Porter's 5-Forces Model

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A means of providing corporations with an analysis of their competition and determining strategy, Porter's five-forces model looks at the strength of five distinct competitive forces, which, when taken together, determine long-term profitability and competition. Porter's work has had a greater influence on business strategy than any other theory in the last half of the twentieth century, and his more recent work may have a similar impact on global competition. Michigan native Michael Porter was born in 1947, was educated at Princeton, and earned an MBA (1971) and Ph.D. (1973) from Harvard. He was promoted to full professor at Harvard at age 34 and is currently C. Roland Christensen Professor of Business Administration at the Harvard Business School. He has published numerous books and articles, the first Interbrand Choice, Strategy and Bilateral Market Power, appearing in 1976. His best known and most widely used and referenced books are Competitive Strategy (1980) and Competitive Advantage (1985). Competitive Strategy revolutionized contemporary approaches to business strategy through application of the five-forces model. In Competitive Advantage, Porter further developed his strategy concepts to include the creation of a sustainable advantage. His other model, the value chain model, centers on product added value. Porter's work is widely read by business strategists around the world as well as business students. Any MBA student recognizes his name as one of the icons of business literature. The Strategic Management Society named Porter the most important living strategist in 1998, and Kevin Coyne of the consulting firm McKinsey and Co. called Porter "the single most important strategist working today, and maybe of all time." The five-forces model was developed in Porter's 1980 book, Competitive Strategy: Techniques for Analyzing Industries and Competitors. To Porter, the classic means of developing a strategya formula for competition, goals, and policies to achieve those goalswas antiquated and in need of revision. Porter was searching for a solution between the two schools of prevailing thought-the Harvard Business School's urging firms to adjust to a unique set of changing circumstances and that of the Boston Consulting Group, based on the experience curve, whereby the more a company knows about the existing market, the more its strategy can be directed to increase its share of the market. Porter applied microeconomic principles to business strategy and analyzed the strategic requirements of industrial sectors, not just specific companies. The five forces are competitive factors which determine industry competition and include: suppliers, rivalry within an industry, substitute products, customers or buyers, and new entrants (see Figure 1). Although the strength of each force can vary from industry to industry, the forces, when considered together, determine long-term profitability within the specific industrial sector. The strength of each force is a separate function of the industry structure, which Porter defines as "the underlying economic and technical characteristics of an industry." Collectively, the five forces affect prices, necessary investment for competitiveness, market share, potential profits, profit

margins, and industry volume. The key to the success of an industry, and thus the key to the model, is analyzing the changing dynamics and continuous flux between and within the five forces. Porter's model depends on the concept of power within the relationships of the five forces.

THE FIVE FORCES

INDUSTRY COMPETITORS.
Rivalries naturally develop between companies competing in the same market. Competitors use means such as advertising, introducing new products, more attractive customer service and warranties, and price competition to enhance their standing and market share in a specific industry. To Porter, the intensity of this rivalry is the result of factors like equally balanced companies, slow growth within an industry, high fixed costs, lack of product differentiation, overcapacity and price-cutting, diverse competitors, high-stakes investment, and the high risk of industry exit. There are also market entry barriers.

PRESSURE FROM SUBSTITUTE PRODUCTS.

Substitute products are the natural result of industry competition, but they place a limit on profitability within the industry. A substitute product involves the search for a product that can do the same function as the product the industry already produces. Porter uses the example of security brokers, who increasingly face substitutes in the form of real estate, money-market funds, and insurance. Substitute products take on added importance as their availability increases.

BARGAINING POWER OF SUPPLIERS.

Suppliers have a great deal of influence over an industry as they affect price increases and product quality. A supplier group exerts even more power over an industry if it is dominated by a few companies, there are no substitute products, the industry is not an important consumer for the suppliers, their product is essential to the industry, the supplier differs costs, and forward integration potential of the supplier group exists. Labor supply can also influence the position of the suppliers. These factors are generally out of the control of the industry or company but strategy can alter the power of suppliers.

BARGAINING POWER OF BUYERS.

The buyer's power is significant in that buyers can force prices down, demand higher quality products or services, and, in essence, play competitors against one another, all resulting in potential loss of industry profits. Buyers exercise more power when they are large-volume buyers, the product is a significant aspect of the buyer's costs or purchases, the products are standard within an industry, there are few changing or switching costs, the buyers earn low profits, potential for backward integration of the buyer group exists, the product is not essential to the buyer's product, and the buyer has full disclosure about supply, demand, prices, and costs.

The bargaining position of buyers changes with time and a company's (and industry's) competitive strategy.

POTENTIAL ENTRANTS.
Threats of new entrants into an industry depends largely on barriers to entry. Porter identifies six major barriers to entry:

Economies of scale, or decline in unit costs of the product, which force the entrant to enter on a large scale and risk a strong reaction from firms already in the industry, or accepting a disadvantage of costs if entering on a small scale. Product differentiation, or brand identification and customer loyalty. Capital requirements for entry; the investment of large capital, after all, presents a significant risk. Switching costs, or the cost the buyer has to absorb to switch from one supplier to another. Access to distribution channels. New entrants have to establish their distribution in a market with established distribution channels to secure a space for their product. Cost disadvantages independent of scale, whereby established companies already have product technology, access to raw materials, favorable sites, advantages in the form of government subsidies, and experience.

