Two business owners are comparing the success of their companies. “My business has a profit of 9%” says the first. The second scoffs “My business makes a profit of 28%.”
Who is doing the best or has the more effective business strategy? It’s the second right?
The conversation develops… The first says, “In my sector, steel, the average is 6%, what’s it in yours?” The other, somewhat reluctantly ”OK I see, it’s pharmaceuticals and the average is 40%.”
So who has the more effective business strategy now? Clearly not the pharmaceuticals business.
Competition works at two levels – By sector, or ‘Market’ level, and at ‘Company’ level. Company strategy performance can only be understood when set against the Market.
This “Market” level of competition is composed of the Five Forces* shown in the diagram below.
If one of these forces shifts, this tool predicts the effect on the strength of Market competition. Our understanding of these shifts is critical for developing our own competitive strategy at Company level. These five forces determine the level of competitive pressure in our sector, and in turn sets the average profit.
The shifts we have observed during Covid 19 are more acute than anything seen before.
The Five Forces model* shows us that competition is fundamentally an exercise in capturing more profit for your business than is captured by rivals. But not just direct competitors, it is also captured from, or by your customers or suppliers, new entrants or alternative solutions.
Competition is seen as a race to be won against rivals, with only one winner. However markets rarely have a single profit ‘winner’, as businesses with distinctive strategies are shielded to an extent from those forces, and those businesses may not even feel they have competitors… Is your strategy distinctive?
As we plan for a lifting of restrictions and a return to the new normal, we need a clear understanding of the forces in our Market Sector. The 5 Forces framework can help us to do this.
So, how strong or weak are the forces that shape the level of competition in your Market?
- How competitive is your market? What is the average profitability?
- Who has the most power that shapes it?
- How powerful are your suppliers, customers and rivals?
- How do your competitors choose to compete (price, quality, volume, area, niche?)
- How do you compete? Is this a distinctive response to the balance of power in your sector? (or do you compete in exactly the same way as your competitors?)
If you compete in the same way as your competitors, you are “competing to be the best”. This is the hardest competitive strategy and the least likely to be successful in the long term. (We will talk about this more in Article 5)
Let’s bring this to life for you…
Many companies have changed strategy en masse during the Covid crisis by responding to rapid shifts in the forces in their markets. Think of the sudden acceptance of the Substitute method of delivering professional services or health care – the “video” call.
Or the numerous delivery services set up by independent food producers and retailers. Suddenly en masse these minnows, who could never dream of competing with the major retailer’s, can (with the help of an entrepreneurial consolidator or two) offer householders across the country access to their desirable products. In the past they would have to get their products listed by the retailers, who traditionally wielded all the force and captured most of the profit.
It is a daunting prospect trying to bring clarity to the uncertainty of shifting markets, so that’s why the process of plotting out your sector is so helpful.
In this template are step by step instructions on how to apply the Five Forces model to your sector, and in this video is a worked example of the Five Forces in action over time.
*The 5 forces model was developed in 1979 by Michael Porter, a double Professor at Harvard Business School, in Economics and also Business Strategy.
This strategic planning framework is rooted in his work on economics and reflects the dynamic but predictable nature of markets.
Other Articles in our Rescue, Recovery, Reinvent Series:-
Article 1 – Businesses That Plan Do Better
Article 2 – Business Strategy, Why Bother?
Article 3 – The Importance of Purpose, Vision and Values