The five forces ( Porter)
The tool: Competitive intensity determines industry profitability. That is is the basic premise of Michael Porter's work. And he went on to describe in detail what the fundamental forces are which drive competitive intensity.
He set out to show that firms in any industry were constrained from maximizing profit not just by rivalry with their competitors but by four further competitive forces. These five forces shape competitive intensity:
- Internal rivalry
- Threat of new entrants
- Ease of substitution
- Customer power
- Supplier power
Internal rivalry: Internal rivalry is shaped by three main sub-forces:
- The number of players: The more numerous the players, the tougher typically the competition
- Market demand growth: The slower growing the market, the tougher typically the competition.
- External pressures: External bodies, in particular government and the trade unions, have great power to influence the nature of competition in many industries. Government regulation, taxation and subsidies can skew both market demand and the competitive landscape. Trade unions can influence competition in a number of ways.
There are other, lesser factors influencing internal rivalry. Barriers to exist are one such such. Season or irregular overcapacity is another factor.
Threat of new entrants: The lower the barriers to entry to a market, the tougher typically the competition. Barriers to entry can be technology, operations, people or cost related, where a new entrants has to:
- develop or acquire a certain technology
- develop or acquire a certain operational process
- gain access to a limited distribution channel
- train or engage scarce personnel
- invest heavily in either capital assets or marketing to become a credible provider
Ease of substitution: The easier it is for customer to use a substitute product or service, the tougher typically the competition.
Customer power: The more bargaining power customer possess, the tougher typically the competition. Often this is no more than a reflection of the number of providers in a marketplace, compared with number of customers. The more choice of provider the customer has, the tougher the competition.
Customer power is also influenced by switching costs. If its easy and relatively painless to switch supplier, competition is tougher. If switching costs are high, competition is less tough.
Supplier power: The more bargaining power suppliers possess, the tougher typically the competition. Best of the organizations learn how to duck, dive and survive.
Overall competitive intensity: Mentioned above are the five main forces shaping the degree of competition in marketplace. Put them all together, and you'll have a measure of how competitive your industry is.
When to use it: Always
When to be wary: Some believe that boundary definition - this activity is part of the industry you operate in, that activity is not - can itself place strategy development in straitjacket.
- An indusrty consists of a set of unrelated buys, sellers, substitutes and competitors that interact at arm's length.
- Wealth will accrue to companies that erect barriers against competitors and potential entrants.
- Uncertainty is low, allowing the prediction of competitive response and contingency planning.
Assessing customer purchase criteria (CPC)
The tool: Discovering why customers buy is first of three tools on how to assess your firm's competitive position in each of your key product/market segments:
- Identify and weight customer purchasing criteria (CPC) - what customers need from their suppliers in each segment - that is, from you and your competitors.
- Derive and weight key success factors (KSFs) - what you and your competitors need to do to satisfy these customer needs and run a successful business.
- Assess your firm's competitive position - how your firm rates against those key success factors relative to your competitors.
How to use it: Start by asking yourself these questions. What do customers in your business's main segments need fro you and your competitors? Are they looking for the lowest possible price for a given level of product or service? The highest-quality product or service irrespective of price? something in between?
Do customers have the same needs in your other business segments? Do customer groups place greater importance on certain needs?
What exactly do they want in terms of product or services? The higher specifications? fastest delivery? The most reliable? The best technical back-up? The most sympathetic customer service?
Customer needs from their suppliers are called customer purchasing criteria (CPC). CPCs can be usually grouped into six categories. They are customer needs relating to the:
- Effectiveness of the product or service: The first need of any customer from any product or service is that the job gets done. You the customer have specific requirement on the features, performance and reliability of the product. You want the job done. Not half-done, not over-done, just done. Depending on the nature of the product or service, your criteria may well include: Quality, Design, Features, Specifications, Functionality, Reliability. Some of these criteria will overlap. You should select two to four effectiveness criteria which are most pertinent to customer needs in your industry.
- Efficiency of the product: The second main customer purchasing criteria heading is efficient. The customer wants to receive the product or get the job done on time. All customer place some level of importance on efficiency for all types of service. Different customer groups may place different levels of importance on efficiency for the same service.
- Range of products provided: The range of products or services provided is an area customers can find important for some products or services, even most important, and for others of no importance at all.
- Relationship with the producer: Your supplier does the job and does it quickly. But do you like them? Is that important? The relationship component in providing a service should never be underestimated.
- Premises - only applicable if customer needs to visit the suppliers premises. Do you need a storefront for your business? What do customers expect of your premises?
- Price: Set your prices sky high and you won't have many customers. Set them too low and you won't stay in business. Think about the buying decisions you make regularly and the influence of price. For non-essential goods or services, we ten to be price sensitive.
