Porter's 5 Forces as an Investor!

Service Business

You can have many ideas for developing your own business - your own capital, loans from family and friends, loans or subsidies. However, if someone would like to take off with a little more impetus, they can also try to get an investor. Business angels or venture capital companies (TVC) offer really large-scale support, both financial, advisory and accounting. However, to convince such an investor to your business, you need to create a really good portfolio of your company, in which it will be indicated why this particular idea will gain an advantage over the competition. Do you know Porter's 5 forces model?

What Porter came up with, and what would be useful for an entrepreneur

Since the project submitted to investors may affect whether the potential company will become a reality for now, it is worth professionally describing your plans to gain an advantage over the competition. It is possible even if you do not have deep knowledge in the field of enterprise analysis - you can rely on theoretical models created by one of the greatest contemporary authorities in the field of economic sciences - Michael Porter.

Michael E. Porter, professor and head of the Institute of Strategy and Competition at Harvard Business School, is a figure known to every student whose field of study is related to economics. The models created by Porter are the foundations for gaining a competitive advantage, both on a small scale (enterprises) and on the largest scale - countries and international competitiveness.

While it may seem that these models are too advanced for a novice entrepreneur, fortunately this is not the case. It is important to focus on a few of the most important issues that Porter described in many of his publications - incl. Competitive strategy, Methods of analyzing sectors and competitors or also Competitive advantage.

For a small entrepreneur who is trying to find an investor, three models should become the most important - the five forces, also known as the diamond, the value chain and the competitive advantage. Each of them indicates certain aspects that, with proper work, can become the main source of competitive advantage over the rest of the companies in a given sector. These aspects are emphasized not only by Porter, but also by analysts of business angels and TVC.

Porter's five forces model (Porter's 5 forces)

The basic assumption of the five forces model (also called, as already mentioned, diamond) is the assumption of the existence of five basic forces: suppliers, buyers, competitive entrepreneurs, competitive products / services and competitive struggle. These forces exist in the market and affect every enterprise that functions in it. At the same time, each of these forces affects the others.

Two of the presented external forces are analogous to each other - it is about how strongly the company will be influenced by its suppliers and buyers. The power of influence of suppliers will be greater if a given sector is highly concentrated, i.e. there are relatively few competitors for a given supplier, and the quality of the products or goods supplied by him will be of great importance for the quality of the final product. Also, the more a supplier monopolizes a given sector, the more difficult and expensive it would be to search for alternative sources of needed resources, the more strong the supplier will be. However, if there is a fierce competition in this sector, it means less dependence on the supplier entering a given industry.

The power of buyers 'influence is a mirror image of the dependencies governing the power of suppliers' influence. In this case, the more the buyers are dependent on a given supplier, the fewer alternatives they have in obtaining suppliers, and the more the quality of their product or satisfaction of needs depends on the supplier's offer, the better for the entrepreneur. It is worse, however, if the company's offer is so little specialized that buyers can obtain the resources on their own - then it can be assumed that the company will find it difficult to find customers or at some point they will no longer need its services.

The other two external factors that have a strong impact on the company are the competition itself - for the company, i.e. other competing companies, and for its offer - i.e. substitutes for a product or service. Too many entrepreneurs in a given industry may eventually result in oversaturation of the market and difficulties in finding buyers. On the other hand, substitutes, especially those of better quality, better meeting the needs of recipients or simply cheaper, are a serious threat to the company.

The last factor in Porter's model is the intensity of competitive struggle, as the only one concerning the interior of a specific sector. The scale of such a fight depends on how many competitors there are on a given market and how their shares are distributed. If there are many of them and none of them is a monopoly, staying in the industry is likely to be easier.

Value chain

According to another model created by Porter, companies that work to increase their own value gain an advantage over competition. What is value? According to this model, goodwill is the sum of its revenues, which include the price of the product and the volume of its sales.

However, running a business is not only about selling a finished product or service - this stage is preceded by many other activities that also have value. The better they are, the better the end result will look. This is the assumption behind the name of the value chain, in which each action is its next link. Therefore, the entrepreneur should successively research the individual elements of the activity that the company deals with and eliminate or improve those that are not perfect.

How to distinguish individual links of the value chain? Porter suggests a simple division of them - into the basic activity, which is strictly related to the manufactured product or service, and an auxiliary, supporting activity. In each of them, specific activities are additionally separated, which, however, do not have to be reflected in each company (e.g. a service company will pay much less attention to storage than a production company).

