A Big Company Strategy Tool Anyone Can Use

In 2007, I walked away from an industry I knew inside and out. I had the relationships, the expertise, and momentum such that everything looked perfect on paper. But I did a simple analysis that made me decide to carve a new path… The analysis used one of the strategy tools that we teach biz school students. While most suitably applied in a large corporate setting, they may have their place in the small business arena as well. The art is in knowing when to use which tool! Small business owners often make critical decisions about expansion without understanding the deeper forces that determine success and profitability in that space. Michael Porter’s Five Forces framework is a tool that any firm can use to assess the attractiveness (long-term prospects of profitability) of an industry. A five forces analysis is used mostly to inform decisions about market entry. It looks at the complete competitive landscape, not just your direct rivals, to reveal hidden threats and opportunities.

Porter’s Five Forces

Developed by Harvard Business School professor Michael Porter in 1979, the Five Forces framework identifies five factors that determine whether an industry is attractive (profitable) or unattractive (difficult to make money in). Briefly, they are:

1. Competitive Rivalry – How intense is the competition among existing players?
2. Supplier Power – How much leverage do your suppliers have over pricing and terms?
3. Buyer Power – How much can customers demand lower prices or better service?
4. Threat of New Entrants – What barriers exist and how easy is it for new competitors to enter your market?
5. Threat of Substitutes – How “sticky” are customers and what alternative products or services could replace yours?

Interestingly, an attractive industry isn’t necessarily one with few competitors. It’s one where the combined forces allow businesses to maintain healthy profit margins. Look at the fast food industry. There are many competitors who thrive by carving out their own niche, product or location-wise.

A Real-World Decision Using Five Forces Analysis

In 2007, I faced a crossroads. My brother and I had spent ten years building a successful value-added reseller business in the wireless infrastructure space. We sold wireless equipment and installation/testing gear to telecommunications companies. When I left the company, I had a choice: start fresh in the same industry with the same customers and suppliers, or walk away entirely and do something else. On paper, it looked like the easy thing to do. I walked through an informal Five Forces analysis in my head. I never wrote it down, but I absolutely walked through the five forces like I’m going to do with you here:

Competitive Rivalry

Here we normally look at the number of competitors, how different their product offerings are, and how fast the industry is growing. If the pie is shrinking we will have to all duke it out for that diminishing pie. But if we all have different products, or the industry is growing really fast, we don’t need to worry much about one another. Want to follow along? Grab the Five Forces Worksheet and assess your industry as you read. In my case there were only a handful of direct competitors, who mostly got along. But it was a tiny industry with only four major customers and a bunch of small ones. We all served the same customers, and the real basis of competition was having an exclusive contract with one of the more well-known product lines. Add to that the fact that we all chased business from the same three large Canadian telcos, and that we were entering a brutal recession with zero growth prospects. Overall, this force was negative.

Supplier Power

Supplier and buyer power normally come down the relative size and number. When there are a large number of small suppliers, none of them have much power. A concentrated supplier base with larger players will have more power. Brand power and switching costs might also be relevant factors. As stated, we competed for the “good” lines, so our suppliers had a huge amount of power. They were massive corporations (billions in revenue) with brand names that our customers demanded. You served at the pleasure of your supplier with a 30-day termination clause. This one was strongly negative.

Buyer Power

It’s relative size and number again. Buyer and supplier power are two sides of the same coin. The textbooks tell you to look at customer concentration, volume of purchases, switching costs, and price sensitivity, but I’ve yet to encounter a situation where it wasn’t dominated by just how many and how big the buyers are. When there are many, individually, they have no bargaining power. Our company had three customers that mattered. Their volumes were significant to us, and while they had some switching costs it wasn’t out of the question. They negotiated aggressively and had alternatives. Their power was indisputable. Strongly negative.

Threat of New Entrants

In general, the easier it is for a new company to enter an industry, the more negative we view an industry, all other things being equal. It’s mostly about “barriers to entry”. Think about a barbershop. There are limited capital requirements, no real benefits to be derived from economies of scale, easy access to necessary suppliers, no significant regulatory barriers, limited customer brand loyalty. This points to very low barriers. My business didn’t have large capital requirements either, but you need established relationships with either suppliers OR customers (preferably both). Newcomers can’t just waltz in and steal business. The barriers were relationship-based, not financial, and take years to build. This force was positive.