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THE FIVE COMPETITIVE FORCES THAT
SHAPE
STRATEGY STRATEGY You're Reading a Preview
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by Michael E. Porter Download With Free Trial
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Editor’s Note: In 1979, Harvard Business Review
published “How Competitive Forces Shape Strat-
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IN ESSENCE, the job of the strategist i stand and cope with competition. Often managers define competition too narr
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delivery industry in Europe. But to understand industry competition and profitabilThe Five Forces That Shape Industry Compe ity in each of those three cases, one must analyze the industry’s underlying structure in terms of the five forces. (See the exThreat hibit “The Five Forces That Shape Industry of New Competition.”) Entrants If the forces are intense, as they are in such industries as airlines, textiles, and hotels, almost no company earns attractive returns on investment. If the forces are benign, Rivalry as they are in industries such as software, Among Bargaining Bargain soft drinks, and toiletries, many companies Power of Power Existing Suppliers are profitable. Industry structure drives Buyer Competitors competition and profitability, not whether an industry produces a product or ser vice, is emerging or mature, high tech or low tech, regulated or unregulated. While a myriad of factors can affect industry profitability Threat of in the short run – including the weather Substitute Products or and the business cycle – industry structure, Services manifested in the competitive forces, sets industry profitability in the medium and long run. (See the exhibit “Differences in You're Reading a Preview Industry Profitability.”) full access withThe a free trial. Understanding the competitive forces, andUnlock their understrongest competitive force or forces dete lying causes, reveals the roots of an industry’s current profitprofitability of an industry and become the most ability while providing a framework for anticipating and strategy formulation. The most salient force, h Download WithtoFree Trial influencing competition (and profitability) over time. A not always obvious. healthy industry structure should be as much a competitive For example, even though rivalry is often fier concern to strategists as their company’s own position. Unmodity industries, it may not be the factor limi derstanding industry structure is also essential to effective ability. Low returns in the photographic film in strategic positioning. As we will see, defending against the instance, are the result of a superior substitut e pr competitive forces and shaping them in a company’s favor Kodak and producers SignFuji, up tothe voteworld’s on thisleading title are crucial to strategy. graphic film, learned with the advent of digital ph Useful Not useful In such a situation, coping with the substitute p Forces That Shape Competition comes the numb er one strategic priority. The configuration of the five forces differs by industry. In Industry structure grows out of a set of econ
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The threat of entry, therefore, puts a cap on the profit potential of an industry. When the threat is high, incumbents must hold down their prices or boost investment to deter new competitors. In specialty coffee retailing, for example, relatively low entry barriers mean that Starbucks must in vest aggressively in modernizing stores and menus. The threat of entry in an industry depends on the height of entry barriers that are present and on the reaction entrants can expect from incumbents. If entry barriers are low and newcomers expect little retaliation from the entrenched competitors, the threat of entry is high and industry profitability is moderated. It is the threat of entry, not whether entry actually occurs, that holds down profitability.
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entry by limiting the willingness of customers to newcomer and by reducing the price the newcom mand until it builds up a large base of customers 3. Customer switching costs. Switching costs are that buyers face when they change suppliers. Such arise because a buyer who switches vendors m ample, alter product specifications, retrain emplo a new product, or modify processes or informatio The larger the switching costs, the harder it will b trant to gain customers. Enterprise resource plan software is an example of a product with very high costs. Once a company has installed SAP’s ERP sys ample, the costs of moving to a new vendor are ast
Industry structure drives competition and profitability, not whether an industry is emerging or mature, high tech or low tech, regulated or unregulated. Barriers to entry. Entry barriers are advantages that incum-
because of embedded data, the fact that interna bents have relative to new entrants. There areYou're seven major been adapted to SAP, major retraining need Readinghave a Preview sources: mission-critical nature of the applications. Unlock full access with4. a free trial. requirements. The need to invest l Capital 1. Supply-side economies of scale. These economies arise when firms that produce at larger volumes enjoy lower costs cial resources in order to compete can deter new per unit because they can spread fixed costs over more units, may be necessary not only for fixed faciliti Download WithCapital Free Trial employ more efficient technology, or command better terms to extend customer credit, build inventories, and from suppliers. Supply-side scale economies deter entry by up losses. The barrier is particularly great if the forcing the aspiring entrant either to come into the industry required for unrecoverable and therefore harder on a large scale, which requires dislodging entrenched comexpenditures, such as up-front advertising or res petitors, or to accept a cost disadvantage. development. While major corporations have th the hu Scale economies can be found in virtually every activity resources to up invade almost any industry, Sign to vote on this title in the value chain; which ones are most important varies requirements in certain fields limit the pool of Useful Not useful 1 by industry. In microprocessors, incumbents such as Intel trants. Conversely, in such fields as tax preparati are protected by scale economies in research, chip fabricaor short-haul trucking, capital requirements ar tion, and consumer marketing. For lawn care companies like and potential entrants plentiful.
