Strategic Positioning & Competitive Advantage

For me, differentiation is about creating customer preference by having a clear message about what you do and for whom and what you don’t.

But this brings up an important issue.

Your differentiation can be shallow or deep.

What do I mean by that?

Well shallow differentiation is based on having a marketing message which is distinct and differentiated from your competitors and valued by your customers.

Deep differentiation goes further. It also has a distinct and differentiated marketing message but the differences between you and your competitors ripple through everything your business does so that the business delivers a unique customer experience.

Shallow differentiation has a clear promise, deep differentiation consistently delivers on that promise.

The difference is critical to your long term success since a promise kept creates satisfied customers who are eager to buy again. A broken promise leads to disappointment and a need to keep finding new customers.

It comes back to how you look at differentiation.

Shallow differentiation comes from seeing it as a marketing and sales issue – the responsibility of the Sales & Marketing Director or the Chief Marketing Officer and their staff. It’s a criticism I have of the USP concept created by Rosser Reeves.

Deep differentiation comes from seeing it as a general management issue where the responsibility belongs to business owner, the chief executive officer, the senior management team and everyone else in the business who has a responsibility to deliver on the promises made to customers.

In shallow differentiation you tell your customers.

In deep differentiation you tell your customers and your employees.

I shudder with horror when I read some blogs and see differentiation as one small topic in a list of marketing tactics.

How you differentiate your business is the key strategic decision in your business.

It’s not something to do quickly and think “I’ve done that. I can now cross it off my to do list and move on.”

Shallow differentiation can require some difficult decisions. For example, it’s often difficult to narrow your focus on a particular customer niche or specialisation since it means saying “no” to many opportunities.

Deep differentiation requires hard work. Yes that four-letter word you should never mention because it puts some people off.

But that’s good.

Differentiation is the source of competitive advantage which has the potential to lead to long term improved profitability.

But the key phase is “sustainable competitive advantage.”

The easier it is to copy, the sooner you are back in the undifferentiated world of commodity products and services.

Shallow differentiation is easy to copy. At its heart, it is just a marketing promise so it’s easy to see and easy to do.

Deep differentiation is hard to copy. It’s embedded in the activities, the routines, the skills and the culture of the business. The impact of deep differentiation is easy to see but it’s hard for a competitor to diagnose and even harder to copy. You only get deep differentiation if you go through a differentiation process.

Back to my original question…

Is your differentiation shallow or deep?

If on reflection you think it’s shallow, then you’ve got more work to do to make sure that the essence comes through in the business activities. If you don’t, then any differentiation advantage you have will be short-lived because your business is based on foundations of sand.

What do you think about the concept of shallow or deep differentiation?

It was Elmer Wheeler who famously said “Sell the sizzle, not the steak.”

Elmer Wheeler is the author of the fascinating book “Tested Sentences That Sell” which shows how fragile the buyer’s mind is and how one way of something encourages a buying decision and a slight variation is rejected.

Although I respect what Elmer Wheeler has to say, I want you to sell the sizzle and the steak.

Unfortunately the meaning of the original “sell the sizzle not the steak” phrase has been corrupted in a way that is damaging both to businesses and to the discipline of marketing.

What Elmer Wheeler meant by the phrase is that you should emphasise the biggest selling point in your proposition – the main reason why customers will want to buy.

In some ways he was encouraging people to move from promoting features to selling benefits. I have no problem with the idea that customers buy for the positive experiences and consequences they expect from owning or using the product. (Just don’t forget the features because they add credibility to the benefit and can become a buying attribute in themselves – ever bought a PC mainly because it has the latest chip from Intel?)

Unfortunately, the idea behind “sell the sizzle, not the steak” has been corrupted.

Too often it is taken to mean hyping up an ordinary product so that it sounds exciting.

That approach creates a brief illusion which may tempt a prospect to buy but it leads to disappointment in the ownership and use stages.

The exciting sounding product turns out to be ordinary and no better than the competitive product that was ignored at half the price.

It’s no surprise that the buyer gets angry.

Angry with the company that tricked him into wasting money.

And agree with himself for allowing himself to be conned.

The company suffers because there’s not going to be any repeat business and with the high costs of winning a customer, that’s where the big money is made.

And the buyer suffers because he gets cynical about marketing and the claims made by other businesses.

But there’s a better way.

Instead of trying to make the ordinary sound exciting, you could make the ordinary become extraordinary.

This is a much better way of doing business and it’s something I’ve written about before as deep differentiation (making the steak special) and shallow differentiation (making the steak sound special) – see Deep Differentiation.

Too often I believe that business owners and managers are wrongly encouraged to spend their time and attention trying to make their marketing message sound good and communicating it in 101 different ways.

Instead the focus should be on the underlying offer.

You can put lipstick on a pig but underneath it is still a pig.

But it’s much better to stop selling pigs.

So focus on the steak – and make sure it’s good, juicy, tender and tasty.

It would be nice to think that you don’t have to worry about the sizzle.

Sometimes you don’t.

Word of mouth recommendations from one enthusiastic buyer to another can be enough.

But often it isn’t.

So you still need a clear marketing message but this time it’s delivering promises that you can keep because you have made the ordinary extraordinary.

The Irresistible Promise is step 2 of my six step profit formula.

The Irresistible Promise Is An Update On The USP

Once you’ve found your starving crowd, you need to make it an offer that is compelling.

Mark Joyner calls it an Irresistible Offer.

Theory of Constraints call it a Mafia Offer (an offer you can’t refuse.)

Rosser Reeves called it a unique selling point or unique selling proposition.

I call it your Irresistible Promise.

Why The Irresistible Promise Is So Important

Customers and consumers are becoming increasingly sceptical about marketing as it becomes more outrageous to attract their attention and the hype gets stronger to try to persuade people to buy.

Your marketing message has to connect at both an emotional and logical level to move past the purchase tipping point but you don’t have to resort to hype and unrealistic offers.

• Customers in your target market should find your offer so distinctive and so attractive that it is virtually irresistible (assuming they’ve got the money.) I call this bullseye marketing.

• The closer what you offer matches what your market wants, need as and sees as an urgent priority, the greater the probability of making the sale. If you sell a commodity product that is identical or virtually identical to every other competitor, then you’re trapped in the possibly sector along with all your other competitors. If you sell a differentiated product, then some will know that what you offer doesn’t fit but for others you will step away from the competitors and move towards the centre of the bullseye and increase the probability of the prospective customer buying.
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• You see your marketing as a firm commitment to deliver on consistently and reliably. The Irresistible Promise is not based on shallow differentiation of a hyped up marketing promise that doesn’t run through your business system or value chain. You’re selling the steak and the sizzle.

