How Competitive Forces Shape Strategy · How Competitive Forces Shape Strategy ... The state of competition in an industry depends on five basic forces, ... Advertising, cus-

How CompetitiveForces Shape Strategy

by Michael E. Porter

Reprint 79208

Harvard Business Review

The essence of strategy formulation is coping withcompetition. Yet it is easy to view competition toonarrowly and too pessimistically. While one some-times hears executives complaining to the con-trary, intense competition in an industry is neithercoincidence nor bad luck.

Moreover, in the fight for market share, competi-tion is not manifested only in the other players.Rather, competition in an industry is rooted in itsunderlying economics, and competitive forces existthat go well beyond the established combatants in aparticular industry. Customers, suppliers, poten-tial entrants, and substitute products are all com-petitors that may be more or less prominent or ac-tive depending on the industry.

The state of competition in an industry dependson five basic forces, which are diagrammed in theExhibit on page 6. The collective strength of theseforces determines the ultimate profit potential ofan industry. It ranges from intense in industries liketires, metal cans, and steel, where no companyearns spectacular returns on investment, to mild inindustries like oil field services and equipment, soft

drinks, and toiletries, where there is room for quitehigh returns.

In the economists’ “perfectly competitive” in-dustry, jockeying for position is unbridled and entryto the industry very easy. This kind of industrystructure, of course, offers the worst prospect forlong-run profitability. The weaker the forces collec-tively, however, the greater the opportunity for su-perior performance.

Copyright © 1979 by the Presidents and Fellows of Harvard College. All rights reserved. HARVARD BUSINESS REVIEW March-April 1979

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HowCompetitive ForcesShape Strategy

Mr. Porter is a specialist in industrial economics andbusiness strategy. An associate professor of business ad-ministration at the Harvard Business School, he has cre-ated a course there entitled “Industry and CompetitiveAnalysis.” He sits on the boards of three companies andconsults on strategy matters, and he has written manyarticles for economics journals and published twobooks. One of them, Interbrand Choice, Strategy and Bi-lateral Market Power (Harvard University Press, 1976) isan out-growth of his doctoral thesis, for which he wonthe coveted Wells prize awarded by the Harvard eco-nomics department. He has recently completed twobook manuscripts, one on competitive analysis in indus-try and the other (written with Michael Spence andRichard Caves) on competition in the open economy.

by Michael E. Porter

Awareness of these forces can help a company stake outa position in its industry that is less vulnerable to attack

Whatever their collective strength, the corporatestrategist’s goal is to find a position in the industrywhere his or her company can best defend itselfagainst these forces or can influence them in its fa-vor. The collective strength of the forces may bepainfully apparent to all the antagonists; but tocope with them, the strategist must delve belowthe surface and analyze the sources of each. For ex-ample, what makes the industry vulnerable to en-try, What determines the bargaining power of sup-pliers?

Knowledge of these underlying sources of com-petitive pressure provides the groundwork for astrategic agenda of action. They highlight the criti-cal strengths and weaknesses of the company, ani-mate the positioning of the company in its indus-try, clarify the areas where strategic changes mayyield the greatest payoff, and highlight the placeswhere industry trends promise to hold the greatestsignificance as either opportunities or threats. Un-derstanding these sources also proves to be of helpin considering areas for diversification.

Contending forcesThe strongest competitive force or forces deter-mine the profitability of an industry and so are ofgreatest importance in strategy formulation. Forexample, even a company with a strong position inan industry unthreatened by potential entrants willearn low returns if it faces a superior or a lower-costsubstitute product—as the leading manufacturersof vacuum tubes and coffee percolators havelearned to their sorrow. In such a situation, copingwith the substitute product becomes the numberone strategic priority.

Different forces take on prominence, of course, inshaping competition in each industry. In the ocean-going tanker industry the key force is probably thebuyers (the major oil companies), while in tires it ispowerful OEM buyers coupled with tough competi-tors. In the steel industry the key forces are foreigncompetitors and substitute materials.

