Book of the week: Competitive Strategy – Techniques for Analyzing Industries and Competitors

Competitive_Strategy_Book_Cover“Competitive Strategy – Techniques for Analyzing Industries and Competitors” by Michael E. Porter. Copyright © 1980 by Michael E. Porter. Published by Free Press / Simon & Schuster, Inc., N.Y. 396 pages…

Take-Aways

  • A sound competitive strategy rests on a solid understanding of the industry environment.
  • Disparate industries share common structural characteristics 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.

What You Will Learn
In this Abstract, you will learn how to analyze the factors that determine your company’s competitive strength.

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. I highly recommend this excellent book. If you’re in business, it’s relevant.

Abstract
Structural Analysis
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 fi ve basic factors:

  • 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. Competitive strategy means taking action to gain a position of strength in your industry,and being able to defend that position successfully against all fi ve forces.

Generic Approaches
Generally speaking, pursue one of these three approaches to achieve competitive excellence:

  • 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.

A firm 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 firm to changes in market preferences. Points of differentiation may become irrelevant to the market. Others may outdo you on focus by defining the target product or market even more narrowly or by doing a better job of appealing to niches within the niche.

Competitive Analysis
To conduct a competitive analysis, take several factors into account, including the competitor’s goals and objectives, your current competitive strengths, self image, perspective on the industry, and strengths and weaknesses. These factors help the analyst answer the following questions about how a competitor will respond to developments that pose a threat:

  • Is the competitor complacent and content with its position in the industry?
  • What will the competitor do if something threatens its position?
  • What are the competitor’s weaknesses?
  • What would spur the competitor to aggressive countermeasures?

Reading and Using Market Signals
Competitors send signals about their intentions and probable moves. Sometimes the signals are mere bluffs. Sometimes they are shots across the bow. Sometimes they indicate an unshakable purpose. Signals are indirect and it is necessary to know how to read them in order to understand what the competitor is doing. The major signals are:

  • Announcement in advance — The competitor makes a public announcement of its plans or intentions, possibly to preempt others, to threaten them, to send up a trial balloon or to clarify its reasons for acting. For example, a firm that is lowering prices may publicly explain its reasons to avoid having its intention interpreted as the fi rst shot in a price war. An announcement’s target is not necessarily other competitors; it may be a message to the financial and investment community.
  • Ex post facto announcement — Firms may announce an event or occurrence after it takes place. For example, “We have increased sales by x.” These announcements demand careful analysis because they may be disinformation that is intended to shape the plans of others in the industry.
  • Industry discussions or comments — Competitors may reveal their views of industry conditions at some forum, such as a seminar or conference. Understanding how your competitors view your industry makes it possible to anticipate their likely moves.
  • Predictable or non-predictable actions — What a competitor does by comparison to what it might have done sends a signal. If a competitor meets a new product introduction
  • by doing nothing that may indicate that the competitor does not perceive the new product as a threat. On the other hand, if within weeks of the 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.

Competition: Your Moves
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 selfinterests 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.

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:

  • 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 step:

  • 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 trade off.
  • Avoid lock-in and switching costs — If switching costs are high, it becomes more difficult to leave a supplier and your fi rm 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 fl exible about prices. Integration may be full or partial.

Intra-Industry Structural Analysis
Most industries have a variety of participants who compete based on different factors. 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 technologically avant-garde?
  • Integration — Does the competitor achieve economies or presence by vertical 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?
  • Financial leverage — Does the firm carry a higher-than-industry-standard amount of debt. If so, why?
  • Relationship with a powerful parent — A competitor’s relationship with a parent company usually affects its strategy, its ability to invest and so on.
  • Government relationships — In some jurisdictions, a privileged relationship with the government can affect borrowing and funding costs, access to contracts, the ability of competitors to penetrate certain markets or businesses, and other factors.
  • To make it possible to map the strategic categories in your industry, identify and classify industry participants according to their competitive strategies. Often, an industry has a number of firms pursuing several strategies. Barriers to entry differ depending on which strategic groups a new entrant tries to penetrate, and whether the entrant comes from another industry altogether or merely from another strategic group in the same industry.

The Evolution of Industries
The evolution of your industry is an important factor in strategy because industries do change. At different stages of evolution, an industry may be more or less promising as a venue in which to invest or compete. Barriers to entry tend to rise as industries mature. These barriers can occur in technology, dealer networks, distribution, substitute products, customer support or financing. The structural analysis outlined above is the starting point for understanding industry evolution. To analyze the evolution of your industry, complement your understanding of those five factors by asking, “What is changing, and how will it affect the rest of these elements?” The answer will vary according to whether the industry is global, fragmented, emerging, in transition or declining.

About the Author
Michael E. Porter is the C. Roland Christensen Professor of Business Administration at the Harvard Business School. He has received the Wells Prize in Economics, the Adam Smith Award, three McKinsey Awards and numerous other honors.


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