📝Five Competitive Forces Shape Strategy
To sustain long-term profitability, companies must respond strategically to competition, extending beyond direct rivals to include five competitive forces.
Savvy customers can force down prices by playing rivals against one another.
Powerful suppliers may constrain profits if they charge higher prices.
Aspiring entrants with new capacity and hunger for market share can ratchet up the investment required to stay in the game.
Substitute offerings can lure customers away from existing products.
Established rivals compete intensely on price and other dimensions.
Commercial aviation is one of the least profitable industries due to strong competitive forces.
Analyzing all five competitive forces provides a complete picture of industry profitability and helps identify game-changing trends early.
Understanding how the five competitive forces influence industry profitability enables strategy development to enhance long-term profits.
Strategists should position their company where the competitive forces are weakest.
In the heavy-truck industry, large buyers, regulated standards, and union power contribute to stiff price competition and high supplier power.
Paccar focused on individual owner-operators, a customer group with limited clout and less price sensitivity, to create sustained long-term profitability.
Paccar developed features like luxurious sleeper cabins and plush leather seats, offering thousands of options for built-to-order trucks.
Customers pay Paccar a 10% premium, and the company has been profitable for 68 straight years, earning a long-run return on equity above 20%.
Companies should exploit changes within the competitive forces.
The Internet and digital distribution created unauthorized downloading, a potent substitute for record companies' services.
Record companies tried to develop digital distribution platforms but major labels hesitated to sell music through a rival's platform.
Apple stepped into this vacuum with iTunes, supporting its iPod, and becoming a powerful new gatekeeper.
The number of major labels was whittled down from six in 1997 to four today.
Companies should use tactics to reduce the share of profits leaking to other players, thereby reshaping the forces.
Standardize part specifications to switch vendors easily, neutralizing supplier power.
Expand services to increase customer switching costs, countering customer power.
Invest more heavily in differentiated products to temper price wars initiated by established rivals.
Elevate fixed costs of competing, like R&D expenditures, to scare off new entrants.
Offer better value through wider product accessibility to limit the threat of substitutes.
Soft-drink producers introduced vending machines and convenience store channels, improving availability relative to other beverages.
Michael E. Porter's 1979 HBR article 'How Competitive Forces Shape Strategy' revolutionized the strategy field and is updated here.
The strategist's job is to understand and cope with competition, which often extends beyond today's direct rivals.
Competition for profits extends beyond established industry rivals to include customers, suppliers, potential entrants, and substitute products.
The extended rivalry from all five forces defines an industry's structure, shaping competitive interaction.
Industry structure drives competition and profitability, not whether an industry is emerging or mature, high-tech or low-tech, regulated or unregulated.
If the five forces are intense, as in industries like airlines, textiles, and hotels, almost no company earns attractive returns on investment.
If the five forces are benign, as in software, soft drinks, and toiletries, many companies are profitable.
While myriad factors affect short-run profitability, industry structure, manifested in competitive forces, sets profitability in the medium and long run.
Understanding competitive forces and their causes reveals roots of current profitability and provides a framework for anticipating and influencing competition.
The configuration of the five competitive forces differs by industry.
In commercial aircraft, fierce rivalry and buyer power are strong, while threat of entry, substitutes, and supplier power are more benign.
In the movie theater industry, the proliferation of substitutes and power of movie producers/distributors are important forces.
The strongest competitive force or forces determine an industry's profitability and become most important for strategy formulation.
Low returns in photographic film, despite fierce rivalry, resulted from a superior substitute product: digital photography.
New entrants bring new capacity and a desire for market share, pressuring prices, costs, and investment.
The threat of entry puts a cap on an industry's profit potential; high threat forces incumbents to deter new competitors.
The threat of entry depends on the height of entry barriers and expected retaliation from incumbents.
Low entry barriers in specialty coffee mean Starbucks must invest aggressively in modernizing stores and menus.
Entry barriers are advantages incumbents have relative to new entrants.
Firms producing at larger volumes enjoy lower per-unit costs, deterring entrants by forcing large scale or cost disadvantage.
Intel is protected by scale economies in research, chip fabrication, and consumer marketing.
Scotts Miracle-Gro finds scale economies most important in supply chain and media advertising.
Buyer willingness to pay increases with the number of other buyers patronizing the company, also known as network effects.
Buyers trusted larger companies like IBM, reducing entry willingness for newcomers.
Online auction participants are attracted to eBay due to its large number of potential trading partners.
Fixed costs buyers face when changing suppliers make it harder for entrants to gain customers.
Enterprise resource planning (ERP) software like SAP has very high switching costs due to embedded data and process adaptations.
Large financial resource investment deters new entrants, especially for unrecoverable expenditures like upfront advertising or R&D.
Capital requirements alone may not deter entry if industry returns are attractive and capital markets are efficient.
Financing for expensive aircraft is available due to high resale value, leading to numerous new airlines.
Incumbents may have cost or quality advantages unavailable to potential rivals, regardless of size.
Advantages stem from proprietary technology, preferential raw material access, favorable geographic locations, established brands, or cumulative experience.