Every industry has an underlying structure, or aset of fundamental economic and technical charac-teristics, that gives rise to these competitive forces.The strategist, wanting to position his or her com-pany to cope best with its industry environment orto influence that environment in the company’s fa-vor, must learn what makes the environment tick.

This view of competition pertains equally to in-dustries dealing in services and to those selling prod-ucts. To avoid monotony in this article, I refer toboth products and services as “products.” The samegeneral principles apply to all types of business.

A few characteristics are critical to the strengthof each competitive force. I shall discuss them inthis section.

Threat of entry

New entrants to an industry bring new capacity,the desire to gain market share, and often substan-tial resources. Companies diversifying through ac-quisition into the industry from other markets of-ten leverage their resources to cause a shake-up, asPhilip Morris did with Miller beer.

The seriousness of the threat of entry depends onthe barriers present and on the reaction from exist-ing competitors that entrants can expect. If barriersto entry are high and newcomers can expect sharpretaliation from the entrenched competitors, obvi-ously the newcomers will not pose a serious threatof entering.

There are six major sources of barriers to entry:1. Economies of scale—These economies deter

entry by forcing the aspirant either to come in on alarge scale or to accept a cost disadvantage. Scaleeconomies in production, research, marketing, andservice are probably the key barriers to entry in themainframe computer industry, as Xerox and GEsadly discovered. Economies of scale can also act ashurdles in distribution, utilization of the salesforce, financing, and nearly any other part of a busi-ness.

2. Product differentiation—Brand identificationcreates a barrier by forcing entrants to spend heavi-ly to overcome customer loyalty. Advertising, cus-tomer service, being first in the industry, and prod-uct differences are among the factors fosteringbrand identification. It is perhaps the most impor-tant entry barrier in soft drinks, over-the-counterdrugs, cosmetics, investment banking, and publicaccounting. To create high fences around their busi-nesses, brewers couple brand identification witheconomies of scale in production, distribution, andmarketing.

3. Capital requirements—The need to investlarge financial resources in order to compete cre-ates a barrier to entry, particularly if the capital isrequired for unrecoverable expenditures in up-frontadvertising or R&D. Capital is necessary not onlyfor fixed facilities but also for customer credit, in-ventories, and absorbing start-up losses. While ma-jor corporations have the financial resources to in-vade almost any industry, the huge capitalrequirements in certain fields, such as computermanufacturing and mineral extraction, limit thepool of likely entrants.

4. Cost disadvantages independent of size—En-trenched companies may have cost advantages not

COMPETITION SHAPES STRATEGY

HARVARD BUSINESS REVIEW March-April 1979 3

The Experience Curve as an Entry BarrierIn recent years, the experience curve has becomewidely discussed as a key element of industry struc-ture. According to this concept, unit costs in manymanufacturing industries (some dogmatic adherentssay in all manufacturing industries) as well as in someservice industries decline with “experience,” or a par-ticular company’s cumulative volume of production.(The experience curve, which encompasses many fac-tors, is a broader concept than the better known learn-ing curve, which refers to the efficiency achieved overa period of time by workers through much repetition.)

The causes of the decline in unit costs are a combi-nation of elements, including economies of scale, thelearning curve for labor, and capital-labor substitu-tion. The cost decline creates a barrier to entry be-cause new competitors with no “experience” facehigher costs than established ones, particularly theproducer with the largest market share, and have diffi-culty catching up with the entrenched competitors.

Adherents of the experience curve concept stressthe importance of achieving market leadership tomaximize this barrier to entry, and they recommendaggressive action to achieve it, such as price cutting inanticipation of falling costs in order to build volume.For the combatant that cannot achieve a healthy mar-ket share, the prescription is usually, “Get out.”

