“By understanding how the five competitive forces influence profitability in your industry, you can develop a strategy for enhancing your company’s long-term profits.”
You know that to sustain long-term profitability you must respond strategically to competition. And you naturally keep tabs on your established rivals. But as you scan the competitive arena, are you also looking beyond your direct competitors? As Porter explains in this update of his revolutionary 1979 HBR article, four additional competitive forces can hurt your prospective profits:
- Savvy customers can force down prices by playing you and your rivals against one another.
- Powerful suppliers may constrain your
profits if they charge higher prices.
- Aspiring entrants, armed with new capacity and hungry for market share, can ratchet up the investment required for you to stay in the game.
Substitute offerings can lure customers away.
Consider commercial aviation: It’s one of the least profitable industries because all five forces are strong. Established rivals compete intensely on price. Customers are fickle, searching for the best deal regardless of carrier. Suppliers—plane and engine manufacturers, along with unionized labor forces—bargain away the lion’s share of airlines’ profits. New players enter the industry in a constant stream. And substitutes are readily available—such as train or car travel.
By analyzing all five competitive forces, you gain a complete picture of what’s influencing profitability in your industry. You identify game-changing trends early, so you can swiftly exploit them. And you spot ways to work around constraints on profitability— or even reshape the forces in your favor.
POSITION YOUR COMPANY WHERE THE FORCES ARE WEAKEST
In the heavy-truck industry, many buyers operate large fleets and are highly motivated to drive down truck prices. Trucks are built to regulated standards and offer similar features, so price competition is stiff; unions exercise considerable supplier power; and buyers can use substitutes such as cargo delivery by rail.
To create and sustain long-term profitability within this industry, heavy-truck maker Paccar chose to focus on one customer group where competitive forces are weakest: individual drivers who own their trucks and
contract directly with suppliers. These operators have limited clout as buyers and are less price sensitive because of their emotional ties to and economic dependence on their own trucks.
For these customers, Paccar has developed such features as luxurious sleeper cabins, plush leather seats, and sleek exterior styling. Buyers can select from thousands of options to put their personal signature on these built-to-order trucks.
Customers pay Paccar a 10% premium, and the company has been profitable for 68 straight years and earned a long-run return on equity above 20%.
EXPLOIT CHANGES IN THE FORCES
With the advent of the Internet and digital distribution of music, unauthorized downloading created an illegal but potent substitute for record companies’ services. The record companies tried to develop technical platforms for digital distribution themselves, but major labels didn’t want to sell their music through a platform owned by a rival.
Into this vacuum stepped Apple, with its iTunes music store supporting its iPod music player. The birth of this powerful new gatekeeper has whittled down the number of major labels from six in 1997 to four today.
RESHAPE THE FORCES IN YOUR FAVOR
Use tactics designed specifically to reduce the share of profits leaking to other players. For example:
- To neutralize supplier power, standardize specifications for parts so your company can switch more easily among vendors.
- To counter customer power, expand your services so it’s harder for customers to leave you fora rival.
- To temper price wars initiated by established rivals, invest more heavily in products that differ significantly from competitors’ offerings.
- To scare off new entrants, elevate the fixed costs of competing; for instance, by escalating your R&D expenditures.
To limit the threat of substitutes, offer better value through wider product accessibility. Soft-drink producers did this by introducing vending machines and convenience store channels, which dramatically improved the availability of soft drinks relative to other beverages.
Awareness of the five forces can help a company understand the structure of its industry and stake out a position that is more profitable and less vulnerable to attack.