L30 - The Five Competitive Forces That Shape Strategy.pdf

LECTURE 30

THE FIVE COMPETITIVE FORCES THAT SHAPE STRATEGY

INSTRUCTOR SLIDESEQUITY

INSTRUCTOR SLIDES | The Five Competitive Forces That Shape

Strategy

Michael Porters Five Forces

Industry structure drives competition and profitability

1. Threat of new entry.

2. Power of suppliers.

3. Power of buyers.

4. Threat of substitutes.

5. Rivalry among existing competitors.

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Threat of Entry

The entry of new firms puts pressure on existing firms profits. Barriers to entry are advantages that incumbents have relative to new entrants. They

may arise from:

o Supply-side economies of scale (e.g. Intel: economies of scale in r&d)o Demand-side benefits of scale. (e.g. MS office)o Customer switching costs. (e.g. ERP SAP)o Capital requirements.o Unequal access to distribution channels.o Restrictive government policy.o Other incumbency advantages (e.g. Cost and quality advantages as a result of

their experience, brand, acces to raw material, etc)

New firms will not be inclined to enter an industry if they expect existing firms to have a strong, antagonistic reaction to their entry.

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Threat of Entry

Expected retaliation is likely to be strong if:

o Incumbents have retaliated vigorously to new entrants in the past.o Incumbents have substantial resources to fight back.o Incumbents have the ability and willingness to lower prices to retain their

market share.o Industry growth is slow, new entrants would only be able to gain market share

by taking it away from incumbents.

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Power of Suppliers

Powerful suppliers can capture a higher proportion of industry profits by:

o Charging higher prices for raw materials. o Limiting quality or services.o Passing on the bulk of costs to industry participants.

The bargaining power of a supplier firm is relatively high if:

o The number of suppliers is small.o The supplier serves multiple industries.o Substitutes are not easily available.o It is relatively easy for the supplier to integrate forward into the industry.o Industry participants would face significant switching costs if they switched

suppliers.

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The Power of Buyers

Powerful buyers may:o Force down prices.o Demand better quality products or services. o Play industry participants off against each other.

Buyers generally have relatively strong negotiating leverage if:o There are only a few buyers (or buyer of large quantities).o The industry offers standardized or undifferentiated products.o Switching costs are low.o It is relatively easy for them to integrate backwards.

Buyers are relatively price sensitive if:o The product constitutes a significant portion of buyers total cost of inputs.o They are under pressure to cut down expenses (due to low profit margins)o Quality of the buyers final product or service does not depend heavily on the

industrys product.

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The Threat of Substitutes

A substitute product is one that performs the same, or a similar, function as that performed by the industrys product.

The threat of a substitute is high if:

1. The substitute offers a better price-performance than the industrys product.2. Buyers face low switching costs.

Note: Analysts should be alert to changes in other industries that can make their products attractive substitutes. (Ej. Empresa DuPont)

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Rivalry among Existing CompetitorsRivalry among industry firms can take the form of: Price discounting. New product introductions. Aggressive advertising.

The impact of rivalry among existing competitors depends on:1. The intensity of competition among companies.2. The basis of competition among companies (si es en precio, no ayuda. Si es en otro

atributo, ayuda a la rentabilidad de las empresas)

The intensity of rivalry is relatively high if: There are a large number of competitors of similar size and power. Industry growth is slow. There are high exit barriers. Industry firms are highly committed to the business. Industry firms are not familiar with each others competitive strategies.

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Rivalry among Existing Competitors

Firms are more likely to compete on price if: They offer products that are almost identical. Customers face low switching costs They incur high fixed costs and low marginal costs. (e.g. Airlines) Capacity enhancements can only be undertaken in large increments. The product has a short shelf life.

Rivals competing on the same dimension:

When all firms compete on the same attribute, one firms gain is anothers loss, and the result is zero-sum competition.