Upstart discounters like Target and Walmart bypass established department stores by locating in freestanding sites.
New entrants must secure product distribution, which can be tough if wholesale/retail channels are limited or tied up by competitors.
Upstart low-cost airlines avoid travel agents and encourage online booking to bypass distribution channels.
Government policy can directly hinder or aid new entry, or amplify/nullify other entry barriers.
Licensing requirements and restrictions on foreign investment directly limit entry into industries like liquor retailing and taxi services.
Patent rules protecting technology or environmental/safety regulations raising scale economies can heighten entry barriers.
Potential entrants' perception of incumbent reaction influences their decision to enter an industry.
Newcomers fear retaliation if incumbents have previously responded vigorously to new entrants.
Newcomers fear retaliation if incumbents possess substantial resources to fight back, including excess cash, borrowing power, and productive capacity.
Newcomers fear retaliation if incumbents are likely to cut prices due to commitment to market share or high fixed costs.
Newcomers fear retaliation if industry growth is slow, meaning volume must be taken from incumbents.
Powerful suppliers capture more value by charging higher prices, limiting quality, or shifting costs to industry participants.
Microsoft's operating system price increases eroded PC makers' profitability, who could not raise their prices due to fierce customer competition.
A supplier group is powerful if it is more concentrated than the industry it sells to.
A supplier group is powerful if it does not depend heavily on the industry for its revenues.
Industry participants face switching costs in changing suppliers, making it hard to play them off against one another.
A supplier group is powerful if it offers differentiated products.
Pharmaceutical companies offering patented drugs have more power over hospitals and other drug buyers.
A supplier group is powerful if there is no substitute for what it provides.
Pilots' unions exercise considerable power over airlines because well-trained pilots have no good alternative.
A supplier group is powerful if it can credibly threaten to integrate forward into the industry.
Powerful customers capture more value by forcing down prices, demanding better quality/service, or playing industry participants against one another.
Buyers are powerful if they have negotiating leverage relative to industry participants, especially if they are price sensitive.
A customer group has negotiating leverage if there are few buyers, or each purchases large volumes relative to a single vendor.
A customer group has negotiating leverage if the industry's products are standardized or undifferentiated.
A customer group has negotiating leverage if buyers face few switching costs in changing vendors.
Buyers can credibly threaten to integrate backward and produce the industry's product themselves if vendors are too profitable.
Producers of soft drinks controlled packaging manufacturers by threatening to make materials themselves.
A buyer group is price sensitive under several conditions.
A buyer group is price sensitive if the product represents a significant fraction of its cost structure or procurement budget.
A buyer group is price sensitive if it earns low profits, is strapped for cash, or is under pressure to trim purchasing costs.
A buyer group is price sensitive if the quality of its products or services is little affected by the industry's product.
A buyer group is price sensitive if the industry's product has little effect on the buyer's other costs.
Most buyer power sources apply equally to consumers and business-to-business customers, with consumers often more price sensitive for undifferentiated, expensive products.
Intermediate customers gain significant bargaining power when they can influence downstream purchasing decisions.
Consumer electronics retailers exert strong influence on end customers.
Producers diminish channel clout through exclusive arrangements, direct marketing, or creating downstream customer preferences for components.
DuPont created clout by advertising its Stainmaster brand to both carpet manufacturers and downstream consumers, who then request the carpet.
A substitute performs the same or similar function by different means, limiting industry profit potential by placing a price ceiling.
Videoconferencing is a substitute for travel.
Substitution threat can be downstream or indirect, replacing a buyer industry's product.
Lawn-care products are threatened when multi-family homes substitute for single-family homes in urban areas.
Airline and travel websites substitute for travel agents.
Substitutes are always present but easy to overlook because they may appear very different from the industry's product.
The threat of a substitute is high if it offers an attractive price-performance trade-off or buyer switching costs are low.
The threat of a substitute is high if it offers an attractive price-performance trade-off to the industry's product.
Conventional long-distance phone service suffered from inexpensive internet-based services like Vonage and Skype.
Video rental outlets struggle against video-on-demand services, online rentals like Netflix, and internet video sites like YouTube.
The threat of a substitute is high if the buyer's cost of switching to the substitute is low.
Switching from branded to generic drugs involves minimal costs, leading to rapid shifts and price falls.
Strategists should be alert to changes in other industries that make them attractive substitutes.
Improvements in plastic allowed it to substitute for steel in many automobile components.
Rivalry includes price discounting, new product introductions, advertising campaigns, and service improvements, limiting industry profitability.
The degree rivalry drives down profit potential depends on its intensity and basis.
The intensity of rivalry is greatest under several conditions.
Rivalry is greatest if competitors are numerous or roughly equal in size and power, making poaching business hard to avoid.
Rivalry is greatest if industry growth is slow, precipitating fights for market share.
Rivalry is greatest if exit barriers are high, keeping companies in the market despite low or negative returns and leading to excess capacity.
Rivalry is greatest if rivals are highly committed to the business with leadership aspirations, often due to non-economic goals.
Rivalry is greatest if firms cannot read each other's signals well due to unfamiliarity, diverse approaches, or differing goals.
