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 berciachalomud.gq - 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, berciachalomud.gq Competitive Advantage: Enduring Ideas and New Opportunities. Professor Michael E. Porter.
A downloader group is powerful if: It is concentrated or downloads in large volumes. Large volume downloaders 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 downloads from the industry are standard or undifferentiated.
The downloaders, sure that they can always find alternative suppliers, may play one company against another, as they do in aluminum extrusion. The products it downloads from the industry form a component of its product and represent a significant fraction of its cost. The downloaders are likely to shop for a favorable price and download selectively.
It earns low profits, which create great incentive to lower its downloading costs. Highly profitable downloaders, however, are generally less price sensitive that is, of course, if the item does not represent a large fraction of their costs. This is true in services like investment banking and public accounting, where errors in judgment can be costly and embarrassing, and in businesses like the logging of oil wells, where an accurate survey can save thousands of dollars in drilling costs.
The Big Three auto producers and major downloaders of cars have often used the threat of self-manufacture as a bargaining lever. But sometimes an industry engenders a threat to downloaders that its members may integrate forward. Most of these sources of downloader power can be attributed to consumers as a group as well as to industrial and commercial downloaders; only a modification of the frame of reference is necessary.
Consumers tend to be more price sensitive if they are downloading products that are undifferentiated, expensive relative to their incomes, and of a sort where quality is not particularly important. The downloading power of retailers is determined by the same rules, with one important addition. A company can improve its strategic posture by finding suppliers or downloaders who possess the least power to influence it adversely. Most common is the situation of a company being able to choose whom it will sell to—in other words, downloader selection.
Rarely do all the downloader groups a company sells to enjoy equal power. Even if a company sells to a single industry, segments usually exist within that industry that exercise less power and that are therefore less price sensitive than others. For example, the replacement market for most products is less price sensitive than the overall market.
As a rule, a company can sell to powerful downloaders and still come away with above-average profitability only if it is a low-cost producer in its industry or if its product enjoys some unusual, if not unique, features. If the company lacks a low cost position or a unique product, selling to everyone is self-defeating because the more sales it achieves, the more vulnerable it becomes.
The company may have to muster the courage to turn away business and sell only to less potent customers. They focus on the segments of the can industry where they can create product differentiation, minimize the threat of backward integration, and otherwise mitigate the awesome power of their customers. In the ready-to-wear clothing industry, as the downloaders department stores and clothing stores have become more concentrated and control has passed to large chains, the industry has come under increasing pressure and suffered falling margins.
The industry has been unable to differentiate its product or engender switching costs that lock in its downloaders enough to neutralize these trends. Substitute products By placing a ceiling on prices it can charge, substitute products or services limit the potential of an industry. Unless it can upgrade the quality of the product or differentiate it somehow as via marketing , the industry will suffer in earnings and possibly in growth.
Sugar producers confronted with the large-scale commercialization of high-fructose corn syrup, a sugar substitute, are learning this lesson today. Substitutes not only limit profits in normal times; they also reduce the bonanza an industry can reap in boom times. In the producers of fiberglass insulation enjoyed unprecedented demand as a result of high energy costs and severe winter weather.
These substitutes are bound to become an even stronger force once the current round of plant additions by fiberglass insulation producers has boosted capacity enough to meet demand and then some. Substitutes often come rapidly into play if some development increases competition in their industries and causes price reduction or performance improvement.
Jockeying for position Rivalry among existing competitors takes the familiar form of jockeying for position—using tactics like price competition, product introduction, and advertising slugfests.
Intense rivalry is related to the presence of a number of factors: Competitors are numerous or are roughly equal in size and power. In many U. Industry growth is slow, precipitating fights for market share that involve expansion-minded members. The product or service lacks differentiation or switching costs, which lock in downloaders and protect one combatant from raids on its customers by another.
Fixed costs are high or the product is perishable, creating strong temptation to cut prices. Many basic materials businesses, like paper and aluminum, suffer from this problem when demand slackens. Capacity is normally augmented in large increments. Exit barriers are high. Excess capacity remains functioning, and the profitability of the healthy competitors suffers as the sick ones hang on. As an industry matures, its growth rate changes, resulting in declining profits and often a shakeout.
In the booming recreational vehicle industry of the early s, nearly every producer did well; but slow growth since then has eliminated the high returns, except for the strongest members, not to mention many of the weaker companies.
The same profit story has been played out in industry after industry—snowmobiles, aerosol packaging, and sports equipment are just a few examples. Technological innovation can boost the level of fixed costs in the production process, as it did in the shift from batch to continuous-line photo finishing in the s.
