Are you planning on starting a new website but want to gauge how profitable the industry sector is before you do? Are you optimizing a site for a client but want to gain a better understanding of the industry in which they operate? Conducting an industry analysis will help identify advantages and any weaknesses a business may have in that industry, and clarify the forces that shape that industry. The better we understand the industry, the more likely we are to grasp the opportunities others may miss.
If a business has a weak position relative to their competitors then optimization efforts might be ineffective as customers will simply click a few different search results and compare offerings.
Then again, a business may enjoy advantages in areas that aren't currently being exploited. Focusing your optimization and positioning efforts in these areas will likely pay higher dividends than optimizing in areas where competitors are strongest. Understanding the forces at work in the industry will help reveal these areas.
I like to analyze industries prior to the optimization process as I find I get a lot of ideas just by breaking the industry down into component parts. Where is the profit in this industry? Is this industry growing quickly? If so, should the emphasis be on acquiring new customers? Or is it stagnant, in which case should the emphasis be on taking market share from competitors? What areas do competitors focus on? What areas do they miss? Where are competitors most vulnerable?
There are various frameworks for conducting an industry analysis. You may have heard of a SWOT analysis, but today we’ll take a look at Porter’s Five Forces analysis.
Why Industry Analysis Is Useful
If you were examining the web design industry, you’d soon come across crowdsourcing sites, such as 99designs.
The existence of these types of sites signal a power imbalance in the design industry. The customer has significant power in that they can request that professional designers submit near-finished work in order to compete for their business.
Some may argue that this is a marketing cost for designers - a way to advertise and get in front of people, but however we look at it, it soon becomes clear the profitability of the web design industry is constrained by two forces: the power of buyers and the low barrier to entry to new competitors. Just about anyone can set-up shop as a web designer. Since suppliers are plentiful, the buyers can easily play the suppliers off against one another - quite literally, in the case of 99designs!
Once we understand these industry forces, we could alter our plan of attack if we were marketing a web design agency. One possible approach would be to focus on geographical advantages. If you’re a web designer based in New York, you’re probably going to get more work out of New York based firms than if you lived in Oklahoma. A marketing campaign that emphasizes the unique selling point of physical location might work well in that it mitigates a force that is strong and operates against them i.e. the number of competitors. If they focus on local, they’ll be competing with local designers, not designers from all over the country, or around the world. Such a business might make a big deal of the fact they’ll come and see their clients face-to-face, their centrally located offices, their geographic location, and the fact they have local knowledge and contacts.
That unique selling point is determined once we’ve made an effort to understand the forces at work in the industry.
The Five Forces
The five forces are:
Let’s compare our web design agency against those five forces.
Power Of Suppliers? Suppliers being people who supply the web businesses with anything they need to produce their output. Suppliers, such as graphics software vendors, have virtually no power in the web design industry. A web designer needs a computer, office space and software, all of which are commodity items. Supply risk is therefore not a significant threat to the profitability of web designer businesses.
The Power Of Buyers? High. Buyers have a lot of choice as the industry is saturated with suppliers.
Barriers To Entry? Low. Anyone with a computer, design skills, and an internet connection can compete.
Competitive Rivalry? Medium/High. There are a lot of agencies chasing prestige work and may take a loss to land work from name companies. This gives them bragging rights and the association may help future marketing efforts.
The Availability Of Substitutes? Medium. A website is a marketing channel. A company could decide to spend money on other channels. They could substitute web design spend for some other marketing spend.
This industry clearly has profitability challenges. By emphasizing local, and a high touch service, a design firm could counter the competitive rivalry force and the barrier to entry force to some degree, and thus limit the power of buyers by focusing on buyers who place high value on face-to-face meetings. That’s just one idea, I’m sure you can think of a few more, but notice how easily these ideas spring to mind once you have a good idea of the forces at work in the industry.
How To Make A Five Forces Analysis
Define The Industry:
Great opportunities are discovered using “out of the box” thinking :)
Further Reading & References:
In conducting research for this article, I have used three main sources: Competitive Strategy: Techniques for Analyzing Industries and Competitors, by Michael E Porter, Business and Competitive Analysis: Effective Application of New and Classic Methods, by Craig S Fleisher and Playing to Win: How Strategy Really Works by A.G. Lafley. Also, here's a presentation that provides a good overview:
http://www.youtube.com/watch?v=KlNlYeS0JTI&feature=player_embedded
by PeterD
http://www.seobook.com/
If a business has a weak position relative to their competitors then optimization efforts might be ineffective as customers will simply click a few different search results and compare offerings.
