Competitive Strategy: Techniques for Analyzing Industries and Competitors

Introduction

When Competitive Strategy was first published eighteen years ago, I hoped that it would have an impact. There were reasons to hope, because the book rested on a body of research that had stood the test of peer review, and the draft chapters had survived the scrutiny of my MBA and executive students.

The reception of the book and the role it has played in launching a new field, however, exceeded my most optimistic expectations. Most business school students around the world are exposed to the ideas in the book, invariably in core courses on policy or strategy, but often in specialized elective courses on competitive strategy and also in fields such as economics, marketing, technology management, and information systems. Practitioners in both large and small companies have internalized the ideas, as I learn from numerous thoughtful letters, personal conversations, and now E-mails. Most strategic consultants use the ideas in the book, and entire firms have emerged to assist companies in employing them. Budding financial analysts must read the book prior to certification.

Competitive strategy, and its core disciplines of industry analysis, competitor analysis, and strategic positioning, are now an accepted part of management practice. That a large number of thoughtful practitioners have embraced the book as a powerful tool has fulfilled a career-long desire to influence what happens in the real world.

Competitive strategy has also become an academic field in its own right. Now rich with its own competing ideas, this field is prominent among management researchers. It has also become a thriving area of inquiry among economists. The extent and vitality of the body of literature that traces in some way from the book, whether pro or con, is enormously gratifying. The number of outstanding scholars who are working in this field—some of whom I have had the privilege of teaching, mentoring, and writing with— has fulfilled my central aspiration of influencing the path of knowledge.

The re-issue of Competitive Strategy has led me to ponder the reasons for the book’s impact. They are clearer to me now with the passage of time. Competition has always been central to the agenda of companies, but it certainly did not hurt that the book came at a time when companies all over the world were struggling to cope with growing competition. Indeed, competition has become one of the enduring themes of our time. The rising intensity of competition has continued until this day, and spread to more and more countries. Translations of the book in mainland China (1997) or into Czech, Slovak, Hungarian, Polish, or Ukrainian would have been unthinkable in 1980.

The book filled a void in management thinking. After several decades of development, the role of general managers versus specialists was becoming better defined. Strategic planning had become widely accepted as the important task of charting a long-term direction for an enterprise. Early thinkers in the field such as Kenneth Andrews and C. Roland Christensen had raised some important questions in developing a strategy, as I note in Competitive Strategy's original introduction. Yet there were no systematic, rigorous tools for answering these questions—assessing a company’s industry, understanding competitors, and choosing a competitive position. Some newly founded strategy consulting firms had moved to fill this void, but the ideas they put forward, such as the experience curve, rested on a single presumed basis of competition and a single type of strategy.

Competitive Strategy offered a rich framework for understanding the underlying forces of competition in industries, captured in the five forces. The framework reveals the important differences among industries, how industries evolve, and helps companies find a unique position. Competitive Strategy provided tools for capturing the richness and heterogeneity of industries and companies while providing a disciplined structure for examining them. The book also brought structure to the concept of competitive advantage through defining it in terms of cost and differentiation, and linking it directly to profitability. Managers looking for concrete ways to tackle strategic planning’s difficult questions quickly embraced the book, which rang true to practitioners.

The book also signaled a new direction and provided an impetus for economic thinking. The economic theory of competition at the time was highly stylized. Economists focused mainly on industries; companies were presumed equal or differing primarily in size or in unexplained differences in efficiency. The prevailing view of industry structure encompassed seller concentration and a few sources of barriers to entry. Managers were all but absent in economic models, with virtually no latitude to affect competitive outcomes. Economists were concerned mainly with the societal and public policy consequences of alternative industry structures and patterns of competition. The aim was to push excess profits down. Few economists had ever even considered the question of what the nature of competition implied for company behavior, or how to push profits up. Moreover, economists also lacked the tools to model competition among small numbers of firms whose behavior affected each other. Competitive Strategy identified a range of phenomena that economists, armed with new game-theoretic techniques, have begun to explore mathematically for the first time.

