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Business strategy underpins all aspects of managing a business even before a business’ inception. One crucial aspect of business strategy is external strategy considerations. This describes the sources of profit in the external environment that you can exploit to generate a competitive profit. These external sources of profit depend on your industry. However, certain strategy analysts have devised methods to appraise the external environment regardless of industry. If you undertake a robust external strategy analysis, you will ensure your startup stays competitive. This article explains some crucial external strategy considerations for startups.
What is External Strategy?
In the context of business strategy, external strategy refers to the way in which you organise your business to stay competitive based on factors that are external to your startup.
There are several different methodologies business strategists have devised over the years to do this. One of the most favoured external strategy approaches is the “Five Forces” model Michael Porter developed. The Five Forces model identifies five factors that businesses across any industry can identify in the external environment to find the sources of profit. By identifying which are the most relevant factors in your industry, you can develop specific ways to maximise your short-term and long-term business strategy.
Porter’s Five Forces are the:
- relationship between you and your industry customers/clients;
- relationship between you and your suppliers;
- extent to which competitors can enter the market;
- extent to which your customer can substitute your industry product with another; and
- way in which these forces determine the sources of rivalry among you and your competitors.
We will look at these five factors in more detail.
1. Customer Bargaining Power
This factor asks how much bargaining power your customers have. Some industries have customers with substantial bargaining power. Other industries are defined by customers with weak bargaining power. It is usually apparent who your customers are. The real challenge is appraising the extent of their bargaining power.
As a rule of thumb, where there are comparatively few customers, bargaining power is higher. This describes industries that supply goods to large international retailers like Sainsbury’s. Likewise, certain heavy industry manufacturers’ assets, like ships and planes, do not have many ready buyers.
On the other hand, if you have lots of customers, you may have more bargaining power. Alternatively, if you possess the sole right to manufacture or distribute a product, you have no real competitors. This allows you to set much higher prices. This is common in industries where acquiring patents is essential, like life sciences and biotech.
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2. Supplier Bargaining Power
Supplier bargaining power operates very similar to customer bargaining power. It is just the inverse. That is, if your suppliers have more bargaining power, this squeezes your industry’s profit. And vice versa.
However, it is more challenging to identify who your suppliers are. Businesses often have more suppliers than they do customers. Obvious suppliers are those businesses that you purchase necessary input goods from to produce your product.
Where suppliers have more bargaining power, this restricts profit. But if you can develop and nurture strong relationships with these suppliers, you may be able to negotiate more favourable terms, which will increase your profit relative to your competitors.
3. Threat of Competitor Entry
Specific industries are inherently easier for competitors to enter into than others. This is common in industries where new insurance requires little to no upfront capital. Common examples of these include professional service providers such as accountants and lawyers.
The opposite of this is industries that require a substantial upfront capital expenditure. This includes heavy industries like:
- metals;
- plastic; and
- automotive.
But it also includes industries that require substantial research and development before they can launch a product. A common startup example is life science and biotech; these startups often require months, if not years’ worth, of financing before they develop the product that they take to market. As a result, it is difficult for new entrants without adequate financing to compete in this industry.
Where it is easy for competitors to enter the market, profits are squeezed. This is because a new entrant can come in and undercut the prices of you and your competitors. But where the threat of entry is low, there are usually fewer competitors, and the prices tend to be higher. This can be a source of profit, although this may be offset by other factors
4. Substitutability
Substitutability refers to how easy it is for your customers to find a separate product from a different market to satisfy the same or similar need. An airline that only provides regional flights is effectively competing with trains and even consumers with their cars. This is because if prices for short-haul tickets become too expensive, customers can achieve the same result using a different product. The same is not valid for long-haul flights.
Perhaps a more common industry for startups is the retail restaurant market. An Italian restaurant may satisfy a particular expectation. But there is a price point at which customers would forgo Italian for another cuisine.
Products with low substitutability include highly regulated professional services. If your business needs to defend itself from litigation, you almost certainly will need to instruct a solicitor. Litigation solicitors operate in a highly regulated profession. Accordingly, the prices are set, and you have very little room to negotiate. This allows solicitors to charge higher fees, which tend to be more uniform across the board.
5. Dynamics Between Competitors
The way in which these forces interact depends on the industry. It follows that different industries have different forces at play. The nature of competition between competitors in an industry, therefore, depends on the industry.
To give an example, airlines have little bargaining power with the suppliers of their jet fuel and their aircraft. This squeezes profits for the industry as a whole. Airlines, therefore, often compete on the strength of their markets across certain regions. Certain airlines operate in high-demand areas, which other airlines struggle to break into. This gives these airlines more bargaining power to charge customers higher airfare, which depends on the fact that specific customers have no choice but to purchase tickets through one or a few airlines (low substitutability). This is an example of where the external forces determine the sources of profit.
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Key Takeaways
You should conduct your industry analysis before your startup begins its journey. A thorough industry analysis can help you determine which industries are profitable and which are not. By leveraging practical external strategy analysis, you can guide your startup with more confidence.
If you need help with your startup, our experienced startup lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.
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