Five forces that shape competitive strategy

Jeffrey D Nygaard

But what does it mean to develop such a strategy? 

The job of a strategist is to position the company to gain advantage over the competition. The strategist has to focus on understanding the external environment, configuring activities to align with overall strategy and sustaining competitive advantage. 

Today, we will look at how to systematically understand the external environment using the "five forces" model.

Competition comes in many forms, not just from rivals. We should think of competition in terms of the five forces: customers, suppliers, rivals, new entrants and substitutes. The relative power of these can determine profitability.

Customers can demand a lower price, higher quality or a higher degree of service, depending on their relative bargaining power. Their power is higher when the products are undifferentiated, customers are few or concentrated, or the cost of switching between providers is low.

Conversely, suppliers are powerful when their product is differentiated by quality or performance characteristics, they are few or concentrated, or the cost of switching between providers is high.

Rivals constitute direct competitors. Several distinct factors can define this relationship: the rate of growth, industry capacity and product differentiation.

Today's new entrants may become your rivals tomorrow. The key is to understand the barriers to entry. Typical barriers include capital requirements, price targets and government regulations.

Substitutes compete for the same customers but are not produced by your company or direct rivals. The threat of substitutes is usually assessed on the basis of price, performance and interchangeability. If the substitute requires significant design modification for the customer, the risk is low.

As you develop a competitive strategy for your business, start by considering the external environment. A review of the external forces lays the foundation for the next steps: game theory, strategy selection and internal alignment.