The strength of rivalry reflects not just intensity but also the basis of competition, influencing profitability.
Rivalry gravitating solely to price is especially destructive to profitability because it transfers profits directly from the industry to customers.
Price cuts are easy for competitors to see and match, leading to successive rounds of retaliation.
Sustained price competition trains customers to pay less attention to product features and service.
Price competition is most liable to occur under several conditions.
Price competition occurs if rivals' products are nearly identical and buyers have few switching costs.
Years of airline price wars reflect identical products and low switching costs.
Price competition occurs if fixed costs are high and marginal costs are low, creating pressure to cut prices to fill excess capacity.
Many basic-materials businesses, like paper and aluminum, suffer from price competition due to high fixed costs and slow demand.
Price competition occurs if capacity must be expanded in large, efficient increments, disrupting supply-demand balance and leading to overcapacity.
Price competition occurs if the product is perishable, creating a strong temptation to cut prices before value is lost.
Competition on non-price dimensions, such as product features or brand image, is less likely to erode profitability.
Rivalry can be positive sum when competitors serve different customer segments with varied offerings, increasing average industry profitability and expanding the industry.
The average return on invested capital varies markedly across U.S. industries, ranging from zero to over 50% between 1992 and 2006.
Soft drinks and prepackaged software were almost six times more profitable than the airline industry over 1992-2006.
The table compares the average Return on Invested Capital (ROIC) for selected U.S. industries between 1992-2006, highlighting significant variations.
| Industry | Average ROIC (1992-2006) |
|---|---|
| Security Brokers and Dealers | 40.9% |
| Soft Drinks | 37.6% |
| Prepackaged Software | 37.6% |
| Pharmaceuticals | 31.7% |
| Perfume, Cosmetics, Toiletries | 28.6% |
| Advertising Agencies | 27.3% |
| Distilled Spirits | 26.4% |
| Semiconductors | 21.3% |
| Medical Instruments | 21.0% |
| Men's and Boys' Clothing | 19.5% |
| Tires | 19.5% |
| Household Appliances | 19.2% |
| Malt Beverages | 19.0% |
| Child Day Care Services | 17.6% |
| Household Furniture | 17.0% |
| Drug Stores | 16.5% |
| Grocery Stores | 16.0% |
| Iron and Steel Foundries | 15.6% |
| Cookies and Crackers | 15.4% |
| Mobile Homes | 15.0% |
| Wine and Brandy | 13.9% |
| Bakery Products | 13.8% |
| Engines and Turbines | 13.7% |
| Book Publishing | 13.4% |
| Laboratory Equipment | 13.4% |
| Oil and Gas Machinery | 12.6% |
| Soft Drink Bottling | 11.7% |
| Knitting Mills | 10.5% |
| Hotels | 10.4% |
| Catalog, Mail-Order Houses | 5.9% |
| Airlines | 5.9% |
| Average Industry ROIC in the U.S. | 14.9% |
Return on invested capital (ROIC) is the appropriate measure of profitability for strategy formulation, accounting for required capital.
Industry structure determines long-run profit potential, not fleeting factors like growth rate or technology.
It is a common mistake to assume fast-growing industries are always attractive.
Growth can mute rivalry, but high growth with low entry barriers can empower suppliers and draw in entrants, not guaranteeing profitability.
Some fast-growth businesses, like personal computers, have been among the least profitable industries.
Advanced technology or innovations alone do not make an industry structurally attractive or unattractive.
Mundane, low-technology industries with price-insensitive buyers, high switching costs, or high entry barriers are often more profitable than sexy high-tech industries.
Government is not a sixth force; its influence on competition is best understood by analyzing how specific policies affect the five competitive forces.
Patents raise barriers to entry, boosting industry profit potential.
Policies favoring unions may raise supplier power and diminish profit potential.
Bankruptcy rules allowing failing companies to reorganize can lead to excess capacity and intense rivalry.
Complements are products or services used together, where the combined customer benefit exceeds the sum of individual values.
Computer hardware and software are valuable together and worthless when separated.
Complements are not a sixth force but affect profitability by influencing the five forces, impacting demand for an industry's product.
Strategists must trace the positive or negative influence of complements on all five forces to ascertain their impact on profitability.
Producers of complementary operating system software, like Microsoft, lowered application software entry barriers by providing tool sets.
The need for appropriate fueling stations makes it difficult for alternative fuel cars to substitute for conventional vehicles.
Apple's iTunes hastened the substitution from CDs to digital music.
JVC persuaded movie studios to favor its VCR standard, influencing complementary industry conditions.
Industry structure is constantly undergoing modest adjustment and can occasionally change abruptly, emanating from inside or outside an industry.
Changes to any of the seven barriers can raise or lower the threat of new entry.
Expiration of a patent, like Merck's Zocor, can unleash new entrants, as three pharmaceutical makers entered that market.
Proliferation of ice cream products filled grocery freezer space, making new makers' distribution access harder.
Strategic decisions of leading competitors often significantly impact the threat of entry.
Retailers like Wal-Mart adopted new procurement/distribution technologies, increasing economies of scale and making entry difficult for small retailers.
