An example of using Porter’s Five Forces for strategy definition. Comparison to other competitive analysis frameworks.
Analyze competition in the context of five forces – direct competition, customer powers, supplier powers, new entrants, substitutes.
The topics of the article:
- Porter’s Five Forces in Strategic Planning
- Five Forces Template + 3 steps to use it with examples
- Best practices of using the framework
- Five Forces compared to SWOT, VRIO, Three Horizons
- Executive Summary
Traditionally, the market position of a company was analysed in the perspective of the existing competition. According to Michael Porter, only looking at market position within the prism of direct competitors is a too narrow approach.
A more accurate estimation of the market potential is a combination of the five basic forces:
- Existing competition
- Future competition (new entrants)
- Customers power
- Suppliers power
In this article, we’ll discuss a practical application of Porter’s Five Forces framework.
The Role of the Framework in Strategic Planning Process
Let’s start with the position of Five Forces in the strategic planning process. Its application area is strategy definition (step 2 on the diagram):
The idea behind the framework is to analyze the key forces that move an industry and develop strategic hypotheses and initiatives that would help improve the market position of a company.
Let’s see how we can use the Five Forces Framework in practice.
Using Five Forces Template: 3 Steps + Examples
Below, we’ll discuss the three steps of using the Five Forces framework:
- Step 1 – Formulating forces and factors as they apply to your industry
- Step 2 – Formulating a strategic hypothesis
- Step 3 – Describing a hypothesis
Step 1. Finding What’s Moving Your Industry
In Porter’s article, there is a phrase that I consider to be a simple formula for finding new factors or even new forces:
“the strategist […] must learn what makes the environment tick.”
The Five Forces are the starting point. The challenge for your team is to look at your company from the viewpoint of those forces and map the underlying factors that make sense for your company.
- Should those be exactly the same forces in a case of your organization?
- Should those be five forces only?
Most likely, the answer is “yes” to both questions (see some thoughts below about the 6th force).
To help you along the way, our template includes some guiding questions:
Force 1. Current competitors
- What are the strengths and weaknesses of our competitors?
- What are we competing on (number of active users, total sales, market share, etc.)?
- Factors important for new and existing customers
- What’s the role of innovations as a factor of rivalry?
Force 2. Customers Power
- What’s the position of our product in a customer’s business?
- What is the adoption curve of our product?
- How can the value created for a customer be quantified?
- To what degree is product standardised?
- What are the costs for a customer to change product?
- How loyal are customers to the brand?
Force 3. Suppliers Power
- What’s our dependency on the suppliers?
- What’s the dependency on distribution channels
- Percentage of standardized procurement processes
- The number of suppliers
Force 4. Future competitors
- What challenges would a new entrant face?
- What are the entry barriers (entry price, cost to get necessary expertise)?
- What are entry facilitators (like no legacy products to support)?
Force 5. Threat of substitute
- Existing substitute products (switching cost, problem/product fit)
- Possible market disruptors (do PESTEL analysis regularly to detect disruptors on your radars early)
Example of BSC Designer
Let’s illustrate how to use the template in practice using our company, BSC Designer (SaaS business in the domain of strategic planning).
Thinking about the “Suppliers” force in the context of our business, the “supplier” term doesn’t really work, because as a software company, there are no raw materials we use.
We can use Porter’s formula and find what’s moving our company in the sense of external dependencies similar to suppliers:
- Technological platforms. How deep is the integration with the platform? What’s our dependency on them? In our case, there is a certain dependency on the platform, and switching to another one will be time-consuming, but I’d say that the dependency is low. Some parts of our product are connected to a third party service (like for example, Google Sign-up or certain charts for dashboards) that might be a problem for customers from China.
- Talents. Should we consider talents to be the suppliers of intellectual potential? While the infrastructure of our solution is well-documented, the dependency on the talents is high.
- Distribution channels. In our case, we sell through e-commerce partners, and the “distribution” happens when our potential customers are engaged with our content through search engines. The dependency on e-commerce is low, as there are many similar services, while the dependency on the search engines is high because right now, there is no good alternative for this distribution channel.
- Local partners. We are presented in markets of Asia, Middle East, Latin America and our teams there help serve local customers, create content, etc. Finding and training a good local partner is time- and resource-consuming, so the dependency here is high as well.
Let’s see what we can do about these insights on the next steps.
