The Five Competitive Forces That Shape Strategy

The Five Competitive Forces That Shape Strategy · Contending Forces · The Experience Curve as an Entry Barrier · Formulation of Strategy · Multifaceted Rivalry. TheFiveCompetitiveForcesThatShapeStrategy MichaelE.Porter| 1979March | 30 minutestoread. Inthishighlyinfluentialpaperattheintersectionofeconomicsandbusiness,authorshowsthatindustry-levelprofitabilityisafactoroffivecompetitiveforces.Unlikeclassicalmicroeconomictheorywhichseescompetitionbetweenindustryrivalsastheonlyforce,itisonlyoneoftheauthor’sfiveforces.Otherfourforcesinfluencingfirm’sbargainpower,thusitsprofitability,are:bargainingpowerofsuppliersandbuyers,threatofnewentrantsandsubstituteproducts.Understandingthesefiveforces,allowsthefirmtoformulatestrategyofhigherprofitability.Somesuchstrategiesmayincludepositioningthecompanytoexploittheweakerforces,exploitthechangeinthestructuralforcesorchangethebalanceitself.Antecedentsofthefiveforcescanbeseeninclassicaleconomics,newinstitutionaleconomicsandSchumpeterianevolutionaryeconomics. Yellowhighlights/annotationsaremyown. Youcandisablethem. Theessenceofstrategyformulationiscopingwithcompetition.Yetitiseasytoviewcompetitiontoonarrowlyandtoopessimistically.Whileonesometimeshearsexecutivescomplainingtothecontrary,intensecompetitioninanindustryisneithercoincidencenorbadluck. Moreover,inthefightformarketshare,competitionisnotmanifestedonlyintheotherplayers.Rather,competitioninanindustryisrootedinitsunderlyingeconomics,andcompetitiveforcesexistthatgowellbeyondtheestablishedcombatantsinaparticularindustry.Customers,suppliers,potentialentrants,andsubstituteproductsareallcompetitorsthatmaybemoreorlessprominentoractivedependingontheindustry. Thestateofcompetitioninanindustrydependsonfivebasicforces,whicharediagrammedintheExhibit.Thecollectivestrengthoftheseforcesdeterminestheultimateprofitpotentialofanindustry.Itrangesfromintenseinindustriesliketires,metalcans,andsteel,wherenocompanyearnsspectacularreturnsoninvestment,tomildinindustrieslikeoilfieldservicesandequipment,softdrinks,andtoiletries,wherethereisroomforquitehighreturns. ⊕ Exhibit:Forcesgoverningcompetitioninanindustry Intheeconomists’“perfectlycompetitive”industry,jockeyingforpositionisunbridledandentrytotheindustryveryeasy.Thiskindofindustrystructure,ofcourse,offerstheworstprospectforlong-runprofitability.Theweakertheforcescollectively,however,thegreatertheopportunityforsuperiorperformance. Whatevertheircollectivestrength,thecorporatestrategist’sgoalistofindapositionintheindustrywherehisorhercompanycanbestdefenditselfagainsttheseforcesorcaninfluencetheminitsfavor.Thecollectivestrengthoftheforcesmaybepainfullyapparenttoalltheantagonists;buttocopewiththem,thestrategistmustdelvebelowthesurfaceandanalyzethesourcesofeach.Forexample,whatmakestheindustryvulnerabletoentry,whatdeterminesthebargainingpowerofsuppliers? Knowledgeoftheseunderlyingsourcesofcompetitivepressureprovidesthegroundworkforastrategicagendaofaction.Theyhighlightthecriticalstrengthsandweaknessesofthecompany,animatethepositioningofthecompanyinitsindustry,clarifytheareaswherestrategicchangesmayyieldthegreatestpayoff,andhighlighttheplaceswhereindustrytrendspromisetoholdthegreatestsignificanceaseitheropportunitiesorthreats.Understandingthesesourcesalsoprovestobeofhelpinconsideringareasfordiversification. ContendingForces