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bents to learn how to produce more efficiently. Entrants try Differences in Industry Profita to bypass such advantages. Upstart discounters such as Target and Wal-Mart, for example, have located stores in freeThe average return on invested capital varies ma standing sites rather than regional shopping centers where established department stores were well entrenched. industry to industry. Between 1992 and 200 6. Unequal access to distribution channels. The new enaverage return on invested capital in U.S. indust low as zero or even negative to more than 50% trant must, of course, secure distribution of its product or end are industries like soft drinks and prepackag service. A new food item, for example, must displace others which have been almost six times more profitab from the supermarket shelf via price breaks, promotions, intense selling efforts, or some other means. The more limairline industry over the period. ited the wholesale or retail channels are and the more that existing competitors have tied them up, the tougher entry into an industry will be. Sometimes access to distribution is so high a barrier that new entrants must bypass distribuable productive capacity, or clout with distribution tion channels altogether or create their own. Thus, upstart and customers. low-cost airlines have avoided distribution through travel • Incumbents seem likely to cut prices becaus agents (who tend to favor established higher-fare carriers) committed to retaining market share at all costs and have encouraged passengers to book their own flights the industry has high fixed costs, which create a on the internet. tivation to drop prices to fill excess capacity. 7. Restrictive government policy. Government policy can • Industry growth is slow so newcomers can ga hinder or aid new entry directly, as well as amplify (or nulonly by taking it from incumbents. lify) the other entry barriers. Government directly limits or An analysis of barriers to entry and expected re even forecloses entry into industries through, for instance, obviously crucial for any company contemplating licensing requirements and restrictions on foreign investindustry. The challenge is to find ways to You're Readingaanew Preview ment. Regulated industries like liquor retailing, taxi services, the entry barriers without nullifying, through he access with a free and airlines are visible examples. GovernmentUnlock policyfullcan ment, thetrial. profitability of participating in the indu THE POWER OF SUPPLIERS. Powerful supplie heighten other entry barriers through such means as expansive patenting rules that protect proprietary technolthe value for themselves by charging hig Download Withmore FreeofTrial ogy from imitation or environmental or safety regulations limiting quality or services, or shifting costs to that raise scale economies facing newcomers. Of course, ticipants. Powerful suppliers, including supplier government policies may also make entry easier – directly can squeeze profitability out of an industry that through subsidies, for instance, or indirectly by funding bato pass on cost increases in its own p rices. Micro sic research and making it available to all firms, new and old, stance, has contributed to the erosion of profitabil reducing scale economies. personalSign computer makers by title raising prices on up to vote on this Entry barriers should be assessed relative to the capasystems. PC makers, competing fiercely for custo Useful Not useful bilities of potential entrants, which may be start-ups, foreign can easily switch among t hem, have limited freedo firms, or companies in related industries. And, as some of their prices accordingly. our examples illustrate, the strategist must be mindfu l of the Companies depend on a wide range of differen
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10th percentile 7.0%
25th percentile
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Profitability of Selected U.S. Industries
Average Return on Invested Capital in U.S. Industries, 1992–2006 50
Strategic Business Models
Average ROIC, 1992–2006
Median:
75th percentile
90th percentile
14.3%
18.6%
25.3%
Security Brokers and Dealers
Soft Drinks
10.9%
Prepackaged Software Pharmaceuticals
40
Perfume, Cosmetics, Toiletries
s e i r t s u d n I f o r e b m u N
28.6
Advertising Agencies
Distilled Spirits
30
27.3%
26.4%
Semiconductors
21.3%
Medical Instruments
21.0%
Men’s and Boys’ Clothing
19.5%
20
Tires
19.5%
Household Appliances
19.2%
Malt Beverages
19.0%
Child Day Care Services
10
17.6%
Household Furniture
17.0%
Drug Stores
16.5%
Grocery Stores 0 0% or lower
5%
10%
15%
20%
25%
30%
ROIC
35% or higher
16.0%
Iron and Steel Foundries
15.6%
Cookies and Crackers
15.4%
Mobile Homes
13.9%
Bakery Products
13.8%
Return on invested capital (ROIC) is the appropriate measure Engines and Turbines of profitability for strategy formulation, not to mention for equity Book Publishing investors. Return on sales or the growth rate of profits fail to Laboratory Equipment account for the capital required to compete in the industry. Here, Oil and Gas Machinery we utilize earnings before interest and taxes dividedYou're by average Reading a PreviewSoft Drink Bottling Knitting Mills invested capital less excess cash as the measure of ROIC. This Hotels measure controls for idiosyncratic differences in capital structure Unlock full access with a free trial. Catalog, Mail-Order Houses and tax rates across companies and industries. Airlines
Source: Standard & Poor’s, Compustat, and author’s calculations
15.0%
Wine and Brandy
13.7% 13.4% 13.4% 12.6% 11.7% 10.5% 10.4% 5.9% 5.9%
Download With Free Trial ment or in learning how to operate a supplier’s equipment (as with Bloomberg terminals used by financial professionals). Or firms may have located their production lines adjacent to a supplier’s manufacturing facilities (as in the case of some beverage companies and container manufacturers). When switching costs are high, industry participants find it hard to play suppliers off against one another. (Note that suppliers may have switching costs as well. This limits their
