How Competitive Forces Shape Strategy

Topics: Barriers to entry, Barriers to exit, Strategic management Pages: 14 (4290 words) Published: May 14, 2011

How Competitive Forces Shape Strategy*

The essence of strategy formulation is coping with competition. Yet it is easy to view competition too narrowly and too pessimistically. While one sometimes hears execu-tives complaining to the contrary, intense competition in an industry is neither coinci-dence nor bad luck. Moreover, in the fight for market share, competition is not manifested only in the other players. Rather, competition in an industry is rooted in its underlying economics, and competitive forces exist that go well beyond the established combatants in a partic-ular industry. Customers, suppliers, potential entrants, and substitute products are all competitors that may be more or less prominent or active depending on the industry. The state of competition in an industry depends on five basic forces, which are di-agrammed in Figure 1. The collective strength of these forces determines the ultimate

Figure 1
Elements of Industry Structure

Entry BarriersRivalry Determinants

Economies of scaleIndustry growth
Proprietary product differencesFixes (or storage) costs/value added
Brand identityIntermittent overcapacity
Switching costsProduct differences
Capital requirementsBrand identity
Access to distributionSwitching costs
Absolute cost advantageConcentration and balance
Proprietary learning curveInformational complexity
Access to necessary inputsDiversity of competitors
Proprietary low-cost product designCorporate stakes
Government Policy Exit barriers
Expected retaliation

Determinants of Supplier PowerDeterminants of Buyer Power

Differentiation of inputsBargaining LeveragePrice Sensitivity
Switching costs of suppliers and firms inBuyer concentrationPrice/total purchases
the industry verses firm concentrationProduct differences
Presence of substitute inputsBuyer volumeBrand identity
Supplier concentrationBuyer switching costsImpact on quality/
Importance of volume to supplier relative to firm switching costs performance
Cost relative to total purchases in the industryBuyer informationBuyer profits
Impact of inputs on cost or differentiationAbility to backwardDecision makers’
Threat of forward integration relative to threat integrate incentives
of backward integration by firms in the industrySubstitute products
Pull through
Determinants of
Substitution Threats
Relative price performance of substitutes
Switching costs
Buyer propensity to substitute

Used with permission of The Free Press, a Division of Macmillan Inc. from Competitive Strategy:
Techniques for Analyzing Industries and Competitors by Michael E. Porter. Copyright © 1980 by
The Free Press. [used in place of article’s Figure 1 as it contains more detail] INDUSTRY COMPETITORS

of Rivalry
Threat of New Entrants
Bargaining Power
of Buyers
Bargaining Power
of Suppliers
Threat of Substitutes

profit potential of an industry. It ranges from intense in industries like tires, metal cans, and steel, where no company earns spectacular returns on investment, to mild in indust-ries like oil field services and equipment, soft drinks, and toiletries, where there is room for quite high returns. In the economists’ “perfectly competitive” industry, jockeying for position is un-bridled and entry to the industry very easy. This kind of industry structure, of course, offers the worst prospect for long-run profitability. The weaker the forces collectively, however, the greater the opportunity for superior performance. Whatever their collective...
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