The 5 competitive market forces

Michael E. Porter of Harvard University developed the Five Forces Framework in the 70’s as a tool for analysing competition of a business, however in modern business it can get confusing when trying to apply this theory in a real-world situation if you don’t know how it relates other theories that are commonly used by successful business.

The five forces model take a lot of the opinions and guesswork out of developing the marketing mix (4Ps), and when you also relate it to Maslow’s Hierarchy of needs, it tells you what to look for at different stages of business start-up, particularly when it comes to pre-start-up planning.

It draws from five forces that determine the competitive intensity and, therefore, the attractiveness (or lack of it) of an industry in terms of its profitability. Under this model, business is not just a tug of war between the biggest players, the best options are the most profitable, so can be applied to businesses of any size.

In start-up mode, the focus in on 4 out of the 5 market forces, and the bottom 4Ps of the marketing mix. However when the focus of the business shifts to sales, competitive rivalry within an industry drives a wedge into your business and weakness are likely to develop in the 4Ps that directly relate to what is considered the strongest market force.

These market forces do not only apply in a start-up but have a large effect on what customers are willing to pay for new products. It is useful to know to work out if you can at least charge enough to cover the costs of production and plan promotions.

An example of a competitive rivalry between larger companies is the failed attempt by the Master’s home improvement stores. Bunnings is what is known as a “category killer”, a store so big that overwhelms all the competition. But the way business is done in the modern era is not just about size and another retail giant Toys “R” us (one of the first category killers) has also recently closed its doors because they couldn’t adapt.

The home improvement market is so big in Australia that the Bunnings only had around 17% of the market, and category killers would often be around 40% of the market, so it seemed likely there would be room for another major player, and the challenge came from a competitor who was already at least an equal another industry (supermarkets).

How did Bunnings fight off the attack from another giant?

  • Products – Bunnings already had an established supply chain and was of sufficient size and demand to restrict access to popular brands from key suppliers, so any new entrant would have to look at different brands of products unfamiliar to the customer (even if it came out of the same factory).
  • Place – Bunnings already had a store located in the best locations, so a competitor was unlikely to find a sufficient sized block of land to build a warehouse that was in a residential area close to renovator customers.
  • Price – While the idea of a category killer was to be the cheapest on price due to economies of scale, Bunnings just had a slogan in all their ads: “If you can find a cheaper price on a stocked item, we’ll beat it by 10%”. This took out shopping around, and people would just go to the most convenient. Bunning would also put their competitor’s brochures on the entry wall to show transparency, so you didn’t even have to go to Masters to see if it was in stock.
  • Promotion – Bunnings was large enough to buy up all the stock of certain suppliers with different features and charge a premium, effectively voiding the price guarantee for different brands and models exclusive to Bunnings.

Lessons learned by going negative… are you just delaying the inevitable?

A similar price-matching tactic was a promotion used by Pizza outlets, who would honour discount vouchers from other chains. Kind of the reverse of matching stocked items and saying to the customer even if it is different, the price is all you care about, so just come to us.

Effectively chains like “Eagle Boys Pizza” (which has also now closed down) would save printing cost and letterbox drops, which would only return about 2% of the number offers homes received in the post, but was considered the standard what to promote Pizza delivery. To counter this, the larger chains went back to the start and focussed on product R&D, then start introducing things like square pizza and other side products not available at the smaller chains.

However, this price matching also opened the market to charge more for delivery deals as vouchers had to be brought into the store to get the cheaper price (so pick-up only). Now it has also opened up a market for Uber eats. It is no longer just Pizza and restaurant food delivery, burger chains, and others can now become rivals in what was the traditional Pizza market, and the long-term result of focusing on only one of the 4Ps.

All this affect the profitability of your business, which is usually measured as a percentage. So, the sales process becomes important when you grow your sales, and you want to maintain your percentages, but increased sales may increase profits if you have fix costs.

You can’t bank a percentage point, you need dollars, so you have to prioritise what in your marketing mix will give you the highest return on your marketing investment.

If you just start a price war to eliminate weakness in your 5 forces, it will decrease your profits.

It goes to show how going negative does not end well in business. It may also be illegal for a bigger business to undercharge to drive a competitor out of business, or engage in “cartel” behaviour, such as price fixing with competitors, and legal costs affect your profits too.

Diagnose your weakness, but have a plan for what to do if you overcome them. Keep it positive, and play the “what if” game.