Understand The Use of Porter’s Five Forces Model in Business

Accessing the Attractiveness of Business Ideas Using Porter’s Five Forces Model.

Porter’s Five Forces Model is one of the business analysis tools one can use in assessing the attractiveness and potential profitability of business ideas. Every business man and women understands that business is all about risk taking. You cannot be hundred percent sure that a business will be successful. However, the level of risks involved in business can be reduced considerably if you take pain in carrying out the analysis of your business ideas before investing your hard earned money. Failure is not an experience that one enjoys. It brings pains and at times regrets. In most cases, some of these pains are avoidable if only we learn how to do the first things first. If you want to go into business, the first thing you need to do is to take a critical look at the business and the industry and consider those factors that can contribute to the success or failure of the business. There are business tools you can use to assess your business ideas. These include among others SWOT Analysis, PESTEL and Porter’s Five Forces Model. But our focus here is on Porter’s Five Forces Model and how you can it to assess your business ideas. Essentially, the Porter’s Five Forces Model focuses on assessing the attractiveness of a business. That is, the possibility of making above average profits. In business, you will find instances where some business ideas were top notched few years ago but today if anyone dares starting the business, it will not bring any profits but losses. Porter’s Five Forces Model asserts that the attractiveness of any business depends on five forces, hence the name. Therefore we shall be looking into these five factors.

Threat of new entrants

If you want to start a new business, the fact that your projection shows that the business will be profitable does not guarantee that the profits can be sustained. In most cases, when you carry out research, you will base your conclusion of the present circumstances. You tend to look at the number of existing competitors. The truth is that, the same way you are planning to enter into the markets, there will be other people that have or will have such intention. This is common when people suddenly discover that a particular business line is lucrative. By the time people start to have information about the business, they begin to lunch the same business. Before you say Jack, the market is already flooded with many competitors. Perhaps your market research revealed the market potential for your business. You need to consider the effects of new entrants coming into the same market with your business. Competition is usually intensified when new entrants come into the market. That is why Porter’s Five Forces Model considers this factor as a threat. How difficult or easy for new entrants to start the same business will determine the strength of this threat. There are certain barriers which can make it difficult for a new entrant to come into the market. These include the following:

Read Also: Why Market Research is Important to Small Business

Capital Requirement: If the amount of capital required to start a particular business is quite huge, this may serve as deterrent to new entrants. Sourcing for funds is a major challenge to budding entrepreneurs.  If your business is the type that one can start with low investment, then you may be susceptible to this threat.

Economies of Scale: The higher the quantity you produce at a time, the lower the cost per unit of your product. If you can produce in a large scale, this can make it difficult for a new entrant to be able to compare favourably in term of costs.

Rules and Regulations: Some businesses are regulated that people cannot just decide to start them even though they have the capital. It may require that one has to obtain specific certification before they can be allowed to start the business. For example, someone cannot just wake up and say he wants to start an audit firm. Before anyone can be allowed to practice as an auditor, it is expected that such person must be a member of a recognized accounting body and must have fulfilled the training requirements. In the same vein, certain business requires approvals from regulatory bodies. Foods and drugs fall into this category.

Product Differentiation: In a commodity market, the competition is quite stiff. If you can differentiate your products, the coming of new entrants into the market may not have much impact on your business. Differentiation may require that you develop a brand with good image in the market or you may decide to create a niche for yourself in the market and focus on it.

Technical Know-how:  Skill is not what one can buy with money. It has to be acquired. If your business requires a special or technical skill, it makes it difficult for people to start. Anybody can start a business that does not require any special skill.

Accessibility to Distribution Channels: Some manufacturers do not sell directly to retailers. Instead, they have authorised resellers or distributors. Before you can become a reseller or distributor, you must meet their minimum requirements. For such products, new entrants may find it difficult to penetrate the market. If they can’t meet the stiff conditions, the best they can do is to become retailers. Therefore, instead of competing with you, they will turn out to be your customers.

Threat of Bargaining Power of Customers

The second factor we are considering in this Porter’s Five Forces Model is the threat of bargaining power of customers. You may be wondering how customers can pose a threat to your business. It is possible! How powerful your customers are may influence what they pay and the terms of payment you agree with. Also, in a situation where you have just few buyers, they may have power to influence your price. If you don’t want to dance to their tunes, they may threaten to switch to your competitor except there is a switching cost that makes this economically difficult. The more customers you have, the more difficult it becomes for a single customer to exert considerable pressure on you. I remember a company I once worked with. Being a marketing company, the company was able to secure a retainer with one big telecommunication company. That contract alone was enough for the company to overshoot its annual budget in term of turnover. As part of the agreement, the company could not work with any other telecommunication company as long as the contract lasted. However, the telecommunication company refused to renew the contract at the end of the third year. This spelled a doom for the company. The company could hardly pay its overheads. Some staffs were laid off while the revenue nosedived. This is the threat facing any mono-customer company. If your business is built around one or few customers, the sustainability of such business is questionable.

Read Also: How To Choose The Right Small Business Idea

Threat of Bargaining Power of Suppliers

The same way your customers can be a threat to you, Porter’s Five Forces Model makes us to understand that suppliers can equally constitute a threat to your business. Do you need to rely on a particular supplier for your materials? This may be as a result of the quality or uniqueness of the products he offers. If that is the case, such supplier can take undue advantage of the situation to increase the price unnecessary. It may be that your supplier suddenly has a new market which he doesn’t has the capacity to meet their needs. What this will lead to is exploitation. So, if you don’t have any other supplier you can turn to, you will simply be operating at his mercy. The increase in the cost of materials will definitely increase the costs of your products. Unfortunately, you may find it difficult to pass the costs to your customers especially if your product has close substitutes.

Threat of Substitutes

The fourth factor we are considering under this Porter’s Five Forces Model is the threat of substitutes. The more the number of substitutes your products have; the higher this threat to your business. Remember that the essence of using Porter’s Five Forces Model is for you to determine the attractiveness and potential profitability of your business. If there are many substitutes to your product, it will be difficult for you to charge high price. This means that the only way to enhance your profits is to reduce your costs. But if you are unfortunate that your business is also exposed to threat of bargaining power of suppliers, your margin will be ridiculously low. Except you are able to leverage on the volume, the business may not be profitable.

Threat of Competition or Rivalry

In any competitive market, it is the survival of the fittest. Porter’s Five Forces Model encourages thorough analysis of the market situation before you start a business. You need to carry out your research to determine the level and number of competition in the market. When there is stiff competition, the product price will be low, thereby impacting on the margin. Also, you may need to spend money on advertisement in other to drive customers to you. If the competition is too stiff for you, this situation may force you out of the market. Depending on the type of business you do, there are businesses where the cost of leaving the market is equally high. If the exit barrier is high, you may find yourself hanging on to the business until everything totally collapses.

Read Also: How to Increase Sales Without Extra Marketing Costs

In summary, the use of Porter’s Five Forces Model to analyse your business before you start is a worthwhile effort. It is better not to start a business that doesn’t have any future than to start and fail gallantly. You must have lost resources and may not have the confidence to start a new business.

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