How Competitive Forces Shape Strategy

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How Competitive Forces Shape Strategy

  1. 1. How Competitive Forces Shape Strategy by Michael E. Porter Harvard Business Review Reprint 79208
  2. 2. HBR J U LY- A U G U S T 1 9 9 7 How Competitive Forces Shape Strategy Awareness of these forces can help a company stake out a position in its industry that is less vulnerable to attack by Michael E. Porter The essence of strategy formulation is coping with drinks, and toiletries, where there is room for quite competition. Yet it is easy to view competition too high returns. narrowly and too pessimistically. While one some- In the economists’ “perfectly competitive” in- times hears executives complaining to the con- dustry, jockeying for position is unbridled and entry trary, intense competition in an industry is neither to the industry very easy. This kind of industry coincidence nor bad luck. structure, of course, offers the worst prospect for Moreover, in the fight for market share, competi- long-run profitability. The weaker the forces collec- tion is not manifested only in the other players. tively, however, the greater the opportunity for su- Rather, competition in an industry is rooted in its perior performance. underlying economics, and competitive forces exist that go well beyond the established combatants in a Mr. Porter is a specialist in industrial economics and particular industry. Customers, suppliers, poten- business strategy. An associate professor of business ad- tial entrants, and substitute products are all com- ministration at the Harvard Business School, he has cre- petitors that may be more or less prominent or ac- ated a course there entitled “Industry and Competitive tive depending on the industry. Analysis.” He sits on the boards of three companies and consults on strategy matters, and he has written many The state of competition in an industry depends articles for economics journals and published two on five basic forces, which are diagrammed in the books. One of them, Interbrand Choice, Strategy and Bi- Exhibit on page 6. The collective strength of these lateral Market Power (Harvard University Press, 1976) is forces determines the ultimate profit potential of an out-growth of his doctoral thesis, for which he won an industry. It ranges from intense in industries like the coveted Wells prize awarded by the Harvard eco- nomics department. He has recently completed two tires, metal cans, and steel, where no company book manuscripts, one on competitive analysis in indus- earns spectacular returns on investment, to mild in try and the other (written with Michael Spence and industries like oil field services and equipment, soft Richard Caves) on competition in the open economy. Copyright © 1979 by the Presidents and Fellows of Harvard College. All rights reserved. HARVARD BUSINESS REVIEW March-April 1979
  3. 3. COMPETITION SHAPES STRATEGY Whatever their collective strength, the corporate A few characteristics are critical to the strength strategist’s goal is to find a position in the industry of each competitive force. I shall discuss them in where his or her company can best defend itself this section. against these forces or can influence them in its fa- vor. The collective strength of the forces may be Threat of entry painfully apparent to all the antagonists; but to New entrants to an industry bring new capacity, cope with them, the strategist must delve below the desire to gain market share, and often substan- the surface and analyze the sources of each. For ex- tial resources. Companies diversifying through ac- ample, what makes the industry vulnerable to en- quisition into the industry from other markets of- try, What determines the bargaining power of sup- ten leverage their resources to cause a shake-up, as pliers? Philip Morris did with Miller beer. Knowledge of these underlying sources of com- The seriousness of the threat of entry depends on petitive pressure provides the groundwork for a the barriers present and on the reaction from exist- strategic agenda of action. They highlight the criti- ing competitors that entrants can expect. If barriers cal strengths and weaknesses of the company, ani- to entry are high and newcomers can expect sharp mate the positioning of the company in its indus- retaliation from the entrenched competitors, obvi- try, clarify the areas where strategic changes may ously the newcomers will not pose a serious threat yield the greatest payoff, and highlight the places of entering. where industry trends promise to hold the greatest There are six major sources of barriers to entry: significance as either opportunities or threats. Un- 1. Economies of scale—These economies deter derstanding these sources also proves to be of help entry by forcing the aspirant either to come in on a in considering areas for diversification. 