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Competitive Strategy
Techniques for Analyzing Industries and Competitors
Michael E. Porter Free Press, 1980 Buy the book
Rating
9 Applicability
9 Innovation
8 Style
Recommendation
This seminal book is a classic and ought to be read by anyone in business. Michael E. Porter's ideas on competitiveness have lost little relevance despite the fact that he first advanced them in this book in 1980. They have now become so much a part of business practice and business language that one reads the book more with a sense of recognition than a sense of discovery. His prose style is clear and straightforward, albeit somewhat plodding, and the book can tend to repeat itself. However, Porter's clarity is a welcome change from the murk you encounter in many other books on business strategy, and his repetition serves a useful pedagogical purpose. getAbstract highly recommends this excellent book. If you're in business, it's relevant.
In this summary, you will learn:
- What five factors influence the competitive situation in any industry;
- How to analyze your strategic position; and
- How to read and use market signals.
Take-Aways
- A sound competitive strategy rests on a solid grasp of the industry environment.
- Disparate industries share common structural traits and are open to comparison.
- Competition will reduce returns to the sum of the risk-free rate of return plus the risk of capital loss.
- To achieve superior returns, firms need to establish a strong position based on brand strength, cost leadership and focus (such as a niche market).
- Five factors determine your strategy: suppliers, competitors, customers, substitutes for your product and the degree of competition in the market.
- Reading market signals is important, as is knowing when they are false or misleading.
- (^) Competitors in an oligopoly find themselves in a Prisoner's Dilemma.
- (^) Not all customers are good – firms should select their buyers carefully.
- (^) Industries can evolve, become global, go through transitions, fragment or decline; a sound strategy should recognize your industry's evolutionary stage.
- (^) Most industries can be "mapped" into sub-sections or groups of competitors who compete on similar grounds, such as cost or quality.
Summary
Competitive Forces A company's competitive strategy must depend on its environment, most immediately the environment of its industry.
The competitive situation in an industry is a function of five basic factors: “The essence of formulating a competitive strategy is relating a company to its environment.”
- The relative power of suppliers.
- The level of threat from potential new industry participants.
- The relative power of customers.
- The level of threat from potential substitutes for the product or service.
- The degree of competition among current industry participants. Competition reduces the return on capital to the sum of the risk-free rate and the risk of losing capital. All five of the above factors contribute to the competitive dynamic of any industry, though any single factor's level of importance varies from industry to industry.
“Understanding the process of industry evolution and being able to predict change are important because the cost of reacting strategically usually increases as the need for change becomes more obvious.” Competitive strategy means taking action to gain a position of strength in your industry, and being able to defend that position successfully against all five forces.
Becoming a Strong Competitor
Generally speaking, pursue one of these three approaches to achieve competitive excellence:
“All firms in an industry are competing, in a broad sense, with industries producing substitute products.”
- Establish superior efficiency and cost effectiveness to assure superior returns.
- Achieve superior differentiation based on brand or design strength, service strength, dealership and distribution strength, or some other characteristics that marks your company as unique in its industry.
- Concentrate on a particular product, market segment, geography or such. By focusing, a firm can develop expertise that its competitors lack. An organization that does not establish leadership through one or more of these approaches is a weak competitor. Each approach has risks. Too much attention on efficiency and cost control may blind a company to changes in market preferences. Points of differentiation may become irrelevant to the market. Others may outdo you on
introduction, the competitor issues three similar products at much lower prices, that sends a powerful message about its commitment to defending its market position.
- (^) Breaking precedent – If a competitor who markets only on the West Coast suddenly begins to market on the East Coast, or begins to slash prices on products the industry never discounts, or takes other unprecedented moves, that sends a strong signal
- (^) Parry – If Firm A begins to enter the market of Firm B, Firm B may signal its willingness to fight by making a similar foray against the market of Firm A.