My training and assignments—first an MBA, then an economics PhD, then the unique Harvard Business School challenge of using the case method to teach practitioners—revealed the gap between actual competition and the stylized models. They also created a sense of urgency to develop tools that would inform actual choices in real markets. With rich industry and company knowledge from many case studies, I was able to offer a more sophisticated view of industry competition and bring some structure to the question of how a firm could outperform its rivals. Industry structure involved five forces, not two. Competitive positions could be thought of in terms of cost, differentiation, and scope. In my theory, managers had important latitude to influence industry structure and to position the company relative to others.

Market signaling, switching costs, barriers to exit, cost versus differentiation, and broad versus focused strategies were just some of the new concepts explored in the book that proved to be fertile avenues for research, including the use of game theory. My approach helped open up new territory for economists to explore, and offered economists in business schools a way of moving beyond the teaching of standard economic concepts and models. Competitive Strategy has not only been widely used in teaching but has motivated and served as a starting point in other efforts to bring economic thinking to bear on practice.¹

What has changed since the book was published? In some ways, everything has changed. New technologies, new management tools, new growth industries, and new government policies have appeared and reappeared. But in another sense, nothing has changed. The book provides an underlying framework for examining competition that transcends industries, particular technologies, or management approaches. It applies to high-tech, low-tech, and service industries. The advent of the Internet can alter barriers to entry, reshape buyer power, or drive new patterns of substitution, for example, yet the underlying forces of industry competition stay the same. Industry changes make the ideas in the book even more important, because of the need to rethink industry structure and boundaries. While 1990s companies may look very different than 1980s companies or 1970s companies, superior profitability within an industry still rests on relative cost and differentiation. One may believe that faster cycle time or total quality hold the key to competing, but the acid test comes in how these practices affect industry rivalry, a company’s relative cost position, or its ability to differentiate itself and command a price premium.

The ideas in the book have endured for the very reason that they addressed the underlying fundamentals of competition in a way that is independent of the specifics of the ways companies go about competing. A number of other books on competition have come and gone because they were really about special cases, or were grounded not in the principles of competitive strategy but in particular competitive practices. That is not to say that Competitive Strategy is the last word on the subject. Quite the contrary, and there is much important thinking that has advanced knowledge, and more will follow. Competitive Strategy remains, however, an enduring foundation and grounding point for thinking about industry competition and positioning within industries to which other ideas can be added and integrated.

What would I modify or change? This is a challenging question for any author to answer objectively. Competitive Strategy could clearly be enriched in the form of new examples, in both old and new industries. The concepts are just as powerful in services as in products, and more service examples could be added. The frameworks have been applied in virtually all significant countries, and an internationalization of the examples would be very much in order. While the industries, companies, and countries change, however, the power of the concepts is enduring.

On the level of ideas, I can honestly say that there is nothing yet that I am persuaded to retract. This does not mean that we have not pushed learning further. Various parts of the framework have been tested, challenged, deepened, and importantly extended by others, mostly academics. It is a source of pride, and some discomfort, that Competitive Strategy has so often been a foil for other authors. It is impossible here to do justice to this literature, which offers much new insight. The supplier side has been fleshed out, for example, as has our understanding of the theoretical underpinnings of barriers to entry. Also, while firms inevitably have a bargaining relationship with suppliers and buyers, firms can enhance total value to be divided by working cooperatively with buyers, suppliers, and producers of complementary products. This was developed in my later book Competitive Advantage, and in subsequent literature.²

Finally, empirical work has verified many of Competitive Strategy’s propositions.

Competitive Strategy has certainly stirred its share of controversy. Some of it involves misunderstandings, and suggests areas where the presentation could be clearer. For example, some have criticized the book for implying a static framework in a world that is rapidly changing. Nothing static was ever intended. Each part of the framework—industry analysis, competitor analysis, competitive positioning—stresses conditions that are subject to change. Indeed, the frameworks reveal the dimensions of change that will be the most significant. Much of the book is about how to understand and deal with change: e.g., industry evolution (Chapter 8); emerging industries (Chapter 10); dealing with industry maturity (Chapter 11); declining industries (Chapter 12); and globalization (Chapter 13). Companies can never stop learning about their industry, their rivals, or ways to improve or modify their competitive position.