Thestrongestcompetitiveforceorforcesdeterminetheprofitabilityofanindustryandsoareofgreatestimportanceinstrategyformulation.Forexample,evenacompanywithastrongpositioninanindustryunthreatenedbypotentialentrantswillearnlowreturnsifitfacesasuperiororalower-costsubstituteproduct—astheleadingmanufacturersofvacuumtubesandcoffeepercolatorshavelearnedtotheirsorrow.Insuchasituation,copingwiththesubstituteproductbecomesthenumberonestrategicpriority. Differentforcestakeonprominence,ofcourse,inshapingcompetitionineachindustry.Intheocean-goingtankerindustrythekeyforceisprobablythebuyers(themajoroilcompanies),whileintiresitispowerfulOEMbuyerscoupledwithtoughcompetitors.Inthesteelindustrythekeyforcesareforeigncompetitorsandsubstitutematerials. Everyindustryhasanunderlyingstructure,orasetoffundamentaleconomicandtechnicalcharacteristics,thatgivesrisetothesecompetitiveforces.Thestrategist,wantingtopositionhisorhercompanytocopebestwithitsindustryenvironmentortoinfluencethatenvironmentinthecompany’sfavor,mustlearnwhatmakestheenvironmenttick. Thisviewofcompetitionpertainsequallytoindustriesdealinginservicesandtothosesellingproducts.Toavoidmonotonyinthisarticle,Irefertobothproductsandservicesas“products.”Thesamegeneralprinciplesapplytoalltypesofbusiness. Afewcharacteristicsarecriticaltothestrengthofeachcompetitiveforce.Ishalldiscusstheminthissection. Threatofentry Newentrantstoanindustrybringnewcapacity,thedesiretogainmarketshare,andoftensubstantialresources.Companiesdiversifyingthroughacquisitionintotheindustryfromothermarketsoftenleveragetheirresourcestocauseashake-up,asPhilipMorrisdidwithMillerbeer. Theseriousnessofthethreatofentrydependsonthebarrierspresentandonthereactionfromexistingcompetitorsthatentrantscanexpect.Ifbarrierstoentryarehighandnewcomerscanexpectsharpretaliationfromtheentrenchedcompetitors,obviouslythenewcomerswillnotposeaseriousthreatofentering. Therearesixmajorsourcesofbarrierstoentry: Economiesofscale:Theseeconomiesdeterentrybyforcingtheaspiranteithertocomeinonalargescaleortoacceptacostdisadvantage.Scaleeconomiesinproduction,research,marketing,andserviceareprobablythekeybarrierstoentryinthemainframecomputerindustry,asXeroxandGEsadlydiscovered.Economiesofscalecanalsoactashurdlesindistribution,utilizationofthesalesforce,financing,andnearlyanyotherpartofabusiness. Productdifferentiation:Brandidentificationcreatesabarrierbyforcingentrantstospendheavilytoovercomecustomerloyalty.Advertising,customerservice,beingfirstintheindustry,andproductdifferencesareamongthefactorsfosteringbrandidentification.Itisperhapsthemostimportantentrybarrierinsoftdrinks,over-the-counterdrugs,cosmetics,investmentbanking,andpublicaccounting.Tocreatehighfencesaroundtheirbusinesses,brewerscouplebrandidentificationwitheconomiesofscaleinproduction,distribution,andmarketing. Capitalrequirements:Theneedtoinvestlargefinancialresourcesinordertocompetecreatesabarriertoentry,particularlyifthecapitalisrequiredforunrecoverableexpendituresinup-frontadvertisingorR&D.Capitalisnecessarynotonlyforfixedfacilitiesbutalsoforcustomercredit,inventories,andabsorbingstart-uplosses.Whilemajorcorporationshavethefinancialresourcestoinvadealmostanyindustry,thehugecapitalrequirementsincertainfields,suchascomputermanufacturingandmineralextraction,limitthepooloflikelyentrants. Costdisadvantagesindependentofsize:Entrenchedcompaniesmayhavecostadvantagesnotavailabletopotentialrivals,nomatterwhattheirsizeandattainableeconomiesofscale.Theseadvantagescanstemfromtheeffectsofthelearningcurve(andofitsfirstcousin,theexperiencecurve),proprietarytechnology,accesstothebestrawmaterialssources,assetspurchasedatpreinflationprices,governmentsubsidies,orfavorablelocations.Sometimescostadvantagesarelegallyenforceable,astheyarethroughpatents.(Forananalysisofthemuch-discussedexperiencecurveasabarriertoentry,seetheinsert.) Accesstodistributionchannels:Thenewcomerontheblockmust,ofcourse,securedistributionofitsproductorservice.Anewfoodproduct,forexample,mustdisplaceothersfromthesupermarketshelfviapricebreaks,promotions,intensesellingefforts,orsomeothermeans.Themorelimitedthewholesaleorretailchannelsareandthemorethatexistingcompetitorshavethesetiedup,obviouslythetougherthatentryintotheindustrywillbe.Sometimesthisbarrierissohighthat,tosurmountit,anewcontestantmustcreateitsowndistributionchannels,asTimexdidinthewatchindustryinthe1950s. Governmentpolicy:Thegovernmentcanlimitorevenforecloseentrytoindustrieswithsuchcontrolsaslicenserequirementsandlimitsonaccesstorawmaterials.Regulatedindustriesliketrucking,liquorretailing,andfreightforwardingarenoticeableexamples;moresubtlegovernmentrestrictionsoperateinfieldslikeski-areadevelopmentandcoalmining.Thegovernmentalsocanplayamajorindirectrolebyaffectingentrybarriersthroughcontrolssuchasairandwaterpollutionstandardsandsafetyregulations. TheExperienceCurveasanEntryBarrier