Porter’s 5 Forces for entrepreneurs

Launching a business idea requires a combination of several qualities: an entrepreneurial mindset, the ability to lead, financial acumen, excellent strategic management of resources, and the creativity to develop innovative products/services. However, possessing all these attributes that characterize an entrepreneurial spirit is not always enough. A methodical and carefully prepared business plan is crucial in determining whether or not a business idea will be profitable. This document is and must be the cornerstone of the business idea. In order to build this strong foundation, we can use different tools to help us define (on paper) our idea, vision and strategies in an existing sector.

Many tools can be used to create a business plan, such as the typical SWOT analysis (Strengths, Weaknesses, Opportunities and Threats), which identifies how an organization is performing and enables effective decision making and strategic planning. Others prefer the Business Model Canvas, which is increasingly being used by entrepreneurs who want to condense their business model down to nine elements (and a single sheet of paper). This is a very graphic approach that allows entrepreneurs to shape their idea and see if it works. Those who are closer to creating a successful startup use Lean Manufacturing, which was originally developed by Toyota and aims to achieve greater productivity, taking into account labor and resource savings in the manufacturing of specific products. This tool reduces the investor’s risk and also provides data on viability.

However, there is another strategic method, which is widely recognized in project management, and can also be useful in the development of a well-designed and structured business plan. When developing a business plan, you must understand, assess and analyze the sector where you want to operate. One way of doing so is by using a method called Porter’s 5 Forces. This model was defined by economist and professor Michael Porter in his book Competitive Strategy, and its purpose is to analyze and evaluate a business idea for a specific sector and verify its profitability. This analysis is performed based on the 5 forces that affect any company or potential business. Working with this tool helps to develop an understanding and recognition of the forces that can put pressure on a business, how to take advantage of opportunities, and which strategies are effective in combating threats to ensure that the business is profitable.

Thoroughly implementing the Porter’s 5 Forces framework requires careful consideration of all the possibilities within each type of threat and whether they represent a large or small risk to the business idea you want to launch. This knowledge is priceless for entrepreneurs because they will be able to judge whether or not they should move forward with the creation and building of the business. Thanks to Porter’s 5 Forces, we can envisage a prospective company within the current map of competition, gauge the profitability of the sector, devise an effective business strategy that minimizes risks, verify the availability and capacity of suppliers, identify market niches, create a product/service that is difficult to replace and, ultimately, develop a marketing plan, as part of the business plan, that achieves the previously established objectives.

If you’re interested in starting a business, it’s time to apply Porter’s 5 Forces. Let’s get started!

Supplier negotiating power

This relates to the ability or degree of power you should have in order to negotiate issues such as price, flexibility of payment and the delivery times of goods. Good agreements with suppliers are essential for success as an entrepreneur, and under no circumstances should you ever work with only one supplier.

In order for this one of Porter’s forces to help you with your business plan, you need to ask and answer the following questions:

• Who are the potential suppliers of your future company? List them in order.
• Are there other suppliers with which negotiations can be improved?
• Have you already approached or negotiated with some of these potential suppliers?
• Do these suppliers find clients easily?
• What could the cost of changing supplier be?
• What could you do if faced with the threat of a price increase from your potential suppliers?
• What would you do if all your suppliers terminated their agreements with your company?

Consumer negotiating power

This Porter’s force relates to the power of customers. It varies greatly depending on whether you create a unique product/service that is difficult to obtain or if the business concept is to sell a mass-market product that can easily be found in any store. In short, the more competition there is, the more power consumers have.

If you’re an entrepreneur and you want to be able to measure this force, you have to ask yourself all these questions:

• How important is the product/service to the consumer?
• What type of purchase will the consumer make: compulsive, considered, regular, etc.?
• Will consumers make purchases through multiple sales channels?
• What will be the volume of purchases made by customers?
• What type of purchase will it be: wholesale or retail?
• Is there a large number of consumers relative to the number of sellers?
• What are the costs if consumers choose the competition?
• Could the business end up being owed for unpaid purchases?

The threat from new competitors

It is often very difficult being the newcomer trying to break into a well-established industry. This threat, described by Michael Porter, refers to the barriers to entry in the sector and whether they are high enough to prevent a lot of new companies from competing, or whether they are very low and the market could easily be inundated with new competitors.

It is important to bear in mind that competition can be fierce. Using this force, the business plan can include measures for gaining a bigger advantage over the competition. For this reason, it is important to conduct a market study and answer the following questions before launching a new business:

• How much capital is needed to get started?
• What is the sector’s growth rate?
• Are the sector’s barriers to entry large or small?
• To what extent does the competition protect their market share?
• Is it possible to work with economies of scale in this sector?
• Are raw materials easily accessible to all?
• What are the relevant government policies (taxation, tariffs, duties, etc.)?
• How can the different distribution channels be accessed?

Threat from substitute products

Entrepreneurs tend to analyze this Porter’s force incorrectly. The threat of substitute products relates to the consumer’s ability to choose a different product/service (not just a competitor’s) instead of our own to solve the same problem or fulfill the same need. For example, the first microwaves competed with conventional ovens (substitute product) even though this was a new product.

The threat from substitute products, which can be regarded as a kind of indirect competition, is often overlooked. When starting a business, it is therefore important to take this force into account and implement strategies to counteract the power of these products. Advertising and promotions in the various sales channels are often used to counter this danger. However, before developing a well-defined strategy to minimize this threat, the entrepreneur must ask themselves a few questions:

• How many substitute products are available? Make a list.
• To what degree do they overlap with the features of your product/service?
• To what degree do they differ from your product/service?
• What is the relative price range of the substitute products?
• What is the relative level of quality of the substitute products?
• What is the cost of the consumer switching from one product to another?
• Does the substitute product have any kind of added value that your product lacks?

Rivalry between competitors

Competitive rivalry is a reasonably obvious force and relates to gathering information on the competition, in order to obtain the necessary data to devise a strategy that will allow an entrepreneur to stand out from the large crowd of competing companies. In turn, it is important to bear in mind that each competitor establishes a series of strategies for distinguishing itself from others. In fact, there are many aspects that increase rivalry, such as the number of competitors, whether they are well positioned, their fixed costs, etc.

As we have done above, we will define a series of questions that the entrepreneur must answer. The key to and strategy for differentiation from the competition will be derived from analyzing the answers to these questions:

• How many competitors does your business idea have?
• What is the turnover of your competitors?
• Can competitors easily lower their prices?
• What are the goals of the competitors?
• Is there much product differentiation among competitors?
• What is the growth rate?
• What differentiates you from the competition?

In summary, as we have seen, developing a business plan using tools that allow you to clearly define the business idea is very important for entrepreneurship. Furthermore, a detailed market study must be conducted; the strategy we are going to use must be carefully considered; our competitive advantage must be established; the profitability of the prospective company must be calculated; and we must innovate with distinctive products/services, all the while being very attentive to the sector we are going to target. Ultimately, competitiveness is a positive thing since it creates the necessary environment to bring out the entrepreneurial spirit that many of us carry inside. And in turn, entrepreneurship drives and improves competitiveness, builds community, enables economic diversification and is essential for job creation. 

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Author: Joan Margarit, Marketing and Communication Analyst

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