Then again, a business may enjoy advantages in areas that aren't currently being exploited. Focusing your optimization and positioning efforts in these areas will likely pay higher dividends than optimizing in areas where competitors are strongest. Understanding the forces at work in the industry will help reveal these areas.
I like to analyze industries prior to the optimization process as I find I get a lot of ideas just by breaking the industry down into component parts. Where is the profit in this industry? Is this industry growing quickly? If so, should the emphasis be on acquiring new customers? Or is it stagnant, in which case should the emphasis be on taking market share from competitors? What areas do competitors focus on? What areas do they miss? Where are competitors most vulnerable?
There are various frameworks for conducting an industry analysis. You may have heard of a SWOT analysis, but today we’ll take a look at Porter’s Five Forces analysis.
Why Industry Analysis Is Useful
If you were examining the web design industry, you’d soon come across crowdsourcing sites, such as 99designs.
The existence of these types of sites signal a power imbalance in the design industry. The customer has significant power in that they can request that professional designers submit near-finished work in order to compete for their business.
Some may argue that this is a marketing cost for designers - a way to advertise and get in front of people, but however we look at it, it soon becomes clear the profitability of the web design industry is constrained by two forces: the power of buyers and the low barrier to entry to new competitors. Just about anyone can set-up shop as a web designer. Since suppliers are plentiful, the buyers can easily play the suppliers off against one another - quite literally, in the case of 99designs!
Once we understand these industry forces, we could alter our plan of attack if we were marketing a web design agency. One possible approach would be to focus on geographical advantages. If you’re a web designer based in New York, you’re probably going to get more work out of New York based firms than if you lived in Oklahoma. A marketing campaign that emphasizes the unique selling point of physical location might work well in that it mitigates a force that is strong and operates against them i.e. the number of competitors. If they focus on local, they’ll be competing with local designers, not designers from all over the country, or around the world. Such a business might make a big deal of the fact they’ll come and see their clients face-to-face, their centrally located offices, their geographic location, and the fact they have local knowledge and contacts.
That unique selling point is determined once we’ve made an effort to understand the forces at work in the industry.
The Five Forces
The five forces are:
- The Power Of Suppliers
- The Power Of Buyers
- Barriers To Entry
- Competitive Rivalry
- The Availability Of Substitutes
Let’s compare our web design agency against those five forces.
Power Of Suppliers? Suppliers being people who supply the web businesses with anything they need to produce their output. Suppliers, such as graphics software vendors, have virtually no power in the web design industry. A web designer needs a computer, office space and software, all of which are commodity items. Supply risk is therefore not a significant threat to the profitability of web designer businesses.
The Power Of Buyers? High. Buyers have a lot of choice as the industry is saturated with suppliers.
Barriers To Entry? Low. Anyone with a computer, design skills, and an internet connection can compete.
Competitive Rivalry? Medium/High. There are a lot of agencies chasing prestige work and may take a loss to land work from name companies. This gives them bragging rights and the association may help future marketing efforts.
The Availability Of Substitutes? Medium. A website is a marketing channel. A company could decide to spend money on other channels. They could substitute web design spend for some other marketing spend.
This industry clearly has profitability challenges. By emphasizing local, and a high touch service, a design firm could counter the competitive rivalry force and the barrier to entry force to some degree, and thus limit the power of buyers by focusing on buyers who place high value on face-to-face meetings. That’s just one idea, I’m sure you can think of a few more, but notice how easily these ideas spring to mind once you have a good idea of the forces at work in the industry.
How To Make A Five Forces Analysis
Define The Industry:
- What are the geographic boundaries of this industry?
- What products and/or services are in this industry?
Define The Players:
- Who are the buyers?
- Who are the suppliers?
- Who are the competitors?
- What are the substitutes?
- Who are the potential entrants?
What are the drivers of each competitive force? Grade them on relative weakness vs strength. Make a note of why they are either weak or strong.
Determine Industry Structure
Determine Industry Structure
- Why is this industry profitable?
- What forces make it profitable?
- Are some competitors better positioned in terms of the five forces than others?
Analyze Changes
- Which forces are changing now, or likely to change in future? Can your business bring about any of these changes? Can your competitors?
Digging Deeper
A common mistake when undertaking this analysis is to define competition too narrowly. Competition is often deemed to be “the other guy who offers the same service”, and that’s the end of it.
By examining each force, we gain a more thorough understanding of how competition works in the industry. This can be useful when constructing an seo/sem campaign, as you may be able to find weak forces in one or more areas that you can exploit. For example, one opportunity might be substitute products. What is your clients product or service a substitute for? You could then target the existing customers of another substitute product or service and encourage them to switch.
Why Five?
The five forces help determine the potential of an industry as they keep us from focusing on any one element. We need to consider all elements in order to get a better idea of industry profitability.