Inrecentyears,theexperiencecurvehasbecomewidelydiscussedasakeyelementofindustrystructure.Accordingtothisconcept,unitcostsinmanymanufacturingindustries(somedogmaticadherentssayinallmanufacturingindustries)aswellasinsomeserviceindustriesdeclinewith“experience,”oraparticularcompany’scumulativevolumeofproduction.(Theexperiencecurve,whichencompassesmanyfactors,isabroaderconceptthanthebetterknownlearningcurve,whichreferstotheefficiencyachievedoveraperiodoftimebyworkersthroughmuchrepetition.) Thecausesofthedeclineinunitcostsareacombinationofelements,includingeconomiesofscale,thelearningcurveforlabor,andcapital-laborsubstitution.Thecostdeclinecreatesabarriertoentrybecausenewcompetitorswithno“experience”facehighercoststhanestablishedones,particularlytheproducerwiththelargestmarketshare,andhavedifficultycatchingupwiththeentrenchedcompetitors. Adherentsoftheexperiencecurveconceptstresstheimportanceofachievingmarketleadershiptomaximizethisbarriertoentry,andtheyrecommendaggressiveactiontoachieveit,suchaspricecuttinginanticipationoffallingcostsinordertobuildvolume.Forthecombatantthatcannotachieveahealthymarketshare,theprescriptionisusually,“Getout.” Istheexperiencecurveanentrybarrieronwhichstrategiesshouldbebuilt?Theansweris:notineveryindustry.Infact,insomeindustries,buildingastrategyontheexperiencecurvecanbepotentiallydisastrous.Thatcostsdeclinewithexperienceinsomeindustriesisnotnewstocorporateexecutives.Thesignificanceoftheexperiencecurveforstrategydependsonwhatfactorsarecausingthedecline. Ifcostsarefallingbecauseagrowingcompanycanreapeconomiesofscalethroughmoreefficient,automatedfacilitiesandverticalintegration,thenthecumulativevolumeofproductionisunimportanttoitsrelativecostposition.Herethelowest-costproduceristheonewiththelargest,mostefficientfacilities. Anewentrantmaywellbemoreefficientthanthemoreexperiencedcompetitors;ifithasbuiltthenewestplant,itwillfacenodisadvantageinhavingtocatchup.Thestrategicprescription,“Youmusthavethelargest,mostefficientplant,”isalotdifferentfrom,“Youmustproducethegreatestcumulativeoutputoftheitemtogetyourcostsdown.” Whetheradropincostswithcumulative(notabsolute)volumeerectsanentrybarrieralsodependsonthesourcesofthedecline.Ifcostsgodownbecauseoftechnicaladvancesknowngenerallyintheindustryorbecauseofthedevelopmentofimprovedequipmentthatcanbecopiedorpurchasedfromequipmentsuppliers,theexperiencecurveisnoentrybarrieratall—infact,neworlessexperiencedcompetitorsmayactuallyenjoyacostadvantageovertheleaders.Freeofthelegacyofheavypastinvestments,thenewcomerorlessexperiencedcompetitorcanpurchaseorcopythenewestandlowest-costequipmentandtechnology. If,however,experiencecanbekeptproprietary,theleaderswillmaintainacostadvantage.Butnewentrantsmayrequirelessexperiencetoreducetheircoststhantheleadersneeded.Allthissuggeststhattheexperiencecurvecanbeashakyentrybarrieronwhichtobuildastrategy. Whilespacedoesnotpermitacompletetreatmenthere,Iwanttomentionafewothercrucialelementsindeterminingtheappropriatenessofastrategybuiltontheentrybarrierprovidedbytheexperiencecurve: Theheightofthebarrierdependsonhowimportantcostsaretocompetitioncomparedwithotherareaslikemarketing,selling,andinnovation. Thebarriercanbenullifiedbyproductorprocessinnovationsleadingtoasubstantiallynewtechnologyandtherebycreatinganentirelynewexperiencecurve.