Matt Kirchner: Porter’s Five Forces in the Finishing Industry
The time comes in the life of most finishing industry businesses when attention turns to growth. Organizations looking for direction as to where to expand need look no further than Michael E. Porter’s ‘Five Forces’ model. While some business theories are a flash in the pan, the one postulated by this Harvard Business School professor more than three decades ago has certainly stood the test of time. Porter contends that five competitive forces shape each and every industry. Custom coaters considering their next strategic move, finishing equipment suppliers considering product additions and chemical system providers contemplating an acquisition will all benefit from measuring their strategies against Porter’s Five Forces, comprised of the following:
Threat of Entry
Basically, how easy is it for competitors to enter the same space and steal market share? Economies of scale (i.e., the more volume the organization produces) often enable a business to make products more efficiently and at a lower cost, making it difficult for new players in the market to match price. How much capital investment is necessary in plant and equipment, for instance, a highly automated finishing process? The more costly it is for a new competitor to enter a market, the less likely they will be to do so. As differentiation can create customer loyalty, how unique or differentiated are the organization’s products or services? For a custom coater, this can be a challenge as the market will often seek to commoditize job-shop-type coating services. Does the company have a proprietary product or process enabling it to provide a solution that no other organization can? Many finishing equipment suppliers have protected their intellectual property with patents, making it more difficult for other suppliers to steal customers. The less likely new competitors are to enter a market, the more pricing leverage and thus margin protection and cash flow will be afforded those already there.
Intensity of Rivalry among Existing Competitors
Most of us have to look back no further than 2009 when the manufacturing economy was in the tank to recall a time in our industry when pricing rivalry was fierce. When industry growth is slow, competitors are equal in size or influence, or products among competitors are not particularly differentiated, pricing competition can become brutal with competitors chasing each other to near-zero margins just to capture or maintain business. In a market where intense competitive rivalry exists it can be difficult to generate profits. Instead, expand in markets where products are differentiated, capacity is added in larger increments and future growth is likely.
Pressure from Substitutes
A few years back, the zinc plating industry was affected by a trend on the part of fabricators who switched some post-plated product to material that had been galvanized and annealed prior to the forming or stamping process, thus eliminating the need to plate the part afterwards. This created a form of competition not from direct competitors but from a buyer’s ability to meet its needs using another solution. The fewer substitutes available to the buyer, the better candidate the market is for expansion.
Bargaining Power of Buyers
At one point in my career I had a customer—a large, Fortune 500 company—that represented 98 percent of my company’s total revenue. That was a customer with some serious buying power. Porter tells us that when a buyer’s profits are low or the product purchased comprises a large portion of the buyer’s overall cost, the buyer has a greater incentive to drive down price. When buyers can provide the product or service internally rather than outsourcing it, their bargaining power increases. As is often the case in the job shop finishing market, buyers have power when they can easily and inexpensively move their work to other suppliers. Seek markets where buyers have less influence, where their purchases are less concentrated and where their ability to find replacement suppliers is more limited.
Bargaining Power of Suppliers
Consider the power a chemical supplier has when a finisher knows that switching to another supplier’s product may require an existing tank of product to be written off as a loss or when the finisher has little alternative but to purchase a specific supplier’s product. If suppliers to a company do not have to contend with substitutes, or if an industry is not an important segment of a supplier group’s market, then the customers in that industry may find themselves at the whim of a supplier that has inordinate pricing power. Find markets where supply chains are not dominated by a small number of suppliers, where substitute products exist and where switching costs are minimal.
Higher barriers to entry, minimal competitive rivalry, fewer substitutes and less powerful customers and suppliers—pay heed to Porter’s Five Forces and your next expansion will more likely be a lucrative one.
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