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June 19 - June 19, 2019
Figure: five forces
The five forces framework explains the industry’s average prices and costs, and therefore the average industry profitability you are trying to beat.
Although SWOT is still used in some quarters, it is biased (in my experience, heavily so) toward confirming managers’ long-standing beliefs, whether those are based on sound economics or on an executive’s personal agenda.
Unit Profit Margin = Price – Cost
Powerful buyers will force prices down or demand more value in the product, thus capturing more of the value for themselves.
When you assess buyer power, the channels through which products are delivered can be as important as the end users.
Powerful suppliers will charge higher prices or insist on more favorable terms, lowering industry profitability.
When you analyze the power of suppliers, be sure to include all of the purchased inputs that go into a product or service, including labor (i.e., your employees).
Industries with high fixed costs (e.g., telecommunications equipment and offshore drilling) are especially vulnerable to large buyers.
The industry needs them more than they need the industry.
Switching costs work in their favor.
Differentiation works in their favor.
They can credibly threaten to vertically integrate into producing the industry’s product itself.
Substitutes—products or services that meet the same basic need as the industry’s product in a different way—put a cap on industry profitability.
How do you assess the threat of a substitute? Look to the economics, specifically to whether the substitute offers an attractive price–performance trade-off relative to the industry’s product.
Switching costs play a significant role in substitution.
Entry barriers protect an industry from newcomers who would add new capacity.
Does producing in larger volumes translate into lower unit costs?
Will customers incur any switching costs in moving from one supplier to another?
Does the value to customers increase as more customers use a company’s product?
Do incumbents have advantages independent of size that new entrants can’t access?
Does government policy restrict or prevent new entrants?
What kind of retaliation should a potential entrant expect should it choose to enter the industry?
If rivalry is intense, companies compete away the value they create, passing it on to buyers in lower prices or dissipating it in higher costs of competing.
How do you assess the intensity of rivalry?
Price competition, Porter warns, is the most damaging form of rivalry.
The five forces framework applies in all industries for the simple reason that it encompasses relationships fundamental to all commerce.
summarizes the dominant impact on profitability of each of the five forces. FIGURE 2-2 How the five forces impact profitability
How can you use industry analysis?
Define the relevant industry by both its product scope and geographic scope.
Geographic scope. Is the cement business global or national?
Industry structure is dynamic, not static,
The real point of competition is earning profits, not taking business away from your rivals.
If you have a real competitive advantage, it means that compared with rivals, you operate at a lower cost, command a premium price, or both.
Competitive advantage is about superior performance.
Long-term ROIC tells you how well a company is using its resources.* It is also, Porter points out, the only measure that matches the multidimensional nature of competition: creating value for customers, dealing with rivals, and using resources productively.
Return on sales (ROS) is used widely, although it ignores the capital invested in the business
Just to keep our terminology straight, for Porter strategy always means “competitive strategy” within a business.
Porter’s research shows that overall corporate return in a diversified corporation is best understood as the sum of the returns of each of its businesses.
If a company has a COMPETITIVE ADVANTAGE, it can sustain higher relative prices and/or lower relative costs than its rivals in an industry.
Strategy choices aim to shift relative price or relative cost in a company’s favor.
The sequence of activities your company performs to design, produce, sell, deliver, and support its products is called the value chain. In turn, your value chain is part of a larger value system.
If your value chain looks like everyone else’s, then you are engaged in competition to be the best.
Relative price and cost are essential for understanding strategy
In this section of chapters, we’ll cover five tests every good strategy must pass: A distinctive value proposition A tailored value chain Trade-offs different from rivals Fit across value chain Continuity over time
If you are trying to serve the same customers and meet the same needs and sell at the same relative price, then by Porter’s definition, you don’t have a strategy. You’re competing to be the best.
The essence of strategy and competitive advantage lies in the activities, in choosing to perform activities differently or to perform different activities from those of rivals.
Focus refers to the breadth or narrowness of the customers and needs a company serves. Differentiation allows a company to command a premium price. Cost leadership allows it to compete by offering a low relative price.
Choices in the value proposition that limit what a company will do are essential to strategy because they create the opportunity to tailor activities in a way that best delivers that kind of value.
By definition, strategy is about creating something unique, making a set of choices that nobody else has made.
