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137

Awareness of these forees can


How help a company stake out
competitive forces a position in its industry that
is less vulnerable to attack
shape strategy

Michael E. Porter

The nature and degree consults on strategy mat- The essenee of strategy formulation is coping with
of competition in an in- ters, and he has written competition. Yet it is easy to view competition too
dustry hinge on five many articles for econom- narrowly and too pessimistically. While one some-
forces: the threat of new ics journals and published times hears executives eomplaining to the eontrary,
entrants, the bargaining two books. One of them, intense eompetition in an industry is neither coin-
power of customers, the Interbrand Choice, Strat- eidence nor bad luck.
bargaining power of sup- egy and Bilateral Market
pliers, the threat of sub- Power (Harvard Univer- Moreover, in the fight for market share, compe-
stitute products or sity Press, 1976) is an out- tition is not manifested only in the other players.
services (where applicahle), growth of his doctoral Rather, competition in an industry is rooted in its
and the jockeying among thesis, for which he won underlying economics, and competitive forces exist
current contestants. the coveted Wells prize that go well beyond the established combatants in
To estahlish a strategic awarded by the Harvard a particular industry. Customers, suppliers, poten-
agenda for dealing with economics department. tial entrants, and substitute products are all com-
these contending currents He has recently completed petitors that may be more or less prominent or ac-
and to grow despite them, two book manuscripts, tive depending on the industry.
a company must under- one on competitive
stand how they work in analysis in industry and
The state of competition in an industry depends
its industry and how they the other (written with on five basic forces, which are diagrammed in the
affect the company in its Michael Spence and Exhibit on page 141. The collective strength of these
particular situation. The Richard Caves) on compe- forces determines the ultimate profit potential of
author details how these tition in the open an industry. It ranges from intense in industries
forces operate and sug- economy. like tires, metal eans, and steel, where no company
gests ways of adjusting to earns spectacular returns on investment, to mild in
them, and, where possihle, industries like oil field services and equipment, soft
of taking advantage of drinks, and toiletries, where there is room for quite
them. high returns.
In the economists' "perfeetly competitive" indus-
Mr. Porter is a specialist try, jockeying for position is unbridled and entry to
in industrial economics
and business strategy. An
the industry very easy. This kind of industry struc-
associate professor of husi- ture, of course, offers the worst prospect for long-
ness administration at the run profitability. The weaker the forces collectively,
Harvard Business School, however, the greater the opportunity for superior
he has created a course performance.
there entitled "Industry Whatever their eoUeetive strength, the eorporate
and Competitive Analy- strategist's goal is to find a position in the industry
sis." He sits on the hoards where his or her company can best defend itself
of three companies and against these forees or ean influence them in its
favor. The collective strength of the forces may be
138 Harvard Business Review March-April 1979