Another misunderstanding revolves around the need to choose between low cost and differentiation. My position is that being the lowest cost producer and being truly differentiated and commanding a price premium are rarely compatible. Successful strategies require choice or they can be easily imitated. Becoming stuck in the middle—the phrase I introduced—is a recipe for disaster. Sometimes companies such as Microsoft get so far ahead that they seem to avoid the need for strategic choices, but this becomes their ultimate vulnerability.

This never meant companies could ignore cost in the pursuit of differentiation, or ignore differentiation in the pursuit of lowest cost. Nor should companies forgo improvements in one dimension that involve no sacrifice in the other. Finally, a lowest-cost or differentiated position, whether broad or focused, involves constant improvement. A strategic position is a path, not a fixed location. I have recently introduced the distinction between operational effectiveness and strategic position that helps to clarify some of this confusion.³

Other controversies raised by the book, however, reflect real differences of opinion. A school of thought has emerged which argues that industries are not important to strategy, because industry structure and boundaries are said to change so rapidly or because profitability is seen as dominated by individual firm position. I have always argued that both industry and position are important, and that ignoring either one exposes a firm to peril. Industry differences in average profitability are large and enduring. Recent statistical evidence confirms the importance of industry in explaining both firm profitability and stock market performance, and finds that industry differences are remarkably stable even in the 1990s.⁴

It also suggests that industry attributes are important in explaining the dispersion of profitability within industries.⁵

It is hard to concoct a logic in which the nature of the arena in which firms compete would not be important to performance outcomes.

Industry structure, embodied in the five competitive forces, provides a way to think about how value is created and divided among existing and potential industry participants. It highlights the fact that competition is more than just rivalry with existing competitors. While there can be ambiguity about where to draw industry boundaries, one of the five forces always captures the essential issues in the division of value. Some have argued for the addition of a sixth force, most often government or technology. I remain convinced that the roles of government or technology cannot be understood in isolation, but through the five forces.

Another school of thought asserts that factor market (input) conditions take primacy over industry competition in determining company performance. Again, there is no empirical evidence to weigh against the considerable evidence about the role of industry, and supplier conditions are part of industry structure. While resources, capabilities, or other attributes related to input markets have a place in understanding the dynamics of competition, attempting to disconnect them from industry competition and the unique positions that firms occupy vis-à-vis rivals is fraught with danger. The value of resources and capabilities is inextricably bound with strategy. No matter how much we learn about what goes on inside firms, then, understanding industries and competitors will continue to be essential to guide what firms should aim to do.

Finally, in recent years there have been some who argue that firms should not choose competitive positions at all but concentrate on, variously, staying flexible, incorporating new ideas, or building up critical resources or core competencies that are portrayed as independent of competitive position.

I respectfully disagree. Staying flexible in strategic terms renders competitive advantage almost unobtainable. Jumping from strategy to strategy makes it impossible to be good at implementing any of them. Continuous incorporation of new ideas is important to maintaining operational effectiveness. But this is surely not at all inconsistent with having a consistent strategic position.

Concentrating only on resources/competencies and ignoring competitive position runs the risk of becoming inward looking. Resources or competencies are most valuable for a particular position or way of competing, not in and of themselves. While the resource/competency perspective can be useful, it does not diminish the crucial need in a particular business to understand industry structure and competitive position. Again, the need to connect competitive ends (a company’s position in the marketplace) and means (what elements allow it to attain that position) is not just crucial but essential.

Competitive Strategy was written at a different time, and spawned not only extensions but competing perspectives. Yet in a curious way, appreciation of the importance of strategy is growing today. Preoccupation with issues internal to companies over the last decade had limits that are becoming apparent, and there is a renewed awareness of the importance of strategy. With greater perspective and less youthful enthusiasm, I hope we can now see, more clearly than ever, the place of competitive strategy in the broader palette of management, and develop a renewed appreciation for an integrated view of competition.