The factors underlying supplier and buyer power change over time, causing their clout to rise or decline.
Competitors like Electrolux were squeezed by retail channel consolidation, with the rise of big-box retailers.
The internet allowed airlines to sell tickets directly, significantly increasing their power to bargain down travel agents' commissions.
Substitutes become more or less threatening due to technological advances creating new substitutes or shifting price-performance comparisons.
Early microwave ovens were expensive, but technological advances made them serious substitutes for conventional ovens.
Flash computer memory improved enough to become a meaningful substitute for low-capacity hard-disk drives.
Rivalry often intensifies as an industry matures, growth slows, and competitors become more alike.
A trend toward intensifying price competition is not inevitable; rivalry can be positive-sum.
The U.S. casino industry saw enormous positive-sum competitive activity focused on new niches and geographic segments.
Mergers and acquisitions can alter industry rivalry by introducing new capabilities and ways of competing.
The internet lowered marginal costs and reduced differentiation in retail brokerage, triggering intense competition on commissions and fees.
Eliminating rivals is a risky strategy because profit windfalls attract new competitors and backlash from customers and suppliers.
Escalating bank consolidations in New York in the 1980s-1990s did not prevent new entrants from diversifying the retail-banking landscape.
Understanding competitive forces is the starting point for strategy development, revealing industry profitability and guiding strategic action.
Strategic action includes positioning to cope with forces, anticipating shifts, and shaping the balance of forces.
Strategy can involve building defenses against competitive forces or finding a position where forces are weakest.
Paccar positioned itself in the heavy-truck market by focusing on owner-operators, a segment with weaker competitive forces.
The five forces framework allows rigorous analysis of entry and exit, identifying industries with good future potential or poor structure.
Industry changes offer opportunities to spot and claim promising new strategic positions if strategists understand competitive forces.
Despite predictions of many new music labels with digital distribution, physical distribution was not the crucial entry barrier.
Large labels' advantages in pooling risks, cushioning failures, and breaking through clutter barred new entrants, not physical distribution.
Digital distribution created an illegal substitute, and major labels allowing Apple to create iTunes shifted industry structure against them.
The number of major record companies declined from six in 1997 to four today.
Companies can shape industry structure by leading new ways of competing that alter the five forces for the better.
In reshaping structure, a company wants competitors to follow, transforming the entire industry, with the innovator benefiting most.
Structure can be reshaped by redividing profitability in favor of incumbents or by expanding the overall profit pool.
Redividing profitability aims to increase the share of profits for industry competitors instead of suppliers, buyers, and substitutes.
Sysco, a food-service distributor, moderated supplier power by introducing private-label brands and shifted competition away from price.
Sysco's investments in IT and regional distribution centers raised entry barriers and made substitutes less attractive.
Industry leaders have a special responsibility for improving industry structure, as their resources and potential benefit are greatest.
Expanding the profit pool involves increasing the overall economic value created by the industry.
Soft-drink producers rationalized bottler networks, benefiting both companies and bottlers by making them more efficient.
Expanding the profit pool creates win-win opportunities for multiple participants and reduces destructive rivalry risks.
Defining the industry where competition actually takes place is crucial for good industry analysis, strategy development, and business unit boundaries.
Mistaking the relevant industry by defining it too broadly or too narrowly leads to strategy errors and obscures important differences.
Industry boundaries consist of product/service scope and geographic scope.
The five forces are the basic tool to resolve questions about industry boundaries.
Automotive motor oil is a distinct industry from truck and stationary engine oils due to different buyers, channels, and structures.
If an industry has similar structure globally, competition is global; if structures differ across regions, each region may be a distinct industry.
A rule of thumb suggests distinct industries may be present if differences in any one force are large, or if multiple forces differ.
Careful five forces analysis reveals competitive threats and major differences even with incorrectly drawn industry boundaries.
Good industry analysis involves defining the industry, identifying participants, assessing competitive forces, and determining overall structure.
Define the relevant industry by identifying its products and geographic scope of competition.
Identify buyers, suppliers, competitors, substitutes, and potential entrants, segmenting them into groups where appropriate.
Assess the underlying drivers of each competitive force to determine which forces are strong, weak, and why.
Determine overall industry structure and test for consistency by analyzing profitability, controlling forces, and positioning of profitable players.
Analyze recent and likely future changes in each force, both positive and negative.
Identify aspects of industry structure that might be influenced by competitors, new entrants, or your company.
Avoid common mistakes to ensure rigorous and accurate industry analysis.
Avoid defining the industry too broadly or too narrowly.
Avoid making lists instead of engaging in rigorous analysis.
Avoid paying equal attention to all forces rather than digging deeply into the most important ones.
Avoid confusing effect, such as price sensitivity, with cause, such as buyer economics.
Avoid using static analysis that ignores industry trends.
Avoid confusing cyclical or transient changes with true structural changes.
Avoid using the framework to declare an industry attractive or unattractive rather than to guide strategic choices.
Understanding industry structure and comprehensive competition reveals drivers, uncovers opportunities, and is crucial for managers and investors alike.