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 Contending forces mainframe computer industry, as Xerox and GE The strongest competitive force or forces deter- sadly discovered. Economies of scale can also act as mine the profitability of an industry and so are of hurdles in distribution, utilization of the sales greatest importance in strategy formulation. For force, financing, and nearly any other part of a busi- example, even a company with a strong position in ness. an industry unthreatened by potential entrants will 2. Product differentiation—Brand identification earn low returns if it faces a superior or a lower-cost creates a barrier by forcing entrants to spend heavi- substitute product—as the leading manufacturers ly to overcome customer loyalty. Advertising, cus- of vacuum tubes and coffee percolators have tomer service, being first in the industry, and prod- learned to their sorrow. In such a situation, coping uct differences are among the factors fostering with the substitute product becomes the number brand identification. It is perhaps the most impor- one strategic priority. tant entry barrier in soft drinks, over-the-counter Different forces take on prominence, of course, in drugs, cosmetics, investment banking, and public shaping competition in each industry. In the ocean- accounting. To create high fences around their busi- going tanker industry the key force is probably the nesses, brewers couple brand identification with buyers (the major oil companies), while in tires it is economies of scale in production, distribution, and powerful OEM buyers coupled with tough competi- marketing. tors. In the steel industry the key forces are foreign 3. Capital requirements—The need to invest competitors and substitute materials. large financial resources in order to compete cre- Every industry has an underlying structure, or a ates a barrier to entry, particularly if the capital is set of fundamental economic and technical charac- required for unrecoverable expenditures in up-front teristics, that gives rise to these competitive forces. advertising or R&D. Capital is necessary not only The strategist, wanting to position his or her com- for fixed facilities but also for customer credit, in- pany to cope best with its industry environment or ventories, and absorbing start-up losses. While ma- to influence that environment in the company’s fa- jor corporations have the financial resources to in- vor, must learn what makes the environment tick. vade almost any industr y, the huge capital This view of competition pertains equally to in- requirements in certain fields, such as computer dustries dealing in services and to those selling prod- manufacturing and mineral extraction, limit the ucts. To avoid monotony in this article, I refer to pool of likely entrants. both products and services as “products.” The same 4. Cost disadvantages independent of size—En- general principles apply to all types of business. trenched companies may have cost advantages not HARVARD BUSINESS REVIEW March-April 1979 3
  4. 4. The Experience Curve as an Entry Barrier In recent years, the experience curve has become the largest, most efficient plant,” is a lot different widely discussed as a key element of industry struc- from, “You must produce the greatest cumulative out- ture. According to this concept, unit costs in many put of the item to get your costs down.” manufacturing industries (some dogmatic adherents Whether a drop in costs with cumulative (not abso- say in all manufacturing industries) as well as in some lute) volume erects an entry barrier also depends on service industries decline with “experience,” or a par- the sources of the decline. If costs go down because of ticular company’s cumulative volume of production. technical advances known generally in the industry or (The experience curve, which encompasses many fac- because of the development of improved equipment tors, is a broader concept than the better known learn- that can be copied or purchased from equipment sup- ing curve, which refers to the efficiency achieved over pliers, the experience curve is no entry barrier at all – a period of time by workers through much repetition.) in fact, new or less experienced competitors may actu- The causes of the decline in unit costs are a combi- ally enjoy a cost advantage over the leaders. Free of the nation of elements, including economies of scale, the legacy of heavy past investments, the newcomer or learning curve for labor, and capital-labor substitu- less experienced competitor can purchase or copy the tion. The cost decline creates a barrier to entry be- newest and lowest-cost equipment and technology. cause new competitors with no “experience” face If, however, experience can be kept proprietary, the higher costs than established ones, particularly the leaders will maintain a cost advantage. But new en- producer with the largest market share, and have diffi- trants may require less experience to reduce their culty catching up with the entrenched competitors. costs than the leaders needed. All this suggests that Adherents of the experience curve concept stress the experience curve can be a shaky entry barrier on the importance of achieving market leadership to which to build a strategy. maximize this barrier to entry, and they recommend While space does not permit a complete treatment aggressive action to achieve it, such as price cutting in here, I want to mention a few other crucial elements anticipation of falling costs in order to build volume. in determining the appropriateness of a strategy built For the combatant that cannot achieve a healthy mar- on the entry barrier provided by the expenence curve: ket share, the prescription is usually, “Get out.” The height of the barrier depends on how important Is the experience curve an entry barrier on which costs are to competition compared with other areas strategies should be built? The answer is: not in every like marketing, selling, and innovation. industry. In fact, in some industries, building a strate- The barrier can be nullified by product or process in- gy on the experience curve can be potentially disas- novations leading to a substantially new technology trous. That costs decline with experience in some in- and thereby creating an entirely new experience dustries is not news to corporate executives. The curve.