Is the experience curve an entry barrier on whichstrategies should be built? The answer is: not in everyindustry. In fact, in some industries, building a strate-gy on the experience curve can be potentially disas-trous. That costs decline with experience in some in-dustries is not news to corporate executives. Thesignificance of the experience curve for strategy de-pends on what factors are causing the decline.

If costs are falling because a growing company canreap economies of scale through more efficient, auto-mated facilities and vertical integration, then the cu-mulative volume of production is unimportant to itsrelative cost position. Here the lowest-cost producer isthe one with the largest, most efficient facilities.

A new entrant may well be more efficient than themore experienced competitors; if it has built thenewest plant, it will face no disadvantage in having tocatch up. The strategic prescription, “You must have

the largest, most efficient plant,” is a lot differentfrom, “You must produce the greatest cumulative out-put of the item to get your costs down.”

Whether a drop in costs with cumulative (not abso-lute) volume erects an entry barrier also depends onthe sources of the decline. If costs go down because oftechnical advances known generally in the industry orbecause of the development of improved equipmentthat can be copied or purchased from equipment sup-pliers, the experience curve is no entry barrier at all –in fact, new or less experienced competitors may actu-ally enjoy a cost advantage over the leaders. Free of thelegacy of heavy past investments, the newcomer orless experienced competitor can purchase or copy thenewest and lowest-cost equipment and technology.

If, however, experience can be kept proprietary, theleaders will maintain a cost advantage. But new en-trants may require less experience to reduce theircosts than the leaders needed. All this suggests thatthe experience curve can be a shaky entry barrier onwhich to build a strategy.

While space does not permit a complete treatmenthere, I want to mention a few other crucial elementsin determining the appropriateness of a strategy builton the entry barrier provided by the expenence curve:M The height of the barrier depends on how importantcosts are to competition compared with other areaslike marketing, selling, and innovation.M The barrier can be nullified by product or process in-novations leading to a substantially new technologyand thereby creating an entirely new experiencecurve.* New entrants can leapfrog the industry lead-ers and alight on the new experience curve, to whichthose leaders may be poorly positioned to jump.M If more than one strong company is building itsstrategy on the experience curve, the consequencescan be nearly fatal. By the time only one rival is leftpursuing such a strategy, industry growth may havestopped and the prospects of reaping the spoils of vic-tory long since evaporated.

*For an example drawn from the history of the automobile industrysee William J. Abernathy and Kenneth Wayne, “The Limits of theLearning Curve,” HBR September/October 1974, p.109.

available to potential rivals, no matter what theirsize and attainable economies of scale. These ad-vantages can stem from the effects of the learningcurve (and of its first cousin, the experience curve),proprietary technology, access to the best raw ma-terials sources, assets purchased at preinflationprices, government subsidies, or favorable loca-tions. Sometimes cost advantages are legally en-

forceable, as they are through patents. (For an anal-ysis of the much-discussed experience curve as abarrier to entry, see the ruled insert above.)

5. Access to distribution channels—The new-comer on the block must, of course, secure distribu-tion of its product or service. A new food product,for example, must displace others from the super-market shelf via price breaks, promotions, intense

4 HARVARD BUSINESS REVIEW March-April 1979

selling efforts, or some other means. The more lim-ited the wholesale or retail channels are and themore that existing competitors have these tied up,obviously the tougher that entry into the industrywill be. Sometimes this barrier is so high that, tosurmount it, a new contestant must create its owndistribution channels, as Timex did in the watch in-dustry in the 1950s.

6. Government policy—The government canlimit or even foreclose entry to industries withsuch controls as license requirements and limits onaccess to raw materials. Regulated industries liketrucking, liquor retailing, and freight forwardingare noticeable examples; more subtle governmentrestrictions operate in fields like ski-area develop-ment and coal mining. The government also canplay a major indirect role by affecting entry barriersthrough controls such as air and water pollutionstandards and safety regulations.