To sustain long-term profitability, companies must respond strategically to competition, extending beyond direct rivals to include five competitive forces.
Savvy customers can force down prices by playing rivals against one another.
Powerful suppliers may constrain profits if they charge higher prices.
Aspiring entrants with new capacity and hunger for market share can ratchet up the investment required to stay in the game.
Substitute offerings can lure customers away from existing products.
Established rivals compete intensely on price and other dimensions.
Commercial aviation is one of the least profitable industries due to strong competitive forces.
Analyzing all five competitive forces provides a complete picture of industry profitability and helps identify game-changing trends early.
Understanding how the five competitive forces influence industry profitability enables strategy development to enhance long-term profits.
Strategists should position their company where the competitive forces are weakest.
In the heavy-truck industry, large buyers, regulated standards, and union power contribute to stiff price competition and high supplier power.
Paccar focused on individual owner-operators, a customer group with limited clout and less price sensitivity, to create sustained long-term profitability.
Paccar developed features like luxurious sleeper cabins and plush leather seats, offering thousands of options for built-to-order trucks.
Customers pay Paccar a 10% premium, and the company has been profitable for 68 straight years, earning a long-run return on equity above 20%.
Companies should exploit changes within the competitive forces.
The Internet and digital distribution created unauthorized downloading, a potent substitute for record companies' services.
Record companies tried to develop digital distribution platforms but major labels hesitated to sell music through a rival's platform.
Apple stepped into this vacuum with iTunes, supporting its iPod, and becoming a powerful new gatekeeper.
The number of major labels was whittled down from six in 1997 to four today.
Companies should use tactics to reduce the share of profits leaking to other players, thereby reshaping the forces.
Standardize part specifications to switch vendors easily, neutralizing supplier power.
Expand services to increase customer switching costs, countering customer power.
Invest more heavily in differentiated products to temper price wars initiated by established rivals.
Elevate fixed costs of competing, like R&D expenditures, to scare off new entrants.
Offer better value through wider product accessibility to limit the threat of substitutes.
Soft-drink producers introduced vending machines and convenience store channels, improving availability relative to other beverages.
Michael E. Porter's 1979 HBR article 'How Competitive Forces Shape Strategy' revolutionized the strategy field and is updated here.
The strategist's job is to understand and cope with competition, which often extends beyond today's direct rivals.
Competition for profits extends beyond established industry rivals to include customers, suppliers, potential entrants, and substitute products.
The extended rivalry from all five forces defines an industry's structure, shaping competitive interaction.
Industry structure drives competition and profitability, not whether an industry is emerging or mature, high-tech or low-tech, regulated or unregulated.
If the five forces are intense, as in industries like airlines, textiles, and hotels, almost no company earns attractive returns on investment.
If the five forces are benign, as in software, soft drinks, and toiletries, many companies are profitable.
While myriad factors affect short-run profitability, industry structure, manifested in competitive forces, sets profitability in the medium and long run.
Understanding competitive forces and their causes reveals roots of current profitability and provides a framework for anticipating and influencing competition.
The configuration of the five competitive forces differs by industry.
In commercial aircraft, fierce rivalry and buyer power are strong, while threat of entry, substitutes, and supplier power are more benign.
In the movie theater industry, the proliferation of substitutes and power of movie producers/distributors are important forces.
The strongest competitive force or forces determine an industry's profitability and become most important for strategy formulation.
Low returns in photographic film, despite fierce rivalry, resulted from a superior substitute product: digital photography.
New entrants bring new capacity and a desire for market share, pressuring prices, costs, and investment.
The threat of entry puts a cap on an industry's profit potential; high threat forces incumbents to deter new competitors.
The threat of entry depends on the height of entry barriers and expected retaliation from incumbents.
Low entry barriers in specialty coffee mean Starbucks must invest aggressively in modernizing stores and menus.
Entry barriers are advantages incumbents have relative to new entrants.
Firms producing at larger volumes enjoy lower per-unit costs, deterring entrants by forcing large scale or cost disadvantage.
Intel is protected by scale economies in research, chip fabrication, and consumer marketing.
Scotts Miracle-Gro finds scale economies most important in supply chain and media advertising.
Buyer willingness to pay increases with the number of other buyers patronizing the company, also known as network effects.
Buyers trusted larger companies like IBM, reducing entry willingness for newcomers.
Online auction participants are attracted to eBay due to its large number of potential trading partners.
Fixed costs buyers face when changing suppliers make it harder for entrants to gain customers.
Enterprise resource planning (ERP) software like SAP has very high switching costs due to embedded data and process adaptations.
Large financial resource investment deters new entrants, especially for unrecoverable expenditures like upfront advertising or R&D.
Capital requirements alone may not deter entry if industry returns are attractive and capital markets are efficient.
Financing for expensive aircraft is available due to high resale value, leading to numerous new airlines.
Incumbents may have cost or quality advantages unavailable to potential rivals, regardless of size.
Advantages stem from proprietary technology, preferential raw material access, favorable geographic locations, established brands, or cumulative experience.
