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Class 6: Chapter 3: The Five Forces Learning Objectives

1. To gain command of the basic concepts and analytical tools widely used to diagnose a companys industry and competitive conditions. 2. To become adept in recognizing the factors that cause competitive pressure in an industry to be fierce, more or less normal, or relatively weak. 3. To learn how to determine whether the competitive pressure in its industry presents a firm with sufficiently attractive opportunities for growth and profitability.


Understanding a Companys Situation

Strategy should always be predicated on deep
understanding of two facets of a companys situation:

External: The industry and competitive environment in which the company operates and the forces acting to reshape this environment Internal: The companys market position and competitivenessits resources and capabilities, its strengths and weaknesses vis--vis rivals, and its windows of opportunity.


Think Strategically About Your Industry and Competitive Environment

Chapter 3 Roadmap

Question 1: What kinds of competitive forces are industry members facing, and how strong is each force individually and are all collectively?
Question 2: what forces are driving industry change and what impacts will they have? Question 3: what market positions do rivals occupywho is strongly positioned and who is not? Question 4: what strategic moves are rivals likely to make next? Question 5: what are the key factors for future competitive success? Question 6: does the outlook for the industry present the company with sufficiently attractive prospects for profitability?


Figure 3.2 The Components of a Companys External Environment


Question 1: What Kinds of Competitive Forces Are Industry Members Facing?

The strength or weakness of competition in an industry is a function of five types of competitive pressures:
1. The market maneuvering and jockeying that goes on among rival sellers. 2. The threat of new entrants into the market. 3. The actions of firms in other industries to win buyers over to their substitute products. 4. The bargaining power exercised by suppliers 5. The bargaining power exercised by buyers

Figure 3.3 The Five-Forces Model of Competition: A Key Analytical Tool


Rivalry Is Usually the Strongest of the Five Competitive Forces

A market is a competitive battlefield where the
contest among industry rivals is ongoing and dynamic.

Each competing company is motivated to employ whatever weapons in its business arsenal it believes will attract and retain buyers, strengthen its market position, and yield good profits. The challenge is to craft a competitive strategy that, at least, allows a company to hold its own against rivals and that, better, will produce a competitive edge over rivals.

Weapons Companies Can Use to Attract

Buyers and Outmaneuver Rivals

Lower prices More or different features Better product performance Higher quality Stronger brand name and image Wider selection of models and styles Bigger/better dealer network

Low interest rate financing Higher levels of advertising Stronger product innovation capabilities Better customer-service capabilities Stronger capabilities to provide buyers with custom-made products Better warranty coverage Quicker or cheaper delivery

Figure 3.2

Factors Affecting the Competitive Pressure Arising from Rivalry in Industry

Figure 3.4


Characterizing Industry Rivalry

Cutthroat or Brutal Fierce to Strong Moderate or Normal
When competitors engage in protracted price wars or habitually undertake other aggressive strategic moves that prove mutually destructive to profitability. When the battle for market share is so vigorous that the profit margins of most industry members are squeezed to bare-bones levels. When the maneuvering among industry members, while lively and healthy, still allows most industry members to earn acceptable profits. When most companies in the industry are relatively well satisfied with their sales growth and market shares, rarely undertake offensives to steal customers away from one another, andbecause of weak competitive forcesearn consistently good profits and returns on investment.


Factors Affecting Competitive Pressures Associated the Threat of Entry

Figure 3.5


Common Barriers to Entry

Cost advantages enjoyed by industry incumbents Strong brand preferences and high degrees of customer
loyalty High capital requirements for market entry The difficulties of building a network of distributors or retailers and securing space on retailers shelves. Restrictive regulatory policies that limit/bar new entrants Tariffs and international trade restrictions The ability and willingness of industry incumbents to launch strong maneuvers to combat a newcomers efforts to secure a profitable volume of sales

The Cost Advantages of Incumbents: An Important Entry Barrier

1. Scale economies in production, distribution, or other activities 2. Learning-based costs savings from experience in performing certain activities such as manufacturing or new product development or inventory management 3. Cost-savings accruing from patents or proprietary technology 4. Partnerships with the best and cheapest suppliers of raw materials and components 5. Favorable locations 6. Lower cost to retain customer compared to gain/take customer 7. Low fixed costs (because incumbents have older facilities that have been mostly depreciated)


Competitive Pressures from the Sellers of Substitute Products

Substitutes: When customers replace your
products with the products from other industries to satisfy their needs.

Examples Cell phones versus phones that use land lines Movie theaters versus Netflix Music CDs versus digital music players (iPods)
The lower the price of substitutes, the higher their quality and performanceand the lower the users switching costs, the more intense the competitive pressures posed by substitute products.

Important Point

Factors Affecting Competitive Pressures from Substitute Products



Competitive Pressures Stemming from the Bargaining Power of Suppliers

Whether the relationships between industry
members and their suppliers represent a weak, moderate, or strong competitive force depends on the degree to which suppliers can influence the terms and conditions of supply in their favor. Powerful or influential suppliers can create competitive pressures because of their ability to charge industry members higher prices and/or make it difficult or costly for industry members to switch to other suppliers.

Factors Affecting Competitive Pressure from the Bargaining Power of Suppliers

Figure 3.7

Competitive Pressures Stemming from the Bargaining Power of Buyers

Buyers can exert strong competitive pressures
on industry members when:

Some or many buyers have sufficient bargaining leverage to obtain price concessions and other favorable terms and conditions of sale. Many buyers are price sensitive and have the power, if they act in unison, to place limits on the prices that industry members can charge.
Not all buyers of an industrys product have equal degrees of bargaining power with sellers, and some may be less sensitive than others to price, quality, or service differences.

Important Point

Factors Affecting Competitive Pressure From the Bargaining Power of Buyers

Figure 3.8

Is the Collective Strength of the Five Competitive Forces Conducive or Not to Good Profitability?
The stronger the collective impact of the five forces, the lower
the combined profitability of industry participants.

Worst case scenarioAn industry is competitively unattractive and less profitable when: Rivalry among industry members is vigorous. Entry barriers are low, making entry likely. Competition from the producers of substitute products is strong. Both suppliers and customers have considerable bargaining power.

An industry is competitively attractive when industry members can

expect to earn good profits and a good return on investment. Best case scenarioAn industry is competitively attractive and more profitable when: Internal rivalry in the industry is weak to moderate High barriers block new entrants from the market Good substitutes do not exist Both suppliers and customers are in weak bargaining positions

How to Analyze Your Industry Using the Five Competitive Forces

Step 1
Identify the specific competitive pressures associated with each of the five forces. Evaluate how strong the pressures comprising each of the five forces are (fierce, strong, moderate to normal, or weak). Determine whether the collective strength of the five competitive forces is conducive to earning attractive profits.

Step 2

Step 3

Effectively matching a firms strategy to competitive conditions requires pursuing strategies that shield the firm from as many different competitive pressures as possible.

Team Exercise

Prepare Your Decisions for the First

Practice Round