*Newentrantscanleapfrogtheindustryleadersandalightonthenewexperiencecurve,towhichthoseleadersmaybepoorlypositionedtojump. Ifmorethanonestrongcompanyisbuildingitsstrategyontheexperiencecurve,theconsequencescanbenearlyfatal.Bythetimeonlyonerivalisleftpursuingsuchastrategy,industrygrowthmayhavestoppedandtheprospectsofreapingthespoilsofvictorylongsinceevaporated. (*)ForanexampledrawnfromthehistoryoftheautomobileindustryseeWilliamJ.AbernathyandKennethWayne,“TheLimitsoftheLearningCurve,”HBRSeptember–October1974,p.109. Thepotentialrival’sexpectationsaboutthereactionofexistingcompetitorsalsowillinfluenceitsdecisiononwhethertoenter.Thecompanyislikelytohavesecondthoughtsifincumbentshavepreviouslylashedoutatnewentrantsorif: Theincumbentspossesssubstantialresourcestofightback,includingexcesscashandunusedborrowingpower,productivecapacity,orcloutwithdistributionchannelsandcustomers. Theincumbentsseemlikelytocutpricesbecauseofadesiretokeepmarketsharesorbecauseofindustrywideexcesscapacity. Industrygrowthisslow,affectingitsabilitytoabsorbthenewarrivalandprobablycausingthefinancialperformanceofallthepartiesinvolvedtodecline. Changingconditions.Fromastrategicstandpointtherearetwoimportantadditionalpointstonoteaboutthethreatofentry. First,itchanges,ofcourse,astheseconditionschange.TheexpirationofPolaroid’sbasicpatentsoninstantphotography,forinstance,greatlyreduceditsabsolutecostentrybarrierbuiltbyproprietarytechnology.ItisnotsurprisingthatKodakplungedintothemarket.Productdifferentiationinprintinghasallbutdisappeared.Conversely,intheautoindustryeconomiesofscaleincreasedenormouslywithpost-WorldWarIIautomationandverticalintegration—virtuallystoppingsuccessfulnewentry. Second,strategicdecisionsinvolvingalargesegmentofanindustrycanhaveamajorimpactontheconditionsdeterminingthethreatofentry.Forexample,theactionsofmanyU.S.wineproducersinthe1960stostepupproductintroductions,raiseadvertisinglevels,andexpanddistributionnationallysurelystrengthenedtheentryroadblocksbyraisingeconomiesofscaleandmakingaccesstodistributionchannelsmoredifficult.Similarly,decisionsbymembersoftherecreationalvehicleindustrytoverticallyintegrateinordertolowercostshavegreatlyincreasedtheeconomiesofscaleandraisedthecapitalcostbarriers. Powerfulsuppliers&buyers Supplierscanexertbargainingpoweronparticipantsinanindustrybyraisingpricesorreducingthequalityofpurchasedgoodsandservices.Powerfulsupplierscantherebysqueezeprofitabilityoutofanindustryunabletorecovercostincreasesinitsownprices.Byraisingtheirprices,softdrinkconcentrateproducershavecontributedtotheerosionofprofitabilityofbottlingcompaniesbecausethebottlers,facingintensecompetitionfrompowderedmixes,fruitdrinks,andotherbeverages,havelimitedfreedomtoraisetheirpricesaccordingly.Customerslikewisecanforcedownprices,demandhigherqualityormoreservice,andplaycompetitorsoffagainsteachother—allattheexpenseofindustryprofits. Thepowerofeachimportantsupplierorbuyergroupdependsonanumberofcharacteristicsofitsmarketsituationandontherelativeimportanceofitssalesorpurchasestotheindustrycomparedwithitsoverallbusiness. Asuppliergroupispowerfulif: Itisdominatedbyafewcompaniesandismoreconcentratedthantheindustryitsellsto. Itsproductisuniqueoratleastdifferentiated,orifithasbuiltupswitchingcosts.Switchingcostsarefixedcostsbuyersfaceinchangingsuppliers.Thesearisebecause,amongotherthings,abuyer’sproductspecificationstieittoparticularsuppliers,ithasinvestedheavilyinspecializedancillaryequipmentorinreaminghowtooperateasupplier’sequipment(asincomputersoftware),oritsproductionlinesareconnectedtothesupplier’smanufacturingfacilities(asinsomemanufactureofbeveragecontainers). Itisnotobligedtocontendwithotherproductsforsaletotheindustry.Forinstance,thecompetitionbetweenthesteelcompaniesandthealuminumcompaniestoselltothecanindustrychecksthepowerofeachsupplier. Itposesacrediblethreatofintegratingforwardintotheindustry’sbusiness.Thisprovidesacheckagainsttheindustry’sabilitytoimprovethetermsonwhichitpurchases. Theindustryisnotanimportantcustomerofthesuppliergroup.Iftheindustryisanimportantcustomer,suppliers’fortuneswillbecloselytiedtotheindustry,andtheywillwanttoprotecttheindustrythroughreasonablepricingandassistanceinactivitieslikeR&Dandlobbying. Abuyergroupispowerfulif: