Strategy & Organization
Week 1 – Competitive Strategy
Article 1 - How competitive forces shape strategy – Michael E.
Porter (1979)
The nature and degree of competition in an industry hinge on five forces:
The threat of new entrants
Bargaining power of customers
Bargaining power of suppliers
Threat of substitute products/services
Jockeying among current contestants
The weaker the forces collectively, the greater the opportunity for
superior performance in terms of profit potential. Knowledge of the
underlying sources of competitive advantage provides the groundwork for
strategic agenda.
Threat of entry: New entrants bring new capacity, the desire to gain
market share, and substantial resources. Seriousness depends on barriers
present and on reaction from existing competitors. There are six major
sources of barriers to entry:
1. Economies of scale – Come in at large scale or accepting cost
disadvantage.
2. Product differentiation – Brand identification forces entrants to
spend heavily to overcome customer loyalty.
3. Capital requirements – Need to invest large financial resources in
order to compete.
4. Cost disadvantages independent of size – Advantages from effects
of the learning or experience curve, proprietary technology, access
to best raw materials, sources, assets at good prices, government
subsidies or favourable locations.
5. Access to distribution channels
6. Government policy – Government can limit or foreclose entry with
controls as license requirements and limits on access to raw
materials, or air and water pollution standards and safety
regulations.
The threat of entry changes as these conditions change.
Strategic decisions involving a large segment of an industry can
have a major impact on the conditions determining the threat of
entry.
Powerful suppliers and buyers: Suppliers can exert bargaining power
on participants in an industry by raising prices or reducing the quality of
purchased goods and services. Customers can force down prices, demand
higher quality or more service, and play competitors off against each
other. The power of each supplier or buyer depends on a number of
,characteristics of the market situation and on the relative importance of
its sales or purchases.
Supplier is powerful if it:
Dominated by a few companies and is more concentrated than the
industry it sells to.
Has a unique or differentiated product, or has built up switching
costs. Switching costs are fixed costs buyers face in changing
suppliers, invested in equipment or software or production
processes.
The industry is not an important customer of the supplier group.
A buyer is powerful if:
It is concentrated or purchases in large volumes.
The product it purchases from the industry are standard or
undifferentiated; can always find alternatives.
The products form a component of its product and represent a
significant fraction of its cost.
It earns low profits, which create great incentives to lower its
purchasing costs.
The industry’s product is unimportant to the quality of the buyers’
products or services.
The industry’s product does not save the buyer money.
The buyers pose a credible threat of integrating backward to make
the industry’s product.
Consumers tend to be more price sensitive if they are purchasing
products that are undifferentiated, expensive relative to their incomes,
and of a sort where quality is not particularly important.
The buying power of retailers is determined by the same rules, with one
addition. Retailers can gain significant bargaining power over
manufacturers when they can influence consumers’ purchasing decisions.
Strategic action
A company can improve its strategic posture by finding suppliers or
buyers who possess the least power to influence it adversely.
Substitute products: By placing a ceiling on prices it can charge,
substitute products or services limit the potential of an industry. Unless it
can upgrade the quality or differentiate, the industry will suffer in earnings
and possibly in growth.
The more attractive the price-performance trade-off offered by substitute
products, the firmer the lid placed on the industry’s profit potential.
Substitute products that deserve the most attention strategically are
those that (a) are subject to trends improving their price-performance
trade-off with the industry’s product, or (b) are produced by industries
earning high profits.
,Jockeying for position: Rivalry among existing competitors takes the
familiar form of jockeying for position- price competition, product
introduction, advertising slugfests. Intensity of rivalry depends on the
following factors:
Competitors are numerous or are roughly equal in size and power.
Industry growth is slow, precipitating fights for market share
involving expansion minded members.
The product lacks differentiation or switching costs, which lock in
buyers and protect one from raids on customers by another.
Fixed costs are high or the product is perishable, creating strong
temptation to cut prices.
Capacity is normally augmented in large increments.
Exit barriers are high. Like specialized assets or management’s
loyalty to a business keep businesses competing even though they
may be earning low or even negative returns.
The rivals are diverse in strategies, origins, and personalities.
As an industry matures, its growth rate changes, resulting in declining
profits and (often) a shakeout.
Formulation of strategy
After assessment of the forces affecting competition in the industry and
their underlying causes, the next step is to identify the company’s
strengths and weaknesses, a plan of action that includes:
Positioning the company so that its capabilities provide the best
defence against the competitive force
Influencing the balance of the forces through strategic moves,
thereby improving the company’s position
Anticipating shifts in the factors underlying the forces and
responding to them, with the hope of exploiting change by choosing
a strategy appropriate for the new competitive balance before
opponents recognize it.
Positioning the company
Knowledge of the company’s capabilities and of the causes of the
competitive forces will highlight the areas where the company should
confront competition and where avoid it.
Influencing the balance
Innovations in marketing can raise brand identification or otherwise
differentiate the product. Capital investments in large-scale facilities or
vertical integration affect entry barriers.
Exploiting industry change
Industry evolution is important strategically because evolution brings with
it changes in the sources of competition I have identified. In product life-
cycle pattern, growth rates change, product differentiation is said to
decline as the business becomes more mature, and the companies tend to
integrate vertically.
, The trends carrying the highest priority from a strategic standpoint are
those that affect the most important sources of competition in the
industry and those that elevate new causes to the forefront.