The potential rival’s expectations about the reac-tion of existing competitors also will influence itsdecision on whether to enter. The company is like-ly to have second thoughts if incumbents have pre-viously lashed out at new entrants or if:M The incumbents possess substantial resources tofight back, including excess cash and unused bor-rowing power, productive capacity, or clout withdistribution channels and customers.M The incumbents seem likely to cut prices be-cause of a desire to keep market shares or because ofindustrywide excess capacity.M Industry growth is slow, affecting its ability to ab-sorb the new arrival and probably causing the finan-cial performance of all the parties involved to de-cline.

Changing conditions

From a strategic standpoint there are two impor-tant additional points to note about the threat ofentry.

First, it changes, of course, as these conditionschange. The expiration of Polaroid’s basic patentson instant photography, for instance, greatly re-duced its absolute cost entry barrier built by propri-etary technology. It is not surprising that Kodakplunged into the market. Product differentiation inprinting has all but disappeared. Conversely, in theauto industry economies of scale increased enor-mously with post-World War II automation and ver-tical integration—virtually stopping successfulnew entry.

Second, strategic decisions involving a large seg-ment of an industry can have a major impact on theconditions determining the threat of entry. For ex-

ample, the actions of many U.S. wine producers inthe 1960s to step up product introductions, raise ad-vertising levels, and expand distribution nationallysurely strengthened the entry roadblocks by raisingeconomies of scale and making access to distribu-tion channels more difficult. Similarly, decisionsby members of the recreational vehicle industry tovertically integrate in order to lower costs havegreatly increased the economies of scale and raisedthe capital cost barriers.

Powerful suppliers & buyers

Suppliers can exert bargaining power on partici-pants in an industry by raising prices or reducingthe quality of purchased goods and services. Power-ful suppliers can thereby squeeze profitability outof an industry unable to recover cost increases in itsown prices. By raising their prices, soft drink con-centrate producers have contributed to the erosionof profitability of bottling companies because thebottlers, facing intense competition from powderedmixes, fruit drinks, and other beverages, have limit-ed freedom to raise their prices accordingly. Cus-tomers likewise can force down prices, demandhigher quality or more service, and play competi-tors off against each other—all at the expense of in-dustry profits.

The power of each important supplier or buyergroup depends on a number of characteristics of itsmarket situation and on the relative importance ofits sales or purchases to the industry comparedwith its overall business.

A supplier group is powerful if:M It is dominated by a few companies and is moreconcentrated than the industry it sells to.M Its product is unique or at least differentiated, orif it has built up switching costs. Switching costsare fixed costs buyers face in changing suppliers.These arise because, among other things, a buyer’sproduct specifications tie it to particular suppliers,it has invested heavily in specialized ancillaryequipment or in reaming how to operate a suppli-er’s equipment (as in computer software), or its pro-duction lines are connected to the supplier’s manu-facturing facilities (as in some manufacture ofbeverage containers).M It is not obliged to contend with other productsfor sale to the industry. For instance, the competi-tion between the steel companies and the alu-minum companies to sell to the can industrychecks the power of each supplier.M It poses a credible threat of integrating forwardinto the industry’s business. This provides a checkagainst the industry’s ability to improve the termson which it purchases.



M The industry is not an important customer of thesupplier group. If the industry is an important cus-tomer, suppliers’ fortunes will be closely tied to theindustry, and they will want to protect the industrythrough reasonable pricing and assistance in activi-ties like R&D and lobbying.