For example, we may note that an industry is growing quickly, but if we disregard the fact there is no barrier to entry, we might overestimate the profit potential. The search marketing industry has been growing quickly, but there are no barriers to entry, so this shifts a lot of power to the buyer and away from suppliers. It’s also an industry where numerous substitution options exist i.e. there are numerous internet marketing channels, and it’s possible some customers will get more bang for their buck using other channels.
The five factors strategy helps us see how much profit is bargained away to customers and suppliers. We focus on structural considerations as a whole, as opposed to isolated factors.
Defining The Industry
It can often be difficult to determine the industry boundaries.
An industry can be defined too broadly or too narrowly. For example, an analysis of the web marketing industry may determine it is global, however marketing is often highly dependent on cultural aspects. A more narrow industry definition, including regionality and geographical factors, might be more applicable when it comes to quantifying the level of competition. The marketing industry in the USA is a different “industry” from the marketing industry in France as most marketing activity undertaken in the US is conducted by US based marketing companies, and very little by suppliers from France. Therefore, the supplier in France and the supplier in the US are in "different" industries from a competitive standpoint. One does not compete directly with the other as their focus is likely to be on their own geographic markets.
There are two main factors in deciding industry boundaries:
A common mistake when undertaking this analysis is to define competition too narrowly. Competition is often deemed to be “the other guy who offers the same service”, and that’s the end of it.
By examining each force, we gain a more thorough understanding of how competition works in the industry. This can be useful when constructing an seo/sem campaign, as you may be able to find weak forces in one or more areas that you can exploit. For example, one opportunity might be substitute products. What is your clients product or service a substitute for? You could then target the existing customers of another substitute product or service and encourage them to switch.
Why Five?
The five forces help determine the potential of an industry as they keep us from focusing on any one element. We need to consider all elements in order to get a better idea of industry profitability.
For example, we may note that an industry is growing quickly, but if we disregard the fact there is no barrier to entry, we might overestimate the profit potential. The search marketing industry has been growing quickly, but there are no barriers to entry, so this shifts a lot of power to the buyer and away from suppliers. It’s also an industry where numerous substitution options exist i.e. there are numerous internet marketing channels, and it’s possible some customers will get more bang for their buck using other channels.
The five factors strategy helps us see how much profit is bargained away to customers and suppliers. We focus on structural considerations as a whole, as opposed to isolated factors.
Defining The Industry
It can often be difficult to determine the industry boundaries.
An industry can be defined too broadly or too narrowly. For example, an analysis of the web marketing industry may determine it is global, however marketing is often highly dependent on cultural aspects. A more narrow industry definition, including regionality and geographical factors, might be more applicable when it comes to quantifying the level of competition. The marketing industry in the USA is a different “industry” from the marketing industry in France as most marketing activity undertaken in the US is conducted by US based marketing companies, and very little by suppliers from France. Therefore, the supplier in France and the supplier in the US are in "different" industries from a competitive standpoint. One does not compete directly with the other as their focus is likely to be on their own geographic markets.
There are two main factors in deciding industry boundaries:
- Scope of the products or services
- Geographical boundaries. Does competition take place globally, or is it regional?
You can use the five forces to help determine the industry boundaries. If the industry structure is the same i.e. same buyers, same suppliers, barriers to entry, and so on, then treat it as the same industry. If the industry forces are different, then treat it as a separate industry for the purposes of this analysis.
Are soft drinks for the home and soft drinks for corporate buyers - such as McDonalds - the same industry for the purposes of analysis? Possibly not. Soft drinks to consumers are heavily marketed on b2c channels and packaged in small, individual containers. Distribution needs to be very wide to get each of these small containers physically close to the consumers. Into vending machines, for example. Sales of soft drinks to corporate buyers, however, are likely to occur via b2b channels, where purchasing is done strategically and delivery is in the form of bulk syrup. The forces are quite different, even though product is exactly the same.
Barrier To Entry
When the barrier to entry is low, incumbents must hold down their prices or boost investment to deter new entrants. The way to counter a low barrier to entry force is attempt to raise it.
Anyone can make a burger, and anyone can get into the burger making business, but few could compete with McDonalds. McDonalds counter the low barrier to entry force by buying up well-positioned locations, operating at significant scale to keep prices low, and investing heavily in brand awareness. This raises the barrier to entry for anyone trying to offer something similar to McDonalds.
Many SEO companies spend a lot of time at conferences and keeping their names “out there”, which goes some way to counter the low barrier to entry in a business where just about anyone can call themselves an SEO. Software companies will likely invest heavily in features, R&D or service levels to ensure new entrants have a steep hill to climb in order to compete.