My thinking on strategy is heavily influenced by Michael Porter and his classic book Competitive Advantage introduced the concept of the value chain analysis.

The value chain is an original Porter concept although he built on the idea of the business system from strategy consultants McKinsey and its main purpose is to help you to find, create or develop competitive advantages.

Image rights for value chain

Types of Competitive Advantage

Michael Porter argues that there are only two types of competitive advantage:

• competitive advantage that comes from differentiation – providing some kind of unique value to particular customers
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• competitive advantage that comes from having the cost leadership position

While it would be nice to have both, under normal conditions, the two forms of competitive advantage are mutually exclusive and, if businesses fail to choose, they get stuck in the middle.

Michael Porter believes that these competitive advantages derive from the activities the business does which are:

• done better than competitors;
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• done differently than competitors;
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• that create unique benefits; or
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• done at a lower cost than competitors.

To understand the source of competitive advantage then you need to perform a value chain analysis which identifies the separate value activities.

The Formal Elements of Value Chain Analysis

Porter built his value chain analysis model on a manufacturing business – back in 1985 there were many more around in the United States.

He split the value chain into two parts:

• Primary value activities
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• Support value activities

Primary value activities included:

• Inbound logistics
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• Operations
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• Outbound logistics
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• Marketing & sales
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• Customer service

Support value activities include:

• Procurement
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• Technology
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• Human resources
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• Firm infrastructure

This is a very general, helicopter view of a business and when you’re carrying out your value chain analysis you are supposed to go much more specific and detailed for your business.

You keep analysing activities which give a differentiation advantage (or have the potential to do so)  or disadvantage and which have a cost advantage or disadvantage.

The idea of value chain analysis is that you understand how your business compares with competitors at a detailed level. You can go into a lot of detail for your own business but you’ll be surprised at what you can learn about your competitors by talking to ex-employees (who may already work for you), suppliers, customers and being the customer yourself.

The value chain has been criticised as too prescriptive because the value chain elements don’t fit all types of businesses. This is missing the point entirely.

You don’t have to follow Michael Porter’s categorisation – and I suspect that he’d be astonished if you did – but if you want to understand the sources of your competitive advantages in terms of differentiation and cost, you do need to perform a value chain analysis which fits your business/industry.

It does take some thought and effort but that can be more of a reason to do it. Your lazy, superficial competitors either won’t understand the value chain or will look at what’s involved and think “That’s too difficult”.

Adapting Value Chain Analysis For Differentiation Or Cost Leadership

In his book Competitive Advantage (a must-read for any strategy professional), there are long chapters for how you can use value chain analysis to create cost or differentiation competitive advantages.

You’ll have guessed from the title of my blog, I’m not a huge fan of the cost leadership. That’s because I think there’s always someone who can come along and product whatever [product or service you sell a bit cheaper. For a cost leadership strategy to work, you have to have a significant cost differential which competitors recognise. Otherwise, you’re caught in a commodity trap selling an undifferentiated product at lower and lower prices.

But you can’t ignore costs if you follow the differentiation advantage path.

If your main differentiators are in marketing and customer service then you must keep a focus on costs in the logistics and operations activities and all the support activities. Your differentiation advantage only excuses you incurring extra costs in the activities which create a competitive advantage and only then if the advantage outweighs the extra costs.

How To Do Value Chain Analysis: Identify Your Value Activities

Use Michael Porter’s model if you find it helpful but otherwise create your own high level process map for your business which can also be used for your competitors.

Then drill down to identify the individual activities which create a differentiation advantage or which incur significant costs. Group minor activities together in categories like “other marketing activities”.

It helps if there are several people working on the value chain analysis. Functional specialists who know what’s happening and others who can provide an outsider’s perspective and ask the “dumb questions” which can challenge conventional wisdom and provide significant insight.

How To Do Value Chain Analysis: Allocate Costs To The Value Chain Activities

You can spend a lot of time trying to allocate costs precisely but it’s a false exercise.

It’s much better to be approximately right than precisely wrong.

Activities will incur some costs directly while other costs need to be apportioned based on various assumptions. Don’t confuse the two since you can draw very different conclusions if you change the underlying assumptions.

How To Do Value Chain Analysis: Identify Sources Of Differentiation Advantage

Differentiation comes from:

• the way individual activities are performed
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• the way related activities link together
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• the way the entire value chain is structured

I recommend you work both ways:

From your current or desired key success factors and differentiation factors through to your value activities in a deliberate challenge to see what you can do to support your differentiation advantages.

Then from your individual activities back out to your customers by asking “is there anything in the way we do this activity (or could do the activity) which creates special value for the customer?”

Differentiation & Your Customer’s Value Chain

You can learn a lot from applying value chain analysis to your own business and thinking through how all the parts fit together to support your customer value proposition.

You may get even more insights by looking at the value chain of your typical customer (or different groups of customers) and identifying ways that you can add value or reduce costs to their business by better understanding:

• What your customers are trying to do.
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• How they operate.
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• Their problems and frustrations.

Having a better understanding of your market and the customers who make it up is potentially a big competitive advantage since it lets you develop better products and to respond to changing needs faster than your competitors.

Is The Value Chain Analysis Only For Big Businesses?

No I don’t think so.

Small businesses are often simpler to understand so it means a value chain analysis can be put together quicker.

There’s no getting away from the idea that competitive advantages and disadvantages flow from the activities you do in your business but you can only understand them and how they link together by doing value chain analysis.

The Value Chain And The Six Step Profit Formula

I use a Six Step Profit Formula to help keep strategic management grounded in what can help you to increase profits in the short and long term.

The value chain is useful in a number of steps. In particular, it has a role to play in helping you to develop your irresistible promise and making sure that you deliver it consistently. It also helps you to think through how you continue to get revenue and profit from the relationship.

The Value Chain Is A Strategic Planning Model

The Value Chain is one of the frameworks included in my Strategic Planning Models guide.

Click the link to fined out what other models could help you to develop a winning business strategy.

What Do You Think About Value Chain Analysis?

Do you find Michael Porter’s ideas for value chain analysis a useful technique for creating competitive advantage, analysing the advantages of competitors and spotting opportunities for advantage?

I’d like to know what you think so please leave a comment.

In particular, do you believe that value chain analysis is a suitable technique for SMEs and businesses that don’t have strategic planning specialists.

I’m ending my look at Michael Porter’s Five Forces Analysis with a look at competitive rivalry, perhaps the most powerful and destructive of the five forces as competitors carelessly compete away any profits and even create price wars that cause long term damage to industry profitability.

Competitive Rivalry Or Rivalry Amongst Existing Firms

Michael Porter introduced the Five Forces model in his book Competitive Strategy and it has since become the standard way to examine the existing industry structure and how it might change in the foreseeable future.

