COMPETITIVE. ADVANTAGE. Creating and Sustaining. Superior Peifonnance. Michael E. Porter. 1&1. THE FREE PRESS. A Division of A1acmillan, Inc. Library of Congress Cataloging-in-Publication Data. Porter, Michael E. Competitive strategy: techniques for analyzing industries and competitors: with a new. PDF | Strategic planning as a formal discipline originated in the s and early s. It soon became a fad, but faded equally quickly when the promised.
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Michael Porter - Competitive medical-site.info - Ebook download as PDF File .pdf), Text File .txt) or read book online. The Five Competitive Forces. That Shape Strategy by Michael E. Porter. FROM THE JANUARY ISSUE. Editor's Note: In , Harvard Business Review. Strategy and Competitiveness, medical-site.info Competitive Advantage: Enduring Ideas and New Opportunities. Professor Michael E. Porter.
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Share Give access Share full text access. Share full text access. Rather, competition in an industry is rooted in its underlying economic structure and goes well beyond the behavior of current competitors.
The state of competition in an industry depends on five basic competitive forces. The collective strength of these forces determines the ultimate profit potential in the industry, where profit potential is measured in terms of long run return on invested capital. Not all industries have the same potential. They differ fundamentally in their ultimate profit potential as the collective strength of the forces differs; the forces range from intense in industries like tires, paper, and steel -- where no firm earns spectacular returns -- to relatively mild in industries like oil-field equipment and services, cosmetics, and toiletries -- where high returns are quite common.
This chapter will be concerned with identifying the key structural features of industries that determine the strength of the competitive forces and hence industry profitability. The goal of competitive strategy for a business unit in an industry is to find a position in the industry where the company can best defend itself against these competitive forces or can influence them in its favor.
Since the collective strength of the forces may well be painfully apparent to all competitors, the key for developing strategy is to delve below the surface and analyze the sources of each. Knowledge of these underlying sources of competitive pressure highlights the critical strengths and weaknesses of the company, animates its positioning in its industry, clarifies the areas where strategic changes may yield the greatest payoff, and highlights the areas where industry trends promise to hold the greatest significance as either opportunities or threats.
Understanding these sources will also prove to be useful in considering areas for diversification, though the primary focus here is on strategy in individual industries. Structural analysis is the fundamental underpinning for formulating competitive strategy and a key building block for most of the concepts in this book. To avoid needless repetition, the term "product" rather than "product or service" will be used to refer to the output of an industry, even though the principles of structural analysis developed here apply equally to product and service businesses.
Structural analysis also applies to diagnosing industry competition in any country or in an international market, though some of the institutional circumstances may differ.
Structural Determinants of the Intensity of Competition Let us adopt the working definition of an industry as the group of firms producing products that are close substitutes for each other.
In practice there is often a great deal of controversy over the appropriate definition, centering around how close substitutability needs to be in terms of product, process, or geographic market boundaries. Because we will be in a better position to treat these issues once the basic concept of structural analysis has been introduced, we will assume initially that industry boundaries have already been drawn. Competition in an industry continually works to drive down the rate of return on invested capital toward the competitive floor rate of return, or the return that would be earned by the economist's "perfectly competitive" industry.
This competitive floor, or "free market" return, is approximated by the yield on long-term government securities adjusted upward by the risk of capital loss. Investors will not tolerate returns below this rate in the long run because of their alternative of investing in other industries, and firms habitually earning less than this return will eventually go out of business. The presence of rates of return higher than the adjusted free market return serves to stimulate the inflow of capital into an industry either through new entry or through additional investment by existing competitors.
The strength of the competitive forces in an industry determines the degree to which this inflow of investment occurs and drives the return to the free market level, and thus the ability of firms to sustain above-average returns. The five competitive forces -- entry, threat of substitution, bargaining power of downloaders, bargaining power of suppliers, and rivalry among current competitors -- reflect the fact that competition in an industry goes well beyond the established players.
Customers, suppliers, substitutes, and potential entrants are all "competitors" to firms in the industry and may be more or less prominent depending on the particular circumstances. Competition in this broader sense might be termed extended rivalry. All five competitive forces jointly determine the intensity of industry competition and profitability, and the strongest force or forces are governing and become crucial from the point of view of strategy formulation.
