5 competitive forces and strategy

Five Competitive Forces and Five Competitive Forces and StrategyStrategy

Reshape the Forces in Your Reshape the Forces in Your FavourFavour

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Learning ObjectivesLearning Objectives

Know the five forces that shape Know the five forces that shape strategy.strategy.

Understand how they shape strategy.Understand how they shape strategy.

Understand PorterUnderstand Porter’’s approach to s approach to strategy formulation using the five strategy formulation using the five forces analysis.forces analysis.

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IntroductionIntroduction

Threat ofNew Entrants

Rivalry amongexisting

competitors

Threat ofSubstitute Products

or Services

Bargainingpower ofSuppliers

BargainingPower of

Customers

The Five Forces That Shape Industry Competition

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IntroductionIntroduction- Profitability of Selected Industries- Profitability of Selected Industries

Average 14 year ROIC

37.6

31.7

21.3

19.5

15.6

13.7

12.6

10.4

5.9

0 5 10 15 20 25 30 35 40

Pkged. Software

Pharma

Semiconductors

Tires

Steel Foundries

Engines/ Turbines

Oil/Gas Machinery

Hotels

Airlines

ROIC (%)

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IntroductionIntroduction

• Rivalry•New Entrants• Substitutes• Suppliers

• Customers

Position your company where the forces are weakest

• Exploit changes in the forces

• Reshape the forces in your favor

ANALYZE THE FIVE FORCES DEVELOP YOUR STRATEGY

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Forces That Shape CompetitionForces That Shape CompetitionExample: Aircraft IndustryExample: Aircraft Industry

Airbus /BoeingHigh rivalry

Substitutes (car/ ship)moderate

Suppliers-Moderatebargaining

power

CustomersAir India

BASingapore Airlines

HighBargaining

power

New EntrantsModerate

threat

Less bargaining power(less focus)

Low threats( less focus)

Low threat(less focus)

(more focus)High rivalryHi bargainingpower

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Let’s pause and check our understandingof the topic so far.

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Quiz 1: Select the best optionQuiz 1: Select the best option

What do PorterWhat do Porter’’s five forces define?s five forces define?

a)a) Value ChainValue Chainb)b) Industry StructureIndustry Structurec)c) Sweet SpotsSweet Spotsd)d) Legal structureLegal structure

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WhatWhat’’s common to auto industry, s common to auto industry, pharma industry and construction pharma industry and construction industry?industry?

a)a) Core CompetenciesCore Competenciesb)b) Supplier IndustriesSupplier Industriesc)c) Drivers of ProfitabilityDrivers of Profitabilityd)d) Return on Invested CapitalReturn on Invested Capital

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Quiz 3: Tick all that applyQuiz 3: Tick all that apply

Which strategies emerge as a result of Which strategies emerge as a result of PorterPorter’’s Five-Force analysis?s Five-Force analysis?

a)a) Position your company where the Position your company where the forces are weakestforces are weakest

b)b) Reshape the forces in your favourReshape the forces in your favourc)c) Introduce disruptive technologiesIntroduce disruptive technologiesd)d) Exploit changes in the forcesExploit changes in the forces

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““Fierce rivalry between Kodak and Fuji Fierce rivalry between Kodak and Fuji is not the main cause of low returns is not the main cause of low returns in the photographic film industryin the photographic film industry””..