Upstart discounters like Target and Walmart bypass established department stores by locating in freestanding sites.
New entrants must secure product distribution, which can be tough if wholesale/retail channels are limited or tied up by competitors.
Upstart low-cost airlines avoid travel agents and encourage online booking to bypass distribution channels.
Government policy can directly hinder or aid new entry, or amplify/nullify other entry barriers.
Licensing requirements and restrictions on foreign investment directly limit entry into industries like liquor retailing and taxi services.
Patent rules protecting technology or environmental/safety regulations raising scale economies can heighten entry barriers.
Potential entrants' perception of incumbent reaction influences their decision to enter an industry.
Newcomers fear retaliation if incumbents have previously responded vigorously to new entrants.
Newcomers fear retaliation if incumbents possess substantial resources to fight back, including excess cash, borrowing power, and productive capacity.
Newcomers fear retaliation if incumbents are likely to cut prices due to commitment to market share or high fixed costs.
Newcomers fear retaliation if industry growth is slow, meaning volume must be taken from incumbents.
Powerful suppliers capture more value by charging higher prices, limiting quality, or shifting costs to industry participants.
Microsoft's operating system price increases eroded PC makers' profitability, who could not raise their prices due to fierce customer competition.
A supplier group is powerful if it is more concentrated than the industry it sells to.
A supplier group is powerful if it does not depend heavily on the industry for its revenues.
Industry participants face switching costs in changing suppliers, making it hard to play them off against one another.
A supplier group is powerful if it offers differentiated products.
Pharmaceutical companies offering patented drugs have more power over hospitals and other drug buyers.
A supplier group is powerful if there is no substitute for what it provides.
Pilots' unions exercise considerable power over airlines because well-trained pilots have no good alternative.
A supplier group is powerful if it can credibly threaten to integrate forward into the industry.
Powerful customers capture more value by forcing down prices, demanding better quality/service, or playing industry participants against one another.
Buyers are powerful if they have negotiating leverage relative to industry participants, especially if they are price sensitive.
A customer group has negotiating leverage if there are few buyers, or each purchases large volumes relative to a single vendor.
A customer group has negotiating leverage if the industry's products are standardized or undifferentiated.
A customer group has negotiating leverage if buyers face few switching costs in changing vendors.
Buyers can credibly threaten to integrate backward and produce the industry's product themselves if vendors are too profitable.
Producers of soft drinks controlled packaging manufacturers by threatening to make materials themselves.
A buyer group is price sensitive under several conditions.
A buyer group is price sensitive if the product represents a significant fraction of its cost structure or procurement budget.
A buyer group is price sensitive if it earns low profits, is strapped for cash, or is under pressure to trim purchasing costs.
A buyer group is price sensitive if the quality of its products or services is little affected by the industry's product.
A buyer group is price sensitive if the industry's product has little effect on the buyer's other costs.
Most buyer power sources apply equally to consumers and business-to-business customers, with consumers often more price sensitive for undifferentiated, expensive products.
Intermediate customers gain significant bargaining power when they can influence downstream purchasing decisions.
Consumer electronics retailers exert strong influence on end customers.
Producers diminish channel clout through exclusive arrangements, direct marketing, or creating downstream customer preferences for components.
DuPont created clout by advertising its Stainmaster brand to both carpet manufacturers and downstream consumers, who then request the carpet.
A substitute performs the same or similar function by different means, limiting industry profit potential by placing a price ceiling.
Videoconferencing is a substitute for travel.
Substitution threat can be downstream or indirect, replacing a buyer industry's product.
Lawn-care products are threatened when multi-family homes substitute for single-family homes in urban areas.
Airline and travel websites substitute for travel agents.
Substitutes are always present but easy to overlook because they may appear very different from the industry's product.
The threat of a substitute is high if it offers an attractive price-performance trade-off or buyer switching costs are low.
The threat of a substitute is high if it offers an attractive price-performance trade-off to the industry's product.
Conventional long-distance phone service suffered from inexpensive internet-based services like Vonage and Skype.
Video rental outlets struggle against video-on-demand services, online rentals like Netflix, and internet video sites like YouTube.
The threat of a substitute is high if the buyer's cost of switching to the substitute is low.
Switching from branded to generic drugs involves minimal costs, leading to rapid shifts and price falls.
Strategists should be alert to changes in other industries that make them attractive substitutes.
Improvements in plastic allowed it to substitute for steel in many automobile components.
Rivalry includes price discounting, new product introductions, advertising campaigns, and service improvements, limiting industry profitability.
The degree rivalry drives down profit potential depends on its intensity and basis.
The intensity of rivalry is greatest under several conditions.
Rivalry is greatest if competitors are numerous or roughly equal in size and power, making poaching business hard to avoid.
Rivalry is greatest if industry growth is slow, precipitating fights for market share.
Rivalry is greatest if exit barriers are high, keeping companies in the market despite low or negative returns and leading to excess capacity.
Rivalry is greatest if rivals are highly committed to the business with leadership aspirations, often due to non-economic goals.
Rivalry is greatest if firms cannot read each other's signals well due to unfamiliarity, diverse approaches, or differing goals.