A buyer group is powerful if:M It is concentrated or purchases in large volumes.Large volume buyers are particularly potent forcesif heavy fixed costs characterize the industry—asthey do in metal containers, corn refining, and bulkchemicals, for example—which raise the stakes tokeep capacity filled.M The products it purchases from the industry arestandard or undifferentiated. The buyers, sure thatthey can always find alternative suppliers, mayplay one company against another, as they do inaluminum extrusion.M The products it purchases from the industry forma component of its product and represent a signifi-cant fraction of its cost. The buyers are likely toshop for a favorable price and purchase selectively.Where the product sold by the industry in questionis a small fraction of buyers’ costs, buyers are usual-ly much less price sensitive.M It earns low profits, which create great incentiveto lower its purchasing costs. Highly profitablebuyers, however, are generally less price sensitive(that is, of course, if the item does not represent alarge fraction of their costs).M The industry’s product is unimportant to thequality of the buyers’ products or services. Wherethe quality of the buyers’ products is very much af-fected by the industry’s product, buyers are general-ly less price sensitive. Industries in which this situ-ation obtains include oil field equipment, where amalfunction can lead to large losses, and enclosuresfor electronic medical and test instruments, wherethe quality of the enclosure can influence the user’simpression about the quality of the equipment in-side.M The industry’s product does not save the buyermoney. Where the industry’s product or service canpay for itself many times over, the buyer is rarelyprice sensitive; rather, he is interested in quality.This is true in services like investment bankingand public accounting, where errors in judgmentcan be costly and embarrassing, and in businesseslike the logging of oil wells, where an accurate sur-vey can save thousands of dollars in drilling costs.M The buyers pose a credible threat of integratingbackward to make the industry’s product. The BigThree auto producers and major buyers of cars haveoften used the threat of self-manufacture as a bar-

gaining lever. But sometimes an industry engendersa threat to buyers that its members may integrateforward.

Most of these sources of buyer power can be at-tributed to consumers as a group as well as to indus-trial and commercial buyers; only a modification ofthe frame of reference is necessary. Consumerstend to be more price sensitive if they are purchas-ing products that are undifferentiated, expensiverelative to their incomes, and of a sort where quali-ty is not particularly important.

The buying power of retailers is determined bythe same rules, with one important addition. Re-tailers can gain significant bargaining power overmanufacturers when they can influence con-sumers’ purchasing decisions, as they do in audiocomponents, jewelry, appliances, sporting goods,and other goods.

Strategic action

A company’s choice of suppliers to buy from or buy-er groups to sell to should be viewed as a crucialstrategic decision. A company can improve itsstrategic posture by finding suppliers or buyers whopossess the least power to influence it adversely.

Most common is the situation of a company be-ing able to choose whom it will sell to—in otherwords, buyer selection. Rarely do all the buyergroups a company sells to enjoy equal power. Even


ExhibitForces governing competition in an industry

if a company sells to a single industry, segmentsusually exist within that industry that exercise lesspower (and that are therefore less price sensitive)than others. For example, the replacement marketfor most products is less price sensitive than theoverall market.

As a rule, a company can sell to powerful buyersand still come away with above-average profitabili-ty only if it is a low-cost producer in its industry orif its product enjoys some unusual, if not unique,features. In supplying large customers with electricmotors, Emerson Electric earns high returns be-cause its low cost position permits the company tomeet or undercut competitors’ prices.

If the company lacks a low cost position or aunique product, selling to everyone is self-defeatingbecause the more sales it achieves, the more vul-nerable it becomes. The company may have tomuster the courage to turn away business and sellonly to less potent customers.

Buyer selection has been a key to the success ofNational Can and Crown Cork & Seal. They focuson the segments of the can industry where they cancreate product differentiation, minimize the threatof backward integration, and otherwise mitigatethe awesome power of their customers. Of course,some industries do not enjoy the luxury of selecting“good” buyers.

As the factors creating supplier and buyer powerchange with time or as a result of a company’sstrategic decisions, naturally the power of thesegroups rises or declines. In the ready-to-wear cloth-ing industry, as the buyers (department stores andclothing stores) have become more concentratedand control has passed to large chains, the industryhas come under increasing pressure and sufferedfalling margins. The industry has been unable todifferentiate its product or engender switchingcosts that lock in its buyers enough to neutralizethese trends.