* New entrants can leapfrog the industry lead- significance of the experience curve for strategy de- ers and alight on the new experience curve, to which pends on what factors are causing the decline. those leaders may be poorly positioned to jump. If costs are falling because a growing company can If more than one strong company is building its reap economies of scale through more efficient, auto- strategy on the experience curve, the consequences mated facilities and vertical integration, then the cu- can be nearly fatal. By the time only one rival is left mulative volume of production is unimportant to its pursuing such a strategy, industry growth may have relative cost position. Here the lowest-cost producer is stopped and the prospects of reaping the spoils of vic- the one with the largest, most efficient facilities. tory long since evaporated. A new entrant may well be more efficient than the *For an example drawn from the history of the automobile industry more experienced competitors; if it has built the see William J. Abernathy and Kenneth Wayne, “The Limits of the newest plant, it will face no disadvantage in having to Learning Curve,” HBR September/October 1974, p.109. catch up. The strategic prescription, “You must have available to potential rivals, no matter what their forceable, as they are through patents. (For an anal- size and attainable economies of scale. These ad- ysis of the much-discussed experience curve as a vantages can stem from the effects of the learning barrier to entry, see the ruled insert above.) curve (and of its first cousin, the experience curve), 5. Access to distribution channels—The new- proprietary technology, access to the best raw ma- comer on the block must, of course, secure distribu- terials sources, assets purchased at preinflation tion of its product or service. A new food product, prices, government subsidies, or favorable loca- for example, must displace others from the super- tions. Sometimes cost advantages are legally en- market shelf via price breaks, promotions, intense 4 HARVARD BUSINESS REVIEW March-April 1979
  5. 5. COMPETITION SHAPES STRATEGY selling efforts, or some other means. The more lim- ample, the actions of many U.S. wine producers in ited the wholesale or retail channels are and the the 1960s to step up product introductions, raise ad- more that existing competitors have these tied up, vertising levels, and expand distribution nationally obviously the tougher that entry into the industry surely strengthened the entry roadblocks by raising will be. Sometimes this barrier is so high that, to economies of scale and making access to distribu- surmount it, a new contestant must create its own tion channels more difficult. Similarly, decisions distribution channels, as Timex did in the watch in- by members of the recreational vehicle industry to dustry in the 1950s. vertically integrate in order to lower costs have 6. Government policy—The government can greatly increased the economies of scale and raised limit or even foreclose entry to industries with the capital cost barriers. such controls as license requirements and limits on access to raw materials. Regulated industries like Powerful suppliers & buyers trucking, liquor retailing, and freight forwarding Suppliers can exert bargaining power on partici- are noticeable examples; more subtle government pants in an industry by raising prices or reducing restrictions operate in fields like ski-area develop- the quality of purchased goods and services. Power- ment and coal mining. The government also can ful suppliers can thereby squeeze profitability out play a major indirect role by affecting entry barriers of an industry unable to recover cost increases in its through controls such as air and water pollution own prices. By raising their prices, soft drink con- standards and safety regulations. centrate producers have contributed to the erosion of profitability of bottling companies because the The potential rival’s expectations about the reac- bottlers, facing intense competition from powdered tion of existing competitors also will influence its mixes, fruit drinks, and other beverages, have limit- decision on whether to enter. The company is like- ed freedom to raise their prices accordingly. Cus- ly to have second thoughts if incumbents have pre- tomers likewise can force down prices, demand viously lashed out at new entrants or if: higher quality or more service, and play competi- The incumbents possess substantial resources to tors off against each other—all at the expense of in- fight back, including excess cash and unused bor- dustry profits. rowing power, productive capacity, or clout with The power of each important supplier or buyer distribution channels and customers. group depends on a number of characteristics of its The incumbents seem likely to cut prices be- market situation and on the relative importance of cause of a desire to keep market shares or because of its sales or purchases to the industry compared industrywide excess capacity. with its overall business. Industry growth is slow, affecting its ability to ab- A supplier group is powerful if: sorb the new arrival and probably causing the finan- It is dominated by a few companies and is more cial performance of all the parties involved to de- concentrated than the industry it sells to. cline. Its product is unique or at least differentiated, or if it has built up switching costs. Switching