The strength of rivalry reflects not just intensity but also the basis of competition, influencing profitability.
Rivalry gravitating solely to price is especially destructive to profitability because it transfers profits directly from the industry to customers.
Price cuts are easy for competitors to see and match, leading to successive rounds of retaliation.
Sustained price competition trains customers to pay less attention to product features and service.
Price competition is most liable to occur under several conditions.
Price competition occurs if rivals' products are nearly identical and buyers have few switching costs.
Years of airline price wars reflect identical products and low switching costs.
Price competition occurs if fixed costs are high and marginal costs are low, creating pressure to cut prices to fill excess capacity.
Many basic-materials businesses, like paper and aluminum, suffer from price competition due to high fixed costs and slow demand.
Price competition occurs if capacity must be expanded in large, efficient increments, disrupting supply-demand balance and leading to overcapacity.
Price competition occurs if the product is perishable, creating a strong temptation to cut prices before value is lost.
Competition on non-price dimensions, such as product features or brand image, is less likely to erode profitability.
Rivalry can be positive sum when competitors serve different customer segments with varied offerings, increasing average industry profitability and expanding the industry.
The average return on invested capital varies markedly across U.S. industries, ranging from zero to over 50% between 1992 and 2006.
Soft drinks and prepackaged software were almost six times more profitable than the airline industry over 1992-2006.
The table compares the average Return on Invested Capital (ROIC) for selected U.S. industries between 1992-2006, highlighting significant variations.
| Industry | Average ROIC (1992-2006) |
|---|---|
| Security Brokers and Dealers | 40.9% |
| Soft Drinks | 37.6% |
| Prepackaged Software | 37.6% |
| Pharmaceuticals | 31.7% |
| Perfume, Cosmetics, Toiletries | 28.6% |
| Advertising Agencies | 27.3% |
| Distilled Spirits | 26.4% |
| Semiconductors | 21.3% |
| Medical Instruments | 21.0% |
| Men's and Boys' Clothing | 19.5% |
| Tires | 19.5% |
| Household Appliances | 19.2% |
| Malt Beverages | 19.0% |
| Child Day Care Services | 17.6% |
| Household Furniture | 17.0% |
| Drug Stores | 16.5% |
| Grocery Stores | 16.0% |
| Iron and Steel Foundries | 15.6% |
| Cookies and Crackers | 15.4% |
| Mobile Homes | 15.0% |
| Wine and Brandy | 13.9% |
| Bakery Products | 13.8% |
| Engines and Turbines | 13.7% |
| Book Publishing | 13.4% |
| Laboratory Equipment | 13.4% |
| Oil and Gas Machinery | 12.6% |
| Soft Drink Bottling | 11.7% |
| Knitting Mills | 10.5% |
| Hotels | 10.4% |
| Catalog, Mail-Order Houses | 5.9% |
| Airlines | 5.9% |
| Average Industry ROIC in the U.S. | 14.9% |
Return on invested capital (ROIC) is the appropriate measure of profitability for strategy formulation, accounting for required capital.
Industry structure determines long-run profit potential, not fleeting factors like growth rate or technology.
It is a common mistake to assume fast-growing industries are always attractive.
Growth can mute rivalry, but high growth with low entry barriers can empower suppliers and draw in entrants, not guaranteeing profitability.
Some fast-growth businesses, like personal computers, have been among the least profitable industries.
Advanced technology or innovations alone do not make an industry structurally attractive or unattractive.
Mundane, low-technology industries with price-insensitive buyers, high switching costs, or high entry barriers are often more profitable than sexy high-tech industries.
Government is not a sixth force; its influence on competition is best understood by analyzing how specific policies affect the five competitive forces.
Patents raise barriers to entry, boosting industry profit potential.
Policies favoring unions may raise supplier power and diminish profit potential.
Bankruptcy rules allowing failing companies to reorganize can lead to excess capacity and intense rivalry.
Complements are products or services used together, where the combined customer benefit exceeds the sum of individual values.
Computer hardware and software are valuable together and worthless when separated.
Complements are not a sixth force but affect profitability by influencing the five forces, impacting demand for an industry's product.
Strategists must trace the positive or negative influence of complements on all five forces to ascertain their impact on profitability.
Producers of complementary operating system software, like Microsoft, lowered application software entry barriers by providing tool sets.
The need for appropriate fueling stations makes it difficult for alternative fuel cars to substitute for conventional vehicles.
Apple's iTunes hastened the substitution from CDs to digital music.
JVC persuaded movie studios to favor its VCR standard, influencing complementary industry conditions.
Industry structure is constantly undergoing modest adjustment and can occasionally change abruptly, emanating from inside or outside an industry.
Changes to any of the seven barriers can raise or lower the threat of new entry.
Expiration of a patent, like Merck's Zocor, can unleash new entrants, as three pharmaceutical makers entered that market.
Proliferation of ice cream products filled grocery freezer space, making new makers' distribution access harder.
Strategic decisions of leading competitors often significantly impact the threat of entry.
Retailers like Wal-Mart adopted new procurement/distribution technologies, increasing economies of scale and making entry difficult for small retailers.
