Porter's Five Forces - Harvard Business Review

by Michael E. Porter

Awareness of the five forces can help a company understand the
structure of its industry and stake out a position that is more profitable
and less vulnerable to attack.

Editor’s Note:
In 1979,
Harvard Business Review
published “How Competitive Forces Shape Strategy”
by a young economist and associate professor,
Michael E. Porter. It was his first HBR article,
and it started a revolution in the strategy field. In
subsequent decades, Porter has brought his signature
economic rigor to the study of competitive
strategy for corporations, regions, nations,
and, more recently, health care and philanthropy.
“Porter’s five forces” have shaped a generation of
academic research and business practice. With
prodding and assistance from Harvard Business
School Professor Jan Rivkin and longtime colleague
Joan Magretta, Porter here reaffirms, updates,
and extends the classic work. He also addresses
common misunderstandings, provides
practical guidance for users of the framework,
and offers a deeper view of its implications for
strategy today.
In essence, the job of the strategist is to understand
and cope with competition. Often, however,
managers define competition too narrowly,
as if it occurred only among today’s
direct competitors. Yet competition for profits
goes beyond established industry rivals to include
four other competitive forces as well:
customers, suppliers, potential entrants, and
substitute products. The extended rivalry that
results from all five forces defines an industry’s
structure and shapes the nature of competitive
interaction within an industry.
As different from one another as industries
might appear on the surface, the underlying
drivers of profitability are the same. The global
auto industry, for instance, appears to
have nothing in common with the worldwide
market for art masterpieces or the heavily
regulated health-care delivery industry in Europe.
But to understand industry competition
and profitability in each of those three cases,
one must analyze the industry’s underlying
structure in terms of the five forces. (See the
exhibit “The Five Forces That Shape Industry
Competition.”)
If the forces are intense, as they are in such
industries as airlines, textiles, and hotels, almost
no company earns attractive returns on


investment. If the forces are benign, as they are
in industries such as software, soft drinks, and
toiletries, many companies are profitable. Industry
structure drives competition and profitability,
not whether an industry produces a
product or service, is emerging or mature, high
tech or low tech, regulated or unregulated.
While a myriad of factors can affect industry
profitability in the short run—including the
weather and the business cycle—industry
structure, manifested in the competitive forces,
sets industry profitability in the medium and
long run. (See the exhibit “Differences in Industry
Profitability.”)
Understanding the competitive forces, and
their underlying causes, reveals the roots of an
industry’s current profitability while providing
a framework for anticipating and influencing
competition (and profitability) over time. A
healthy industry structure should be as much a
competitive concern to strategists as their company’s
own position. Understanding industry
structure is also essential to effective strategic
positioning. As we will see, defending against
the competitive forces and shaping them in a
company’s favor are crucial to strategy.
Forces That Shape Competition
The configuration of the five forces differs by
industry. In the market for commercial aircraft,
fierce rivalry between dominant producers
Airbus and Boeing and the bargaining
power of the airlines that place huge orders
for aircraft are strong, while the threat of entry,
the threat of substitutes, and the power of
suppliers are more benign. In the movie theater
industry, the proliferation of substitute
forms of entertainment and the power of the
movie producers and distributors who supply
movies, the critical input, are important.
The strongest competitive force or forces determine
the profitability of an industry and become
the most important to strategy formulation.
The most salient force, however, is not
always obvious.
For example, even though rivalry is often
fierce in commodity industries, it may not be
the factor limiting profitability. Low returns in
the photographic film industry, for instance,
are the result of a superior substitute product—
as Kodak and Fuji, the world’s leading
producers of photographic film, learned with
the advent of digital photography. In such a situation,
coping with the substitute product becomes
the number one strategic priority.
Industry structure grows out of a set of economic
and technical characteristics that determine
the strength of each competitive force.
We will examine these drivers in the pages that
follow, taking the perspective of an incumbent,
or a company already present in the industry.
The analysis can be readily extended to understand
the challenges facing a potential entrant.
Threat of entry.
New entrants to an industry
bring new capacity and a desire to gain
market share that puts pressure on prices,
costs, and the rate of investment necessary to
compete. Particularly when new entrants are
diversifying from other markets, they can leverage
existing capabilities and cash flows to
shake up competition, as Pepsi did when it entered
the bottled water industry, Microsoft did
when it began to offer internet browsers, and
Apple did when it entered the music distribution
business.
The threat of entry, therefore, puts a cap on
the profit potential of an industry. When the
threat is high, incumbents must hold down
their prices or boost investment to deter new
competitors. In specialty coffee retailing, for
example, relatively low entry barriers mean
that Starbucks must invest aggressively in
modernizing stores and menus.
The threat of entry in an industry depends
on the height of entry barriers that are present
and on the reaction entrants can expect from
incumbents. If entry barriers are low and newcomers
expect little retaliation from the entrenched
competitors, the threat of entry is
high and industry profitability is moderated. It
is the
threat
of entry, not whether entry actually
occurs, that holds down profitability.
Barriers to entry.
Entry barriers are advantages
that incumbents have relative to new entrants.
There are seven major sources:
1.
Supply-side economies of scale.
These economies
arise when firms that produce at larger
volumes enjoy lower costs per unit because
they can spread fixed costs over more units,
employ more efficient technology, or command
better terms from suppliers. Supplyside
scale economies deter entry by forcing
the aspiring entrant either to come into the
industry on a large scale, which requires dislodging
entrenched competitors, or to accept
a cost disadvantage.
Scale economies can be found in virtually
every activity in the value chain; which ones
Michael E. Porter
is the Bishop William
Lawrence University Professor at
Harvard University, based at Harvard
Business School in Boston. He is a sixtime
McKinsey Award winner, including
for his most recent HBR article,
“Strategy and Society,” coauthored
with Mark R. Kramer (December 2006).

page 4
are most important varies by industry.
1
In microprocessors,
incumbents such as Intel are
protected by scale economies in research, chip
fabrication, and consumer marketing. For lawn
care companies like Scotts Miracle-Gro, the
most important scale economies are found in
the supply chain and media advertising. In
small-package delivery, economies of scale
arise in national logistical systems and information
technology.
2.
Demand-side benefits of scale.
These benefits,
also known as network effects, arise in industries
where a buyer’s willingness to pay for
a company’s product increases with the number
of other buyers who also patronize the
company. Buyers may trust larger companies
more for a crucial product: Recall the old
adage that no one ever got fired for buying
from IBM (when it was the dominant computer
maker). Buyers may also value being in a
“network” with a larger number of fellow customers.
For instance, online auction participants
are attracted to eBay because it offers
the most potential trading partners. Demandside
benefits of scale discourage entry by limiting
the willingness of customers to buy from a
newcomer and by reducing the price the newcomer
can command until it builds up a large
base of customers.

