3 Cost Elements of Green Hydrogen

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Green Hydrogen is considered key to a sustainable and climate neutral energy supply. Neither its production nor its consumption emits carbon dioxide, it can be stored and transported without significant losses and allows for sector coupling. However, these benefits com at a cost. For 2019, statista estimates the costs of the production for green hydrogen at 16.50 €/kg.

Key Drivers of Hydrogen Production Costs

The main obstacle to the commercial success of green hydrogen is its cost compared to other sources of energy. Therefore, one of the most important questions is: How can we reduce

Production costs? To better understand this question and its implications, let’s take a deep dive into what contributes to hydrogen’s production costs.

The main elements defining its production costs are:

  • investment,
  • fixed operational costs,
  • variable operational costs and
  • utilisation.

By investment is meant all expenditure related to hardware incl. engineering and erecting – from electrolysis to piping and fencing. It is primarily impacted by the size and type of electrolysis. As large scale industrial production of electrolysis systems is still in its infancy, Fraunhofer’s IMS assumes that investment costs of electrolysis projects will be roughly cut to 50% of today’s cost level by 2030.

Fixed operational cost (OPEX) is primarily defined by labour and maintenance. Thus, the most probable scenario here are cost increases induced by general inflation effects. Besides, no significant cost changes can be anticipated.

Variable OPEX is dominated by cost of electricity. Cost for water and other consumables which are required in minor quantities can be neglected for an initial estimation of production costs. Renewable electrical power can be generated for 0.03 to 0.17 €/kWh, depending on the utilized energy source and the size of the production facility.

The fourth factor influencing the hydrogen costing system is the utilization of the electrolysis. While variable OPEX is directly proportional to hydrogen production, investment costs and fixed OPEX are constant annual costs. Its impact on cost of production is depending on the overall hydrogen production and thus on capacity utilization. As producers generally try to increase utilization as much as possible, it directly depends on the availability of renewable electricity.

Dependencies in Cost of Production

Cost of production for green hydrogen can, slightly simplified, be calculated from these four factors and the time of depreciation, which is in many cases 10 years. The respective formula is:

 

CoP = V + (F + I / t) / (U * N)

 

CoP = cost of production [€/kg]

V = variable OPEX [€/kg]

F = fixed OPEX [€/a]

I = invest [€]

t = time of depreciation [a]

U = utilization [%]

N = nominal Production [kg/a]

 

As highlighted before, producers can primarily influence two factors: the cost of electricity, i.e. variable OPEX, and capacity utilization. Hydrogen production costs are reduced for lower electricity costs and increasing capacity utilization. Unfortunately, these two factors are not independent of each other for green hydrogen production.

In the example calculations shown in the table below, I assumed a 10 MW electrolysis with 65% efficiency, which would results in an annual hydrogen production of 1,500 t at 100% utilization. The overall investment cost is set at 10 M€ with a 10 years linear depreciation and 150 k€ annual fixed costs. For variable OPEX, only cost of electricity is included while all other costs are neglected for simplicity’s sake.

Bearing in mind that potential sites for large-scale hydropower plants are already used in Germany and thus the optimum scenario with a 10 MW hydropower station is unrealistic, the data showcase the reverse trend in variable and fixed elements in production costs.

Optimizing Cost of Production

Looking at the calculated cost of production, the key question is how to produce green hydrogen both ecologically and economically. One important factor will surely be e reduction in hardware cost. Even if a certain fraction of this effect will be balanced by inflation effects, the relative cost of electrolysis units will go down compared to other energy conversion technologies.

While investment costs for electrolysis technology can be expected to decline over time, a similar effect cannot be expected for wind and solar power. Thus, cost reduction for variable OPEX is rather unlikely, especially as sites with optimum wind and solar conditions will soon be utilized and new wind and solar parks will rather be built on B or C sites with lower average power production.