Substitute products

By placing a ceiling on prices it can charge, substi-tute products or services limit the potential of anindustry. Unless it can upgrade the quality of theproduct or differentiate it somehow (as via market-ing), the industry will suffer in earnings and possi-bly in growth.

Manifestly, the more attractive the price-perfor-mance trade-off offered by substitute products, thefirmer the lid placed on the industry’s profit poten-tial. Sugar producers confronted with the large-scale commercialization of high-fructose cornsyrup, a sugar substitute, are learning this lessontoday.

Substitutes not only limit profits in normaltimes; they also reduce the bonanza an industry canreap in boom times. In 1978 the producers of fiber-glass insulation enjoyed unprecedented demand asa result of high energy costs and severe winterweather. But the industry’s ability to raise priceswas tempered by the plethora of insulation substi-tutes, including cellulose, rock wool, and styro-foam. These substitutes are bound to become aneven stronger force once the current round of plantadditions by fiberglass insulation producers hasboosted capacity enough to meet demand (and thensome).

Substitute products that deserve the most atten-tion strategically are those that (a) are subject totrends improving their price-performance trade-offwith the industry’s product, or (b) are produced byindustries earning high profits. Substitutes oftencome rapidly into play if some development in-creases competition in their industries and causesprice reduction or performance improvement.

Jockeying for position

Rivalry among existing competitors takes the fa-miliar form of jockeying for position—using tacticslike price competition, product introduction, andadvertising slugfests. Intense rivalry is related tothe presence of a number of factors:M Competitors are numerous or are roughly equalin size and power. In many U.S. industries in recentyears foreign contenders, of course, have becomepart of the competitive picture.M Industry growth is slow, precipitating fights formarket share that involve expansion-minded mem-bers.M The product or service lacks differentiation orswitching costs, which lock in buyers and protectone combatant from raids on its customers by an-other.M Fixed costs are high or the product is perishable,creating strong temptation to cut prices. Many ba-sic materials businesses, like paper and aluminum,suffer from this problem when demand slackens.M Capacity is normally augmented in large incre-ments. Such additions, as in the chlorine and vinylchloride businesses, disrupt the industry’s supply-demand balance and often lead to periods of overca-pacity and price cutting.M Exit barriers are high. Exit barriers, like very spe-cialized assets or management’s loyalty to a partic-ular business, keep companies competing eventhough they may be earning low or even negativereturns on investment. Excess capacity remainsfunctioning, and the profitability of the healthycompetitors suffers as the sick ones hang on.1 If the



entire industry suffers from overcapacity, it mayseek government help—particularly if foreign com-petition is present.M The rivals are diverse in strategies, origins, and“personalities.” They have different ideas abouthow to compete and continually run head-on intoeach other in the process.

As an industry matures, its growth rate changes, re-sulting in declining profits and (often) a shakeout.In the booming recreational vehicle industry of theearly 1970s, nearly every producer did well; butslow growth since then has eliminated the high re-turns, except for the strongest members, not tomention many of the weaker companies. The sameprofit story has been played out in industry after in-dustry—snowmobiles, aerosol packaging, andsports equipment are just a few examples.

An acquisition can introduce a very different per-sonality to an industry, as has been the case withBlack & Decker’s takeover of McCullough, the pro-ducer of chain saws. Technological innovation canboost the level of fixed costs in the production pro-cess, as it did in the shift from batch to continuous-line photo finishing in the 1960s.

While a company must live with many of thesefactors—because they are built into industry eco-nomics—it may have some latitude for improvingmatters through strategic shifts. For example, itmay try to raise buyers’ switching costs or increaseproduct differentiation. A focus on selling efforts inthe fastest-growing segments of the industry or onmarket areas with the lowest fixed costs can reducethe impact of industry rivalry. If it is feasible, acompany can try to avoid confrontation with com-petitors having high exit barriers and can thussidestep involvement in bitter price cutting.