Itisconcentratedorpurchasesinlargevolumes.Largevolumebuyersareparticularlypotentforcesifheavyfixedcostscharacterizetheindustry—astheydoinmetalcontainers,cornrefining,andbulkchemicals,forexample—whichraisethestakestokeepcapacityfilled. Theproductsitpurchasesfromtheindustryarestandardorundifferentiated.Thebuyers,surethattheycanalwaysfindalternativesuppliers,mayplayonecompanyagainstanother,astheydoinaluminumextrusion. Theproductsitpurchasesfromtheindustryformacomponentofitsproductandrepresentasignificantfractionofitscost.Thebuyersarelikelytoshopforafavorablepriceandpurchaseselectively.Wheretheproductsoldbytheindustryinquestionisasmallfractionofbuyers’costs,buyersareusuallymuchlesspricesensitive. Itearnslowprofits,whichcreategreatincentivetoloweritspurchasingcosts.Highlyprofitablebuyers,however,aregenerallylesspricesensitive(thatis,ofcourse,iftheitemdoesnotrepresentalargefractionoftheircosts). Mostofthesesourcesofbuyerpowercanbeattributedtoconsumersasagroupaswellastoindustrialandcommercialbuyers;onlyamodificationoftheframeofreferenceisnecessary.Consumerstendtobemorepricesensitiveiftheyarepurchasingproductsthatareundifferentiated,expensiverelativetotheirincomes,andofasortwherequalityisnotparticularlyimportant. Thebuyingpowerofretailersisdeterminedbythesamerules,withoneimportantaddition.Retailerscangainsignificantbargainingpowerovermanufacturerswhentheycaninfluenceconsumers’purchasingdecisions,astheydoinaudiocomponents,jewelry,appliances,sportinggoods,andothergoods. Strategicaction.Acompany’schoiceofsupplierstobuyfromorbuyergroupstoselltoshouldbeviewedasacrucialstrategicdecision.Acompanycanimproveitsstrategicposturebyfindingsuppliersorbuyerswhopossesstheleastpowertoinfluenceitadversely. Mostcommonisthesituationofacompanybeingabletochoosewhomitwillsellto—inotherwords,buyerselection.Rarelydoallthebuyergroupsacompanysellstoenjoyequalpower.Evenifacompanysellstoasingleindustry,segmentsusuallyexistwithinthatindustrythatexerciselesspower(andthatarethereforelesspricesensitive)thanothers.Forexample,thereplacementmarketformostproductsislesspricesensitivethantheoverallmarket. Asarule,acompanycanselltopowerfulbuyersandstillcomeawaywithabove-averageprofitabilityonlyifitisalow-costproducerinitsindustryorifitsproductenjoyssomeunusual,ifnotunique,features.Insupplyinglargecustomerswithelectricmotors,EmersonElectricearnshighreturnsbecauseitslowcostpositionpermitsthecompanytomeetorundercutcompetitors’prices. Ifthecompanylacksalowcostpositionorauniqueproduct,sellingtoeveryoneisself-defeatingbecausethemoresalesitachieves,themorevulnerableitbecomes.Thecompanymayhavetomusterthecouragetoturnawaybusinessandsellonlytolesspotentcustomers. BuyerselectionhasbeenakeytothesuccessofNationalCanandCrownCork&Seal.Theyfocusonthesegmentsofthecanindustrywheretheycancreateproductdifferentiation,minimizethethreatofbackwardintegration,andotherwisemitigatetheawesomepoweroftheircustomers.Ofcourse,someindustriesdonotenjoytheluxuryofselecting“good”buyers. Asthefactorscreatingsupplierandbuyerpowerchangewithtimeorasaresultofacompany’sstrategicdecisions,naturallythepowerofthesegroupsrisesordeclines.Intheready-to-wearclothingindustry,asthebuyers(departmentstoresandclothingstores)havebecomemoreconcentratedandcontrolhaspassedtolargechains,theindustryhascomeunderincreasingpressureandsufferedfallingmargins.Theindustryhasbeenunabletodifferentiateitsproductorengenderswitchingcoststhatlockinitsbuyersenoughtoneutralizethesetrends. Substituteproducts