It’s hard enough to make a buck these days. You’re going to need a whole lot more than a good idea. In fact, as we found out, you’ll need to take several adversarial forces into consideration. It’s like fighting a battle on many fronts at the same time. You’re surrounded!
It’s always good to get a handle on these situations, so we identify the various forces, what they’re trying to do, the damage they can inflict, and hopefully develop strategies to overcome them. Or at least hold them at bay!
In 1979, Michael Porter, a professor at Harvard University, identified five of these forces, gave them each a name, and described the pressure they put on you as a producer trying to establish and maintain a margin.
- The Bargaining Power of Suppliers
Your product is made up of various parts and relies on others for supply and manufacturing services. These suppliers want to get the most they can out of you without charging so much that you’ll go to another supplier or manufacturer. Their prices and fees are constantly increasing, putting mounting pressure on you to raise your prices or take a smaller margin.
Some producers try to avoid some of this pressure by doing their own manufacturing. But this approach creates massive overhead always hungry for bucks, even when sales are slow. This supply-sided approach is dangerous for companies in the startup, buildup, and build out phases. A better approach is to outsource as much as possible and focus on sales.
One strategy we discovered that seems to work very well is to take on your suppliers as strategic allies. Build a relationship of trust with them. Advise them of your plans. Show them how they will sell more to you if you are successful. Call them in advance if you’re going to be late on a payment and give them a plan to bring your account current within 60 days. And sign a long-term contract with them to make them feel secure about their “investment” in your company’s growth.
- The Bargaining Power of Buyers
Your buyers include several levels of customers who will only pay so much for your product. That price is determined by several factors including, your customers’ value perception, the velocity price point of your category, your competition, and your marketing program. Customers really set the price for your product.
With CPG products, you typically have to go through several middlemen to get to your end-user consumer. Each one of them is looking for a margin. The margin of the first middleman (usually a distributor or jobber), for instance, dramatically affects the price paid by the second middleman (usually the retailer). By the time your product finally gets to the retail shelf, it can be priced twice as high as what you sold it for.
The best strategy is to thoroughly understand the margins of the middlemen, how that affects the shelf price that you want to see, and how best to not leave any money on the table. We highly recommend that you carefully study and use the Rule of 99.
Another strategy is to sell in volume to help you achieve the shelf price you desire. When they buy big, they sell big. They have to because they don’t have room store it!
- Competitive Rivalry
You may be entering a highly competitive category. The pre-existing pricing within that category puts pressure on you to compete pricewise. You can’t just charge based on what you have into your product. You must work backwards from the shelf price to discover what your price must be.
As your category shifts in price, you will be pressured to adjust your prices accordingly lest you be seen by the end-user buyer as too pricey for their consideration.
The best strategy we have found to deal with competition is to distinguish your product and its benefits in such a way that you create your own new and different category. Given the ongoing changes in market dynamics, old paradigms can become less relevant. If you approach the market with a product that is more relevant to current demand, you will have competitive advantage.
- The Threat of New Entrants
You will be forever threatened by new entries that attempt to offer more, charge less, or appeal to a new or previously unaddressed customer need. Simply being new will garner them attention that can take away from your products.
New entrants also take up precious mind share, shelf space, and market share. Suddenly, your distributors are focused on the new kid in town. Suddenly, your retailers are being given promotional consideration to display the product of new entrants.
We believe the best strategy to protect against new entrants is to provide exceptional customer service, engage in effective customer feedback programs, and set up formal lines of communication between Sales and Customer Service on the one hand, and Production and Marketing on the other. Think of your company as having only two divisions, Sales and Sales Support.
- The Threat of Substitute Products or Services
Sometimes there can be a sea change in the marketplace. The solution to a problem can become obsolete because the problem itself changed. This can give rise to alternatives that may not even be in your category.
Henry Ford said, “If I asked my customers what they wanted, they would’ve said faster horses!” But his alternative to transportation put the horses, the buggies, and the buggy whips out of business.
We see this today with technology. We have boxes of technological office equipment, for instance, that’s only a few years old, yet totally obsolete. It makes us wonder if those manufacturers saw it coming.
Today, breakthroughs in packaging, sustainability, and components are putting constant pressure on product producers to be ahead of the curve. We believe the best strategy to avoid substitute products is to be the substitute product. Anticipate and lead as opposed to waiting until your decreased sales forces you to make a change.
Be aware of the megatrends building right now. Nielsen has documented a major megatrend in the consumers’ desire for earth-friendly packaging and sustainable manufacturing practices.
Conclusion:
Having successfully built a national brand, we know that there are many more pressures than just Porter’s five forces. For instance, there is the relationship with your bank or funder, the relationship with your employees, and your ability to execute leadership and basic business management.
However, we are grateful to Porter for getting us started on this critical analysis and discussion. The direction we got out of this was – identify each force and craft a strategy to defend yourself when you are being attacked from all sides!