If the barriers to entry are low, then the threat of entry is high, which in turn limits profitability unless demand in the industry is growing faster than supply. Some businesses, like McDonalds, will counter this force with sheer scale, driving down the cost per unit. You can only compete with McDonalds pricing and convenience advantages if you do so at scale, and that scale is expensive. New entrant competitors in the burger business often position in areas where McDonalds are weakest i.e. offering gourmet burgers that that might cost more, but aren’t generic. Competitors could make a big deal about being small.
The advantages of economies of scale can be found throughout the value chain and the reason why companies tend to get bigger - they have to - else they put themselves at ongoing risk from new entrants.
The downside risk for these companies is that they can’t change and adapt quickly. It’s like trying to maneuver a container ship, whilst the small business can change direction on a whim. The small business is like the speedboat, the big business is like a container ship. This is the reason small companies tend to focus on new, innovative areas of the market. The big companies may not be able to make money out of these areas (yet) due to company cost structures and/or they can’t adapt quickly enough to seize these opportunities.
Another benefit of scale that we see often on the web is demand-side economies of scale, otherwise known as network effects. Anyone can start a social network, but few can compete with Facebook. Their competitive advantage is largely due to network effects - the more people on a social network, the more value it has, and the more people will be willing to join. These demand side economies of scale erect a barrier to entry, thus retaining and increasing profitability, because customers are unwilling to sign up to smaller networks. This demand side barrier has been so effective for Facebook that even the likes of Google have trouble countering it.
We could even apply this type of analysis to the search results. If some serps are “easy” to get, then you may experience profitability issues. If they are easy for you to get, they are easy for some new entrant to get, too. As Google raises the bar, and makes it more expensive to compete, the threat from new entrants and/or those with less funding diminishes. Those who have more to spend, and/or are bigger businesses will likely find the serps more profitable than in the past as they no longer suffer the structural problem of a low barrier to entry. If you have the funds, then Google making it harder to optimize actually works in your favour.
Switching Costs
Almost everything has a switching cost whereby it costs a customer to change services. The more entrenched a product or service, the higher the switching cost, and therefore the higher the barrier to competitors. Microsoft Office has hung around in the enterprise, despite being less than ideal, because the switching cost - involving staff training and industry document standards - is high.
Capital Requirements
If you want to run a search engine to rival Google, then the capital requirements are significant.
However, if the return is there, capital is typically available, especially if the capital can be turned back into cash if the business doesn’t work out.
For example, the bank might be happy to lend on a hotel as they can still convert their capital back into cash by selling the asset. If a business relies on a large advertising spend, however, then capital may be more difficult to come by as it can’t be converted back into cash if things go badly. Capital alone is not a significant barrier to entry.
Incumbency
Incumbency can counter low barriers to entry. It’s easy to start a search blog, but difficult to draw attention away from the incumbents in this space. The established sites have built up loyal audiences over time. To beat incumbents, you’ve usually got to do something remarkably superior, complementary, or be prepared for a long battle.
Application Of Five Forces Theory
Start by evaluating your position against the five main criteria and identify where forces are strong and where they are weak.
If the buyer is in a powerful position, and switching costs are low, then sending them to a landing page where your prices are high but your features are the same as the competition is unlikely to work. The buyer will likely click back and compare. In order for a conversion to take place in this scenario, the business would need to justify the higher prices by, say, focusing on the additional value offered.
If your prospective customers do face switching costs, then perhaps the copy could focus on how the business will help the customer absorb this cost. For example, a landing page could highlight trial offers and special deals if the buyer is switching from a competitors product.
Keep in mind that buyers are less price sensitive if your pricing represents a fraction of their total spend, but very price sensitive if you supply them with something that makes up a lot of their operating cost. If you offer an SEO service and you target small companies or individuals, then obviously the price structure needs to reflect this. Likewise, if you’re pitching to a company that spends millions on marketing a month, you’re more likely to focus on the value proposition as they are unlikely to care about a few thousand here and there as search marketing isn’t a large part of their operating cost.
Could your service make a major difference to your buyers costs? Can you lower the cost of their supply chain? If so, then the buyer will be less sensitive to price and more interested in value. If all your competitors are focusing their efforts at one step in the supply chain, could your advertising be directed a different step in the chain?
Drug companies now advertise their product to the end consumer when previously the advertising has been directed at the decision maker - their doctor. “Ask your doctor if (product) is right for you!”. Pressure is then put on the doctor to prescribe that brand over others because the patient is specifically requesting it.
Rivalry
Rivalry will likely be strongest when there isn’t one clear market leader, competitors are similar in size, and they make similar offers. It’s also likely to be strong if the industry is low growth as one competitor will likely try and grab another competitors share, whereas if the industry is growing quickly, this isn’t so much of a problem.
