I wish I could travel back in time and teach my younger self Michael Porter’s five forces. If I had understood this framework back then, I would have made better choices when selecting what startups and business ideas to pursue. The five forces provide an easy way to judge the overall competitiveness of an industry. The stronger the forces, the harder it will be to carve out a sustainable business. For example, knowing the five forces framework now allows me to look at an eCommerce startup and realize that it’s in a super competitive market with little to no barriers to entry, tons of substitute products, and countless firms. No wonder eCommerce is such a tough business!
An intimate understanding of the five forces is not necessary to run a “pulse check” on the viability of a business, only a basic one. Let’s look at all five:
- The Threat of New Entrants: How easy is it for a competitor to enter the market? If you are using distribution channels, how easy is it to access these channels? One thing I have learned in the startup game is that “if you build it, they WILL come.” However, the ‘they” are not customers, its competitors. If you can build a product with relative ease and a handful of engineers, other people can too. Once you have some success, competitors will enter the market for their share of the profits. What competitive advantage are you developing to protect yourself?
- The Power of Suppliers: If you are using suppliers – how easy is it to switch? Can you substitute inputs to your product easily if needed? If your suppliers have a great deal of power, it will likely affect your profitability as you scale.
- The Power of Buyers: How much power do your buyers have? Are there many options in the market? How difficult is it to switch products? If your entering a market where the buyer has many options and a low switching cost, it will be easier for them to squeeze your margins. On the flip side, if the customer switching cost is very high, customers will have less leverage.
- The Threat of Substitution: how many substitute products are available? It’s important to note that people generally underestimate the substitution rate for their products. For example, I was once having a conversation with a VP of sales at one of the leading native advertising companies, and he indicated that they had one competitor, the other main player in the native advertising space. I thought to myself, “that’s not true at all, ANY digital advertising product is a substitute.” It’s easy to shift budget from channel to channel. If substitutes are high, it will make it more challenging to sell your product.
- Competitive Rivalry: How easy is it to maintain a competitive advantage through innovation? Are advertising costs high or low? How many firms are in the industry? How responsive are the other firms to changes in the market? It is difficult for a startup to maintain an advantage in an industry with an intense competitive dynamic.
No industry is perfect, but it should be easier to carve out a defensible niche in an industry where the five forces are weaker. Many startups come into an industry with a new disruptive business model, only to find that they are eaten alive by competition two or three years down the road. If you run analysis on your own business and it doesn’t look great, that doesn’t mean that you should pivot away from your model. Instead, think of the analysis as arming you with knowledge. Now you can adjust your strategy to protect against the forces and build a sustainable business. Take a stab at it for your current company, or a company you are eyeing, and see what insights arise.
In my next post on Tuesday, February 25th, I will run through a five forces analysis of my last startup, FameBit.