It’s not a coincidence that Michael Porter placed competitive rivalry in the centre of his famous Five Forces diagram.

The 5 Levels of Competition

It’s easy to falls into the trap of thinking that all competition is bad but without competitors, you’ve got no one to look good against. It’s been established that it is easier to make a decision between A and B because the brain can compare and contrast than it is to decide to buy A on its own.

I recently wrote about the 5 Levels Of Business Competition which is an important framework for assessing the intensity of competitive rivalry and what you can do to move it in the right direction.

The Symptoms of Competitive Rivalry

Competitive rivalry become intense when one or more competitors either sees an opportunity to grow and acquire the customers of competitors or feels the need to attract more customers because of low profitability.

Industries where competitive rivalry is a major issue will usually have many competitors who are struggling to make an adequate return on investment so profitability will generally be low. A few competitors – those that have established competitive advantage – will make a treasonable profit but more many, intense competitive rivalry means a fight to break even and generate enough cash to survive.

Competitive rivalry intensifies through retaliation as competitors react to aggressive strategies with their own aggressive or defensive strategies.

This rivalry often comes through in terms of lower prices, as competitors use marginal costing to justify a contribution to overheads. However, competitive rivalry can also come through in advertising, product introductions and customer service battles.

Much of the competitive rivalry is damaging to long term profitability in the industry since it raises customer expectations of value for money although advertising can expand the market or establish differentiation through branding.

Richard D’Aveni came up with the term hypercompetition to describe situations where rivals fight hard against each other. The danger is that the firms head toward the model economists call perfect competition.

The Factors That Determine Competitive Rivalry

Competitive rivalry arises from a number of factors that work together to either give competing firms an incentive to try to break ranks or a vulnerability to the other Five Forces.

Moving from the growth to the maturity stage of the product life cycle and then into decline can increase rivalry. In the growth stage, firms get used to the business growing as more customers come into the market. However new demand eventually reaches saturation point and replacement demand isn’t sufficient to continue to provide growth opportunities. Firms will therefore look to grow through taking existing customers away from competitors.

It gets worse if the industry moves into the decline stage of the product life cycle or if the wider economy goes into recession, especially if the industry is cyclical and exaggerates the effect. Competitors will see their own sales volumes go down and in the absence of industry-wide  information, assume that their rivals are cutting prices.

High fixed costs, low variable costs and low capacity utilisation provide the economic rationale for trying to increase market share because a small increment of extra volume has a disproportionate effect on profitability. Unfortunately the reverse is also true, lost volumes in this situation has a significant downward impact on competitors’ profitability making a response the natural reaction. Price wars can develop very quickly and especially if competitors are manipulated by big customers into believing short term offers are bigger and more long term than they really are.

Competitive rivalry increases with commodity products and reduces if there is effective differentiation or switching costs. Customers have an incentive to stay loyal rather than shop around for the lowest prices.

Competitive rivalry is also a function of the competitors in the market. The most orderly markets tend to be where one has established a clear leadership position and the others are tucked in behind, taking advantage of the price umbrella established by the leader. These firms can coexist if they know their place in the market and stick to it.

However, if two or more firms are competing for market leadership and market share offers economies of scale and experience curve savings (see the Competitive Advantage matrix) then rivalry intensifies. It gets worse if competitors don’t understand each other and find it difficult to interpret the intentions of each other because of different goals. Competitors from different countries and cultures can make the existing firms particularly sensitive because of fears over low-cost competition.

Competition makes it difficult for the weak firms to make a profit. It’s therefore important that the loss-making firms can exit the market easily. If there are high exit barriers, then competition increases in a desperate fight for survival.

Using The Generic Strategies To Defend Against The Damage Done By Competitive Rivalry

Michael Porter’s generic strategies offer a way out of the worst damage from competitive rivalry.

If the business is differentiated, then it effectively creates its own private market, insulated to some extent from what’s happening in the wider market. The business can’t be complacent because big changes will cause the customer value line to shift, making established positions uncompetitive without a response to improve customer value or reduce price.

If the business genuinely has a substantial cost advantage, it can afford to sell at prices that will make its competitors weep. A strong short term argument can be made for pricing based on marginal costs with its contribution to overheads but it makes no sense for any competitor to go below marginal cost unless it is desperate for cash to stave off imminent bankruptcy.

It is the businesses that are stuck in the middle that have the most strategic threat if rivalry increases.

Other Articles On The Five Forces

Michael Porter has developed the standard way to look at industry analysis with the Five Forces model.

If you are new to it and you want to understand how the forces interact, you should read the other articles:

Five Forces Analysis

Barriers To Entry & The Threat Of New Entrants

Bargaining Power Of Buyers

Bargaining Power Of Suppliers

Threat of Substitutes

Have You Experienced The Damage Done By Intense Competitive Rivalry?

Has your business been caught in a price war or other competitive battle which seriously eroded profits. I’d like to hear the story so please leave a comment.

I’ve seen several.

The first was a company I worked for when the recession of 1990/91 was the trigger to shift us from co-existence to conflict. WE were caught in the classic profit squeeze of falling sales volumes, price cuts and lower productivity as the hourly paid workers tried to stretch their work out to fill the week. Profits fell from £100k or more a month to a £30k loss in three months and whilst the business was restored to profit, margins never returned to the old levels.

The second was a client I started working with after the damage was done. They couldn’t understand why their accounts showed losses every month but investigation into their price changes showed that competitive rivalry from the main competitor changing its value chain by outsourcing inefficient operations had forced them to slash prices beyond a level that was sensibly economically.

One of the most popular tools in business planning and strategic planning is SWOT Analysis.

What is SWOT Analysis?

SWOT stands for:

• Strengths – factors that are good in the business now
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• Weaknesses – factors that are bad in the business now
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• Opportunities – factors that could be good in the future
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• Threats – factors that could be bad in the future

Image from Jean-Louis Zimmermann

The SWOT Analysis lets you summarise a business strategy and the major issues so that it can be understood quickly and simply. A SWOT matrix – it is usually presented in four sections – is therefore a common element in business plans prepared for bank managers and other financial providers.

According to Wikipedia the SWOT analysis was developed by Albert Humphrey at Stanford University in the 1960s.

SWOT Analysis is a relative tool:

• There must be an overall goal or objective to base the SWOT assessments. Opportunities are things that help you to reach the goal, threats are things that may stop you reaching the goal. As the goal changes, the assessment of the SWOT elements changes.
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• Strengths and weaknesses are relative to competitors. Let’s jump from business to athletics for a moment. Anyone running in the 100 metres sprint in the Olympics is going to be very fast by normal standards but some runners will have explosive starts and others will finish very quickly. It’s the same in business so don’t confuse qualifying criteria which are necessary to play the game with winning criteria.

