I met a guy named Dan Neukomm recently who has a real zest for business-life. He’s got an MBA degree from Paris (where as an American he was a minority) and he has been a key member of a couple of successful start-ups.
He and I brainstormed mutual areas of interests and strategic planning was one of them. He kindly agreed to share his thoughts on one key strategic model: The 5 Forces from Michael Porter.
Here’s the Q&A — I hope you enjoy it:
Please explain the origin of “Michael Porter’s Five Competitive Forces That Shape Strategy”
Strategic assessment models are utilized by senior management and other stakeholders to assess external factors to direct and efficiently distribute resources driving growth.
While many such models exist, few have become as widely valued and practiced as the Five Forces model, developed by Harvard Business School professor Michael Porter.
This model helps to analyze external variables and structure, primarily at the industry level, which influence the attractiveness of entering and successfully competing in a specific marketplace/industry.
Each of the five forces can be attributed a weighted numerical strength on a scale of 1 to 10 and then added together to determine industry attractiveness.
Please describe each of the Five Competitive Forces?
Porter’s Competitive Forces are barriers to entry, bargaining power of suppliers, bargaining power of buyers, threat of substitutes, and competitive rivalry among existing players.
1. Barriers to Entry
Accurately assessing barriers to entry in a given industry are vital to understanding the ability of a venture to succeed. High barriers to entry almost always directly relate to higher costs, both for the venture under consideration as well as potential competition in the future.
Understanding those barriers can help to effectively identify and leverage market entry routes without removing existing barriers for future entrants to navigate. Examples of barriers include economies of scale, IP protection and government regulatory restrictions.
2. Bargaining Power of Suppliers
The power of suppliers is almost entirely supply side driven, resulting in reduced costs as the competition among suppliers rises, and increased costs as suppliers monopolize the supply chain.
Attractive, high growth markets tend to present low supplier power at early stages of the industry life cycle, steadily increasing as growing volume and high margins attract additional suppliers.
Examples of supplier power include the concentration of suppliers, threat of forward vertical integration, and costs associated with switching suppliers.
3. Bargaining Power of Buyers
Buyer power can have considerable implications and influence on price and is a function basic demand side economics. Buyers can be defined as end consumers in B2C sales or another business in B2B sales. The power of buyers in the marketplace can have two distinct impacts.
First, an increasing number of buyers in the market, resulting from increased demand, results in higher prices. Second, as the volume and demand of buyers increases so does the incentive for buyer collaboration to leverage economies of scale.
This can be further offset by attracting additional suppliers who in turn offer more choice and drive prices back down. Identifying and measuring variables influencing buyer power are necessary for accurately assessing viability and price control.
Such variables include product differentiation, brand identity/value, buyer’s incentives and the threat of reverse vertical integration.
4. Threat of Substitutes
The threat of substitutes relates to those products or services that can directly displace or offset the demand and/or consumption of the penetrating product or service being considered.
Perhaps the most considerable implication is the ability for the buyer to directly substitute the product or service for a something similar but equally effective at satisfying demand. Another consideration is the cost incurred by the buyer to switch to the substitute.
5. Existing Rivalry
Those firms currently competing within the target industry whose existing competitive dynamic is dictated by numerous factors define this. These include the concentration within the industry, the differentiation among products/services, the barriers to exit and the growth rate of the industry.
If the market is large and rapidly growing, it is more likely to contain a large number of competitors with a diverse offering of products and services and diluted liquidity values for exit due to the high number of options.
When’s the best time to use the Five Forces framework?
Where ultimately will the Five Forces analysis lead a business to (what results?)?
The Five Forces Model should be utilized for determining market viability as well as identifying and ultimately avoiding potentially risky and costly pursuits.
Most importantly, Five Forces provides a relatively subjective framework with which to input values designed to determine strategic direction and resource allocation accordingly.
Remember, Five Forces is only one strategic assessment model designed to help understand the variables that shape the competitive dynamic of a given industry. As such, other models should be utilized in conjunction so as to paint as clear and concise picture of both internal and external factors for consideration.
Can you give us a Five Forces example?
In 2001, I founded and grew Mountain Oxygen, a company which provided oxygen products, systems and services to visitors of high altitude ski resorts in Utah and Colorado who suffered mild symptoms of altitude discomfort such as fatigue and insomnia.
Our core/primary service was renting oxygen generators via hotels and resorts to guests for the duration of their stay so they could rest, rejuvenate and enjoy their limited and expensive vacation time.
Porters Five Forces directly articulates the assessment I went through to determine the competitive dynamic and ultimate success of this venture and as such is outlined in further detail below.
Since the recreational oxygen market at high altitude ski resorts in Colorado and Utah did not exist prior to Mountain Oxygen, there were relatively few barriers to entry, making the venture appealing and lucrative (i.e. no IP needs, limited gov’t regulation and no competition).
I was able to secure (at a cost) exclusive agreements with ski resorts and hotels to be the sole supplier of such services, giving me considerable control over my buyers allowing my firm to dictate price more aggressively.