painfully apparent to all the antagonists; hut to cope A few eharacteristics are critical to the strength
with them, the strategist must delve below the sur- of eaeh competitive force. I shall diseuss them in
face and analyze the sources of each. For example, this section.
what makes the industry vulnerable to entry? What
determines the bargaining power of suppliers?
Knowledge of these underlying sources of eom- Threat of entry
petitive pressure provides the groundwork for a
strategic agenda of action. They highlight the criti- New entrants to an industry bring new eapaeity,
eal strengths and weaknesses of the company, ani- the desire to gain market share, and often substan-
mate the positioning of the company in its industry, tial resources. Companies diversifying through ac-
clarify the areas where strategic ehanges may yield quisition into the industry from other markets often
the greatest payoff, and highlight the places where leverage their resources to cause a shake-up, as
industry trends promise to hold the greatest signif- Philip Morris did with Miller beer.
icance as either opportunities or threats. Under- The seriousness of the threat of entry depends on
standing these sources also proves to be of help in the harriers present and on the reaction from exist-
considering areas for diversification. ing competitors that the entrant can expect. If barri-
ers to entry are high and a newcomer can expect
sharp retaliation from the entrenched eompeti-
tors, obviously he will not pose a serious threat of
entering.
There are six major sources of barriers to entry:
Contending forces 1. Economies of scale—These economies deter en-
try by foreing the aspirant either to come in on a
large seale or to accept a eost disadvantage. Seale
The strongest eompetitive foree or forces determine eeonomies in produetion, researeh, marketing, and
the profitability of an industry and so are of greatest serviee are prohably the key barriers to entry in the
importance in strategy formulation. For example, mainframe computer industry, as Xerox and GE
even a company with a strong position in an indus- sadly discovered. Eeonomies of seale ean also act as
try unthreatened by potential entrants will earn hurdles in distribution, utilization of the sales foree,
low returns if it faces a superior or a lower-eost sub- finaneing, and nearly any other part of a business.
stitute product—as the leading manufaeturers of 2. Product differentiation—Brand identification
vacuum tubes and coffee percolators have learned ereates a barrier by forcing entrants to spend heavily
to their sorrow. In such a situation, coping with the to overcome customer loyalty. Advertising, eustom-
substitute product becomes the number one strate- er service, being first in the industry, and product
gie priority. differenees are among the faetors fostering hrand
Different forees take on prominenee, of eourse, identification. It is perhaps the most important entry
in shaping eompetition in each industry. In the barrier in soft drinks, over-the-counter drugs, cos-
oeean-going tanker industry the key foree is prob- meties, investment banking, and public aeeounting.
ably the buyers (the major oil companies), while in To create high fences around their businesses, brew-
tires it is powerful OEM buyers coupled with tough ers eouple brand identifieation with eeonomies of
competitors. In the steel industry the key forces are seale in production, distribution, and marketing.
foreign competitors and substitute materials. 3. Capital requirements—The need to invest large
Every industry has an underlying strueture, or finaneial resourees in order to compete ereates a
a set of fundamental economic and technical char- barrier to entry, particularly if the eapital is required
acteristics, that gives rise to these competitive forces. for unreeoverable expenditures in up-front advertis-
The strategist, wanting to position his company to ing or R&D. Capital is necessary not only for fixed
cope best with its industry environment or to in- facilities but also for customer credit, inventories,
fiuenee that environment in the company's favor, and absorbing start-up losses. While major corpora-
must leam what makes the environment tiek. tions have the financial resources to invade almost
This view of eompetition pertains equally to in- any industry, the huge capital requirements in eer-
dustries dealing in services and to those selling tain fields, such as eomputer manufacturing and
products. To avoid monotony in this artiele, I re- mineral extraction, limit the pool of likely entrants.
fer to both products and services as "produets." 4. Cost disadvantages independent of size—En-
The same general prineiples apply to all types of trenched companies may have eost advantages not
business. available to potential rivals, no matter what their
Cotnpetition shapes strategy 139