New entrants can also expect a barrier in the form of government policy through federal and state regulations and licensing. New firms can expect retaliation from existing companies and also face changing barriers related to technology, strategic planning within the industry, and manpower and expertise problems. The entry deterring price or the existence of a prevailing price structure presents an additional challenge to a firm entering an established industry. In summary, Porter's five-forces models concentrates on five structural industry features that comprise the competitive environment, and hence profitability, of an industry. Applying the model means, to be profitable, the firm has to find and establish itself in an industry so that the company can react to the forces of competition in a favorable manner. For Porter, Competitive Strategy is not a book for academics but a blueprint for practitioners-a tool for managers to analyze competition in an industry in order to anticipate and prepare for changes in the industry, new competitors and market shifts, and to enhance their firm's overall industry standing. Throughout the relevant sections of Competitive Strategy, Porter uses numerous industry examples to illustrate his theory. Since those examples are now over twenty years old, changes in technology and other industrial shifts and trends have made them somewhat obsolete. Although immediate praise for the book and the five-forces model was exhaustive, critiques of Porter have appeared in business literature. Porter's model does not, for example, consider nonmarket changes, such as events in the political arena that impact an industry. Furthermore, Porter's model has come under fire for what critics see as his under-evaluation of government regulation and antitrust violations. Overall, criticisms of the model find their nexus in the lack of consideration by Porter of rapidly changing industry dynamics. In virtually all instances, critics also present alternatives to Porter's model.

Yet, in a Fortune interview in early 1999, Porter responded to the challenges, saying he welcomed the "fertile intellectual debate" that stemmed from his work. He admitted he had ignored writing about strategy in recent years but emphasized his desire to reenter the fray discussing his work and addressing questions about the model, its application, and the confusion about what really constitutes strategy. Porter's The Competitive Advantage of Nations (1990) and the more recent On Competition (1998) demonstrate his desire to further stimulate discussion in the business and academic worlds.

Porter's Generic Strategies

Choosing Your Route to Competitive Advantage

Just one strategic option for airlines. iStockphoto/alandj

Which do you prefer when you fly: a cheap, no-frills airline, or a more expensive operator with fantastic service levels and maximum comfort? And would you ever consider going with a small company which focuses on just a few routes? The choice is up to you, of course. But the point we're making here is that when you come to book a flight, there are some very different options available. Why is this so? The answer is that each of these airlines has chosen a different way of achieving competitive advantage in a crowded marketplace. The no-frills operators have opted to cut costs to a minimum and pass their savings on to customers in lower prices. This helps them grab market share and ensure their planes are as full as possible, further driving down cost. The luxury airlines, on the other hand, focus their efforts on making their service as wonderful as possible, and the higher prices they can command as a result make up for their higher costs. Meanwhile, smaller airlines try to make the most of their detailed knowledge of just a few routes to provide better or cheaper services than their larger, international rivals. These three approaches are examples of "generic strategies", because they can be applied to products or services in all industries, and to organizations of all sizes. They were first set out by Michael Porter in 1985 in his book Competitive Advantage: Creating and Sustaining Superior Performance. Porter called the generic strategies "Cost Leadership" (no frills), "Differentiation" (creating uniquely desirable products and services) and "Focus" (offering a specialized service in a niche market). He then subdivided the Focus strategy into two parts: "Cost Focus" and "Differentiation Focus". These are shown in Figure 1 below.

The terms "Cost Focus" and "Differentiation Focus" can be a little confusing, as they could be interpreted as meaning "A focus on cost" or "A focus on differentiation". Remember that Cost Focus means emphasizing cost-minimization within a focused market, and Differentiation Focus means pursuing strategic differentiation within a focused market.

The Cost Leadership Strategy

Porter's generic strategies are ways of gaining competitive advantage in other words, developing the "edge" that gets you the sale and takes it away from your competitors. There are two main ways of achieving this within a Cost Leadership strategy:

Increasing profits by reducing costs, while charging industry-average prices. Increasing market share through charging lower prices, while still making a reasonable profit on each sale because you've reduced costs.

Remember that Cost Leadership is about minimizing the cost to the organization of delivering products and services. The cost or price paid by the customer is a separate issue!

The Cost Leadership strategy is exactly that it involves being the leader in terms of cost in your industry or market. Simply being amongst the lowest-cost producers is not good enough, as you leave yourself wide open to attack by other low cost producers who may undercut your prices and therefore block your attempts to increase market share. You therefore need to be confident that you can achieve and maintain the number one position before choosing the Cost Leadership route. Companies that are successful in achieving Cost Leadership usually have:

Access to the capital needed to invest in technology that will bring costs down. Very efficient logistics. A low cost base (labor, materials, facilities), and a way of sustainably cutting costs below those of other competitors.

The greatest risk in pursuing a Cost Leadership strategy is that these sources of cost reduction are not unique to you, and that other competitors copy your cost reduction strategies. This is why it's important to continuously find ways of reducing every cost. One successful way of doing this is by adopting the Japanese Kaizen philosophy of "continuous improvement".

The Differentiation Strategy

Differentiation involves making your products or services different from and more attractive those of your competitors. How you do this depends on the exact nature of your industry and of the products and services themselves, but will typically involve features, functionality, durability, support and also brand image that your customers value. To make a success of a Differentiation strategy, organizations need:

Good research, development and innovation. The ability to deliver high-quality products or services. Effective sales and marketing, so that the market understands the benefits offered by the differentiated offerings.

Large organizations pursuing a differentiation strategy need to stay agile with their new product development processes. Otherwise, they risk attack on several fronts by competitors pursuing Focus Differentiation strategies in different market segments.

