Simplified Strategy for Finance Professionals - Porter's 5 Forces

Understanding strategy is one of the critical competencies that CFO's and FP&A's should develop. In my new series of blogs, I am going to cover the most common strategic tools that should all senior finance professionals to understand.

Our strategy tool today is Porter's five forces.

As a CFO or FP&A you will be required to act as a strategic business advisor, and deeply understand the industry factors represented by 5 forces which are Threat of new entrants, Power of suppliers, Power of buyers, Threat of substitutes, and Rivalry among existing competitors.

This will help to develop strategies and action plans to mitigate risks from the forces that have negative impacts and reduce the share of profits going to suppliers, buyers, substitutes, competitors or new entrants.

So, let’s explain the 5 forces:

1. Rivalry among existing competitors

The first of the Five Forces refers to the number of competitors and their ability to undercut a company. The larger the number of competitors, along with the number of equivalent products and services they offer, the lesser the power of a company.

2. Threat of new entrants

A company's power is also affected by the force of new entrants into its market. The less time and money it cost for a competitor to enter a company's market and be an effective competitor, the more an established company's position could be significantly weakened.

3. Power of Suppliers

The next factor in the Porter model addresses how easily suppliers can drive up the cost of inputs. It is affected by the number of suppliers of key inputs of a good or service, how unique these inputs are, and how much it would cost a company to switch to another supplier. The fewer suppliers to an industry, the more a company would depend on a supplier.

4. Power of Customers

The ability that customers must drive prices lower, or their level of power is one of the Five Forces. It is affected by how many buyers or customers a company has, how significant each customer is, and how much it would cost a company to find new customers or markets for its output.

5. Threat of Substitutes

Substitute goods or services that can be used in place of a company's products or services pose a threat. Companies that produce goods or services for which there are no close substitutes will have more power to increase prices and lock in favourable terms. When close substitutes are available, customers will have the option to forgo buying a company's product, and a company's power can be weakened.

Follow my weekly strategy series, every week I cover one strategy tool.