Customer switching costs.
Switching costs
are fixed costs that buyers face when they
change suppliers. Such costs may arise because
a buyer who switches vendors must, for example,
alter product specifications, retrain employees
to use a new product, or modify processes
or information systems. The larger the
switching costs, the harder it will be for an entrant
to gain customers. Enterprise resource
planning (ERP) software is an example of a
product with very high switching costs. Once a
company has installed SAP’s ERP system, for
example, the costs of moving to a new vendor
are astronomical because of embedded data,
the fact that internal processes have been
adapted to SAP, major retraining needs, and
the mission-critical nature of the applications.
4.
Capital requirements.
The need to invest
large financial resources in order to compete
can deter new entrants. Capital may be necessary
not only for fixed facilities but also to extend
customer credit, build inventories, and
fund start-up losses. The barrier is particularly
great if the capital is required for unrecoverable
and therefore harder-to-finance expenditures,
such as up-front advertising or research
and development. While major corporations
have the financial resources to invade almost
any industry, the huge capital requirements in
certain fields limit the pool of likely entrants.
Conversely, in such fields as tax preparation
services or short-haul trucking, capital requirements
are minimal and potential entrants
plentiful.
It is important not to overstate the degree to
which capital requirements alone deter entry.
If industry returns are attractive and are expected
to remain so, and if capital markets are
efficient, investors will provide entrants with
the funds they need. For aspiring air carriers,
for instance, financing is available to purchase
expensive aircraft because of their high resale
value, one reason why there have been numerous
new airlines in almost every region.
5.
Incumbency advantages independent of
size.
No matter what their size, incumbents
may have cost or quality advantages not available
to potential rivals. These advantages can
stem from such sources as proprietary technology,
preferential access to the best raw material
sources, preemption of the most favorable
geographic locations, established brand identities,
or cumulative experience that has allowed
incumbents to learn how to produce more efficiently.
Entrants try to bypass such advantages.
Upstart discounters such as Target and Wal-
The Five Forces That Shape Industry Competition
Bargaining
Power of
Suppliers
Threat
of New
Entrants
Bargaining
Power of
Buyers
Threat of
Substitute
Products or
Services
Rivalry
Among
Existing
Competitors

Mart, for example, have located stores in freestanding
sites rather than regional shopping
centers where established department stores
were well entrenched.
6.
Unequal access to distribution channels.
The new entrant must, of course, secure distribution
of its product or service. A new food
item, for example, must displace others from
the supermarket shelf via price breaks, promotions,
intense selling efforts, or some other
means. The more limited the wholesale or retail
channels are and the more that existing
competitors have tied them up, the tougher
entry into an industry will be. Sometimes access
to distribution is so high a barrier that new
entrants must bypass distribution channels altogether
or create their own. Thus, upstart
low-cost airlines have avoided distribution
through travel agents (who tend to favor established
higher-fare carriers) and have encouraged
passengers to book their own flights on
the internet.
7.
Restrictive government policy.
Government
policy can hinder or aid new entry directly, as
well as amplify (or nullify) the other entry barriers.
Government directly limits or even forecloses
entry into industries through, for instance,
licensing requirements and restrictions
on foreign investment. Regulated industries
like liquor retailing, taxi services, and airlines
are visible examples. Government policy can
heighten other entry barriers through such
means as expansive patenting rules that protect
proprietary technology from imitation or
environmental or safety regulations that raise
scale economies facing newcomers. Of course,
government policies may also make entry easier—
directly through subsidies, for instance, or
Differences in Industry Profitability
The average return on invested capital varies markedly from industry to industry. Between 1992 and 2006, for example, average return on invested
capital in U.S. industries ranged as low as zero or even negative to more than 50%. At the high end are industries like soft drinks and prepackaged
software, which have been almost six times more profitable than the airline industry over the period.
Profitability of Selected U.S. Industries
Average ROIC, 1992–2006
Number of Industries
ROIC
0% 5% 10% 15% 20% 25% 30% 35%
40
50
30
20
10
0
10th percentile
7.0%
25th
percentile
10.9%
Median:
14.3%
75th percentile
18.6%
90th percentile
25.3%
or lower or higher
Average Return on Invested Capital
in U.S. Industries, 1992–2006
Security Brokers and Dealers
Soft Drinks
Prepackaged Software
Pharmaceuticals
Perfume, Cosmetics, Toiletries
Advertising Agencies
Distilled Spirits
Semiconductors
Medical Instruments
Men’s and Boys’ Clothing
Tires
Household Appliances
Malt Beverages
Child Day Care Services
Household Furniture
Drug Stores
Grocery Stores
Iron and Steel Foundries
Cookies and Crackers
Mobile Homes
Wine and Brandy
Bakery Products
Engines and Turbines
Book Publishing
Laboratory Equipment
Oil and Gas Machinery
Soft Drink Bottling
Knitting Mills
Hotels
Catalog, Mail-Order Houses
Airlines
Return on invested capital (ROIC) is the appropriate measure
of profitability for strategy formulation, not to mention for equity
investors. Return on sales or the growth rate of profits fail to
account for the capital required to compete in the industry. Here,
we utilize earnings before interest and taxes divided by average
invested capital less excess cash as the measure of ROIC. This
measure controls for idiosyncratic differences in capital structure
and tax rates across companies and industries.
Source: Standard & Poor’s, Compustat, and author’s calculations
Average industry
ROIC in the U.S.
14.9%
40.9%
37.6%
37.6%
31.7%
28.6%
27.3%
26.4%
21.3%
21.0%
19.5%
19.5%
19.2%
19.0%
17.6%
17.0%
16.5%
16.0%
15.6%
15.4%
15.0%
13.9%
13.8%
13.7%
13.4%
13.4%
12.6%
11.7%
10.5%
10.4%
5
5.9%
.9%

page 6
indirectly by funding basic research and making
it available to all firms, new and old, reducing
scale economies.
Entry barriers should be assessed relative to
the capabilities of potential entrants, which
may be start-ups, foreign firms, or companies
in related industries. And, as some of our examples
illustrate, the strategist must be mindful
of the creative ways newcomers might find
to circumvent apparent barriers.
Expected retaliation.
How potential entrants
believe incumbents may react will also influence
their decision to enter or stay out of an
industry. If reaction is vigorous and protracted
enough, the profit potential of participating in
the industry can fall below the cost of capital.
Incumbents often use public statements and
responses to one entrant to send a message to
other prospective entrants about their commitment
to defending market share.
Newcomers are likely to fear expected retaliation
if:
• Incumbents have previously responded
vigorously to new entrants.
• Incumbents possess substantial resources
to fight back, including excess cash and unused
borrowing power, available productive capacity,
or clout with distribution channels and customers.
• Incumbents seem likely to cut prices because
they are committed to retaining market
share at all costs or because the industry has
high fixed costs, which create a strong motivation
to drop prices to fill excess capacity.
• Industry growth is slow so newcomers can
gain volume only by taking it from incumbents.
An analysis of barriers to entry and expected
retaliation is obviously crucial for any company
contemplating entry into a new industry.
The challenge is to find ways to surmount the
entry barriers without nullifying, through
heavy investment, the profitability of participating
in the industry.
The power of suppliers.
Powerful suppliers
capture more of the value for themselves by
charging higher prices, limiting quality or services,
or shifting costs to industry participants.
Powerful suppliers, including suppliers of labor,
can squeeze profitability out of an industry
that is unable to pass on cost increases in
its own prices. Microsoft, for instance, has contributed
to the erosion of profitability among
personal computer makers by raising prices on
operating systems. PC makers, competing
fiercely for customers who can easily switch
among them, have limited freedom to raise
their prices accordingly.
Companies depend on a wide range of different
supplier groups for inputs. A supplier
group is powerful if:
• It is more concentrated than the industry it
sells to. Microsoft’s near monopoly in operating
systems, coupled with the fragmentation of PC
assemblers, exemplifies this situation.
• The supplier group does not depend
heavily on the industry for its revenues. Suppliers
serving many industries will not hesitate to
Industry Analysis in Practice
Good industry analysis looks rigorously
at the structural underpinnings
of profitability. A first step is to understand
the appropriate time horizon.
One of the essential tasks in industry
analysis is to distinguish temporary or
cyclical changes from structural
changes. A good guideline for the appropriate
time horizon is the full business
cycle for the particular industry. For
most industries, a three-to-five-year horizon
is appropriate, although in some industries
with long lead times, such as
mining, the appropriate horizon might
be a decade or more. It is average profitability
over this period, not profitability
in any particular year, that should be the
focus of analysis.
The point of industry analysis is not
to declare the industry attractive or unattractive
but to understand the underpinnings
of competition and the root
causes of profitability.
As much as possible,
analysts should look at industry
structure quantitatively, rather than be
satisfied with lists of qualitative factors.
Many elements of the five forces can be
quantified: the percentage of the buyer’s
total cost accounted for by the industry’s
product (to understand buyer price sensitivity);
the percentage of industry sales
required to fill a plant or operate a logistical
network of efficient scale (to help assess
barriers to entry); the buyer’s switching
cost (determining the inducement an
entrant or rival must offer customers).
The strength of the competitive
forces affects prices, costs, and the investment
required to compete; thus
the forces are directly tied to the income
statements and balance sheets of
industry participants.
Industry structure
defines the gap between revenues
and costs. For example, intense rivalry
drives down prices or elevates the costs of
marketing, R&D, or customer service, reducing
margins. How much? Strong suppliers
drive up input costs. How much?
Buyer power lowers prices or elevates the
costs of meeting buyers’ demands, such
as the requirement to hold more inventory
or provide financing. How much?
Low barriers to entry or close substitutes
limit the level of sustainable prices. How
much? It is these economic relationships
that sharpen the strategist’s understanding
of industry competition.
Finally, good industry analysis does
not just list pluses and minuses but
sees an industry in overall, systemic
terms.
Which forces are underpinning
(or constraining) today’s profitability?
How might shifts in one competitive
force trigger reactions in others? Answering
such questions is often the source of
true strategic insights.