costs Changing conditions are fixed costs buyers face in changing suppliers. From a strategic standpoint there are two impor- These arise because, among other things, a buyer’s tant additional points to note about the threat of product specifications tie it to particular suppliers, entry. it has invested heavily in specialized ancillary First, it changes, of course, as these conditions equipment or in reaming how to operate a suppli- change. The expiration of Polaroid’s basic patents er’s equipment (as in computer software), or its pro- on instant photography, for instance, greatly re- duction lines are connected to the supplier’s manu- duced its absolute cost entry barrier built by propri- facturing facilities (as in some manufacture of etary technology. It is not surprising that Kodak beverage containers). plunged into the market. Product differentiation in It is not obliged to contend with other products printing has all but disappeared. Conversely, in the for sale to the industry. For instance, the competi- auto industry economies of scale increased enor- tion between the steel companies and the alu- mously with post-World War II automation and ver- minum companies to sell to the can industry tical integration—virtually stopping successful checks the power of each supplier. new entry. It poses a credible threat of integrating forward Second, strategic decisions involving a large seg- into the industry’s business. This provides a check ment of an industry can have a major impact on the against the industry’s ability to improve the terms conditions determining the threat of entry. For ex- on which it purchases. HARVARD BUSINESS REVIEW March-April 1979 5
  6. 6. The industry is not an important customer of the supplier group. If the industry is an important cus- Exhibit tomer, suppliers’ fortunes will be closely tied to the Forces governing competition in an industry industry, and they will want to protect the industry through reasonable pricing and assistance in activi- ties like R&D and lobbying. A buyer group is powerful if: It is concentrated or purchases in large volumes. Large volume buyers are particularly potent forces if heavy fixed costs characterize the industry—as they do in metal containers, corn refining, and bulk chemicals, for example—which raise the stakes to keep capacity filled. The products it purchases from the industry are standard or undifferentiated. The buyers, sure that they can always find alternative suppliers, may play one company against another, as they do in aluminum extrusion. The products it purchases from the industry form a component of its product and represent a signifi- cant fraction of its cost. The buyers are likely to shop for a favorable price and purchase selectively. Where the product sold by the industry in question is a small fraction of buyers’ costs, buyers are usual- ly much less price sensitive. gaining lever. But sometimes an industry engenders It earns low profits, which create great incentive a threat to buyers that its members may integrate to lower its purchasing costs. Highly profitable forward. buyers, however, are generally less price sensitive (that is, of course, if the item does not represent a Most of these sources of buyer power can be at- large fraction of their costs). tributed to consumers as a group as well as to indus- The industry’s product is unimportant to the trial and commercial buyers; only a modification of quality of the buyers’ products or services. Where the frame of reference is necessary. Consumers the quality of the buyers’ products is very much af- tend to be more price sensitive if they are purchas- fected by the industry’s product, buyers are general- ing products that are undifferentiated, expensive ly less price sensitive. Industries in which this situ- relative to their incomes, and of a sort where quali- ation obtains include oil field equipment, where a ty is not particularly important. malfunction can lead to large losses, and enclosures The buying power of retailers is determined by for electronic medical and test instruments, where the same rules, with one important addition. Re- the quality of the enclosure can influence the user’s tailers can gain significant bargaining power over impression about the quality of the equipment in- manufacturers when they can influence con- side. sumers’ purchasing decisions, as they do in audio The industry’s product does not save the buyer components, jewelry, appliances, sporting goods, money. Where the industry’s product or service can and other goods. pay for itself many times over, the buyer is rarely price sensitive; rather, he is interested in quality. Strategic action This is true in services like investment banking A company’s choice of suppliers to buy from or buy- and public accounting, where errors in judgment er groups to sell to should be viewed as a crucial can be costly and embarrassing, and in businesses strategic decision. A company can improve its like the logging of oil wells, where an accurate sur- strategic posture by finding suppliers or buyers who vey can save thousands of dollars in drilling costs. possess the least power to influence it adversely. The buyers pose a credible threat of integrating Most common is the situation of a company be- backward to make the industry’s product. The Big ing able to choose whom it will sell to—in other Three auto producers and major buyers of cars have words, buyer selection. Rarely do all the buyer often used the threat of self-manufacture as a bar- groups a company sells to enjoy equal power. Even 6 HARVARD BUSINESS REVIEW March-April 1979