Step 2. Convert Outputs of 5 Forces into Strategic Hypothesis
In the previous step, we added specific factors to each of the Five Forces. The next step is to:
- Decide what your company can do about them and
- Prioritize your efforts.
A common sense rule:
Finding weak points and having a risk mitigation plan in place is less expensive than dealing with the same problem in crisis times.
We saw this scenario at the beginning of 2021. Due to the semiconductor shortage, many automakers faced supply problems. A more agile Tesla was able to mitigate the dependency on microchips effectively.
Example of BSC Designer
Let’s get back to our case:
- Some of the factors require more research. For example, we cannot remove the dependency of our content marketing on search engines, but we can study this factor more to better understand the rules of the game (we discussed before the SEO metrics that we use)
- Some of the factors have low priority because of their low impact on the force. There is a certain dependency on technological platforms in our example, but it is a good dependency.
- Some factors have a high impact and possibilities for improvement. In our case, we can work with local partners to optimize the dependencies.
Following the outputs of previous steps, we create hypotheses for the Suppliers Power force:
- Learn best practices for SEO. Track the latest trends in the search engines industry to make sure our content marketing keeps working effectively.
- Optimize the way we work with local partners. Mitigate the dependency on local partners by introducing training and quality standards
Step 3. Describe and Quantify Strategic Hypotheses
In strategic planning, a hypothesis is well formulated when the underlying factors were analysed, quantified via performance indicators, and action plans were suggested.
Once the strategic hypothesis is formulated, we need to follow the next step of the strategic planning process – strategy description.
The hypotheses should be converted into more specific goals, with such attributes as:
- Rationale that stands behind the goal
- Specific hypothesis that we are going to work on
- Success factors and expected outcomes
- Action plan
- KPIs that quantify the success factors and expected outcomes
Let’s use this approach for one of the hypotheses found.
Goal: Optimize the way we work with local partners.
Rationale: Our success in local markets mostly depends on how local partners are effective in serving local customers.
Hypothesis: Investing in training for local partners will pay back in the form of higher value for customers and better economic outcomes.
- Easy onboarding for local partners
- Effective product and concept training for the partners
- Partners create high value for the local clients
- Local partners stay longer with the company and increase local market share
Leading KPIs (aligned with success factors):
- Diversity of cases to learn the product, %
- Coach support when learning the concept, hours/month
- Time to performance, days
Lagging KPIs (aligned with expected outcomes):
- Freemium to paid accounts conversion for a local market, %
- Monthly qualified leads from the market
- Partner training program. Training in the product as well as in the concept.
- Timeline: 3 months
- KPI: % of partners who passed the training
The Five Forces template was used to formulate strategic hypotheses and describe them according to the strategic planning process.
The next steps include:
- Cascading of suggested strategies if needed
- Action according to the suggested initiatives
- Performance reporting
- Validation of the results
- Learning loop
Best Practices for the Five Forces Framework
One of the less tangible forces is the force of substitutes.
- Substitutes can be existing products. Today, people drink coffee, but one day, coffee might be replaced with an existing energy drink.
- Substitutes can be what are today called market disruptors. Instead of replacing coffee with an energy drink, five centuries of the coffee experience in the western world could be replaced with something not really known yet.
Consultants like talking about existing substitute products, as it is easier to evaluate the risk of substitution based on the data.
How to leverage the risk of market disruptors?
- We see Google and Facebook acquiring companies that could potentially become new disruptors
- We see retail banks that don’t do enough to compete with fintechs
- We see Tesla that seems to follow the strategy – “the best way to predict the future is to create it.”
What strategy will prove to be effective? It looks like most companies are aware of the coming changes, but as demonstrated by Theodore Levitt in classical “Marketing Myopia”, few are actually prepared.
My suggestion for an organization is to:
- Invest time in regular PESTEL analysis, meditate about new trends and the way they could change the world.
- Have a good innovation pipeline for testing and implementing those findings
A more simple yet effective way would be to follow the examples of powers like China and outsource most of the hard work to sci-fi authors and wait for innovations coming.
6th Force – Complementary Products
Some authors add Complementary Products as a 6th force to the framework. Should your company consider this force as well? It depends on the nature of your competitive environment.
In the case of BSC Designer, a natural complimentary service for our product, are companies that do strategic consulting.
- Should we have them as a separate force in the framework?
As mentioned before, in our case, instead of the “Suppliers” force, we have something close to “Partners,” so in our specific case, there is no need for an additional force.