Michael E. Porter

Brookline, Massachusetts

January 1998

1

. Notable examples include S. Oster, Modern Competitive Analysis, Second Edition, Oxford University Press, 1994; A. Dixit and B. Nalebuff, Thinking Strategically: The Competitive Edge in Business, Politics, and Everyday Life, W. W. Norton & Company, New York, 1991; and D. Besanko, D. Dranove; and M. Shanley, The Economics of Strategy, Northwestern University, 1996.

2

. The most important single contribution is A. Brandenburger and B. Nalebuff, Co-opetition, Currency/Doubleday, New York, 1996.

3

. M. E. Porter, What is Strategy?, Harvard Business Review; November-December 1996.

4

. In assessing the statistical evidence, it is important also to note that the relative contribution of industry in explaining profitability is biased downward by overly broad SIC code industry definitions, overly broad line of business definitions in financial reporting, and the fact that partitioning of variance techniques artificially diminishes the measured contribution of industry. See A. McGahan and M.E. Porter, What Do We Know About Variance in Accounting Profitability?, Harvard Business School manuscript, August 1997.

5

. See also A. McGahan and M.E. Porter, How Much Does Industry Matter, Really?, Strategic Management Journal, July 1997, pp. 15-30; A. McGahan and M.E. Porter, The Persistence of Shocks to Profitability, Harvard Business School working paper, January 1997; A. McGahan and M.E. Porter, The Emergence and Sustainability of Abnormal Profits, Harvard Business School working paper, May 1997; A. McGahan, The Influence of Competitive Positioning on Corporate Performance, Harvard Business School working paper, May 1997; and J.W. Rivkin, Reconcilable Differences: The Relationship Between Industry Conditions and Firm Effects, unpublished working paper, Harvard Business School, 1997.

Preface

This book, which marks an important place in an intellectual journey that I have been on for much of my professional life, grows out of my research and teaching in industrial organization economics and in competitive strategy. Competitive strategy is an area of primary concern to managers, depending critically on a subtle understanding of industries and competitors. Yet the strategy field has offered few analytical techniques for gaining this understanding, and those that have emerged lack breadth and comprehensiveness. Conversely, since economists have long studied industry structure, but mostly from a public policy perspective, economic research has not addressed itself to the concerns of business managers.

As one teaching and writing in both business strategy and industrial economics, my work at the Harvard Business School over the past decade has sought to help bridge this gap. The genesis of this book was in my research on industrial economics, which began with my doctoral dissertation and has continued since. The book became a fact as I prepared material to use in the Business Policy course at the school in 1975 and as I developed a course called Industry and Competitive Analysis and taught it to MBA and executive students over the last several years. I not only drew on statistically based scholarly research in the traditional sense but also on studies of hundreds of industries that have been the result of preparation of teaching materials, my own research, supervision of dozens of industry studies by teams of MBA students, and my work with U.S. and international companies.

This book is written for practitioners who need to develop strategy for a particular business and for scholars trying to understand competition better. It is also directed at others who want to understand their industry and competitors. Competitive analysis is important not only in the formulation of business strategy but also in corporate finance, marketing, security analysis, and many other areas of business. I hope that the book will offer valuable insight to practitioners in many different functions and at many organizational levels.

It is also hoped that the book will contribute to the development of sound public policy toward competition. Competitive Strategy examines the way in which a firm can compete more effectively to strengthen its market position. Any such strategy must occur in the context of rules of the game for socially desirable competitive behavior, established by ethical standards and through public policy. The rules of the game cannot achieve their intended effect unless they anticipate correctly how businesses respond strategically to competitive threats and opportunities.

I have had considerable help and support in making this book a reality. The Harvard Business School lent a unique setting in which to do this research, and Deans Lawrence Fouraker and John McArthur have provided useful comments, institutional support, and, most importantly, encouragement right from the beginning. The Division of Research at the School extended much of the financial support for the study, in addition to support from the General Electric Foundation. Richard Rosenbloom, as Director of the Division of Research, has been not only a patient investor but also a valued source of commentary and advice.