- So, what is the main cause?So, what is the main cause?a)a) Expensive camerasExpensive camerasb)b) Internet photosInternet photosc)c) Digital photographyDigital photographyd)d) Reduced family bondingReduced family bonding

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Threat of EntryThreat of Entry

Pepsi >>>Bottled Water

Microsoft>>>Internet Browser Apple>>>

Music Distribution

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Barriers to EntryBarriers to Entry- there are seven major sources- there are seven major sources

1.1. Supply-side economies of scaleSupply-side economies of scale2.2. Demand-side benefits of scaleDemand-side benefits of scale3.3. Customer switching costsCustomer switching costs4.4. Capital requirementsCapital requirements5.5. Incumbency advantages independent of Incumbency advantages independent of

sizesize6.6. Unequal access to distribution channelsUnequal access to distribution channels7.7. Restrictive government policyRestrictive government policy

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Barriers to EntryBarriers to Entry1. Supply-side economies of scale1. Supply-side economies of scale

R&D

Chip Fab

Consumer Marketing

NewEntrants

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Barriers to EntryBarriers to Entry2. Demand-side benefits of scale2. Demand-side benefits of scale

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Barriers to EntryBarriers to Entry3. Customer switching costs3. Customer switching costs

Customer Lockin

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Barriers to EntryBarriers to Entry4. Capital Requirements4. Capital Requirements

High capital requirements

= high barrier to entry

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Barriers to EntryBarriers to Entry5. Incumbency advantages independent of size5. Incumbency advantages independent of size

Proprietary technologyProprietary technology Access to best raw materialsAccess to best raw materials Favorable locationFavorable location Established brandEstablished brand Rich cumulative experienceRich cumulative experience

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Barriers to EntryBarriers to Entry6. Unequal access to distribution channels6. Unequal access to distribution channels

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Barriers to EntryBarriers to Entry7. Restrictive government policy7. Restrictive government policy

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Barriers to EntryBarriers to Entry

Flying over barriers

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Expected RetaliationExpected Retaliation

Anheuser Busch

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Expected RetaliationExpected Retaliation

The challenge is to find ways to The challenge is to find ways to surmount the entry barriers without surmount the entry barriers without nullifying, through heavy investment, nullifying, through heavy investment, the profitability of those participating the profitability of those participating in the industry.in the industry.

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The Power of SuppliersThe Power of Suppliers

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Power of SuppliersPower of SuppliersA supplier group is powerful if….A supplier group is powerful if….

Concentration/ (opposite of Concentration/ (opposite of fragmentation)fragmentation)

Not dependent on business volumesNot dependent on business volumes

Switching costsSwitching costs

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Power of SuppliersPower of SuppliersA supplier group is powerful if..A supplier group is powerful if..

Differentiated productsDifferentiated products

No substituteNo substitute

Forward integrationForward integration

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The Power of BuyersThe Power of Buyers

Is he?

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Power of BuyersPower of BuyersA customer group has negotiating leverage if:A customer group has negotiating leverage if:

Concentration/ fragmentationConcentration/ fragmentation

Standardized/ undifferentiated Standardized/ undifferentiated productsproducts

Low switching costsLow switching costs

Backward integrationBackward integration

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Power of BuyersPower of BuyersA buyer group is price sensitive if:..A buyer group is price sensitive if:..

Significant portion of budgetSignificant portion of budget Cost pressuresCost pressures Quality unimportantQuality unimportant Little impact on other costsLittle impact on other costs

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Power of BuyersPower of Buyers……

Consumer electronics Consumer electronics retailers, jewelry retailers, jewelry retailers, and retailers, and agricultural-equipment agricultural-equipment distributors are distributors are examples of examples of distribution channels distribution channels that exert a strong that exert a strong influence on end influence on end customers.customers.

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The Threat Of SubstitutesThe Threat Of Substitutes

Videoconferencing is a substitute for Videoconferencing is a substitute for traveltravelPlastic is a substitute for aluminumPlastic is a substitute for aluminum

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The Threat of SubstitutesThe Threat of SubstitutesThe threat of a substitute is high if….The threat of a substitute is high if….

Attractive price-performance trade-Attractive price-performance trade-offoffSwitching costs lowSwitching costs low

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Rivalry among existing competitorsRivalry among existing competitors

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RivalryRivalryThe intensity of rivalry is great if….The intensity of rivalry is great if….