page 7
extract maximum profits from each one. If a
particular industry accounts for a large portion
of a supplier group’s volume or profit, however,
suppliers will want to protect the industry
through reasonable pricing and assist in activities
such as R&D and lobbying.
• Industry participants face switching costs
in changing suppliers. For example, shifting
suppliers is difficult if companies have invested
heavily in specialized ancillary equipment or in
learning how to operate a supplier’s equipment
(as with Bloomberg terminals used by financial
professionals). Or firms may have located their
production lines adjacent to a supplier’s manufacturing
facilities (as in the case of some beverage
companies and container manufacturers).
When switching costs are high, industry participants
find it hard to play suppliers off against
one another. (Note that suppliers may have
switching costs as well. This limits their power.)
• Suppliers offer products that are differentiated.
Pharmaceutical companies that offer
patented drugs with distinctive medical benefits
have more power over hospitals, health
maintenance organizations, and other drug
buyers, for example, than drug companies offering
me-too or generic products.
• There is no substitute for what the supplier
group provides. Pilots’ unions, for example,
exercise considerable supplier power over
airlines partly because there is no good alternative
to a well-trained pilot in the cockpit.
• The supplier group can credibly threaten
to integrate forward into the industry. In that
case, if industry participants make too much
money relative to suppliers, they will induce
suppliers to enter the market.
The power of buyers.
Powerful customers—
the flip side of powerful suppliers—can capture
more value by forcing down prices, demanding
better quality or more service (thereby
driving up costs), and generally playing industry
participants off against one another, all at the expense
of industry profitability. Buyers are powerful
if they have negotiating leverage relative to
industry participants, especially if they are price
sensitive, using their clout primarily to pressure
price reductions.
As with suppliers, there may be distinct
groups of customers who differ in bargaining
power. A customer group has negotiating leverage
if:
• There are few buyers, or each one purchases
in volumes that are large relative to the
size of a single vendor. Large-volume buyers are
particularly powerful in industries with high
fixed costs, such as telecommunications equipment,
offshore drilling, and bulk chemicals.
High fixed costs and low marginal costs amplify
the pressure on rivals to keep capacity filled
through discounting.
• The industry’s products are standardized
or undifferentiated. If buyers believe they can
always find an equivalent product, they tend to
play one vendor against another.
• Buyers face few switching costs in changing
vendors.
• Buyers can credibly threaten to integrate
backward and produce the industry’s product
themselves if vendors are too profitable. Producers
of soft drinks and beer have long controlled
the power of packaging manufacturers
by threatening to make, and at times actually
making, packaging materials themselves.
A buyer group is price sensitive if:
• The product it purchases from the industry
represents a significant fraction of its cost
structure or procurement budget. Here buyers
are likely to shop around and bargain hard, as
consumers do for home mortgages. Where the
product sold by an industry is a small fraction
of buyers’ costs or expenditures, buyers are usually
less price sensitive.
• The buyer group earns low profits, is
strapped for cash, or is otherwise under pressure
to trim its purchasing costs. Highly profitable
or cash-rich customers, in contrast, are
generally less price sensitive (that is, of course,
if the item does not represent a large fraction of
their costs).
• The quality of buyers’ products or services
is little affected by the industry’s product.
Where quality is very much affected by the industry’s
product, buyers are generally less price
sensitive. When purchasing or renting production
quality cameras, for instance, makers of
major motion pictures opt for highly reliable
equipment with the latest features. They pay
limited attention to price.
• The industry’s product has little effect on
the buyer’s other costs. Here, buyers focus on
price. Conversely, where an industry’s product
or service can pay for itself many times over by
improving performance or reducing labor, material,
or other costs, buyers are usually more
interested in quality than in price. Examples include
products and services like tax accounting
or well logging (which measures below-ground
Industry structure drives
competition and
profitability, not whether
an industry is emerging
or mature, high tech or
low tech, regulated or
unregulated.

page 8
conditions of oil wells) that can save or even
make the buyer money. Similarly, buyers tend
not to be price sensitive in services such as investment
banking, where poor performance
can be costly and embarrassing.
Most sources of buyer power apply equally
to consumers and to business-to-business customers.
Like industrial customers, consumers
tend to be more price sensitive if they are purchasing
products that are undifferentiated, expensive
relative to their incomes, and of a sort
where product performance has limited consequences.
The major difference with consumers
is that their needs can be more intangible
and harder to quantify.
Intermediate customers, or customers who
purchase the product but are not the end user
(such as assemblers or distribution channels),
can be analyzed the same way as other buyers,
with one important addition. Intermediate
customers gain significant bargaining power
when they can influence the purchasing decisions
of customers downstream. Consumer
electronics retailers, jewelry retailers, and agricultural-
equipment distributors are examples
of distribution channels that exert a strong influence
on end customers.
Producers often attempt to diminish channel
clout through exclusive arrangements with
particular distributors or retailers or by marketing
directly to end users. Component manufacturers
seek to develop power over assemblers
by creating preferences for their
components with downstream customers.
Such is the case with bicycle parts and with
sweeteners. DuPont has created enormous
clout by advertising its Stainmaster brand of
carpet fibers not only to the carpet manufacturers
that actually buy them but also to downstream
consumers. Many consumers request
Stainmaster carpet even though DuPont is not
a carpet manufacturer.
The threat of substitutes.
A substitute performs
the same or a similar function as an industry’s
product by a different means. Videoconferencing
is a substitute for travel. Plastic is
a substitute for aluminum. E-mail is a substitute
for express mail. Sometimes, the threat of
substitution is downstream or indirect, when a
substitute replaces a buyer industry’s product.
For example, lawn-care products and services
are threatened when multifamily homes in
urban areas substitute for single-family homes
in the suburbs. Software sold to agents is
threatened when airline and travel websites
substitute for travel agents.
Substitutes are always present, but they are
easy to overlook because they may appear to
be very different from the industry’s product:
To someone searching for a Father’s Day gift,
neckties and power tools may be substitutes. It
is a substitute to do without, to purchase a
used product rather than a new one, or to do it
yourself (bring the service or product inhouse).
When the threat of substitutes is high, industry
profitability suffers. Substitute products or
services limit an industry’s profit potential by
placing a ceiling on prices. If an industry does
not distance itself from substitutes through
product performance, marketing, or other
means, it will suffer in terms of profitability—
and often growth potential.
Substitutes not only limit profits in normal
times, they also reduce the bonanza an industry
can reap in good times. In emerging economies,
for example, the surge in demand for
wired telephone lines has been capped as
many consumers opt to make a mobile telephone
their first and only phone line.
The threat of a substitute is high if:
• It offers an attractive price-performance
trade-off to the industry’s product. The better
the relative value of the substitute, the tighter
is the lid on an industry’s profit potential. For
example, conventional providers of long-distance
telephone service have suffered from the
advent of inexpensive internet-based phone
services such as Vonage and Skype. Similarly,
video rental outlets are struggling with the
emergence of cable and satellite video-on-demand
services, online video rental services such
as Netflix, and the rise of internet video sites
like Google’s YouTube.
• The buyer’s cost of switching to the substitute
is low. Switching from a proprietary,
branded drug to a generic drug usually involves
minimal costs, for example, which is why the
shift to generics (and the fall in prices) is so substantial
and rapid.
Strategists should be particularly alert to
changes in other industries that may make
them attractive substitutes when they were not
before. Improvements in plastic materials, for
example, allowed them to substitute for steel
in many automobile components. In this way,
technological changes or competitive discontinuities
in seemingly unrelated businesses can

