Industry Analysis & Competitive Advantage

Industry Analysis & Competitive Advantage

In this lesson, you will:
• discover the importance of industry analysis and the concept of competitive advantage
• learn in detail about Porter’s Five Forces
• be introduced to useful competitive strategies

Industry Analysis

Industry analysis is a tool that facilitates a company’s understanding of its position relative to other companies that produce similar products or services. Understanding the forces at work in the overall industry is an important component of effective strategic planning.

Industry analysis enables small business owners to identify the threats and opportunities facing their businesses, and to focus their resources on developing unique capabilities that could lead to a competitive advantage.

What is Competitive Advantage?

A superiority gained by an organization when it can provide the same value as its competitors but at a lower price, or can charge higher prices by providing greater value through differentiation. Competitive advantage results from matching core competencies to the opportunities.

Porter’s Five Forces model is an analysis tool that uses five industry forces to determine the intensity of competition in an industry and its profitability level.

Porter’s Five Competitive Forces include:

(1) Threat of new entrants – 
barriers to entry act as a deterrent against new competitors.

(2) Rivalry among existing firms – 
intense competition leads to reduced profit potential for companies in the same industry.

(3) Pressure from substitute products or services – 
availability of substitute products will limit your ability to raise prices.

(4) Bargaining power of buyers – 
powerful buyers have a significant impact on prices.

(5) Bargaining power of suppliers – 
powerful suppliers can demand premium prices and limit your profit.
All five competitive forces jointly determine the intensity of industry competition and profitability.
Let’s take an in-depth look at each of these forces:

(1) Threat of new entrants

New entrants to an industry bring new capacity and the desire to gain market share, and they often also bring substantial resources. As a result, prices can be low, cost can be high, and profits can be low.

There is a relationship between threat of new entrants, barriers to entry, and reaction from existing competitors.

For example:
– If barriers are high and reaction is high, then the threat of entry is low.
– If barriers are low and reaction is low, then the threat of entry is high.

There are seven major barriers to entry, including: (1) economies of scale, (2) product differentiation, (3) capital requirements, (4) switching costs, (5) access to distribution channels, (6) cost disadvantages independent of scale, and (7) government policy.

(2) Rivalry among existing firms

Rivalry tactics include price competition, advertising battles, new product introduction, and increased customer service or product/service warranties. Competitors are mutually dependent in terms of action and reaction, moves and countermoves, or offensive and defensive tactics.

Intense rivalry is the result of a number of interacting structural factors such as:
– numerous or equally balanced competitors
– slow industry growth
– high fixed costs or storage costs
– lack of differentiation or switching costs
– capacity increased in large increments
– diverse competitors
– high strategic stakes
– high exit barriers

(3) Pressure from substitute products or services

In a broad sense, all firms in an industry are competitors with industries producing substitute products. Substitutes limit the potential returns of an industry by placing a ceiling on the prices firms can profitably charge.

The more attractive the price-performance alternative offered by substitutes, the stronger or firmer the lid on industry profits. Substitute products that deserve the most attention are those that are subject to trends improving their price-performance trade-off with the industry’s product or produced by industries earning high profits.

(4) Bargaining power of buyers

Buyers compete with the industry by forcing down prices, bargaining for higher quality or more services, and playing competitors against each other—all at the expense of industry profits.

A buyer group is powerful under the following circumstances: 
– it purchases large volumes relative to seller sales.
– the products it purchases from the industry represent a significant fraction of the buyer’s costs or purchases.
– the products it purchases from the industry are standard or undifferentiated.
– it faces few switching costs.
– it earns low profits.
– the buyer has full information about demand, prices and costs: informed customers become empowered customers.

(5) Bargaining power of suppliers

Suppliers can exert bargaining power over participants in an industry by threatening to raise prices or reduce the quality of purchased goods or services. The conditions making suppliers powerful tend to mirror those making buyers powerful.

