Think like a manager: Understanding the 5 forces affecting your business

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6 May 2021
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Understanding the five forces affecting your business

Managers are often promoted because they’re good at their job, not necessarily because of their business acumen. As a ground level employee, you’re typically assigned tasks which will work towards the overall strategy of the business, but you rarely get a chance to shape it.

As you work your way up through leadership roles, you’ll be expected to take a more active part in shaping the strategy itself. It’s not enough to just be good at your specific area anymore. Being a manager requires a number of different skills, and a different mindset.

Any successful business strategy must, first and foremost, align with your market. This means recognising who your customers are, who your competitors are and why customers come to you rather than them.

Understanding all of this can feel like a daunting task for a new manager. Luckily, Michael E. Porter created a helpful tool for finding and understanding your business’s position in its market and its long-term profitability. Doing exactly what it says on the tin, ‘Porter’s 5 Forces’ examines the five most prominent forces that affect every business.1 And to make it even easier, we’re going to go through the forces with you.

 

1. Competitive rivalry within your industry

Perhaps the single most important force that affects business strategy is whether you have any competitors, and what they’re doing. If there are lots of other businesses doing the same thing as you, then you’re going to have to work harder to stand out and be noticed. This may mean investing in advertising or finding another way to differentiate your services. Sales and Marketing managers should always know what sets you apart from the others – do you offer something different, or are your prices lower? 

If you have no, or very few, rivals in your market, then you have more freedom to set the standard of price, quality and service. If you have many, then you also need to consider how easy it is for customers to switch from you to them, and how to build brand loyalty.

Recognising where you stand in relation to your rivals also helps you establish your pricing structure. In general, when you have more competitors, you have less scope to raise your prices. There are other forces that affect this too, but if for some reason you’re charging more than the others, then you shouldn’t be surprised if you attract fewer customers. Perhaps this works for your business model, or perhaps you need to find ways to keep budgets tighter.

 

2. Threat of new entrants

Now you know about any existing rivals in your industry, you should start thinking about how easy it would be for a new company to start up. This is important, because a business strategy needs to reflect the level of risk that someone new or unexpected begins siphoning away your customer base.

Begin by establishing the barrier for entry into your market. If there are particularly high setup costs for a new business (such as buying equipment or licences), or it requires expertise few will have, then you can probably be reasonably confident that there aren’t going to be too many new competitors popping up overnight. However, if it would be quite simple and easy for a new company – or for an established company that’s taking a new direction – to enter your market, then you should have fallbacks in place.

If you see new rivals as a realistic threat, your business strategy must be agile enough to react. Are you able to change your prices to be more competitive? This is risky, as any price rises can affect customer loyalty and lowering prices can affect profit margins. The Finance Manager should know the business’s financial position in order to help make these decisions.

 

3. Threat of substitutes

Customers come to you because your products or services fulfil a need that they have. If they can find this elsewhere – even in a different way – then this should be regarded as a rival as well.

For example, people buy cars to get around easier. Companies that make and sell cars will view each other as competitors, but they also need to recognise the threat of bicycles and public transport as a potential substitute in the eyes of their customers.

Think about how similar they are and how likely people will be to swap from you to them. Similarly, think about the cost to the customers to switch over and their relative value given their respective prices.

As a manager, you should keep this in mind when developing strategies, such as when thinking about how to advertise and discuss the benefits and pricing of your business’s offerings. It’s also important when adding or removing any services or features from the things you sell, to understand how it will affect your positioning – not just within your direct markets but also comparative to even more distant competitors.

 

4. Bargaining power of suppliers

The next force relates directly to the business’s supply chain, by asking how much power your suppliers have over you. You’re the customer for your suppliers, which means you can decide to shop around and look for better deals. But, if they are the only ones who sell what you need, or you’re tied into a long-term contract, it might not be so easy to switch.

Your business can’t run without a supplier – whether it’s food for a restaurant, parts for machinery or specialist software you use. Your business strategy should reflect this. Once again, we can look at the financial impact and recognise that the amount you pay for supplies will affect your bottom line. There’s also the fact that your operations can be limited by the quality of what they supply and the timeliness.

If they’re the only ones who can supply specialist equipment, then they hold a lot of power and influence. However, if there are many other suppliers, then you have more bargaining power, as they know you could leave them and start buying from one of their competitors. Managers in every department should understand their supply chain, it order to know whether they could be getting better value elsewhere.

 

5. Bargaining power of customers

This final force is the exact reverse of the previous one. While you’re assessing your relationship with suppliers, your customers will be assessing their own relationship with you. A good business strategy needs to take into account how much or how little power your customers have.

If you have a lot of competitors, then your customers have more choice and therefore more power. Equally, the more customers you have, the less of a worry it is when you lose some to a competitor. If your business model is based around only having a small number of customers, then each one has a lot of power.

Other factors to think about include how to calculate the value of a customer, how easy it is for them to switch to a different company and their sensitivity to fluctuations in your price. Additionally, you should know how easy it is for your customers to find information on alternatives. In many markets, the internet gives your customers access to information immediately. In other areas, it might take more effort to compare like for like services.

There may also be costs and time involved for the customer to switch. For example, they may be tied into contracts, or have setup fees when joining someone new.

When planning their strategy, managers and business leaders should think about ways to create customer loyalty. This may be through your lower prices, a reward scheme, making it easier to switch to you or any other way that works.

 

For new and old managers alike, it’s important to take the time to examine your market position, and how these five forces affect your business. By understanding what customers want from you, why they do or don’t pick you over your competitors and the power dynamics at play, you can start creating a business strategy that better reflects your situation. Then, you can create exciting new plans to build on this, taking your business to new heights.

 

Explore our Learning Solutions to discover more practical skills for Leadership and Management. 

 

1 Porter, M. E. (1979) How competitive forces shape strategy. Harvard Business School