The Focus Strategy

Companies that use Focus strategies concentrate on particular niche markets and, by understanding the dynamics of that market and the unique needs of customers within it, develop uniquely low cost or well-specified products for the market. Because they serve customers in their market uniquely well, they tend to build strong brand loyalty amongst their customers. This makes their particular market segment less attractive to competitors. As with broad market strategies, it is still essential to decide whether you will pursue Cost Leadership or Differentiation once you have selected a Focus strategy as your main approach: Focus is not normally enough on its own. But whether you use Cost Focus or Differentiation Focus, the key to making a success of a generic Focus strategy is to ensure that you are adding something extra as a result of serving only that market niche. It's simply not enough to focus on only one market segment because your organization is too small to serve a broader market (if you do, you risk competing against better-resourced broad market companies' offerings.) The "something extra" that you add can contribute to reducing costs (perhaps through your knowledge of specialist suppliers) or to increasing differentiation (though your deep understanding of customers' needs).

Generic strategies apply to not-for-profit organizations too. A not-for-profit can use a Cost Leadership strategy to minimize the cost of getting donations and achieving more for their income, while one with pursing a Differentiation strategy will be committed to the very best outcomes, even if the volume of work they do as a result is lower. Local charities are great examples of organizations using Focus strategies to get donations and contribute to their communities.

Choosing the Right Generic Strategy

Your choice of which generic strategy to pursue underpins every other strategic decision you make, so it's worth spending time to get it right.

But you do need to make a decision: Porter specifically warns against trying to "hedge your bets" by following more than one strategy. One of the most important reasons why this is wise advice is that the things you need to do to make each type of strategy work appeal to different types of people. Cost Leadership requires a very detailed internal focus on processes. Differentiation, on the other hand, demands an outward-facing, highly creative approach. So, when you come to choose which of the three generic strategies is for you, it's vital that you take your organization's competencies and strengths into account. Use the following steps to help you choose. Step 1: For each generic strategy, carry out a SWOT Analysis of your strengths and weaknesses, and the opportunities and threats you would face, if you adopted that strategy. Having done this, it may be clear that your organization is unlikely to be able to make a success of some of the generic strategies. Step 2: Use Five Forces Analysis to understand the nature of the industry you are in. Step 3: Compare the SWOT Analyses of the viable strategic options with the results of your Five Forces analysis. For each strategic option, ask yourself how you could use that strategy to:

Reduce or manage supplier power. Reduce or manage buyer/customer power. Come out on top of the competitive rivalry. Reduce or eliminate the threat of substitution. Reduce or eliminate the threat of new entry.

Select the generic strategy that gives you the strongest set of options.

Tip: Porter's Generic Strategies offer a great starting point for strategic decision making. Once you've made your basic choice, though, there are still many strategic options available. Bowman's Strategy Clock helps you think at the next level of details, in that it splits Porter's options into eight sub-strategies. You can also use USP Analysis and Core Competence Analysis to identify the areas you should focus on to stand out in your marketplace.

Key Points:
According to Porter's Generic Strategies model, there are three basic strategic options available to organizations for gaining competitive advantage. These are: Cost Leadership, Differentiation and Focus. Organizations that achieve Cost Leadership can benefit either by gaining market share through lowering prices (whilst maintaining profitability) or by maintaining average prices and therefore increasing profits. All of this is achieved by reducing costs to a level below those of the organization's competitors. Companies that pursue a Differentiation strategy win market share by offering unique features that are valued by their customers. Focus strategies involve achieving Cost Leadership or Differentiation within niche markets in ways that are not available to more broadly-focused players.

Apply This to Your Life

Ask yourself what your organization's generic strategy is. How does this affect the choices your make in your job? If you're in an organization committed to achieving Cost Leadership, can you reduce costs by hiring less expensive staff and training them up, or by reducing staff turnover? Can you reduce training costs by devising in-house schemes for sharing skills and knowledge amongst team members? Can you reduce expenses by using technology such as video conferencing over the Internet? If your organization is pursuing a Differentiation strategy, can you improve customer service? Customer Experience Mapping may help here. Can you help to foster a culture of continuous improvement and innovation in your team? And if you're working for a company that has a chosen a Focus strategy, what knowledge or expertise can you use or develop to add value for your customers that isn't available to broad market competitors?

DEVELOPING COMPETITIVE STRATEGY

John E. Stinson and William A. Day Competitive strategies. All companies have one (or more). Sometimes they are clear and well understood throughout the organization. Sometimes they are rather muddy. Sometimes they have been deliberately established; sometimes they have simply evolved. For our purposes here, we are assuming that it is better if the strategies are deliberately established, clear, and well understood. (This is an assumption we could test, but let's leave that for another day.) "'Customer focus' is knowing what customers want and fulfilling their expectations with innovative products and quality services. To accomplish this, Ameritech focuses its operations squarely on specific customer markets: Residential Services, Business Services, Long-Distance Companies, Public Telephone, Mobile Communications, Directory publishing and Information Services." (Ameritech Annual Report, 1989) That's a brief statement of Ameritech' s competitive strategy. It tells us that Ameritech will compete in some segments of the telecommunications industry but not in others. They will provide residential telephone service, for example, but will not manufacture and wholesale telephone equipment. It also says that they will attempt to attract and retain customers by providing high-quality service and innovative products. They are not trying to be the lowest-priced competitor. The statement thus demonstrates the two questions that form the basis for any competitive strategy: (1) In which industry/segments will the firm compete? (2) On what basis will the firm build a meaningful competitive advantage? In this module, we will focus on the development of competitive strategy. We will examine some common strategies utilized by organizations. We will learn about environmental scanning and driving forces, learn how to do strategic analysis, and determine how to maintain competitive advantage. STRATEGY IN ACTION When Ray Kroch started McDonald's, he started with small, walk-up stores located in suburban areas. The stores, staffed by 3-4 people and open from 11:00 AM to 11:00 PM, offered only a very limited menu (hamburgers, cheeseburgers, french fries, shakes, and soft drinks). His target customers were primarily young people and young families. To attract customers, McDonald's offered low prices. Their hamburgers cost 10 cents. At that time, a hamburger in most restaurants cost between 25 and 50 cents. They also differentiated themselves by offering fast service (immediate availability of product). Rather than having customers wait while the food was prepared, it was always ready at McDonald's. Once you placed your order, there was almost zero wait-time. This in contrast to their competition, where you had to place an order, wait while the food was

