This article uses Porter’s 5 Forces to analyze how you should determine a location for your new business by considering marketplace threats that will affect your profits.
Whether you are starting a new business or expanding a present business, finding a location is an important decision that in many cases can create a competitive advantage or even inadvertently a disadvantage. It can be an unfortunate miscalculation if a business ends up picking their location on price alone as there are many other important factors to be considered when making this decision. This educational article is here to help shed light on the many factors at play when choosing a location, so that the only calculations you do, can be productive.
In Your Business Plan
In a normal situation the selection of a business location would be examined in your business plan. This usually occurs when analyzing the operating environment for your business: political, economic, social, technological, environmental and legal issues would all be included to determine how these issues will impact the development of your venture. Furthermore, this would be followed by an industry analysis and then your operations plan. These are important factors in determining a location so it is essential to do a brief examination to think about the outside factors that will affect your businesses future.
Using Michael Porter’s 5 Forces Model is an excellent tool to use in discovering what opportunities lie within and what are the disadvantages to a particular location. Use this tool to understand your situation and one by one write down your observations. This will allow you to brainstorm relevant questions and factors for your market or situation and discover how it will affect you and your choices.
The Five Forces
Adapted from Harvard Business Review. From “How Competitive Forces Shape Strategy” by Michael E. Porter, March 1979. Copyright Ó 1979 by the Harvard Business School Publishing Corporation; all rights reserved.
1. Competitive Rivalry
This is the number of rivals in your given location including how strong they are. You do not want to locate near or close-by a strong rival as it is much harder to infiltrate and pull business away from them. You must determine who they are and examine how does the quality of their products and services compare to yours. Taking this into consideration opens up questions such as, are you going to need a price advantage to compete with them in this location, if so, how will that affect your bottom line? If this location does not have a lot of competitive rivalry, then no one else is doing what you do, which puts you into a better situation to attain profits and strength.
2. Supplier Power
This usually refers to how easy it is for your suppliers to increase their prices. But it can also refer to how many potential suppliers you have, how unique the products they supply are to you and how expensive it is to switch to another supplier. When finding a location, it is important to find a centralized position where your suppliers surround you. If you deal in large shipping items or a lot of parts, being close to transporters in an industrial area is extremely helpful. While in comparison a restaurant that uses fresh local produce would want to be close to a farmers market. The concept here is to position your business where the suppliers are plenty and you have more to choose from, thus resulting in a better supplier position for your business. With fewer close suppliers, the supplier has more power and can charge you more and impact your profit.
3. Buyer Power
How easy is it for buyers to drive your prices down? When you have a location that has plenty of buyers that is a definite competitive advantage. But you also have to think about where your big buyers are located. 80% of business is done by 20% of your customers so knowing who they are, and where they are is an important factor in where you should locate to remain in proximity to them. You should think about how easily they could change to a rival and what it might cost your business. Most importantly is that when you only deal with a few customers they have much more power than when you have many.
4. Threat of Substitution
This refers to the likelihood that your customers may find a different way of doing what you do. Another way of looking at this is convenience. If you choose a location that makes it difficult to enter on a heavy traffic road, far from normal traffic/out of the way or just plain inconvenient, then the natural tenacity for customers is to find a substitute or even find a way to do it themselves. Often restaurants will choose a main street to locate, which is great for walking traffic, but where crossing traffic is more inconvenient or parking is a nightmare. A substitution that is easy to navigate, closer or cost’s less can especially weaken your position in these cases which definitely threatens the profitability of your business.
5. Threat of New Entry
How easily can competitors move into your location’s vicinity? If you think it could be easy, then you may need to think more strategically about your location. Researching your market and the regulations of the location may create opportunities to protect your business from others encroaching on it. If the area is already heavily populated and you are the only one present this creates valuable protection against new entrants. It is important to understand that if it takes very little money or effort to enter your market and compete effectively, then you will have little protection for your business against others who choose to do the same. So, choosing a location with strong, durable barriers to entry can create many advantages for your business success.
There are lots of factors that can be considered when choosing your locations business, and as this article highlights a short industry analysis will prove very valuable when you are starting to look for your BIG business location.