Porter’s Five Forces Model, Generic Strategies and the Saddle Curve

Most students of strategic planning are at least aware of Michael Porter’s five forces model of competitive advantage.  These forces – supplier power, customer power, threat of new entry, substitute products and industry rivalry – are an excellent way to understand the most powerful forces affecting a company’s competitive position and likelihood of profiting from a market.  In Simplified Strategic Planning, we examine the external variables which are most like to drive these forces for a company by researching the external data (such as the balance between number of customers and number of competitors in a segment, the threat of substitute products or services, and the economics of the supplier market).  Internally, a company’s strategy can be developed to adapt to, and sometimes, mold these forces as well, ideally by focusing on the use of a unique strategic competency that separates the company from competition and likely new entrants.

One great way to think about all of the five forces in your strategic planning is to think about the choices (outside of purchasing from your company) available to your customers and suppliers.  Anything that increases the choices available to customers decreases your power, and anything that decreases their choices increases your power.  

One of the key ideas we use in Simplified Strategic Planning starts with the basic question of how you can gain – or lose – market share to a competitor.  One of the most fundamental insights that affects market share is a behavior continuum we refer to as specialty and commodity behavior.  Michael Porter describes these behaviors in his “generic strategies”, but usually refers to them as “uniqueness as perceived by the customer” and “low cost position”.  As I state in the book “Simplified Strategic Planning:  A No-Nonsense Guide for Busy People Who Want Results”, both of the generic strategies that work for the specialty focused company are viable strategies for a profitable business – that is, the differentiation strategy (specialty/broad market) and part of what Porter calls the “focus” strategy (which he uses to cover both specialty and commodity/niche market).  I would contend that the commodity side of Porter’s “focus” strategy (what I call “alley shop”) is not viable – since it generally results in both low volume and low margins – and that is why we split the niche strategies into “segmentation” and “alley shop”.

In “Simplified Strategic Planning”, I noted the existence of the “Saddle Curve”, which is simply the tendency of companies to achieve higher profit on either end of the specialty/commodity continuum.  The basic idea behind this curve is that companies with a clear commodity or specialty strategy will be more profitable than those that flounder in between the two.  One of the reasons why the five forces exert such power on profitable strategies is that they tend to force companies away from the extremes of this curve and into the middle, where profit is minimized.  As an example, consider a situation where customers can choose substitute products.  The customers’ desire is inevitably to maximize value by getting better products, better service and lower prices.  Where the customer has less choice, the real-world trade-off between these can be forced into the customers’ decision-making processes (“Do I buy the expensive, better product or the cheaper, worse product?”).  Customers who have more choices can demand that these compromises not be made – which inevitable drives a company into the middle of the curve, where profit is lower.  The only force that usually does not show its main effect on the saddle curve is the power of suppliers.  When that force comes into play, the profit of the company is affected because profit can be the result of forcing suppliers to move towards the center of the curve.

Where do you see your company on this curve?  How do the five forces affect your position on the curve, and your strategies for positioning in your markets?  If you would like a straightforward, no-nonsense process for working these ideas into your strategic planning, consider attending our two-day simplified strategic planning seminar soon!

What is the best strategy for retailers?

There just doesn't seem to be a retail strategy that works these days.  If you've been watching the news lately, you've probably come to the conclusion that brick-and-mortar retailing is sick, if not dying.  Just check out this article:  "Everything must go".  But is this the end for retailers?  Is there any way forward?

Let's examine what looks like the biggest issue:  online sales are still growing, at the expense of traditional retail.  You don't have to be an expert in consumer behavior to understand why.  There are compelling reasons for consumers to prefer making their purchases online.  I call these the Four C's of Online Advantage:

1.  Cost - Online stores tend to be cheaper.  Without the expenses (labor and real estate) associated with brick-and-mortar, online stores can profitably offer products at lower prices.