Formulation of strategyOnce having assessed the forces affecting competi-tion in an industry and their underlying causes, thecorporate strategist can identify the company’sstrengths and weaknesses. The crucial strengthsand weaknesses from a strategic standpoint are thecompany’s posture vis-à-vis the underlying causesof each force. Where does it stand against substi-tutes? Against the sources of enery barriers?

Then the strategist can devise a plan of actionthat may include (l) positioning the company sothat its capabilities provide the best defense againstthe competitive force; and/or (2) influencing thebalance of the forces through strategic moves,thereby improving the company’s position; and/or(3) anticipating shifts in the factors underlying the

forces and responding to them, with the hope of ex-ploiting change by choosing a strategy appropriatefor the new competitive balance before opponentsrecognize it. I shall consider each strategic ap-proach in turn.

Positioning the company

The first approach takes the structure of the indus-try as given and matches the company’s strengthsand weaknesses to it. Strategy can be viewed asbuilding defenses against the competitive forces oras finding positions in the industry where the forcesare weakest.

Knowledge of the company’s capabilities and ofthe causes of the competitive forces will highlightthe areas where the company should confront com-petition and where avoid it. If the company is a low-cost producer, it may choose to confront powerfulbuyers while it takes care to sell them only prod-ucts not vulnerable to competition from substi-tutes.

The success of Dr Pepper in the soft drink indus-try illustrates the coupling of realistic knowledge ofcorporate strengths with sound industry analysis toyield a superior strategy. Coca-Cola and PepsiColadominate Dr Pepper’s industry, where many smallconcentrate producers compete for a piece of the ac-tion. Dr Pepper chose a strategy of avoiding thelargest-selling drink segment, maintaining a nar-row flavor line, forgoing the development of a cap-tive bottler network, and marketing heavily. Thecompany positioned itself so as to be least vulnera-ble to its competitive forces while it exploited itssmall size.

In the $11.5 billion soft drink industry, barriers toentry in the form of brand identification, large-scalemarketing, and access to a bottler network are enor-mous. Rather than accept the formidable costs andscale economies in having its own bottler net-work—that is, following the lead of the Big Two andof Seven-Up—Dr Pepper took advantage of the dif-ferent flavor of its drink to “piggyback” on Cokeand Pepsi bottlers who wanted a full line to sell tocustomers. Dr Pepper coped with the power ofthese buyers through extraordinary service and oth-er efforts to distinguish its treatment of them fromthat of Coke and Pepsi.

Many small companies in the soft drink businessoffer cola drinks that thrust them into head-to-headcompetition against the majors. Dr Pepper, howev-er, maximized product differentiation by maintain-ing a narrow line of beverages built around an un-usual flavor.

Finally, Dr Pepper met Coke and Pepsi with anadvertising onslaught emphasizing the alleged


uniqueness of its single flavor. This campaign builtstrong brand identification and great customer loy-alty. Helping its efforts was the fact that Dr Pep-per’s formula involved lower raw materials cost,which gave the company an absolute cost advan-tage over its major competitors.

There are no economies of scale in soft drink con-centrate production, so Dr Pepper could prosper de-spite its small share of the business (6%). Thus DrPepper confronted competition in marketing butavoided it in product line and in distribution. Thisartful positioning combined with good implemen-tation has led to an enviable record in earnings andin the stock market.

Influencing the balance

When dealing with the forces that drive industrycompetition, a company can devise a strategy thattakes the offensive. This posture is designed to domore than merely cope with the forces themselves;it is meant to alter their causes.

Innovations in marketing can raise brand identi-fication or otherwise differentiate the product. Cap-ital investments in large-scale facilities or verticalintegration affect entry barriers. The balance offorces is partly a result of external factors and partlyin the company’s control.

Exploiting industry change

Industry evolution is important strategically be-cause evolution, of course, brings with it changes inthe sources of competition I have identified. In thefamiliar product life-cycle pattern, for example,growth rates change, product differentiation is saidto decline as the business becomes more mature,and the companies tend to integrate vertically.

