1. The Five Competitive Forces That Shape Strategy A summary of Porter’s 2008 HBR article
MGMT 7022
Spring Banks

2. The Job of the Strategist
Understand and cope with competition
This means competition for your profits
More than just your direct competitors!
Also….
Customers
Suppliers
Potential entrants
Substitute products

3. If the forces are:
Intense – there will be no good profits earned by any market participant
Airlines, textiles, hotels – hospitals?
Benign – almost all participants can make good returns
Software, soft drinks, pharma?

4. Structure begets profit
“Industry structure, manifested in the competitive forces sets industry profitability in the medium and long run”
“The strongest competitive force or forces determine the profitability of an industry and become the most important to strategy”

5. Threat of Entry
New entrants bring capacity and a desire for market share
Puts pressure on prices
Entrants coming from other industry leverage existing cash flows and capabilities
Pepsi-water, Apple-music, Microsoft-browser
The threat depends on the size of barriers and likely reaction from incumbents

6. Barriers to Entry Supply-side economies of scale
New entrants must come big or accept a cost disadvantage
Demand side economies of scale
Buyers are more willing to buy if many are already buying
Customer switching costs
High switching costs mean difficult entry
Capital Requirements
Facilities, customer credit, inventory, start-up losses
If returns are attractive, the money can be found

7. Barriers to Entry Incumbency advantages independent of size
Established brand, better locations
Unequal access to distribution channels
Healthcare involves brokers, payers, employers
Restrictive government policies
Usually protects the entrenched incumbent
CON, licensing laws, patents
Expected Retaliation
Have they previously retaliated? Do they have deep pockets?
If fixed costs high, incumbents are more likely to drop prices
Growth is slow, so entrants only grow by stealing customers

8. The Power of Suppliers Suppliers are powerful if:
They are more concentrated than the industry they sell to
Microsoft, Hill-Rom
They don’t depend heavily on the industry for its revenue
Industry participants face high switching costs in changing suppliers
EMR, automated IV equipment
Suppliers offer products that are differentiated
Patented drug, Davinci robotics
There is no substitute for what the supplier group provides
Pilots, Physicians

9. The Power of Buyers Buyers are powerful if:
There are few of them, or they purchase in large volumes
Offshore drilling, monopsonistic insurance carriers
The industry’s products are standardized/undifferentiated
Gasoline, groceries, Ref. lab services
Switching costs in changing vendors is low
Buyers can credibly threaten to integrate backward and produce the industry’s products themselves
Payers purchasing primary care providers

10. The Power of Buyers Buyers are price sensitive if:
The product it purchases represents a significant portion of its budget
Home mortgages, transplants
The buyer group earns low profits/ is strapped for cash
State Medicaid programs
The quality of the buyers’ products is little affected by the industry’s product
Maintenance vehicles on hospital campuses
The industry’s product has little effect on the buyer’s other costs.

11. The Threat of Substitutes
A substitute performs the same function as an industry's product, just in a different way.
Videoconferencing vs. travel/ face to face meetings
Urgent Care vs Ed visit
Online scheduling vs. travel agent
Non-purchase (doing without) can be a substitute!
“Substitute products/service limit an industry’s profit by placing a ceiling on prices”

12. The Threat of Substitute is high if:
It offers an attractive price/performance trade-off to the industry’s product
The buyer’s cost of switching is low
Brand vs. generic drugs
Be alert to changes coming from other industries that can offer unpredicted substitutes in your own!
Tesla seems intent on disrupting the power distribution industry after perfecting car batteries

13. Rivalry amongst Competitors
The intensity of rivalry is greatest if:
Competitors are numerous or equally sized
Industry growth is slow
Means tough fights for market share
Exit barriers are high
High fixed costs - TKA
Rivals are highly committed to their business and have aspirations for leadership
Competing for image – transplant programs
Firms cannot read each others signals well

14. Rivalry amongst Competitors
Price competition will occur when:
Products are nearly identical/ low switching costs
Fixed costs are high and marginal costs low
Capacity must be expanded in large increments to be efficient
The product is perishable
Food, hotel rooms, airline seats, OR time?

15. Rivalry amongst Competitors
Competition based on other than price is less likely to erode profit
Product features, brand image, quality, etc
Improves customer value and can support higher prices
Competition will be zero sum if all competitors are attempting to meet the same needs in the same way
Competition can be positive sum if each competitor is trying to meet a different need or serve a different customer

16. Factors, not Forces
The following are attributes of an industry, not the underlying structure:
Industry growth rate
Technology and Innovation
Government
Complementary products/services
None of these are inherently good or bad for profitability, but should be considered

17. Changes in Industry Structure
The five forces help understand shifts in structure:
Changes to entry barriers raise/lower threat of entrants
Buyer/Supplier power changes with technology, etc.
Ex. Internet changed pricing power of travel agents
Shifting threat of substitution
Flash memory, microwave ovens
New bases of rivalry
Price matters more as HDHPs are sold
M&A activity increases to stop competition (NOT to improve quality)

18. Example – Paccar heavy truck maker
Strategy is…”building defenses against the competitive forces or finding a position in the industry where the forces are weakest”
Example – Paccar heavy truck maker
Focuses on owner-operators who take pride in their truck and depend on it for their living
Able to command a 10% premium
Focus is on selling where the forces are weakest

19. Strategy is…”exploiting industry change”
Example – Music industry going digital
Predictions were that digital music would eliminate all barriers to new groups getting their music out (and sold)
BUT – distribution was not the actual barrier to entry
Large labels could pool risk better, had advantages in getting music heard on radio stations, etc.
Major labels shrunk from 6 to 4
This was an opportunity for Apple to jump in with iTunes

20. Strategy is…”shaping industry structure”
Re-dividing profitability in favor of incumbents
The goal here is to reduce the share of profits taken by suppliers, buyers, substitutes or sacrificed to fend of entrants
Sysco Foods, ACOs
IBM as a counter example – their actions undermined the PC industry
Expanding the profit pool when demand grows, quality rises, intrinsic costs lower
ACA, Medicare – legislation that acts to grow demand
How the new pie gets divided will be determined by the 5 forces

21. Defining the industry
The fives forces help us define the boundaries of each industry we compete in
Separate strategy is needed for each industry we choose to be in
“Thinking comprehensively about structure can uncover opportunities: differences in customers, suppliers, substitutes, potential entrants and rivals that can become the basis for distinct strategies”