2.  Choice - Online stores can offer a broader inventory.  Low turnover products are more practical when your traffic is virtual and you may not even have to own or store your inventory.

3.  Convenience - Bad snowstorm?  Don't feel like fighting traffic?  You can shop online without leaving your bed.

4.  Customization - Online stores get more data about shoppers more quickly and cheaply than brick-and-mortar stores.  This one is a hidden weapon, and a powerful one.  Even the smallest online retailer has better data about why traffic comes to their store and much easier means of reaching out to past customers.

With just these four advantages, brick-an-mortar retail looks like a bad bet.  Is there any way to beat these odds?  First, you have to accept a basic idea in strategy for consumer markets:  you cannot win fighting against what the customer wants.  If customers prefer the cost, choice, convenience and customization, they will prefer online.  Strategically, you can attempt to match these advantages, but you will be matching your weakness to the strength of online shopping.  This is not to say that you shouldn't try to be competitive in these areas, but rather that attempting to be equal will cost you more than it is worth.

So what are the advantages brick-and-mortar can bring to the battle?  There are several tremendous advantages you should be using in your retail business.

1.  Experience - No matter how great a website or shopping app is, it is simple not physical presence.  Customers can only see and perhaps hear a website.  In brick-and-mortar, customers can also feel, touch, smell, taste and physically interact with your store, products and people.

2.  Immediacy - Customers can walk into a brick-and-mortar store and walk out with a product in a matter of minutes.  Even the best online distribution systems can't perform that well for physical products. 

3.  Social contact - brick-and-mortar stores enable customers to interact with staff and each other.  In some cases, there is a social life centered around traditional retail that is hard to replicate online.  In all cases, customers get to conduct transactions with human beings, which is a preferred mode for some purchases.

4.  Distribution - in some markets, such as fresh produce, delivering the right product to the customer at the right time is a very difficult challenge.  Online distribution systems, especially the last leg from the retailer to the customer, face great difficulty delivering such products efficiently.

These four areas make up the basic reasons why some customers will always prefer brick-and-mortar for certain transactions.  By implication, there are some retail experiences that may always be local rather than online - farmers markets, bars and fitness centers, to name a few.

But what if you are in one of the retail markets that is more prone to online shopping?  The strategic options for those retailers become much more difficult.  Basically, to compete effectively with online retail, a brick-and-mortar store must deliver greater value from its advantages than it loses to disadvantages for each customer it seeks to win.  Mathematically, traditional retailers cannot win every contested customer, but they must win enough of those customers to create sustainable turnover.  Here are a few options that make sense:

1.  Give up the commodity customer - some customers will always seek the cheapest source, no matter what.  In many markets, these are simply not the right customer for brick-and-mortar.  The cost of getting these customers in the door far exceeds the margin you can make from them long term. 

2.  Make the store an experience - if the store is enjoyable, some customers may prefer the sensory stimulation and social experience.

3.  Put more social in the store - I am not referring to social networking, which may help, but rather making the store a focal point for the community it serves.  A store that facilitates community will be preferred by some customers.

4.  Emphasize the immediate interaction - a store that delivers value because the last leg of the transaction is nearly instantaneous gains a big advantage over online competition.

Examining these four ideas suggests that certain models of brick-and-mortar retail are going to be more successful than others.  Commodity strategies, such as those commonly seen in big box retail, will be more challenged than the strategies of niche stores.  Customers will not look favorably upon a bland, impersonal warehouse filled with products if they can get a better deal with wider selection online.  They will also not abide ill-trained and uncaring retail staff, since an impersonal transaction can be done much more efficiently online.

The road ahead for brick-and-mortar retail is not easy.  Some costs may go up, while many will feel tremendous pricing pressure from online competitors.  A clear strategy that targets and caters to a specific group of customers is required to succeed in the changing retail world.  Any retailer who fails at this is doomed - but those who succeed will find a strong long-term position in their markets.  Strategic planning is the key to finding this success.