analysis provides a detailed description of a company’s external environment, which is a valuable input to strategy development. It makes it possible to tackle the questions of

  • how a company can best take advantage of its strengths and weaknesses,
  • what is necessary to stay successful in the market,
  • if an existing or a new market share is attractive for the company,
  • if it makes sense to focus on cost reduction or value enhancement,
  • etc.

 

Further, linking the five forces analysis with a scenario-based approach can lay the foundation for a company to apply dynamic strategic planning, thus enabling the enterprise to react to market change while it is happening or even to anticipate it.

Follow us on LinkedIn to learn on a regular basis how you can make the most of management tools, so that you will stay one step ahead of your competitors.

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Why strategies don’t work – Part 2

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Some years agoTom’s startup really made it: the online platform devised by him and his friends revolutionised the market. The trio’s strategy had paid off and within only three years their firm, having set off as a small living-room startup, had developed into a booming business with 15 employees, a turnout of hundreds of millions and a market share of over 30 percent.

But despite the seemingly positive figures Tom feels the pressure imposed by investors constantly growing and his position is becoming shaky. While revenues and his market share have lived up to his expectations, his company has still not been able to generate profits even though initial development expenditures and marketing costs were not higher than expected.

 

Tom is not the only person who has to fight these difficulties. According to an up-to-date study carried out by David J. Collis from Harvard Business School business strategies misfire because they fail to consider their whole strategic landscape. Young businesses and startups in particular founder regularly as they do no sufficiently take into account value capture and value realisation.

A company’s strategic landscape

As was described in this mini series’ first part, a firm’s strategic landscape comprises business opportunities, the value potential of the respective business model, an enterprise’s value capture and value realisation and their final output.

For a business strategy to be successful, you need to look at all five of these areas, find a suitable answer that does justice to each of them and unhesitatingly translate them into consistent action. While, as was explained in my latest blog, established companies tend to lose track of changes in business opportunities, startups typically make mistakes in a different area of their strategic landscape.

Common mistakes committed by startups

The main strength of startups is that they address so-called hot topics and transform them into a novel business model, or that they fundamentally change the way customers’ needs are met. Naturally, this strategy concentrates on the first two components of their strategic landscape, i.e. business opportunities and value potential.

Yet, to go beyond business opportunities and attractive business models and to lead a company to long-term success, careful consideration should be given to the remaining three elements of a company’s strategic landscape. This is a standard weakness of young businesses and startups: They overestimate the opportunity of making profits in the new market, whereas they ignore the strong likelihood that competitors will eventually copy their ideas, or the young firm fails to build efficient structures and to develop necessary competences of staff.

What follows is, as with Tom and his friend’s firm, that these companies my be capable of creating considerable growth and amplify substantial market shares, but in the long run they will find it difficult to create attractive margins from their turnover and their gained market share.

Robust strategies for startups

If you wish to develop a robust strategy, you have to field all aspects of a company’s strategic landscape. From the outset, startups ought to include questions of value capture and value realisation in their strategic planning.

A good starting point is the following set of four questions:

  • Will our business sector deliver decent profits?
  • How will established companies react to our market launch?
  • How easily will our business model be imitated?
  • How can a startup be scaled up efficiently?

The first question can reveal if a business concept or model should be put to the test in the first place. An attractive business concept with low profit potential (e.g. because the market is too small, necessary investment expenditures will be too high or expected margins too small) will not prove successful in the long run.

Questions 2 and 3 address the behaviour of competitors. In most cases an innovative startup enters an existing market in a new kind of way. But this also means that there are established companies unwilling to give up market shares. Sooner or later they will respond to the new competitor. Depending on how strong their market power is, they may severely hinder a startup’s market development.

When it comes to digital business models, you’ll have to check how easy it is to copy it. If its only innovation consists of not more than a few lines of code, it won’t take long until the idea is imitated. In such a scenario it will be unlikely for a company to gain both high market shares and high profit margins.

The last question examines the company’s future development. The characteristic agility and dynamic resilience embraced by many startups is a good precondition for generating new ideas and launching them into the market. For growth and profitability, however, other skills are required. Long-term success requires you to look ahead and provide, right from the start, the basis for developing structures and competences crucial for further expansion, even if you may not need them at the moment, and to implement this process of company growth early on.

If you wish to know how to combine all elements of your strategic landscape into a sustainable strategy, contact us for an informal free initial consultation.

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