Porter’s Five Forces Analysis

I posted a while back on Michael E. Porter’s idea that either you can compete on cost or differentiation but not both. How should you make that decision?  How will you know if your choice will be profitable?

First of all my advice is to NEVER compete on cost as a small company.  As Porter points out, without adequate market share, you won’t have the weight to pull it off.  Secondly if you’re going to compete from a differentiation standpoint, what things should you consider?  Fortunately, Porter has give us a good tool for this as well.

Enter the Five Forces Analysis.  This framework helps us analyze the competition within our industry and thus determine if we will be profitable or not.  The five forces are:

  1. Threat of new entrants.  If this is a lucrative market, other players will be tempted to enter.  Any barriers to entry?
  2. Threat of substitutes.  What other options does the market have in-place of your product or service?  If you are building brick homes can the market choose wood?  If you are providing custom software development might a client choose something off the shelf?
  3. Bargaining Power of Buyers.  This is especially true in small markets with only a few clients.  Can they align and force you to lower prices?
  4. Bargaining Power of Suppliers.  Is there only one or few suppliers for your raw materials?  Can they force you to pay higher prices?  Are there any substitutes?
  5. Competitive Rivalry.  Are there already other players in your market that offer similar goods or services at a similar price?

While certainly not the only thing you should look at while going to market with a new offering, this tool is an excellent framework to look at your overall positioning.

Good luck!

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