We Are Dealing with Educated Hypothesis, not Indisputable Truths
At some point, the users of the Five Forces, SWOT or similar strategic planning frameworks might have an impression that such tools convert vague insights into indisputable truths.
The strategic planning frameworks don’t make the insights more trustworthy; they help to better organize them!
It’s important to understand that the outputs of the frameworks are educated hypotheses. It means that:
- We need to properly describe hypotheses to make them “educated” (like we did in step 3).
- The process of the description doesn’t make the hypothesis true, but it challenges us with the right questions and helps to move in the right direction.
- While the hypothesis might be based on intuition, its validation should be based on hard data. That’s the role of the leading and lagging indicators on step 3 of the Five Forces process.
BSC Designer allows assigning weight to each of the forces as well as to each of the factors. If you prefer to have the performance within each force calculated, that’s the right approach to do it.
Such an approach helps to prioritize strategic choices:
- Factors with higher weight that belong to the forces with higher weight will receive the highest priority
- The performance gaps for the factors with high weight should be the focus points for improvements
If you use BSC Designer for automation, you will find Absolute weight analysis useful, as it will help you to find the factors with the highest absolute weight and/or factors with low performance.
When talking about forces, we often refer to the idea of dependency.
- There are good dependencies, like the IT platform, that help you solve certain challenges effectively.
- There are bad dependencies, like a single just-in-time supplier (see the example of microchips crisis).
In the context of dependencies, it makes sense to analyze your business from the viewpoint of complexity (before, we discussed how to detect and quantify complexities).
Five Forces Compared to Other Frameworks
Before, we discussed the different tools for strategic planning. Among them, we have three frameworks that focus on competitive analysis:
- Three Horizons
Let’s see the advantages and application areas of each framework compared to Five Forces.
Five Forces vs. SWOT
What’s the difference between Five Forces and SWOT? Actually, they complement each other.
With Five Forces, we build a competition model first. The framework prescribes the strategist to find underlying factors by looking at the company and its market from the viewpoint of Five Forces:
- Existing competition
- Power of customers
- Power of suppliers
- New entrants
- Substitute products
Once the initial analysis is finished, strategists can follow a classical SWOT process:
- Analyze underlying factors and come up with a strategic hypothesis
- Match strength and opportunities
- Convert weaknesses and threats to strength and opportunities
Five Forces vs. VRIO
VRIO framework uses a different approach to the challenges of strategic planning.
With Five Forces, the analysis starts from a general competitive model to specific opportunities that the company uses to confront rivals.
In VRIO, the direction is opposite; we start with specific “resources and capabilities” and analyze if they could lead a company to a general (“sustainable” in the terminology of VRIO) competitive advantage.
Five Forces vs. Three Horizons
Another framework that resonates a lot with Five Forces is Three Horizons that we discussed before.
In contrast to Five Forces, Three Horizons looks at business growth and innovation planning according to three time horizons.
While the frameworks take a different approach, they actually complement each other:
- Horizon 1 (now) from Three Horizons corresponds to the Competition Force of Five Forces, e.g. positioning the company in the context of existing competition, customer and supplier forces.
- Horizon 2 (near term) corresponds with the New Entrants force + includes an improvement plan for the discoveries of horizon 1.
- Horizon 3 (future) corresponds to the Substitute Product Force or possible market disruption.
The Three Horizons framework will be useful for prioritizing the hypothesis produced by the application of Five Forces.
The Five Forces framework suggests a comprehensive approach to the analysis of competition.
Instead of simply looking at the direct competition (the first force), four additional forces are taken into account:
- Customer powers
- Supplier powers
- New entrants
- Substitute products
We discussed an example of the practical application of the framework that includes three steps:
- Step 1. Mapping factors that are “moving” the industry
- Step 2. Converting those factors in strategic hypotheses
- Step 3. Describing hypotheses with KPIs and strategic initiatives
The framework was also compared to similar frameworks for strategic planning:
- Five Forces with its competitive model beats SWOT in the context of competitive analysis.
- The VRIO framework addresses the same problem, but in contrast to Five Forces, it moves from specific to general, e.g. from specific resource/capabilities to sustainable competitive advantage.
- The Three Horizons framework adds value to the Five Forces by applying time prioritization to the factors of the competitive forces.
What’s your experience with the Five Forces framework? Feel free to share your thoughts in the comments.
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