Try to ascertain the character of the rivalry. Is ego and empire building a major factor? Consider the flagship Apple stores. It’s possible these shops run at a loss in terms of their retail offering, but are valuable in terms of brand awareness and recognition. This can be difficult to determine, of course. Any industry where there is intense rivalry bound up with ego will face profitability issues, at least in the short term, as one competitor might be trying to run another out of business as they are engaged in a loss making war of attrition.
One of the easiest comparisons to make is price. Price wars often happen when there is low switching cost and sellers are offering generic product. Rental cars fall into this category. Any industry battling fiercely on price will have structural limits to profitability as margins are cut to the bone and passed onto customers in the form of low prices.
If a product is perishable, it will be vulnerable to price cutting. We often think of perishability in terms of food use-by dates, but many industries suffer perishability problems. Mobile phones can become obsolete, information can become outdated and hotel rooms can’t be sold once the clock ticks over to a new day. Products and services will be vulnerable on price if they are ending their useful life. Brand, image, service levels, and features are a lot less vulnerable to price as they aren’t perishable.
Dull established industries with high barriers to entry and high switching costs, such as big business software systems like SAP are likely to be profitable compared to most Silicon Valley internet startups where the dead body count is high. Are these two really in the same industry? It doesn’t help that we only tend to hear about the outliers, such as Instagram, that make the high-tech industry sound like a certified gold mine. The internet industry has significant structural problems affecting profitability, typically in terms of the level of competition, low barriers to entry and access to capital.
Also consider the role of complements. Complements are products used to help provide a service. For example, Adwords is a complement to a PPC marketing campaign. Without Google, a PPC campaign is significantly diminished in terms of reach. So, Google has considerable clout in this space as they have few competitors. There is supplier risk because Google may stop campaigns and/or suspend accounts.
Another way of looking at complements is the sum value is greater than the parts. For example, a smartphone is near useless without software, but with software, it transforms from being a phone to being a computer in your pocket. Complements may affect demand for your product or service. If you produce iphone apps, then your future is linked to that of Apple and their market penetration. Apple also owns the supply chain. Apple, therefore, can exert a lot of control and this has an impact of potential profitability for vendors. It’s best for mobile apps publishers, from a profitability point of view, when there are multiple providers of smartphones and market share is split between them. The likes of Apple would have less power to demand high fees from software vendors and would more likely incentivise production by passing on more profit to the application developer.
Shifts Over Time
This analysis is done at a fixed point in time, but as we all know, industry is fluid.
In the case of the online industry, significant changes can occur quickly. Take, for example, the rise of mobile computing. More tablets and mobile phones are being sold than laptops and desktop computers, therefore the entire paradigm is changing.
Makers of hardware are on notice. Anyone who depends on that hardware is on notice. Software vendors who don’t adapt to mobile computing risk competitors jumping into that market and eating their market share.
As far as search marketing goes, just what is the optimal marketing channel on mobile? Do people really sift through large lists of search results on their tiny screens? Perhaps other forms of pay-per-click will rise and SEO will diminish?
Buyer and supplier power can also change. At present, the power of internet content suppliers is rock bottom. Technology in general, and the search engines in particular, have played a part in devaluing content and shifting revenue to themselves. One consequence is that a lot of quality content is disappearing behind paywalls and into Amazon publishing. As Amazon makes it easier to publish and monetarize written content, and as more people take up tablets and mobile computing, then the utility of search engines may start to dwindle as content producers focus on other channels.
Being aware of the five forces helps us size up profitability and potential for opportunity. It is particularly valuable if the industry is on the verge of strategic change in one or more areas as this presents new opportunity to gain strategic advantage against incumbents.
Using Strategy Analysis For Positioning
Look for areas in an industry where forces are weakest and position accordingly.
In Competitive Strategy: Techniques for Analyzing Industries and Competitors by Micheal Porter, outlines a great example of positioning in the trucking industry.
Using the Five Forces analysis framework, he determined the trucking industry is characterized by operators who run large fleets. They have an incentive to drive down the price of trucks as trucks are a major part of their costs.
Most truck suppliers built near identical trucks to a set of industry standards, so pricing is fierce. This is a very capital intensive business. So how has one supplier managed to charge a 10% premium for their trucks and maintain 20% market share for decades?
Paccar, a truck manufacturer based in Washington, focus on one group of customers: owner-operators. Owner-operators buy their own trucks and contract directly with suppliers. Because these buyers aren’t buying fleets, they don’t have much leverage when it comes to price, and as it turns out, aren’t as price sensitive as we’d expect.