- (^) " Fighting Brand " – Coca-Cola introduced Mr. Pibb, a beverage similar to Dr. Pepper, when Dr. Pepper seemed to be building market share. Maxwell House issued Horizon, which resembled Folgers, in areas where Folgers was trying to establish a presence.
- (^) Lawsuits – Filing a private antitrust lawsuit may be a relatively mild signal, or may be an attempt to force a resource-constrained defendant to invest in a legal defense instead of a market move. “It seems to be an accepted fact that industries tend to consolidate over time, but as a general statement, it simply is not true.”
The Competitive Dilemma
Firms often face something akin to the Prisoner's Dilemma, in which two convicts face a narrow range of choices. If neither betrays the other, both live and get out of jail. If they betray each other, they both will hang. If only one betrays the other, the traitor goes free and gets a reward while the betrayed gets hung. In parallel, companies may take actions that will lead to good results for the industry as a whole, or they may pursue their self-interests at the risk of leaving themselves and the rest of the industry in worse shape.
In a competitive industry, firms need to anticipate what their competitors are likely to do. This anticipation should be grounded in an informed understanding of the possibilities and constraints faced by each competitor. Information is critical, and the release of information can and should be an important part of strategy. Pay particular attention to disclosures in annual reports and other public documents. Information disclosure should be selective and planned, based in part on the use that your competitors are likely to make of the information.
“Some entity is almost always threatened by the advent of an emerging industry.”
Vendor Strategy, Customer Strategy
A firm should select its vendors and its buyers with great care. Not every customer is a good customer. A buyer who is too costly to service, too demanding or too powerful may be bad for business.
The most important factors in selecting buyers are:
“Competition in global industries presents some unique strategic issues compared to domestic competition.”
- The buyer's requirements in comparison to the firm's capacity.
- (^) The buyer's potential for growth.
- (^) The buyer's negotiating leverage and disposition to use it.
- (^) The cost of satisfying the buyer. Similar strategic considerations should inform your selection of suppliers, with particular emphasis on these steps:
“An enhanced level of ’financial consciousness’ along a variety of dimensions is often necessary in maturity, whereas in the developmental period of the industry areas such as new products and research may have rightly held center stage.”
- Avoid reliance on a single supplier – Spread purchases across a number of suppliers to minimize your firm's dependence and the supplier's power. Spreading purchases may have a cost, so it is important to optimize the cost-benefit tradeoff.
- Avoid lock-in and switching costs – If switching costs are high, it becomes more difficult to leave a supplier and your firm is locked in.
- Assist other potential suppliers – Firms are well advised to help other potential suppliers come up to standard, because it is in the buyer's interest to have numerous, highly motivated suppliers.
- Encourage standardization – Standardization turns supplies into commodities, pushes prices down and eliminates switching cost.
- Threaten "backward integration " – Threatening to make a product in-house that you currently purchase can motivate suppliers to be more cooperative, attentive and flexible about prices. Integration may be full or partial.
Competition in Your Industry
Most industries have a variety of participants who compete based on different factors.
“The essence of the capacity decision, then, is not the discounted cash flow calculation but the numbers that go into it, including probability assessments about the future.” The following are the most common strategic possibilities:
- Focus – How tightly the firm specializes.
- Brand strength – The reliance on brand rather than price or some other variable.
- Brand audience – Does the firm seek to establish its brand with end-users or with distribution channels?
- Channel strategy – Does the firm use dealerships, retail stores and direct-to- consumer Internet sales or some other channel strategy?
- Quality – Does the competitor differentiate itself with superior quality?
- Technological innovation – Does the competitor establish itself as technol ogically advanced?
- Integration – Does the competitor achieve economies or presence by verti cal integration, that is, by owning or controlling its production facilities, market channels and such?
- Cost – Does the competitor differentiate itself on the basis of cost?
- Customer service – Does the competitor differentiate itself by offering extraordinary customer service?
- Price – Does the competitor have a unique or differentiating price policy?