The experience curve as an entry barrier


In recent years, the experience ership to maximize this barrier to lot different from, "You must less experience to reduce their
curve has become widely dis- entry, and they recommend produce the greatest cumulative costs than the leaders needed.
cussed as a key element of aggressive action to achieve it, output of the item to get your All this suggests that the experi-
industry structure. According to such as price cutting in anticipa- costs down." ence curve can be a shaky
this concept, unit costs in many tion of falling costs in order to Whether a drop in costs with entry barrier on which to build a
manufacturing industries (some build volume. For the combatant cumulative (not absolute) vol- strategy.
dogmatic adherents say in all that cannot achieve a healthy ume erects an entry barrier also While space does not permit a
manufacturing industries) as market share, the prescription is depends on the sources of the complete treatment here, I want
well as in some service indus- usually, "Get out." decline. If costs go down to mention a few other crucial
tries decline with "experience," Is the experience curve an because of technical advances elements in determining the
or a particular company's cumu- entry barrier on which strategies known generally In the industry appropriateness of a strategy
lative volume of production. should be built? The answer is: or because of the development built on the entry barrier pro-
(The experience curve, which not in every industry. In fact, in of improved equipment that can vided by the experience curve;
encompasses many factors, is a some industries, building a strat- be copied or purchased from D The height of the barrier
broader concept than the better- egy on the experience curve can equipment suppliers, the experi- depends on how important costs
known learning curve, which be potentially disastrous. That ence curve is no entry barrier at are to competition compared
refers to the efficiency achieved costs decline with experience in all-infacf, new or less experi- with other areas like marketing,
over a period of time by workers some industries is not news to enced competitors may actually selling, and innovation.
through much repetition.) corporate executives. The sig- enjoy a cost advantage over the D The barrier can be nullified
The causes of the decline in nificance of the experience leaders. Free of the legacy of by product or process innova-
unit costs are a combination of curve for strategy depends on heavy past investments, the tions leading to a substantially
elements, including economies what factors are causing the newcomer or less experienced new technology and thereby
of scale, the learning curve for decline. competitor can purchase or creating an entirely new experi-
labor, and capital-labor substitu- If costs are falling because a copy the newest and lowest-cost ence curve.' New entrants can
tion. The cost decline creates a growing company can reap equipment and technology. leapfrog the industry leaders
barrier to entry because new economies of scale through If, however, experience can and alight on the new experi-
competitors with no "experi- more efficient, automated facili- be kept proprietary, the leaders ence curve, to which those
ence" face higher costs than ties and vertical integration, then will maintain a cost advantage. leaders may be poorly posi-
established ones, particularly the cumulative volume of pro- But new entrants may require tioned to jump.
the producer with the largest duction is unimportant to its rela- D If more than one strong
market share, and have difficulty tive cost position. Here the company is building its strategy
catching up with the entrenched lowest-cost producer is the one on the experience curve, the
competitors. with the largest, most efficient consequences can be nearly
Adherents of the expenence facilities. fatal. By the time only one rival is
curve concept stress the impor- A new entrant may well be left pursuing such a strategy,
tance of achieving market lead- more efficient than the more industry growth may have
experienced competitors; if it stopped and the prospects of
has built the newest plant, it will reaping the spoils of victory long
face no disadvantage in having since evaporated.
to catch up. The strategic pre-
scription, "You must have the
largest, most efficient plant," is a

"For an example drawn Irom Ihehisiory of the automobile induslry, see William J.
Abemathy and Kenneth Wayne. "The Limits of the Learning Curve," HBR September-
October 1974, p.109.

size and attainable economics of scale. These ad- ample, must displace others from the supermarket
vantages ean stem from the effeets of the learning shelf via price breaks, promotions, intense selling
eurve (and of its first eousin^ the experienee eurve), efforts, or some other means. The more limited the
proprietary teehnology, aceess to the best raw ma- wholesale or retail channels are and the more that
terials sources, assets purchased at preinflation existing competitors have these tied up, obviously
prices, government subsidies, or favorable loeations. the tougher that entry into the industry will be.
Sometimes eost advantages are legally enforceable, Sometimes this barrier is so high that, to surmount
as they are through patents. (For an analysis of the it, a new contestant must create its own distribution
much-diseussed experience eurve as a barrier to channels, as Timex did in the watch industry in
entry, see the ruled insert ahove.) t h e 19SOS.
5. Access to distribution channels—The new boy 6. Government policy—The government can limit
on the block must, of course, secure distribution of or even foreclose entry to industries with such con-
his product or service. A new food product, for ex- trols as license requirements and limits on access to
140 Harvard Business Review March-April 1979

