I think it's important for new investors to understand some basics of business strategy. Below I have decided to use a basic strategy framework to describe how market forces will effect a lemonade stand.
Porters 5 Forces and a Lemonade Stand
Porters 5 Forces model is the classic framework for analyzing business competition and potential profitability. It is one of the first things introduced in a quality business school curriculum and has been referenced for decades. At it’s highest level, this model looks at expected external factors and how it will effect profitability.
Billy gets some lemons and opens up shop on the sidewalk. Here are some threats he will face:
1. New Entrants Billy’s friend Colin sees that there is demand for Billy’s lemonade and decides to open up a discount lemonade shop. Now that there are two stands, Billy will have to lower the price of his drink to compete or no one will come to his stand anymore.
2. Substitutes Billy’s other friend Joey hears that the cool kids drink iced tea in the summer. Joey opens up a tea stand, and more of Billy’s business falls off.
3. Bargaining customers There are now two lemonade stands and one iced tea stand. The thirsty people realize that the drink stands are competing. Sally approaches Billy and offers him 50 cents for a cup of lemonade, even though he’s charging a dollar. But since Sally is the only one there, Billy gives in an reduces his price.
4. Bargaining suppliers Due to a large hurricane that destroyed 4 out of the 5 top lemon groves in the world, the one undamaged grove is raising their prices. With a higher lemon cost, Billy’s profit takes a hit. Is this the end?
5. Rivalry Although discouraged at first by the competition, Billy realized that there were actions he could take to improve his business:
*His mom shared her secret recipe for purple lemonade and all the kids love it. No one else can figure it out.
*He hosted a ladies night where the first 10 girls drink for free. All the boys came to hang out and were thirsty too.
*When competition caused profit to fall, he started to think of the cheap low-margin lemonade as the advertisement, and focused on upselling popsicles when customers arrived.
This, in a nutshell, is how competition drives innovation and ultimately benefits the consumer. This example also underscores the huge importance of finding your competitive advantage and building a sustainable moat in order to mitigate the impact of these external forces.
Thankfully, Billy was able to stay in business due to the innovation of his purple lemonade and the enduring demand for popsicles. Meanwhile, Colin and Joey failed in their ability to pivot. The realities of competition caught up with them and they paid the price– literally.
Please let me know if you find value in this, or if there are other related topics you are interested in learning more about!
-Paul
Submitted December 31, 2017 at 04:33PM by PWUsername http://ift.tt/2CvBm2Z