These buyers take a lot of pride in their trucks, so choose to spend money on customization. The trucks are made-to-order and include sleek exteriors, plush seating, noise insulation, high end stereo systems, and other enhancements. They’re aerodynamic, which reduces fuel consumption, they maintain re-sale value, they have a roadside assistance program, a high-tech spare parts system - all key considerations for lone owner-operators.
By focusing on one sector of the market where price forces are weakest (lone operators), Paccar have side-stepped a sector where price forces are strongest (fleet buyers). Their entire value chain is aligned with the owner-operator sector of the market.
Companies can influence competitive forces. They can address supplier power by making generic parts and inputs, thus making it easy for them to switch suppliers and thus negate the power of unique suppliers. To counter price cutting rivals, companies can offer more unique and valuable services. To limit new competitors, companies can heavily invest in R&D and sophisticated systems.
Industry Analysis Is Always Changing
I hope this article has given you food for thought. I find this type of analysis useful for search marketing indirectly. It gets me thinking - broadly - about where the untapped opportunities in an industry might lay, and where the competition is likely to be strong and difficult to counter.
This article makes a good point that industry analysis is getting even more challenging as industries fracture and fragment:
Are soft drinks for the home and soft drinks for corporate buyers - such as McDonalds - the same industry for the purposes of analysis? Possibly not. Soft drinks to consumers are heavily marketed on b2c channels and packaged in small, individual containers. Distribution needs to be very wide to get each of these small containers physically close to the consumers. Into vending machines, for example. Sales of soft drinks to corporate buyers, however, are likely to occur via b2b channels, where purchasing is done strategically and delivery is in the form of bulk syrup. The forces are quite different, even though product is exactly the same.
Barrier To Entry
When the barrier to entry is low, incumbents must hold down their prices or boost investment to deter new entrants. The way to counter a low barrier to entry force is attempt to raise it.
Anyone can make a burger, and anyone can get into the burger making business, but few could compete with McDonalds. McDonalds counter the low barrier to entry force by buying up well-positioned locations, operating at significant scale to keep prices low, and investing heavily in brand awareness. This raises the barrier to entry for anyone trying to offer something similar to McDonalds.
Many SEO companies spend a lot of time at conferences and keeping their names “out there”, which goes some way to counter the low barrier to entry in a business where just about anyone can call themselves an SEO. Software companies will likely invest heavily in features, R&D or service levels to ensure new entrants have a steep hill to climb in order to compete.
If the barriers to entry are low, then the threat of entry is high, which in turn limits profitability unless demand in the industry is growing faster than supply. Some businesses, like McDonalds, will counter this force with sheer scale, driving down the cost per unit. You can only compete with McDonalds pricing and convenience advantages if you do so at scale, and that scale is expensive. New entrant competitors in the burger business often position in areas where McDonalds are weakest i.e. offering gourmet burgers that that might cost more, but aren’t generic. Competitors could make a big deal about being small.
The advantages of economies of scale can be found throughout the value chain and the reason why companies tend to get bigger - they have to - else they put themselves at ongoing risk from new entrants.
The downside risk for these companies is that they can’t change and adapt quickly. It’s like trying to maneuver a container ship, whilst the small business can change direction on a whim. The small business is like the speedboat, the big business is like a container ship. This is the reason small companies tend to focus on new, innovative areas of the market. The big companies may not be able to make money out of these areas (yet) due to company cost structures and/or they can’t adapt quickly enough to seize these opportunities.
Another benefit of scale that we see often on the web is demand-side economies of scale, otherwise known as network effects. Anyone can start a social network, but few can compete with Facebook. Their competitive advantage is largely due to network effects - the more people on a social network, the more value it has, and the more people will be willing to join. These demand side economies of scale erect a barrier to entry, thus retaining and increasing profitability, because customers are unwilling to sign up to smaller networks. This demand side barrier has been so effective for Facebook that even the likes of Google have trouble countering it.
We could even apply this type of analysis to the search results. If some serps are “easy” to get, then you may experience profitability issues. If they are easy for you to get, they are easy for some new entrant to get, too. As Google raises the bar, and makes it more expensive to compete, the threat from new entrants and/or those with less funding diminishes. Those who have more to spend, and/or are bigger businesses will likely find the serps more profitable than in the past as they no longer suffer the structural problem of a low barrier to entry. If you have the funds, then Google making it harder to optimize actually works in your favour.
Switching Costs
Almost everything has a switching cost whereby it costs a customer to change services. The more entrenched a product or service, the higher the switching cost, and therefore the higher the barrier to competitors. Microsoft Office has hung around in the enterprise, despite being less than ideal, because the switching cost - involving staff training and industry document standards - is high.