For example, even a company with a very strong market position in an industry where potential entrants are no threat will earn low returns if it faces a superior, lower-cost substitute. Even with no substitutes and blocked entry, intense rivalry among existing competitors will limit potential returns. The extreme case of competitive intensity is the economist's perfectly competitive industry, where entry is free, existing firms have no bargaining power against suppliers and customers, and rivalry is unbridled because the numerous firms and products are all alike.
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 downloaders the major oil companies , whereas in tires it is powerful original equipment OEM downloaders coupled with tough competitors.
In the steel industry the key forces are foreign competitors and substitute materials. The underlying structure of an industry, reflected in the strength of the forces, should be distinguished from the many short-run factors that can affect competition and profitability in a transient way. For example, fluctuations in economic conditions over the business cycle influence the short-run profitability of nearly all firms in many industries, as can material shortages, strikes, spurts in demand, and the like.
Although such factors may have tactical significance, the focus of the analysis of industry structure, or "structural analysis," is on identifying the basic, underlying characteristics of an industry rooted in its economics and technology that shape the arena in which competitive strategy must be set. Firms will each have unique strengths and weaknesses in dealing with industry structure, and industry structure can and does shift gradually over time.
Yet understanding industry structure must be the starting point for strategic analysis. A number of important economic and technical characteristics of an industry are critical to the strength of each competitive force. These will be discussed in turn. Prices can be bid down or incumbents' costs inflated as a result, reducing profitability.
Companies diversifying through acquisition into the industry from other markets often use their resources to cause a shake-up, as Philip Morris did with Miller beer. Thus acquisition into an industry with intent to build market position should probably be viewed as entry even though no entirely new entity is created.
The threat of entry into an industry depends on the barriers to entry that are present, coupled with the reaction from existing competitors that the entrant can expect. Economies of scale refer to declines in unit costs of a product or operation or function that goes into producing a product as the absolute volume per period increases.
Economies of scale deter entry by forcing the entrant to come in at large scale and risk strong reaction from existing firms or come in at a small scale and accept a cost disadvantage, both undesirable options. Scale economies can be present in nearly every function of a business, including manufacturing, downloading, research and development, marketing, service network, sales force utilization, and distribution.
For example, scale economies in production, research, marketing, and service are probably the key barriers to entry in the mainframe computer industry, as Xerox and General Electric sadly discovered.
Scale economies may relate to an entire functional area, as in the case of a sales force, or they may stem from particular operations or activities that are part of a functional area. For example, in the manufacture of television sets, economies of scale are large in color tube production, and they are less significant in cabinetmaking and set assembly.
It is important to examine each component of costs separately for its particular relationship between unit cost and scale. Units of multibusiness firms may be able to reap economies similar to those of scale if they are able to share operations or functions subject to economies of scale with other businesses in the company.
For example, the multibusiness company may manufacture small electric motors, which are then used in producing industrial fans, hairdryers, and cooling systems for electronic equipment. If economies of scale in motor manufacturing extend beyond the number of motors needed in any one market, the multibusiness firm diversified in this way will reap economies in motor manufacturing that exceed those available if it only manufactured motors for use in, say, hairdryers.
Thus related diversification around common operations or functions can remove volume constraints imposed by the size of a given industry.
The prospective entrant is forced to be diversified or face a cost disadvantage. Potentially shareable activities or functions subject to economies of scale can include sales forces, distribution systems, downloading, and so on.
The benefits of sharing are particularly potent if there are joint costs. Joint costs occur when a firm producing product A or an operation or function that is part of producing A must inherently have the capacity to produce product B. 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.
Many of the costs must be borne to put the plane into the air and there is capacity for freight regardless of the quantity of passengers the plane is carrying. Thus the firm that competes in both passenger and freight may have a substantial advantage over the firm competing in only one market.
This same sort of effect occurs in businesses that involve manufacturing processes involving by-products. The entrant who cannot capture the highest available incremental revenue from the by-products can face a disadvantage if incumbent firms do. A common situation of joint costs occurs when business units can share intangible assets such as brand names and know-how. The cost of creating an intangible asset need only be borne once; the asset may then be freely applied to other business, subject only to any costs of adapting or modifying it.
Thus situations in which intangible assets are shared can lead to substantial economies. A type of economies of scale entry barrier occurs when there are economies to vertical integration, that is, operating in successive stages of production or distribution.
