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The structural analysis of industries






 

Competitive strategy must grow out of a sophisticated understanding of the structure of the industry and how it is changing. In any industry, whether

 

 


it is domestic or international, the nature of, competition is embodied in five competitive forces: (1) the threat of new entrants, (2) the threat of substitute products or services, (3) the bargaining power of suppliers, (4) the bargaining power of buyers, and (5) the rivalry among the existing competitors (see Figure 2-1).4

The strength of the five forces varies from industry to industry and determines long-term industry profitability. In industries in which the five forces are favorable, such as soft drinks, mainframe computers, database publishing, pharmaceuticals, and cosmetics, many competitors earn attractive returns on invested capital. Industries in which pressure from one or more of the forces is intense, such as rubber, aluminum, many fabricated metal products, semiconductors, and small computers, are ones where few firms are very profitable for long periods.

The five competitive forces determine industry profitability because they shape the prices firms can charge, the costs they have to bear, and the investment required to compete in the industry. The threat of new entrants limits the overall profit potential in the industry, because new entrants bring new capacity and seek market share, pushing down margins. Powerful buyers or suppliers bargain away the profits for themselves. Fierce competitive rivalry erodes profits by requiring higher costs of competing (such as for advertising, sales expense, or R& D) or by passing on profits to customers in the form of lower prices. The presence of close substitute products limits the price competitors can charge without inducing substitution and eroding industry volume.

The strength of each of the five competitive forces is a function of industry structure, or the underlying economic and technical characteristics of an industry. Buyer power, for example, is a function of such things as the number of buyers, how much of a firm's sales are at risk to any one buyer,

 


 

 


and whether a product is a significant fraction of buyers' own costs which leads to price sensitivity.5 The threat of entry depends on the height of barriers to entry, such as brand loyalty, economies of scale, or the need to penetrate distribution channels.

Every industry is unique and has its own unique structure. In pharmaceuticals, for example, barriers to entry are high because of the need for huge fixed research and development costs and economies of scale in selling to physicians. Substitutes for an effective drug are slow to develop, and buyers have not historically been price sensitive. Suppliers, who provide mostly commodities, have little clout. Finally, rivalry has been moderate and focused not on price cutting that erodes industry profits but on other variables such as R& D that tend to expand overall industry volume. The existence of patents has also slowed competitive imitation. Industry structure in pharmaceuticals has been highly favorable to profitability, supporting sustained returns on investment among the highest of any major industry.

Industry structure is relatively stable but can change over time as an industry evolves. The consolidation of distribution channels that is taking place in a number of European countries, for example, is increasing buyer power. The industry trends that are the most important for strategy are those affecting its underlying structure. Firms, through their strategies, can also influence the five forces for better or for worse. The introduction of computer information systems in the airline industry, for example, is raising barriers to entry by requiring investments in the hundreds of- millions of dollars.

Industry structure is significant in international competition for a number of reasons. First, it creates differing requirements for success in different industries. Competing in a fragmented industry such as apparel requires greatly differing resources and skills from competing in commercial aircraft. A nation provides a better environment for competing in some industries than others.

Second, industries important to a high standard of living are often those that are structurally attractive. Structurally attractive industries, with sustainable entry barriers in such areas as technology, specialized skills, channel access, and brand reputation, often involve high labor productivity and will earn more attractive returns to capital. Standard of living will depend importantly on the capacity of a nation's firms to successfully penetrate structurally attractive industries. The attractiveness of an industry is not reliably indicated by size, rapid growth, or newness of technology, attributes often stressed by executives and by government planners, but by industry structure. By targeting entry into structurally unattractive industries, developing nations have frequently made poor use of scarce national resources.

A final reason why industry structure is important in international competition is that structural change creates genuine opportunities for competitors from a nation to penetrate new industries. Japanese copier companies, for

 


example, successfully challenged American dominance (notably that of Xerox and IBM) by stressing an underserved product segment (small copiers), employing a new approach to the buyer (the use of dealers instead of direct sale), altering the manufacturing process (mass production versus batch), and modifying the approach to pricing (outright sale versus capital-intensive copier rental). The new strategy reduced entry barriers and nullified the previous leader's advantages. How a nation's environment points the way or pressures its firms to perceive and respond to such structural changes is of central importance to understanding the patterns of international success.

 


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