prepared, wait to be served, and wait for your check. Thus McDonald's used a classic strategy. They focused on a specific type of customer, in a specific type of location, with a limited product line, minimizing their costs, and competing on the bases of price and fast service. "It offered a limited selection of clothes --- so he called it the Limited." ("Leslie Wexner knows what women want," Fortune, August 1985) Since opening his first Limited in Columbus, Ohio in 1963, Les Wexner has refined the concept of identifying niche markets and serving them with differentiated products. The primary target customer for the Limited has been a fashion-conscious woman (frequently a business woman) who has a variety of needs in her wardrobe. She likes play clothes, dress-up clothes, wear-to-work clothes, great looking lingerie, and international looking accessories. The key term is fashion-conscious. The Limited has targeted women who want the latest designer looks, but at a price the working woman can afford. The Limited sells private label clothes with the most contemporary look (Wexner dislikes the term knock-offs) at a fraction of the prices charged by the designer shops. Speed is the critical element in Wexner's strategy. The limited searches the world for fashion ideas and plugs dozens of knocked-off looks into their stores. They quickly drop the dogs and ride the winners, replenishing the supply of popular looks. The Limited has trimmed the design-order cycle to 60 days, in contrast to the six months to one year required by most of their competitors. This is facilitated by an information system with point-of-sale computers that track daily sales on a store-by-store basis, pre-arranged manufacturing contracts with numerous plants, primarily located in the Far East, and an incredibly efficient distribution system centered in Columbus, Ohio. Thus, it is not just having the right look for the target customers. It is having it more quickly, being able to replenish it more rapidly, and having it at a reasonable cost. Do strategies ever change? Of course. As the environment changes, as industry segments and competitive conditions change, strategies must change. McDonald's is a good example. McDonald's today differs dramatically from the low priced, focused chain established by Ray Kroch in the 1950s. Now there are Big Mac's, Happy meals, Egg McMuffins, Chef Salads, Ronald McDonald's, and even pizza! As the industry matured and demographics changed, McDonald's broadened their scope. To maintain growth, they targeted children and then the elderly as customers. They offered an expanded line of foods to attract a greater variety of customers. Perhaps most significantly, McDonald's moved away from being the low price competitor. They no longer use price as the competitive advantage. Consistency of product and service, community involvement, and convenience provided by a multitude of locations are now the primary competitive advantages they capitalize on. SCANNING THE ENVIRONMENT FOR DRIVING FORCES

Companies do not exist in isolation. They are part of an industry or industries and function within a competitive environment. They are also, however, impacted by even broader environmental factors. They may be constrained by regulations promulgated by the political/legal system. Changing social values or changing demographic patterns may alter consumers' tastes. A recession or an economic boom will probably impact on profitability. Technological developments may open the door to new products and allow for innovation in process that may affect costs or quality. All of these environmental systems (political/legal, social/demographic, economic, and technological) are as important to the company as their industry/competitive environment. Companies need thus to be continually involved in environmental scanning. They need to be constantly analyzing their environment, searching for changes which may have an impact on their operations. These changes, frequently called driving forces, may present either threats or opportunities to the company. Relevant driving forces change over time. Likewise, relevance of driving forces differs from industry to industry and company to company. Currently, however, some or all of the following are generally recognized as relevant driving forces by many organizations. * Instantaneous communication The information revolution has significantly impacted on our concept of time and place. Electronic mail, teleconferencing, fax- - these and other technologies allow us to communicate with one another instantaneously, regardless of where we are located. Using electronic data bases, we are able to obtain information in real-time, regardless of the location where that information was originally housed. This revolution has had, and will continue to have, a major impact on the way we do business. It has facilitated a global marketplace. It enables just-in-time inventory systems. It is the backbone of nicheing and micro-marketing. Presently, we have seen only the tip of the iceberg. Instantaneous communication will be a necessity for success in the increasingly tumultuous competitive world. * Advances in manufacturing technology Computer Integrated Manufacturing, Flexible Manufacturing Systems, Concurrent Engineering, Just-In-Time. Advances in manufacturing technology, such as those noted, have dramatically changed the factory floor. Dirty, greasy, labor-intensive manufacturing may soon become part of a disappearing era. In its place will be the highly automated factory, operated by fewer but more highly skilled workers utilizing the most advanced information technology. These advances, pioneered by the Japanese but increasingly incorporated by US and European companies, permanently lower the cost structure of the products produced, increase quality (defined as consistent conformance to established engineering standards), decrease turnaround time and make the manufacturing system more responsive to customer demand. * The physical environment of the world The hole in the ozone layer, acid rain, the crisis in solid waste disposal, hazardous waste, smog, global warming, the disappearing rain