The study would not have been possible without the efforts of a highly talented and dedicated group of research associates who have worked with me over the last five years in conducting industry research and preparing case material. Jessie Bourneuf, Steven J. Roth, Margaret Lawrence, and Neal Bhadkamkar—all MBA’s from Harvard—have each spent at least one year working with me full time on the study.

I have also benefited very much from research by a number of my doctoral students in the area of competitive strategy. Kathryn Harrigan’s work on declining industries was a major contribution to Chapter 12. Work by Joseph D’Cruz, Nitin Mehta, Peter Patch, and George Yip has also enriched my appreciation of important topics covered in the book.

My colleagues at Harvard and associates in outside firms have played a central role in developing the book. Research that I coauthored with Richard Caves, a valued friend and colleague, made an important intellectual contribution to the book; he has also commented perceptively on the entire manuscript. Members of the Business Policy faculty at Harvard, particularly Malcolm Salter and Joseph Bower, helped me to sharpen my thinking and offered valued support. Catherine Hayden, Vice President of Strategic Planning Associates, Inc. has been a continued source of ideas, besides commenting on the entire manuscript. Joint research and innumerable discussions with Michael Spence increased my understanding of strategy. Richard Meyer has taught my course in Industry and Competitive Analysis with me, and stimulated my thinking in many areas. Mark Fuller was of assistance through his work with me on case development and industry studies. Thomas Hout, Eileen Rudden, and Eric Vogt—all of the Boston Consulting Group—contributed to Chapter 13. Others who have offered encouragement and useful comments on the manuscript in its various stages include Professors John Lintner, C. Roland Christensen, Kenneth Andrews, Robert Buzzell, and Norman Berg; as well as John Nils Hanson (Gould Corporation), John Forbus (McKinsey and Company), and my editor Robert Wallace.

I also owe a great debt to Emily Feudo and particularly Sheila Barry, both of whom managed the production of the manuscript and added to my peace of mind and productivity as I worked on this study. Finally, I would like to thank my students in Industry and Competitive Analysis, Business Policy, and Field Studies in Industry Analysis courses for their patience in serving as the guinea pigs while trying out the concepts in this book, but more importantly for their enthusiasm in working with the ideas and helping me clarify my thinking in innumerable ways.

Introduction, 1980

Every firm competing in an industry has a competitive strategy, whether explicit or implicit. This strategy may have been developed explicitly through a planning process or it may have evolved implicitly through the activities of the various functional departments of the firm. Left to its own devices, each functional department will inevitably pursue approaches dictated by its professional orientation and the incentives of those in charge. However, the sum of these departmental approaches rarely equals the best strategy.

The emphasis being placed on strategic planning today in firms in the United States and abroad reflects the proposition that there are significant benefits to gain through an explicit process of formulating strategy, to insure that at least the policies (if not the actions) of functional departments are coordinated and directed at some common set of goals. Increased attention to formal strategic planning has highlighted questions that have long been of concern to managers: What is driving competition in my industry or in industries I am thinking of entering? What actions are competitors likely to take, and what is the best way to respond? How will my industry evolve? How can the firm be best positioned to compete in the long run?

Yet most of the emphasis in formal strategic planning processes has been on asking these questions in an organized and disciplined way rather than on answering them. Those techniques that have been advanced for answering the questions, often by consulting firms, either address the diversified company rather than the industry perspective or consider only one aspect of industry structure, like the behavior of costs, that cannot hope to capture the richness and complexity of industry competition.

This book presents a comprehensive framework of analytical techniques to help a firm analyze its industry as a whole and predict the industry’s future evolution, to understand its competitors and its own position, and to translate this analysis into a competitive strategy for a particular business. The book is organized into three parts. Part I presents a general framework for analyzing the structure of an industry and its competitors. The underpinning of this framework is the analysis of the five competitive forces acting on an industry and their strategic implications. Part I builds on this framework to present techniques for the analysis of competitors, buyers, and suppliers; techniques for reading market signals; game theoretic concepts for making and responding to competitive moves; an approach to mapping strategic groups in an industry and explaining differences in their performance; and a framework for predicting industry evolution.

