5 points to analyse before starting your new business
If you are thinking about starting your new business then you are reading the right article. You will learn how to evaluate a business idea by observing the business environment from five different aspects. If you have not been studying business management then this is the most important thing you need to learn.
The Porter's Five Forces approach studies five different types of forces to assess the attractiveness of the business. Let’s see one, under each definition I will share a real life example.
1. Threat of new entrants
If new companies can enter the industry easily, the increased competition can force prices down and thus decrease profits for the industry.
Take the web-design business for example. Being a web developer in the early 2000s was a very profitable business as not too many experts were available. A website could cost up to $100,000. In the early 2010s there were easy to use web-design tools available that made it easy for almost anyone to create a good looking website. Design agency prices dropped over 95% - one could buy a website for $2,000. Today, only very large organizations pay for web-design services.
2. Intensity of competition
Industries with significant direct competition can reduce profits because of price cutting to gain market share.
For example, cellular telephone service providers have dropped prices over time to gain market share from other providers. They can still maintain sufficient profitability to run their businesses, but their profit margins have been dropped over 80% in the past 15 years.
3. Pressure from substitute products or services
If a new product or service meets the basic needs of existing products or services, then those new offerings can force prices down and decrease profits. If your products or services can be replaced by more attractive alternatives then potential customers will not be interested in buying from you.
For example, email is seen as a substitute for postal mail by many, driving demand down for postal mail.
4. Bargaining power of buyers
Powerful buyers (customers) can use their clout to force prices down and thus decrease profits for the business.
This is especially true in the case of professional service businesses like consultation, recruitment and training solutions where delivering a service is relatively low-cost and profit margins are high. The only way to counter it is to generate sufficient demand to be able to say no to clients who want to reduce fees.
5. Bargaining power of suppliers
Powerful suppliers, such as the companies who provide parts and supplies, can negotiate high prices if companies find those parts and supplies essential to their operations.
This is especially present in low margin businesses such as selling fashion clothing, fashion watches and low-cost jewelry. Let’s say you buy an item for $10 and sell it for $17. If marketing your product require $3 per sale for example - that will leave you a $4 profit on each sale. If the supplier decides to increase their price per item from $10 to $12 then you will immediately lose 50% of your $4 profit per sale.
If you plan a new business, make sure to analyze the business environment based on the previously described five criteria and evaluate the risks wisely.
The safest business models share the following characteristics:
Difficult to enter the market
Little or moderate competition
No direct substitute products or services are available
Buyers have little bargaining power
Suppliers have little bargaining power