Understanding industry attractiveness

the five forces framework

 Attractiveness beyond growth rates

A turning point: an Industrial Organization (IO)-based theory of
business strategy: Porter 1980, Competitive strategy.
Turns the structuralist paradigm in IO (Structure-Conduct-Performance,
SCP) in a theory of business strategy
A framework for analyzing industry attractiveness

Conduct
Pricing behavior
Product strategy and advertising
Research and innovation
Plant investment
Legal tactics

Performance

Production and allocative efficiency

Progress
Full employment
Equity

Market structure
Number of sellers and buyers
Product differentiation
Barriers to Entry
Cost structures
vertical integration
Conglomerateness

Conduct
Pricing behavior
Product strategy and advertising
Research and innovation
Plant investment
Legal tactics

Basic conditions
Supply
Raw materials
Technology
Unionization
Product durability
Value/weight
Business attitudes
Public policies

Demand
Price elasticity
Substitutes
Rate of growth
Cyclical/seasonal
characteristics
Purchase method
Marketing type

Market structure
Number of sellers and buyers
Product differentiation
Barriers to Entry
Cost structures
vertical integration
Conglomerateness

Porter on strategy
Translating the IO paradigm from the public policy point of view to a
firm perspective
Competition in an industry continually works to drive down the rate of
return on invested capital toward the competitive floor rate of return
The goal of competitive strategy for a business unit in an industry is to
find a position in the industry where the company can best defend itself
against these competitive forces or can influence them in its favor.

Since the collective strength of the forces may well be painfully apparent
to all competitors, the key for developing strategy is to delve below the
surface and analyze the source of each.
Knowledge of those underlying sources of competitive pressure
highlights the critical strengths and weaknesses of the company,
animates its positioning in its industry, clarifies the areas where strategic
changes may yield the greatest payoff, and highlights the areas where
industry trends promise to hold the greatest significance as either
opportunities and threats

Extended rivalry: the five forces

Barriers to entry
The principal weapon: the erection of barriers to entry
Barrier to entry: a cost differential favoring the incumbent firm and
deterring potential entrants

Strategically manipulable sources of barriers to entry?

Economies of scale ; joint costs
Product differentiation
Switching costs
Access to distribution channels
Costs differentials independent of scale (legal protection, location,
experience curves)
Patents
Assets specificity
Government Policy

Strategic behavior and barriers to entry

The strategic problem is well recognized when there are multiple
incumbents
But: the problem is seen only through the lens of a collective action
problem. How could multiple incumbents collude to build the right
amount of barriers to entry?
An investment in entry deterrence protects not only the investor but also
his oligopolistic rivals

Rivalry and barriers

Different sources of barriers are compatible with different patterns of
collective behavior
In the absence of tight collusion, oligopolists have an incentive to divert
their rivalrous behavior to activities that raise entry barriers
E.g. price competition vs. product differentiation

 Problem: in most cases, understanding the strategic nature of barrierbuilding requires a full specification of the game structure and
information available to players (e.g. models of credible entrydeterrence)
Traditional IO gives no cues for this

Barriers to exit work similarly to barriers to entry. Exit barriers limit the ability of a firm
to leave theto
market
and
can exacerbate
rivalry
-barriers
unable to leave
the industry,
a firm
Barriers
exit
work
similarly
to
to
entry.
Exit
barriers
must compete. Some of an industry's entry and exit barriers can be summarized as
follows:of a firm to leave the market and can exacerbate rivalry
ability

Easy to Enter if there is:

Difficult to Enter if there is:

Common technology

Patented or proprietary know-how

Little brand franchise

Difficulty in brand switching

Access to distribution channels

Restricted distribution channels

Low scale threshold

High scale threshold

Easy to Exit if there are:

Difficult to Exit if there are:

Salable assets

Specialized assets

Low exit costs

High exit costs

Independent businesses

Interrelated businesses

DYNAMIC NATURE OF INDUSTRY RIVALRY

Our descriptive and analytic models of industry tend to examine the industry at a
given state. The nature and fascination of business is that it is not static. While we
are prone to generalize, for example, list GM, Ford, and Chrysler as the "Big 3" and

limit the

Substitute products ...

firms in an industry compete also with firms producing substitute products
(e.g. sugar and fructose) (The price of aluminum beverage cans is
constrained by the price of glass bottles, steel cans, and plastic containers. )
Threats:

The relative price of substitute products declines
Substitutes are produced in high profit industry

Consumers switching costs decline
Competitors plan to increase market penetration or production capacity.

Power of Suppliers ...

Powerful suppliers can squeeze profits out of downstream industries..
Threats:

A small number of dominant, highly concentrated suppliers exists.



Few good substitute raw materials or suppliers are available. The
supplied product is a crucial input to buyers business



The industry is not an important customer of the supplier group



Supplied goods are differentiated. The cost of switching raw materials or
suppliers is high.



Credible threats of forward integration by suppliers

Power of Buyers ...

buyers can compete with the industry by forcing down prices, bargaining
for higher quality/more services, play competitors against each other..
Threats:

Buyers are concentrated, or large buying volume

The products being purchased are standard or undifferentiated making it
easy to switch to other suppliers.

Buyers purchases represent a major portion of the sellers total
revenue.

Buyers have full information

Buyers experience low profits

Retailers gain power when they can influence consumers decisions

Intensity of rivalry among existing competitors

Rivalry intensity among competitors increases as:

The number of competitors increases or they become equal in size.

Little or no product differentiation

High fixed costs. Capacity augmented in large increments

Barriers to leaving the industry are high.


Demand for the industrys products declines or industry growth slows.

Understanding shifts in competition patterns:

life cycle effects
acquisitions and new actors entry
innovation

Interactions of entry/exit barriers: