Porter's 5 forces - how they work, 3 examples, and why it's better to be a thief ~ Sounds + Food 'n' Retail

Porters_five_forces.PNGThe five-forces model, as developed by Micheal E. Porter, illustrates the biggest factors that may enter into the strategic decision-making process. These are, on a vertical level, suppliers and customers, on a horizontal level, competition from products, new entrants (can also be vertical), and rivals.

To explain the horizontal/vertical, often when you talk of horizontal, you mean companies and products that are on the same level as you, competing for the attention of the same customers (and suppliers). Vertical relationships are those which a company depends on, either their relationship with suppliers or their relationship with customers. Each of these also operates on their own horizontal axis. The more powerful players on that level become, the more they can affect players on the other levels.

There are different levels of importance per force, depending on the context and type of the firm. When a company is more powerful horizontally, a market-leader, even a monopolist, it does not have to worry about suppliers as much, and is perhaps able, financially, to integrate vertically, taking over some of its suppliers and/or some of the middle-men that stand between the company and its customers. Vertical integration can be important when you want to control the supply chain for some reason, e.g. to increase the level of quality of your products. It can also become important if competition on your horizontal axis is threatening or may become so in the future.

3 examples
You can see this play out in a number of retail-situations. Apple, which is strictly focussed on design and marketing, outsources the manufacturing of most of its products, but is fairly vertically orientated towards the customer-side, doing most of its business in its retail-locations and online stores. Because of this concentration of power in the middle and proximity to the customer, it also has more power over its suppliers, able to make strong demands, and it's also better equipped to compete with horizontal players like HP or Sony, who are not as vertically integrated towards the consumer. The added benefit of a close customer-presence is also that you can use this as an opportunity to create customer-focussed products, something a lot of non-verticallly integrated players are not so good at.

Another fascinating company is Amazon, who spotted an opportunity to surpass brick & mortar stores, by becoming a distributor with a web-based store-front. Traditionally, the book-industry was organised as follows. A book gets printed, it then gets distributed, it then lands in a store, and then the customer buys it. Amazon integrated three of these functions: distribution, store, and customers (four, if you include ebooks into the formula). The end-result was that the customer became empowered: he could review books, even sell books second-hand. Which disempowered other stores where this was not possible, and publishers, who were before able to simply push out best-sellers downstream. Publishers are still powerful of course, essentially acting as a gatekeeper to writers, but this will change as soon as online publishing can be consumed comfortably.

A final example is Ikea, which is surprisingly similar to Amazon. It also started as a distributor, back in the day when a store-front was a newspaper-advert and phone-line. Ikea saved money, by working closely together with manufacturers in Poland, even building and buying machinery for them. The end-result were standardised designs, at low costs, and produced on a massive scale. It became close to the customer, by using its warehouses as store-fronts, and enabling customers to buy via catalogue and later via the web-site. Its competition was the traditional furniture store, conservative and producing designs that were both expensive and focussed on exclusivity (which translates to small-scale production). Because of this perceived strength, they were arrogant enough to not worry so much about prices on the vertical axis, both from their suppliers and for their customers. All of which could be exploited by some frugal and out-of-the-box thinking (a combo which fits surprisingly well together).

These are all three examples of durable goods. If you get into food however, even restaurants, the formula changes. But that is a story for another day.

Be a thief
Isn't 5-forces fun? I think so. So what can we learn from this? For one, that it's important to consider strategy on multiple axes. How will a business deal with its suppliers, its customers, its competition?

Also, it is actually a weakness to be too vertically or horizontally integrated, as that creates a certain arrogance and/or passivity towards how you deal with these parties. New entrants will eventually come, and probably on a different axis all-together. Being too integrated, means that the business has many dependancies, which will make it all that more slower to react to changes.

What I think always pays off, is to be close to customers. By constantly adjusting your strategy, so that the value proposition for customers is increased and personalised for them, you ensure a certain loyalty (which gives you time to change) and you can sense it sooner when their attention drifts towards other types of products.

A final thought. Business is very much an art-form and in art there is one great saying: "Good artists copy, great artist steal." The copying refers to that everything has been done to a degree. People have sold computers, books, furniture, and those products are clearly fulfilling a demand, which, for now, continues to exist. Where people can innovate is in creating new combinations of things. In other words, if you copy a competitor's business-model, you gain only the part of the market that does not already get served by the existing business-model.

If instead you steal the good parts from other business models, and create your own combinations of these good things, you can create greater value-propositions for customers than already exist. This applies just as much to combinations of five forces, as it does for anything else.


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