Not businesses are a success.
While there are many factors influencing whether or not a business will turn a profit, all successful businesses start with one thing in common – a good business idea.
Aspiring entrepreneurs often run in circles, trying to figure out whether or not their latest hare-brained startup inspiration is financially feasible.
Will the business model work? Will it turn a profit? Will customers support their new business? Is there any way to know whether or not their business idea will work before betting the farm?
Good news: Entrepreneurs have a framework for testing business idea feasibility without diving in head first.
Porter’s Five Forces
So back in the 70’s a Harvard professor named Michael Porter, published an interesting theory on business feasibility that became known as Porter’s Five Forces. In his attempt to create a formula of sorts that would help answer one of the preliminary questions of business planning – “Will my idea make money?”- he created a nifty little exercise that can be extremely helpful to entrepreneurs.
Porter’s Five Forces Analysis assesses the potential for profitability in an industry. With a little adaptation, it is also useful as a way of assessing the balance of power in more general business situations. While very useful in the planning stages of business, this analysis is not limited to strictly new business development.
Let’s take a look at the five forces:
- Supplier Power: The power of suppliers to drive up the prices of your inputs.
- Buyer Power: The power of your customers to drive down your prices.
- The Threat of Substitution: The extent to which different products and services can be used in place of your own.
- The Threat of New Entry: The ease with which new competitors can enter the market if they see that you are making good profits (and then drive your prices down).
- Competitive Rivalry: The strength of competition in the industry. Note: this force is the strongest of the five and is also influenced directly by the other four.
The Five Forces in the Real World
Let’s look at some applications:
How’s the threat of new entrants in say, a landscape company? High – there’s a very low cost of entry in this market so this force will be a challenge.
What about for a pharmacy? How’s the threat of new entrants in that highly regulated industry? Low. Why? Because it’s expensive, requires highly educated staff, and is tightly regulated.
See how two different business – landscape vs. pharmacy – can be uniquely affected by the different forces?
Not only is this analysis good for helping you decide the feasibility of going into a new business, but it can also help you identify potential challenges and give you some framework on how to overcome them.
Applying Porter’s Theory to Your Business
Once you’ve got a business in mind, you can use the analysis to guide you on what needs to happen so that you can “shift” the power in your favor.
Consider how Competitive Rivalry is lowest when differentiation – or niche markets of offerings – are present. If your business begins to experiencing the revenue-draining effects of high competitive rivalry, you can combat such downturns by upping your business’ specialized offerings.
By applying Porter’s Five Forces to your own business, you can not only craft a much more relevant business plan, but you can also troubleshoot when things – i.e., sales – go array.