No discussion of competition would be complete without a mention of Porter’s Five Forces model.
Porter’s Five Forces is a conceptual framework designed to help business decision makers better understand the ways in which the pressures of competition influence an industry or industry sector.
First introduced in 1979 by influential business and economics professor Michael Porter, this framework is a straightforward and time-tested tool.
It is true that no two industries will have the exact same characteristics, but there are some underlying drivers present in each industry or an economic sector in some form.
The forces that a Five Forces analysis takes into account are present in every industry—the goal is not to uncover which forces of competition exist, but to what degree they interact with one another, and how these interactions shape a given industry.
The application of a Five Forces analysis yields the following insights:
- The intensity of competition within an industry
- The attractiveness/fitness of an industry for a venture or business model
- The profitability potential of an industry
- Key elements of an organizational strategy
- Ease of entry into an industry
01. Rivalry Among Competitors
At the center of Porter’s Five Forces model is the competitive force that exists between companies that offer competing products or services.
Competition within an industry is the direct and indirect competition that most people think of when they hear the word.
It is the jockeying for position and back-and-forth claim and relinquishment of market share.
The intensity of the rivalry that exists between competitors translates into the amount of control each industry actor (business entity) has.
The higher the intensity of the direct competition between industry actors, the more pressure each feels and the less control each can exert as a result.
Suppliers and customers alike can simply move on to a competitor if your deal isn’t a perfect fit, which means a considerable amount of resources and strategy are committed to responding to the pressures of direct competition.
A high-competition industry may not always be one that is crowded with industry actors.
High competitor rivalry exists when there are numerous similar product or service offerings—these circumstances can exist between only a few business entities or between many.
On the other hand, if the intensity of competition is low, then each industry actor feels less pressure from direct competition and subsequently is able to exert more control over pricing, distribution, and ultimately their bottom line.
With less pressure from the competition, business entities have a higher degree of control over improving their bottom line and more room to maneuver when it comes to strategy.
02. Potential of New Entrants into the Industry
If the rivalry between current industry actors applies pressure to firms, then it should be no surprise that the possibility of new entrants is a source of competitive pressure as well.
The threat of new industry entrants is directly impacted by that industry’s barriers to entry.
An industry with low barriers to entry is one that is accessible to new firms with relatively low effort and cost.
In an industry with low barriers to entry, there is a constant threat of new entrants who will increase the intensity of competition between industry actors by introducing competing products or services.
On the other hand, an industry with high barriers to entry is one that is not readily accessible by new or existing firms without a significant investment of resources.
Once that resource hurdle has been cleared, these firms can enjoy relatively lower levels of comparative pressure from the threat of new entrants, and these industries generally have lower levels of competition between industry actors as a result.
Barriers to entry:
Barriers to entry are diverse and often specific to the nature of a given industry. Common barriers to entry include the following:
- Economies of scale or scope
- High product differentiation
- High capital requirements
- Other cost disadvantages
- Restricted access to distribution channels
- Intense competition due to a shrinking industry
- Prohibitive government policy
03. Power of Suppliers
The power that suppliers exert on industry actors (their customers) is a pressure that new ventures quickly become acquainted with.
The connection between the amount of power that suppliers can exert and the way it impacts the competitive profile of an industrial sector, however, is often overlooked.
Entrepreneurs often think of their supply chain in linear terms—as a direct line. Nothing could be further from the truth.
It is much more accurate to think of your supply chain as a single part of a supply network—a web instead of a chain—and not to forget that your suppliers experience their own competitive pressures, as do their own partners and suppliers, and so on.
What the power of suppliers translates into for industry actors is the ease with which suppliers can drive up the price of goods and services.
This power is accentuated when there are a small number of suppliers that provide an essential or unique product or service that industry actors rely on.
Remember, your suppliers are industry actors in their own industries. When there is low competition within their industries, they gain the power to make a greater impact on their bottom line.
Unfortunately for you, that means higher supplier costs of goods and services!
Think of it this way;
the more a firm—or a group of firms—relies on a single supplier, the more power that supplier has.
04. Power of Customers
In an industry where firms have a high amount of power, prices are driven up.
When power is in the hands of the customers, prices are driven down.
If a firm has just a few very important customers, those customers have a high degree of power over that firm with regard to prices.
Conversely, an industry that has a large, diverse customer base is one where the customers have a relatively low amount of power.
Just as the power that suppliers hold is not thought of as competitive pressure, the pressure that customers put on a firm is also often overlooked as a competitive force by many entrepreneurs.
05. The Threat of Substitute Products
The threat of substitute products or services also puts pressure on a firm.
Substitute products and services are those that can be used in place of those that are offered by an industry actor.
The question of substitute products is especially relevant in the case of startups that are introducing products or services to the market that are completely new or unique.
Think about what customers are using instead of your new product—even if they aren’t using anything.
- In the case of new services, are your customers simply doing it themselves?
“Nothing” as a substitute product can present a real challenge for new ventures.
If “nothing” is performing fine and not costing your customers anything, then changing their behavior becomes very difficult.
The same goes for services that may be substituted by customers simply doing it themselves.
It may seem like an absurd thing to say, but the tradeoffs your product or service provides have to be very favorable compared to “nothing.”