forests - these are examples of the concerns of an increasingly environmentally aware public. Firms that through their operations pose a threat to the environment may expect to come under increasing social pressure and possibly increasing government regulations. Conversely, firms that produce products and/or provide services that are environmentally neutral or positive can expect to be looked upon more favorably by the consuming public. * The development of a global community We are far from being one world. But, increasingly we are separated less and less on the basis of political or economic systems. The greater differences will tend to be between the haves and the have-nots, regardless of geographic region. Facilitated by transportation and communication technology, business perspectives have also changed. We have moved from the national firm to the national firm with some international manufacturing and sales and then to the multinational firm with major autonomous operations in numerous countries. We now face the advent of the "stateless" corporation with a totally global perspective. * Diversity of the workforce As we move toward the year 2000, the population of the U. S. and to a lesser extent some other developed countries will become increasingly diverse. This will have significant impact on the available workforce. The available workforce will consist of a greater proportion of Blacks, of Hispanics, of Vietnamese, and of women, for example. These diverse populations will bring their diverse cultures into the workplace with them. How will organizations develop unity among these diverse cultures? * The depletion of human resources Winning against global competition requires skilled people utilizing advanced technology, functioning cooperatively and making decisions relatively autonomously. The declining pool of high-school graduates - further reduced by the increasing proportion that are functionally illiterate, numerically incapable, and/or lack basic work values, and the proportion disabled by drug and alcohol addiction - may make critical human skills a scarce resource. Firms with long-term perspectives that want to build their competitive advantage should be developing plans and building coalitions now to impact on the availability of future human resources. INDUSTRY ANALYSIS The normal starting point for strategy development is industry analysis. Through industry analysis, we attempt to determine the relative attractiveness of the industry (generally the long-term profit potential of the industry) and identify areas of opportunity within the industry. It is useful to start with an analysis of industry characteristics. These may include market size of the industry, the competitive scope, the market growth rate, industry profitability, stage in the industry life cycle, the degree of fragmentation, industry capacity utilization, and typical capital requirements. An examination of these characteristics gives us an understanding of the basic structure of the industry.

A complementary approach to industry analysis has been proposed by Michael Porter. He proposed a five forces model of industry analysis based on what he calls competitive forces. The forces he identifies are rivalry among existing competitors, the potential entry of new competitors, the threat of substitute products, the power of suppliers, and the power of buyers. In Porter's model, the most attractive industries are those where there is less rivalry among competitors, where there are few substitute products, where entry into the industry by new competitors is difficult and where suppliers and buyers have little power. While we talk of industry analysis, you should recognize that industries are composed of numerous segments, and much of the analysis is done at the segment level. A segment is a coherent subset of an industry. Segments can be defined around product lines, customer groups, geographic regions, channels of distribution, operational processes, among other options. For example, the computer industry can be segmented along product lines, ranging from micro computers, to minis, to mainframes, to supercomputers. It can also be segmented on the basis of customer groups. DEC, for example, has segmented the industry into 18 segments based around customer groups. These ranged from health care to manufacturing. We judge the attractiveness of an industry on the basis of its long term financial and strategic strength. Generally, industries, or segments, that have larger market size, greater growth rate and higher industry profitability, and that are at an earlier stage in the life-cycle are judged to be more attractive. We must be cautious, however, to focus on the future, not on the past. We are attempting to determine the long term profit potential (future) of the industry. We are concerned with the future growth rate, for example, not just the historic growth rate. We scan the environment, looking for driving forces that might change the structure or functioning of the industries. In addition to examining overall attractiveness, we search for areas of opportunity within the industry or segment. For example, will there be opportunities for: *New products or services *Extensions of products or services *New customers *New technologies *New processes to serve customers *Ways to improve products or services Our final conclusion regarding industry attractiveness, thus, is a subjective judgment based upon financial and strategic attractiveness and the available opportunities. (See Exhibit 2 for a set of Standard Analytic Questions that provide guidance for an industry analysis)

COMPETITIVE INTELLIGENCE How are your competitors approaching the industry? What are each of their competitive advantages? What are their unique competencies? Where are they focusing their attention? Competitive intelligence is one of a company's most important assets. It is important to know your competitors, hopefully to know them better than they know themselves. You buy your competitors' products and dissect them to determine their technology and cost structure. You comparison-shop their services to determine their unique features. You study their advertisements, you read trade journals that talk of their plans and achievements, you scrutinize their annual reports for hints of their strategy and plans and assess their financial strength. For each competitor, we need to know their competitive strategy, their strengths and weaknesses, from both a financial and a strategic perspective, and any likely moves they might make to improve their competitive position. In addition to analyzing the internal strength of each competitor, we need to anticipate how they might react to any external environmental changes. Are there driving forces that might improve the competitive position of any of the competitors? Might the driving forces have a negative impact on any of them? Are they likely to move to take advantage of industry opportunities? How will they respond to threats? On the basis of our analysis, we draw conclusions regarding the future actions and future effectiveness of each competitor. What are they likely to do, and how strong are they likely to be? (Exhibit 3 provides a set of Standard Analytic Questions to help gather competitive intelligence.) COMPANY STRENGTHS AND STRATEGIC HEALTH Know Thyself! Just as strategy development starts with an analysis of the external competitive environment, it concludes with an internal analysis of the company. What is the company and what can it be? Starting with the identification of any current strategies, we need to analyze the historic performance of the company and the strategic strength of the company. We consider sales volume and trends in sales volume. We compare financial ratios with others in the industry to determine relative strength and compare the ratios over time to determine trends. We evaluate the technological strength of the company, considering both technologies related to service or product development and technologies related to process development.