Capital Requirements
If you want to run a search engine to rival Google, then the capital requirements are significant.
However, if the return is there, capital is typically available, especially if the capital can be turned back into cash if the business doesn’t work out.
For example, the bank might be happy to lend on a hotel as they can still convert their capital back into cash by selling the asset. If a business relies on a large advertising spend, however, then capital may be more difficult to come by as it can’t be converted back into cash if things go badly. Capital alone is not a significant barrier to entry.
Incumbency
Incumbency can counter low barriers to entry. It’s easy to start a search blog, but difficult to draw attention away from the incumbents in this space. The established sites have built up loyal audiences over time. To beat incumbents, you’ve usually got to do something remarkably superior, complementary, or be prepared for a long battle.
Application Of Five Forces Theory
Start by evaluating your position against the five main criteria and identify where forces are strong and where they are weak.
If the buyer is in a powerful position, and switching costs are low, then sending them to a landing page where your prices are high but your features are the same as the competition is unlikely to work. The buyer will likely click back and compare. In order for a conversion to take place in this scenario, the business would need to justify the higher prices by, say, focusing on the additional value offered.
If your prospective customers do face switching costs, then perhaps the copy could focus on how the business will help the customer absorb this cost. For example, a landing page could highlight trial offers and special deals if the buyer is switching from a competitors product.
Keep in mind that buyers are less price sensitive if your pricing represents a fraction of their total spend, but very price sensitive if you supply them with something that makes up a lot of their operating cost. If you offer an SEO service and you target small companies or individuals, then obviously the price structure needs to reflect this. Likewise, if you’re pitching to a company that spends millions on marketing a month, you’re more likely to focus on the value proposition as they are unlikely to care about a few thousand here and there as search marketing isn’t a large part of their operating cost.
Could your service make a major difference to your buyers costs? Can you lower the cost of their supply chain? If so, then the buyer will be less sensitive to price and more interested in value. If all your competitors are focusing their efforts at one step in the supply chain, could your advertising be directed a different step in the chain?
Drug companies now advertise their product to the end consumer when previously the advertising has been directed at the decision maker - their doctor. “Ask your doctor if (product) is right for you!”. Pressure is then put on the doctor to prescribe that brand over others because the patient is specifically requesting it.
Rivalry
Rivalry will likely be strongest when there isn’t one clear market leader, competitors are similar in size, and they make similar offers. It’s also likely to be strong if the industry is low growth as one competitor will likely try and grab another competitors share, whereas if the industry is growing quickly, this isn’t so much of a problem.
Try to ascertain the character of the rivalry. Is ego and empire building a major factor? Consider the flagship Apple stores. It’s possible these shops run at a loss in terms of their retail offering, but are valuable in terms of brand awareness and recognition. This can be difficult to determine, of course. Any industry where there is intense rivalry bound up with ego will face profitability issues, at least in the short term, as one competitor might be trying to run another out of business as they are engaged in a loss making war of attrition.
One of the easiest comparisons to make is price. Price wars often happen when there is low switching cost and sellers are offering generic product. Rental cars fall into this category. Any industry battling fiercely on price will have structural limits to profitability as margins are cut to the bone and passed onto customers in the form of low prices.
If a product is perishable, it will be vulnerable to price cutting. We often think of perishability in terms of food use-by dates, but many industries suffer perishability problems. Mobile phones can become obsolete, information can become outdated and hotel rooms can’t be sold once the clock ticks over to a new day. Products and services will be vulnerable on price if they are ending their useful life. Brand, image, service levels, and features are a lot less vulnerable to price as they aren’t perishable.
Dull established industries with high barriers to entry and high switching costs, such as big business software systems like SAP are likely to be profitable compared to most Silicon Valley internet startups where the dead body count is high. Are these two really in the same industry? It doesn’t help that we only tend to hear about the outliers, such as Instagram, that make the high-tech industry sound like a certified gold mine. The internet industry has significant structural problems affecting profitability, typically in terms of the level of competition, low barriers to entry and access to capital.
Also consider the role of complements. Complements are products used to help provide a service. For example, Adwords is a complement to a PPC marketing campaign. Without Google, a PPC campaign is significantly diminished in terms of reach. So, Google has considerable clout in this space as they have few competitors. There is supplier risk because Google may stop campaigns and/or suspend accounts.
Another way of looking at complements is the sum value is greater than the parts. For example, a smartphone is near useless without software, but with software, it transforms from being a phone to being a computer in your pocket. Complements may affect demand for your product or service. If you produce iphone apps, then your future is linked to that of Apple and their market penetration. Apple also owns the supply chain. Apple, therefore, can exert a lot of control and this has an impact of potential profitability for vendors. It’s best for mobile apps publishers, from a profitability point of view, when there are multiple providers of smartphones and market share is split between them. The likes of Apple would have less power to demand high fees from software vendors and would more likely incentivise production by passing on more profit to the application developer.