Finally, electrolysis utilization may be increased by use of power storage and a combination of several renewable electricity sources. Batteries or similar electricity storages can significantly increase utilization but are quite expensive as of today. Thus, an optimization of utilization comes at the cost of increased investments and the effect on hydrogen’s production costs are rather negative.

The approach to improve utilization by using several power sources, e.g. wind and solar power, seems to be more promising in reducing lower production costs. This scenario, however, requires an increased power supply which needs to be provided for. This may impact the average cost of electricity and thus has to be evaluated separately.

This example calculation and the discussion of its results highlight the complexity in green hydrogen economics. Contact us or follow us on LinkedIn to learn more about the topic.

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The 7 Colors of Hydrogen

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Hydrogen (H), a colourless, odourless, tasteless, flammable gaseous substance that is the simplest member of the family of chemical elements.

Hydrogen is colourless – that is a well known fact and not only a definition from Encyclopædia Britannica, and yet, hydrogen is frequently referred to a having a specific colour. However, the colour coding does not define the actual optical appearance of the gas. Rather, it is used to indicate its ecological footprint and its carbon intensity in particular.

Occurrence and Production of Hydrogen

With more than 90% of all atoms and roughly 75% of matter, hydrogen is the most common chemical element in the universe. However, hydrogen only contributes to less than 1% of earth’s overall mass and hardly any terrestrial hydrogen is available as H2 but in more complex molecules like water or methane (i.e. natural gas), making it impossible to exploit natural hydrogen reservoirs on earth.

To make hydrogen available in large quantities one needs to split up molecules which are available in vast quantity. This is primarily done using three processes: steam reforming, methane pyrolysis, and electrolysis.

Today’s hydrogen production primarily relies on steam reforming. In steam reforming, a hydrocarbon – primarily methane – reacts with steam to hydrogen and carbon monoxide. In a subsequent process step, additional water is used to produce carbon dioxide and additional hydrogen from the carbon monoxide.

Another technology, methane pyrolysis, uses methane as starting point. The gas is thermally cracked into hydrogen and carbon. As carbon is a solid, it can easily be separated and stored or used in other processes, thus avoiding any carbon dioxide emissions to the atmosphere.

Perhaps the best-known process for hydrogen production probably is water electrolysis. As most terrestrial hydrogen can be found in water, this technology levers the largest hydrogen reservoir on earth. Electricity is used to split water into hydrogen and oxygen. As no carbonaceous molecules are involved in the process, it does not emit any carbon dioxide at all.

That is How Hydrogen Becomes Colourful

Hydrogen and its derivatives, i.e. energy carriers produced from hydrogen, are an important building block for a sustainable and climate neutral energy supply as no carbon dioxide is emitted when using hydrogen. For a sound evaluation of hydrogen’s climate impact, however, it is necessary to understand the way it is produced – and that is why its colour nomenclature makes sense.

The color of hydrogen determines both the primary hydrogen and energy carrier and the production process. This set of information allows for a rough estimation of the climate footprint of a specific batch of hydrogen and thus whether is can be considered climate friendly or not.

Unfortunately, different users are using different color codes which, in some details, differ from each other. We are following the definitions used by Germany’s National Hydrogen Council and the German Government.

Hydrogen produced from methane and other hydrocarbons using steam reforming is labeled as grey hydrogen. Assuming perfect process conditions, four hydrogen molecules and one carbon dioxide molecule are produced from one methane and two water molecules. The energetic efficiency of the process is at roughly 70%.

The carbon dioxide emissions from this process can be captured and permanently stored underground, either in gas caverns or suited geological formations. While the required process steps prevent emitting carbon dioxide in the atmosphere, they also reduce efficiency as additional energy is required for carbon sequestration and compression. Hydrogen produced by steam reforming from fossil hydrocarbons utilizing carbon capture is labeled as blue hydrogen.