raw materials. Regulated industries like trucking, Powerful suppliers &l buyers
liquor retailing, and freight forwarding are notice-
able examples; more subtle government restrietions Suppliers can exert bargaining power on participants
operate in fields like ski-area development and coal in an industry by raising prices or reducing the
mining. The government also can play a major in- quality of purchased goods and services. Powerful
direct role by affecting entry barriers through con- suppliers can thereby squeeze profitability out of an
trols such as air and water pollution standards and industry unable to recover cost increases in its own
safety regulations. prices. By raising their prices, soft drink concentrate
producers have contributed to the erosion of profit-
The potential rival's expectations about the reaction ability of bottling companies because the bottlers,
of existing competitors also will influence its deci- facing intense competition from powdered mixes,
sion on whether to enter. The company is likely to fruit drinks, and other beverages, have limited free-
have second thoughts if incumbents have previ- dom to raise their prices accordingly. Customers
ously lashed out at new entrants or if: likewise ean foree down prices, demand higher
• The incumbents possess substantial resources quality or more service, and play competitors off
to fight baek, including excess cash and unused bor- against each other—all at the expense of industry
rowing power, productive capacity, or clout with dis- profits.
tribution channels and customers. The power of each important supplier or buyer
• The incumbents seem likely to cut prices be- group depends on a numher of characteristics of its
cause of a desire to keep market shares or because market situation and on the relative importance of
of industrywide excess capacity. its sales or purchases to the industry compared with
n Industry growth is slow, affecting its ability to its overall business.
absorb the new arrival and probably causing the A suppher group is powerful if:
financial performance of all the parties involved to D It is dominated by a few companies and is more
decline. concentrated than the industry it sells to.
D Its product is unique or at least differentiated,
Changing conditions or if it has built up switching costs. Switching costs
From a strategic standpoint there are two important are fixed costs buyers face in changing suppliers.
additional points to note about the threat of entry. These arise beeause, among other things, a buyer's
First, it changes, of course, as these conditions product speeifications tie it to particular suppliers,
change. The expiration of Polaroid's basic patents it has invested heavily in specialized ancillary equip-
on instant photography, for instance, greatly re- ment or in learning how to operate a supplier's
duced its absolute cost entry barrier built by pro- equipment [as in computer software), or its produc-
prietary teehnology. It is not surprising that Kodak tion lines are connected to the supplier's manufac-
plunged into the market. Product differentiation in turing facilities (as in some manufacture of beverage
printing has all hut disappeared. Conversely, in the containers).
auto industry economies of scale increased enor- D It is not obliged to contend with other products
mously with post-World War II automation and ver- for sale to the industry. For instance, the competi-
tical integration—virtually stopping successful new tion between the steel companies and the alum-
entry. inum companies to sell to the can industry checks
Second, strategic deeisions involving a large seg- the power of each supplier.
ment of an industry can have a major impact on the n It poses a credible threat of integrating forward
conditions determining the threat of entry. For ex- into the industry's business. This provides a check
ample, the actions of many U.S. wine producers in against the industry's ability to improve the terms
the r96os to step up product introductions, raise ad- on which it purchases.
vertising levels, and expand distribution nationally D The industry is not an important customer of
surely strengthened the entry roadblocks by raising the supplier group. If the industry is an important
economies of scale and making access to distribution customer, suppliers' fortunes will be closely tied to
channels more difficult. Similarly, decisions by the industry, and they will want to protect the in-
members of the recreational vehicle industry to dustry through reasonable pricing and assistance in
vertically integrate in order to lower costs have activities like R&D and lobbying.
greatly increased the economies of scale and raised
the capital cost barriers. A buyer group is powerful if:
• It is concentrated or purchases in large vol-
umes. Large-volume buyers are particularly potent
Competition shapes strategy 141