What Is TOWS Analysis?

Sometimes the SWOT acronym is changed around to be TOWS – Threats, Opportunities, Weaknesses and Strengths.

Inevitably these are very similar but the emphasis is different.

Strengths and weaknesses focus on the internal aspects of the business while opportunities and threats refer to the external environment.

SWOT Analysis therefore leads with the emphasis on the internal aspects of the business and how they can relate to the external.

TOWS Analysis leads with consideration of the external issues and how they can be influenced or mitigated by the internal issues.

When To Use SWOT Analysis Instead Of TOWS Analysis

Different strategy consultants will prefer one approach rather than the other while others may be flexible and say the use of SWOT or TOWS analysis depends on issues facing the business.

If the external environment is considered fairly certain, then it makes sense to lead with the internal analysis of strengths and weaknesses.

If the external environment is rocky and with high government debts, austerity measures, the potential collapse of the Euro and the knock-on effect of a banking crisis, then it may make more sense in 2011 to lead with the big external issues and identify the major threats and opportunities.

The Importance Of SWOT Analysis

A SWOT Analysis is important for both the person doing the strategic business planning and for anyone reading the business plan and thinking about investing money or time in the business.

For the business manager who is preparing the strategy or the business plan, SWOT analysis helps to avoid a positive bias. An entrepreneur can get excited about an idea and fall into the trap of focusing on the opportunity and the available strengths.

There are important and it is important to play to your strengths but people often fail to implement their business plans because they don’t stop to consider what could go wrong. How weaknesses can prove to be critical and if the gap is closed, then the plan hits a brick wall. Or how external threats can come along and change expectations of the future.

For the reader of the business plan, the SWOT analysis has two important features:

1. It provides evidence that the business owner has considered the upsides and downsides and may identify a few issues that the investor wasn’t aware of.
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2. Inevitably the reader of the business plan will be having ideas and may be preparing a SWOT analysis as he or she reads through the plan. Comparing the two versions of the SWOT analysis and finding a lot of common ground can give confidence in other aspects of the plan. Divergence may reveal that the business owner hasn’t given the plan as much attention as it deserves.

Every SWOT analysis is different.

Two businesses in the same industry may have similar goals but very different strengths and weaknesses which could impact on the assessment of the external opportunities or threats.

The same business may consider two different big strategic goals and do a SWOT analysis for each. There are likely to be some common factors to each but there will also be significant differences because particular SWOT elements are relevant or irrelevant to different goals.

Advantages Of SWOT Analysis

The advantages of doing a SWOT Analysis are:

• It is relatively simple to start although it often needs challenging and refining to produce something of value.
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• Preparing a SWOT analysis is a collaborative exercise and helps to get other management team members involved because it looks across the entire business. Operations people can feel left out when talking about customers and marketing needs but SWOT brings the issues together.
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• It’s a strategic planning tool that is relevant to small businesses and huge organisations and they can both get something out of thinking about strengths, weaknesses, opportunities and threats.
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• SWOT is very flexible and can be done for a business or even an individual thinking about changing jobs.
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• It is a great way to combine and present insights from the various other strategy tools and models available like the Five Forces, versions of PEST analysis and the Competitive Advantage Matrix.

Disadvantages Of SWOT Analysis

The disadvantages of doing a SWOT Analysis are:

•  Doing a SWOT Analysis is not the beginning and end of the strategic planning work. Some people place too much emphasis on it but it is only one tool or common framework.
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• SWOT Analysis has almost become too familiar and therefore isn’t given the rigorous thought it deserves.
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• It can become a box filling exercise. The SWOT template has spaces for 6 of each so you get 6 of each meaning some categories are forced and others ignore potentially important issues.
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• Strengths and weaknesses are often listed as absolutes rather than relative to the competition. I remember one business wanted to export more and listed as a strength that the sales team were learning German which was seen as a potentially big market – but the business would have been competing against German suppliers.
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• The SWOT analysis is subjective – it is based on opinions and not facts.
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• Complicated situations have to be simplified to be included with the SWOT analysis and interrelationships may be lost.
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• Prioritisations of opportunities and threats are often unclear. Expectations are a combination of probability and pay-off/potential cost.

How Not To Do A SWOT Analysis

I have seen some lists of strengths, weaknesses, opportunities and threats where it appears that you go through and cross out the ones that don’t apply and the one’s that you’re left with is your SWOT analysis.

Do not do it like this. Remember GIGO – garbage in, garbage out.

If you’re going to do a SWOT analysis, take the time and effort to think through your business and what’s really happening now and what may happen in the future. It’s the only way you’ll find insight which will help you to make better decisions in your business.

How To Do A SWOT Analysis

A SWOT analysis can be a very simple starting point for strategic planning or it can be part of the end results of a much more elaborate strategic planning process.

It can also be done by one person as a briefing for a management meeting to kick-start discussions or it can be prepared as a group brainstorming session to get the management team involved.

1. Start your SWOT analysis by getting clear on your goal and time-scale – for example you could start your SWOT analysis with the challenging objective of “doubling profits within the next year” or “selling $ 1million of exports to the United States in the next six months”.
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   The issues involved with those two different goals are very different and will colour your thinking. The longer the time-scale, the greater the uncertainties that come from the external environment. It’s relatively easy to think 6 to 12 months ahead but much more difficult to think 5 to 10 years into the future.
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2. Decide if you are going to do a SWOT analysis or TOWS analysis depending on whether you think the bigger issues are inside or outside your business. I’m going to assume you stick with SWOT and follow the traditional sequence of strengths, weaknesses, opportunities and threats.
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3. Identify your strengths. I recommend you start off by listing general strengths about the business including special skills and capabilities, resources including people, brands, machinery, money, contacts and relationships.
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   Do a reality check when you’ve got a provisional list of strengths.Are they relevant to the goal you’ve set? If not take them off the list because they are clutter. Yes it’s nice to have a long list of strengths and it may make you feel good if you list more strengths than weaknesses but if any don’t apply, cross them off.
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   Are they a relative strength compared with competitors who may be trying to achieve the same goal. Sometimes strengths fight strengths e.g. relative buying power of two businesses may give one a cost advantage, other times strengths fight against weaknesses.
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4. Identify your weaknesses relative to the goal. What could stop you from achieving it that’s a factor inside your business. This time it might be a lack of skills and capabilities, resources including people, brands, equipment, money, contacts and relationships.
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   Threats may include an over-reliance on one or two key people. If anything were to happen to them (and it may include you) then your plans may be in disarray.
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5. Switch from looking inside the firm and look outside. It can be useful to run through Michael Porter Five Forces model of industry analysis and wider environmental scanning like PEST (Political, Economic, Social, Technological) which are combined in the SKEPTIC environmental scanning model.
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   Some external forces nag away at managers as a constant source of concern and they don’t need any help to identify them but others, potential just as big but not as tangible today need some coaxing out of minds onto paper.
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6. Identify the positive forces and opportunities which may help you to reach your goal. These may include a rapidly growing market, changing customer tastes in favour of your product, general economic prosperity, favourable exchange rate movements which are particularly important if you are exporting/importing while your competitors are domestically based.
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7. Identify the negative forces and threats in the external environment which may stop you from reaching your goal. Threats and opportunities can be prioritised by assessing the probability of them happening and their likely impact. The tsunami and nuclear power problems happened in Japan earlier in 2011 and were devastating but the threat had existed for many years. Then consider grading from 1 to 5 or high, medium and low to help you to prioritise and keep the SWOT matrix focused on the big issues.