Here the entrant must enter integrated or face a cost disadvantage, as well as possible foreclosure of inputs or markets for its product if most established competitors are integrated. Foreclosure in such situations stems from the fact that most customers download from in-house units, or most suppliers "sell" their inputs in-house. The independent firm faces a difficult time in getting comparable prices and may become "squeezed" if integrated competitors offer different terms to it than to their captive units.
The requirement to enter integrated may heighten the risks of retaliation and also elevate other entry barriers discussed below. Product Differentiation. Product differentiation means that established firms have brand identification and customer loyalties, which stem from past advertising, customer service, product differences, or simply being first into the industry.
Differentiation creates a barrier to entry by forcing entrants to spend heavily to overcome existing customer loyalties. This effort usually involves start-up losses and often takes an extended period of time. Such investments in building a brand name are particularly risky since they have no salvage value if entry fails. Product differentiation is perhaps the most important entry barrier in baby care products, over-the-counter drugs, cosmetics, investment banking, and public accounting.
In the brewing industry, product differentiation is coupled with economies of scale in production, marketing, and distribution to create high barriers. Capital Requirements. Capital may be necessary not only for production facilities but also for things like customer credit, inventories, or covering start-up losses. Xerox created a major capital barrier to entry in copiers, for example, when it chose to rent copiers rather than sell them outright which greatly increased the need for working capital.
Whereas today's major corporations have the financial resources to enter almost any industry, the huge capital requirements in fields like computers and mineral extraction limit the pool of likely entrants. Even if capital is available on the capital markets, entry represents a risky use of that capital which should be reflected in risk premiums charged the prospective entrant; these constitute advantages for going firms.
Switching Costs. A barrier to entry is created by the presence of switching costs, that is, one-time costs facing the downloader of switching from one supplier's product to another's.
Switching costs may include employee retraining costs, cost of new ancillary equipment, cost and time in testing or qualifying a new source, need for technical help as a result of reliance on seller engineering aid, product redesign, or even psychic costs of severing a relationship. If these switching costs are high, then new entrants must offer a major improvement in cost or performance in order for the downloader to switch from an incumbent. For example, in intravenous IV solutions and kits for use in hospitals, procedures for attaching solutions to patients differ among competitive products and the hardware for hanging the IV bottles are not compatible.
Here switching encounters great resistance from nurses responsible for administering the treatment and requires new investments in hardware. Access to Distribution Channels. A barrier to entry can be created by the new entrant's need to secure distribution for its product.
To the extent that logical distribution channels for the product have already been served by established firms, the new firm must persuade the channels to accept its product through price breaks, cooperative advertising allowances, and the like, which reduce profits. The manufacturer of a new food product, for example, must persuade the retailer to give it space on the fiercely competitive supermarket shelf via promises of promotions, intense selling efforts to the retailer, or some other means.
The more limited the wholesale or retail channels for a product are and the more existing competitors have these tied up, obviously the tougher entry into the industry will be. Existing competitors may have ties with channels based on long relationships, high-quality service, or even exclusive relationships in which the channel is solely identified with a particular manufacturer. Sometimes this barrier to entry is so high that to surmount it a new firm must create an entirely new distribution channel, as Timex did in the watch industry.
Cost Disadvantages Independent of Scale. Established firms may have cost advantages not replicable by potential entrants no matter what their size and attained economies of scale. For example, Frasch sulphur firms like Texas Gulf Sulphur gained control of some very favorable large salt dome sulphur deposits many years ago, before mineral rightholders were aware of their value as a result of the Frasch mining technology.
Discoverers of sulphur deposits were often disappointed oil companies who were exploring for oil and not prone to value them highly. Costs decline because workers improve their methods and become more efficient the classic learning curve , layout improves, specialized equipment and processes are developed, better performance is coaxed from equipment, product design changes make manufacturing easier, techniques for measurement and control of operations improve, and so on.
Experience is just a name for certain kinds of technological change and may apply not only to production but also to distribution, logistics, and other functions. As is the case with scale economies, cost declines with experience relate not to the entire firm but arise from the individual operations or functions that make up the firm. Experience can lower costs in marketing, distribution, and other areas as well as in production or operations within production, and each component of costs must be examined for the effects of experience.