forces if heavy fixed costs characterize the industry


Exhibit
—as they do in metal containers, eorn refining, and Forces governing competition in an industry
bulk chemicals, for example—which raise the stakes
to keep capacity filled.
D The products it purchases from the industry
are standard or undifferentiated. The buyers, sure
that they can always find alternative suppliers, may
play one company against another, as they do in
aluminum extrusion.
D The products it purchases from the industry
form a component of its product and represent a
significant fraction of its cost. The buyers are likely
to shop for a favorable priee and purehase selec-
tively. Where the product sold by the industry in
question is a small fraction of buyers' costs, buyers
are usually much less price sensitive.
• It earns low profits, which create great incen-
tive to lower its purehasing costs. Highly profitable
buyers, however, are generally less price sensitive
(that is, of course, if the item does not represent a
large fraction of their costs).
D The industry's product is unimportant to the
quality of the buyers' products or services. Where
the quality of the buyers' products is very much
affected by the industry's product, buyers are gen-
erally less price sensitive. Industries in which this
situation obtains include oil field equipment, where
a malfunction can lead to large losses, and en-
closures for electronic medical and test instruments,
where the quality of the enclosure can influence the
user's impression about the quality of the equip- sive relative to their incomes, and of a sort where
ment inside. quality is not particularly important.
n The industry's product does not save the buyer The buying power of retailers is determined by
money. Where the industry's product or service can the same rules, with one important addition. Re-
pay for itself many times over, the buyer is rarely tailers can gain significant bargaining power over
price sensitive; rather, he is interested in quality. manufacturers when they can influence consumers'
This is true in services like investment banking and purchasing decisions, as they do in audio compo-
public accounting, where errors in judgment can be nents, jewelry, appliances, sporting goods, and other
costly and embarrassing, and in businesses like the goods.
logging of oil wells, where an accurate survey can
save thousands of dollars in drilling costs. Strategic action
• The buyers pose a credible threat of integrat- A company's choice of suppliers to buy from or
ing backward to make the industry's product. The buyer groups to sell to should be viewed as a crucial
Big Three auto producers and major buyers of cars strategic decision. A company can improve its stra-
have often used the threat of self-manufacture as a tegie posture by finding suppliers or buyers who
bargaining lever. But sometimes an industry en- possess the least power to inffuence it adversely.
genders a threat to huyers that its members may in- Most common is the situation of a company being
tegrate forward. able to choose whom it will sell to—in other words,
buyer selection. Rarely do all the buyer groups a
Most of these sources of buyer power can be at- company sells to enjoy equal power. Even if a com-
tributed to consumers as a group as well as to in- pany sells to a single industry, segments usually exist
dustrial and commercial buyers; only a modifica- within that industry that exercise less power [and
tion of the frame of reference is necessary. Consum- that are therefore less price sensitive) than others.
ers tend to be more price sensitive if they are pur- For example, the replacement market for most pro-
chasing products that are undifferentiated, expen- ducts is less price sensitive than the overall market.
142 Harvard Business Review Miirch-April 1979