page 9
have major impacts on industry profitability.
Of course the substitution threat can also shift
in favor of an industry, which bodes well for its
future profitability and growth potential.
Rivalry among existing competitors.
Rivalry
among existing competitors takes many familiar
forms, including price discounting, new
product introductions, advertising campaigns,
and service improvements. High rivalry limits
the profitability of an industry. The degree to
which rivalry drives down an industry’s profit
potential depends, first, on the
intensity
with
which companies compete and, second, on the
basis
on which they compete.
The intensity of rivalry is greatest if:
• Competitors are numerous or are roughly
equal in size and power. In such situations, rivals
find it hard to avoid poaching business.
Without an industry leader, practices desirable
for the industry as a whole go unenforced.
• Industry growth is slow. Slow growth precipitates
fights for market share.
• Exit barriers are high. Exit barriers, the flip
side of entry barriers, arise because of such
things as highly specialized assets or management’s
devotion to a particular business. These
barriers keep companies in the market even
though they may be earning low or negative returns.
Excess capacity remains in use, and the
profitability of healthy competitors suffers as
the sick ones hang on.
• Rivals are highly committed to the business
and have aspirations for leadership, especially
if they have goals that go beyond economic
performance in the particular industry.
High commitment to a business arises for a variety
of reasons. For example, state-owned competitors
may have goals that include employment
or prestige. Units of larger companies
may participate in an industry for image reasons
or to offer a full line. Clashes of personality
and ego have sometimes exaggerated rivalry to
the detriment of profitability in fields such as
the media and high technology.
• Firms cannot read each other’s signals well
because of lack of familiarity with one another,
diverse approaches to competing, or differing
goals.
The strength of rivalry reflects not just the
intensity of competition but also the basis of
competition. The
dimensions
on which competition
takes place, and whether rivals converge
to compete on the
same dimensions
, have a
major influence on profitability.
Rivalry is especially destructive to profitability
if it gravitates solely to price because price
competition transfers profits directly from an
industry to its customers. Price cuts are usually
easy for competitors to see and match, making
successive rounds of retaliation likely. Sustained
price competition also trains customers
to pay less attention to product features and
service.
Price competition is most liable to occur if:
• Products or services of rivals are nearly
identical and there are few switching costs for
buyers. This encourages competitors to cut
prices to win new customers. Years of airline
price wars reflect these circumstances in that
industry.
• Fixed costs are high and marginal costs are
low. This creates intense pressure for competitors
to cut prices below their average costs,
even close to their marginal costs, to steal incremental
customers while still making some contribution
to covering fixed costs. Many basicmaterials
businesses, such as paper and aluminum,
suffer from this problem, especially if demand
is not growing. So do delivery companies
with fixed networks of routes that must be
served regardless of volume.
• Capacity must be expanded in large increments
to be efficient. The need for large capacity
expansions, as in the polyvinyl chloride business,
disrupts the industry’s supply-demand
balance and often leads to long and recurring
periods of overcapacity and price cutting.
• The product is perishable. Perishability
creates a strong temptation to cut prices and
sell a product while it still has value. More products
and services are perishable than is commonly
thought. Just as tomatoes are perishable
because they rot, models of computers are perishable
because they soon become obsolete,
and information may be perishable if it diffuses
rapidly or becomes outdated, thereby losing its
value. Services such as hotel accommodations
are perishable in the sense that unused capacity
can never be recovered.
Competition on dimensions other than
price—on product features, support services,
delivery time, or brand image, for instance—is
less likely to erode profitability because it improves
customer value and can support higher
prices. Also, rivalry focused on such dimensions
can improve value relative to substitutes
or raise the barriers facing new entrants. While
nonprice rivalry sometimes escalates to levels
Rivalry is especially
destructive to
profitability if it
gravitates solely to price
because price
competition transfers
profits directly from an
industry to its customers.

page 10
that undermine industry profitability, this is
less likely to occur than it is with price rivalry.
As important as the dimensions of rivalry is
whether rivals compete on the
same
dimensions.
When all or many competitors aim to
meet the same needs or compete on the same
attributes, the result is zero-sum competition.
Here, one firm’s gain is often another’s loss,
driving down profitability. While price competition
runs a stronger risk than nonprice competition
of becoming zero sum, this may not
happen if companies take care to segment
their markets, targeting their low-price offerings
to different customers.
Rivalry can be positive sum, or actually increase
the average profitability of an industry,
when each competitor aims to serve the needs
of different customer segments, with different
mixes of price, products, services, features, or
brand identities. Such competition can not
only support higher average profitability but
also expand the industry, as the needs of more
customer groups are better met. The opportunity
for positive-sum competition will be
greater in industries serving diverse customer
groups. With a clear understanding of the
structural underpinnings of rivalry, strategists
can sometimes take steps to shift the nature of
competition in a more positive direction.
Factors, Not Forces
Industry structure, as manifested in the
strength of the five competitive forces, determines
the industry’s long-run profit potential
because it determines how the economic
value created by the industry is divided—how
much is retained by companies in the industry
versus bargained away by customers and suppliers,
limited by substitutes, or constrained by
potential new entrants. By considering all five
forces, a strategist keeps overall structure in
mind instead of gravitating to any one element.
In addition, the strategist’s attention remains
focused on structural conditions rather
than on fleeting factors.
It is especially important to avoid the common
pitfall of mistaking certain visible attributes
of an industry for its underlying structure.
Consider the following:
Industry growth rate.
A common mistake is
to assume that fast-growing industries are always
attractive. Growth does tend to mute rivalry,
because an expanding pie offers opportunities
for all competitors. But fast growth
can put suppliers in a powerful position, and
high growth with low entry barriers will draw
in entrants. Even without new entrants, a high
growth rate will not guarantee profitability if
customers are powerful or substitutes are attractive.
Indeed, some fast-growth businesses,
such as personal computers, have been among
the least profitable industries in recent years.
A narrow focus on growth is one of the major
causes of bad strategy decisions.
Technology and innovation.
Advanced technology
or innovations are not by themselves
enough to make an industry structurally attractive
(or unattractive). Mundane, low-technology
industries with price-insensitive buyers,
high switching costs, or high entry barriers
arising from scale economies are often far
more profitable than sexy industries, such as
software and internet technologies, that attract
competitors.
2
Government.
Government is not best understood
as a sixth force because government
involvement is neither inherently good nor
bad for industry profitability. The best way to
understand the influence of government on
competition is to analyze how specific government
policies affect the five competitive
forces. For instance, patents raise barriers to
entry, boosting industry profit potential. Conversely,
government policies favoring unions
may raise supplier power and diminish profit
potential. Bankruptcy rules that allow failing
companies to reorganize rather than exit can
lead to excess capacity and intense rivalry.
Government operates at multiple levels and
through many different policies, each of
which will affect structure in different ways.
Complementary products and services.
Complements are products or services used together
with an industry’s product. Complements
arise when the customer benefit of two
products combined is greater than the sum of
each product’s value in isolation. Computer
hardware and software, for instance, are valuable
together and worthless when separated.
In recent years, strategy researchers have
highlighted the role of complements, especially
in high-technology industries where they
are most obvious.
3
By no means, however, do
complements appear only there. The value of a
car, for example, is greater when the driver also
has access to gasoline stations, roadside assistance,
and auto insurance.
Complements can be important when they