Part II shows how the analytical framework described in Part I can be used to develop competitive strategy in particular important types of industry environments. These differing environments reflect fundamental differences in industry concentration, state of maturity, and exposure to international competition. These differing environments are crucial in determining the strategic context in which a business competes, the strategic alternatives available, and the common strategic errors. Part II examines fragmented industries, emerging industries, the transition to industry maturity, declining industries, and global industries.

Part III of the book completes the analytical framework by systematically examining the important types of strategic decisions that confront firms in competing in a single industry: vertical integration, major capacity expansion, and entry into new businesses. (Divestment is considered in detail in Chapter 12 in Part II.) The analysis of each strategic decision draws on application of the general analytical tools of Part I as well as on other economic theory and on administrative considerations in managing and motivating an organization. Part III is designed not only to help a company make these key decisions but also to give it insight into how its competitors, customers, suppliers, and potential entrants might make them.

To analyze competitive strategy for a particular business, the reader can draw on the book in a number of ways. First, the general analytical tools of Part I can be utilized. Second, the chapter or chapters from Part II that bear on the key dimensions of the firm’s industry can be used to provide some more specific guidance for strategy formulation in the business’s particular environment. Finally, if the business is considering a particular decision, the reader can refer to the appropriate chapter in Part III. Even if a particular decision is not imminent, Part III will usually be helpful in reviewing decisions that have already been made and in examining the past and present decisions of competitors.

Whereas the reader can dip into a particular chapter, a great deal is gained by having a working understanding of the entire framework as a starting point for attacking a particular strategic problem. The parts of the book are meant to enrich and reinforce each other. Sections seemingly not important to the firm’s own position may well be crucial in looking at competitors, and the broad industry circumstances or the strategic decision currently on the table may change. Reading the full book may appear formidable, but the effort will be rewarded in terms of the speed and clarity with which a strategic situation can then be assessed and a competitive strategy developed.

It will soon be apparent from reading the book that a comprehensive analysis of an industry and its competitors requires a great deal of data, some of it subtle and difficult to obtain. The book aims to provide the reader with a framework for deciding what data is particularly crucial, and how it can be analyzed. Reflecting the practical problems of doing such an analysis, however, Appendix B provides an organized approach to actually conducting an industry study, including sources of field and published data as well as guidance in field interviewing.

This book is written for practitioners, that is, managers seeking to improve the performance of their businesses, advisors to managers, teachers of management, security analysts or other observers trying to understand and forecast business success or failure, or government officials seeking to understand competition in order to formulate public policy. The book is drawn from my research in industrial economics and business strategy and my teaching experience in the MBA and executive programs at the Harvard Business School. It draws upon detailed studies of hundreds of industries with all varieties of structures and at widely differing states of maturity. The book is not written from the viewpoint of the scholar or in the style of my more academically oriented work, but it is hoped that scholars will nevertheless be interested in the conceptual approach, the extensions to the theory of industrial organization, and the many case examples.

Review: The Classic Approach to Formulation of Strategy

Essentially, developing a competitive strategy is developing a broad formula for how a business is going to compete, what its goals should be, and what policies will be needed to carry out those goals. To serve as a common starting point for the reader before plunging into the analytical framework of this book, this section will review a classic approach to strategy formulationI

that has become a standard in the field. Figures I-1

and 1-2

illustrate this approach.

Figure I-1

illustrates that competitive strategy is a combination of the ends (goals) for which the firm is striving and the means (policies) by which it is seeking to get there. Different firms have different words for some of the concepts illustrated. For example, some firms use terms like mission or objective instead of goals, and some firms use tactics instead of operating or functional policies. Yet the essential notion of strategy is captured in the distinction between ends and means.