As a rule, a company can sell to powerful buyers pered by the plethora of insulation substitutes, in-
and still come away with above-average profitabil- cluding cellulose, rock wool, and styrofoam. These
ity only if it is a low-cost producer in its industry or substitutes arc bound to become an even stronger
if its product enjoys some unusual, if not unique, force once the current round of plant additions by
features. In supplying large customers with electric fiberglass insulation producers has boosted capacity
motors, Emerson Electric eams high returns because enough to meet demand (and then some).
its low cost position permits the company to meet Substitute products that deserve the most atten-
or undercut competitors' prices. tion strategically are those that (a) are subject to
If the company lacks a low cost position or a trends improving their price-performance trade-ofT
unique product, selling to everyone is self-defeating with the industry's produet, or (b) are produced by
because the more sales it achieves, the more vul- industries earning high profits. Substitutes often
nerable it becomes. The eompany may have to mus- eome rapidly into play if some development in-
ter the courage to turn away business and sell only creases competition in their industries and causes
to less potent customers. priee reduction or performance improvement.
Buyer selection has been a key to the success of
National Can and Crown Cork & Seal. They focus
on the segments of the can industry where they can Jockeying for position
create product differentiation, minimize the threat
of backward integration, and otherwise mitigate the Rivalry among existing competitors takes the famil-
awesome power of their customers. Of course, some iar form of jockeying for position—using tactics like
industries do not enjoy the luxury of selecting price competition, product introduction, and adver-
"good" buyers. tising slugfests. Intense rivalry is related to the pres-
As the factors creating supplier and buyer power ence of a number of factors:
change with time or as a result of a company's n Competitors are numerous or are roughly equal
strategic decisions, naturally the power of these in size and power. In many U.S. industries in recent
groups rises or deelines. In the ready-to-wear cloth- years foreign contenders, of course, have hecome
ing industry, as the huyers (department stores and part of the competitive picture.
clothing stores) have become more concentrated and • Industry growth is slow, precipitating fights
control has passed to large chains, the industry has for market share that involve expansion-minded
come under increasing pressure and suffered falling members.
margins. The industry has heen unable to differen- D The product or service lacks differentiation
tiate its product or engender switching costs that or switching costs, which lock in buyers and protect
lock in its buyers enough to neutralize these trends. one combatant from raids on its customers by an-
other.
D Fixed costs are high or the product is per-
Substitute products ishable, creating strong temptation to cut prices.
Many basic materials businesses, like paper and
By placing a ceiling on priecs it can charge, substi- aluminum, suffer from this problem when demand
tute products or services limit the potential of an slackens.
industry. Unless it can upgrade the quality of the n Capacity is normally augmented in large incrc-
product or differentiate it somehow (as via market- ments. Such additions, as in the chlorine and vinyl
ing), the industry will sufTcr in earnings and pos- chloride husinesses, disrupt the industry's supply-
sibly in growth. demand balance and often lead to periods of over-
Manifestly, the more attractive the price perform- capacity and price cutting.
anee trade-off offered by substitute products, the D Exit barriers are high. Exit barriers, like very
firmer the lid placed on the industry's profit poten- specialized assets or management's loyalty to a par-
tial. Sugar producers confronted with the large scale ticular business, keep companies competing even
commercialization of high-fructose corn syrup, a though they may be earning low or even negative
sugar substitute, are learning this lesson today. returns on investment. Excess capacity remains
Substitutes not only limit profits in normal times; functioning, and the profitability of the healthy
they also reduce the bonanza an industry can reap competitors suffers as the sick ones hang on.^ If
in boom times. In r978 the producers of fiberglass the entire industry suffers from overcapacity, it may
insulation enjoyed unprecedented demand as a re-
sult of high energy costs and severe winter weather. i. Fur a mure complttL- dis;:ussian of exit barriers anJ ihcit implitatinns fin
strategy, sec my article, "Please Note Lniiation of Nearest Exit," CohjoTula
But the industry's ability to raise prices was tem- Mani!f!,cmi!nt Review, Wimtr 1976, p- ^'-
Competition shapes strategy 143

