May the Forces Be With You!

Although Michael Porter’s Five Forces* were introduced 30 years ago, the concepts that Porter introduced are as valid today as they were then. The concepts are most often applied to large companies; small and midsize businesses can profit from applying the concepts to their strategy as well. And while everyone has heard of the Five Forces, how many have actually used them to evaluate their own businesses? You don’t have to raise your hand if you have not.

Over the next few months, The COO’s Bulldog will help you carry out a “Five Forces” checkup, using a series of questions to help you consider your own business. This month, we will look at the Threat of New Entrants.

First a quick review. The Five Forces that Michael Porter identified are:

• Threat of New Entrants
• Bargaining Power of Buyers
• Threat of Substitute Products or Services
• Bargaining Power of Suppliers
• Rivalry Among Existing Competitors

Threat of New Entrants

There are three concepts that are core to Threat of New Entrants: perceived threat of entry, barriers to entry and threat of retaliation. It is the perceived threat of entry by new competitors that, according to Porter, sets a limit on profits by dictating how much companies spend on staving off the threat. If the competitors do not see much of a threat, they will spend less defending against the threat, hence higher profitability.

Barriers to entry, advantages shared by those in the marketplace already, are one reason why there may or may not be a perceived threat of entry. If the barriers are high enough, there may not be a threat. Another way to phrase this is by looking at your own company’s competitive advantage. You really need to ask yourself, what are your true competitive advantages, and are they really advantages?

Recently I was involved in a discussion with an entrepreneur who was expounding on his competitive advantages. One listener challenged the entrepreneur, pointing out that most of his competitors probably claimed the same competitive advantages. You need to dig down within your market and your business to discover what, if any, competitive advantages you really have. What is unique about your offering that others will find hard to copy?

Here are some questions to ask yourself about the Treat of New Entrants:

Do you have any advantages of scale?

In other words, do you have any advantages due to the size of your operations? Can you gain advantage through increased efficiencies, better buying power or better customer service? Can you gain efficiencies by integrating your supply chain with providers or customers? You can also turn this around and find advantages based on small scale, for example, could you gain advantage by being more nimble and turning around new products or custom orders more quickly?

Do you have any advantages that will keep customers from switching away from you?

One of the great advantages of many software systems is that once the system is implemented, it is costly (both in terms of actual money and time) to switch away from the system. Other advantages may be geographical proximity; shortening a supply chain can make production more nimble. In the service arena, some find advantage in being the top provider of their service, others in integrating complementary services (the old best of breed argument!).

A note of caution; low cost is not always a great advantage. Some entrepreneurs and in particular new entrants in the consulting field fall for the lowest price trap. A perfect market is defined as having low entrance and exit costs and stiff competition. Our current economic circumstances have created a “perfect market” for such services. It is very difficult to compete on price in a perfect market, as there is always a new entrant ready to charge less.

What are your market’s capital requirements?

The current economy and financial situation make it difficult for many new entrants to raise the capital required to enter into a market. If your market has high capital requirements, new entrants may have difficulty acquiring the capital required to enter into a market. Is this the case with your market, or do you need to be wary because capital requirements are low, meaning that there could be numerous new entrants?

What are your non-size advantages?

Do you have any advantages based on Intellectual Property or other trade secrets? Do you know your industry so well that it will be difficult for a new entrant to match your quality or expertise? Even more important, can a new entrant bring something new that will be disruptive in the marketplace and change the way companies operate? If that is a possibility, do you need to take advantage and make the change first?

Are you prepared and willing to deal with new entrants?

Many new entrants will gauge whether or not the current players in a market will retaliate on their entrance. Starbuck’s, for example, miscalculated the response of McDonald’s when they introduced breakfast sandwiches. McDonald’s did not consider themselves a player in the coffee field until Starbucks entered the hot food arena.

How have you responded to challenges in the past? Have you responded to challenges in the past? Is you market big enough to tolerate more competition (the idea of 4 restaurants on a corner will create more business for all).

Coming in April, The Bargaining Power of Suppliers.

*The Five Competitive Forces That Shape Strategy, Michael Porter, Harvard Business Review, January 2008

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