Practical Tips When Preparing Your SWOT Analysis

Sometimes you’ll look at a particular issue and think it could be a strength or a weakness, or an opportunity or a threat. If it’s minor, ignore but if it could be a big issue, split it into two aspects and list as both

e.g. strategic issue – technology is very close to allowing the super widget to be created.

Opportunity – being first to market with a reliable super widget will create a huge buzz inside and outside the company.

Threat – competitor A is working on a super widget prototype and, if it works, prices are normal widgets could fall sharply.

When looking at your products or services for strengths and weaknesses, try to see through the eyes of customer. We all have a tendency to fall in love with our own products so use customer feedback from surveys,  complaints and informal discussions.

Try not to be overly critical or positive. I’ve seen SWOT matrices where it is clear there is positive or negative bias.

Don’t try to create equal numbers just for the sake of making the chart look sensible but if it looks unbalanced, have a think about the other squares. How is your business performing? If it is doing well, especially when compared with competitors, then it’s likely you have more strengths. If is is struggling while competitors are prospering, then you have weaknesses.

Using A SWOT Analysis

There are two elements to SWOT analysis:

1. Putting the matrix together
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2. Drawing conclusions that influence decisions and actions

Get a view on your strategic position compared to competitors. Is it strong, average or poor? Does the future look full of promise or can you expect things to be difficult over the next few years?

The SWOT Analysis gains much more power when you use the internal logic to help you to think about strategic options rather than just using the SWOT matrix to summarise what you intend to do. That is, you can start looking at the dependencies between strengths, weaknesses, opportunities and threats.

There are four options within the SWOT analysis matrix:

• Strengths & Opportunities – how you can use the strengths within your business to take advantage of opportunities in the external environment – this is an offensive strategy where you are taking the imitative and making good things happen.
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• Strengths & Threats – how you can use your internal strengths to make sure that external threats don’t cause severe impacts on your business. Like much of SWOT thinking, this is relative to competitors and “forewarned is forearmed” is an effective way to think about these issues.
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• Weaknesses & Opportunities – what you can do to stop existing internal weaknesses affecting your ability to take advantage of opportunities.
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• Weaknesses & Threats – what you can do to stop internal weaknesses compounding with external threats – for example you may believe that you have a higher break even level than competitors and if you sense difficult times ahead, you can take action now to reduce your fixed costs or improve contribution margins.

SWOT Analysis Template

You can search on the internet for a SWOT analysis template but really there is nothing to it.

If you go into Word and create a 2 x 2 table and head up the top two columns Strengths and Weaknesses and the bottom two columns Opportunities and Threats and then click on the order list or bullet points for each table cell, you have built your own SWOT template. These have the advantage that provided you are brief, you can get the entire SWOT matrix on one page.

For TOWS analysis you just reverse.

You don’t have to follow the 2 x 2 matrix format so you can create a 1 column 4 row table instead and give more details. This allows you to capture more fully your thoughts and issues on the individual strengths, weaknesses, opportunities and threats but you lose the advantage of seeing the entire SWOT analysis on one page.

Some business planning software has a SWOT analysis template included.

SWOT Analysis & Differentiation

If your business has been following a differentiation strategy and you have established a clear gap between you and your competitors, then strengths may include:

• Customer loyalty & high levels of satisfaction
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• Strong brand and reputation – the business name means something
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• Ability to charge a price premium and make higher profit margins
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• Patents that stop competitors imitator key parts of the product

Weaknesses may include:

• Higher costs
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• Lost competitiveness on one customer value criteria you believe is important because a competitor has innovated in a way that you didn’t expect.

Opportunities may include:

• Strengthening the differentiation advantage
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• Taking those advantages and expanding into new markets.

Threats may include:

• Changes in customers needs, wants and tastes -these will change the appeal of customer value attributes and their relative importance.
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• Losing focus on the key differentiators by trying to broaden customer appeal too much.

SWOT Analysis Examples

I believe very strong that your SWOT analysis should be different from in some respects to your closest competitors and I’m wary of using SWOT proforma checklists and ticking off those that apply.

However if you search the Internet, you will find plenty of SWOT examples all the way down to individual businesses (for business student questions like “What are the important factors a SWOT analysis for Google will show?”) and for trade and industry sectors like restaurants, hotels and retailers.

You can use these SWOT examples in two ways:

1. To get you started – sometimes it is tough starting with a blank piece of paper or your SWOT template although some SWOT issues are usually very clear.
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2. To help you to review what you’ve included in your SWOT analysis. This is particularly true if you are preparing your SWOT matrix without doing the strategic analysis from the Five Forces, PEST and customer value analysis.

Feedback On My SWOT Analysis page

Have you found my summary of SWOT analysis helpful?

What points would you emphasise about doing a SWOT matrix?

Let me know please by leaving a comment.

The threat of substitutes is an important element in the Five Forces Analysis model introduced by Michael Porter in his book Competitive Strategy.

The issue of the threat of substitutes is always a factor which limits the profit potential of a market.

In times of economic difficulties, the threat accelerates sharply but it also represents an opportunity to help lure new customers into your market as customers priorities, needs and wants change.

Other Articles On Industry Analysis and the Five Forces Model

This article on the threat of substitutes can be read in isolation but if you are not familiar with Michael Porter’s Five Forces model, it will help to read Porter’s Five Forces first and then later read about the other forces that influence industry profitability.

Threat of New Entrants

Bargaining Power Of Buyers

Bargaining Power Of Suppliers

Threat of Competitive Rivalry

What Is The Threat of Substitutes?

The threat of substitutes force recognises that every customer has a choice when they buy which is not limited to the same industry or market.

There are different ways to satisfy a particular need. See What Are You Doing On Saturday Night.

Substitutes Offer Customers the Choice Of How To Solve A Problem

If I want to travel from my home in Birmingham to Paris, I can:

• Drive (including the Channel Tunnel);
• Travel by train;
• Fly.