THE POWER OF BUYERS. Powerful customer side of powerful suppliers – can capture more va ing down prices, demanding better quality or m playin (therebySign driving costs), and generally up toup vote on this title participants off against one another, all at the Useful Not useful industry profitability. Buyers are powerful if they tiating leverage relative to industry participants if they are price sensitive, using their clout prima
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can credibly threaten to integrate backward and Producers often attempt to diminish chan produce the industry’s product themselves if vendors are through exclusive arrangements with particular d too profitable. Producers of soft drinks and beer have long or retailers or by marketing directly to end use controlled the power of packaging manufacturers by threatnent manufacturers seek to develop power over a ening to make, and at times actually making, packaging ma by creating preferences for their component terials themselves. stream customers. Such is the case with bicycle A buyer group is price sensitive if: with sweeteners. DuPont has created enormou • The product it purchases from the industry represents advertising its Stainmaster brand of carpet fiber a significant fraction of its cost structure or procurement to the carpet manufacturers that actually buy budget. Here buyers are likely to shop around and bargain also to downstream consumers. Many consume hard, as consumers do for home mor tgages. Where the prodStainmaster carpet even though DuPont is no uct sold by an industry is a small fraction of buyers’ costs or manufacturer. expenditures, buyers are usually less price sensitive. THE THREAT OF SUBSTITUTES. A substitute • The buyer group earns low profits, is strapped for cash, the same or a similar function as an industry’s pr or is otherwise under pressure to trim its purchasing costs. different means. Videoconferencing is a substitut Highly profitable or cash-rich customers, in contrast, are genPlastic is a substitute for aluminum. E-mail is a erally less price sensitive (that is, of course, if the item does for express mail. Sometimes, the threat of subs not represent a large fraction of the ir costs). downstream or indirect, when a substitute replac • The quality of buyers’ products or services is little afindustry’s product. For example, lawn-care produ fected by the industr y’s product. Where quality is very much vices are threatened when multifamily homes in affected by the industr y’s product, buyers are generally less substitute for single-family homes in the suburbs price sensitive. When purchasing or renting production qualsold to agents is threatened when airline and trav ity cameras, for instance, makers of major motion pictures substitute for travel agents. opt for highly reliable equipment with the latest features. You're Reading aSubstitutes Preview are always present, but they are ea They pay limited attention to price. look because they may appear to b e very differen full access with a free trial. the buyer’s industry’s product: To someone searching for a Fa • The industry’s product has little effect onUnlock other costs. Here, buyers focus on price. Conversely, where gift, neckties and power tools may be substitutes an industry’s product or service can pay for itself many times do without, to purchase a used product r Download Withstitute Freeto Trial over by improving per formance or reducing labor, material, a new one, or to do it yourself (bring the service or other costs, buyers are usually more interested in quality in-house). than in price. Examples include products and services like tax When the threat of sub stitutes is high, industry accounting or well logging (which measures below-ground ity suffers. Substitute products or services limit an conditions of oil wells) that can save or even make the buyer profit potential by placing a ceiling on prices. throug money. Similarly, buyers tend not to be price sensitive in serdoes notSign distance itselfon from up to vote this substitutes title vices such as investment banking, where poor performance performance, marketing, or other means, it wil Useful Not useful can be costly and embarrassing. terms of profitability – and often growth p otentia Most sources of buyer power apply equally to consumSubstitutes not only limit profits in normal t ers and to business-to-business customers. Like industrial also reduce the bonanza an industry can reap in g
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buyer’s cost of switching to the substitute is low. Switching from a proprietary, branded drug to a generic drug usually involves minimal costs, for example, which is why the shift to generics (and the fall in prices) is so substantial and rapid. Strategists should be particularly alert to changes in other industries that may make them attractive substitutes when they were not before. Improvements in plastic materials, for example, allowed them to substitute for steel in many automobile components. In this way, technological changes
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may participate in an industry for image reasons a full line. Clashes of personality and ego have exaggerated rivalry to the detriment of profitabil such as the media and h igh technology. • Firms cannot read each other’s signals well lack of familiarity with one another, diverse app competing, or differing goals. The strength of rivalry reflects not just the i competition but also the basis of competition. sions on which competition takes place, and whe
Rivalry is especially destructive to profitability if it gravitate solely to price because price competition transfers profits dire from an industry to its customers.