Thus, in the theoretical model, the value chain consists of five links of the main activity and four auxiliary activities. The first basic activities are the logistics of internal activities, concerning e.g. storage, transport, supply - that is, obtaining what the company needs to create a product or service.The second stage is the creation, or actually production, and then the entrepreneur focuses on the logistics of external activities - that is, storing the finished product, transporting it and handing it over to the buyer. Then the link is marketing and too - that is, broadly understood advertising, promotion, market research, etc. - all activities that are to promote a product or service. The last link in the basic activity is services, i.e. the handling of the finished product. Depending on the industry, it may be, for example, additional service, product installation or customer service.

On the other hand, in the field of auxiliary activities, the first link concerns the structure of the company - i.e. accounting, bookkeeping, relations with contractors, legal background, etc. Therefore, these are all those aspects that do not directly translate into the production of the product, but without which the company could not exist. It is similar with human resource management - the second aspect, which includes hiring, recruiting, performance evaluation, payroll and bonus programs. The development of technology will not be a link that should be paid attention to in every industry (invaluable in a company producing electronic equipment, but of little importance in an elite restaurant with traditional dishes), but it certainly should never be ignored. The last aspect of auxiliary activity is procurement - raw materials, materials, but also other purchases necessary for the company's operation.

In his model, Porter indicated step by step individual aspects that, on the one hand, can give the company a really big leap in terms of added value, but on the other hand, they can be a weak point that needs to be fixed. Therefore, it is worth analyzing each of them in detail.

Model of competitive advantage

According to the definition contained in the encyclopedia of management, the concept of competitive advantage is the achievement by an enterprise of a superior position over most of its competitors on the market. Having it, the company can offer its recipients services and products of high quality, meeting their needs, and at the same time being more attractive than the offers of other companies operating in the industry. More attractive - that is, cheaper, but not only that, because according to Porter's theory, an offer that is unique in various respects will be attractive to the recipient.

In order to become unique for the recipient, the entrepreneur should identify a competitive niche existing in his industry. Depending on what the niche will cover, the strategy to be adopted will be different. In the original model, Porter distinguished three strategies - cost, differentiation and niche focus. The first cost strategy is the most basic - the entrepreneur obtains an advantage over other market participants with the lower price of his offer. Porter assumes that it is not necessary to give up the quality of products - it is enough to improve the production process, choose more effective distribution channels, etc. The differentiation strategy assumes developing an image that will distinguish the entrepreneur's product from the competition. An example is the Yves Saint Laurent fashion house, which was promoted thanks to original ideas - such as women's clothing in tuxedos, previously reserved for men. The niche market strategy is the least flexible, but also profitable - it requires finding a group of customers or a place where what a given company produces is not yet offered.

The Porter model was the basis for creating a slightly different model of competitive advantage, now more “up-to-date” and more frequently used. According to it, competitive advantage is divided into three types - qualitative, price and information. The qualitative advantage concerns the product or service itself, distribution, service, packaging, etc. (i.e. analogous to the differentiation strategy). The more the offer is tailored to the needs of the recipients and the better it satisfies them, the greater this type of advantage will be. Price advantage (in Porter's cost) concerns price shaping at a level lower than that of other competitors. Its instruments are also various kinds of promotions, rebates and discounts for regular customers. On the other hand, the third type, the information advantage, can improve the company's situation in two ways. It will affect it on its own when the company informs recipients about its offer more effectively than the competition, at the same time trying to shape their preferences in such a way that they can be satisfied by the offered goods or services. On the other hand, the information advantage may also serve as an auxiliary function in relation to the price and quality advantage - the information provided to the recipients concerns precisely the aspects of price or quality of products, compared to the competition.

Achieving one competitive advantage allows for more flexible shaping of other aspects - that is, for example, by choosing to beat the competition in terms of quality, the entrepreneur will be able to slightly modify the prices. At the same time, the advantage also gives the opportunity to develop the company, and thus - its increasing stability on the market.

The presented models of valuation of gaining a competitive advantage do not exhaust the topic - each industry may have its own idea for "eliminating" the competition, and each investor may have his own view on which paths lead to the most stable company. However, entrepreneurs who start their careers and are looking for an investor will certainly not lose by relying on these methods, the creator of which is one of the greatest contemporary authorities in the field of economics and competitive strategies.