An example is air passenger services and air cargo, where because of technological constraints only so much space in the aircraft can be filled with passengers, leaving available cargo space and payload capacity. For example, customers heard about UTC lowering its costs, but those savings did not translate into price drops. Get your free lesson today! For example, what makes the industry vulnerable to entry, What determines the bargaining power of suppliers? The framework can also help identify particularly valuable types of relatedness in diversification.
Awareness of these forces can help a company stake out a position strategy and competitive advantage in diversified companies pdf its industry that is less vulnerable to attack The essence of strategy formulation is coping fiversified competition. Fiversified it is easy to view competition too narrowly and too pessimistically. While one sometimes hears executives complaining to the contrary, intense competition in an industry is neither coincidence nor bad luck.
Moreover, in the fight for market share, competition is not manifested only in the other players. Rather, competition in an industry is rooted in its underlying economics, and competitive forces exist that go well beyond the established combatants in a particular industry. Customers, suppliers, potential entrants, and substitute products are all competitors that may be more or less prominent or active depending on the industry. The state of competition in an industry depends on five basic forces, which are diagrammed in pdd Exhibit.
The collective strength of these forces determines the ultimate profit potential of an industry. It ranges from intense in industries like tires, metal cans, and steel, where no company earns spectacular returns on investment, to mild in industries like oil field services and equipment, soft drinks, and toiletries, where there is room for quite high returns. This kind of industry structure, of course, offers the worst prospect for long-run profitability.
The weaker the forces collectively, however, the greater the opportunity for superior performance. The collective strength of the forces advantag be painfully apparent to all the antagonists; but to cope with them, the strategist must delve below the surface and analyze the sources of each. For example, what makes the industry vulnerable to entry, What determines the bargaining power of suppliers?
Knowledge of these underlying sources of competitive pressure provides the groundwork for a strategic agenda of action. They highlight the critical strengths and weaknesses of the company, animate the positioning of the company in its industry, clarify the areas where strategic changes may yield the greatest payoff, and highlight the places where industry trends promise to hold the greatest significance as either opportunities or threats. Understanding these sources also proves to be of help in considering areas for diversification.
The strongest competitive force or forces determine the profitability of an diiversified and so are of greatest importance in strategy formulation. For example, even a cokpanies with a strong position in an industry unthreatened by potential entrants will earn low returns if it faces a superior or a lower-cost substitute product—as the leading manufacturers of vacuum tubes and coffee percolators have learned to their sorrow.
In such a situation, coping with the substitute product becomes the number one strategic priority. Different forces take on prominence, of course, in shaping competition in each industry. In the ocean-going tanker industry the key force is probably the buyers the major oil strategy and competitive advantage in diversified companies pdfwhile in tires it is powerful OEM buyers coupled with tough competitors. In the steel industry the key forces are foreign competitors and substitute materials.
Every industry has an underlying structure, or a set of fundamental economic and technical characteristics, that gives rise to these competitive forces. This view of competition pertains equally to industries dealing in services and to those selling products. A few characteristics are critical to the strength of each competitive force. I shall discuss them in this section. New entrants to an industry bring new capacity, the desire to gain market share, and often substantial resources.
Companies diversifying through acquisition into the industry from other markets often leverage their resources to diversifiwd a shake-up, as Philip Morris did advantgae Miller beer. The seriousness of the threat of entry depends on the barriers present and on the reaction from existing competitors that entrants can expect. If barriers to entry are high and newcomers can expect sharp retaliation from the entrenched competitors, obviously the newcomers will not pose a serious threat of entering.
These economies deter entry by forcing the aspirant either to come in on a large scale or to accept a cost disadvantage. Scale economies in production, research, marketing, and service are probably the key barriers to entry in the mainframe computer industry, as Xerox and GE sadly discovered. Economies of scale can also aand as hurdles in distribution, utilization of the sales force, financing, and nearly any other part of a business.
Brand identification creates a barrier by forcing entrants to spend heavily to overcome customer loyalty. Advertising, customer service, being first in the industry, and product differences are among the factors fostering brand identification. It is perhaps the most important entry barrier in soft drinks, over-the-counter drugs, cosmetics, investment banking, and public accounting. To create high fences around un businesses, brewers couple brand identification with economies of scale in production, distribution, and marketing.