Turquoise hydrogen is hydrogen produced by methane pyrolysis. As with grey and blue hydrogen, the production process utilizes fossil hydrocarbons. But since the byproduct is not carbon dioxide but solid carbon, carbon dioxide emissions are avoided if the energy required for the pyrolysis process is produced in a carbon neutral way. The technology is currently being developed but not yet commercially available at larger scale.

Red, yellow, and green hydrogen all stem from electricity using water electrolysis. There are no direct carbon dioxide emissions, and the energetic efficiency of commercial systems today is in the 60-65% ballpark. The different colors signify differnt sources of electricity.

Yellow hydrogen is hydrogen made from grid power. The energy mix, i.e. the percentage of fossil, nuclear, and renewable energy, is given by the power generation at the very moment the hydrogen is produced. The measure of carbon dioxide emissions of yellow hydrogen are varying because the energy mix is constantly changing – due to availability in solar and wind power and changes on the demand side. In case of a high percentage of coal and gas in the energy mix, the effective emissions of yellow hydrogen may temporarily even be worse than those of grey hydrogen.

In case only electricity from nuclear power plants is used for hydrogen production, this hydrogen is labeled as red. No carbon dioxide is emitted in its entire production process and thus it is climate neutral. However, nuclear power generation produces radioactive wastes which need to be securely stored for centuries. Thus, red hydrogen comes with additional risks.

Electrolysis utilizing only electricity from renewable sources, i.e. wind solar and hydro power, produces so-called green hydrogen. In the process, neither carbon dioxide nor any other harmful substances are produced. Unfortunately, the availability of renewable electricity is generally limited by weather conditions. Therefore, for a continuous production of green hydrogen, large scale batteries are required for storage of electricity.

Finally, orange hydrogen summarizes all production pathways utilizing waste or biomass as input. It is, however, impossible to have a general statement on overall efficiency and cabron bioxide emissions as this will vary depending on the input and the respectively used production technology.

You like to learn more about how to set up a sustainable and economical hydrogen supply? Contact us or follow us on LinkedIn for regular updates.

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Tool Box Talks: PESTEL Analysis

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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 a PESTEL analysis.

What is a PESTEL analysis and when should it be used?

PESTEL analysis is a strategic planning tool. However, it is also used in strategic marketing or quality management. It analyses the external environment of an organisation and provides a holistic overview of external factors the organization should be aware of.
PESTEL analysis is the first of several steps in strategic planning activitities. Whenever external, macroscopic driving forces need to be considered in the planning process, PESTEL analysis is the tool of choice.

How is a PESTEL analysis used?

PESTEL is an acronym for:
P – political factors
E – economic factors
S – social factors
T – technical factors
E – environmental factors
L – legal factors
Conducting a PESTEL analysis requires several steps to be taken. First, the facilitator needs to select a goup of people representing as many different parts and functions of the organization as possible. This group brainstorms driving forces for each of the six topics.
Next, people external tot he organization are interviewed. This ensures that results are unbiased and helps broadening the background from which ideas are taken, thus reducing the risk of missing important factors in the analysis.
IN the next step, the identified driving forces are evaluated. To do so, all available data on each of the factors are collected and reviewed in order to identify the potential impact on the organisation’s objectives.
Finally, the list of driving forces is refined based on the previous data evaluation. The result is a list of relevant external factors for each of the six categories. This list is the input for subsequent process steps, e.g. a SWOT analysis.

Beware of pitfall!

While searching external driving forces, a PESTEL analysis focuses on six different topics to help create a holistic picture of the environment. In doing so, the tool forces the user to adopt different points of view on the environment. Though this aids to minimize bias effects it does not guarantee that the team will identify all relevant factors. Thus, while preparing for a PESTEL analysis, the group discussion leader needs to pay attention on the selection of participants – both the internals for step one and the externals involved in step two. The broader the experience and background of those involved, the higher the likelihood that all relevant driving forces will be captured.
The same is true for the data analysis in step three. In order to obtain reliable results, the team needs to ensure that inputs are not only taken from a few limited sources. Instead, they should try using a baseline as broad as possible in order to avoid biased data. Again, the use of external experts in data gathering and data evaluation may be helpful in generating a neutral and balanced data set.