Numerous competitorsNumerous competitors Slow industry growthSlow industry growth High exit barriersHigh exit barriers Committed rivalsCommitted rivalsMyopiaMyopia

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RivalryRivalry

Dimensions of competitionDimensions of competition Competing solely on price Competing solely on price

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RivalryRivalryPrice competition is most liable to occur if…Price competition is most liable to occur if…

Identical products/ servicesIdentical products/ services Few switching costsFew switching costs Fixed costs highFixed costs high Marginal costs lowMarginal costs low

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RivalryRivalryPrice & Non-Price Factors of CompetitionPrice & Non-Price Factors of Competition

1. Premium2. Competitive

3. Leader

1. Comprehensive2. Standard3. Minimal

1. Excellent2. Average

3. Acceptable

1. Prestigious2. Respected3. Functional

1. Original2. Customized

3. Basic

1. Restricted2. Selective3. Universal

PRICE FEATURES QUALITY

SUPPORT AVAILABILITY REPUTATION

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Implications for StrategyImplications for StrategyThree possible strategies emerge from Five-forces analysis:Three possible strategies emerge from Five-forces analysis:

Position your company where the forces are Position your company where the forces are weakestweakest

Exploit changes in the forcesExploit changes in the forces

Reshape the forces in your favour.Reshape the forces in your favour.

The best strategies exploit more than one of these three The best strategies exploit more than one of these three possibilities.possibilities.

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Strategy :Strategy :Positioning the CompanyPositioning the Company

Paccar has been profitable for 68 straight years.Paccar has been profitable for 68 straight years.It has earned long-run return on equity above It has earned long-run return on equity above 20% .20% .Paccar illustrates the principles of positioning a Paccar illustrates the principles of positioning a company within a given industry structure.company within a given industry structure.

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Strategy: Exploiting Industry ChangeStrategy: Exploiting Industry Change

The rise of DellThe rise of Dell’’s direct-distribution model in s direct-distribution model in the personal computer industry exploited a the personal computer industry exploited a number of industry trends.number of industry trends.

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Strategy: Shaping Industry StructureStrategy: Shaping Industry Structure

Intel has spent billions of dollars on its Intel has spent billions of dollars on its ““Intel InsideIntel Inside”” advertising campaign focused on computer users – its advertising campaign focused on computer users – its customerscustomers’’ customers. This has made it harder for PC customers. This has made it harder for PC makers to switch to rival chip producers like AMD.makers to switch to rival chip producers like AMD.Intel has shaped the microprocessor industry.Intel has shaped the microprocessor industry.

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Competition Competition

In a world of more open competition and In a world of more open competition and relentless change, it is more important relentless change, it is more important than ever to think structurally about than ever to think structurally about competition.competition.

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Summing UpSumming Up

By analyzing all five competitive forces, you gain By analyzing all five competitive forces, you gain a complete picture of whata complete picture of what’’s influencing s influencing profitability in your industry. profitability in your industry.

You identify game-changing trends early, so you You identify game-changing trends early, so you can swiftly exploit them. can swiftly exploit them.

And you spot ways to work around constraints on And you spot ways to work around constraints on profitability – or even reshape the forces in your profitability – or even reshape the forces in your favour.favour.

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Quiz 1: True or False?Quiz 1: True or False?

““Understanding the competitive forces Understanding the competitive forces and their underlying causes, reveals and their underlying causes, reveals the sources of industrythe sources of industry’’s politics and s politics and offers guidance on employee offers guidance on employee retention.retention.””

