Summary of the article
“The five competitive forces that shape strategy”
by Porter (2008)
In order to sustain long-term profitability you must respond strategically to competition, but
do you also look beyond your direct competitors?
The job of the strategist is to understand and cope with competition, but competition is
often defined too narrowly as today’s direct competitors
4 additional competitive forces can hurt your profits:
1. Savvy customers can force down prices by playing you and your rivals against one
another
2. Powerful suppliers may constrain your profits if they charge higher prices
3. Aspiring entrants, armed with new capacity and hungry for market share can ratchet
up the investment required for you to stay in the game
4. Substitute offerings can lure customers away
As different industries can be (cars vs. art), the underlying drivers (5 forces) of profitability
are the same
If the 5 forces are intense (airline, textile, hotel industry), almost no company earns
attractive returns on investment
If the 5 forces are benign (software, soft drinks, toiletries industry), many companies are
profitable
Industry structure set industry profitability in the medium and long run
, The configuration of the 5 forces differs by industry: the strongest competitive forces
determine the profitability of an industry and become the most important to strategy
formulation, but the strongest force is not always obvious
We will analyze the forces from the perspective of an incumbent to understand the
challenges facing a potential entrant
Threat of new entrants
New entrants bring new capacity and a desire to gain market share that puts pressure on
prices, costs and rate of investment necessary to compete
Especially when entrant is diversifying from another market
E.g. Pepsi with water bottles, Microsoft with internet browsers, Apple with music
distribution
Threat of entry depends on height of entry barriers & reaction entrants can expect from
incumbents
Sources of barriers to entry
- Supply-side economies of scale
o Economies that arise when firms produce at larger volumes and enjoy lower
costs per unit because they can spread fixed costs over more units
o Deters entry by forcing the entrant to come into the industry on a large scale
or to accept a cost disadvantage
o Can be found in every activity in the value chain
- Demand-side benefits of scale
o Aka: Network effects, arise when a buyer’s willingness to pay for a product
increases with the number of other buyers who also patronize the company
o Buyers trust larger companies more for a crucial product; buyers value being
in a network with larger number of fellow customers
- Customer switching costs
o Switching costs are fixed costs that buyers face when they change suppliers
(e.g. retrain your employees to use a new product)
o The larger the switching costs, the harder it will be for an entrant to gain
customers
- Capital requirements
o The need to invest large financial resources in order to compete can deter
new entrants
o Barrier is especially great for unrecoverable and harder-to-finance
expenditures (e.g. advertising, R&D)
o This is counterfeited when industry returns are attractive and investors are
willing to provide funds to entrants
- Incumbency advantages independent of size
o Advantages that are not available to entrants like proprietary technology,
access to best raw material sources, most favorable geographic location,
established brand identity etc.
- Unequal access to distribution channels
“The five competitive forces that shape strategy”
by Porter (2008)
In order to sustain long-term profitability you must respond strategically to competition, but
do you also look beyond your direct competitors?
The job of the strategist is to understand and cope with competition, but competition is
often defined too narrowly as today’s direct competitors
4 additional competitive forces can hurt your profits:
1. Savvy customers can force down prices by playing you and your rivals against one
another
2. Powerful suppliers may constrain your profits if they charge higher prices
3. Aspiring entrants, armed with new capacity and hungry for market share can ratchet
up the investment required for you to stay in the game
4. Substitute offerings can lure customers away
As different industries can be (cars vs. art), the underlying drivers (5 forces) of profitability
are the same
If the 5 forces are intense (airline, textile, hotel industry), almost no company earns
attractive returns on investment
If the 5 forces are benign (software, soft drinks, toiletries industry), many companies are
profitable
Industry structure set industry profitability in the medium and long run
, The configuration of the 5 forces differs by industry: the strongest competitive forces
determine the profitability of an industry and become the most important to strategy
formulation, but the strongest force is not always obvious
We will analyze the forces from the perspective of an incumbent to understand the
challenges facing a potential entrant
Threat of new entrants
New entrants bring new capacity and a desire to gain market share that puts pressure on
prices, costs and rate of investment necessary to compete
Especially when entrant is diversifying from another market
E.g. Pepsi with water bottles, Microsoft with internet browsers, Apple with music
distribution
Threat of entry depends on height of entry barriers & reaction entrants can expect from
incumbents
Sources of barriers to entry
- Supply-side economies of scale
o Economies that arise when firms produce at larger volumes and enjoy lower
costs per unit because they can spread fixed costs over more units
o Deters entry by forcing the entrant to come into the industry on a large scale
or to accept a cost disadvantage
o Can be found in every activity in the value chain
- Demand-side benefits of scale
o Aka: Network effects, arise when a buyer’s willingness to pay for a product
increases with the number of other buyers who also patronize the company
o Buyers trust larger companies more for a crucial product; buyers value being
in a network with larger number of fellow customers
- Customer switching costs
o Switching costs are fixed costs that buyers face when they change suppliers
(e.g. retrain your employees to use a new product)
o The larger the switching costs, the harder it will be for an entrant to gain
customers
- Capital requirements
o The need to invest large financial resources in order to compete can deter
new entrants
o Barrier is especially great for unrecoverable and harder-to-finance
expenditures (e.g. advertising, R&D)
o This is counterfeited when industry returns are attractive and investors are
willing to provide funds to entrants
- Incumbency advantages independent of size
o Advantages that are not available to entrants like proprietary technology,
access to best raw material sources, most favorable geographic location,
established brand identity etc.
- Unequal access to distribution channels