The factors underlying supplier and buyer power change over time, causing their clout to rise or decline.
Competitors like Electrolux were squeezed by retail channel consolidation, with the rise of big-box retailers.
The internet allowed airlines to sell tickets directly, significantly increasing their power to bargain down travel agents' commissions.
Substitutes become more or less threatening due to technological advances creating new substitutes or shifting price-performance comparisons.
Early microwave ovens were expensive, but technological advances made them serious substitutes for conventional ovens.
Flash computer memory improved enough to become a meaningful substitute for low-capacity hard-disk drives.
Rivalry often intensifies as an industry matures, growth slows, and competitors become more alike.
A trend toward intensifying price competition is not inevitable; rivalry can be positive-sum.
The U.S. casino industry saw enormous positive-sum competitive activity focused on new niches and geographic segments.
Mergers and acquisitions can alter industry rivalry by introducing new capabilities and ways of competing.
The internet lowered marginal costs and reduced differentiation in retail brokerage, triggering intense competition on commissions and fees.
Eliminating rivals is a risky strategy because profit windfalls attract new competitors and backlash from customers and suppliers.
Escalating bank consolidations in New York in the 1980s-1990s did not prevent new entrants from diversifying the retail-banking landscape.
Understanding competitive forces is the starting point for strategy development, revealing industry profitability and guiding strategic action.
Strategic action includes positioning to cope with forces, anticipating shifts, and shaping the balance of forces.
Strategy can involve building defenses against competitive forces or finding a position where forces are weakest.
Paccar positioned itself in the heavy-truck market by focusing on owner-operators, a segment with weaker competitive forces.
The five forces framework allows rigorous analysis of entry and exit, identifying industries with good future potential or poor structure.
Industry changes offer opportunities to spot and claim promising new strategic positions if strategists understand competitive forces.
Despite predictions of many new music labels with digital distribution, physical distribution was not the crucial entry barrier.
Large labels' advantages in pooling risks, cushioning failures, and breaking through clutter barred new entrants, not physical distribution.
Digital distribution created an illegal substitute, and major labels allowing Apple to create iTunes shifted industry structure against them.
The number of major record companies declined from six in 1997 to four today.
Companies can shape industry structure by leading new ways of competing that alter the five forces for the better.
In reshaping structure, a company wants competitors to follow, transforming the entire industry, with the innovator benefiting most.
Structure can be reshaped by redividing profitability in favor of incumbents or by expanding the overall profit pool.
Redividing profitability aims to increase the share of profits for industry competitors instead of suppliers, buyers, and substitutes.
Sysco, a food-service distributor, moderated supplier power by introducing private-label brands and shifted competition away from price.
Sysco's investments in IT and regional distribution centers raised entry barriers and made substitutes less attractive.
Industry leaders have a special responsibility for improving industry structure, as their resources and potential benefit are greatest.
Expanding the profit pool involves increasing the overall economic value created by the industry.
Soft-drink producers rationalized bottler networks, benefiting both companies and bottlers by making them more efficient.
Expanding the profit pool creates win-win opportunities for multiple participants and reduces destructive rivalry risks.
Defining the industry where competition actually takes place is crucial for good industry analysis, strategy development, and business unit boundaries.
Mistaking the relevant industry by defining it too broadly or too narrowly leads to strategy errors and obscures important differences.
Industry boundaries consist of product/service scope and geographic scope.
The five forces are the basic tool to resolve questions about industry boundaries.
Automotive motor oil is a distinct industry from truck and stationary engine oils due to different buyers, channels, and structures.
If an industry has similar structure globally, competition is global; if structures differ across regions, each region may be a distinct industry.
A rule of thumb suggests distinct industries may be present if differences in any one force are large, or if multiple forces differ.
Careful five forces analysis reveals competitive threats and major differences even with incorrectly drawn industry boundaries.
Good industry analysis involves defining the industry, identifying participants, assessing competitive forces, and determining overall structure.
Define the relevant industry by identifying its products and geographic scope of competition.
Identify buyers, suppliers, competitors, substitutes, and potential entrants, segmenting them into groups where appropriate.
Assess the underlying drivers of each competitive force to determine which forces are strong, weak, and why.
Determine overall industry structure and test for consistency by analyzing profitability, controlling forces, and positioning of profitable players.
Analyze recent and likely future changes in each force, both positive and negative.
Identify aspects of industry structure that might be influenced by competitors, new entrants, or your company.
Avoid common mistakes to ensure rigorous and accurate industry analysis.
Avoid defining the industry too broadly or too narrowly.
Avoid making lists instead of engaging in rigorous analysis.
Avoid paying equal attention to all forces rather than digging deeply into the most important ones.
Avoid confusing effect, such as price sensitivity, with cause, such as buyer economics.
Avoid using static analysis that ignores industry trends.
Avoid confusing cyclical or transient changes with true structural changes.
Avoid using the framework to declare an industry attractive or unattractive rather than to guide strategic choices.
Understanding industry structure and comprehensive competition reveals drivers, uncovers opportunities, and is crucial for managers and investors alike.