The airlines that fly from Birmingham are not just competing between British Airways, Air France and BMI Baby. They must recognise that I have substitute solutions to meet my desire to travel to Paris.

This threat of substitutes (driving or train) places restrictions on what the airlines have to offer to convince me that flying is the best solution. The customer value attribute map or what Blue Ocean Strategy calls the strategy canvas is a useful way to look across the dimensions of customer value to show the advantages and disadvantages of substitutes from the customer’s perspective.

The Threat of Substitutes Increases In A Recession

Takeaway restaurants have seen a migration of customers in the recession and open up opportunities for businesses like Housebites.

The threat of substitutes can impact your business both ways and, if you owned a takeaway business, you need to have marketing strategies to tempt people away from restaurants and defend against the threat of the ready meals.

For example to tempt regular restaurant trade to the substitute takeaway service, a takeaway business could emphasise the quality of the food and give tips on how you can turn your Chinese takeaway into a romantic event at home or into a party night with a small group of friends.

To protect against the threat of substitution from ready meals, the takeaway business would again emphasise quality, introduce a delivery service (it is what stops me buying fish and chips compared to Indian, Chinese, pizza etc) and have a regular buyer reward scheme e.g. buy on four occasions and get the fifth free (with some kind of value limit).

Threat of Substitutes: The Theory

Let’s take a look at how Michael Porter explained the threat of substitutes in his Five Forces Model.

The main issue is that the existence of substitute products and services place a ceiling on the price a market and companies with the market can sustain.

Going back to the takeaway food example, the closer the price the cost of the takeaway gets to the price of a restaurant meal, the less threat it is as a substitute solution.

The key issues on the threat of substitutes are:

• The willingness of customers to switch across different products (which is often a factor of how easy it is to compare and contrast the different offerings); and
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• The relative price/value offered by the different substitutes.

If we return to my example of getting to Paris for a weekend break, what I want is to travel easily, quickly and cheaply so that I have most opportunity to enjoy my time in Paris.

A cheap flight going out early Friday morning and returning late afternoon on Sunday is ideal but what if I can’t fly out until 4:00pm on the Friday?

That writes off Friday as a holiday and if combined with a forced early flight back on Sunday, it means I’m paying for the flight and two nights in Paris for the pleasure of having effectively one full day to relax and have a good time.

That could make other methods of transport attractive, especially if I lived near the south coast of England and if I have the belief that Airlines Suck (an interesting perspective on the difference between customer satisfaction and  customer value.)

Alternatively the flight times could tempt me to look at flying to Paris from a substitute airport or could get me thinking about substituting Paris for Rome, Florence, Prague or any of the other great cities in Europe. What I really want is a lovely weekend break.

The comparisons are difficult. I’m not comparing like with like and that’s why the desire to switch is so important. If I really want to go to Paris for a special reason, my potential substitutes narrow to how I can get there in ways that maximise my time in Paris and minimise the pain of the journey.

Differentiation And The Threat of Substitution

Effective differentiation will create buyer preference within a product category because it helps one product stand out as a bullseye match between what it offers and what the customer wants.

A product that has very strong differentiation will turn competitors’ products into possible substitutes rather than direct alternatives. The threat doesn’t go away entirely but it is reduced.

Substitutes and Customer Value

Customers want value for money and because this is a ratio, it can get better if:

• The value or benefits you receive as a customer increase.

• The price you pay reduces.

Value for money gets worse when the value reduces or the price increases.

The relative customer value between different substitutes can change because of changes in one alternative rather than the other which is why it’s important to watch what’s happening in the substitute markets.

Even with the Euro crisis, the UK has seen the value of sterling fall against the Euro, making the Christmas shopping trip to Paris a lot less attractive than in the last couple of years. The thrill of the experience of visiting Paris hasn’t changed but the price has in sterling terms.

Other times, it is the value that changes between substitutes. Some products can make fast incremental or breakthrough changes in performance which shift the relative appeal of the products and increase the threat of substitution.

Analysing The Threat Of Substitutes

Step 1  of assessing the threat from substitutes is very much seeing your business as competing within a market and also within a wider generic solution market.

Too often business managers are focused on their direct competitors and miss what’s happening in substitute markets until sales volumes are disappearing quickly.

What problems do your products or services solve? Make a list.

Then identify how else a customer can potentially solve these problems. What substitutes will the customer consider as viable alternatives?

Then start looking at each substitute so you understand the appeal.

• What benefits does the substitute provide compared to you?
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• What price point is it at?
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• What is the weakness of the substitute? What constraints or limitations does it impose on a customer?
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• Why would a customer switch between substitutes?
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• What barriers are there to stop customers switching?
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• What trends are there is the substitute markets? Where is customer value being gained or lost? What can cause sudden changes in price?

When you have the basic information, you can then start to look at building strategies to either defend against the threat of substitutes or to attract customers from another substitute market.

How can you tilt the value for money comparison in your favour by increasing the perceived value or reducing the perceived price?

How can you:

1. Identify potential switchers from a substitute market?
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2. Communicate and educate about your offerings?
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3. Tempting them into wanting to make a trial purchase?
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4. Provide reassurance against any fears of switching?
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5. Retain their customer loyalty?

A lot of this is good marketing but it is aimed at encouraging customers of substitutes to switch to a different product and when they do, to choose you.

Conclusion on the Threat of Substitutes

I have tried to show that substitution between products and services is both an opportunity and a threat and therefore can appear on both sides of your SWOT analysis.

If you don’t recognise the existence of substitutes, you won’t put in place the right defensive strategies to keep some of your current customers and you won’t follow offensive strategies to attract new customers to you.

If you want to know more about Michael Porter and his Five Forces model, his Competitive Strategy book is rightly considered a classic.

The bargaining power of buyers or customers is one of the five forces that determine industry profitability in Michael Porter‘s Five Forces Analysis model explained in his book Competitive Strategy.

The basic idea is that by using their  bargaining power as a powerful buyer, some customers can capture a high proportion of the value you create for them by forcing down your selling prices and increasing your costs to serve them.

This applies to both business to business transactions and business t o consumer although it’s usually a more powerful force in B2B because of the size of the deals.

Introduction To The Bargaining Power Of Buyers And Customers

This is the third article focused on Michael Porter’s Five Forces model for Industry Analysis:

Introduction To Five Forces Analysis

The Threat of New Entrants

The other forces are:

Bargaining Power Of Suppliers

Threat Of Substitutes

Threat Of Competitive Rivalry

This focuses on how buyers can use bargaining power to reduce the profits of a business and what the business can do to resist.

Negotiations With Buyers – Win-Win or Win-Lose?

There are two elements to any negotiation between a buyer and a seller:

1. How can you add value to my business?
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2. What price will you charge?