Byplacingaceilingonpricesitcancharge,substituteproductsorserviceslimitthepotentialofanindustry.Unlessitcanupgradethequalityoftheproductordifferentiateitsomehow(asviamarketing),theindustrywillsufferinearningsandpossiblyingrowth. Manifestly,themoreattractivetheprice-performancetrade-offofferedbysubstituteproducts,thefirmerthelidplacedontheindustry’sprofitpotential.Sugarproducersconfrontedwiththelarge-scalecommercializationofhigh-fructosecornsyrup,asugarsubstitute,arelearningthislessontoday. Substitutesnotonlylimitprofitsinnormaltimes;theyalsoreducethebonanzaanindustrycanreapinboomtimes.In1978theproducersoffiberglassinsulationenjoyedunprecedenteddemandasaresultofhighenergycostsandseverewinterweather.Buttheindustry’sabilitytoraisepriceswastemperedbytheplethoraofinsulationsubstitutes,includingcellulose,rockwool,andstyrofoam.Thesesubstitutesareboundtobecomeanevenstrongerforceoncethecurrentroundofplantadditionsbyfiberglassinsulationproducershasboostedcapacityenoughtomeetdemand(andthensome). Substituteproductsthatdeservethemostattentionstrategicallyarethosethat(a)aresubjecttotrendsimprovingtheirprice-performancetrade-offwiththeindustry’sproduct,or(b)areproducedbyindustriesearninghighprofits.Substitutesoftencomerapidlyintoplayifsomedevelopmentincreasescompetitionintheirindustriesandcausespricereductionorperformanceimprovement. Jockeyingforposition Rivalryamongexistingcompetitorstakesthefamiliarformofjockeyingforposition—usingtacticslikepricecompetition,productintroduction,andadvertisingslugfests.Intenserivalryisrelatedtothepresenceofanumberoffactors: Competitorsarenumerousorareroughlyequalinsizeandpower.InmanyU.S.industriesinrecentyearsforeigncontenders,ofcourse,havebecomepartofthecompetitivepicture. Industrygrowthisslow,precipitatingfightsformarketsharethatinvolveexpansion-mindedmembers. Theproductorservicelacksdifferentiationorswitchingcosts,whichlockinbuyersandprotectonecombatantfromraidsonitscustomersbyanother. Fixedcostsarehighortheproductisperishable,creatingstrongtemptationtocutprices.Manybasicmaterialsbusinesses,likepaperandaluminum,sufferfromthisproblemwhendemandslackens. Capacityisnormallyaugmentedinlargeincrements.Suchadditions,asinthechlorineandvinylchloridebusinesses,disrupttheindustry’ssupply-demandbalanceandoftenleadtoperiodsofovercapacityandpricecutting. Exitbarriersarehigh.Exitbarriers,likeveryspecializedassetsormanagement’sloyaltytoaparticularbusiness,keepcompaniescompetingeventhoughtheymaybeearningloworevennegativereturnsoninvestment.Excesscapacityremainsfunctioning,andtheprofitabilityofthehealthycompetitorssuffersasthesickoneshangon. Foramorecompletediscussionofexitbarriersandtheirimplicationsforstrategy,seemyarticle,“PleaseNoteLocationofNearestExit,”CaliforniaManagementReview,Winter1976,p.21.Iftheentireindustrysuffersfromovercapacity,itmayseekgovernmenthelp—particularlyifforeigncompetitionispresent. Therivalsarediverseinstrategies,origins,and“personalities.”Theyhavedifferentideasabouthowtocompeteandcontinuallyrunhead-onintoeachotherintheprocess. Asanindustrymatures,itsgrowthratechanges,resultingindecliningprofitsand(often)ashakeout.Intheboomingrecreationalvehicleindustryoftheearly1970s,nearlyeveryproducerdidwell;butslowgrowthsincethenhaseliminatedthehighreturns,exceptforthestrongestmembers,nottomentionmanyoftheweakercompanies.Thesameprofitstoryhasbeenplayedoutinindustryafterindustry—snowmobiles,aerosolpackaging,andsportsequipmentarejustafewexamples. Anacquisitioncanintroduceaverydifferentpersonalitytoanindustry,ashasbeenthecasewithBlack&Decker’stakeoverofMcCullough,theproducerofchainsaws.Technologicalinnovationcanboosttheleveloffixedcostsintheproductionprocess,asitdidintheshiftfrombatchtocontinuous-linephotofinishinginthe1960s. Whileacompanymustlivewithmanyofthesefactors—becausetheyarebuiltintoindustryeconomics—itmayhavesomelatitudeforimprovingmattersthroughstrategicshifts.Forexample,itmaytrytoraisebuyers’switchingcostsorincreaseproductdifferentiation.Afocusonsellingeffortsinthefastest-growingsegmentsoftheindustryoronmarketareaswiththelowestfixedcostscanreducetheimpactofindustryrivalry.Ifitisfeasible,acompanycantrytoavoidconfrontationwithcompetitorshavinghighexitbarriersandcanthussidestepinvolvementinbitterpricecutting. FormulationofStrategy