Porters Five Forces – Competitive Analysis

“Find out how to use porter strategy to find out who has the bargaining power in your industry”

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The bargaining power of your customers

When developing your 3 to 5 year strategy you should consider the relative bargaining or negotiating power of the different players in your industry, once you understand where the negotiating power resides you can plan how you might respond.  

In your analysis the question you seek to answer is  

You will find that powerful customers will often ask for higher quality or improved service at the same price or simply for a better price. In general terms the more powerful your customers are the less profitable your industry will be.

However, you cannot determine the likely profitability of your industry by looking at this one factor alone, you will also need to consider your suppliers, competitors, new entrants and substitute products.

Porter Strategy & the Bargaining Power of Customers example:

This is a simplified example, so how will you determine the bargaining power of your customers?

Bargaining Power of Customers, Your How to Guide

To analyze the Bargaining Power of your Customers you will need to review your industry by considering the following generic criteria.

• The differentiation of outputs
• Switching costs
• Presence of Substitutes
• Industry concentration relative to buyer concentration
• Importance of volume to buyers
• Cost relative to total buyer purchases
• Impact of outputs on the cost of differentiation
• Buyer information about supplier products
• Buyer profitability
• Decision makers incentives
• Threat of backward integration

Now, lets explain and illustrate each of these points

The Differentiation of Outputs

You will find that most marketing is aimed at trying to differentiate your brand or your products from those of your competitors. This can be seen in the insurance industry in Australia where all brands are essentially the same however each brand consumes considerable resources to position their brand or product as somehow different.

When considering the differentiation of outputs, you need to determine if the products or services in your industry are similar or are you able to easily differentiate your products and services from those of your competitors?

You need to answer this from your customer’s perspective, quite often an organization will be able to differentiate their product or service however, the difference is not important to their customers.

If your customers perceive that your products or services are different to your competitors and your customer values that difference then you will have some protection during negotiations, however, if your customer perceives that your products/services are essentially the same as your competitors then they will have more bargaining power.

Example Porter Strategy & The Differentiation of Outputs:

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Switching Costs

A switching cost is a cost that your customer would incur if they ceased buying from you and commenced buying from one of your competitors.
These costs could be anything from

• The cost for legal to prepare and review of new contracts,
• The cost of stocking spare parts specific to your competitors products
• The cost of adopting a new ordering systems
• The cost of retraining your employees, or  
• These maybe intangible costs such as increased risk (the unknown).

Example 1, Porter Strategy and Switching Costs:

Example 2, Porter Strategy and Switching Costs:

Example 3, Porter Strategy and Switching Costs:

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Presence of Substitutes

A substitute is a different product or service that can be used instead of your industries products or services. A substitute is not a competitor’s version of your product. Substitutes are typically products/services that are not in your industry.

Example, Porter Strategy and the Presence of Substitutes:

Some common everyday substitutes  

• Electricity for petrol as a fuels in cars
• Hiring a gardener instead of buying a lawnmower
• Hiring a cleaner instead of buying a vacuum cleaner
• Using glue instead of nails
• Using wood look plastic instead of wood in furniture
• Building a house with a steel frame instead of a timber frame
• Putting a tin roof on your house instead of a tiled roof
• Shopping on the internet instead of going to the shopping center

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Industry concentration relative to buyer concentration

By measuring the ratio of the number of competitors to the number of buyers you can get an idea of the likelihood that buyers can shop around and place you under commercial pressure.

As the number of buyers increases relative to the number of competitors the negotiating power of anyone buyer deceases.

Conversely as the number of buyers reduces relative to the number of competitors the power of the buyer increases.
 

Example 1, Porter Strategy & Industry concentration relative to buyer concentration

Example 2, Porter Strategy & Industry concentration relative to buyer concentration

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Importance of volume to buyers

Buyers who buy only a few of your products each year are less likely to shop around for price on those items.

Example, Porter Strategy & Importance of Volume to buyers

In general terms the more frequent your customer purchases and the more they purchase each time the more they are likely to negotiate on price, quality and service.

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Cost relative to total buyer purchases

Buyers tend to prioritize their negotiation efforts in the areas where they spend the most money. If your product or service is a large expense for your customer, then you are more likely to be the focus of their negotiations.

However, if your product or service is insignificant to your customers overall purchasing you are less likely to be the focus of their negotiations.

Example, Porter Strategy & cost relative to total buyer purchases

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Impact of outputs on the cost of differentiation

This is an interesting area for consideration, and it boils down to a simple question
“Does a unique quality of your product or service help your customer to differentiate their product or service?”  

If your product is a key component of your customer’s product then your customer will have less bargaining power.

For example:

Whereas if your product is less than significant to your customer’s product or service then your customer will have more negotiating power.

For example:

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Buyer information about supplier products

This tends to relate to technical products, where the technology in the product is different to the technology of the industry. You are trying to answer the question

For example:

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Buyer profitability

Buyer profitability – are your customers profitable and likely to remain profitable?

The more profitable your customers are the less likely they are to be concerned with the amount you charge.

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Decision makers incentives

The decision maker within your customers business may be receiving incentives from your competitors such as free tickets. However they are equally likely to be given incentives, to negotiate, by their employer.

The presence of incentives influences the decision, with part of the decision based on something other than merit.

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Threat of backward integration

Could your customer set up and provide your product or service, eliminating the need for you? 

It is more likely that your customer will enter into your industry if their business is large compared with the average size of a business in your industry.

If your customers tend to be smaller than you or your competitors then they are unlikely to start doing what you do.

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Porters Five Forces and the Bargaining Power of Customers - Template

The following free strategic planning template can be used to determine if each of the factors that affect the bargaining power of your customers has a positive or negative impact on their bargaining power.

You can then give an overall rating for this force.

Go to our porter strategy download page

Porter Strategy Links

The Bargaining Power of Customers is one of the five forces in the Porter Model, read up on each of the five forces and become a skilled strategic leader.

Each page includes a free strategic planning template, listing the common factors to consider.

• The Threat of New Entrants into your Industry
• The Bargaining Power of Suppliers
• Threat of Substitute Products
• Industry Rivalry

Follow each link for even more porter strategy examples