seek government help—particularly if foreign com- competitive force; and/or (2) influencing the bal-
petition is present. ance of the forces through strategic moves, thereby
• The rivals are diverse in strategies, origins, and improving the company's position; and/or (3) an-
"personalities." They have different ideas about ticipating shifts in the factors underlying the forces
hovk' to compete and continually run head-on into and responding to them, with the hope of exploit-
each other in the process. ing change by choosing a strategy appropriate
for the new competitive balance before opponents
As an industry matures, its growth rate changes, re- recognize it. I shall consider each strategic approach
sulting in declining profits and (often) a shakeout. in turn.
In the hooming recreational vehicle industry of the
early 1970s, nearly every producer did well; but slow
growth since then has eliminated the high returns, Positioning the company
except for the strongest members, not to mention
many of the weaker companies. The same profit The first approach takes the structure of the indus-
story has been played out in industry after industry try as given and matches the company's strengths
—snowmobiles, aerosol packaging, and sports equip- and weaknesses to it. Strategy can he viewed as
ment are just a few examples. building defenses against the competitive forces or
An acquisition can introduce a very different per- as finding positions in the industry where the forces
sonality to an industry, as has been the case with are weakest.
Black fit Decker's takeover of McCuUough, the Knowledge of the company's capabilities and of
producer of chain saws. Teehnological innovation the causes of the competitive forces will highlight
can boost the level of fixed costs in the production the areas where the company should confront com-
process, as it did in the shift from batch to continu- petition and where avoid it. If the company is a low-
ous-line photo finishing in the 1960s. cost producer, it may choose to confront powerful
While a company must live with many of these buyers while it takes care to sell them only products
factors—because they are built into industry eco- not vulnerable to competition from substitutes.
nomics—it may have some latitude for improving The success of Dr Pepper in the soft drink in-
matters through strategic shifts. For example, it may dustry illustrates the coupling of realivStic knowledge
try to raise buyers' switching costs or increase prod- of corporate strengths with sound industry analysis
uet differentiation. A focus on selling efforts in to yield a superior strategy. Coca-Cola and Pepsi-
the fastest-growing segments of the industry or on Cola dominate Dr Pepper's industry, where many
market areas with the lowest fixed costs can reduce small concentrate produeers compete for a piece of
the impact of industry rivalry. If it is feasible, a the action. Dr Pepper chose a strategy of avoiding
eompany can try to avoid confrontation with com- the largest-selling drink segment, maintaining a nar-
petitors having high exit barriers and can thus side- row flavor line, forgoing the development of a cap-
step involvement in bitter price cutting. tive bottler network, and marketing heavily. The
company positioned itself so as to be least vulner-
able to its competitive forces while it exploited its
small size.
In the $11.s billion soft drink industry, barriers
to entry in the form of hrand identification, large-
Formulation of strategy scale marketing, and aceess to a bottler network are
enormous. Rather than accept the formidable costs
and scale economies in having its own bottler net-
Once the corporate strategist has assessed the forces work—that is, following the lead of the Big Two
affecting competition in his industry and their un- and of Seven-Up—Dr Pepper took advantage of the
derlying causes, he can identify his company's different fiavor of its drink to "piggyback" on Coke
strengths and weaknesses. The crucial strengths and and Pepsi bottlers who wanted a full line to sell
weaknesses from a strategic standpoint are the com- to customers. Dr Pepper coped with the power of
pany's posture vis-a-vis the underlying causes of these buyers through extraordinary service and
each force. Where does it stand against substitutes? other efforts to distinguish its treatment of them
Against the sources of entry barriers? from that of Coke and Pepsi.
Then the strategist can devise a plan of action that Many small companies in the soft drink business
may include (1) positioning the company so that its offer cola drinks that thrust them into head-to-head
capabilities provide the best defense against the competition against the majors. Dr Pepper, however.
144 Harvard Business Review March-April 1979

