Category Archives: Major theories

The concepts and frameworks that I think best explains history, economics and organizations.

Michael Porter: The Five Competitive Forces That Shape Strategy – Harvard Business Review

The Five Forces that Shape Competition

I. THREAT OF NEW ENTRANTS

Barriers to entry
1. Supply-side economies of scale: Firms that produce at large volumes enjoy lower cost per unit
2. Demand-side benefits of scale: Buyers trust larger companies and companies their competitors use.
3. Customer switching costs.
4. Capital requirements: High up-front cost
5. Incumbency advantages: Proprietary tech, preferential access to raw materials, most favorable locations, established brand.
6. Unequal access to distribution channels
7. Restrictive government policy: licensing, restrictions on foreign investment, etc.

Expected retaliation: Newcomers are likely to fear retaliation if:
1. Incumbents previously responded aggressively
2. Incumbent possess substantial resources to fight back, excess cash, unused borrowing power, productive capacity, clout with distribution channel and customers
3. Incumbents can cut prices to retain market share
4. Industry growth is so slow it can take volume from incumbents

II. THE BARGAINING POWER OF SUPPLIERS
Powerful suppliers capture value by:
– Charging higher prices
– Limiting quantity of services
– Shifting costs to industry participants

A supply group is powerful if:
– It is more concentrated than the industry it sells to
– It does not depend heavily on the industry for its revenues
– Industry participants face switching costs
– Supplier products are differentiated and not easily substituted
– Suppliers can integrate forward into the same market as participants

III. THE BARGAINING POWER OF BUYERS
Powerful customers can:
– Force down prices
– Demand better quality or higher service level
– Play industry participants off against each other

A customer group has negotiating leverage if:
– There are few buyers or one buys large share of volume
– Industry products are standardized or undifferentiated, buyer can play one vendor against another
– Buyer face few switching costs
– Buyer can integrate backward and produce product themselves

A buyer group is price sensitive if:
– The product is significant portion of cost structure or procurement budget – buyers will shop around and bargain hard
– group earns low profits, strapped for cash, under pressure to cut costs
– buyer’s product is little affected by quality of industry’s product. Opposite case – major motion picture studios are not price sensitive and will pay premium for highly reliable equipment
– industry’s product has litte effect on buyer’s other costs. Opposite case – tax accounting or oil well measurement can save money over time. Buyer will pay premium if cost of mistakes is high, like in investment banking

IV. THE THREAT OF SUBSTITUTES

Threat of substitute is high if:
– It offers attractive price-performance trade-off to industry’s product. Example, VOIP threat to long-distance telephone service.
– Buyer’s cost of switching is low

V. RIVALRY AMONG EXISTING COMPETITORS
– Price discounting
– New product introductions
– Ad campaigns
– Service improvements

Intensity of rivalry is greatest if:
– Competitors are numerous or equal in size or power
– Industry growth is slow – participants fight for market share
– Exit barriers are high – highly specialized assets or management’s devotion to particular business
– Rivals are highly committed to business and have aspirations for leadership. Example – state-owned competitors have goals that include employment or prestige.
– Firms cannot read each other’s signals well because of lack of familiarity with each other.

Price competition is most likely if:
– Products or services of rivals are nearly identical and low switching costs
– Fixed costs are high and marginal costs are low. Example: Basic materials or delivery companies – routes must be served even if demand is not growing
– Capacity must be expanded in large increments to be efficient.
– The product is perishable – high pressure to cut prices and sell product while it still has value

FACTORS, NOT FORCES – Do not mistake visible attributes of an industry for its underlying structure
– Fast-growing industries are not always attractive: invites competitors, makes suppliers more powerful, customers may seek lower priced substitute.

– Technology and innovation not always attractive – More mundane industries with price-insensitive buyers, high-switching costs or high barriers to entry can be more profitable than high technology industries.
– Government – Policies on patents, labor unions, bankruptcy rules, etc. will affect structure

Source: The Five Competitive Forces That Shape Strategy