In addition to analysis of the company as a whole, the company's relative strengths and weaknesses in each relevant segment are analyzed. We identify share of market and level of profitability in each segment and note changes or trends. We compare our cost position and our quality position to our competitors and note any changes or trends. We assess our customers' satisfaction with our products or services and note changes or trends. It is also critical to identify what Prahalad and Hamel call the "core competencies of the corporation." (The Core Competence of the Corporation, Harvard Business Review, May 1990.) For example, Cooper Industries, as noted in the following quote, has clearly identified their core competence. "We come from as long line of people who forge, cast, drill, bore, grind, heat treat, and fabricate things out of metal. Now we use other materials and processes as well. But it all boils down to manufacturing. We know a lot about that. And we know that our future depends on doing it better than anybody else." (Cooper Industries, promotional brochure, 1989) What is it that the company can do, and do very well? Like Cooper, it may be manufacturing. Or it may be product development, or customer service, or selecting sites, or responding quickly to customer needs. - the possibilities are limitless. The key thing is that it be what you do best - hopefully better than anyone else. As we analyze the company, we are searching for areas where we have the strengths and competencies to build on, and areas where we have weaknesses that may create problems for us. Comparing our strengths and our core competencies with the areas of attractive opportunity within the industry helps us define our answer to the first question, "In what segments of the industry will we compete?" (Exhibit 4 a set of Standard Analytic Questions to help assess strategic health) SELECTING THE BASIS FOR COMPETITION On what basis can we build a meaningful competitive advantage? Why will customers chose to use our product or service rather than that of our competitors? How will we compete for business? These questions must be clearly answered in any competitive strategy. McDonald's, for example, in their original strategy said that people would buy their hamburgers because they were cheaper and because of the quick service. The Limited provided designer fashion at a price the working woman could afford - quickly. This was their competitive advantage. Anything that adds value which is important to the customer can be used as a basis for competitive advantage. In his classic book, Competitive Strategy, Michael Porter (Competitive Strategy, Free Press, 1980) talks of two potential bases for competition:

(1) being the lowest cost provider (price) or (2) differentiating the product or service in some way. Actually, this dichotomy is probably a bit too simplistic and not terribly practical. A company can differentiate itself in many ways. The durability of the product, the speed of response to customer wants, customer service, convenience, consistency of performance, community involvement, and environmental consciousness are just a few of the more common. While the term quality is often used when discussing differentiation, we need to be cautious. Quality has different meanings to different people. Sometimes it is durability. Sometimes it is unique features. Sometimes it means conformance to standards, or "fit and finish" as it is called in the automotive industry. The root for our competitive advantage is in our core competencies. It must be something that we can do very well. But it must also be consistent with our competitive environment. It must be valued by a significant proportion of the customers in the industry segments we are targeting. Further, it should not duplicate a competitive advantage of a significant competitor. We need to provide something that is of value to customers and do it better than competitors. That is how we gain competitive advantage. IMPLEMENTING STRATEGY Strategy without action has no value. As noted in the Performance Criteria for Developing Competitive Strategy (Exhibit 5) the outcome of strategy development is an action plan based firmly on and designed to implement the strategy of the company. In the past, strategic plans were often developed by staff specialists, utilizing sophisticated analytical techniques. Too frequently, this resulted in attractive, bound volumes that sat on the shelves of line managers gathering dust. The strategies, while they might have been ingenious, were not executed. This is less prevalent today. More organizations are recognizing that the information necessary for developing strategy is equally vital for effectively running a business. Thus, strategy development has become the job of line managers. Frequently, strategy is developed by a team of line managers from different functions, directed by the general manager. In addition to insuring that functional conflicts are minimized, this maximizes the likelihood that the strategy will be effectively implemented. Since they have been involved in its development, participants will be more highly committed to its implementation. To assist in implementation, the strategy should be incorporated as an integral part of the company's mission statement and clearly communicated, both internally and externally. From an internal perspective, a clear understanding of the strategy helps to provide a unity of direction. All members of the business need to have a sense of where the

organization is going. Particularly as organizations become flatter, as they become more decentralized, as more people have authority to act for the company, an understanding of the future of the business is necessary -- otherwise, how can people throughout the organization make reasonable decisions? In addition, a clear understanding of strategy has a major impact on the commitment of people in the organization. People cannot be motivated, they cannot be committed to an organization unless they understand the organization. People cannot be committed to a program or plan, a direction, unless they know about the program or direction. Thus, a clear statement of strategy, continually reiterated (not just written down in some dusty volume) will build commitment to the organization and its future. An understanding of the strategy is also important to external constituencies. For example, customers and suppliers cannot be partners in accomplishment unless they understand what you are trying to accomplish. MAINTAINING COMPETITIVE ADVANTAGE In a recent conversation on corporate leadership, Ralph Schey, CEO of Scott Fetzer noted that it is more difficult to stay a leader than to become one. The same is probably true about businesses; it is probably more difficult for a firm to maintain a competitive advantage than to gain one in the first place. There are probably many reasons. One major reason is the financial reporting system. The typical financial reporting system focuses on the past, rather than the future and on operations, rather than on strategy. Thus, it is very easy for a firm that is watching its numbers to feel a sense of security at the very time its competitive advantage is eroding. There is also a natural human tendency to be satisfied with success, to worry a little less about the future, and to develop a feeling of invincibility. Think of all the old phrases: "If it ain't broke, don't fix it." "Don't mess with success." "Fat and happy." These reflect a contentment that discourages innovation and gives competitors the opportunity to overturn our advantage. In fact, innovation is the key to maintaining competitive advantage. Any advantage can be imitated; none last forever. The environment is continually changing. Competitors are continually developing. Thus, any company that stops scanning the environment and analyzing driving forces, any company that stops looking for opportunities in its competitive environment, any company that stops innovating will inevitably lose its competitive advantage. This does not mean that a company must continually make wholesale changes. It does not, regardless of the title of Tom Peters book, Thriving on Chaos, mean that chaos is necessary. In contrast, there needs to be a stability of direction. But, most innovation is not tumultuous, but rather incremental. It is the accumulation of many small insights, many small advances that lead to continual improvement. And it is that continual

improvement, the continual evolution and development of the competitive advantage, that leads to long-term success. Copyright 1990 by J. E. Stinson and W. A. Day Exhibit 1 Learning Objectives After completing this module, you should be able to: Describe the concept of competitive strategy. Identify an industry. Identify a firm's competitive strategy. Describe environmental scanning. Define driving forces. Identify significant driving forces that might impact on an industry or business. Describe the purpose of industry analysis. Describe the process of industry analysis. Identify factors to be included in an industry analysis. Identify an industry segment. Describe three bases for segmenting an industry. Explain how industry analysis is used in strategy development. Describe the purpose of competitive intelligence. Describe the process of competitive intelligence. Identify factors to be included in competitive intelligence. Explain how competitive intelligence is used in strategy development. Describe the purpose of company analysis. Describe the process of company analysis.

