“Awareness of the five forces can help a company understand the structure of its industry and stake out a position that is more profitable and less vulnerable to attack.”(1)
As a business owner, if you understand the impact of the competitive forces, you can learn how the influences impact your company’s strategy and its profitability, which will impact the value of your business. By recognizing trends early, you can make changes quicker, so you can exploit them or identify ways to improve your position, so you may be able to manage your profitability better and increase the value of your business.
The Five Competitive Forces (1)
1. Rivalry Between Firms/Competition: Rivalry between firms can be either concentrated or diffused. The greater level of diffusion will generate higher levels of competition for you, which may force you to lower prices put pressure on your margins and reduce your profitability.
2. New Entrants: The question that arises is how easily a firm can enter your market. The higher the barrier to entry the lower the number of firms participating in the market and competing against you, which improves your margins and profitability.
3. Substitutes: How easily can your customers switch to a substitute product or service? If your product or service has a distinct competitive advantage your level of competition may be reduce, which could increase your margins and profitability. If your product or service can be substituted easily, competition may be higher, putting pressure on your margins and reducing your profits.
4. Buyers/Customers: This relates to the number of buyers and sellers in your industry. If it a buyer’s market, which would be your customers, they may be able to leverage the position and dictate price, which could put pressure on margins and profitability. On the other hand, if you have a unique product or service you may be to leverage that position and dictate price, which could result in higher margins and profitability.
5. Suppliers/Vendors: This is just the opposite of the previous discussion. It reflects the number of buyers and sellers in the marketplace. You are now the buyer. If there are more sellers than buyers in the market you may be able negotiate lower prices, which could improve your margins and profitability. On the other hand, if you need a unique product, the supplier is in stronger position to set price, which could put pressure on your margins and profitability. Also, your ability to shift suppliers easily may be reduced, which could increase your operational risk.
To understand how the influences of the competitive forces impact your business answer the following questions.
1. Describe the level of competition within your industry. Would you define it has strong or weak?
2. If you were going to enter the industry list what would be needed to startup. Is the barrier of entry low or high?
3. List the other products or services that could be used in place of your product or service. Is the availability of substitutes high or low?
4. List the characteristics of your customers. Are they sensitive to prices? Can your customers dictate prices or are you able to dictate price?
5. List the characteristics of your vendors and the products they supply to you. Are your vendors able to dictate price or can you negotiate prices or change vendors easily?
Readjusting the Forces in Your Favor
Here are some suggestions to use to potentially improve your margins and profitability.
1. To balance supplier power, you can standardize parts, so you are not as dependent on one supplier and can easily move your business to another vendor.
2. You can offset customer power, if you diversify and expand your products and services, so your customers are less willing to do business with a competitor.
3. To combat price increases by competitors, expand and invest in products and services that differentiates you from the market.
4. To reduce the force of substitution, create a value proposition that produces a wider distribution of your product or service, so it becomes more accessible and readily available.