Figure I-1

, which can be called the Wheel of Competitive Strategy, is a device for articulating the key aspects of a firm’s competitive strategy on a single page. In the hub of the wheel are the firm’s goals, which are its broad definition of how it wants to compete and its specific economic and noneconomic objectives. The spokes of the wheel are the key operating policies with which the firm is seeking to achieve these goals. Under each heading on the wheel a succinct statement of the key operating policies in that functional area should be derived from the company’s activities. Depending on the nature of the business, management can be more or less specific in articulating these key operating policies; once they are specified, the concept of strategy can be used to guide the overall behavior of the firm. Like a wheel, the spokes (policies) must radiate from and reflect the hub (goals), and the spokes must be connected with each other or the wheel will not roll.

FIGURE I-1. The Wheel of Competitive Strategy

Figure I-2

illustrates that at the broadest level formulating competitive strategy involves the consideration of four key factors that determine the limits of what a company can successfully accomplish. The company’s strengths and weaknesses are its profile of assets and skills relative to competitors, including financial resources, technological posture, brand identification, and so on. The personal values of an organization are the motivations and needs of the key executives and other personnel who must implement the chosen strategy. Strengths and weaknesses combined with values determine the internal (to the company) limits to the competitive strategy a company can successfully adopt.

FIGURE I-2. Context in Which Competitive Strategy Is Formulated

The external limits are determined by its industry and broader environment. Industry opportunities and threats define the competitive environment, with its attendant risks and potential rewards. Societal expectations reflect the impact on the company of such things as government policy, social concerns, evolving mores, and many others. These four factors must be considered before a business can develop a realistic and implementable set of goals and policies.

The appropriateness of a competitive strategy can be determined by testing the proposed goals and policies for consistency, as shown in Figure I-3

.

FIGURE I-3 Tests of Consistencya

Internal Consistency

Are the goals mutually achievable?

Do the key operating policies address the goals?

Do the key operating policies reinforce each other?

Environmental Fit

Do the goals and policies exploit industry opportunities?

Do the goals and policies deal with industry threats (including the risk of competitive response) to the degree possible with available resources?

Does the timing of the goals and policies reflect the ability of the environment to absorb the actions?

Are the goals and policies responsive to broader societal concerns?

Resource Fit

Do the goals and policies match the resources available to the company relative to competitors?

Does the timing of the goals and policies reflect the organization’s ability to change?

Communication and Implementation

Are the goals well understood by the key implementers?

Is there enough congruence between the goals and policies and the values of the key implementers to insure commitment?

Is there sufficient managerial capability to allow for effective implementation?

a

These questions are a modified version of those developed in Andrews (1971).

These broad considerations in an effective competitive strategy can be translated into a generalized approach to the formulation of strategy. The outline of questions in Figure I-4

gives such an approach to developing the optimal competitive strategy.

FIGURE 1-4 Process for Formulating a Competitive Strategy

A.  What is the Business Doing Now?

1.  Identification

What is the implicit or explicit current strategy?

2.  Implied Assumptions II

What assumptions about the company’s relative position, strengths and weaknesses, competitors, and industry trends must be made for the current strategy to make sense?

B.  What is Happening in the Environment?

1.  Industry Analysis

What are the key factors for competitive success and the important industry opportunities and threats?

2.  Competitor Analysis

What are the capabilities and limitations of existing and potential competitors, and their probable future moves?

3.  Societal Analysis

What important governmental, social, and political factors will present opportunities or threats?

4.  Strengths and Weaknesses

Given an analysis of industry and competitors, what are the company’s strengths and weaknesses relative to present and future competitors?

C.  What Should the Business be Doing?

1.  Tests of Assumptions and Strategy

How do the assumptions embodied in the current strategy compare with the analysis in B above? How does the strategy meet the tests in Figure I-3

?

2.  Strategic Alternatives

What are the feasible strategic alternatives given the analysis above? (Is the current strategy one of these?)

3.  Strategic Choice

Which alternative best relates the company’s situation to external opportunities and threats?

Although the process shown in Figure I-4

may be intuitively clear, answering these questions involves a great deal of penetrating analysis. It is answering these questions that is the purpose of this book.