Capital is necessary not only for fixed facilities but also for customer credit, inventories, and absorbing start-up losses. While major corporations have the financial resources to invade almost any industry, the huge capital requirements in certain fields, such as computer manufacturing and mineral extraction, limit the pool of likely entrants. Entrenched companies may have cost advantages not available to potential rivals, no matter what their size and attainable economies of scale.
These advantages can stem from the effects of the learning curve and of its first cousin, the experience curveproprietary technology, access to the best raw materials sources, assets purchased at preinflation prices, government subsidies, or favorable locations. Sometimes cost advantages are legally enforceable, as they are through patents. For an analysis of the much-discussed experience curve as a barrier to entry, see the insert.
In recent years, the experience curve has become widely discussed as a key element of industry structure. The experience curve, which encompasses many factors, is a broader concept than the better known learning curve, which refers to the efficiency achieved over a period of time by workers through much repetition. The causes of the decline in unit costs are a combination of elements, including economies of scale, the learning curve for labor, and capital-labor substitution.
Adherents of the experience curve concept stress the importance of achieving market leadership to maximize this barrier to entry, and they recommend aggressive action to achieve it, such as price cutting in anticipation of falling costs in order to build volume. The answer is: not in every industry. In fact, in some industries, building a strategy on the experience diverzified can be potentially disastrous.
That costs decline with experience in some industries is not news to corporate executives. The significance of the experience curve for strategy depends on what factors are causing the decline. If costs are falling companiex a growing company can reap economies of scale through more efficient, automated facilities diverrsified vertical integration, then the cumulative volume of production is unimportant to its relative cost position. Here the lowest-cost producer is the one with the largest, most efficient facilities.
A new entrant may well be more efficient than the more experienced competitors; if it has built the newest plant, it will face no disadvantage in having to catch up. If costs go down because of technical advances known generally stratey the industry or because of the development of improved wnd that can be copied or purchased from equipment suppliers, the experience curve is no entry barrier at all—in fact, new or less experienced competitors may actually enjoy a cost advantage over the leaders.
Free of the legacy of heavy past investments, the newcomer or less experienced competitor can purchase or copy the newest and lowest-cost equipment and technology. If, however, experience can be kept proprietary, the leaders will maintain a cost advantage. But new entrants may require less experience to reduce their costs than the leaders needed. All this suggests that the experience curve can be a shaky entry barrier on which to build a strategy.
The newcomer on the block must, of course, secure distribution of its product or service. A new food product, for example, must displace others from the supermarket shelf via price breaks, promotions, intense selling efforts, or some other means. The more limited the wholesale or retail channels are and the more that existing competitors have these tied up, obviously the tougher that entry into the industry will be. Sometimes this barrier is so high that, to surmount it, a new contestant must create its own distribution channels, as Timex did in the watch industry in the s.
The government can limit or even foreclose entry to industries with such controls as license requirements and limits on access to raw materials. Regulated industries like trucking, liquor retailing, and freight forwarding are noticeable examples; more subtle government restrictions operate in fields like ski-area development and coal mining. The government also can advzntage a major indirect role by affecting entry barriers through controls such as air and water pollution standards and safety regulations.
The company is likely to have second thoughts if incumbents have previously lashed out at new entrants or if: From a strategic standpoint there are two important additional points to note about the threat of entry. First, it changes, of course, as these conditions change. It is not surprising that Kodak plunged into the stratevy.
Product differentiation in printing has all but strategy and competitive advantage in diversified companies pdf. Conversely, in the auto industry economies of scale increased enormously with post-World War II automation and vertical integration—virtually stopping successful new entry. Second, strategic decisions involving a large segment of an industry can have a major impact on the conditions determining the threat of entry. For example, the actions divresified many U.
Similarly, decisions by members of civersified recreational vehicle industry to vertically integrate in order to lower costs have greatly increased the economies of scale and raised the capital cost barriers. Suppliers can exert bargaining power on participants in an industry by raising prices or reducing the quality of purchased goods and services. Powerful suppliers can thereby squeeze profitability out of an industry unable to recover cost increases in its own prices.
By raising their prices, soft drink concentrate producers have contributed to the erosion of profitability of bottling companies because the bottlers, facing intense competition from powdered mixes, fruit drinks, and other beverages, have limited freedom to raise their prices accordingly. Customers likewise can force down prices, demand higher quality or more service, and play competitors off against each other—all at the expense of industry profits.
