Strategic Tool Box Serie (#1) Porter’s 5 Forces: the competitive analysis tool

Origin of the 5-forces tool

Developed in 1979 by Michael Porter, professor of strategy at Harvard, the five forces represent the challenges and possible threats faced by any business in a constantly changing environment. It is a strategic intelligence tool that characterizes a competitive environment and not a particular company: for all the competitors involved, the analysis is the same and the key success factors are the same. What differs is a company’s ability to master them.

When to use it?

Porter’s strength is to be used whenever a major change impacts your market: new competitors, technological breakthrough, merger and acquisition. This does not preclude having recourse to an external consulting firm to go further in the analysis if necessary.

What is it used for ?

Analyze its market, the competitive environment of a company. Prepare its strategy vis-à-vis competitive intensity. Anticipate and be proactive in its market by identifying the key success factors. Guide your choices in terms of investment and ‘innovation

Description of the tool

Bargaining power of clients

It is about the ability of customers to influence the business.

This factor can have many facets. The main thing, of course, is negotiating your prices, especially if the company operates in B2B. Indeed, if the majority of your turnover comes from a few large account customers, they can easily negotiate lower prices. As you can imagine, this can quickly take a toll on the company’s total sales and ultimately its bottom line.

This effect is more attenuated if the company operates in B2C: many customers with an average basket of a relatively small amount will have more difficulty negotiating prices.

In general, the more the company has different clients, the weaker their negotiating power will be because it is then necessary that they agree together to have a real influence, which is much more complex for a large group of individuals.

However, discussing the price is not their only bargaining power. Customers can also influence manufacturing, distribution or communication processes. For example, a company’s customers may demand a better environmental or social conscience from the company, which would force the company to review its manufacturing, sourcing or delivery methods.

Warning: In this age of social media, a bad image can spread at breakneck speed if customers have something big to criticize about a business.

Bargaining power of suppliers

This strength, the second of Porter’s 5 strengths, is very similar to the bargaining power of your clients. Suppliers can impose price increases on you that will negatively impact the margins of a company such as EBITA to name just one. This scenario can turn out to be a disaster if the company does not have sufficient negotiating power to pass these increased costs on to its customers through higher prices. This may be the case if the customers themselves have too much bargaining power, if the competitive environment is too strong or if the government has the capacity to freeze prices.

Suppliers can also ask for other concessions: reduce payment terms or even pay in advance, have the company cover transport costs at its own expense, ask to place larger orders, etc. However, the more suppliers available, the less their bargaining power will be. Indeed, if a company can easily find a new supplier if another is demanding too much of it, then the influence of the latter will be much weaker. As you have no doubt already understood, if suppliers and customers have too much bargaining power, they can logically have a strong impact on the activity of a company, and therefore on its financial results.

Direct competition

It is the influence of direct competitors on the activity of a company. First, of course, they can take market share from the company you’re interested in. Most importantly, they can force it to continually adapt its strategy to theirs.

So a competitor who decides to launch a major marketing campaign has a good chance of forcing the company you are reviewing to do the same so as not to fall too far behind. The same goes for their R&D and innovation policy or their pricing policy: a competitor who lowers its prices too much will force other companies in the sector to also reduce theirs and therefore reduce their income.

Substitute products

This strength is very close to that of direct competitors. It is a matter for a company to adapt its strategy according to the substitute products (ie of a different type of product but which meets the same need) that exist in its market.

This is the case, for example: coaching apps versus gyms or even video on demand services like Netflix or Amazon Prime versus traditional TV channels. If these substitutes are less expensive than your company’s products, then it may be forced to lower its prices so as not to be completely abandoned by its customers.

Unlike the powers of customers and suppliers, if there are too many substitute products then their influence is all the greater: it is easier to manage a single potential adversary than dozens.

Threat of new entrants

The last of Porter’s 5 forces is the risk of new competitors entering the market for the company you are evaluating. Indeed, if a company outside your environment decides to launch a product in your market then it can totally revive the dice, especially if it is a much larger company than those already present.

Thus, an infinite number of scenarios are possible: this new entrant will be a direct competitor, or it is possible to establish a partnership with him. A good example of such a partnership is the one between a French supermarket chain called Monoprix and Amazon. Amazon had announced that they would launch a grocery delivery service in France (Prime Now). Monoprix, rather than taking the risk of seeing this new competitor crush it, decided to sign a partnership with it. Prime Now delivers Monoprix products and Amazon has installed its electronic cabinets (Amazon Lockers) in many Monoprix in the Paris region. A good example that shows how to ally with a newcomer rather than waiting for them to take market share.

In general, the more barriers there are to entering a market, the more companies operating there are protected. The barriers can be multiple and of different kinds: legal, technological, image, etc.

How to put the tool into practice?

This tool allows you to structure your market analysis.

In summary, here is how in 5 steps, to put the tool into practice in a very simple way.

1. Start by bringing together the qualitative and quantitative data collected on your market and the results of your monitoring.

2. The weight of the 5 forces that apply in your market. Deepen your research if necessary. Complete your diagnosis in the form of a radar comprising the 5 forces and with a scale from 1 (weak influence) to 5 (strong pressure). Check whether the impact taken individually is low, medium or high.

3 .Analyze the diagnosis: consider the situation as a whole to determine whether there is a danger for the company. Focus on a few hard spots.

4. Look for ways to limit the negative effects or find areas of differentiation. Set up your strategy based on these key success factors. Evaluate the necessary investments and set up your action plan.

5.Set up a strategic watch to follow the hard spots or all 5 forces

Results

The 5 forces tool allows, among other things, to obtain several reports that will be important in the analysis and deployment of your strategy, such as:

-Market analysis report

-List of strategic actions to be taken to strengthen its position in its market.

-Recommendations for monitoring strategy to be put in place

Conclusion

Porter’s 5 forces is a tool available to everyone that allows you to take stock of your business ecosystem on a regular basis. Of course, an analysis does not preclude calling on a specialist auditor, if only to consolidate and develop your analysis.