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Arrival of new entrants into an Arrival of new entrants into an industry puts pressure on what?industry puts pressure on what?

a)a) UnemploymentUnemploymentb)b) Technology investmentTechnology investmentc)c) Government controlsGovernment controlsd)d) PricesPrices

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When new entrants are diversifying When new entrants are diversifying from other markets, they tend to from other markets, they tend to leverage existing capabilities and leverage existing capabilities and cash flows, to do what?cash flows, to do what?

a)a) Beat down suppliersBeat down suppliersb)b) Shake up the competitionShake up the competitionc)c) Establish community reputationEstablish community reputationd)d) Bully customersBully customers

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Quiz 4: Tick all that applyQuiz 4: Tick all that apply

Which of these are barriers to entry in Which of these are barriers to entry in an industry?an industry?

a)a) High industry growthHigh industry growthb)b) Abundance of suppliersAbundance of suppliersc)c) High customer switching costsHigh customer switching costsd)d) High capital requirementsHigh capital requirements

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Quiz 5: Select the best optionQuiz 5: Select the best optionWhere a buyerWhere a buyer’’s willingness to pay for s willingness to pay for

a companya company’’s product increases with s product increases with the number of other buyers who the number of other buyers who also patronize the company, it is also patronize the company, it is referred to as what?referred to as what?

a)a) Network EffectsNetwork Effectsb)b) Windfall EffectsWindfall Effectsc)c) Honey TrapHoney Trapd)d) Buzz EffectsBuzz Effects

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Fixed costs that buyers face when they Fixed costs that buyers face when they change suppliers are referred to as change suppliers are referred to as what?what?

a)a) OverheadsOverheadsb)b) Marginal costsMarginal costsc)c) Administrative costsAdministrative costsd)d) Switching costsSwitching costs

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Quiz 7: True or false?Quiz 7: True or false?

““It is easy to borrow funds to enter an It is easy to borrow funds to enter an industry if it is attractive, even if the industry if it is attractive, even if the capital markets are inefficient.capital markets are inefficient.””

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Quiz 8: true/ falseQuiz 8: true/ false

““Sometimes access to distribution is so Sometimes access to distribution is so high a barrier, that new entrants high a barrier, that new entrants must bypass distribution channels must bypass distribution channels altogether or create their ownaltogether or create their own””

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Quiz 9: Select the best optionQuiz 9: Select the best optionWhen does supplier power increase?When does supplier power increase?a)a) When number of suppliers is largeWhen number of suppliers is largeb)b) When industry participants face When industry participants face

switching costs in changing switching costs in changing supplierssuppliers

c)c) When a supplier supplies to just When a supplier supplies to just one industryone industry

d)d) When they supply standardized When they supply standardized productsproducts

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Buyers increase their power over Buyers increase their power over suppliers by threatening to do suppliers by threatening to do what?what?

a)a) Forward integrationForward integrationb)b) Backward integrationBackward integrationc)c) Increase product varietyIncrease product varietyd)d) Improve product qualityImprove product quality

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Quiz 11: True or False?Quiz 11: True or False?

High fixed costs and low marginal High fixed costs and low marginal costs reduce the pressure on rivals costs reduce the pressure on rivals to keep capacity filled through price to keep capacity filled through price discounting.discounting.

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Quiz 12: True or FalseQuiz 12: True or False

““Rivalry can actually increase Rivalry can actually increase average profitability of an industry, average profitability of an industry, when each competitor aims to serve when each competitor aims to serve the needs of different customer the needs of different customer segments, with different mixes of segments, with different mixes of price, products, services, features or price, products, services, features or brand identities.brand identities.””

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ReferencesReferencesMichael E Porter, Michael E Porter, Competitive Advantage: Competitive Advantage: Creating & Sustaining Superior Creating & Sustaining Superior PerformancePerformance ( The Free Press, 1998) ( The Free Press, 1998)Pankaj Ghemawat; Pankaj Ghemawat; Strategy and the Strategy and the Business LandscapeBusiness Landscape;(Pearson Education, ;(Pearson Education, 2006)2006)Adam M Brandenburger & Barry J Adam M Brandenburger & Barry J Nalebuff; Nalebuff; Co-opetitionCo-opetition ( Currency ( Currency Doubleday, 1996)Doubleday, 1996)