Additionally the act of establishing and maintaining non-compete agreements meant that almost impenetrable barriers of entry existed for future competition.
Since there were numerous suppliers resulting in relatively limited power, my costs remained low. Furthermore, the availability of substitutes was also extremely low, entirely due to the specific nature of the need my firm was meeting.
For example, once vacationing in a resort town like Aspen and altitude malaise sets in, the only other option is to retreat to lower elevations as no drug is available that is immediately effective in alleviating adverse symptoms. As such, my firm was the only provider of the only solution!
My business maintained low buyer power as a result of minimal substitute products and lack of competition allowing me to maintain price control and increase margins.
OK, lets integrate the weighted values of the five forces to this model:
Total weight: 7 out of 50 and as such very, very attractive/lucrative.
Food for thought: The lack of non-compete clauses at host resorts would have meant additional competition and subsequently increased buyer power resulting in lower prices and tighter margins.
This would have increased the weighted value of both power of buyers and competitive rivalry towards 7 or 8 out of ten shifting the over-all industry attractiveness score accordingly.
Mountain Oxygen was split up and sold in 2006 to strategic buyers.
Is there a Five Forces diagram for us to look at?
Can you recommend any Michael Porter books?
Competitive Strategy: Techniques for Analyzing Industries and Competitors by Michael Porter.
What are your other favorite strategic planning frameworks besides Porter’s Five Forces model?
SWOT also helps to identify and match internal strengths and weaknesses to external opportunities and threats. Understanding Michael Porter’s Value Chain (another Michael Porter model) is also useful in measuring and guiding supply chain dynamics.
If someone wanted to get in touch with you, what’s the best way for them to contact you?
You can email me at email@example.com or here’s my LinkedIn profile.
Note: Check out Michael Porter Wikipeida for more about this leading strategic planner.
I’ve been fascinated by the power of blogging since I began experiencing it back in April.
Now I’m interested in multi-user blogging: specifically, providing a platform that allows multiple people to blog.
Some Top Multi-User Blog Tools
The two multi-user blog tools that I’m noticing the most buzz about in my couple of hours of research are:
Both are free, though you may have to pay someone to customize it for you or to buy some add-ons.
Here is an interesting comparison of WordPress MU versus Drupal MU.
Other multi-user blog software includes (all of them appear to be free):
Paid Multi-User Blog Tools
A couple of multi-user blog tools that cost money include:
Make sure that whatever multi-user blog tool you pick is well-supported. One tool called Lyceum has a notice on their site that their development team’s last bug fix appears to have been June of 2008.
Other multi-user blogging tools I’ve heard mentioned include the Blog product that comes as an add-on to Scoop and Elgg.
I’ve been teaching someone on our team recently about how a sales pipeline works — and so I thought I’d summarize my sales approach here for you (I’ve used this for straight up sales as well as for partner sales).
Note: I’m going to refer to the party I’m selling to as a “customer” but it could easily be a partner in the case of partnership sales.
There are any number of sales pipeline stages you can use: I’m going to use Leads, 10% Opportunities, 50% Opportunities, 90% Opportunities and Closed Won/Lost. I first adopted this methodology when I began using Salesforce.com which mapped well to how my mind works. …
I’ve been into motivational business quotes lately and I was reading the Tao of Warren Buffett (which I highly recommend!) and it reminded of the great quotes Mr. Buffett has shared.
Here are some of my favorite Buffett quotes:
How to define friendship …
I’m a big fan of using Colonel John Boyd’s OODA Loop strategy for reacting to events in business.
I’m so into the OODA Loop theory that I once chanted “OODA, OODA” (like “Toga, Toga”) at a strategy session!
OODA stands for:
Observe — As in collect the inputs/data of the situation.
Orient — Analyze the inputs/data to determine your position.
Decide — Determine your course of action.
Act — Execute your decision.
It’s called an OODA Loop (or OODA Cycle) because the event/situation taking place may be changing and so you may have to change your decisions as new data/inputs are gathered.
While Col. John Boyd’s OODA Loops were created in military situations, he made recommendations on their use in business (and OODA Loop Theory is widely used in business today).
For example, Boyd recommended that decisions/actions be distributed throughout a business organization so that decisions and actions are made by the people who are directly observing and oriented to a situation (as opposed to an isolated commander/CEO who is only indirectly involved).
Colonel John R. Boyd is no relation to famous businessman John Boyd Dunlop who founded Dunlop the tire company or peace nobelist Lord John Boyd (United Nations, nutrition).
I’m a huge fan of Charles T. Munger (aka “Warren Buffett’s right-hand man”) – I named Poor Charlie’s Almanack the #1 book in The 20 Best Business Books Of All Time because I find myself quoting and utilizing his knowledge all the time.
In the mean time, here are some of my favorite Charlie Munger quotes:
Here’s another one: PEST Analysis (by the way, there are many variations of PEST Analysis and so I’ve listed all of the ones at the bottom of this article with their definitions).
What is a PEST Analysis?