Shifts Over Time
This analysis is done at a fixed point in time, but as we all know, industry is fluid.
In the case of the online industry, significant changes can occur quickly. Take, for example, the rise of mobile computing. More tablets and mobile phones are being sold than laptops and desktop computers, therefore the entire paradigm is changing.
Makers of hardware are on notice. Anyone who depends on that hardware is on notice. Software vendors who don’t adapt to mobile computing risk competitors jumping into that market and eating their market share.
As far as search marketing goes, just what is the optimal marketing channel on mobile? Do people really sift through large lists of search results on their tiny screens? Perhaps other forms of pay-per-click will rise and SEO will diminish?
Buyer and supplier power can also change. At present, the power of internet content suppliers is rock bottom. Technology in general, and the search engines in particular, have played a part in devaluing content and shifting revenue to themselves. One consequence is that a lot of quality content is disappearing behind paywalls and into Amazon publishing. As Amazon makes it easier to publish and monetarize written content, and as more people take up tablets and mobile computing, then the utility of search engines may start to dwindle as content producers focus on other channels.
Being aware of the five forces helps us size up profitability and potential for opportunity. It is particularly valuable if the industry is on the verge of strategic change in one or more areas as this presents new opportunity to gain strategic advantage against incumbents.
Using Strategy Analysis For Positioning
Look for areas in an industry where forces are weakest and position accordingly.
In Competitive Strategy: Techniques for Analyzing Industries and Competitors by Micheal Porter, outlines a great example of positioning in the trucking industry.
Using the Five Forces analysis framework, he determined the trucking industry is characterized by operators who run large fleets. They have an incentive to drive down the price of trucks as trucks are a major part of their costs.
Most truck suppliers built near identical trucks to a set of industry standards, so pricing is fierce. This is a very capital intensive business. So how has one supplier managed to charge a 10% premium for their trucks and maintain 20% market share for decades?
Paccar, a truck manufacturer based in Washington, focus on one group of customers: owner-operators. Owner-operators buy their own trucks and contract directly with suppliers. Because these buyers aren’t buying fleets, they don’t have much leverage when it comes to price, and as it turns out, aren’t as price sensitive as we’d expect.
These buyers take a lot of pride in their trucks, so choose to spend money on customization. The trucks are made-to-order and include sleek exteriors, plush seating, noise insulation, high end stereo systems, and other enhancements. They’re aerodynamic, which reduces fuel consumption, they maintain re-sale value, they have a roadside assistance program, a high-tech spare parts system - all key considerations for lone owner-operators.
By focusing on one sector of the market where price forces are weakest (lone operators), Paccar have side-stepped a sector where price forces are strongest (fleet buyers). Their entire value chain is aligned with the owner-operator sector of the market.
Companies can influence competitive forces. They can address supplier power by making generic parts and inputs, thus making it easy for them to switch suppliers and thus negate the power of unique suppliers. To counter price cutting rivals, companies can offer more unique and valuable services. To limit new competitors, companies can heavily invest in R&D and sophisticated systems.
Industry Analysis Is Always Changing
I hope this article has given you food for thought. I find this type of analysis useful for search marketing indirectly. It gets me thinking - broadly - about where the untapped opportunities in an industry might lay, and where the competition is likely to be strong and difficult to counter.
This article makes a good point that industry analysis is getting even more challenging as industries fracture and fragment:
- Among the paradoxes they observe is that market segments in many industries are fragmenting, even as global firms require increasingly large markets to drive growth and profitability. Combining those "profit pools" is like trying to combine the water in thousands of bathtubs — there are profits to be had, but how do you combine them so that they become material?
- But as they also point out, the most important competition for many organizations today comes from firms who aren't even technically competing in the same business. Netflix going into the production of its own proprietary TV programs? Best Buy doing sophisticated analysis for health care providers to see how well their cardiac treatment projects are going? Who would have predicted those shifts?”
Great opportunities are discovered using “out of the box” thinking :)
Further Reading & References:
In conducting research for this article, I have used three main sources: Competitive Strategy: Techniques for Analyzing Industries and Competitors, by Michael E Porter, Business and Competitive Analysis: Effective Application of New and Classic Methods, by Craig S Fleisher and Playing to Win: How Strategy Really Works by A.G. Lafley. Also, here's a presentation that provides a good overview:
http://www.youtube.com/watch?v=KlNlYeS0JTI&feature=player_embedded
http://www.seobook.com/
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