I

. This section draws heavily on work by Andrews, Christensen, and others in the Policy group at the Harvard Business School. For a more complete articulation of the concept of strategy see Andrews (1971); and more recently Christensen, Andrews, and Bower (1977). These classic accounts also discuss the reasons why explicit strategy is important in a company, as well as the relationship between strategy formulation and the broader role and functions of general management. Planning strategy is far from the only thing that general management does or should do.

II

. Given the premise that managers honestly try to optimize the performance of their businesses, the current strategy being followed by a business must reflect assumptions management is making about its industry and the business’s relative position in the industry. Understanding and addressing these implied assumptions can be crucial to giving strategic advice. Usually a great deal of convincing data and support must be mustered to change these assumptions, and this is where much if not most attention needs to be focused. The sheer logic of the strategic choice is not enough; it will not be convincing if it ignores management’s assumptions.

I

General Analytical Techniques

Part I lays the analytical foundation for the development of competitive strategy, built on the analysis of industry structure and competitors. Chapter 1 introduces the concept of structural analysis as a framework for understanding the five fundamental forces of competition in an industry. This framework is the starting point from which much of the subsequent discussion in the book begins. The structural analysis framework is used in Chapter 2 to identify at the broadest level the three generic competitive strategies that can be viable in the long run.

Chapters 3, 4, and 5 deal with the other key part of the formulation of competitive strategy: competitor analysis. In Chapter 3 a framework for analyzing competitors is presented. which aids in diagnosing probable moves by competitors and their ability to react. Chapter 3 gives detailed questions that can help the analyst to assess a particular competitor. Chapter 4 shows how company behavior gives off a variety of types of market signals that can be used to enrich competitor analysis and as a basis for taking strategic actions. Chapter 5 sets forth a primer for making, influencing, and reacting to competitive moves. Chapter 6 elaborates on the concept of structural analysis for developing strategies toward buyers and suppliers.

The final two chapters of Part I bring industry and competitor analysis together. Chapter 7 shows how to analyze the nature of competition within an industry, employing the concept of strategic groups and the principle of mobility barriers that are deterrents to shifts in strategic position. Chapter 8 concludes the discussion of general analytical techniques by examining ways of predicting the process of industry evolution and some of the implications of that evolution for competitive strategy.

1

The Structural Analysis of Industries

The essence of formulating competitive strategy is relating a company to its environment. Although the relevant environment is very broad, encompassing social as well as economic forces, the key aspect of the firm’s environment is the industry or industries in which it competes. Industry structure has a strong influence in determining the competitive rules of the game as well as the strategies potentially available to the firm. Forces outside the industry are significant primarily in a relative sense; since outside forces usually affect all firms in the industry, the key is found in the differing abilities of firms to deal with them.

The intensity of competition in an industry is neither a matter of coincidence nor bad luck. Rather, competition in an industry is rooted in its underlying economic structure and goes well beyond the behavior of current competitors. The state of competition in an industry depends on five basic competitive forces, which are shown in Figure 1-1

. The collective strength of these forces determines the ultimate profit potential in the industry, where profit potential is measured in terms of long run return on invested capital. Not all industries have the same potential. They differ fundamentally in their ultimate profit potential as the collective strength of the forces differs; the forces range from intense in industries like tires, paper, and steel—where no firm earns spectacular returns—to relatively mild in industries like oil-field equipment and services, cosmetics, and toiletries—where high returns are quite common.

FIGURE 1-1. Forces Driving Industry Competition

This chapter will be concerned with identifying the key structural features of industries that determine the strength of the competitive forces and hence industry profitability. The goal of competitive strategy for a business unit in an industry is to find a position in the industry where the company can best defend itself against these competitive forces or can influence them in its favor. Since the collective strength of the forces may well be painfully apparent to all competitors, the key for developing strategy is to delve below the surface and analyze the sources of each. Knowledge of these underlying sources of competitive pressure highlights the critical strengths and weaknesses of the company, animates its positioning in its industry, clarifies the areas where strategic changes may yield the greatest payoff, and highlights the areas where industry