What are the benefits of using a PESTEL analysis?

A PESTEL analysis generates an overview of factors potentially impacting an organization. In this way the results assist in better understanding the external context in which an organization is operating. This understanding is one of the key requirements when setting up a quality management system according ISO 9001. Results from a PESTEL analysis may also be used as in input for strategic planning like, for example, a scenario analysis.

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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Consulting Made in Westerwald

Westerwald Future

The Westerwald is something special: economically strong with many small and medium-sized industrial and artisan businesses, yet not an industrial metropolis, but a scenically highly attractive location that visitors associate more with vacations than with work.

The strength of the local economy is demonstrated by the development of value creation: While the GDP nationwide has only increased by just under 17% in the last decade, growth in the Westerwald was nearly 50%, which is three times higher than the national average.

This provides local businesses with the best conditions to shape a successful future. However, success is not a constant, and this applies in the Westerwald as well as in any other region. Changes in boundary conditions, inefficient handling of scarce resources, or internal misjudgments can lead formerly successful business models to become unsustainable. To remain successful in the long term, companies should therefore fundamentally seek solutions to continuously enhance their future viability.

Solutions from the Westerwald

RNO-Consulting develops such tailor-made solutions. As a regionally rooted management consultancy, we not only utilize tried-and-true approaches but also consider the specific characteristics of businesses in the Westerwald – so that you not only remain successful but also strengthen your unique identity.

Risk minimized

Only those who recognize risks and threats can actively minimize them. RNO-Consulting assists you in efficiently identifying relevant risks and developing and implementing effective countermeasures. This way, we ensure the long-term security of your success.

Opportunities maximized

There are many opportunities and improvement possibilities, but they must be seized. We solve problems within your company, optimize processes and workflows, and assist you in establishing targeted innovation management. This enables you to fully unleash your potentials.

Success granted

Success doesn’t happen by chance; it’s the result of focused efforts. RNO-Consulting is your partner in guiding these efforts in the right direction. This ensures that you stay one step ahead of your competition.

Consultng Made in Westerwald

Consulting at the highest level according to international standards, implementation- and application-oriented for medium-sized businesses, down-to-earth and hands-on like the region – that’s consulting Made in Westerwald, and that’s what RNO-Consulting stands for.

Contact us and get to know us – without obligation and of course free of charge!

International standards – RNO-Consulting operates according to ISO 20700 and is listed with the International Council for Management Consulting Institutes through its owner, Dr. Tobias Panne.

Consulting for medium-sized businesses – since 2020, RNO-Consulting has been certified by the Bundesverband Mittelständischer Wirtschaft for its quality work as a consultant for the medium-sized business sector.

Made in Westerwald – from the region, for the region. As a Westerwald-based company, we are committed to the region and place special emphasis on strengthening it..

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Successfully implementing change – Part 2

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It was Christine’s dream job: project manager for a large digitization project at an established, economically strong medium-sized company. She had the opportunity to fully contribute her experience, the pay and working conditions were attractive, the company offered perspectives beyond the project, and the position itself was a significant career advancement for her.

The first few months were unexpectedly tough. Even though the entire management officially supported the project and its goals, no one wanted to engage in the associated changes. But with her persistent nature and her skills as a change manager, she was eventually able to anchor the necessity of change and form a leadership team that truly supported the project. Christine’s second challenge now was to successfully implement the project.

The power of status quo

The first part of this mini-series showed what obstacles make the preparation of change processes difficult and how important decisions are made in the planning of changes that significantly influence later success. But even if “planning is half the battle,” implementation remains the second half that contributes just as much to the success – or failure – of a project.

