In business, your ability to make a good profit is dependent on your position within the market. As an example, do you have competitors offering similar products; is it easy for people to enter a market when they see you are making a profit? Can customers bully you into lowering your prices? If you don't think about your position in the market, it is very easy to spend a great amount of time and yet still struggle to stay ahead.
This is where a tool like Porters Five forces can be used in your business. The tool was created to help us understand who has the most power in a market situation and was developed by Michael Porter in reaction to the SWOT analysis, which he considered un-rigorous and ad hoc. The tool can also illuminate whether a product or service is likely to be profitable in a given market. Much like the SWOT analysis presented previously, this tool helps to illuminate market dynamics which provide a robust foundation to your organizations VoC initiative. By understanding these forces, you will be in a better position to understand the VoC information you gather as well as how to leverage it to a more successful product.
The tool assumes there are five forces determining market power. Porter defined the five forces as:
- Supplier power
- Buyer power
- Competitive rivalry
- Threat of substitution
- Threat of new entry
Any of these forces can work for you or against you in the market. To use Porters Five forces tool, you should look at each of the variables individually and then weigh the relative advantage/disadvantage of entering this market with your product or service. We will explain how to use Porter's five forces as part of the market requirements document we present in Chapter 9, Completing the Circle – Using the Customers Voice in Your Organization.
Figure 3.5: Five-force diagram
Supplier Power—this is a basic assessment on how easy it is for suppliers to drive up prices on the goods and services you need for your product, or reduce quantity supplied. Suppliers of raw materials, services, and labor can have power over a firm when there are is lack of alternative suppliers or substitutes, or when the cost of switching from one supplier to another is high. The fewer the supplier choices you have and the more you need the suppliers, the more powerful they are.
Factors contributing to supplier power:
- Differentiation: How specialized are the products the supplier is providing you
- Sources: The amount and variety of sources for the products or raw materials required to make your product
- Substitute Products: How easy is it to use an alternative product or raw material in your design
- Supplier Channel: How strong is the suppliers own channel and how much control do they have over the channel
Buyer Power—Conversely, this is an evaluation of how easy it is for buyers to drive the prices down (and reduce your margins). Buyer power grows when they become more concentrated or organized, when the product is undifferentiated, or when switching costs are low. If you deal with a few, powerful buyers who also have access to alternatives, they are often able to dictate terms to you.
Factors contributing to buyer power:
- Substitute Products: How easy is it for the consumer to buy a different product that meets the same customer goal
- Buyer information: How available is information about your product, capabilities, competition, and so on.
- Switching Costs: Ease of the customer to use a competitive product without severely impacting their costs
- Buyer volume: If there are few buyers for your product, they will have more control over your ability to control the market
- Commoditization: How plentiful and alike are the competitive products where it is extremely easy to switch out one product for another at little or no cost
Competitive rivalry—this is an evaluation of the number and capabilities of your competition. For most industries, the intensity of competitive rivalry is the major determinant of the competiveness of the market. If you have many competitors and they offer equally functional products and services, you will likely have little power as the suppliers and customers will go elsewhere if they do not get a good deal from you. It is even more unattractive if the market is stable or declining, exit barriers are high, or competitors have high stakes in staying in the segment. Conversely, if no one else can do what you do or offer the products you offer, then you can have much higher power.
Factors contributing to competitive rivalry:
- Competitor pipelines: Does the competition have a robust pipeline of new products continually being released to the market?
- Innovation: What is the innovation process at your competitors and how quickly are they able to adapt new processes and technologies to create new and unique products?
- Customer understanding: Do they have a developed VoC process to understand the customers current and future needs?
- Engineering and manufacturing capabilities: How good is the technological staff at developing products the customers need in a way that is timely and cost effective?
- Strategic plans: The ability of an organization to chart a future course and put together the plans necessary to get them there
- Budget and organization size: How many resources and money can the organization draw upon to make new products?
Threat of substitutions—This is affected by the capabilities of your buyers to find a different way to achieve their goal without using a product like yours. Substitutes impart limits on prices and profitability. If technology advances, prices and profits in these industries are likely to fall. As an example, if you were a low priced camera manufacturer or a handheld calculator vendor, you have probably seen your market evaporate as more and more customers use their phones for basic picture taking and calculations. If substitution is easy and viable, then this weakens your power.
Factors contributing to threat of substitution:
- Quantity and availability: Volume of possible substitute products in the market
- Functionality of substitutes: How well can they perform the duties and meet the requirements of the customer?
- Price of substitutes: What is their purchase price and total cost relative to yours?
- Buyer propensity to substitute: Is the customer willing to switch from one supplier to another with no qualms?
- Buyer switching costs: What is the actual cost for the buyer to switch to a substitute product?
- Perceived level of differentiation: Does your product have unique characteristics or functions versus the competition, and most importantly, does the customer have that perception?
- Ease of substitution: How much of a drop-in replacement is the substitute product for yours? If it is a resistor, it is very easy. If it is a CRM system, not so much.
Threat of new entry—Profitable markets with attractive yields will attract new players. Power is also affected by the ability of new competitors to enter your market as more entrants typically reduce profitability for incumbent firms in the industry. If it costs little in time or money to enter the market, if there are few economies of scale or if you have little intellectual property protection, then new competitors can enter your market and weaken your position. If there are strong barriers to entry, your position can be upheld.
Factors contributing to threat of substitution:
- Intellectual property: How many patents and trade secrets do you have that the competition cannot copy?
- Capital requirements: Is there a high cost to enter a market? This is a large benefit for the incumbent. What is the cost to exit?
- Distribution channel: Will your distributors easily carry a competitive product, or is their investment into your product and technology such that they would not want to do that?
- Government policy: Are there rules or regulations that define who can play in the market?
- Economies of scale: If you have the ability to ramp up or down based on buyer demand, you will have an advantage in the market.
- Brand equity: How much value do the customers put into working with you, your company, your brand, and everything that represents to them?
- Switching costs: The actual costs a customer must make, both in terms of money and time to switch to an alternative product.
- Customer loyalty: Will the customers stick with you, even if there are occasional problems or things do not go as planned and just as importantly, how much of an evangelist will they become for you?
- Industry profitability: If there are a lot of profits to be had in a market space, you will find a lot of new competitors, unless some of the other variables (capital requirements, intellectual property safeguards, government policies, brand loyalty, and others) come into play.
These forces can be put into a diagram like the following one to analyze your situation. Use this as a template to evaluate and brainstorm the relevant factors for your market or product. It is also recommended that you summarize the scale and force on the diagram in the accompanying circle using:
- +: A force moderately in your favor
- ++: A force strongly in your favor
- -: A force moderately against you
- - -: A force strongly against you
Figure 3.6: Five-force diagram with detail
The five forces framework has been challenged by some and adaptations and modifications have been suggested by others by adding forces such as innovation, complementary products and services, and government. However, it can be argued that these other factors only serve to influence the original five and this should be adequate for most analysis.
Once you've completed a five forces analysis, you will see clearly where you are at risk so you can take steps to overcome those risks and if you are looking to enter a new market, you can see at a glance how potentially attractive it will be for your organization.