page 11
affect the overall demand for an industry’s
product. However, like government policy,
complements are not a sixth force determining
industry profitability since the presence of
strong complements is not necessarily bad (or
good) for industry profitability. Complements
affect profitability through the way they influence
the five forces.
The strategist must trace the positive or negative
influence of complements on all five
forces to ascertain their impact on profitability.
The presence of complements can raise or
lower barriers to entry. In application software,
for example, barriers to entry were lowered
when producers of complementary operating
system software, notably Microsoft, provided
tool sets making it easier to write applications.
Conversely, the need to attract producers of
complements can raise barriers to entry, as it
does in video game hardware.
The presence of complements can also affect
the threat of substitutes. For instance, the need
for appropriate fueling stations makes it difficult
for cars using alternative fuels to substitute
for conventional vehicles. But complements
can also make substitution easier. For
example, Apple’s iTunes hastened the substitution
from CDs to digital music.
Complements can factor into industry rivalry
either positively (as when they raise
switching costs) or negatively (as when they
neutralize product differentiation). Similar
analyses can be done for buyer and supplier
power. Sometimes companies compete by altering
conditions in complementary industries
in their favor, such as when videocassette-recorder
producer JVC persuaded movie studios
to favor its standard in issuing prerecorded
tapes even though rival Sony’s standard was
probably superior from a technical standpoint.
Identifying complements is part of the analyst’s
work. As with government policies or important
technologies, the strategic significance
of complements will be best understood
through the lens of the five forces.
Changes in Industry Structure
So far, we have discussed the competitive
forces at a single point in time. Industry structure
proves to be relatively stable, and industry
profitability differences are remarkably
persistent over time in practice. However, industry
structure is constantly undergoing
modest adjustment—and occasionally it can
change abruptly.
Shifts in structure may emanate from outside
an industry or from within. They can
boost the industry’s profit potential or reduce
it. They may be caused by changes in technology,
changes in customer needs, or other
events. The five competitive forces provide a
framework for identifying the most important
industry developments and for anticipating
their impact on industry attractiveness.
Shifting threat of new entry.
Changes to any
of the seven barriers described above can raise
or lower the threat of new entry. The expiration
of a patent, for instance, may unleash new
entrants. On the day that Merck’s patents for
the cholesterol reducer Zocor expired, three
pharmaceutical makers entered the market
for the drug. Conversely, the proliferation of
products in the ice cream industry has gradually
filled up the limited freezer space in grocery
stores, making it harder for new ice cream
makers to gain access to distribution in North
America and Europe.
Strategic decisions of leading competitors
often have a major impact on the threat of entry.
Starting in the 1970s, for example, retailers
such as Wal-Mart, Kmart, and Toys “R” Us
began to adopt new procurement, distribution,
and inventory control technologies with large
fixed costs, including automated distribution
centers, bar coding, and point-of-sale terminals.
These investments increased the economies
of scale and made it more difficult for
small retailers to enter the business (and for existing
small players to survive).
Changing supplier or buyer power.
As the
factors underlying the power of suppliers and
buyers change with time, their clout rises or
declines. In the global appliance industry, for
instance, competitors including Electrolux,
General Electric, and Whirlpool have been
squeezed by the consolidation of retail channels
(the decline of appliance specialty stores,
for instance, and the rise of big-box retailers
like Best Buy and Home Depot in the United
States). Another example is travel agents, who
depend on airlines as a key supplier. When the
internet allowed airlines to sell tickets directly
to customers, this significantly increased their
power to bargain down agents’ commissions.
Shifting threat of substitution.
The most common
reason substitutes become more or less
threatening over time is that advances in technology
create new substitutes or shift priceThe
Five Competitive Forces That Shape Strategy
page 12
performance comparisons in one direction or
the other. The earliest microwave ovens, for
example, were large and priced above $2,000,
making them poor substitutes for conventional
ovens. With technological advances,
they became serious substitutes. Flash computer
memory has improved enough recently
to become a meaningful substitute for low-capacity
hard-disk drives. Trends in the availability
or performance of complementary producers
also shift the threat of substitutes.
New bases of rivalry.
Rivalry often intensifies
naturally over time. As an industry matures,
growth slows. Competitors become
more alike as industry conventions emerge,
technology diffuses, and consumer tastes converge.
Industry profitability falls, and weaker
competitors are driven from the business. This
story has played out in industry after industry;
televisions, snowmobiles, and telecommunications
equipment are just a few examples.
A trend toward intensifying price competition
and other forms of rivalry, however, is by
no means inevitable. For example, there has
been enormous competitive activity in the U.S.
casino industry in recent decades, but most of
it has been positive-sum competition directed
toward new niches and geographic segments
(such as riverboats, trophy properties, Native
American reservations, international expansion,
and novel customer groups like families).
Head-to-head rivalry that lowers prices or
boosts the payouts to winners has been limited.
The nature of rivalry in an industry is altered
by mergers and acquisitions that introduce
new capabilities and ways of competing.
Or, technological innovation can reshape rivalry.
In the retail brokerage industry, the advent
of the internet lowered marginal costs
and reduced differentiation, triggering far
more intense competition on commissions and
fees than in the past.
In some industries, companies turn to mergers
and consolidation not to improve cost and
quality but to attempt to stop intense competition.
Eliminating rivals is a risky strategy, however.
The five competitive forces tell us that a
profit windfall from removing today’s competitors
often attracts new competitors and backlash
from customers and suppliers. In New
York banking, for example, the 1980s and 1990s
saw escalating consolidations of commercial
and savings banks, including Manufacturers
Hanover, Chemical, Chase, and Dime Savings.
But today the retail-banking landscape of Manhattan
is as diverse as ever, as new entrants
such as Wachovia, Bank of America, and Washington
Mutual have entered the market.
Implications for Strategy
Understanding the forces that shape industry
competition is the starting point for developing
strategy. Every company should already
know what the average profitability of its industry
is and how that has been changing over
time. The five forces reveal
why
industry profitability
is what it is. Only then can a company
incorporate industry conditions into strategy.
The forces reveal the most significant aspects
of the competitive environment. They also provide
a baseline for sizing up a company’s
strengths and weaknesses: Where does the
company stand versus buyers, suppliers, entrants,
rivals, and substitutes? Most importantly,
an understanding of industry structure
guides managers toward fruitful possibilities
for strategic action, which may include any or
all of the following: positioning the company
to better cope with the current competitive
forces; anticipating and exploiting shifts in the
forces; and shaping the balance of forces to create
a new industry structure that is more favorable
to the company. The best strategies exploit
more than one of these possibilities.
Positioning the company.
Strategy can be
viewed as building defenses against the competitive
forces or finding a position in the industry
where the forces are weakest. Consider,
for instance, the position of Paccar in the market
for heavy trucks. The heavy-truck industry
is structurally challenging. Many buyers operate
large fleets or are large leasing companies,
with both the leverage and the motivation to
drive down the price of one of their largest
purchases. Most trucks are built to regulated
standards and offer similar features, so price
competition is rampant. Capital intensity
causes rivalry to be fierce, especially during
the recurring cyclical downturns. Unions exercise
considerable supplier power. Though
there are few direct substitutes for an 18-
wheeler, truck buyers face important substitutes
for their services, such as cargo delivery
by rail.
In this setting, Paccar, a Bellevue, Washington–
based company with about 20% of the
North American heavy-truck market, has cho-
Eliminating rivals is a
risky strategy. A profit
windfall from removing
today’s competitors often
attracts new competitors
and backlash from
customers and suppliers.