When implementing changes, it is also about overcoming the power of the status quo and the inhibiting forces described in the first part of this series. Four elements can help you successfully master this challenge.

Preconditions for successful change

If you want to reap the fruits of success after a good preparation of your change project, you should show your stakeholders that your initiative is successful. At first glance, this may sound like a catch-22 situation, but it can be achieved through four simple elements.

Enable employees

First and foremost, you need to ensure that your employees can act in line with your change project. In established companies, there are a multitude of defined processes and (partially unwritten) rules. These more or less fixed guidelines significantly determine how the company operates and functions.

Changes always mean that certain areas should be handled differently than before. This means that some of the existing guidelines need to be disregarded. However, this only works if you enable and encourage your employees to override existing norms and standards where necessary.

Generate quick wins

In most cases, a change project will not consist of a single measure, but rather a multitude of smaller steps. It is important to take the first relevant steps as quickly as possible.

This can demonstrate, on the one hand, that you are proactive and driving your initiative forward, and on the other hand, that you are heading in the right direction and your project is successful (despite any naysayers). If you can communicate early successes quickly, you solidify your position in the company and gain additional supporters who were initially skeptical of your project. This gives your project new momentum, which is essential for its further implementation.

Consolidate success and initiate further change

In addition to achieving early successes, it is critical to anchor the changes achieved sustainably in the organization. As just shown, achieving milestones leads to even hesitant employees supporting the project. However, if your organization quickly falls back into old habits, this is grist to the mill for those who would like to see the project fail.

At the same time, it is important not to rest on what has already been achieved, but to continue at the same pace and take further steps towards the stated goal.

Anchoring new behaviour

While at the beginning of a change project existing processes and rules need to be broken in order to enable change in the first place, at the end of the initiative it is necessary to establish and anchor new behaviors. Only in this way will the participants in the company also adhere to the new ways of working in the long term, and not fall back into previous patterns out of old habits.

If a company fulfills all four points in the implementation of change measures, it has a good chance of successfully completing the change project.

If you want to be successful in your next change project, contact us.

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Tool Box Talks: Portfolio Matrix

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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 a portfolio matrix.

What is a portfolio matrix and when should it be used?

A portfolio matrix is a portfolio management tool that assists its user in keeping track of several projects within the project portfolio. By visualizing process adherence it enables the portfolio manager to identify critical projects at a glance.

This tool is particularly useful when it comes to coordinating a greater set of projects, where the portfolio manager is not identical with the project manager. It helps to gain an overarching view of the project portfolio and to focus resources on those projects whose success is currently under threat.

How is a portfolio matrix used?

A portfolio matrix shows all portfolio projects’ target performances on process adherence, considering two dimensions for each project:

1.) How much does work progress deviate from original time schedules? (x-axis)

2.) How well is current spending within the frame of the pre-arranged budget? (y-axis)

If project portfolios are relatively small, these two dimensions can be visualised by means of a three-step scale (below plan – on plan – ahead of plan), if a portfolio comprises a greater number of projects, it makes sense to use a five-step scale (far below / well ahead of plan – slightly below / ahead of plan – on plan). Here standardized project reports should be used to update regularly the data input.

After each data update the respective project’s process adherence is plotted on the matrix. A project which is located in the middle of the matrix is exactly on schedule in terms of time and costs. The more a project diverges from the middle axis, the greater are the deviations from plan.

If this is the case, the responsible portfolio manager should take necessary measures to ensure process success.

Beware of pitfall!

A portfolio matrix is designed to show deviations from a project’s targets. However, a deviation is not necessarily to be seen as negative. For while it may sound so when a project exceeds the current target budget, there will probably be no reason for the portfolio manager to intervene if the project is ahead of schedule and the costs are in line with the reached project status. So before measures are taken, the deviations in the portfolio matrix should always be discussed in detail with the project manager.

