Porter’s five forces
The strategic analysis model of the five forces of competition was created by Michael Porter in 1979. Porter used five structural units to describe ways to achieve a competitive advantage and long-term profitability of a company or a certain product. The main goal of this strategy is to adapt to a competitive environment. Porter’s theory of competition suggests that there are five driving forces that determine a company’s level of profit in the market:
- new competitors (new players in the market);
- existing competitors in the industry;
- companies that offer substitute products;
- the influence of suppliers;
- customer influence.
The golden rule of Porter’s theory of the five forces of competition is the weaker the influence of the competitive forces, the more opportunities the company has for making high profits in the industry. The five forces model is most often used in strategic management and in marketing. An example: a watch store is located in a shopping mall. Only one or a maximum of two competitors work alongside that store, therefore, there are four competitors. The negative impact will be eight, if, for example, the store is located at the end of the corridor, and competitors are closer to the entrance and entice visitors.
Opportunities will be equal to five, because, if there is a free space, the store will be able to move closer. It is necessary to carry out the calculation: “(4+8)-5”, the result is seven. This means that the threat from existing competitors has a rating of seven. This is quite a lot, based on a 10-point scale. The express method allows to see only the big picture, in order to thoroughly understand the problem, an in-depth analysis method is needed.
Porter’s four generic competitive strategies
According to Porter, there are four competitive strategies in the market: cost leadership, cost focus, differentiation, and differentiation focus. The cost leadership strategy protects the company from competitors, as it provides income in conditions that are not available to other players. For example, this strategy can be seen in the promotion of essential goods: toothpastes (Colgate), drinks (Coca-cola), milk, etc.
The point of their competitive strategy is the approach of undifferentiated marketing. Very often, in the promotion of their products, they use emotional images and general human values: happiness, health, a healthy family, etc.
The differentiation strategy is all about creating a unique product or service, the improvement of an ordinary standardized product with the aim of selling it at a higher price. Distinction and uniqueness protect the product from direct competition with substitute products, create consumer loyalty to the brand and reduces price sensitivity.
For example, the shampoo market has Head & Shoulders that claims to specialize in the treatment of dandruff; Fructis aims to strengthen hair; Dove is for nutrition and recovery; etc. Each of these companies strives to highlight their product, giving it special qualities and image, for which the consumer is willing to pay higher than for ordinary shampoo.
The differentiation focus strategy directs all the company’s efforts onto a specific group of consumers or geographical market segment, namely the creation of a product or price advantage in a narrow market segment. Examples may include a focus on local companies and local leadership; production of specialized magazines for narrow audiences; specialized clothing stores (plus size, expectant mothers, uniforms), etc.
Finally, the cost focus strategy implies finding a focused market with little competition and offering it the lowest prices possible. This strategy is aimed at niche markets, understanding their dynamics and customers’ needs, and ensuring that the prices remain low.
BCG matrix was developed by the Boston Consulting Group in the late 1960s and is one of the first portfolio analysis models. The foundation of the BCG matrix is based on two hypotheses:
- The leading company in the segment has a competitive advantage in production costs, which means the highest level of profitability in the market.
- In order to function effectively in fast-growing segments, the company must invest in the development of goods at a high level; and vice versa, the presence on the market with low growth rates allows to reduce the cost of product development.
The main task of the BCG model is to determine priorities in the development of assortment units of the company, to identify key areas for future investments. This method helps to understand investing in the development of which goods and services will be the most profitable.
The following products can be analyzed in the BCG model:
- Separate areas of the company’s business that are not interconnected. For example, insurance and production of carbonated drinks.
- Separate groups of goods sold by the enterprise in one market. For example, life insurance, car insurance, home insurance, etc.
- Separate units of goods and services within the same group of goods. For example, car insurance may be CTP, CASCO, supplementary insurance, etc.
As a result of the construction of the BCG matrix, all product groups or individual products of the company are divided into 4 quadrants. The product group development strategy depends on which quadrant the product is in.
The first quadrant is “question marks”. In the first quadrant of the BCG matrix, there are such business lines of the company that are represented in fast-growing industries or segments, but have a low market share or, in other words, occupy a weak market position. Such activities require a high level of investment in order to grow in accordance with the market and strengthen the position of the product.
If a business direction falls into this quadrant of the BCG matrix, the company must decide whether there are sufficient resources for the development of the product in this market at the moment (if yes, investments are directed to the development of knowledge and key advantages of the product). If the company does not have sufficient resources for the development of goods on the market, the goods do not develop.
The second quadrant is “stars”. In the second quadrant of the BCG matrix there are the directions of business of the company, which are the leaders in their rapidly growing industry. The company should support and strengthen this type of business, which means that it is possible to increase investments. One of the best resources of the company (personnel, scientific developments, money) should be allocated for these business directions. This type of business is the future stable source of income for the company.
The third quadrant is “cash cows”. It is a business with a high relative market share on a slowly growing or stagnating market. The goods and services of the company presented in this quadrant of the BCG matrix are the main generators of profits and income. These products do not require high investment, only maintaining the current level of sales. The company can use income flow from more promising areas of business — “stars” or “question marks”.
The fourth quadrant is “dogs”. This quadrant of the BCG matrix focuses on areas of business with a low relative market share on a slowly growing or stagnating market. These directions of business usually bring little profit and are unpromising for the company. The strategy for working with these goods is the reduction of all investments, possible closure of a business or its sale.