They are nearly always the most significant in the early and growth phase of a product's development, and later reach diminishing proportional improvements. Often economies of scale are cited among the reasons that costs decline with experience.
Economies of scale are dependent on volume per period, and not on cumulative volume, and are very different analytically from experience, although the two often occur together and can be hard to separate. The dangers of lumping scale and experience together will be discussed further.
If costs decline with experience in an industry, and if the experience can be kept proprietary by established firms, then this effect leads to an entry barrier. Newly started firms, with no experience, will have inherently higher costs than established firms and must bear heavy start-up losses from below- or near-cost pricing in order to gain the experience to achieve cost parity with established firms if they ever can.
Established firms, particularly the market share leader who is accumulating experience the fastest, will have higher cash flow because of their lower costs to invest in new equipment and techniques. However, it is important to recognize that pursuing experience curve cost declines and scale economies may require substantial up-front capital investment for equipment and startup losses.
If costs continue to decline with volume even as cumulative volume gets very large, new entrants may never catch up. A number of firms, notably Texas Instruments, Black and Decker, Emerson Electric, and others have built successful strategies based on the experience curve through aggressive investments to build cumulative volume early in the development of industries, often by pricing in anticipation of future cost declines. The decline in cost from experience can be augmented if there are diversified firms in the industry who share operations or functions subject to such a decline with other units in the company, or where there are related activities in the company from which incomplete though useful experience can be obtained.
When an activity like the fabrication of raw material is shared by several business units, experience obviously accumulates faster than it would if the activity were used solely to meet the needs in one industry. Or when the corporate entity has related activities within the firm, sister units can receive the benefits of their experience at little or no cost since much experience is an intangible asset. This sort of shared learning accentuates the entry barrier provided by the experience curve, provided the other conditions for its significance are met.
Experience is such a widely used concept in strategy formulation that its strategic implications will be discussed further. Government Policy. The last major source of entry barriers is government policy. Government can limit or even foreclose entry into industries with such controls as licensing requirements and limits on access to raw materials like coal lands or mountains on which to build ski areas. Regulated industries like trucking, railroads, liquor retailing, and freight forwarding are obvious examples.
More subtle government restrictions on entry can stem from controls such as air and water pollution standards and product safety and efficacy regulations. For example, pollution control requirements can increase the capital needed for entry and the required technological sophistication and even the optimal scale of facilities.
Standards for product testing, common in industries like food and other health-related products, can impose substantial lead times, which not only raise the capital cost of entry but also give established firms ample notice of impending entry and sometimes full knowledge of the new competitor's product with which to formulate retaliatory strategies.
Government policy in such areas certainly has direct social benefits, but it often has secondary consequences for entry which are unrecognized. Expected Retaliation The potential entrant's expectations about the reaction of existing competitors also will influence the threat of entry. If existing competitors are expected to respond forcefully to make the entrant's stay in the industry an unpleasant one, then entry may well be deterred.
The Entry Deterring Price The condition of entry in an industry can be summarized in an important hypothetical concept called the entry deterring price: the prevailing structure of prices and related terms such as product quality and service which just balances the potential rewards from entry forecast by the potential entrant with the expected costs of overcoming structural entry barriers and risking retaliation.
If the current price level is higher than the entry deterring price, entrants will forecast above-average profits from entry, and entry will occur.
Of course the entry deterring price depends on entrants' expectations of the future and not just current conditions. The threat of entry into an industry can be eliminated if incumbent firms choose or are forced by competition to price below this hypothetical entry deterring price.
If they price above it, gains in terms of profitability may be short-lived because they will be dissipated by the cost of fighting or coexisting with new entrants.
Properties of Entry Barriers There are several additional properties of entry barriers that are crucial from a strategic standpoint. First, entry barriers can and do change as the conditions previously described change.
The expiration of Polaroid's basic patents on instant photography, for instance, greatly reduced its absolute cost entry barrier built by proprietary technology. It is not surprising that Kodak plunged into the market. Product differentiation in the magazine printing industry has all but disappeared, reducing barriers. Conversely, in the auto industry, economies of scale increased with post-World War II automation and vertical integration, virtually stopping successful new entry.