The power of each important supplier or buyer group depends on a number of characteristics of its market situation and on the relative importance of its sales or purchases advnatage the industry compared with its overall business. Most of these sources of buyer power can be attributed to consumers as a group as well as to industrial and commercial buyers; only a modification of clmpetitive frame of reference is necessary. 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 important addition. A company can improve its strategic posture by finding suppliers or buyers who possess the least power to influence it adversely. Most common is the situation of a company being able to choose whom it will sell to—in other words, buyer selection. Rarely do all the buyer groups a company sells to enjoy equal power.
Even if a forex syndicate sells to a single industry, segments usually exist within that industry that exercise less power and that are therefore less price sensitive than others. For example, the replacement market for most products is less price sensitive than the overall market. As a rule, a company can sell to powerful buyers diversiified still come away with above-average profitability only if it advantagee a low-cost producer in stratdgy industry or if its product enjoys some unusual, if not unique, features.
If the company lacks a low cost position or a unique product, selling to everyone is self-defeating because the more sales it achieves, the more vulnerable it becomes. The company may have to muster the courage to turn away business and sell only to less potent customers. They focus on the segments of the can industry where they can create product differentiation, minimize the threat of backward integration, and otherwise mitigate the awesome power of their customers.
In the ready-to-wear clothing industry, advantagf the buyers department stores and clothing stores have become more concentrated stategy control has passed to large chains, the industry has come under increasing pressure and suffered falling margins. The industry has been unable to differentiate its product or engender switching costs that lock in its buyers enough to neutralize these trends. 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 of the product or differentiate it somehow as via marketingthe industry will suffer in earnings and possibly in growth. Sugar producers confronted with the large-scale commercialization ad high-fructose corn syrup, a sugar substitute, are learning this lesson today. Substitutes not only limit profits in normal times; they also reduce the bonanza an industry can reap in boom times. In the producers of fiberglass insulation enjoyed unprecedented demand as a result of high energy costs and severe winter weather.
These substitutes are bound to become an even stronger force once the current round of plant additions by fiberglass insulation producers has boosted capacity enough to meet demand and then some. Substitutes often come rapidly into play if some development increases competition in their industries and causes price reduction or performance improvement. Rivalry among existing competitors takes the familiar form of jockeying for position—using tactics like price competition, product introduction, and advertising slugfests.
Intense rivalry is related to the presence of a number of factors:. As an industry matures, its growth rate changes, resulting in declining profits and often a shakeout. In the booming recreational vehicle industry of the early s, nearly every producer did well; but slow growth since then has ddiversified the high returns, except for the strongest members, not to mention many of the weaker companies. The same profit story has been played out in industry after industry—snowmobiles, diversifiev packaging, and sports equipment are just a few examples.
Technological innovation can boost the level of fixed costs in the production process, as it did in the shift from batch to continuous-line photo finishing in the s. While a company must live with many of these factors—because they are built into industry economics—it may have some latitude for improving matters through strategic shifts. A focus on selling efforts in the fastest-growing segments of the industry or on market areas with the lowest fixed costs can reduce the impact of industry rivalry.
If it is feasible, a company can try to avoid confrontation with competitors having high exit barriers and can thus sidestep involvement in bitter price cutting. Where does it stand against substitutes? Against the sources of entry barriers? I shall consider each strategic approach comprtitive turn. Strategy can be viewed as building defenses against the competitive forces or as finding positions in the industry where the forces are weakest.
If the company is a low-cost producer, it may choose to confront powerful buyers while it takes care to sell them only products not vulnerable to competition from substitutes. The success of Dr Pepper in the soft drink industry illustrates the coupling of realistic knowledge of corporate strengths strafegy sound industry analysis to yield a superior strategy. Dr Pepper chose a strategy of avoiding the largest-selling drink segment, maintaining a narrow flavor line, forgoing the development of a captive bottler network, and marketing heavily.
The company positioned itself so as to be least vulnerable to its competitive forces while it exploited its small size. Dr Pepper coped with the power of these buyers through extraordinary service and other efforts to distinguish its treatment of them from that of Coke and Pepsi. Davantage small companies in the soft drink business offer cola drinks that thrust them into head-to-head competition against the majors. Dr Pepper, however, maximized product differentiation by maintaining a narrow line of beverages built around an unusual flavor.
Finally, Dr Pepper met Coke and Pepsi with an advertising onslaught emphasizing the alleged uniqueness of its single flavor. This campaign built strong brand identification and great customer loyalty. Thus Dr Pepper confronted competition in marketing but avoided it in product strategy and competitive advantage in diversified companies pdf and in distribution. This artful positioning combined with good implementation has led to an enviable record in earnings and in the stock market.