Finding out CPCs: All this is very well in theory, you may ask, but how do you know what customers want? Simple. Ask them! It doesn't take long. You'd be surprised how after just a few discussions with any one customer group a predictable pattern begins to emerge. Some may consider one need 'very important' others just 'important'. But it's unlikely that another will say that it's 'unimportant'.
When to be wary: Some customers may have a hidden agenda. They see the meeting as an opportunity get you to nudge down your price. Or to improve your service offering, incurring extra cost, with no increase in pricing. They may rate price as a most important CPC even though they are primarily concerned with product quality.
Deriving Key Success Factors (KSFs)
The tool: Key Success Factors(KSFs) are what firms need to get right to satisfy the customer purchasing criteria (CPCs) of the previous tool and run a sound business. Typical KSFs are product or service quality, consistency, availability, range and product development (R&D). On the service side, KSFs can include distribution capability, sales and marketing effectiveness, customer service and post-sale technical support. Other KSFs relate to the cost side of things, such as location of premises, scale of operations, state-of-the-art, cost effective equipment and operational process efficiency.
How to use it: To identify which are the most important KSFs for each of your main business segments, you need to undertake these steps:
- Convert CPCs into KSFs: 1) Differentiation-related 2) Cost-related: We need to work out what your business has to do to meet those CPCs. KSFs are often the flip side to CPC. Functionality may be CPC, so R&D becomes a KSF. Reliability may be a CPC, so quality control becomes a KSF. There's one CPC that needs special attention, and that's price. Customers of most services expect a keep price. Producers need to keep their costs down. Price is a CPC, cost competitiveness a KSF.
- Assess two more KSFs: 1) Management 2) Market Share: There are two more sets to be considered: management and market share. How important is management in genera in your industry? Think on whether a well-managed company, the superb sales and marketing team reinforced by an efficient operations team, but with an average products, would outperform a poorly managed company with a super product in your industry. There's one final KSF - an important one - that we need to take into account that isn't directly derived from a CPC: market share. The larger the relative market share, the stronger should be the provider. A high market share can manifest itself in number of different competitive advents. Once such area is a lower unit cost, but we've already covered this under economies of scale in cost-related KSFs, so we must be careful not to double count.
- Apply weights to the KSFs. You've worked out which are the most important KSFs in your business. Each one has been ranked in order of importance. Now you need to weigh them. A simple quantitative approach works best.
- Identify any must-have KSFs. Are any of the KSFs in your industry must haves? Bear this in mind assessing your competitive position.
When to be wary: Don't end up with too many KSFs of you may lose the wood for the trees.
A systematic approach for deriving KSF weightings:
Here's a step-by-step systematic approach to weighting KSFs:
- Use judgment on the power of the incumbent to derive a weighting for market share of i per cent, typically in the range of 15 to 25 per cent.
- Revisit the importance of price to the customer. If you judged the customer need of medium importance, give cost competitive ness a weighting of 20-25 per cent. If low, 15-20 per cent. If high, 35-plus per cent. If yours is a commodity business, it could be 40-45 per cent, with a correspondingly low weighting for market share. Settle on c per cent.
- Think on the importance of management factors to the success of your business, especially marketing. Settle on m per cent, typically within a 0 to 10 per cent range.
- You've now used up a total of (i+c+m)per cent of your available weighting.
- The balance, namely 100 - (i+c+m) per cent, will be the total weighting for service factors.
- Revisit the list of KSDs relating to service issues, excluding price, which has already been covered. Where you've judged a factor to be of low importance, give it a KSF score of 1. Where high, 5. Rate pro rata for in between.
- Add up the total score for these service-related KSDs (excluding price)=S
- Assign weighting to each service KSF as follows: weighting (per cent) = KSF Score * (1-[i+c+m])/S
- Round each of them up or down to the nearest 5 per cent.
- Adjust further if necessary so that the sum of all KSD weights is 100 per cent.
- Eyeball them for sense, make the final adjustment.
- Check that sum is still 100 percent.
Weighing economies of scale
The tool: Size is important. Qualification: Size is important in certain sectors, less so in others.
Another qualification: even in sectors where size is important, small players can survive - if they are nimble.
There are four main economies of scale across the value chain:
How to use it: How important are economies of scale in your sector? Are there purchasing, technical, efficiency or indivisibility economies?
When to use it: Use it when economies of scale are important in your sector and to your business.
When to be wary: Remember it represents only one of many key success factors. Differentiation may be the name of your game.
Another qualification: even in sectors where size is important, small players can survive - if they are nimble.
There are four main economies of scale across the value chain:
- Purchasing economies - the larger the producer, the more likely they will be able to drive a harder bargain with suppliers.
- Technical economies - the machinery needed to produce 20,000 widgets a day is unlikely to be 20 times as expensive as that needs to produce 1000 a day.
