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Finance Strategy: Rethinking Porter’s 5 Forces for FP&A

  • By Bryan Lapidus, FP&A
  • Published: 7/11/2018
Michael Porter first published his famous Five Forces framework in 1979, and it has since become a staple of business thought to explain the attractiveness of a market or segment. The forces are set in opposition to each other to describe who has the power to extract significant profit by examining influences sales prices and structural costs.

But what if there is a shift taking place, where the macro forces that started in information technology and are disrupting business structures could allow us to turn this paradigm upside down? Are there instances where these forces can be profit-accretive rather than profit-destructive? If the answer is yes, then finance has to re-evaluate its valuation models to capitalize on these relationships to derive value for its business. 

Let’s take a look at each of Porter’s forces:

BUYER’S BARGAINING POWER
Traditional view:
The buyer’s bargaining power is the ability to force prices lower. Through their size they can command volume discounts, or through competition they can easily shift to other sources. Example: Walmart can demand low prices for its goods because it buys in huge quantities.

New approach: Customers have more data to share, which allows buyers/customers to integrate into the company processes. 

Implications for FP&A: Businesses can partner with your customers and integrate the information they provide through direct purchases, browsing history or social media comments. 

Tips for FP&A: Customer acquisition is multiples more expensive than retention, so lifetime value models may indicate a company accept lower margins on individual transactions.

SUPPLIERS’ BARGAINING POWER
Traditional view:
Suppliers can exercise power when there are few substitutes, or there is high concentration, or a high cost of switch to other suppliers. Example: the power of OPEC during the oil crisis of the 1970s to limit output and raise prices among buying nations and corporations.

New approach: Vendors are embedded in the company and often tightly integrated in the supply chain of information and logistics. In some cases, they simply take over what you need.

Implications for FP&A: This mirrors the buyers’ bargaining power, and so the opportunity to partner with your customers and integrate the information they provide. 

Tips for FP&A: Think about a “lifetime value of your suppliers.” Look for ways to maximize the ROI on vendor networks, potentially trading transactional costs for integration value. How do you move them the value chain with them? The low-cost provider may not deliver as much long term value as a willing partner. Beware: Higher integration also increases costs to switch suppliers, which may lock you into suppliers. Build IT integrations in a way that maintain flexibility by using common technology that allows vendors to plug/unplug quickly.

NEW ENTRANTS
Traditional view:
Profitable industries, or those ripe for disruption, will attract competitors, relative to the ease of getting into the market. Example: AT&T purchasing Time Warner to compete with Google and Verizon on content and distribution.

New approach: Old walls that once defended industries are falling quickly as it is easier than ever to disrupt technology and scale barriers. The surplus of capital (private equity, low interest rates, tax cuts) has created an ecosystem where companies create new ideas/products/services with an eye to selling them. 

Implications for FP&A: Strategic acquisition is as much a part of your strategy as research and development, and therefore can be as much a part of your capital strategy or investment portfolio. 

Tips for FP&A: Consider building a market-scanning process to look for opportunities; larger companies may have resources for M&A. For more mature companies, incumbent status may be a detriment because established processes and high hurdle rates on the existing portfolio limit the ability to be agile and risk-taking on new opportunities. Is your investment analysis process limiting innovation? Partnership deals with new entrants may combine competencies; be sure the business case includes learning new capabilities.

SUBSTITUTE PRODUCTS
Traditional view: Substitute products and services can take away your market share by providing alternatives that meets your customers’ needs. Examples include your mobile phone replacing digital cameras, compact discs, even computers and televisions.

New approach: Over time, the lines between new entrants and substitutes has blurred—new entrants may disrupt old industries through substitution. This is especially true where vaporization, meeting customer needs through software-delivered services that once could only be met with tangible goods. Example: Facebook acquired Instagram to keep its dominance of helping people connect to each other, and copied many of Snapchat’s features to inhibit. 

Implications for FP&A: The companies creating substitute products may be new to field, so the response is similar to that of new entrants. 

Tips for FP&A: Acquire the disrupting company to for its technology, methods or people. Internally, it may be useful to develop a venture capital approach of funding some risky, potentially disruptive ideas through a stage-gate process to gain learnings and test theories. Self-disruption may require lower returns on investment; be sure your investment processes is not leading you to favor incumbent products over disrupting substitutes.

INTENSE SEGMENT RIVALRY
Traditional view: Competition between numerous strong or aggressive rivals mean that it is hard to outmaneuver and differentiate. A traditional example was retail clothing stores, where several large department stores competed ferociously.

New approach: Development of rival technologies or platforms upon which services can be offered can be a huge risk. Industry consortia can help to set standards to develop an ecosystem where all can thrive. Example: Zelle was founded to develop a platform for peer-to-peer payments and includes rivals such Bank of America, JPMorgan Chace, and Wells Fargo.

Implications for FP&A: Is there a sustainable competitive advantage? Working with these forces or working against them creates opportunities as well as stresses. 

Tips for FP&A: Finance can foster adaptability by advocating for modernized infrastructure and investment in people, even when the ROI is hard to calculate. It is a strategic, long-range decision to carve out capital for initiatives to insure the investment is made, but it may also be the most important one. Flexible systems are lower risk and may have a longer life; consider this into investment calculations.

Check out AFP's interactive Roadmap to The Future of Finance to learn how you can master the new capabilities and models impacting finance.

Connect with Bryan Lapidus, FP&A, via email, LinkedIn or Twitter.

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