  7. 7. COMPETITION SHAPES STRATEGY if a company sells to a single industry, segments Substitutes not only limit profits in normal usually exist within that industry that exercise less times; they also reduce the bonanza an industry can power (and that are therefore less price sensitive) reap in boom times. In 1978 the producers of fiber- than others. For example, the replacement market glass insulation enjoyed unprecedented demand as for most products is less price sensitive than the a result of high energy costs and severe winter overall market. weather. But the industry’s ability to raise prices As a rule, a company can sell to powerful buyers was tempered by the plethora of insulation substi- and still come away with above-average profitabili- tutes, including cellulose, rock wool, and styro- ty only if it is a low-cost producer in its industry or foam. These substitutes are bound to become an if its product enjoys some unusual, if not unique, even stronger force once the current round of plant features. In supplying large customers with electric additions by fiberglass insulation producers has motors, Emerson Electric earns high returns be- boosted capacity enough to meet demand (and then cause its low cost position permits the company to some). meet or undercut competitors’ prices. Substitute products that deserve the most atten- If the company lacks a low cost position or a tion strategically are those that (a) are subject to unique product, selling to everyone is self-defeating trends improving their price-performance trade-off because the more sales it achieves, the more vul- with the industry’s product, or (b) are produced by nerable it becomes. The company may have to industries earning high profits. Substitutes often muster the courage to turn away business and sell come rapidly into play if some development in- only to less potent customers. creases competition in their industries and causes Buyer selection has been a key to the success of price reduction or performance improvement. National Can and Crown Cork & Seal. They focus on the segments of the can industry where they can Jockeying for position create product differentiation, minimize the threat Rivalry among existing competitors takes the fa- of backward integration, and otherwise mitigate miliar form of jockeying for position—using tactics the awesome power of their customers. Of course, like price competition, product introduction, and some industries do not enjoy the luxury of selecting advertising slugfests. Intense rivalry is related to “good” buyers. the presence of a number of factors: As the factors creating supplier and buyer power Competitors are numerous or are roughly equal change with time or as a result of a company’s in size and power. In many U.S. industries in recent strategic decisions, naturally the power of these years foreign contenders, of course, have become groups rises or declines. In the ready-to-wear cloth- part of the competitive picture. ing industry, as the buyers (department stores and Industry growth is slow, precipitating fights for clothing stores) have become more concentrated market share that involve expansion-minded mem- and control has passed to large chains, the industry bers. has come under increasing pressure and suffered The product or service lacks differentiation or falling margins. The industry has been unable to switching costs, which lock in buyers and protect differentiate its product or engender switching one combatant from raids on its customers by an- costs that lock in its buyers enough to neutralize other. these trends. Fixed costs are high or the product is perishable, creating strong temptation to cut prices. Many ba- Substitute products sic materials businesses, like paper and aluminum, By placing a ceiling on prices it can charge, substi- suffer from this problem when demand slackens. tute products or services limit the potential of an Capacity is normally augmented in large incre- industry. Unless it can upgrade the quality of the ments. Such additions, as in the chlorine and vinyl product or differentiate it somehow (as via market- chloride businesses, disrupt the industry’s supply- ing), the industry will suffer in earnings and possi- demand balance and often lead to periods of overca- bly in growth. pacity and price cutting. Manifestly, the more attractive the price-perfor- Exit barriers are high. Exit barriers, like very spe- mance trade-off offered by substitute products, the cialized assets or management’s loyalty to a partic- firmer the lid placed on the industry’s profit poten- ular business, keep companies competing even tial. Sugar producers confronted with the large- though they may be earning low or even negative scale commercialization of high-fructose corn returns on investment. Excess capacity remains syrup, a sugar substitute, are learning this lesson functioning, and the profitability of the healthy today. competitors suffers as the sick ones hang on.1 If the HARVARD BUSINESS REVIEW March-April 1979 7
