Setting up a Business or Entering a New Market? - Consider These Important Factors

Michael Porter’s Five Forces

Michael Porter’s Five Forces

If you're considering setting up a business or diversifying into a new market you'll doubtless do some research to establish the commercial viability and attractiveness of the market you're entering. Michael Porter, an American academic based at Harvard Business School, author of 18 books and known for his theories on economics, business strategy and social causes developed a framework known as the Five Forces, a really useful analysis tool which aims to determine the competitive intensity and the corresponding attractiveness of a market.

Internal rivalry relates to the supply and demand for products and services within a market. If demand is significantly greater than supply then suppliers may be free to charge a premium and bolster their profits. As more companies enter the market supply may begin to exceed demand and the opportunity for establishing a profitable business is adversely affected as too many companies compete for whatever business is available. The aim here is to identify new opportunities and be first to market. However, this in itself can be challenging with the need to educate people about the value of your product or service and raise awareness. Factors that influence internal rivalry include the ability of companies to continually innovate, the effectiveness of their competitive strategy and their cost bases. Maintaining market share by adding value rather than competing on price is key - Amazon is a great example of a business continually improving its service e.g. payment methods, product range, a growing online community providing feedback on items bought and sellers, various delivery options and a hassle free returns policy. What could you be doing to improve your customer’s experience before they buy, during the sales process and afterwards?

The ease of market entry determines how many suppliers will be able to offer the products and services. Specialist training and certification, investment in research and development, technical expertise and the heavy capital costs of plant and machinery will all discourage new entrants and at the same time protect incumbents. Intellectual property, such as patents and exclusive distribution rights will also have a discouraging effect. 

How easily people can substitute your product or service will also influence the attractiveness of the market. Does your company have direct or indirect competition i.e. are your competitors able to offer an identical or similar product or service? Companies are becoming much better at influencing the ease of substitution e.g. mobile phone contracts locking people in to a particular network for a 2/3 year period or the inability to migrate data from one cloud based software application to another. “Carrot” and “stick” approaches can be used here with companies incentivising customers to continue purchasing with loyalty schemes and penalising those wanting to leave by making early termination charges to exit contracts.

When setting up your business will you be committing yourself to a lengthy franchise agreement which restricts what you’re able to sell? Will the successful launch of your latest product be dependent on raw materials sourced from a single supplier? Are your supplier’s prices constantly changing and you're unable to pass on these costs to your own customers? Are you an e-commerce business that uses only one delivery company? All of these scenarios tip the balance of power in favour of your supplier. What can you do to mitigate this? 

Buyers will often vote with their feet if you increase your prices beyond a certain point. The elasticity of demand is determined by the number of people that will cease purchasing your product or service for a given price increase. You can influence this in many ways such as effective differentiation, developing greater customer loyalty through improved customer service and becoming a "one stop shop", such as with Google, where people benefit from the convenience of using you for all their requirements. Brand loyalty is hugely influential in this too and you only have to look at companies such as Apple and Samsung to appreciate this.  

The Five Forces model is just one of many excellent business tools that can help you to identify the risk and reward associated with setting up a new business or entering a new market. 

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