 

Another trap is lacking awareness of priorities of projects. While the portfolio matrix informs about deviations from set targets, it does not make any statement about how relevant projects are within the portfolio. If you wish to make prioritization visible, a weighting factor can be introduced, which is reprresented by a colour code or the physical size of the projects within the matrix.

What are the benefits of using a portfolio matrix?

A portfolio matrix shows portfolio mangers at once what projects within the portfolio work out according to plan and where there are deviations from schedule. This will enable them to focus their attention on projects about to fail.

 

In this way, a portfolio matrix helps companies to use management resources effectively and to direct their focus on activities requiring extra attention.

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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Successfully implementing change – Part 1

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It was Christine’s dream job: project manager for a big digitalization project in an established, thriving medium-sized company. She had the opportunity to make full use of her experience, the job was well-paid while she had attractive working conditions, the company offered career advancement opportunities beyond this project and by accepting the position she had made a great career move.

But after only a few weeks she became disillusioned with her new job. No matter who Christine talked to within the executive or management board, everybody supported the digitalization project – but as soon as there was talk about necessary changes to be made, she met with resistance from all sides. “This won’t work”, „It’s too risky“, „Let’s wait and see …“, “Yes, but …” – those were the usual reactions.

The power of the status quo

Cases like Christine’s, in which she met resistance to change is nothing new. As long as you only talk about goals to be achieved, it will be relatively easy to find approval. However, once you start listing the changes required to reach these goals, you’ll suddenly be confronted with a wave of doubts and rejection.

By the way, what is it that makes the status quo so much more attractive compared to change? One reason is sheer force of habit. Humankind gets used to things and processes in less than no time. Once committed to memory, operations are carried out automatically, hence requiring less attention and concentration. To change a routine habit, you need a great deal of energy as you have to focus on the new way of handling things plus put a lot of energy into resisting well-established processes.

Another obstructive force against change is fear. With the status quo, people have the feeling that they know the processes, the way things are connected and their consequences and they tend to think they can control all these things. When you tread new paths, this alleged security is gone because the take-off into the unknown undoubtedly has its risks.

There are many more factors, such as “one’s personal experience” or “personal pride”. The list could be endless; but it all boils down to one truth: To bring about real change, you need to overcome the attraction of established customs.

How change can be successfully put into practice

Seeing this, it is hardly surprising that about three quarters of all change initiatives in companies are doomed to failure. At the same time, at least every fourth initiative is successful. The good news is that chances of success are significantly higher if several aspects are taken into account when it comes to preparing the implementation of change. In the first part of our mini series “Successfully implementing change” we start with taking a closer look at the preparation process necessary for a change initiative to go as planned.

Creating awareness

“We’ve always done it like that.” is often seen as one of the most dangerous statements – and at least in terms of change this is only too true. If efforts to bring about change are to be successful, the mindset behind this declaration has to be overcome.

To do so, all involved persons have to made aware that the changes in question are not only important but absolutely necessary to ensure the success or even the survival of the respective company. Unless it is clear to everybody that carrying on is no alternative; no-one will accept the necessity for change.

Forming a coalition of leadership

While this is being done, you should draw up a competent leadership team. When assembling these change agents you should consider the following aspects:

  1. The team should have sufficient power and authority to put the intended changes into practice.
  2. The change agents should play a key role within the existing organization and ideally be representative of it.
  3. Each change agent should be completely committed to the cause.

It is especially the last point that is vital for successfully implementing change: Those who doubt that change makes sense or will prove advantageous, have no business to be part of the change agent team.

A useful tool to identify suitables candidates for this squad is the stakeholder matrix. A good point of departure is the dimension “interest” as it shows how strongly a person supports the change about to be reached. The dimension “power” must in no way be reduced to questions of rank and hierarchy but should describe how well someone is capable of encouraging others to participate in the process and of winning them over.