The first is collaborative. The customer wants the supplier to add as much value as possible and the supplier wants to establish the existence of benefits which create a competitive advantage over the competition.

When it comes to price, any reduction the buyer negotiate with a supplier transfers profit from the supplier to the buyer.

In a commodity business where there is little or no differentiation, little time is spent of the first question because buyer preference is won on price. A stronger buyer will negotiate hard on the customer value elements and then claim that the produce /  service combination is close to what’s available from competitors so a deal is possible if “the price is right.”

How well each party performs in he negotiations will depend on individual negotiation skills of the buyer and sales-person and the industry structure which usually biases the negotiating power one way or another.

Two Major Factors Determine Relative Bargaining Power Of Buyers

1. The price sensitivity of the customer to paying a high or low price.
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2. The relative bargaining power that comes from a readiness to walk away from any deal and go elsewhere.

Price Sensitivity And Its Impact On the Bargaining Power Of The Buyer

Buyers will be more willing to switch from one supplier to another to get a lower price if:

1. The product is important to the buyer because it represents a high proportion of costs but there is little difference in the products from one supplier or another. The buyer knows that the product can be bought from somewhere but doesn’t particularly care where, provided the price is the lowest.
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2. The buyer will be much more sensitive to price if the buyer and its industry is under competitive pressure in its own market and has to fight for every drop of profit. Good times economically can protect suppliers from the excessive use of the bargaining power of buyers but as markets get tougher (see PEST Analysis) pressure to reduce prices will increase as buyers try to compensate for profit lost in its market. This can be a major threat which should be on your SWOT analysis.

The Ability To Walk Away And Its Impact On The Bargaining Power Of Buyers?

The second factor that determines whether buyers or sellers capture the majority of the profit from a transaction is the bargaining power that comes from the knowledge you can walk away from any deal you don’t like.

It’s a wonderful position to be in

If you are a seller and the business is performing well, it is important to keep reminding yourself that you always have a choice. You don’t have to accept any deal the supplier proposes, only the deals that are profitable.

Michael Porter’s Five Forces model says that the buyer has the advantage in bargaining power if:

1. The buyer is large and the supplier is small. This suggests that the deal is more important to the supplier.
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2. There are few buyers and many suppliers. The buyer has the choice of many suppliers to play off against each other but the supplier knows that to achieve good sales volumes, at least one of the small number of large accounts needs to be captured.
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3. The buyer knows the undifferentiated product very well and has no problem comparing goods and prices from different suppliers. Buying apples v apples and dominating the price negotiation is easy. It gets much more difficult to compare apples with oranges and feel confident that the deal is right for you.
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4. The buyer does not incur any penalties or other switching costs from moving its purchases from one supplier to another.
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5. The buyer can make a credible threat to enter the suppliers industry and provide its own supplies of the product unless the price is very low while the supplier cannot move into their customers market safely. This issue of vertical integration forward and back is a big topic which I will be covering in future business strategy articles.
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6. There are substitutes available from another a related industry and supplies are readily available.

Can you see how some of these factors apply to your relationships with your customers and hinder your negotiations?

The Bargaining Power Of Buyers May Not Just Be Price Pressure

It is easy to fall into the trap of thinking that the bargaining power of a buyer is focused on getting the best price and often it is.

Sometimes a strong buyer will insist on extra service requirements (next day delivery at no cost) or a favourable financial arrangement (extended credit terms or consignment stock) which increases the costs to service and makes that customer less profitable to the supplier.

How To Protect Your Business From The Bargaining Power Of Buyers

Chapter 6 of Michael Porter’s book Competitive Strategy is titled Strategy Towards Buyers and Suppliers and looks in detail at the bargaining power of buyers.

You can reduce the bargaining power of buyers through strategy although you may not like some implications.

1. You can differentiate your products or services. If a buyer wants what you sell but cannot get it from someone else, then the power relationship shifts in your favour. Although a professional buyer will try to knock down your prices and get the best deal, you may have a stronger position that you think. It is a common problem in negotiating to think that the other party has the stronger bargaining power because you want the business.
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2. You can also use the other generic strategy, cost leadership to protect your profits. Competitors who behave rationally can only go to a certain price before they lose money. Irrational competitors who lose money on each transactions won’t be survive for long.
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3. You can target the less price sensitive buyers and buyers where the costs to serve are less. If you don’t have a differentiation or cost advantage, then the high volume customers may not be right for you. The sales volumes may look good but margins will be small and you will be better filling your capacity with business from smaller customers.
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4. Understand your product or service costs and be ready to walk away from any deal that is wrong. If you don’t have a walk away price, the buyer will know that he or she can keep pushing to extract more price reductions. Understand the cost implications of the extras that a powerful buyer will ask for and where you or they have a cost advantage. I worked with a client who came under pressure to concede on extended terms and foreign exchange risks when it would have cost the buyer much less to put those aspects into place.
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5. Make sure you’re not trying to sell an over-engineered or r-specified solution. Different buyers want different things and if you’re selling something with features or benefits that the buyer doesn’t appreciate then you’re incurring costs to provide something that the buying won’t pay for. Have a low-priced base offering and add extras to it that the buyer does want.
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6. To fight back against the bargaining power of buyers who are highly concentrated, a firm can consolidate its part of the industry value chain.

How To Choose Buyers Who Won’t Use Their Bargaining Power

Factors to look out for when looking for buyers who are not sensitive to price and therefore less likely to use their bargaining power include:

• Buyers for whom the cost of the purchase is small relative to the rest of the business – who cares about the cost of paper clips when time is limited and there are more important things to do.
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• Where the penalty for product failure is high – sometimes quality and reliability is much more important than price.
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• The product will be an important part of the supplier’s product because it is a de facto standard – PC assemblers risk being excluded from consideration by their customers if they don’t use Windows and Intel microprocessors.
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• The buyer wants a custom designed product and there are few suppliers with the capabilities to deliver to the right standard.
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• The buyer is very profitable and is in a powerful position with its customers and can pass on cost increases easily.
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• The buyer is poorly informed about the market.

Conclusion on The Bargaining Power Of Buyers

Powerful buyers represent a serious threat to the profitability of individual firms and all the firms in the industry.

Careful strategy can help you to reduce the damaging effects of the bargaining power of buyers.

Today we will look at how you can use barriers to entry to reduce the threat of new entrants into your market.

The threat of new entrants is one of the forces in Michael Porter’s Five Forces model of industry analysis.

This threat applies to any business of any size, big or small.

It can be particularly damaging if your market is a fixed size and suddenly you find that you have to share it with a competitor who has decided that they see an opportunity.

A simple example is if you own the only shoe shop in a small town selling shoes and boots for men, women and children. The demand and supply balance is in your favour until another entrepreneur opens up a women’s shoe shop with the latest, fashionable designs.