- Efficiency economies - the process for producing 20,000 widgets a day is likely to me more highly automated, from handling inputs through manufacturing to handling outputs, and with more advanced or streamlined business processes, for example in R&D, than for the smaller plant.
- Indivisibility exonomies - some items are beyond the reach of the smaller producer to buy, whether state-of-the-art equipment.
Economies of scale apply as much to service businesses as in manufacturing and to small as much as to global businesses.
When to use it: Use it when economies of scale are important in your sector and to your business.
When to be wary: Remember it represents only one of many key success factors. Differentiation may be the name of your game.
Corporate environment as a sixth force
The tool: Does government help or hinder your business? Does government, whether local, central or European, through taxation or regulation, greatly influence profitability in your industry.
How to use it: The corporate environment is defined as the combined influence of all external organizations, other than Porter's specified competitors, new entrants, substitutes, customers and suppliers, on the firm.
The corporate environment thus defined includes state and industry-wide bodies such as:
- Central government, through taxation, subsidization, trade restrictions, regulation, employment law, health/safety/environment law, industrial restructuring and even the maintenance of political stability.
- Local government, whether county, borough, region or providence
- National regulatory bodies, such as Ofcom or Ofgem in the UK.
- International regulatory directrives, such as the Basel accords on the capital adequacy of financial institutions.
- Pressure groups, such as industry associations, trade unions, Greenpeace.
The influence of these bodies can greatly influence both market demand and industry competition.
When to use it: When the corporate environment is a determining influence on the profitability in your industry.
When to be wary: When the corporate environment in one of the many factors influencing internal rivalry, such as the number of players or market demand growth, and does not merit recognition as a sixth force.
Complements as a sixth force
The tool: Do complements influence profitability in your industry? The other major claimant to the positions of 'sixth force' in the industry competition is complements.
How to use it: Complements are more than just supplies to firm. The value of a assembled PC is intricately bound up with the value of its inter processor - a separate company and one which may extract more value from my purchase than the PC manufacturer itself. This would not be the case with an Apple Mac.
Complements are broader too than direct supplies. An airline depends its profitability not just on the five forces, but on the continuity of operations at its complements - airports, air traffic control, suppliers of aviation fuel, inclusive tour operators.
When to use it: When complements clearly play a major role in driving profitability in a particular industry - for example, agin, in airlines.
When to be wary: When complements play a relatively minor role and do not merit identification as a sixth force.
How to use it: Complements are more than just supplies to firm. The value of a assembled PC is intricately bound up with the value of its inter processor - a separate company and one which may extract more value from my purchase than the PC manufacturer itself. This would not be the case with an Apple Mac.
Complements are broader too than direct supplies. An airline depends its profitability not just on the five forces, but on the continuity of operations at its complements - airports, air traffic control, suppliers of aviation fuel, inclusive tour operators.
When to use it: When complements clearly play a major role in driving profitability in a particular industry - for example, agin, in airlines.
When to be wary: When complements play a relatively minor role and do not merit identification as a sixth force.
PESTEL analysis
The tool: PESTEL analysis offers a framework for identifying external, often government influenced issues affecting industry competition. It is an acronym of these six groups of issues: political, economic, social, technological, environmental and legal.
How to use it: Examples of the issues covered in PESTEL analysis are:
When to use it: PESTEL analysis is an aid to the brainstorming of industry issues. Use it if you are accustomed to it, but be aware of its limitations.
When to be wary: At best the analysis represents a rather unstructured, non-analytical, unranked identification of key industry issues will be as needles in a haystack.
The tool: PESTEL analysis offers a framework for identifying external, often government influenced issues affecting industry competition. It is an acronym of these six groups of issues: political, economic, social, technological, environmental and legal.
How to use it: Examples of the issues covered in PESTEL analysis are:
- Political - government taxation, legal and regulatory intervention in the marketplace.
- Economic - the macro-economic backdrop, including economic growth, inflation, interest rates and exchange rates.
- Social - the societal backdrop, including population trends, consumption patterns, age distribution.
- Technological - trends in R&D and innovation, affecting both product and production, and the threat from substitute products
- Environmental - trends in weather and climate, and the impact of climate change on your firms operations and customer preference.
- Legal- trends in laws which impact on a firms operations and decision making, including employment, health/safety/environment, antitrust, customer protection, capital adequacy and governance laws.
PESTEL analysis is sometimes used to throw up the range of opportunities and threats needed for SWOT analysis.
When to use it: PESTEL analysis is an aid to the brainstorming of industry issues. Use it if you are accustomed to it, but be aware of its limitations.
When to be wary: At best the analysis represents a rather unstructured, non-analytical, unranked identification of key industry issues will be as needles in a haystack.
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