These trends are not so important in themselves;what is critical is whether they affect the sources ofcompetition. Consider vertical integration. In thematuring minicomputer industry, extensive verti-cal integration, both in manufacturing and in soft-ware development, is taking place. This very signif-icant trend is greatly raising economies of scale aswell as the amount of capital necessary to competein the industry. This in turn is raising barriers to en-try and may drive some smaller competitors out ofthe industry once growth levels off.

Obviously, the trends carrying the highest priori-ty from a strategic standpoint are those that affectthe most important sources of competition in theindustry and those that elevate new causes to theforefront. In contract aerosol packaging, for exam-ple, the trend toward less product differentiation isnow dominant. It has increased buyers’ power, low-ered the barriers to entry, and intensified competi-

tion.The framework for analyzing competition that I

have described can also be used to predict the even-tual profitability of an industry. In long-range plan-ning the task is to examine each competitive force,forecast the magnitude of each underlying cause,and then construct a composite picture of the likelyprofit potential of the industry.

The outcome of such an exercise may differ agreat deal from the existing industry structure. To-day, for example, the solar heating business is popu-lated by dozens and perhaps hundreds of compa-nies, none with a major market position. Entry iseasy, and competitors are battling to establish solarheating as a superior substitute for conventionalmethods.

The potential of this industry will depend largelyon the shape of future barriers to entry, the im-provement of the industry’s position relative tosubstitutes, the ultimate intensity of competition,and the power captured by buyers and suppliers.These characteristics will in turn be influenced bysuch factors as the establishment of brand identi-ties, significant economies of scale or experiencecurves in equipment manufacture wrought by tech-nological change, the ultimate capital costs to com-pete, and the extent of overhead in production facil-ities.

The framework for analyzing industry competi-tion has direct benefits in setting diversificationstrategy. It provides a road map for answering theextremely difficult question inherent in diversification decisions: “What is the potential of thisbusiness?” Combining the framework with judg-ment in its application, a company may be able tospot an industry with a good future before this goodfuture is reflected in the prices of acquisition can-didates.

Multifaceted rivalryCorporate managers have directed a great deal of at-tention to defining their businesses as a crucial stepin strategy formulation. Theodore Levitt, in hisclassic 1960 article in HBR, argued strongly foravoiding the myopia of narrow, product-orientedindustry definition.2 Numerous other authoritieshave also stressed the need to look beyond productto function in defining a business, beyond nationalboundaries to potential international competition,and beyond the ranks of one’s competitors today tothose that may become competitors tomorrow. Asa result of these urgings, the proper definition of acompany’s industry or industries has become anendlessly debated subject.



One motive behind this debate is the desire to ex-ploit new markets. Another, perhaps more impor-tant motive is the fear of overlooking latent sourcesof competition that someday may threaten the in-dustry. Many managers concentrate so single-mindedly on their direct antagonists in the fight formarket share that they fail to realize that they arealso competing with their customers and their sup-pliers for bargaining power. Meanwhile, they alsoneglect to keep a wary eye out for new entrants tothe contest or fail to recognize the subtle threat ofsubstitute products.

The key to growth—even survival—is to stakeout a position that is less vulnerable to attack fromhead-to-head opponents, whether established or

new, and less vulnerable to erosion from the direc-tion of buyers, suppliers, and substitute goods. Es-tablishing such a position can take many forms—solidifying relationships with favorable customers,differentiating the product either substantively orpsychologically through marketing, integrating for-ward or backward, establishing technological lead-ership.1For a more complete discussion of exit barriers and their impli-cations for strategy, see my article, “Please Note Location ofNearest Exit,” California Management Review, Winter 1976, p.21.2Theodore Levitt, “Marketing Myopia,” reprinted as an HBRClassic, September-October 1975, p. 26.

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