Why New Entrants Will Be Attracted To A Market?

Any indication that a market is growing, that it is under-served in meeting customers specific needs or particularly profitable will trigger interest from an entrepreneur who believes that there is money to be made from taking part in your market.

Evidence that existing businesses are making good profits will persuade entrepreneurs that this as an opportunity too good to miss.

So before you order a second Porsche for your wife (or husband) and move into a ten bedroom mansion, you need to think what these signs of success are saying to potential competitors.

Barriers To Entry Make It More Difficult For New Entrants And Reduce The Threat Of Entry

To discourage new firms entering your market and competing for your customers and profits, you need to have barriers to entry in place as a defensive strategy.

Without them, potential rivals are free to entry the market whenever they want.

The Common Barriers To Entry

Common barriers to entry include:

1. Entrants must make a big financial investment to buy equipment, in research and development, in stocks / inventory or to build a brand.
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2. Established firms have cost advantages unavailable to new entrants
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3. There are supply restrictions, either from incoming  materials from suppliers or outgoing to customers which make it more difficult for new entrants to become established
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4. High customer loyalty from buyers makes it much harder for new entrants to attract customers or even low cost trials
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5. Legal barriers and patents
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6. Threat of retaliation from existing competitors

A More Detailed Look At How Barriers To Entry Can Be Used To Reduce The Threat Of New Entrants

Financial Investment As A Barrier To Entry

Some industries require a large financial investment before a new business can start which creates a financial barrier and psychological barrier to entry.

Investments may be in:

• Plant & equipment
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• Lease commitments for buildings – even though the financial commitment isn’t paid upfront, landlords may want guarantees
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• Research and/or development
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• Inventory

This introduces doubt into the minds of the prospective entrepreneur and any financial backers.

Some potential competitors won’t be able to raise the funds and others won’t be prepared to risk so much on a new venture which may not succeed.

Other industries require virtually no financial investment which makes entry into those markets look very attractive for any cash-poor entrepreneur. These businesses need rely on other barriers to entry.

Cost Advantages As A Barrier To Entry

Businesses enter new markets because they expect to earn a profit – i.e. that revenues will exceed costs. If the new entrant isn’t cost competitive with existing companies, then it is clear that a profitable opportunity doesn’t exist.

Cost advantages can come from three main sources:

1. Economies of scale – the bigger the business, the lower the average unit costs. For more details see economies of scale.
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2. The experience curve – the more you perform an activity, the more opportunity you have for finding the best ways to do it for the least cost.
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3. Low cost input prices, either from a favourable location e.g. a lower wage economy or long term supply contracts at very good prices.

These factors naturally favour the existing companies in the market although increased globalisation is opening up many markets to competition from the lower wage economies for the first time.

New technology can undermine the cost position of the existing competitors.

Where brand names are important, a new competitor has a major problem becoming known and accepted unless it is prepared to invest heavily in sustained advertising and/or buy market share at a low price to stimulate trial and hopefully repeat purchases.

Supply Restrictions As A Barrier To Entry

A new entrant in the market may find it difficult to buy the supplies necessary to compete (including skilled labour) or it may be that it finds that distribution channels to the customers/consumers are reluctant to add extra lines and won’t drop existing proven products from their range.

Customer Loyalty As A Barrier To Entry

Happy customers who are delighted with the service and the products from the existing companies may be very reluctant to risk buying from a new competitor.

Depending on how important the product is, even a much lower price may not compensate for the uncertainty of dealing with a new company.

It may also be difficult for customers to suddenly switch from one supplier to another because of incompatibilities. For example, it is a big decision to switch computer suppliers because of all the inconvenience and effort required.

Legal Barriers And Patents As A Barrier To Entry

New companies may have to deal with difficult legislation issues and even legislation that doesn’t affect incumbents. When I worked for a company with an iron foundry back in the early nineties, we did not have to meet environmental legislation that a new competitor would have had to comply with.

The market may also be protected through effective patents which stop a competitor bringing out a product very similar to your own.

Threat Of Retaliation From Existing Competitors As A Barrier To Entry

Any new entrant is attracted by the prospects of high profit so if existing competitors can put together a convincing threat that they will stop this happening (by cutting prices or extensive advertising), the new company will see high profit will not materialise.

But it is difficult to pull off.

Threatening retaliation against a new entrant means sacrificing the short term profitability of existing businesses so the new competitor has to be seen as a major threat which justifies the costs.

Barriers To Entry – An Effective Deterrent?

High barriers to entry are good if you are already established in a market but bad if you are investigating a market as a possible route for expansion.

The factors can change which is why it is important to keep reviewing Michael Porter’s Five Forces model and the danger is that once one entrant has succeeded, other copycats may see that entry barriers like the threat of retaliation were an illusion.

Barriers To Entry May Be Reduced From Closely Connected Industries

The other issue when assessing entry barriers is that your starting point matters.

If you already have relationships with the prospective customers, a well known brand which is portable to this new market or you have the supply capabilities, your ability to enter a new market successfully is very different from a totally new company.

Can You Increase The Barriers To Entry?

To make your industry analysis better and to protect your business from the threats of new entrants, can you find ways to move these factors in your favour?

Are you doing everything you could to capitalise on your cumulative experience so that you find better ways to provide your product or service?

Can you find ways to increase customer loyalty so that they are unlikely to be tempted away by new entrants or existing rivals?

Is your patent protection as strong as it could be?

Overcoming Barriers To Entry

The entire issue of the threat of new entrants and the issue of barriers to entry all depends on where you are coming from.

If you are already in the industry you want high barriers but if you are outside looking to get in, ideally you want low barriers for you but high barriers for every other possible entrant.

So after you have identified the potential barriers to entry for your industry, put yourself in the shoes of a new competitor eager to enter the market.

Ask yourself how you would get around the barriers.

Can you reconstruct the industry?

Traditional High Street operations like banks and insurance brokers have been disrupted by first telephone and then Internet technologies.

Amazon have done the same with books, CDs and DVDs replacing a bricks and mortar presence with a huge website with many more products and product reviews.

Can you separate out the constraining area and subcontract to take advantage of other companies’ economies of scale and learning?

Can you license trademarks, patents and products so that you collaborate with a key player and help them compete against the other competitors?

More On Industry Analysis and the Five Forces Model

My related blogs start with an introduction to industry analysis and Michael Porter Five Forces Analysis Model.

I’ll also be writing about

Supplier Power

Buyer Power

Threat Of Substitutes

Competitive Rivalry

Your Thoughts On Barriers To Entry and the Threat of New Entrants

It will be great if you can share your thoughts and experience of barriers to entry? When have they protected your business or a business you know?

How have you managed to work around traditional barriers to entry which looked formidable?