or competitive discontinuities in seemingly unrelated busiconverge to compete on the same dimensions, nesses can have major impacts on industry profitability. Of influence on profitability. course the substitution threat can also shift in favor of an Rivalry is especially destructive to profitability industry, which bodes well for its future profitability and tates solely to price b ecause price competition tra You're Reading a Preview growth potential. its directly from an industry to its customers. Pri UnlockRivalry full access with a freeeasy trial.for competitors to see and match, m RIVALRY AMONG EXISTING COMPETITORS. usually among existing competitors takes many familiar forms, incessive rounds of retaliation likely. Sustained pri cluding price discounting, new product introductions, adalso trains customers to pay less attention Download Withtion Free Trial vertising campaigns, and service improvements. High rivalry features and service. limits the profitability of an industry. The degree to which riPrice competition is most liable to occur if: valry drives down an industry’s profit potential depends, first, • Products or services of rivals are nearly ide on the intensity with which companies compete and, second, there are few switching costs for buyers. This e on the basis on which they compete. competitors to cut prices to win new customers. in tha The intensity of rivalry is greatest if: line price wars circumstances Sign upreflect to votethe onsethis title • Competitors are numerous or are roughly equal in size • Fixed costs are high and marginal costs are Useful Not useful and power. In such situations, rivals find it hard to avoid creates intense pressure for competitors to cut p poaching business. Without an industry leader, practices detheir average costs, even close to t heir marginal co sirable for the industry as a whole go unenforced. incremental customers while still making some co
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soon become obsolete, and information may be perishable opportunities for all competitors. But fast grow if it diffuses rapidly or becomes outdated, thereby losing its suppliers in a powerful position, and high growth value. Services such as hotel accommodations are perishable entry barriers will draw in entrants. Even witho in the sense that unused capacity can never be recovered. trants, a high growth rate will not guarantee pro Competition on dimensions other than price – on product customers are powerful or substitutes are attract features, support services, delivery t ime, or brand image, for some fast-growth businesses, such as personal instance – is less likely to erode profitability because it imhave been among the least profitable industries proves customer value and can support higher prices. Also, years. A narrow focus on growth is one of the rivalry focused on such dimensions can improve value relaof bad strategy decisions. tive to substitutes or raise the barriers facing new entrants. Technology and innovation. Advanced techno While nonprice rivalry sometimes escalates to levels that novations are not by themselves enough to mak undermine industry profitability, this is less likely to occur try structurally attractive (or unattractive). Mun than it is with price rivalry. technology industries with price-insensitive bu As important as the dimensions of rivalry is whether riswitching costs, or high entry barriers arising f vals compete on the same dimensions. When all or many economies are often far more profitable than competitors aim to meet the same needs or compete on the tries, such as software and internet t echnologies, same attributes, the result is zero-sum competition. Here, competitors.2 one firm’s gain is often another’s loss, driving down profitGovernment. Government is not best under ability. While price competition runs a stronger risk than sixth force because government involvement is nonprice competition of becoming zero sum, this may not herently good nor bad for industry profitability happen if companies take care to segment their markets, way to understand the influence of government o targeting their low-price offerings to different customers. tion is to analyze how specific government policie Rivalry can be positive sum, or actually increase the averfive competitive forces. For instance, patents rai age profitability of an industr y, when each competitor boosting industry profit potential. Conv You're aims Readingtoaentry, Preview to serve the needs of different customer segments, with difernment policies favoring unions may raise supp Unlock access with free trial. profit potential. Bankruptcy rules ferent mixes of price, products, services, features, or full brand andadiminish identities. Such competition can not only support higher avfailing companies to reorganize rather than exit c erage profitability but also expand the indu stry, as the needs Download Withexcess Freecapacity Trial and intense rivalry. Government o of more customer groups are better met. The opportunity multiple levels and through many different polic for positive-sum competition will be greater in industries which will affect structure in different ways. serving diverse customer groups. With a clear understandComplementary products and services. Com ing of the structural underpinnings of rivalry, strategists can are products or services used together with an sometimes take steps to shift the nature of competition in product. Complements arise when the custom a more positive direction. of two products combined is greater Sign up to vote on this title than the su product’s value in isolation. Computer hardwar Useful Not useful Factors, Not Forces ware, for instance, are valuable together and worth Industry structure, as manifested in the strength of the five separated. competitive forces, determines the industry’s long-run profit In recent years, strategy researchers have high