Oncehavingassessedtheforcesaffectingcompetitioninanindustryandtheirunderlyingcauses,thecorporatestrategistcanidentifythecompany’sstrengthsandweaknesses.Thecrucialstrengthsandweaknessesfromastrategicstandpointarethecompany’sposturevis-à-vistheunderlyingcausesofeachforce.Wheredoesitstandagainstsubstitutes?Againstthesourcesofentrybarriers? Thenthestrategistcandeviseaplanofactionthatmayinclude(1)positioningthecompanysothatitscapabilitiesprovidethebestdefenseagainstthecompetitiveforce;and/or(2)influencingthebalanceoftheforcesthroughstrategicmoves,therebyimprovingthecompany’sposition;and/or(3)anticipatingshiftsinthefactorsunderlyingtheforcesandrespondingtothem,withthehopeofexploitingchangebychoosingastrategyappropriateforthenewcompetitivebalancebeforeopponentsrecognizeit.Ishallconsidereachstrategicapproachinturn. Positioningthecompany Thefirstapproachtakesthestructureoftheindustryasgivenandmatchesthecompany’sstrengthsandweaknessestoit.Strategycanbeviewedasbuildingdefensesagainstthecompetitiveforcesorasfindingpositionsintheindustrywheretheforcesareweakest. Knowledgeofthecompany’scapabilitiesandofthecausesofthecompetitiveforceswillhighlighttheareaswherethecompanyshouldconfrontcompetitionandwhereavoidit.Ifthecompanyisalow-costproducer,itmaychoosetoconfrontpowerfulbuyerswhileittakescaretosellthemonlyproductsnotvulnerabletocompetitionfromsubstitutes. ThesuccessofDrPepperinthesoftdrinkindustryillustratesthecouplingofrealisticknowledgeofcorporatestrengthswithsoundindustryanalysistoyieldasuperiorstrategy.Coca-ColaandPepsiColadominateDrPepper’sindustry,wheremanysmallconcentrateproducerscompeteforapieceoftheaction.DrPepperchoseastrategyofavoidingthelargest-sellingdrinksegment,maintaininganarrowflavorline,forgoingthedevelopmentofacaptivebottlernetwork,andmarketingheavily.Thecompanypositioneditselfsoastobeleastvulnerabletoitscompetitiveforceswhileitexploiteditssmallsize. Inthe$11.5billionsoftdrinkindustry,barrierstoentryintheformofbrandidentification,large-scalemarketing,andaccesstoabottlernetworkareenormous.Ratherthanaccepttheformidablecostsandscaleeconomiesinhavingitsownbottlernetwork—thatis,followingtheleadoftheBigTwoandofSeven-Up—DrPeppertookadvantageofthedifferentflavorofitsdrinkto“piggyback”onCokeandPepsibottlerswhowantedafulllinetoselltocustomers.DrPeppercopedwiththepowerofthesebuyersthroughextraordinaryserviceandothereffortstodistinguishitstreatmentofthemfromthatofCokeandPepsi. Manysmallcompaniesinthesoftdrinkbusinessoffercoladrinksthatthrustthemintohead-to-headcompetitionagainstthemajors.DrPepper,however,maximizedproductdifferentiationbymaintaininganarrowlineofbeveragesbuiltaroundanunusualflavor. Finally,DrPeppermetCokeandPepsiwithanadvertisingonslaughtemphasizingtheallegeduniquenessofitssingleflavor.Thiscampaignbuiltstrongbrandidentificationandgreatcustomerloyalty.HelpingitseffortswasthefactthatDrPepper’sformulainvolvedlowerrawmaterialscost,whichgavethecompanyanabsolutecostadvantageoveritsmajorcompetitors. Therearenoeconomiesofscaleinsoftdrinkconcentrateproduction,soDrPeppercouldprosperdespiteitssmallshareofthebusiness(6%).ThusDrPepperconfrontedcompetitioninmarketingbutavoideditinproductlineandindistribution.Thisartfulpositioningcombinedwithgoodimplementationhasledtoanenviablerecordinearningsandinthestockmarket. Influencingthebalance Whendealingwiththeforcesthatdriveindustrycompetition,acompanycandeviseastrategythattakestheoffensive.Thispostureisdesignedtodomorethanmerelycopewiththeforcesthemselves;itismeanttoaltertheircauses. Innovationsinmarketingcanraisebrandidentificationorotherwisedifferentiatetheproduct.Capitalinvestmentsinlarge-scalefacilitiesorverticalintegrationaffectentrybarriers.Thebalanceofforcesispartlyaresultofexternalfactorsandpartlyinthecompany’scontrol. Exploitingindustrychange