Developing a vision and a strategy

The first and foremost job of the change agents is to develop a vision for the change initiative. This vision depicts how the company will look like after the project has been completed: What will have changed, what will remain the same and why will this future situation be better than the present state of affairs? The vision serves as a compass for all activities connected with the project.

Once the goal has been defined, the team can begin to design a strategy that spells out how the organization can develop from the current situation to the company described in the vision. In a way, this guiding vision is like the book of rules for the change process and defines the most important steps on the way to realizing the vision.

Communicating the vision

Communicating this vision is the last key element in preparing change. Usually, staff members are keen on participating in improvement processes of their company. However, this can only be effective if you know where it is that your organization is going.

Here good timing is essential. Without a general awareness that change is strictly necessary, it will be difficult to earn wholehearted approval for the developed vision. Some people will utterly refuse the idea that things have to be changed at all.

If, on the other hand, those in charge one-sidedly emphasize that change is necessary without drawing a clear picture of where the relevant changes are leading, this will cause enormous internal upheaval and make it difficult for people to have trust in the management team, severely hampering the change initiative’s progress.

If a company follows all four pieces of advice when planning to introduce a change initiative, it will be ready for successful implementation. Those aspects and factors that need to be considered to finally reach the set targets, will be the subject of the second part of our blog series.

Should you wish to lead your next project of change to successful completion and are seeking support, do contact us – for free and without any further obligations.

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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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Tool Box Talks: Decision Matrix

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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 a decision matrix.

What is the use of a decision matrix and when should it be applied?

Whenever you have to choose from several options of action while trying to achieve several targets at once, a decision matrix will help you to make an objective choice.

When it comes to innovation projects, you often can choose from a range of paths to pursue. Seldom is it clear which of these options will lead to the best result. This is where a decision matrix can be helpful by being explicit about how individual targets are assessed and by ranking all available options in a way that makes sense.

How is a decision matrix used?

When a decision matrix is used to reach a decision, three steps are necessary:

  1. Defining the assessment criteria
  2. Evaluating all options on the basis of these criteria
  3. Choosing the best option following this assessment

To define the relevant assessment criteria, you make a list of all targets or requirements to be met. Make sure that the respective criteria are as independent as possible. Sometimes you may have to combine several similar criteria into a single one. For instance, “acquisition costs” and “operating expenses” can be subsumed under “life-cyle costs”. Should some of the criteria differ in relevance, they can be weighted by different factors counteracting this imbalance.

The second step is to go through each available option by applying these criteria one after the other. Experience has shown that a single 3-step rating system is sufficient (1 = hardly true / 2 = true / 3 = going beyond expectations). If weighting is used, the assessment results have to be multiplied by the respective weighting factor. Then the individual evaluation figures for each option have to be totalled.

Last, the results are put to discussion within the resolutions committee deciding with which option is to be chosen and what is to happen with the remaining options.

Beware of pitfall!

When using the decision matrix, you need to pay double attention: First and foremost, make sure the chosen assessment criteria are independent of each other; for if there is a correlation between several criteria, it is one and the same topical area that is being assessed, thus falsifying the final result. If such interdependencies cannot be avoided, an intelligent weighting can be a valuable remedy by equal weighting of, let’s say, financial, technical and logistical aspects.

Equally important is the process of decision making. As is true for all management tools, the decision matrix delivers more or less unambiguous results. However, it should never automatically trigger a decision. Every result has to be discussed and, particularly so when there are only slight differences between the different options or when the results go against expectations, they have to undergo critical examination.

Why use a decision matrix?

As has been said before, a decision matrix makes it possible to evualate all available options by comparing them with each other, visualising them and making them measurable. In this way this tool allows decision makers to have an open discussion about the pros and cons of each individual option, showing very clearly how suitable each option is for reaching the set targets.

Nevertheless, the decision matrix does not by itself arrive at a decision for or against an option. This has to be brought about by the responsible staff members within a company. Likewise, even the option rated highest can be voted down – on the basis of a decision matrix providing the relevant arguments.

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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