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barriers to entry. In application software, for exa ers to entry were lowered when producers of co tary operating system software, notably Microsof Industry Analysis in Practice tool sets making it easier to write applications. Good industry analysis looks rigorously at the the need to attract producers of complements ca structural underpinnings of profitability. A first riers to entry, as it does in video game hardware. step is to understand the appropriate time The presence of complements can also affect horizon. One of the essential tasks in industry of substitutes. For instance, the need for appropri analysis is to distinguish temporary or cyclical changes stations makes it difficult for cars using alternati from structural changes. A good guideline for the substitute for conventional vehicles. But comple appropriate time horizon is the full business cycle for also make substitution easier. For example, App the particular industry. For most industries, a threehastened the substitution from CDs to digital mu to-five-year horizon is appropriate, although in some Complements can factor into industry rivalry industries with long lead times, such as mining, the tively (as when they raise switching costs) or neg appropriate horizon might be a decade or more. It is when they neutralize product differentiation). Sim average profitability over this period, not profitability in ses can be done for buyer and supplier power. S any particular year, that should be the focus of analysis. companies compete by altering conditions in co The point of industry analysis is not to declare tary industries in their favor, such as when vid the industry attractive or unattracti ve but to recorder producer JVC persuaded movie studio understand the underpinnings of competition and the root causes of profitability. As much as its standard in issuing prerecorded tapes even possible, analysts should look at industry structure val Sony’s standard was probably superior from quantitatively, rather than be satisfied with lists of standpoint. qualitative factors. Many elements of the five forces Identifying complements is part of the analyst can be quantified: the percentage of the buyer’s government policies or important techno You're Readingwith a Preview total cost accounted for by the industry’s product (to strategic significance of complements will be b understand buyer price sensitivity); the percentage of Unlock full access with a free trial. the lens of the five forces. stood through industry sales required to fill a plant or operate a logis-
tical network of efficient scale (to help assess barriers
Download to entry); the buyer’s switching cost (determining the inducement an entrant or rival must offer customers).
The strength of the competitive forces affects prices, costs, and the investment required to compete; thus the forces are directly t ied to the income statements and balance sheets of industry participants. Industry structure defines the gap between revenues and costs. For example, intense rivalry drives down prices or elevates the costs of marketing, R&D, or customer service, reducing margins. How much? Strong suppliers drive up input
in Industry Structure WithChanges Free Trial
So far, we have discussed the competitive forces point in time. Industry structure proves to be rel ble, and industry profitability differences are persistent over time in practice. However, industr is constantly undergoing modest adjustment – an ally it can change Sign up toabruptly. vote on this title Shifts in structure may emanate from outside a Useful Not useful or from within. They can boost the industry’s profi or reduce it. They may be caused by changes in t changes in customer needs, or other events. Th
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The Five Competitive Forces That Shape Strategy
example, retailers such as Wal-Mart, Kmart, and Toys “R” Us and geographic segments (such as riverboats, trop began to adopt new procurement, distribution, and inventies, Native American reservations, international tory control technologies with large fixed costs, including and novel customer groups like families). Head automated distribution centers, bar coding, and point-of-sale valry that lowers prices or boosts the payouts to w terminals. These investments increased the economies of been limited. scale and made it more difficult for small retailers to enter The nature of rivalry in an industry is altered b the business (and for existing small players to survive). and acquisitions that introduce new capabilities a competing. Or, technological innovation can resha Changing supplier or buyer power. As the factors underlying the power of suppliers and buyers change with time, In the retail brokerage industry, the advent of th their clout rises or declines. In the global appliance industry, lowered marginal costs and reduced differentiati for instance, competitors including Electrolux, General Elecing far more intense competition on commission tric, and Whirlpool have been s queezed by the consolidation than in the past. of retail channels (the decline of appliance specialty stores, In some industries, companies turn to merger for instance, and the rise of big-box retailers like Best Buy solidation not to improve cost and quality but to and Home Depot in the United States). Another example is stop intense competition. Eliminating rivals is a travel agents, who depend on airlines as a key supplier. When egy, however. The five competitive forces tell us th the internet allowed airlines to sell tickets directly to cuswindfall from removing today’s competitors ofte tomers, this significantly increased their power to bargain new competitors and backlash from customers a down agents’ commissions. ers. In New York banking, for example, the 1980s saw escalating consolidations of commercial an Shifting threat of substitution. The most common reason banks, including Manufacturers Hanover, Chem substitutes become more or less threatening over time is that advances in technology create new substitutes or