Choosing An Industry Using Porter’s 5 Forces Model

Entrepreneurship is a thrilling aspiration to most individuals wishing to be their own boss, earn beyond ordinary pay grade, and have free reign on how the business activities should go about. You can franchise a big brand and join the food service industry, create your own product line with your designs and compete in fashion, set prices, conduct witty gimmicks, and become a competitor of the brands you once looked up to. Over the Internet, there are so much success stories that just ignite that fire to get up and start your own.

Now that you plan to start your own entrepreneurial adventure, you’re asking yourself what kind of business you want to start. You start considering your skill sets and available resources. You start researching the legal requirements and begin completing all of them. But have you ever stopped to consider the different factors that will affect your business once you are inside the industry, competing with all the other companies? Have you thought about whether you can survive the competition by just selling something that is already offered elsewhere, with little to no unique qualities?

To become successful in business, you need to first understand what goes on in the industry you want to enter. Michael Porter, a prominent figure in business and economics, suggests that there are five factors that affect the competition of a given industry:

1. Bargaining Power of Suppliers. Product pricing is not always a discretionary amount. It is affected by different expenses to be incurred by the company, mostly from purchasing raw materials. Now, if there are a lot of suppliers that a company can choose from, these suppliers would not dare to set their prices high. If they do, then companies would simply switch to other cheaper suppliers. However, if there is just one or two suppliers providing for the businesses in the industry, then, because of lack of cheaper competitors, the suppliers can freely set their prices high, which would mean that the companies would have to also increase their prices.

As a fledgling entrepreneur, your choice therefore would either be to choose an industry where there is little threat from the suppliers, become the supplier yourself, or find a trusted supplier who would provide you the best price among all, even if it would still be costly.

2. Bargaining Power of Buyers. Buyers also have the power to affect your pricing. They can even affect the way you conduct your business in certain scenarios. Things like trends and consumer preferences are examples of how buyers will require you to adapt and make changes.

Bargaining power of buyers is high when there are a lot of vendors competing in the industry, or the substitute products can easily replace yours without incurring much cost. This is why businesses in open markets, like food carts, rarely set their prices high.

The challenge for you as an entrepreneur is to weaken the bargaining power of buyers by either implementing loyalty perks, introduce new and innovative products, and prove that your brand is something that they would want not just for utility. Make them want you among all the competitors, no matter the changes you make.

3. Threat of New Entrants. The term “threat of new entrants” is applicable from those who are already inside the industry. For entrepreneurs who are just starting to plan out the business, you look at the barriers to entry. These “barriers” are the necessary requirements in putting up a business in the same industry. These include level of capital needed, strictness of government regulations, certifications needed, and equipment — everything that can block you or prove as a challenge in entering.

However, industries who have little to no barrier to entry may sound an easy target for you, but in the long run, this would mean that more competitors can just come in any time. It would just be a matter of time that you would be facing other new entrants in the competition. This is not a problem if you know that you will be offering something specialized and more targeted than the other existing competitors. But for open markets like in the case of food carts, the plethora of new entrants make gaining a competitive advantage difficult.

4. Threat of Substitute Products. Your competitors are not just the companies that provide the same products/services as you do. Sometimes, you are also competing with other products that can serve as a substitute of yours. For example, energy drinks can be competitors of soft drinks because they both act as refreshments, even though the former is more directed toward sports, and the latter is not.

In understanding the level of threat of substitute products, consider the switching costs (the cost necessary for the buyer to switch to the substitute product), the tendency of the buyers to look for substitutes, and the availability. If you know for a fact that your buyers would have to pay shipping fees in order to use a substitute, then you may consider it not a threat to your business and the industry.

5. Intensity of Rivalry. Finally, conduct a thorough investigation on the level of competition between the already existing companies in the industry. How do they compete? How high are their marketing expenses to best one another? How established are their brands? Are there product differentiations between rivals, or are they head to head selling the same type of product/services? Are they competing in a clean manner, or are they using illegal or deceitful strategies to win the market? Most of all, do you have a chance to thrive in the market once you reach their level?

Porter’s way of guiding the entrepreneur on how to select the most promising industry to enter, is a tried and tested tool. In combination with other factors to consider, this would be a great help in improving your chances in starting a successful business.

*Originally published by the Manila Bulletin, C-4, Sunday, August 28, 2016. Written by Ruben Anlacan, Jr. (President, BusinessCoach, Inc.) All rights reserved. May not be reproduced or copied without express written permission of the copyright holders.