Porter, M.E.

(March–April 1979) How Competitive Forces Shape Strategy, Harvard Business

Review.

Whatever their collective strength, the corporate strategist’s goal is to find a position in the
industry where his or her company can best defend itself against these forces or can
influence them in its favor. The collective strength of the forces may be painfully apparent
to all the antagonists; but to cope with them, the strategist must delve below the surface
and analyze the sources of each. For example, what makes the industry vulnerable to entry,
What determines the bargaining power of suppliers?

Knowledge of these underlying sources of competitive pressure provides the groundwork

for a strategic agenda of action. They highlight the critical strengths and weaknesses of the
company, animate the positioning of the company in its industry, clarify the areas where
strategic changes may yield the greatest payoff, and highlight the places where industry
trends promise to hold the greatest significance as either opportunities or threats.
Understanding these sources also proves to be of help in considering areas for
diversification.

Threat of entry

New entrants to an industry bring new capacity, the desire to gain market share, and often
substantial resources. Companies diversifying through acquisition into the industry from
other markets often leverage their resources to cause a shake-up, as Philip Morris did with
Miller beer.

There are six major sources of barriers to entry:

1. Economies of scale

These economies deter entry by forcing the aspirant either to come in on a large scale or to
accept a cost disadvantage. Scale economies in production, research, marketing, and
service are probably the key barriers to entry in the mainframe computer industry, as
Xerox and GE sadly discovered. Economies of scale can also act as hurdles in distribution,
utilization of the sales force, financing, and nearly any other part of a business.

2. Product differentiation

Brand identification creates a barrier by forcing entrants to spend heavily to overcome

customer loyalty. Advertising, customer service, being first in the industry, and product
differences are among the factors fostering brand identification. It is perhaps the most
important entry barrier in soft drinks, over-the-counter drugs, cosmetics, investment
banking, and public accounting. To create high fences around their businesses, brewers
couple brand identification with economies of scale in production, distribution, and
marketing.
3. Capital requirements

The need to invest large financial resources in order to compete creates a barrier to entry,
particularly if the capital is required for unrecoverable expenditures in up-front
advertising or R&D. Capital is necessary not only for fixed facilities but also for customer
credit, inventories, and absorbing start-up losses. While major corporations have the
financial resources to invade almost any industry, the huge capital requirements in certain
fields, such as computer manufacturing and mineral extraction, limit the pool of likely
entrants.

4. Cost disadvantages independent of size

Entrenched companies may have cost advantages not available to potential rivals, no
matter what their size and attainable economies of scale. These advantages can stem from
the effects of the learning curve (and of its first cousin, the experience curve), proprietary
technology, access to the best raw materials sources, assets purchased at preinflation
prices, government subsidies, or favorable locations. Sometimes cost advantages are legally
enforceable, as they are through patents. (For an analysis of the much-discussed
experience curve as a barrier to entry, see the insert.)

5. Access to distribution channels

The newcomer on the block must, of course, secure distribution of its product or service. A
new food product, for example, must displace others from the supermarket shelf via price
breaks, promotions, intense selling efforts, or some other means. The more limited the
wholesale or retail channels are and the more that existing competitors have these tied up,
obviously the tougher that entry into the industry will be. Sometimes this barrier is so high
that, to surmount it, a new contestant must create its own distribution channels, as Timex
did in the watch industry in the 1950s.

6. Government policy

The government can limit or even foreclose entry to industries with such controls as
license requirements and limits on access to raw materials. Regulated industries like
trucking, liquor retailing, and freight forwarding are noticeable examples; more subtle
government restrictions operate in fields like ski-area development and coal mining. The
government also can play a major indirect role by affecting entry barriers through controls
such as air and water pollution standards and safety regulations.

Powerful suppliers & buyers

Suppliers can exert bargaining power on participants in an industry by raising prices or

reducing the quality of purchased goods and services. Powerful suppliers can thereby
squeeze profitability out of an industry unable to recover cost increases in its own prices.
By raising their prices, soft drink concentrate producers have contributed to the erosion of
profitability of bottling companies because the bottlers, facing intense competition from
powdered mixes, fruit drinks, and other beverages, have limited freedom to
raise their prices accordingly. Customers likewise can force down prices, demand higher
quality or more service, and play competitors off against each other—all at the expense of
industry profits.

The power of each important supplier or buyer group depends on a number of

characteristics of its market situation and on the relative importance of its sales or
purchases to the industry compared with its overall business.

A supplier group is powerful if:

 It is dominated by a few companies and is more concentrated than the industry it sells to.
 Its product is unique or at least differentiated, or if it has built up switching costs. Switching
costs are fixed costs buyers face in changing suppliers. These arise because, among other
things, a buyer’s product specifications tie it to particular suppliers, it has invested heavily
in specialized ancillary equipment or in reaming how to operate a supplier’s equipment (as
in computer software), or its production lines are connected to the supplier’s
manufacturing facilities (as in some manufacture of beverage containers).
 It is not obliged to contend with other products for sale to the industry. For instance, the
competition between the steel companies and the aluminum companies to sell to the can
industry checks the power of each supplier.
 It poses a credible threat of integrating forward into the industry’s business. This provides a
check against the industry’s ability to improve the terms on which it purchases.
 The industry is not an important customer of the supplier group. If the industry is an
important customer, suppliers’ fortunes will be closely tied to the industry, and they will
want to protect the industry through reasonable pricing and assistance in activities like
R&D and lobbying.

A buyer group is powerful if:

 It is concentrated or purchases in large volumes. Large volume buyers are particularly

potent forces if heavy fixed costs characterize the industry—as they do in metal containers,
corn refining, and bulk chemicals, for example—which raise the stakes to keep capacity
filled.
 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.
 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 price and
purchase selectively. 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 incentive to lower its purchasing 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).
 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 generally less price sensitive. Industries in which this situation obtains include
oil field equipment, where a malfunction can lead to large losses, and enclosures for
 electronic medical and test instruments, where the quality of the enclosure can influence
the user’s impression about the quality of the equipment inside.
 The industry’s product does not save the buyer money. Where the industry’s product or
service can pay for itself many times over, the buyer is rarely price sensitive; rather, he is
interested in quality. This is true in services like investment banking and public accounting,
where errors in judgment can be costly and embarrassing, and in businesses like the logging
of oil wells, where an accurate survey can save thousands of dollars in drilling costs.
 The buyers pose a credible threat of integrating backward to make the industry’s product.
The Big Three auto producers and major buyers of cars have often used the threat of self-
manufacture as a bargaining lever. But sometimes an industry engenders a threat to buyers
that its members may integrate forward.

Most of these sources of buyer power can be attributed to consumers as a group as well as
to industrial and commercial buyers; only a modification of the frame of reference is
necessary. Consumers tend to be more price sensitive if they are purchasing products that
are undifferentiated, expensive relative to their incomes, and of a sort where quality is not
particularly important.

The buying power of retailers is determined by the same rules, with one important
addition. Retailers can gain significant bargaining power over manufacturers when they
can influence consumers’ purchasing decisions, as they do in audio components, jewelry,
appliances, sporting goods, and other goods.