Porter’s Five Competitive Forces (Part 2)

By Rolfe Larson on July 28, 2011

My previous blog identified the five competitive forces developed by Harvard professor Michael Porter, which should be addressed in every business plan.  This blog profiles each of these forces. 

Rivalry among Existing Competitors

For most companies, competition comes from existing companies operating in that market. Competitive strategies involve deciding  how to achieve and maintain superiority over those existing competitors, in areas such as quality, price, innovation or service.

Threat of New Entrants

New competitors could show up any time, unraveling your business plan.  Best to focus on market segments where that’s less likely to happen.  Similarly,  it’s a good thing if it’s easy for firms to leave the market.  Sometimes firms continue to exert competitive pressure even if they’re losing money.  Think airline industry.

The best market segments present high entry and low exit barriers.

A good estimate of entry barriers is how much effort and money it will take to start your company. If it requires substantial development time and capital (say, more than a year and $1 million), you probably have high entry barriers. That makes it difficult for new competitors to show up suddenly to eat your lunch.  Ideally, you have something that provides advantages that lower your market entry costs, such as unique intellectual property (e.g., patents), areas of expertise, exclusive location, or access to capital.

Exit barriers can be determined by evaluating longevity of current competitors.  If companies come and go quickly, such as in the restaurant industry, the odds are exit barriers are relatively low.

Bargaining Power of Buyers (Customers)

Customers will make or break your business; even more so if they have lots of power.  If Walmart is your primary customer, you have no bargaining power. They dictate all specifications and all prices.

You have more power if you have more customers, if your products are unique, or if you have information the buyer does not have (such as your cost and profit structure).

Bargaining Power of Suppliers

When there are few substitutes, suppliers such as raw materials, labor, or components have power over your firm.  They know your choices are limited and can set their prices accordingly.

You’ll have more bargaining power if you have multiple suppliers, and if any  one type of supplier represents a small portion of your completed product or service.

Threat of Substitute Products or Services

You’ll be better off if there are few substitutes for your offerings.  The last thing you want is to enter a market where customers can easily choose unrelated products to meet their needs.  In that case, your competitors are the providers of any of those substitute products, which can mean far more competitors than you imagined.

Good luck!

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For more resources, see our Library topic Business Planning.