Exactly why is digital business so disruptive to traditional business models and traditional notions of industry competition? A useful way to analyze the situation is by looking at Porter’s model of the five forces of industry competition and exploring how digital business is impacting each of the various forces.
According to Michael E. Porter, in one of his landmark books, titled Competitive Strategy, “In any industry, whether it is domestic or international or produces a product or a service, the rules of competition are embodied in five competitive forces: the entry of new competitors, the threat of substitutes, the bargaining power of buyers, the bargaining power of suppliers, and the rivalry among the existing competitors.”
Let’s look at each of these five forces and examine the role and impact of digital business:
The entry of new competitors
There’s no doubt that digital business is changing the nature of competition. Today, it’s not just traditional industry competitors you need to worry about, but new entrants from outside your industry, equipped with new digitally based business models and value propositions.
This is often tech giants and startups that have envisioned and built a new business model from the ground up, powered by a new platform ecosystem for digital business. They’re leveraging the familiar social, mobile, analytics and cloud technologies, but are often adding in personas and context, intelligent automation, the Internet of Things, and cybersecurity to further enhance the value proposition of their platform.
In effect, tomorrow’s leader may not be someone you know. We often think of industry competition as a perpetual battle between the same set of incumbents, but in reality, things are far more dynamic and transitory. As an example, whereas 89% of the Fortune 500 went out of business between 1955 and 2014, in recent years, according to R “Ray” Wang of Constellation Research, 52% have been merged, acquired, gone bankrupt or fallen off the list solely since 2000.
Why can new entrants move in so easily? Digital business changes the rules by lowering the traditional barriers to entry. A digitally based business model requires far less capital and can bring large economies of scale for example.
The threat of substitutes
The threat of substitutes has to do with the threat of substitute products or services. In terms of digital business, this can come from a purely digital substitute or a hybrid digital/physical substitute. Taxi services, such as Uber and EasyTaxi for example, provide a hybrid model via a digital app for consumers and taxi drivers, coupled with the physical taxis.
Digital services wrapped around a physical product are another example and can range from one extreme such as the industrial Internet to another such as home automation technologies or personal fitness products. In addition, the long-term revenue stream from the digital services may be worth far more than the one time sale of the physical product.
The threat of substitutes is high in many industries since switching costs are low and buyer propensity to substitute is high. In the taxi services example, customers can easily switch from traditional models to the new model simply by installing an app on their smartphone. Propensity to switch from the traditional model is high due to consumer wait times for taxis, lack of visibility into taxi location and so on.
The bargaining power of buyers
Perhaps the strongest of the five forces impacting industry competition is the bargaining power of buyers since the biggest driver of digital business comes from the needs and expectations of consumers and customers themselves.
This bargaining power lays out a new set of expectations for the digital customer experience and necessitates continual corporate innovation across business models, processes, operations, products and services.
Customers and consumers have amassed far more bargaining power today due to instant access to information, insights from social media including access to reviews and feedback, low switching costs via digital channels, price sensitivity, access to substitute products and services with greater ease of use and convenience, as well as increased industry competitiveness as a result of the other forces.
The bargaining power of suppliers
Suppliers can accelerate or slow down the adoption of a digitally based business model based upon how it impacts their own situation. Those pursuing digital models themselves, such as the use of APIs to streamline their ability to form new partnerships and manage existing ones, may help accelerate your own model.
Those who are suppliers to the traditional models, and who question or are still determining their new role in the digital equivalent, may use their bargaining power to slow down or dispute the validity or legality of the new model.
Good examples are the legal and business issues surfacing around the digital-sharing economy (i.e. ride-sharing, room-sharing etc.) where suppliers and other constituents work to ensure the business model and process innovations still adhere to established rules, regulations, privacy, security and safety. This is a positive and needed development since, coupled with bargaining power of buyers, it can help to keep new models “honest” in terms of how they operate.
The rivalry among the existing competitors
Finally, existing competitors are all looking at digital business, trying to understand the disruptions occurring, and prepare their response. The responses can range all the way from defensive to offensive measures, and even a first-mover attack. This rivalry among competitors is always in play, but in recent years digital business has added fuel to the fire, just as the e-business era did many years ago.
The rivalry is heating up because entry and exit barriers are going down due to the comparative low-cost of digital business models, and in many cases new entrants do not even need to own physical assets or infrastructure. In particular, the “platform” model is seeing considerable success in the marketplace by simply connecting stakeholders and applying a set of peripheral services to enhance the customer experience.
By doing so, platform operators are moving to the forefront of service delivery and getting closer to the customer without even owning assets or employees working in that particular industry. According to a recent article in The Guardian, “Today, any service provider, and even content provider, risks becoming hostage to the platform operator, which, by aggregating all those peripherals and streamlining the experience of using them, suddenly moves from the periphery to the centre.”
Overall, as you prepare your various digital business initiatives, the five forces framework can be a useful way to think about the various headwinds and tailwinds acting on your envisioned model and how various constituents may react. In combination with the usual value chain analysis, it can help to inform your strategy and provide some useful insights into what you may encounter along the way.