04 - Five Competitive Forces in Strategy

Five Competitive Forces That Shape Strategy

• Awareness of these forces helps companies understand industry structure and position themselves for profitability.
• Managers often narrowly define competition, focusing only on direct competitors.
• Competition for profits also includes customers, suppliers, potential entrants, and substitute products.
• The interplay of these five forces shapes industry structure and competitive interaction.
• Industries, despite surface differences, share the same underlying profitability drivers.
• Analyzing the five forces clarifies the root cause of industry profitability.

Differences in Industry Profitability

• Profitability varies significantly across different industries in the US between 1992 and 2006.
• Industries exhibit a wide range of profitability, as measured by return on invested capital (ROIC).
• ROIC is determined by the relative strength of the five competitive forces each industry faces.

Threat of New Entrants

• New entrants bring new capacity and aim for market share, putting downward pressure on price, costs, and investment.
• Entry barriers hinder new entrants and allow incumbents to manage the threat.
• The extent of this threat depends on entry barriers and the expected reaction from incumbents. High entry barriers limit the threat, while low barriers and little expected retaliation lead to high threat.

Bargaining Power of Suppliers

• Powerful suppliers, especially those concentrated for inputs, can influence pricing and quality, negatively impacting profitability.
• Companies depend on various supplier groups—powerful suppliers exert more control.
• Industry participants face high switching costs for changing suppliers (e.g., specialized equipment).
• Supplier-offered products (e.g., specialty drugs) create more bargaining leverage.
• Suppliers can integrate into the industry, increasing their power, impacting industry profitability

Bargaining Power of Buyers

• Powerful buyers can affect price, quality, and service, reducing industry profitability.
• A few large buyers can exert substantial influence over prices.
• Switching costs for buyers limit their ability to pressure prices, influencing buy/sell behavior.

Threat of Substitute Products or Services

• Substitute products or services cap industry pricing.
• Substitute threat is high when price-performance is attractive, and buyer switching costs are low.

Rivalry Among Existing Competitors

• Intense rivalry among competitors can negatively impact profitability.
• Rivalry is high when competitors are numerous, roughly equal, and growth is slow.
• Excessive price competition erodes profits.
• Innovation, differentiation, strategic positioning, and nonprice competition can mitigate rivalry.

Shaping Industry Structure

• Understanding the five forces helps companies position themselves in industries to better compete, anticipate and influence competition.
• Strategy aims to shape the industry in favor of the organization, either by redistributing profitability (to incumbents' favor) or expanding the total economic value (profit pool).
• Industry environments constantly change. Analyzing the five forces can help strategists anticipate how these changes will impact the industry.
• Positioning the company within the industry involves either finding the position with the weakest forces or finding ways to make a position within an industry have lower competitive pressures.