page 13
sen to focus on one group of customers: owneroperators—
drivers who own their trucks and
contract directly with shippers or serve as subcontractors
to larger trucking companies. Such
small operators have limited clout as truck
buyers. They are also less price sensitive because
of their strong emotional ties to and economic
dependence on the product. They take
great pride in their trucks, in which they spend
most of their time.
Paccar has invested heavily to develop an
array of features with owner-operators in
mind: luxurious sleeper cabins, plush leather
seats, noise-insulated cabins, sleek exterior styling,
and so on. At the company’s extensive network
of dealers, prospective buyers use software
to select among thousands of options to
put their personal signature on their trucks.
These customized trucks are built to order, not
to stock, and delivered in six to eight weeks.
Paccar’s trucks also have aerodynamic designs
that reduce fuel consumption, and they maintain
their resale value better than other trucks.
Paccar’s roadside assistance program and ITsupported
system for distributing spare parts
reduce the time a truck is out of service. All
these are crucial considerations for an owneroperator.
Customers pay Paccar a 10% premium,
and its Kenworth and Peterbilt brands
are considered status symbols at truck stops.
Paccar illustrates the principles of positioning
a company within a given industry structure.
The firm has found a portion of its industry
where the competitive forces are weaker—
where it can avoid buyer power and pricebased
rivalry. And it has tailored every single
part of the value chain to cope well with the
forces in its segment. As a result, Paccar has
been profitable for 68 years straight and has
earned a long-run return on equity above 20%.
In addition to revealing positioning opportunities
within an existing industry, the five
forces framework allows companies to rigorously
analyze entry and exit. Both depend on
answering the difficult question: “What is the
potential of this business?” Exit is indicated
when industry structure is poor or declining
and the company has no prospect of a superior
positioning. In considering entry into a new industry,
creative strategists can use the framework
to spot an industry with a good future
before this good future is reflected in the
prices of acquisition candidates. Five forces
analysis may also reveal industries that are not
necessarily attractive for the average entrant
but in which a company has good reason to believe
it can surmount entry barriers at lower
cost than most firms or has a unique ability to
cope with the industry’s competitive forces.
Exploiting industry change.
Industry changes
bring the opportunity to spot and claim promising
new strategic positions if the strategist
has a sophisticated understanding of the competitive
forces and their underpinnings. Consider,
for instance, the evolution of the music
industry during the past decade. With the advent
of the internet and the digital distribution
of music, some analysts predicted the
birth of thousands of music labels (that is,
record companies that develop artists and
bring their music to market). This, the analysts
argued, would break a pattern that had held
since Edison invented the phonograph: Between
three and six major record companies
had always dominated the industry. The internet
would, they predicted, remove distribution
as a barrier to entry, unleashing a flood of
new players into the music industry.
A careful analysis, however, would have revealed
that physical distribution was not the
crucial barrier to entry. Rather, entry was
barred by other benefits that large music labels
enjoyed. Large labels could pool the risks of developing
new artists over many bets, cushioning
the impact of inevitable failures. Even
more important, they had advantages in breaking
through the clutter and getting their new
artists heard. To do so, they could promise
radio stations and record stores access to wellknown
artists in exchange for promotion of
new artists. New labels would find this nearly
impossible to match. The major labels stayed
the course, and new music labels have been
rare.
This is not to say that the music industry is
structurally unchanged by digital distribution.
Unauthorized downloading created an illegal
but potent substitute. The labels tried for years
to develop technical platforms for digital distribution
themselves, but major companies hesitated
to sell their music through a platform
owned by a rival. Into this vacuum stepped
Apple with its iTunes music store, launched in
2003 to support its iPod music player. By permitting
the creation of a powerful new gatekeeper,
the major labels allowed industry
structure to shift against them. The number of
major record companies has actually de-
Using the five forces
framework, creative
strategists may be able to
spot an industry with a
good future before this
good future is reflected in
the prices of acquisition
candidates.

page 14
clined—from six in 1997 to four today—as
companies struggled to cope with the digital
phenomenon.
When industry structure is in flux, new and
promising competitive positions may appear.
Structural changes open up new needs and
new ways to serve existing needs. Established
leaders may overlook these or be constrained
by past strategies from pursuing them. Smaller
competitors in the industry can capitalize on
such changes, or the void may well be filled by
new entrants.
Shaping industry structure.
When a company
exploits structural change, it is recognizing,
and reacting to, the inevitable. However,
companies also have the ability to shape industry
structure. A firm can lead its industry
toward new ways of competing that alter the
five forces for the better. In reshaping structure,
a company wants its competitors to follow
so that the entire industry will be transformed.
While many industry participants
may benefit in the process, the innovator can
benefit most if it can shift competition in directions
where it can excel.
An industry’s structure can be reshaped in
two ways: by redividing profitability in favor of
incumbents or by expanding the overall profit
pool. Redividing the industry pie aims to increase
the share of profits to industry competitors
instead of to suppliers, buyers, substitutes,
and keeping out potential entrants. Expanding
the profit pool involves increasing the overall
pool of economic value generated by the industry
in which rivals, buyers, and suppliers
can all share.
Redividing profitability.
To capture more profits
for industry rivals, the starting point is to
Defining the Relevant Industry
Defining the industry in which competition
actually takes place is important for good industry
analysis, not to mention for developing
strategy and setting business unit boundaries.
Many strategy errors emanate from
mistaking the relevant industry, defining it
too broadly or too narrowly. Defining the industry
too broadly obscures differences
among products, customers, or geographic
regions that are important to competition,
strategic positioning, and profitability. Defining
the industry too narrowly overlooks commonalities
and linkages across related products
or geographic markets that are crucial to
competitive advantage. Also, strategists must
be sensitive to the possibility that industry
boundaries can shift.
The boundaries of an industry consist of
two primary dimensions. First is the
scope of
products or services
. For example, is motor oil
used in cars part of the same industry as
motor oil used in heavy trucks and stationary
engines, or are these different industries? The
second dimension is
geographic scope
. Most
industries are present in many parts of the
world. However, is competition contained
within each state, or is it national? Does competition
take place within regions such as Europe
or North America, or is there a single global
industry?
The five forces are the basic tool to resolve
these questions. If industry structure for two
products is the same or very similar (that is, if
they have the same buyers, suppliers, barriers
to entry, and so forth), then the products are
best treated as being part of the same industry.
If industry structure differs markedly, however,
the two products may be best understood
as separate industries.
In lubricants, the oil used in cars is similar
or even identical to the oil used in trucks, but
the similarity largely ends there. Automotive
motor oil is sold to fragmented, generally unsophisticated
customers through numerous
and often powerful channels, using extensive
advertising. Products are packaged in small
containers and logistical costs are high, necessitating
local production. Truck and power
generation lubricants are sold to entirely different
buyers in entirely different ways using a
separate supply chain. Industry structure
(buyer power, barriers to entry, and so forth) is
substantially different. Automotive oil is thus a
distinct industry from oil for truck and stationary
engine uses. Industry profitability will differ
in these two cases, and a lubricant company
will need a separate strategy for
competing in each area.
Differences in the five competitive forces
also reveal the geographic scope of competition.
If an industry has a similar structure in
every country (rivals, buyers, and so on), the
presumption is that competition is global, and
the five forces analyzed from a global perspective
will set average profitability. A single global
strategy is needed. If an industry has quite
different structures in different geographic regions,
however, each region may well be a distinct
industry. Otherwise, competition would
have leveled the differences. The five forces analyzed
for each region will set profitability
there.
The extent of differences in the five forces
for related products or across geographic
areas is a matter of degree, making industry
definition often a matter of judgment. A rule
of thumb is that where the differences in any
one force are large, and where the differences
involve more than one force, distinct industries
may well be present.
Fortunately, however, even if industry
boundaries are drawn incorrectly, careful five
forces analysis should reveal important competitive
threats. A closely related product
omitted from the industry definition will show
up as a substitute, for example, or competitors
overlooked as rivals will be recognized as potential
entrants. At the same time, the five
forces analysis should reveal major differences
within overly broad industries that will indicate
the need to adjust industry boundaries or
strategies.