Identify factors to be included in company analysis. Explain how company analysis is used in strategy development. Define core competencies. Explain how core competencies are used in strategy development. Describe the concept of competitive advantage. Identify five potential bases of competitive advantage. Explain how firms develop competitive advantage. Describe three factors which influence the implementation of strategy. Identify two reasons why firms lose their competitive advantage. Explain what firms should do to maintain competitive advantage. Exhibit 2 Standard Analytic Questions for Industry Analysis * What is the market size of the industry? What is the scope of competition (regional, national, global)? How many competitors are there in the industry and what is their relative size? Is the industry fragmented with many small companies or concentrated and dominated by a few? Who are the primary customers in the industry? What is their relative size and to what extent do they have power over prices? Who are the critical suppliers to the industry? To what extent do they have power over costs? To what extent is backward and forward integration prevalent within the industry? How easy is it to enter or exit the industry? What is the rate of technological change in the industry? Does this change impact on product development, process development, or both.

How differentiated are the products or services of firms in the industry? Are they highly differentiated, or is it basically a commodity industry? Are there substitute products or services competing for customers? How close are the substitutes? Are there economies of scale in the industry? What are the capital requirements for the typical firm in the industry? What is the typical cost structure within the industry? What is the typical fixed cost/variable cost relationship? What is the degree of capacity utilization in the industry? Where is the industry in terms of the industry life cycle? What is the industry growth rate? Are there any trends in the growth rate? What is the industry profitability? Are there any trends in the rate of profitability? What are the relevant driving forces? What will be their probable impact on the industry? What are the potential threats to the industry? What areas of opportunity are there within the industry? How do you rate the overall attractiveness of the industry? What are the primary reasons for your rating? *This checklist can be used to evaluate the industry as a whole and/or any relevant segment of the industry. Exhibit 3 Standard Analytic Questions for Competitive Intelligence Who are the significant competitors? What is the strategy of each competitor? What is the competitive advantage of each competitor? What is the growth rate of each competitor? Is there any trend in the growth rate? How profitable is each of the competitors? Are there any trends in profitability?

How strong, financially, is each of the competitors? What is the cost structure of each competitor? What is the quality level of each competitor? What are the core competencies of each competitor? What are the significant weaknesses of each competitor? Will any of the driving forces have a unique impact on any of the competitors? Will the impact be negative or positive? Are any of the competitors likely to make any significant changes? What will they be? How would you rate the relative competitive strength of each competitor? What are the reasons for your rating? * *This rating, and the analysis leading up to it, may have to be done on a segment by segment basis. Exhibit 4 Standard Analytic Questions for Assessing Strategic Health What is the overall company strategy? Does it differ by segment? What is the financial strength of the company? What technologies are used by the company? What is the relative strength in each? What the core competencies of the company? What is the sales volume in each relevant segment? Are there any trends in sales volume? What is the market share in each segment? Are there any trends? How profitable is each of the segments? What is the cost position relative to competition? Are there any significant trends? What is the quality position relative to competition? Are there any significant trends or changes? How loyal are the customers? How satisfied are they? Are there any trends in customer reaction?

What are the relative response time to changes in customer requirements? What is the quality of the people in the organization? Do they have the high level of skills and abilities needed for the firm of the future? What are (can be) the company's competitive advantages? How would you rate the strategic health of the company? What are the reasons for your rating?

Exhibit 5 PERFORMANCE CRITERIA: Developing Competitive Strategy The outcome of strategy development is an action plan based firmly on and designed to implement the strategy of the company. An outstanding plan will reflect a high degree of creativity; it will not simply copy competitors' approaches. It will reflect breadth of understanding of the business world and the environment in which the particular company is functioning. It will be based on a realistic scenario of the future, promote long-term effectiveness, and consider moral obligations to all relevant constituents of the business. The strategy identifies the industry segments in which the company will compete, the bases of competition and the competitive advantage(s) to be sought in each of the segments, and the relative priority of each of the segments. The strategy will clearly establish priorities for action. In particular, it will identify target segments within the industry. These are the segments in which the company will invest resources to attempt to build strong long-term competitive superiority. The target segments are selected considering three factors: (1) the long-term profit potential of the industry segment, (2) the relative strengths of competitors within the segment, and (3) the strengths, or distinctive competencies, of the company. Segments in which the company will maintain position and those in which the company will not compete or will withdraw from competition will also be identified. The strategy will also clearly identify the bases on which the company will compete in each relevant segment. These are selected based on the strengths or distinctive competencies of the company and are intended to provide competitive advantages for the company within the segment.