A supplier group is powerful if the following apply: 
– it is dominated by a few companies and is more concentrated than the industry it sells to.
– it is not obligated to contend with other substitute products for sale to the industry.
– the industry is not an important customer of the supplier group.
– the supplier’s product is an important input to the buyer’s business.
– the supplier group’s products are differentiated or it has built up switching costs.

Typical Steps in Industry Analysis 

(1) Define the relevant industry:
• What products are in it?
• Which ones are part of another distinct industry?
• What is the geographic scope of competition?

(2) Identify the participants and segment them into groups, if appropriate:
Who are
• the buyers and buyer groups?
• the suppliers and supplier groups?
• the competitors?
• the substitutes?
• the potential entrants?

(3) Assess the underlying drivers of each competitive force to determine which forces are strong and which are weak and why. 

(4) Determine overall industry structure, and test the analysis for consistency:
• Why is the level of profitability what it is?
• Is the industry analysis consistent with actual long-run profitability?
• Are more-profitable players better positioned in relation to the five forces? 

(5) Analyze recent and likely future changes in each force, both positive and negative.

(6) Identify aspects of industry structure that might be influenced by competitors, by new entrants, or by your company. 

Competitive Strategy
Competitive Strategy involves taking offensive or defensive actions to create a better position in an industry and to cope with the Five Competitive Forces in order to achieve a superior return on investment.

Porter’s three competitive strategies include: 
(1) Differentiation
(2) Low-Cost Leadership
(3) Focus

(1) Differentiation

The differentiation strategy involves an attempt to distinguish the firm’s products or services from others in the industry. An organization may use advertising, distinctive product features, exceptional service, or new technology to achieve a product that is perceived as unique.

This strategy usually targets customers who are not particularly concerned with price, so it can be quite profitable – customers are loyal and will pay high prices for the product. Companies that pursue a differentiation strategy typically need strong marketing abilities, a creative flair, and a reputation for leadership.

A differentiation strategy can reduce rivalry with competitors and fight off the threat of substitute products because customers are loyal to the company’s brand. However, companies must remember that successful differentiation strategies require a number of costly activities, such as product research and design and advertising.

(2) Low-Cost Leadership

The organization aggressively seeks efficient facilities, pursues cost reductions, and uses tight cost controls to produce products more efficiently than competitors. A low-cost position means that the company can undercut competitors’ prices and still offer comparable quality and earn a reasonable profit. Being a low-cost producer provides a successful strategy to defend against the five competitive forces.

For example, the most efficient, low-cost company is in the best position to succeed in a price war while still making a profit. Likewise, the low-cost producer is protected from powerful customers and suppliers because customers cannot find lower prices elsewhere.

If substitute products or potential new entrants occur, the low-cost producer is better positioned than higher-cost rivals to prevent loss of market share. The low price acts as a barrier against new entrants and substitute products.

The low-cost leadership strategy tries to increase market share by emphasizing low cost compared to competitors. This strategy is concerned primarily with stability.

(3) Focus

With Porter’s third strategy, the organization concentrates on a specific regional market or buyer group. The company will use either a focused differentiation or focused low-cost, but only for a narrow target market.

Managers must think carefully about which strategy will provide their company with its competitive advantage.

In his studies, Porter found that some businesses did not consciously adopt one of these three strategies and were stuck with no strategic advantage. Without a strategic advantage, businesses earned below-average profits compared with those that used one of these three strategies.

These three strategies require different styles of leadership and can translate into different corporate cultures. A firm that is “stuck in the middle” is the one that has failed to develop its strategy in at least one of the three directions. It has low profitability, lost high-volume customers, lost high-margin businesses and blurred corporate culture.

Risks in pursuing the three generic strategies include: 
– failing to attain or sustain the strategy.
– eroding the strategic advantage with industry evolution.

[Optional] The Five Competitive Forces That Shape Strategy

Watch this 13-minute Harvard Business Review interview of Michael Porter where he talks about the Five Forces:

Jim Rohn