page 15
determine which force or forces are currently
constraining industry profitability and address
them. A company can potentially influence all
of the competitive forces. The strategist’s goal
here is to reduce the share of profits that leak
to suppliers, buyers, and substitutes or are sacrificed
to deter entrants.
To neutralize supplier power, for example, a
firm can standardize specifications for parts to
make it easier to switch among suppliers. It
can cultivate additional vendors, or alter technology
to avoid a powerful supplier group altogether.
To counter customer power, companies
may expand services that raise buyers’ switching
costs or find alternative means of reaching
customers to neutralize powerful channels. To
temper profit-eroding price rivalry, companies
can invest more heavily in unique products, as
pharmaceutical firms have done, or expand
support services to customers. To scare off entrants,
incumbents can elevate the fixed cost of
competing—for instance, by escalating their
R&D or marketing expenditures. To limit the
threat of substitutes, companies can offer better
value through new features or wider product
accessibility. When soft-drink producers introduced
vending machines and convenience
store channels, for example, they dramatically
improved the availability of soft drinks relative
to other beverages.
Sysco, the largest food-service distributor in
North America, offers a revealing example of
how an industry leader can change the structure
of an industry for the better. Food-service
distributors purchase food and related items
from farmers and food processors. They then
warehouse and deliver these items to restaurants,
hospitals, employer cafeterias, schools,
and other food-service institutions. Given low
barriers to entry, the food-service distribution
industry has historically been highly fragmented,
with numerous local competitors.
While rivals try to cultivate customer relationships,
buyers are price sensitive because food
represents a large share of their costs. Buyers
can also choose the substitute approaches of
purchasing directly from manufacturers or
using retail sources, avoiding distributors altogether.
Suppliers wield bargaining power:
They are often large companies with strong
brand names that food preparers and consumers
recognize. Average profitability in the industry
has been modest.
Sysco recognized that, given its size and national
reach, it might change this state of affairs.
It led the move to introduce private-label
distributor brands with specifications tailored
to the food-service market, moderating supplier
power. Sysco emphasized value-added
services to buyers such as credit, menu planning,
and inventory management to shift the
basis of competition away from just price.
These moves, together with stepped-up investments
in information technology and regional
distribution centers, substantially raised the
bar for new entrants while making the substitutes
less attractive. Not surprisingly, the industry
has been consolidating, and industry
profitability appears to be rising.
Industry leaders have a special responsibility
for improving industry structure. Doing so
often requires resources that only large players
possess. Moreover, an improved industry structure
is a public good because it benefits every
firm in the industry, not just the company that
initiated the improvement. Often, it is more in
the interests of an industry leader than any
other participant to invest for the common
good because leaders will usually benefit the
most. Indeed, improving the industry may be a
leader’s most profitable strategic opportunity,
in part because attempts to gain further market
share can trigger strong reactions from ri-
Typical Steps in Industry Analysis
Define the relevant industry:
•
What products are in it? Which ones
are part of another distinct industry?
•
What is the geographic scope of
competition?
Identify the participants and segment
them into groups, if appropriate:
Who are
•
the buyers and buyer groups?
•
the suppliers and supplier groups?
•
the competitors?
•
the substitutes?
•
the potential entrants?
Assess the underlying drivers of each
competitive force to determine which
forces are strong and which are weak
and why.
Determine overall industry structure,
and test the analysis for consistency:
•
Why
is the level of profitability what
it is?
•
Which are the
controlling
forces for
profitability?
•
Is the industry analysis consistent
with actual long-run profitability?
•
Are more-profitable players better
positioned in relation to the five
forces?
Analyze recent and likely future
changes in each force, both positive
and negative.
Identify aspects of industry structure that
might be influenced by competitors, by
new entrants, or by your company.