Porter's Five Forces is a framework for industry analysis and business strategy development formed by Michael E. Porter of Harvard Business School in 1979. It draws upon Industrial Organization (IO) economics to derive five forces that determine the competitive intensity and therefore attractiveness of a market. Attractiveness in this context refers to the overall industry profitability. An "unattractive" industry is one in which the combination of these five forces acts to drive down overall profitability. A very unattractive industry would be one approaching "pure competition", in which available profits for all firms are driven to normal profit. Three of Porter's five forces refer to competition from external sources. The remainder are internal threats. Porter referred to these forces as the micro environment, to contrast it with the more general term macro environment. They consist of those forces close to a company that affect its ability to serve its customers and make a profit. A change in any of the forces normally, requires a business unit to re-assess the marketplace given the overall change in industry information. The overall industry attractiveness does not imply that every firm in the industry will return the same profitability. Firms are able to apply their core competencies, business model or network to achieve a profit above the industry average. A clear example of this is the airline industry. As an industry, profitability is low and yet individual companies, by applying unique business models, have been able to make a return in excess of the industry average. Porter's five forces include - three forces from 'horizontal' competition: threat of substitute products, the threat of established rivals, and the threat of new entrants; and two forces from 'vertical' competition: the bargaining power of suppliers and the bargaining power of customers. This five forces analysis, is just one part of the complete Porter strategic models. The other elements are the value chain and the generic strategies.[citation needed] Porter developed his Five Forces analysis in reaction to the then-popular SWOT analysis, which he found unrigorous and ad hoc.[1] Porter's five forces is based on the Structure-ConductPerformance paradigm in industrial organizational economics. It has been applied to a diverse range of problems, from helping businesses become more profitable to helping governments stabilize industries.[2]

Contents
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1 The five forces o 1.1 The threat of the entry of new competitors o 1.2 The threat of substitute products or services o 1.3 The bargaining power of customers (buyers) o 1.4 The bargaining power of suppliers o 1.5 The intensity of competitive rivalry 2 Usage 3 Criticisms

4 See also 5 References 6 Further reading 7 External links

[edit] The five forces

[edit] The threat of the entry of new competitors
Profitable markets that yield high returns will attract new firms. This results in many new entrants, which eventually will decrease profitability for all firms in the industry. Unless the entry of new firms can be blocked by incumbents, the abnormal profit rate will tend towards zero (perfect competition).

The existence of barriers to entry (patents, rights, etc.) The most attractive segment is one in which entry barriers are high and exit barriers are low. Few new firms can enter and nonperforming firms can exit easily. Economies of product differences Brand equity Switching costs or sunk costs Capital requirements Access to distribution Customer loyalty to established brands Absolute cost Industry profitability; the more profitable the industry the more attractive it will be to new competitors.

[edit] The threat of substitute products or services

The existence of products outside of the realm of the common product boundaries increases the propensity of customers to switch to alternatives:

Buyer propensity to substitute Relative price performance of substitute Buyer switching costs Perceived level of product differentiation Number of substitute products available in the market Ease of substitution. Information-based products are more prone to substitution, as online product can easily replace material product. Substandard product Quality depreciation

[edit] The bargaining power of customers (buyers)

The bargaining power of customers is also described as the market of outputs: the ability of customers to put the firm under pressure, which also affects the customer's sensitivity to price changes.

Buyer concentration to firm concentration ratio Degree of dependency upon existing channels of distribution Bargaining leverage, particularly in industries with high fixed costs Buyer volume Buyer switching costs relative to firm switching costs Buyer information availability Ability to backward integrate Availability of existing substitute products Buyer price sensitivity Differential advantage (uniqueness) of industry products RFM Analysis

[edit] The bargaining power of suppliers

The bargaining power of suppliers is also described as the market of inputs. Suppliers of raw materials, components, labor, and services (such as expertise) to the firm can be a source of power over the firm, when there are few substitutes. Suppliers may refuse to work with the firm, or, e.g., charge excessively high prices for unique resources.

Supplier switching costs relative to firm switching costs Degree of differentiation of inputs Impact of inputs on cost or differentiation Presence of substitute inputs Strength of distribution channel Supplier concentration to firm concentration ratio Employee solidarity (e.g. labor unions) Supplier competition - ability to forward vertically integrate and cut out the BUYER

Ex. If you are making biscuits and there is only one person who sells flour, you have no alternative but to buy it from him.

[edit] The intensity of competitive rivalry

For most industries, the intensity of competitive rivalry is the major determinant of the competitiveness of the industry.

Sustainable competitive advantage through innovation Competition between online and offline companies Level of advertising expense Powerful competitive strategy The visibility of proprietary items on the Web[3] used by a company which can intensify competitive pressures on their rivals.

How will competition react to a certain behavior by another firm? Competitive rivalry is likely to be based on dimensions such as price, quality, and innovation. Technological advances protect companies from competition. This applies to products and services. Companies that are successful with introducing new technology, are able to charge higher prices and achieve higher profits, until competitors imitate them. Examples of recent technology advantage in have been mp3 players and mobile telephones. Vertical integration is a strategy to reduce a business' own cost and thereby intensify pressure on its rival...

[edit] Usage
Strategy consultants occasionally use Porter's five forces framework when making a qualitative evaluation of a firm's strategic position. However, for most consultants, the framework is only a starting point or "checklist" they might use " Value Chain " afterward. Like all general frameworks, an analysis that uses it to the exclusion of specifics about a particular situation is considered nave. According to Porter, the five forces model should be used at the line-of-business industry level; it is not designed to be used at the industry group or industry sector level. An industry is defined at a lower, more basic level: a market in which similar or closely related products and/or services are sold to buyers. (See industry information.) A firm that competes in a single industry should develop, at a minimum, one five forces analysis for its industry. Porter makes clear that for diversified companies, the first fundamental issue in corporate strategy is the selection of industries (lines of business) in which the company should compete; and each line of business should develop its own, industry-specific, five forces analysis. The average Global 1,000 company competes in approximately 52 industries (lines of business).

[edit] Criticisms