  8. 8. entire industry suffers from overcapacity, it may forces and responding to them, with the hope of ex- seek government help—particularly if foreign com- ploiting change by choosing a strategy appropriate petition is present. for the new competitive balance before opponents The rivals are diverse in strategies, origins, and recognize it. I shall consider each strategic ap- “personalities.” They have different ideas about proach in turn. how to compete and continually run head-on into each other in the process. Positioning the company The first approach takes the structure of the indus- As an industry matures, its growth rate changes, re- try as given and matches the company’s strengths sulting in declining profits and (often) a shakeout. and weaknesses to it. Strategy can be viewed as In the booming recreational vehicle industry of the building defenses against the competitive forces or early 1970s, nearly every producer did well; but as finding positions in the industry where the forces slow growth since then has eliminated the high re- are weakest. turns, except for the strongest members, not to Knowledge of the company’s capabilities and of mention many of the weaker companies. The same the causes of the competitive forces will highlight profit story has been played out in industry after in- the areas where the company should confront com- dustry—snowmobiles, aerosol packaging, and petition and where avoid it. If the company is a low- sports equipment are just a few examples. cost producer, it may choose to confront powerful An acquisition can introduce a very different per- buyers while it takes care to sell them only prod- sonality to an industry, as has been the case with ucts not vulnerable to competition from substi- Black & Decker’s takeover of McCullough, the pro- tutes. ducer of chain saws. Technological innovation can The success of Dr Pepper in the soft drink indus- boost the level of fixed costs in the production pro- try illustrates the coupling of realistic knowledge of cess, as it did in the shift from batch to continuous- corporate strengths with sound industry analysis to line photo finishing in the 1960s. yield a superior strategy. Coca-Cola and PepsiCola While a company must live with many of these dominate Dr Pepper’s industry, where many small factors—because they are built into industry eco- concentrate producers compete for a piece of the ac- nomics—it may have some latitude for improving tion. Dr Pepper chose a strategy of avoiding the matters through strategic shifts. For example, it largest-selling drink segment, maintaining a nar- may try to raise buyers’ switching costs or increase row flavor line, forgoing the development of a cap- product differentiation. A focus on selling efforts in tive bottler network, and marketing heavily. The the fastest-growing segments of the industry or on company positioned itself so as to be least vulnera- market areas with the lowest fixed costs can reduce ble to its competitive forces while it exploited its the impact of industry rivalry. If it is feasible, a small size. company can try to avoid confrontation with com- In the $11.5 billion soft drink industry, barriers to petitors having high exit barriers and can thus entry in the form of brand identification, large-scale sidestep involvement in bitter price cutting. marketing, and access to a bottler network are enor- mous. Rather than accept the formidable costs and scale economies in having its own bottler net- Formulation of strategy work—that is, following the lead of the Big Two and Once having assessed the forces affecting competi- of Seven-Up—Dr Pepper took advantage of the dif- tion in an industry and their underlying causes, the ferent flavor of its drink to “piggyback” on Coke corporate strategist can identify the company’s and Pepsi bottlers who wanted a full line to sell to strengths and weaknesses. The crucial strengths customers. Dr Pepper coped with the power of and weaknesses from a strategic standpoint are the these buyers through extraordinary service and oth- company’s posture vis-à-vis the underlying causes er efforts to distinguish its treatment of them from of each force. Where does it stand against substi- that of Coke and Pepsi. tutes? Against the sources of enery barriers? Many small companies in the soft drink business Then the strategist can devise a plan of action offer cola drinks that thrust them into head-to-head that may include (l) positioning the company so competition against the majors. Dr Pepper, howev- that its capabilities provide the best defense against er, maximized product differentiation by maintain- the competitive force; and/or (2) influencing the ing a narrow line of beverages built around an un- balance of the forces through strategic moves, usual flavor. thereby improving the company’s position; and/or Finally, Dr Pepper met Coke and Pepsi with an (3) anticipating shifts in the factors underlying the advertising onslaught emphasizing the alleged 8 HARVARD BUSINESS REVIEW March-April 1979
  9. 9. COMPETITION SHAPES STRATEGY uniqueness of its single flavor. This campaign built tion. strong brand identification and great customer loy- The framework for analyzing competition that I alty. Helping its efforts was the fact that Dr Pep- have described can also be used to predict the even- per’s formula involved lower raw materials cost, tual profitability of an industry. In long-range plan- which gave the company an absolute cost advan- ning the task is to examine each competitive force, tage over its major competitors. forecast the magnitude of each underlying cause, There are no economies of scale in soft drink con- and then construct a composite picture of the likely centrate production, so Dr Pepper could prosper de- profit potential of the industry. spite its small share of the business (6%). Thus Dr The outcome of such an exercise may differ a Pepper confronted competition in marketing but great deal from the existing industry structure. To- avoided it in product line and in distribution. This day, for example, the