While a company must live with many of these factors—because they are built into industry economics—it may have some latitude for improving matters through strategic shifts. A focus on selling efforts in the fastest-growing segments of the industry or on market areas with the lowest fixed costs can reduce the impact of industry rivalry.
If it is feasible, a company can try to avoid confrontation with competitors having high exit barriers and can thus sidestep involvement in bitter price cutting. Where does it stand against substitutes?
Against the sources of entry barriers? I shall consider each strategic approach in turn. Strategy can be viewed as building defenses against the competitive forces or as finding positions in the industry where the forces are weakest. If the company is a low-cost producer, it may choose to confront powerful downloaders while it takes care to sell them only products not vulnerable to competition from substitutes.
The success of Dr Pepper in the soft drink industry illustrates the coupling of realistic knowledge of corporate strengths with sound industry analysis to yield a superior strategy. Dr Pepper chose a strategy of avoiding the largest-selling drink segment, maintaining a narrow flavor line, forgoing the development of a captive bottler network, and marketing heavily.
The company positioned itself so as to be least vulnerable to its competitive forces while it exploited its small size. Dr Pepper coped with the power of these downloaders through extraordinary service and other efforts to distinguish its treatment of them from that of Coke and Pepsi.
Many small companies in the soft drink business offer cola drinks that thrust them into head-to-head competition against the majors. Dr Pepper, however, maximized product differentiation by maintaining a narrow line of beverages built around an unusual flavor.
Finally, Dr Pepper met Coke and Pepsi with an advertising onslaught emphasizing the alleged uniqueness of its single flavor. This campaign built strong brand identification and great customer loyalty. New Markets Bring New Challenges At all times, new industries and markets are emerging based on innovations introduced to the consumer. In a new industry, it takes longer for the rules of competition to be clear, and this gives companies a range of experimental competitive strategies.
In emerging industries, companies have only limited information on competitors, most often coming only from customer reviews and trading conditions. However, there are some things we can know for sure about emerging markets. They have high upfront costs and businesses need capital to establish themselves. In a new market, the volume of production is small, and this generates high costs, besides the need for training of inexperienced employees.
Competitive Strategy In new markets, gains come with scale, and you have to understand how companies are pursuing it. Another challenge for companies is to find their first customers and convince them, often educating them about the potential of the product or service, which tends to have high costs associated with marketing.
Knowing When To Exit Eventually, products will be commoditized, and the profits of a certain line will always tend to shrink over time.
Companies go into decline when a substitute product arises, usually through technological or sociological innovation. An example of an industry that has undergone a sociological shift is the cigarette industry, once the harm of the product has been discovered.
When a segment is declining, traditional companies tend not to want to abandon it, as there are also exit barriers. Companies rely on specialized assets in factories, labor, and even marketing.
Therefore, in some cases, maintaining production may be more profitable than discontinuing a product line. Fixed exit costs, such as long-term contracts with suppliers and equipment rentals, can make it difficult for a company to exit a specific market. Moreover, there is the question of interrelationship. A company may be so integrated into a larger strategy that abandoning a product line could impact the strategy as a whole or erase its own identity.
To understand how to overcome exit barriers, one must develop leadership and become the only surviving company in that segment. With dominance, it is possible to discontinue products without being threatened. Another path is a niche strategy, finding a section that remains stable and then building the position in this segment.
Competing Globally Today, more and more companies are competing globally, offering their services and products worldwide. Multinational companies, however, have even greater challenges when we talk about competitive strategies. They have far more competitors and market particularities than a locally operating company.
When talking about a global market, each country has different laws for work, import, management practices and various other particularities.
It may be difficult for a company to understand new markets and adapt to them. It is also crucial to know the competitive landscape of each country of operation, understanding the local competitors. Many foreign governments, for example, offer public financing to national companies or have protectionist rules that change the dynamics of that market. Therefore, it is crucial to understand the political and cultural context of the market to win.
Some common strategies to win in a global market are: Emphasize relations with market governments to reduce barriers to global competition, such as import or export duties; Concentrate on a specific segment and compete globally for it. Excerpt Chapter 1: The Structural Analysis of Industries The essence of formulating competitive strategy is relating a company to its environment.
Although the relevant environment is very broad, encompassing social as well as economic forces, the key aspect of the firm's environment is the industry or industries in which it competes. Industry structure has a strong influence in determining the competitive rules of the game as well as the strategies potentially available to the firm.
Forces outside the industry are significant primarily in a relative sense; since outside forces usually affect all firms in the industry, the key is found in the differing abilities of firms to deal with them. The intensity of competition in an industry is neither a matter of coincidence nor bad luck.
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.