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For both small and big businesses, managing business effectively is difficult. One of the most essentials skills needed is the ability to assess the competitive environment. Entrepreneur and managers must comprehend the competitive environment of the business.
There are several ways to analyze the market and business environment. SWOT analysis is the most commonly used tool. Applying Porter’s Five Forces analysis is also a great way.
The Porter’s Five Forces tool is a very powerful tool. It is simple but excellent for judging exactly where power lies. As it helps to understand not only the strength of current competitive position but also the strength of an expected position, it is very useful.
It is a critical part of your planning process. If you gain a proper understanding of where the power lies, you can take advantage of the company’s strengths. You can also improve your firm’s weaknesses. Overall, you will not take any wrong steps.
The tool is generally used to identify whether new products or services will be profitable. It also helps to understand the balance of power.
The analysis peeks at the strength of 5 vital forces which affect business competition. The five different forces are:
- Supplier power
- Buyer power
- Competitive rivalry
- The threat of substitution
- The threat of new entry
Supplier power is the ability of vendors to increase prices of your inputs. Buyer power refers to the customers’ power drive down prices. Competitive rivalry is the strength of competition. The threat of substitution is the degree to which different products and services can be used instead of your offering. The threat of new entry is how easily new competitors can enter the market.
The analysis entails thinking about how each of these forces affects your business. You are expected to identify the strength of each of the forces. By doing so, you can swiftly assess the strength of your business position. The analysis also increases your chances to earn more profit in the industry.
After assessing the forces, you have to find ways to affect the forces. Remember that your aim is to move the balance of power more in your favour.
Now, let’s discuss the 5 forces which determine competitive power in details.
Often, the first step is to assess how easy it is for the suppliers to increase prices of inputs. This depends on the following factors:
- The number of suppliers of the key input
- How unique their product or service is
- Their strengths and how much control they have over you
- The cost of switching from one to another
Fewer number of supplier choices means you need suppliers’ help more. This also means that fewer suppliers make them more powerful.
When assessing buyer power, you have to ask yourself how easy it is for the customers to bring prices down. This depends on the following factors:
- The number of buyers
- The importance of each customer to a business
- The cost to consumers switching from your offering to products and services by another company.
If you handle only some powerful purchasers, they often dictate the terms to you.
The critical thing to consider here is the number and capability of your business competitors. If there are many competitors and if they offer equally appealing products and services, you will perhaps have very little power. This is because suppliers and buyers will choose the competing companies if they do not like the deal you are offering.
You will be very powerful if your product or service is unique. If competitors cannot offer what you provide, you will have immense strength. In short, the factors to be considered in this step are:
- The number of competitors
- The quality different between your product and competitor’s product
- Any other differences
- Switching costs involved for suppliers and buyers
- Customer loyalty
Threat of Substitution
The ability of your buyers to find an alternative is considered here. If you provide unique software which automates a significant process, consumers can easily substitute by conducting the process manually. They may choose to outsource it as well. If the substitution is easy and viable, it weakens your business. Factors you can assess are:
- Performance of the substitute product
- Cost of change
Threat of New Entry
Other’s ability to enter the market can affect power too. The below factors affect this:
- Time and cost of entering the market and competing
- If there are few economies of scale in place
- The amount of protection for the key technologies
The new businesses can swiftly enter the market and weaken your position. However, if the market has strong and durable barriers to entry, you can maintain a favourable position.
How does Porter’s Five Forces Model vary from SWOT
SWOT is one of the most commonly used businesses tool. Both the analyses in discussion can portray the strengths and weakness of your business. However, there are some major distinctions. The level of specificity, competition and time orientation are some differences.
SWOT can be described a more general and overall assessment. Typically, the Five Forces model focuses on a single growth decision. SWOT is often used to get a picture of firm’s current position. After conducting the SWOT analysis, you can consider future strategic options. Five Forces assesses the viability of a specific product or service.
SWOT focuses on your business and its position while you can use Five Forces to analyze competitors. Porter’s Five Forces helps find out how competitors could inhibit you. Time orientation is another factor which differentiates SWOT and the Five Forces model. SWOT primarily assesses your current position and the future endeavors. On the other hand, Porter’s Five Forces analysis focuses mostly on future decisions of your company.