When each firm concentrates on a different segment or feature, profitability may improve as the needs of a wider variety of customers are satisfied Positive-sum competition.

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Fleeting Factors

1. Industry Growth Rate

A high growth rate is not always a positive sign for an industry, it can work against industry participants in the following ways: Rapid growth can increase the bargaining power of suppliers. It can make the industry more attractive to potential entrants. It cannot guarantee profitability if the threat of substitutes is high.

2. Technology and Innovation

Low-tech industries with price insensitive buyers, high switching costs or high entry barriers may be more profitable than sexy industries.

(buscar en industrias aburridas)

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Fleeting Factors

3. Government

The impact of government policies on an industry is best evaluated in terms of their impact on the five competitive forces. o For example, licensing requirements raise barriers to entry, increasing an

industrys profit potential. On the other hand, policies in favor of labor unions increase the bargaining power

of suppliers, limiting profitability.

4. Complementary Products and Services

Complements are goods and services that are used together with the industrys product.

They can raise or lower barriers to entry, can affect the threat of substitutes, and can also influence the intensity of industry rivalry.

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Changes in Industry Structure

The structure of any given industry changes over time. This makes it essential for analysts to be on the lookout for changes as they can have a significant impact on industry profitability.

1. Shifting threat of new entry. (e.g.: expiration of a patent)

2. Changing supplier or buyer power.

3. Shifting threat of substitution.

4. New bases for rivalry. (rivalry among firms intensifies as the industry matures and growth slows down).

Note: The nature of competition in the industry is also affected by companies pursuing mergers and acquisitions to improve their cost and/or quality.

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Positioning the Company

The five forces framework may:

Reveal profitable positioning opportunities within the industry.

Allow a company to evaluate whether an industry is declining, in such a case, the company may look to exit the industry.

Help identify industries that have bright prospects.

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Exploiting Industry Change

Example:

Consider the music industry:

Unauthorized music downloads over the internet were replacing services provided by record companies. Different record companies tried to overcome this problem by creating technical platforms for digital distribution of music, but competitors remained reluctant to distribute their products through a channel owned by a rival.

Apple was successfully able to exploit this change in the industry by introducing its iTunes music store, which has wrestled the dominant position in the industry away from the 4 (previously 6) major labels.

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Shaping Industry Structure

A company may reshape industry structure by:1. Redividing profitability. (capturar una porcin ms grande del pie)2. Expanding the profit pool. (incrementar el pie)

A company may reduce the share of industry profits captured by suppliers, buyers, and substitutes or sacrificed to deter entrants by reducing: Customer power. (airlines vs travel agents reduce agent commissions) Supplier power. Threat of entry. Rivalry. Threat of substitutes.

Increase the overall pool of economic vale: finding new buyers, coordinating witthsuppliers to limit unnecessary costs and agreeing on better quality standards to be able to charge premium prices.

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Typical Steps in Industry Analysis

Define the relevant industry (products and geographic scope)

Identify the participants and segment them into groups (buyers, suppliers, competitors, substitutes and potential entrants), if appropriate

Assess the underlying drivers of each competitive force to determine which forces are strong and which are weak and why

Determine overall industry structure, and test the analysis for consistency (nivel de rentabilidad y como se la reparten. Es consistente en el largo plazo)

Analyze recent and likely future changes in each force, both positive and negative

Identify aspects of industry structure that might be influenced by competitors, by new entrants, or by your company

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Common Pitfalls

While conducting an analysis, avoid the following common mistakes:

Defining the industry too broadly or too narrowly. Making lists instead of engaging in rigorous analysis. Paying equal attention to all of the forces rather than digging deeply into the most

important ones. Confusing effect with cause. Using static analysis that ignores industry trends. Confusing cyclical or transient changes with true structural changes. Using the framework to declare an industry attractive or unattractive rather than

using it to guide strategic choices.

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Documents

L30 - The Five Competitive Forces That Shape Strategy.pdf