maximized product differentiation by maintaining icant trend is greatly raising economies of scale as
a narrow line of beverages built around an unusual well as the amount of capital necessary to compete
flavor. in the industry. This in tum is raising barriers to
Finally, Dr Pepper met Coke and Pepsi with an ad- entry and may drive some smaller competitors out
vertising onslaught emphasizing the alleged unique- of the industry once growth levels off.
ness of its single flavor. This campaign built strong Obviously, the trends carrying the highest prior-
brand identifieation and great customer loyalty. ity from a strategic standpoint are those that affect
Helping its efforts was the fact that Dr Pepper's the most important sources of competition in the
formula involved lower raw materials cost, which industry and those that elevate new causes to the
gave the company an absolute cost advantage over forefront. In contract aerosol packaging, for exam-
its major competitors. ple, the trend toward less product differentiation is
There are no economies of scale in soft drink now dominant. It has increased buyers' power, low-
concentrate production, so Dr Pepper could prosper ered the barriers to entry, and intensified compe-
despite its small share of the business (6%). Thus tition.
Dr Pepper confronted competition in marketing The framework for analyzing competition that I
but avoided it in product line and in distribution. have described can also be used to predict the even-
This artful positioning combined with good imple- tual profitability of an industry. In long-range plan-
mentation has led to an enviable record in earnings ning the task is to examine each competitive force,
and in the stock market. forecast the magnitude of each underlying cause,
and then construct a composite picture of the likely
profit potential of the industry.
Influencing the balance The outcome of such an exercise may differ a
great deal from the existing industry structure. To-
when dealing with the forces that drive industry day, for example, the solar heating business is pop-
competition, a company can devise a strategy that ulated by dozens and perhaps hundreds of com-
takes the offensive. This posture is designed to do panies, none with a major market position. Entry
more than merely cope with the forces themselves; is easy, and competitors are battling to establish
it is meant to alter their causes. solar heating as a superior substitute for conven-
Innovations in marketing can raise brand identifi- tional methods.
cation or otherwise differentiate the product. Capi- The potential of this industry will depend largely
tal investments in large-scale facilities or vertical in- on the shape of future barriers to entry, the im-
tegration affect entry barriers. The balance of forces provement of the industry's position relative to sub-
is partly a result of external factors and partly in stitutes, the ultimate intensity of competition, and
the company's control. the power captured by buyers and suppliers. These
eharaeteristics will in turn he influenced by such
factors as the establishment of brand identities, sig-
Exploiting industry change nificant economies of scale or experience curves in
equipment manufacture wrought by teehnological
Industry evolution is important strategically because ehange, the ultimate capital costs to compete, and
evolution, of course, brings with it changes in the the extent of overhead in production facilities.
sources of competition I have identified. In the The framework for analyzing industry competi-
familiar product life-cycle pattern, for example, tion has direct benefits in setting diversification
growth rates change, product differentiation is said strategy. It provides a road map for answering the
to decline as the business becomes more mature, extremely difficult question inherent in diversifica-
and the companies tend to integrate vertically. tion decisions: "What is the potential of this busi-
These trends are not so important in themselves; ness?" Combining the framework with judgment in
what is critical is whether they affect the sources its application, a company may be able to spot an
of competition. Consider vertical integration. In the industry with a good future before this good future
maturing minicomputer industry, extensive verti- is refiected in the prices of acquisition candidates.
cal integration, both in manufaeturing and in soft-
ware development, is taking place. This very signif-

2. Theodore Levitt, "Marketing Myopia," reprinted as an HBR Classic,


Sepicmber-Ociiibci iy7s, p. 16.
Competition shapes strategy 145

Multifaceted rivalry

Corporate managers have directed a great deal of


attention to defining their businesses as a crucial
step in strategy formulation. Theodore Levitt, in
his classic i960 article in HBR, argued strongly for
avoiding the myopia of narrow, product-oriented in-
dustry definition.- Numerous other authorities have
also stressed the need to look beyond product to
function in defining a business, beyond national
boundaries to potential international competition,
and beyond the ranks of one's competitors today to
those that may become competitors tomorrow. As
a result of these urgings, the proper definition of a
eompany's industry or industries has become an
endlessly debated subject.
One motive behind this debate is the desire to ex-
ploit new markets. Another, perhaps more impor-
tant motive is the fear of overlooking latent sources
of competition that someday may threaten the in-
dustry. Many managers concentrate so single-mind-
edly on their direet antagonists in the fight for mar-
ket share that they fail to realize that they are also
competing with their customers and their suppliers
for bargaining power. Meanwhile, they also neglect
to keep a wary eye out for new entrants to the eon-
test or fail to recognize the subtle threat of sub-
stitute produets.
The key to growth—even survival—is to stake out
a position that is less vulnerable to attack from head-
to-head opponents, whether established or new, and
less vulnerable to erosion from the direction of buy-
ers, suppliers, and substitute goods. Establishing
such a position can take many forms—solidifying
relationships with favorable customers, differentiat-
ing the product either substantively or psychologi-
cally through marketing, integrating forward or
backward, establishing technological leadership.^
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