shift and Dime Savings. But today the retail-banking price-performance comparisons in one direction or the other. of Manhattan is as diverse as ever, as new entran The earliest microwave ovens, for example, were large Reading and Wachovia, Bank of America, and Washington Mu You're a Preview priced above $2,000, making them poor substitutes for conentered the market. full access with a free trial. ventional ovens. With technological advances, Unlock they became Implications for Strategy serious substitutes. Flash computer memory has improved enough recently to become a meaningful substitute for lowDownload WithUnderstanding Free Trial the forces that shape industry co capacity hard-disk drives. Trends in the availability or peris the starting point for developing strategy. Every formance of complementary producers also s hift the threat should already know what the average profitab of substitutes. industry is and how that has been changing over five forces reveal why industry profitability is wha New bases of rivalry. Rivalry often intensifies naturally over time. As an industry matures, growth slows. Competithen can a company incorporate industry cond tors become more alike as industry conventions emerge, strategy.Sign up to vote on this title technology diffuses, and consumer tastes converge. Industry The forces reveal the most significant aspects o Useful Not useful profitability falls, and weaker competitors are driven from petitive environment. They also provide a baseline
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Using the five forces framework, creative strategists may be able to spot an industry with a good future before this good futu is reflected in the prices of acquisition candidates.
dustry structure that is more favorable to the company. The has tailored every single part of the value chain to best strategies exploit more than one of these possibilities. with the forces in its segment. As a result, Pacca profitable for 68 years straight and has earned Positioning the company. Strategy can be viewed as building defenses against the competitive forces or finding a posireturn on equity above 20%. tion in the industry where the forces are weakest. Consider, In addition to revealing positioning opportuni for instance, the position of Paccar in the market for heavy an existing industry, the five forces framework a trucks. The heavy-truck industry is structurally challenging. panies to rigorously analyze entry and exit. Both Many buyers operate large fleets or are large leasing comanswering the difficult question: “What is the p panies, with both the leverage and the motivation to drive this business?” Exit is indicated when industry s down the price of one of the ir largest purchases. Most trucks poor or declining and the company has no prosp are built to regulated standards and offer similar features, so perior positioning. In considering entry into a ne price competition is rampant. Capital intensity causes rivalry creative strategists can use the framework to spo try with a good future be fore this good future is r to be fierce, especially during the recurring cyclical downturns. Unions exercise considerable supplier power. Though the prices of acquisition candidates. Five forces an there are few direct substitutes for an 18-wheeler, truck buyalso reveal industries that are not necessarily att ers face important substitutes for their services, such as cargo the average entrant but in which a company has g delivery by rail. it can surmount entry barriers at lowe You're Readingtoa believe Preview most firms or has a unique ability to cope with the In this setting, Paccar, a Bellevue, Washington–based comfull access with a free trial.forces. pany with about 20% of the North AmericanUnlock heavy-truck competitive market, has chosen to focus on one group of customers: Exploiting industry change. Industry change owner-operators – drivers who own their trucks and contract Download Withopportunity Free Trial to spot and claim promising new str directly with shippers or serve as subcontractors to larger tions if the strategist has a sophisticated unders trucking companies. Such small operators have limited clout the competitive forces and their underpinnings as truck buyers. They are also less price sensitive because of for instance, the evolution of the music industry their strong emotional ties to and economic dependence on past decade. With the advent of the internet and the product. They take great pride in their trucks, in which distribution of music, some analysts predicted t they spend most of their time. thousands labels (that Signofupmusic to vote on this titleis, record comp Paccar has invested heavily to develop an array of feadevelop artists and bring their music to market Useful Not useful tures with owner-operators in mind: luxurious sleeper cabins, analysts argued, would break a pattern that had plush leather seats, noise-insulated cabins, sleek exterior stylEdison invented the phonograph: Between thr ing, and so on. At the company’s extensive network of dealers, major record companies had always dominated
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The Five Competitive Forces That Shape Strategy
This is not to say that the music industry is structurally unchanged by digital distribution. Unauthorized downloading created an illegal but potent substitute. The labels tried for years to develop technical platforms for digital distribution themselves, but major companies hesitated to sell their music through a platform owned by a rival. Into this vacuum
share of profits that leak to suppliers, buyers, and or are sacrificed to deter entrants. To neutralize supplier power, for example, a firm dardize specifications for parts to make it easier among suppliers. It can cultivate additional vendo technology to avoid a powerful supplier group
Faced with pressures to gain market share or enamored w innovation for its own sake, managers can spark new kinds of competition that no incumbent can win.
