The determination of a strategy is rooted in determining how a company stacks up against basic market forces, how it can defend itself against these forces and how it can influence these forces. Fortunately, Michael E. Porter in his article How Competitive Forces Shape Strategy defined these market forces for us. Known as Porter’s 5 forces they consist of:
The industry – this is the jockeying for position among current competitors, this can consists of price competition, new product introduction or advertising slugfests.
The threat of new entrants – the seriousness of the threat of entry depends on the barriers to entry and reaction from existing companies. There are 6 major barriers to entry: 1) economies of scale 2) product differentiation 3) capital requirements 4) cost disadvantages independent of size 5) access to distribution channels 6) government policy. A new company will generally have second thoughts about entering an industry if the incumbent has substantial resources to fight back, the incumbent seems likely to cut prices or industry growth is slow.
The threat of substitute products/services – substitutes can place a ceiling on prices that are charged and limit the potential of an industry.
The bargaining power of suppliers – suppliers can squeeze profitability by increasing prices or lowering the quality of the goods.
The bargaining power of buyers (customers) – customers can force down prices, demand better quality, more service or play competitors off on each other.
Once you assess how the market forces are affecting competition in your industry and their underlying causes, you can identify the underlying strength and weaknesses of your company, determine where it stands against each force and then determine a plan of action. Plans of action may include:
Positioning the company – match your strengths and weaknesses to the company’s industry, build defenses against competitive forces or find a position in the industry where forces are the weakest. You need to know your company’s capabilities and the causes of the competitive forces
Influencing the balance – take the offensive, for example innovative marketing can raise brand identification or differentiate the product.
Exploiting industry change – an evolution of an industry can bring changes in competition. For example, in an industry life-cycle growth rates change and/or product differentiation declines; anticipate shifts in the factors underlying these forces and respond to them.
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