Industryevolutionisimportantstrategicallybecauseevolution,ofcourse,bringswithitchangesinthesourcesofcompetitionIhaveidentified.Inthefamiliarproductlife-cyclepattern,forexample,growthrateschange,productdifferentiationissaidtodeclineasthebusinessbecomesmoremature,andthecompaniestendtointegratevertically. Thesetrendsarenotsoimportantinthemselves;whatiscriticaliswhethertheyaffectthesourcesofcompetition.Considerverticalintegration.Inthematuringminicomputerindustry,extensiveverticalintegration,bothinmanufacturingandinsoftwaredevelopment,istakingplace.Thisverysignificanttrendisgreatlyraisingeconomiesofscaleaswellastheamountofcapitalnecessarytocompeteintheindustry.Thisinturnisraisingbarrierstoentryandmaydrivesomesmallercompetitorsoutoftheindustryoncegrowthlevelsoff. Obviously,thetrendscarryingthehighestpriorityfromastrategicstandpointarethosethataffectthemostimportantsourcesofcompetitionintheindustryandthosethatelevatenewcausestotheforefront.Incontractaerosolpackaging,forexample,thetrendtowardlessproductdifferentiationisnowdominant.Ithasincreasedbuyers’power,loweredthebarrierstoentry,andintensifiedcompetition. TheframeworkforanalyzingcompetitionthatIhavedescribedcanalsobeusedtopredicttheeventualprofitabilityofanindustry.Inlong-rangeplanningthetaskistoexamineeachcompetitiveforce,forecastthemagnitudeofeachunderlyingcause,andthenconstructacompositepictureofthelikelyprofitpotentialoftheindustry. Theoutcomeofsuchanexercisemaydifferagreatdealfromtheexistingindustrystructure.Today,forexample,thesolarheatingbusinessispopulatedbydozensandperhapshundredsofcompanies,nonewithamajormarketposition.Entryiseasy,andcompetitorsarebattlingtoestablishsolarheatingasasuperiorsubstituteforconventionalmethods. Thepotentialofthisindustrywilldependlargelyontheshapeoffuturebarrierstoentry,theimprovementoftheindustry’spositionrelativetosubstitutes,theultimateintensityofcompetition,andthepowercapturedbybuyersandsuppliers.Thesecharacteristicswillinturnbeinfluencedbysuchfactorsastheestablishmentofbrandidentities,significanteconomiesofscaleorexperiencecurvesinequipmentmanufacturewroughtbytechnologicalchange,theultimatecapitalcoststocompete,andtheextentofoverheadinproductionfacilities. Theframeworkforanalyzingindustrycompetitionhasdirectbenefitsinsettingdiversificationstrategy.Itprovidesaroadmapforansweringtheextremelydifficultquestioninherentindiversificationdecisions:“Whatisthepotentialofthisbusiness?”Combiningtheframeworkwithjudgmentinitsapplication,acompanymaybeabletospotanindustrywithagoodfuturebeforethisgoodfutureisreflectedinthepricesofacquisitioncandidates. MultifacetedRivalry Corporatemanagershavedirectedagreatdealofattentiontodefiningtheirbusinessesasacrucialstepinstrategyformulation.TheodoreLevitt,inhisclassic1960articleinHBR,arguedstronglyforavoidingthemyopiaofnarrow,product-orientedindustrydefinition. TheodoreLevitt,“MarketingMyopia,”reprintedasanHBRClassic,September–October1975,p.26.Numerousotherauthoritieshavealsostressedtheneedtolookbeyondproducttofunctionindefiningabusiness,beyondnationalboundariestopotentialinternationalcompetition,andbeyondtheranksofone’scompetitorstodaytothosethatmaybecomecompetitorstomorrow.Asaresultoftheseurgings,theproperdefinitionofacompany’sindustryorindustrieshasbecomeanendlesslydebatedsubject. Onemotivebehindthisdebateisthedesiretoexploitnewmarkets.Another,perhapsmoreimportantmotiveisthefearofoverlookinglatentsourcesofcompetitionthatsomedaymaythreatentheindustry.Manymanagersconcentratesosingle-mindedlyontheirdirectantagonistsinthefightformarketsharethattheyfailtorealizethattheyarealsocompetingwiththeircustomersandtheirsuppliersforbargainingpower.Meanwhile,theyalsoneglecttokeepawaryeyeoutfornewentrantstothecontestorfailtorecognizethesubtlethreatofsubstituteproducts. Thekeytogrowth—evensurvival—istostakeoutapositionthatislessvulnerabletoattackfromhead-to-headopponents,whetherestablishedornew,andlessvulnerabletoerosionfromthedirectionofbuyers,suppliers,andsubstitutegoods.Establishingsuchapositioncantakemanyforms—solidifyingrelationshipswithfavorablecustomers,differentiatingtheproducteithersubstantivelyorpsychologicallythroughmarketing,integratingforwardorbackward,establishingtechnologicalleadership.