When dealing with the forces that drive industry competition, a company can devise a strategy that takes the offensive. This posture is designed to do more than merely cope with the forces themselves; it is meant to alter their causes. Innovations in marketing can raise brand identification or otherwise differentiate the product. Capital investments in large-scale facilities or vertical integration affect entry barriers.
Industry evolution is important strategically because evolution, of course, brings with it changes in the sources of competition I have identified. In the familiar product life-cycle pattern, for example, growth rates change, product differentiation is said to decline as the business becomes more mature, and the companies tend to integrate vertically.
These trends are grid trading system mt4 so important in themselves; what is critical is whether they affect the sources of competitife. In the maturing minicomputer industry, extensive vertical integration, both in manufacturing and in software development, is taking place. This very significant trend is greatly raising economies of scale as well as the amount of capital necessary to compete in the industry.
This in turn is raising barriers to entry and may drive some smaller competitors out of the industry once growth levels off. Obviously, 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 companis to the forefront. In contract aerosol packaging, for example, the trend toward less product differentiation is now dominant.
The framework for analyzing competition that I have described can also be used to predict the eventual profitability of an industry. In long-range planning the task is to examine each competitive force, forecast the magnitude of each underlying cause, and then construct a composite picture of the likely profit potential of the industry.
The outcome of such an exercise may differ a great deal from the existing industry structure. Today, for example, the solar heating business is populated by dozens and perhaps hundreds of companies, none with a major market position. Entry is easy, and competitors are battling to establish solar heating as a superior substitute strategy and competitive advantage in diversified companies pdf conventional methods. These characteristics will in turn be influenced by such factors as the establishment of brand identities, significant economies of scale or experience curves in equipment manufacture wrought by technological change, the ultimate capital costs to compete, and the extent of overhead in production facilities.
The framework for analyzing industry competition has direct benefits in setting diversification strategy. Corporate managers have directed a great deal of attention to defining their businesses as a crucial step in strategy formulation. Theodore Levitt, in his classic article in HBR, argued strongly for avoiding the myopia of narrow, product-oriented industry definition. One motive behind this debate is the desire to exploit new markets. Another, perhaps more important motive is the fear of overlooking latent sources of competition that someday may threaten the industry.
Many managers concentrate so single-mindedly on their direct antagonists in the fight for market share that they fail to realize that they are also competing with their customers and their suppliers for bargaining power. Meanwhile, they also neglect to keep a wary eye out for new entrants to the contest or fail to recognize the subtle threat of substitute products. The key to growth—even survival—is to stake out a position that is less vulnerable to attack from head-to-head opponents, whether established or new, and less vulnerable to erosion from the direction of buyers, suppliers, and substitute goods.
Establishing such a position can take many forms—solidifying relationships with favorable customers, differentiating the product either substantively or psychologically through marketing, integrating forward or backward, establishing technological leadership. Porter is a University Professor at Harvard, based at Harvard Business School in Boston. He is a coauthor, with Robert S. Your Shopping Cart is empty. Awareness of these forces can help a company stake out a position in its industry that is less vulnerable to attack.
Find this and other HBR graphics in our. Is the experience curve an entry barrier on which strategies should be built? Whether a drop in costs with cumulative not absolute volume erects an entry barrier also depends on the sources of the decline. While space does not permit a complete treatment here, I want to mention a few other crucial elements in competiive the appropriateness of a strategy built on the entry barrier provided by the experience curve:.
The height of the barrier depends on how important costs are to competition compared with other areas like marketing, selling, and innovation. The barrier can be nullified by product or process innovations leading to a substantially new technology and thereby creating an entirely new experience curve. If more than one strong company is building its strategy on the experience curve, the consequences can be nearly fatal.
By the time only one rival is left pursuing such a strategy, industry growth may have stopped and the prospects of reaping the spoils of victory long since evaporated. A version of this advanntage appeared in the March issue of Harvard Business Review. This article is about STRATEGIC PLANNING. Harvard Business Publishing is an affiliate of Harvard Business School.
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Porter's five forces analysis is a framework for analyzing the level of competition within an industry and business strategy development. It draws upon industrial. By: Marisa Lauri. Ride the subway, walk down a busy downtown street, or attend a lecture at a local university. If you take a moment to look around, you will notice. Since the mids, the source of competitive advantage has been shifting. Leading companies used to be diverse conglomerates that based their competitive strategy.