Michael Porter's 5 Forces on Entrepreneurship
Confession: before business school, I did not know who Michael Porter was and if you said anything about forces I would think about Star Wars.
While I still associate the force with Star Wars, I have grown to appreciate Porter’s Five Forces and use it as a framework with clients and how to view industries. For the uninitiated, Porter’s Five Forces is a tool for examining industries through five key elements. The magnitudinal effect of theses forces differ between industries and are important in order to understand competition along with recognizing how businesses evolve. The Five Forces are:
- Competition*: sometimes labeled as “competitive rivalry,” think of how competition impacts a market, for example, the soft drink market has incredible competitive rivalry as a global industry that requires a large sum of capital to compete compared to dry cleaners, yes there are national dry cleaners, yet in reality there are many competitors which creates a large amount of individual/local competition with smaller national competition. Essentially, the power of a local dry cleaner is low compared to the high influence of Coca-Cola or Pepsi.
- Potential of new entrants*: often referred to as “barriers to entry,” this is the force that determines the difficulty for an individual or company to start a business in a specific industry. A classic example is the airline industry which has high barriers to entry because of the amount of regulations that require compliance, the cost of aircraft, etc. Compare the airline industry to an individual web designer who simply needs an internet connection to enter the market.
- Power of suppliers*: some industries are highly dependent on suppliers who hold great power and can dramatically influence price and strategy. Our smartphones contain specific minerals and elements, if the price of these minerals increases, then the supplier would be able to charge more which would in turn cause prices in the smartphone industry to rise.
- Power of customers*: consumer purchasing patterns are a strong force in the open market. Customers have a greater amount of power when there are few customers in an industry compared to industries that rely on high-volume sales at low costs. Large big-box retailers will not lose much sleep if I am no longer a customer, yet in the the high-end market of designer jewelry, exotic cars, software, etc. a few customers switching to a competitor can make a large difference in a company’s bottom line, strategy, and future.
- Threats of substitutable products*: which products and services are you willing to substitute due to price, your loyalty, or convenience? I am an iPhone customer and will likely not change to Samsung as the substitution ramifications are more than I am willing to accept (loss of iMessage, shared contacts and photos with my wife, compatibility with Apple TV, etc.). On the other hand, when I fill my gas tank, the main decision for my choice is convenience. I have no loyalty to Chevron, Shell, or the Kroger near my home. Instead, I want to conveniently enter and exit the station. I am willing to substitute brands frequently like many others which impacts the power of the Gas Station industry.
With the introduction of Porter’s Five Forces in hand, the main point I want to make is the volatility of the entrepreneurship market, specifically freelancers and small business owners that specialize in digital arenas (web design, content marketing, digital advertising, graphic design, etc.). Porter can teach us about entrepreneurship as we examine barriers to entry which have never been lower for us digital types since it is possible to work with global clients from the comfort of a coffee shop. However, these low barriers to entry are causing competition to spike and an uncertain future for individuals and companies in countries with relatively high costs of living.
As an example, for Elisha Consulting, I focus on marketing strategy and execution (market research, analytics, design, and campaign execution). My barriers to entry were minuscule as I started my business in a matter of days thanks to an online legal service. I have worked with nearly a dozen companies and at one point had four contract workers, all in the matter of less than a year. My story is similar to others in that I moved into the digital industry quickly and with few obstacles.
However, I have uncovered a paradox which is explained by Porter’s Five Forces. I enjoyed a low barrier to entry as I have creative software, a fast internet connection, years of experience, and a supportive network which allowed me to easily start my business and acquire clients. Others have started their own freelancing career or business in the same fashion. We are the digital nomads who can work for anyone from anywhere. The low barriers to entry have impacted marketing firms and other traditional businesses as they have higher costs than many freelancers or small businesses which fuels competition.
While traditional businesses have felt the sting of the internet revolution for the past decade, now it is the Western freelancer and small business owner who is experiencing the threat of new entrants. There are multiple online websites that offer digital services for as low as $5; that deserves a pause, a company can have their corporate logo designed for $5 which they might use for the next decade, talk about a high return on investment. I, like many others, can not compete with a $5 competitor.
Interestingly, I have met with potential clients who lament these new low-cost competitors as they are taking away from their revenue and want me to develop and execute a marketing strategy to counter this movement. When I produce a scope of work with pricing, there is hesitancy, and some have ended up going with one of the low-cost competitors that they themselves are trying to market against - this is the paradox. Companies want to compete against the force of low barriers to entry yet they outsource their work to these same services that they want to challenge.
Do not take what I have written as a complaint, I have always been an observer of culture and am simply stating what many individuals and businesses are experiencing. We live in exciting times and Michael Porter appears to be correct again. By using his Five Forces we can help explain the disruption being felt in the digital marketplace.
Will traditional marketing agencies survive, will freelancers inherit the earth, will low-cost competition saturate the market with $5 solutions, or will something completely new like artificial intelligence create automated marketing campaigns? These are all interesting questions and will be answered in the near future, while the industry continues to change, we can still utilize the Five Forces to teach us about entrepreneurship and adapt to stay competitive.