My father keeps a copy of Michael Porter’s Competitive Strategy on his bookshelf. An imposing dark gray tome, Competitive Strategy is a business classic. I remember reading it sometime in high school, and not understanding very much of it. It was only six years later in a college macroeconomics class, my professor helped me understand the value of the Five Forces. For startups entering a period of increased capital cost, the wisdom of Porter’s Five Forces is more important to consider now than they have been in the past few years.
The Five Forces are:
- The Threat of New Entrants: How easy is it for new companies to pursue this market? What barriers to entry exist?
- The Threat of Substitutes: What switching costs exist to keep customers with one vendor? How differentiated are the existing products in the market?
- The Bargaining Power of Suppliers: How much leverage do the suppliers an industry have? how concentrated are they? This can be labor or components of the product the startup must source from third parties.
- The Bargaining Power of Buyers: How much leverage to buyers have in an industry? How concentrated is the demand?
- The Intensity of Competition: the greater the threat of new entrants, the greater the threat of substitutes the greater the bargaining power of suppliers and the greater the bargaining power of buyers, the more intense the competition.
The past two years have been an era of growth at any cost. Damn the burn rate, full speed ahead. In this bull market, fundraising became a competitive advantage for startups. After having raised a huge investment, a startup could crown itself the winner of a category. Able to hire more people, spend more to acquire leads and close more customers by sustaining a greater burn rate, these cash-flush startups grew faster than their competitors, attracting more investment and reinforcing their capital supremacy.
As the cost of capital increases in 2016, these winner take all rounds will become less and less common. So the disparity across competitors’ balance sheets will contract. Instead of competing on fundraising ability and absolute growth, startups will have to compete on more fundamental and enduring competitive barriers that manifest themselves in better unit economics. It’s not that fundraising will not remain a critical skill in 2016. Rather, fundraising will no longer be exclusively sufficient.
Cue Porter’s Five Forces. The least competitive sectors, and consequently, the ones that will engender companies with the best unit economics, are the sectors in which buyers are clamouring for unique technologies and products that few others can replicate and can’t be found anywhere else.
If you’re thinking about starting a new business, consider evaluating your ideas with Porter’s Five Forces and pursuing those ideas with enduring barriers to entry. In a more capital constrained startup ecosystem, your startup will have a structural competitive advantage.