Second, although entry barriers sometimes change for reasons largely outside the firm's control, the firm's strategic decisions also can have a major impact. For example, the actions of many U. Similarly, decisions by members of the recreational vehicle industry to vertically integrate into parts manufacture in order to lower costs have greatly increased the economies of scale there and raised the capital cost barriers.
Finally, some firms may possess resources or skills which allow them to overcome entry barrier into an industry more cheaply than most other firms. For example, Gillette, with well-developed distribution channels for razors and blades, faced lower costs of entry into disposable lighters than did many other firms. The ability to share costs also provides opportunities for low-cost entry. In Chapter 16 we will explore the implications of factors like these for entry strategy in some detail.
Experience and Scale as Entry Barriers Although they often coincide, economies of scale and experience have very different properties as entry barriers. The presence of economies of scale always leads to a cost advantage for the large-scale firm or firm that can share activities over small-scale firms, presupposing that the former have the most efficient facilities, distribution systems, service organizations, or other functional activities for their size.
This cost advantage can be matched only by attaining comparable scale or appropriate diversification to allow cost sharing. The large-scale or diversified firm can spread the fixed costs of operating these efficient facilities over a large number of units, whereas the smaller firm, even if it has technologically efficient facilities, will not fully utilize them.
Experience is a more ethereal entry barrier than scale, because the mere presence of an experience curve does not insure an entry barrier. Another crucial prerequisite is that the experience be proprietary, and not available to competitors and potential entrants through 1 copying, 2 hiring a competitor's employees, or 3 downloading the latest machinery from equipment suppliers or downloading know-how from consultants or other firms.
Frequently, experience cannot be kept proprietary; even when it can, experience may accumulate more rapidly for the second and third firms in the market than it did for the pioneer because followers can observe some aspects of the pioneer's operations.
Where experience cannot be kept proprietary, new entrants may actually have an advantage if they can download the latest equipment or adapt to new methods unencumbered by having operated the old way in the past. New entrants can leapfrog the industry leaders and alight on the new experience curve, to which the leaders may be poorly positioned to jump.
For example, Hewlett-Packard has erected substantial barriers based on technological progressiveness in industries in which other firms are following strategies based on experience and scale, like calculators and minicomputers. By the time only one rival is left pursuing such a strategy, industry growth may have stopped and the prospects of capturing the experience curve benefits long since evaporated.
Rivalry occurs because one or more competitors either feels the pressure or sees the opportunity to improve position. In most industries, competitive moves by one firm have noticeable effects on its competitors and thus may incite retaliation or efforts to counter the move; that is, firms are mutually dependent. This pattern of action and reaction may or may not leave the initiating firm and the industry as a whole better off. If moves and countermoves escalate, then all firms in the industry may suffer and be worse off than before.
Some forms of competition, notably price competition, are highly unstable and quite likely to leave the entire industry worse off from the standpoint of profitability.
Price cuts are quickly and easily matched by rivals, and once matched they lower revenues for all firms unless industry price elasticity of demand is high enough. Advertising battles, on the other hand, may well expand demand or enhance the level of product differentiation in the industry for the benefit of all firms. Rivalry in some industries is characterized by such phrases as "warlike," "bitter," or "cutthroat," whereas in other industries it is termed "polite" or "gentlemanly.
Numerous or Equally Balanced Competitors. When firms are numerous, the likelihood of mavericks is great and some firms may habitually believe they can make moves without being noticed. Even where there are relatively few firms, if they are relatively balanced in terms of size and perceived resources, it creates instability because they may be prone to fight each other and have the resources for sustained and vigorous retaliation. When the industry is highly concentrated or dominated by one or a few firms, on the other hand, then there is little mistaking relative strength, and the leader or leaders can impose discipline as well as play a coordinative role in the industry through devices like price leadership.
In many industries foreign competitors, either exporting into the industry or participating directly through foreign investment, play an important role in industry competition. Foreign competitors, although having some differences that will be noted later, should be treated just like national competitors for purposes of structural analysis.
Slow Industry Growth. Slow industry growth turns competition into a market share game for firms seeking expansion. Market share competition is a great deal more volatile than is the situation in which rapid industry growth insures that firms can improve results just by keeping up with the industry, and where all their financial and managerial resources may be consumed by expanding with the industry. High Fixed or Storage Costs. High fixed costs create strong pressures for all firms to fill capacity which often lead to rapidly escalating price cutting when excess capacity is present.