PEST is an acronym that stands for the following four Macro-Economic factors:
PEST analyses are best used to measure a market situation (this differs from SWOT Analysis as SWOT is best used to measure a company or business unit situation). A good time to do a PEST Analysis is right before a SWOT Analysis. More PEST Analysis definitions and history can be found at PEST Analysis Wikipedia
The best uses for PEST Analysis are:
PEST Analysis Example/Template
Here’s a good sample PEST Analysis of Yahoo
And, as promised here are those other variations of PEST with their definitions:
You can tell that some people are really into these things!
If you like my articles on SWOT, PEST, etc. then you might want to check out my posting on DOS Exercise.
I often get asked the following questions from business owners and leaders:
Well, I’ve got my own thoughts but there’s a guy you’d much rather hear from — he’s been doing mergers and acquisition (M&A) deals for 20 years.
His name is Doug Hubert (pictured) and he leads the M&A work as a Managing Director at CBIZ Inc.
He and I graduated high school together and even though I haven’t done a good job staying in touch, he was kind enough to share seven tips for you to use to maximize value in your business. Here they are!
1. Build a deep management team
One of the most difficult challenges for an entrepreneur, and one of the critical differences between a good company and a great company, is the depth and quality of the senior managerial team.
Too many entrepreneurs make the mistake of trying to run and grow their businesses with only one or two people capable of making critical decisions.
As a result, most businesses will plateau in their growth. If your company can’t function efficiently without your direct daily involvement, then you need to immediately begin to hire and develop talent or the future of your business is in jeopardy.
Jack Welch, the former CEO of General Electric, considered talent development and succession planning one of his greatest accomplishments in his tenure. Treat this issue with the same importance.
2. Diversify your customer base
Your largest customer should ideally be no more than 15%-20% of your revenues and/or profitability. While it’s often efficient and easy to allow a major customer to develop into a substantial portion of your sales, nothing could be more dangerous to the future health and value of a business.
Once a customer becomes a critical portion of your revenues and/or profits, then they own you. They can begin to dictate the
financial terms of the relationship and any change in their business, be it financial, personnel or otherwise, has a direct effect on the health and value of your business.
While it might require extra effort and possibly some short-term sacrifices to your bottom line as you build other accounts, the long-term benefit of a diversified customer base is a significant reduction in your financial risk profile.
3. Maintain quality financial information
A consistent area of weakness with most small and middle-sized companies is the lack of strong financial documentation. Most business
owners don’t want to spend the extra money to obtain an audit, believing a review or a compilation is just as good-it’s not.
Audited financials provide credibility with bankers, commercial financing sources, insurance companies, and most importantly, potential buyers.
The extra money spent will be recovered in a higher premium when the business is eventually sold.
4. Develop a proprietary product or service
To truly thrive as a company, you must distinguish yourself in the marketplace by offering a unique product or service that can’t easily be replicated by competitors. While this seems obvious, very few companies are dedicated to creating this distinction.
Ask yourself if your customers, employees and competitors can all quickly describe what differentiates your company. A superior product or service will create the opportunity for a pricing advantage in good times and customer loyalty in difficult periods.
5. Focus on profitability
Too many business owners measure the success of their business on top-line revenues rather than pre-tax profitability. Value is created through maximizing profit, not maximizing revenue growth-a $25 million company earning $5 million pre-tax is worth more than a $40 million company earning $2 million pre-tax.
Another common mistake is desire to limit profitability to limit taxes. While fast growing businesses often need the extra cash to fund growth, this approach loses money for business owners, as the focus becomes tax avoidance rather than operational efficiency and profit maximization.
There are legal ways to minimize your taxes through the use of an S-Corporation or LLC rather than a C-Corporation.
6. Prepare and execute a business plan
Establish operational and financial plans and goals for your business in one, three and five year increments and share them with your employees. The plans should take into account various economic, industry and company specific scenarios and how management would react to each.
In addition to creating a road map for your future growth, this will focus your business and your employees around quantifiable goals and will allow you to make better business decisions as you grow your business.
7. Seek the help of outside professional advisors
Seek the assistance of outside professionals, especially a full service accounting firm, who can provide valuable advice as you grow your business.
Not only can they provide objective counsel as you grow your business, they can help you avoid disastrous legal, financial and operational mistakes that may have significant financial consequences down the road.
Similarly, if you plan on selling your business or are approached by a buyer, an investment banker can ensure that you obtain the best possible transaction by re-stating your financials, preparing a memorandum that highlights the intrinsic value of your business (including off-balance sheet items) and quietly approaching other buyers to ensure a competitive process.
CBIZ Mergers & Acquisitions Group, Inc. (“CM&A”) is the investment-banking arm of CBIZ, Inc. (NYSE:CBZ). CM&A predominantly represents owners of businesses with revenues between $15-300 Million in mergers & acquisitions transactions. CM&A offers a comprehensive and customized approach and welcomes all inquiries, which are treated in confidence.
To learn more about valuing a company and other mergers and acquisitions information, and to learn more about Doug, visit the CBIZ Website.
©2009, CBIZ, Inc.