solar heating business is popu- artful positioning combined with good implemen- lated by dozens and perhaps hundreds of compa- tation has led to an enviable record in earnings and nies, none with a major market position. Entry is in the stock market. easy, and competitors are battling to establish solar heating as a superior substitute for conventional Influencing the balance methods. When dealing with the forces that drive industry The potential of this industry will depend largely competition, a company can devise a strategy that on the shape of future barriers to entry, the im- takes the offensive. This posture is designed to do provement of the industry’s position relative to more than merely cope with the forces themselves; substitutes, the ultimate intensity of competition, it is meant to alter their causes. and the power captured by buyers and suppliers. Innovations in marketing can raise brand identi- These characteristics will in turn be influenced by fication or otherwise differentiate the product. Cap- such factors as the establishment of brand identi- ital investments in large-scale facilities or vertical ties, significant economies of scale or experience integration affect entry barriers. The balance of curves in equipment manufacture wrought by tech- forces is partly a result of external factors and partly nological change, the ultimate capital costs to com- in the company’s control. pete, and the extent of overhead in production facil- ities. Exploiting industry change The framework for analyzing industry competi- Industry evolution is important strategically be- tion has direct benefits in setting diversification cause evolution, of course, brings with it changes in strategy. It provides a road map for answering the the sources of competition I have identified. In the extremely difficult question inherent in diversi familiar product life-cycle pattern, for example, fication decisions: “What is the potential of this growth rates change, product differentiation is said business?” Combining the framework with judg- to decline as the business becomes more mature, ment in its application, a company may be able to and the companies tend to integrate vertically. spot an industry with a good future before this good These trends are not so important in themselves; future is reflected in the prices of acquisition can- what is critical is whether they affect the sources of didates. competition. Consider vertical integration. In the maturing minicomputer industry, extensive verti- Multifaceted rivalry cal integration, both in manufacturing and in soft- ware development, is taking place. This very signif- Corporate managers have directed a great deal of at- icant trend is greatly raising economies of scale as tention to defining their businesses as a crucial step well as the amount of capital necessary to compete in strategy formulation. Theodore Levitt, in his in the industry. This in turn is raising barriers to en- classic 1960 article in HBR, argued strongly for try and may drive some smaller competitors out of avoiding the myopia of narrow, product-oriented the industry once growth levels off. industry definition.2 Numerous other authorities Obviously, the trends carrying the highest priori- have also stressed the need to look beyond product ty from a strategic standpoint are those that affect to function in defining a business, beyond national the most important sources of competition in the boundaries to potential international competition, industry and those that elevate new causes to the and beyond the ranks of one’s competitors today to forefront. In contract aerosol packaging, for exam- those that may become competitors tomorrow. As ple, the trend toward less product differentiation is a result of these urgings, the proper definition of a now dominant. It has increased buyers’ power, low- company’s industry or industries has become an ered the barriers to entry, and intensified competi- endlessly debated subject. HARVARD BUSINESS REVIEW March-April 1979 9
  10. 10. One motive behind this debate is the desire to ex- new, and less vulnerable to erosion from the direc- ploit new markets. Another, perhaps more impor- tion of buyers, suppliers, and substitute goods. Es- tant motive is the fear of overlooking latent sources tablishing such a position can take many forms— of competition that someday may threaten the in- solidifying relationships with favorable customers, dustry. Many managers concentrate so single- differentiating the product either substantively or mindedly on their direct antagonists in the fight for psychologically through marketing, integrating for- market share that they fail to realize that they are ward or backward, establishing technological lead- also competing with their customers and their sup- ership. pliers for bargaining power. Meanwhile, they also 1 For a more complete discussion of exit barriers and their impli- neglect to keep a wary eye out for new entrants to cations for strategy, see my article, “Please Note Location of the contest or fail to recognize the subtle threat of Nearest Exit,” California Management Review, Winter 1976, p. 21. substitute products. 2 The key to growth—even survival—is to stake Theodore Levitt, “Marketing Myopia,” reprinted as an HBR Classic, September-October 1975, p. 26. out a position that is less vulnerable to attack from head-to-head opponents, whether established or Reprint 79208 To place an order, call 800-988-0886. 10 HARVARD BUSINESS REVIEW March-April 1979

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