stepped Apple with its iTunes music store, launched in 2003 To counter customer power, companies may expa to support its iPod music player. By permitting the creation that raise buyers’ switching costs or find alternat of a powerful new gatekeeper, the major labels allowed inof reaching customers to neutralize powerful ch dustry structure to shift against them . The number of major temper profit-eroding price rivalry, companies record companies has actually declined – from six in 1997 to more heavily in unique products, as pharmaceu four today – as companies struggled to cope with the digital have done, or expand support services to custome phenomenon. off entrants, incumbents can elevate the fixed c When industry structure is in flux, new and promising – for instance, by escalating their R&D You're Readingpeting a Preview competitive positions may appear. Structural changes open expenditures. To limit the threat of substitutes, access with free trial. up new needs and new ways to serve existing Unlock needs. full Estabcanaoffer better value through new features or wid lished leaders may overlook these or be constrained by past accessibility. When soft-drink produ cers introduce strategies from pursuing them. Smaller competitors in the and convenience store channels, for exa Download Withmachines Free Trial industry can capitalize on such changes, or the void may well dramatically improved the availability of soft drin be filled by new entrants. to other beverages. Sysco, the largest food-service distributor in N Shaping industry structure. When a company exploits structural change, it is recognizing, and reacting to, the inica, offers a revealing example of how an indus evitable. However, companies also have the ability to shape can change the structure of an industry for the be industry structure. A firm can lead its industry toward new service distributors purchase Sign up to vote on thisfood title and related i ways of competing that alter the five forces for the better. farmers and food processors. They then warehou Useful Not useful In reshaping structure, a company wants its competitors liver these items to restaurants, hospitals, emplo to follow so that the entire industry will be transformed. rias, schools, and other food-service institutions. While many industry participants may benefit in the process, barriers to entry, the food-service distribution
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credit, menu planning, and inventory management to shift the basis of competition away from just price. These moves, together with stepped-up investments in information technology and regional distribution centers, substantially raised the bar for new entrants while making the substitutes less attractive. Not surprisingly, the industry has been consolidating, and industry profitability appears to be rising. Industry leaders have a special responsibility for improving industry structure. Doing so often requires resources that only large players possess. Moreover, an improved industry structure is a public good because it benefits every firm in the industry, not just the company that initiated the im-
Defining the Relevant Industry
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provement. Often, it is more in the interests of a leader than any other participant to invest for th good because leaders will usually benefit the mo improving the industry may be a leader’s most strategic opportunity, in part because attempts ther market share can trigger strong reactions f customers, and even suppliers. There is a dark side to shaping industry struct equally important to understand. Ill-advised chan petitive positioning and operating practices can industry structure. Faced with pressures to gain m or enamored with innovation for its own sake, man
The five forces are the basic tool to
has a similar structure in every
resolve these questions. If industry
(rivals, buyers, and so on), the
Defining the industry in which competi-
structure for two products is the same
sumption is that competition is
tion actually takes place is import ant
or very similar (that is, if they have the
and the five forces analyzed fro
for good industry analysis, not to
same buyers, suppliers, barriers to en-
global perspective will set ave
mention for developing strategy and
try, and so forth), then the products are
profitability. A single global str
setting business unit boundaries. Many
best treated as being part of the same
needed. If an industry has quit
strategy errors emanate from mistak-
industry. If industry structure differs
ent structures in different geog
ing the relevant industry, defining it too
markedly, however, the two products
regions, however, each region
broadly or too narrowly. Defining the
may be best separate Unlock full understood access with as a free trial.
well be a distinct industry. Oth
industry too broadly obscures differ-
industries.
competition would have levele
ences among products, customers, or
You're Reading a Preview
In lubricants, the oil used in cars is
ferences. The five forces analy
geographic regions that are important
Download With Free similar or even identical to theTrial oil used
to competition, strategic positioning,
in trucks, but the similarity largely ends
and profitability. Defining the industry
there. Automotive motor oil is sold to
forces for related products or a
too narrowly overlooks commonalities
fragmented, generally unsophisticated
geographic areas is a matter o
and linkages across related products or
customers through numerous and of-
making industry definition ofte
geographic markets that are crucial to
ten powerful channels, using extensive
ter of judgment. A rule of thum
competitive advantage. Also, strate-
advertising. Products are packaged in
each region will set profitability
The extent of differences in
Sign up to vote on this title
where the differences in any o
gists must be sensitive to the possibil-
Useful small containers and logistical costs are
ity that industry boundaries can shift.