page 16
vals, customers, and even suppliers.
There is a dark side to shaping industry
structure that is equally important to understand.
Ill-advised changes in competitive positioning
and operating practices can
undermine
industry structure. Faced with pressures to
gain market share or enamored with innovation
for its own sake, managers may trigger
new kinds of competition that no incumbent
can win. When taking actions to improve their
own company’s competitive advantage, then,
strategists should ask whether they are setting
in motion dynamics that will undermine industry
structure in the long run. In the early days
of the personal computer industry, for instance,
IBM tried to make up for its late entry
by offering an open architecture that would set
industry standards and attract complementary
makers of application software and peripherals.
In the process, it ceded ownership of the
critical components of the PC—the operating
system and the microprocessor—to Microsoft
and Intel. By standardizing PCs, it encouraged
price-based rivalry and shifted power to suppliers.
Consequently, IBM became the temporarily
dominant firm in an industry with an enduringly
unattractive structure.
Expanding the profit pool.
When overall demand
grows, the industry’s quality level rises,
intrinsic costs are reduced, or waste is eliminated,
the pie expands. The total pool of value
available to competitors, suppliers, and buyers
grows. The total profit pool expands, for example,
when channels become more competitive
or when an industry discovers latent buyers
for its product that are not currently being
served. When soft-drink producers rationalized
their independent bottler networks to
make them more efficient and effective, both
the soft-drink companies and the bottlers benefited.
Overall value can also expand when
firms work collaboratively with suppliers to
improve coordination and limit unnecessary
costs incurred in the supply chain. This lowers
the inherent cost structure of the industry, allowing
higher profit, greater demand through
lower prices, or both. Or, agreeing on quality
standards can bring up industrywide quality
and service levels, and hence prices, benefiting
rivals, suppliers, and customers.
Expanding the overall profit pool creates
win-win opportunities for multiple industry
participants. It can also reduce the risk of destructive
rivalry that arises when incumbents
attempt to shift bargaining power or capture
more market share. However, expanding the
pie does not reduce the importance of industry
structure. How the expanded pie is divided will
ultimately be determined by the five forces.
The most successful companies are those that
expand the industry profit pool in ways that
allow them to share disproportionately in the
benefits.
Defining the industry.
The five competitive
forces also hold the key to defining the relevant
industry (or industries) in which a company
competes. Drawing industry boundaries
correctly, around the arena in which competition
actually takes place, will clarify the causes
of profitability and the appropriate unit for
setting strategy. A company needs a separate
strategy for each distinct industry. Mistakes in
industry definition made by competitors
present opportunities for staking out superior
strategic positions. (See the sidebar “Defining
the Relevant Industry.”)
Competition and Value
The competitive forces reveal the drivers of industry
competition. A company strategist who
understands that competition extends well beyond
existing rivals will detect wider competitive
threats and be better equipped to address
them. At the same time, thinking comprehensively
about an industry’s structure can uncover
opportunities: differences in customers,
suppliers, substitutes, potential entrants, and
rivals that can become the basis for distinct
strategies yielding superior performance. In a
world of more open competition and relentless
change, it is more important than ever to
think structurally about competition.
Understanding industry structure is equally
important for investors as for managers. The
five competitive forces reveal whether an industry
is truly attractive, and they help investors
anticipate positive or negative shifts in industry
structure before they are obvious. The
five forces distinguish short-term blips from
structural changes and allow investors to take
advantage of undue pessimism or optimism.
Those companies whose strategies have industry-
transforming potential become far clearer.
This deeper thinking about competition is a
more powerful way to achieve genuine investment
success than the financial projections
and trend extrapolation that dominate today’s
investment analysis.
Common Pitfalls
In conducting the analysis avoid
the following common mistakes:
• Defining the industry too
broadly or too narrowly.
• Making lists instead of engaging
in rigorous analysis.
• Paying equal attention to all of
the forces rather than digging
deeply into the most important
ones.
• Confusing effect (price sensitivity)
with cause (buyer economics).
• Using static analysis that ignores
industry trends.
• Confusing cyclical or transient
changes with true structural
changes.
• Using the framework to declare
an industry attractive or unattractive
rather than using it to
guide strategic choices.

page 17
If both executives and investors looked at
competition this way, capital markets would be
a far more effective force for company success
and economic prosperity. Executives and investors
would both be focused on the same fundamentals
that drive sustained profitability. The
conversation between investors and executives
would focus on the structural, not the
transient. Imagine the improvement in company
performance—and in the economy as a
whole—if all the energy expended in “pleasing
the Street” were redirected toward the factors
that create true economic value.
Posted by Sikander Hayat at 06:01 0 comments
Labels: Management And Strategy
Harvard Business Review - A Stealthier Way to Raise Money
By David Champion

When entrepreneurs want money to
grow their business, their first port of
call is often the venture capitalist. They
know that such financing means a
loss of control – VCs demand big equity
stakes and a seat on the board and often
bring in outside managers to supervise
the business – but the benefits have traditionally
outweighed the costs.
For some entrepreneurs, however, the
scales are now tipping in the other direction.
For them, loss of control is no
longer the only – or even the biggest –
downside of VC funding. Rather, it’s the
fear that the intensive networking of VC
firms may compromise the ideas on
which their new companies are founded.
Many start-ups depend not on a new,
patentable technology but on a new application
of an existing technology. Their
business models are highly susceptible
to imitation, and any potential breach of
security is cause for alarm.
It’s not that the entrepreneurs question
the integrity of individual venture
capitalists. Rather, they worry that strategically
sensitive information could leak
out as the VC firm discusses the new venture
with outside partners and experts.
As Peter Thimmesch, founder of Arizonabased
Visitalk.com, says, “It’s not so much
that the VC firms are consciously indiscreet.
It’s more that many of the people
they talk to – and even their employees –
may well be working with one of our
competitors next month.”
Entrepreneurs like Thimmesch are
searching for other sources of money.
And they are often finding new kinds of
investors who are not only tight-lipped
but also more willing to align themselves
with the founders’ vision and strategy.
Talking to Angels
For Visitalk, a supplier of Internet telephony,
growth financing has come
entirely from individual investors. Raised
in a wealthy family, Thimmesch was fortunate
to have ready access to a group of
people who were willing to invest large
amounts of cash. And he soon came to
find that expanding that base was fairly
easy. “Anyone who’s rich,” he comments,
“always knows someone else who’s really
rich.” In the company’s second round of
financing, he was able to quickly raise
$20 million.
From Thimmesch’s viewpoint, angel
investors have many advantages over
VCs. For a start, they aren’t that interested
in obtaining exhaustive information
about a company and its plans. In
many cases, an impressive product demo
is all it takes to get them to invest. And
unlike VC firms, private investors are
usually not interested in a quick, fiveyear
exit. They often invest to be part of
the excitement of the new economy – it’s
as much an adventure as a financial deal.
As a result, they tend to be highly supportive
of management’s vision and
strategy.“Our shareholder meetings,” says
Thimmesch, “are like church revivals.”
Even better, private investors put the
company’s interests above their own.
Thimmesch had no difficulty getting
shareholders to release the company
from the obligation to include existing
investors in subsequent financing rounds;
that’s freed the company’s hand in dealing
with potential corporate investors
and strategic partners.
Raiding Corporate Coffers
Corporate investment, too, is on the
rise. Last year, in fact, Intel was one of
the country’s largest investors in new
t rend

When entrepreneurs get financing from big VC firms,
they often lose control over their idea and their business.
An increasing number are unwilling to make that deal.
Today’s business models are
highly susceptible to imitation,
and any potential breach of
security is cause for alarm.

ventures. Greg Amadon, cofounder of
TeraBeam, a company that makes equipment
for wireless optical data transmission,
drew on a group of corporate
investors to reduce his reliance on VCs.
He has found those investors to be supportive
and discreet partners in the company’s
early development.
Unlike VCs, corporate investors are
usually quite happy to sign nondisclosure
agreements. As businesses themselves,
they understand a company’s
concern that strategic information will
leak to competitors. They also have
sound commercial reasons for giving a
new venture the confidentiality and
space it needs. In TeraBeam’s case, corporate
investors wanted privileged access
to a new technology that could
change their businesses. The last thing
they wanted was for news about Tera-
Beam to end up in the hands of their
competitors. As Amadon puts it, “They
were interested in getting an edge.”
Although some corporate investors
operate much like VC firms, others more
closely resemble private investors in
their enthusiasm. That’s usually because
they are close to the technology themselves,
and their managers often share
the outlook of – and may even personally
know – the venture’s founders.

Some companies have all the money
they need under their noses. InfoSpace,
an Internet and wireless infrastructure
company, was entirely funded by its
employees until its IPO.
The obvious benefit of employee ownership
is that it strengthens organizational
enthusiasm and commitment. But
InfoSpace chairman and founder Naveen
Jain believes that it also helps companies
stay focused on profitability. “In many
cases,” he says, “the money from outside
investors like VC firms goes to PR firms,
advertising media, and so forth. That’s
great for getting name recognition ahead
of an IPO, but it doesn’t help you build a
successful business model.”
Discreet and cooperative investors can
make a founder’s life safer and easier.
And the benefits don’t stop there. Nonprofessional
investors are much less
likely than professional VCs to haggle
over money. Entrepreneurs who look
beyond the VC firms for capital may find
that they end up keeping a bigger chunk
of their company for themselves.
Entrepreneurs who receive funding from private investors rather
than VCs may end up with more money in the bank for themselves.