high, necessitating local production.
involve more than one force, d
Truck and power generation lubricants
industries may well be present
The boundaries of an industry con-
useful areNot large, and where the differ
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The Five Competitive Forces That Shape Strategy
trigger new kinds of competition that no incumbent can win. Typical Steps in Industry Analysi When taking actions to improve their own company’s competitive advantage, then, strategists should ask whether they Define the relevant industry: are setting in motion dynamics that will undermine industry What products are in it? Which ones are part o structure in the long run. In the early days of the personal another distinct industry? computer industry, for instance, IBM tried to make up for What is the geographic scope of competition its late entry by offering an open architecture that would set industry standards and attract complementary makers Identify the partici pants and segment them int of application software and peripherals. In the process, it groups, if appropriate: ceded ownership of the critical components of the PC – the Who are operating system and the microprocessor – to Microsoft and the buyers and buyer groups? Intel. By standardizing PCs, it encouraged price-based rivalry the suppliers and supplier groups? and shifted power to suppliers. Consequently, IBM became the competitors? the temporarily dominant firm in an industry with an endurthe substitutes? ingly unattractive structure. the potential entrants? Expanding the profit pool. When overall demand grows, the industry’s quality level rises, intrinsic costs are reduced, Assess the underlying drivers of each competi or waste is eliminated, the pie expands. The total pool of force to determine which forces are strong and value available to competitors, suppliers, and buyers grows. are weak and why. The total profit pool expands, for example, when channels Determine overall industry structure, and tes become more competitive or when an industry discovers analysis for consistency: latent buyers for its product that are not currently being Why is the level of profitability what it is? served. When soft-drink producers rationalized their indeWhich are the controlling forces for profitabilit pendent bottler networks to make them more efficient and You're Reading a Preview Is the industry analysis consistent with actual effective, both the soft-drink companies and the bottlers long-run profitability? Unlock access with a free trial. benefited. Overall value can also expand when firmsfull work Are more- profitable players better positioned collaboratively with suppliers to improve coordination and relation to the five forces? limit unnecessary costs incurred in the supply chain. This Download With Free Trial lowers the inherent cost structure of the industry, allowing Analyze recent and likely future changes in eac higher profit, greater demand through lower prices, or both. force, both positive and negative. Or, agreeing on quality standards can bring up industrywide Identify aspec ts of industry structure that migh quality and service levels, and hence prices, benefiting rivals, influenced by competitors, by new entrants, suppliers, and customers. your company. Expanding the overall profit pool creates win-win opporSign up to vote on this title tunities for multiple industry par ticipants. It can also reduce Useful Not useful the risk of destructive rivalry that arises when incumbents Common Pitfalls attempt to shift bargaining power or capture more marIn conducting the analysis avoid the f ollowing ket share. However, expanding the pie does not reduce the ■
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Competition and Value The competitive forces reveal the drivers of industry competition. A company strategist who understands that competition extends well beyond existing rivals will detect wider competitive threats and be better equipped to address them. At the same time, thinking comprehensively about an industry’s structure can u ncover opportunities: differences in customers, suppliers, substitutes, potential entrants, and ri vals that can become the basis for distinct strategies yielding superior performance. In a world of more open competition and relentless change, it is more important than ever to think structurally about competition. Understanding industry structure is equally important for investors as for managers. The five competitive forces reveal whether an industry is truly attractive, and they help investors anticipate positive or negative shifts in industry structure before they are obvious. The five forces distinguish short-term blips from structural changes and allow investors to take advantage of undue pessimism or optimism. Those companies whose strategies have industry-transforming potential become far clearer. This deeper thinking about competition is a more powerful way to achieve genuine
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investment success than the financial projections extrapolation that dominate today’s investment a If both executives and investors looked at co this way, capital markets would be a far more effe for company success and economic prosperity. and investors would both be focused on the sa mentals that drive sustained profitability. The co between investors and executives would focus o tural, not the transient. Imagine the improveme pany performance – and in the economy as a wh the energy expended in “pleasing the Street” were toward the factors that create true economic valu
1. For a discussion of the value chain framework, see Michael E petitive Advantage: Creating and Sustaining Superior Performa Press, 1998).
2. For a discussion of how internet technology improves the at some industries while eroding the profitability of others, see Mi “Strategy and the Internet” (HBR, March 2001).
3. See, for instance, Adam M. Brandenburger and Barry J. Nalebu (Currency Doubleday, 1996).
Reprint R0801E To order, see page 139.
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