The “Five Forces” Framework for

Industry Analysis Sources

Sourcesof
ofBargaining
BargainingPower:
Power:
Suppliers
Suppliers

Switching
Switchingcosts
costs Differentiation
Differentiationofofinputs
inputs
Supplier
Supplierconcentration
concentration Presence
Presenceofofsubstitute
substituteinputs
inputs
Importance
Importanceofofvolume
volumetotosuppliers
suppliers
Impact
Impactofofinputs
inputsononcost
costor
ordifferentiation
differentiation
Threat
Threatofofforward/backward
forward/backwardintegration
integration
Cost
Costrelative
relativetotototal
totalpurchases
purchasesininindustry
industry

New
NewEntrants
Entrants
Entry
EntryBarriers:
Barriers:
Industry
IndustryCompetitors
Competitors Substitutes
Economies
Economiesof ofscale
scale Substitutes
Brand identity
Brand identity Factors
FactorsAffecting
AffectingRivalry:
Rivalry: Threat
Capital ThreatDetermined
Determinedby:
by:
Capitalrequirements
requirements
Proprietary Industry
Industrygrowth Concentration
Concentrationand andbalance
Proprietaryproduct
productdifferences
differences growth balance Relative
Relativeprice
priceperformance
performanceofof
Switching costs Fixed
Fixedcosts/value
costs/valueadded
added Intermittent
Intermittentovercapacity
overcapacity substitutes
Switching costs substitutes
Access Product
Productdifferences Brand
Brandidentity
Accesstotodistribution
distribution differences identity Switching
Switchingcosts
costs
Proprietary Switching
Switchingcosts Informational
Informationalcomplexity
Proprietarylearning
learningcurve
curve costs complexity Buyer
Buyerpropensity
propensitytotosubstitute
substitute
Access Diversity
Diversityofofcompetitors Corporate
Corporatestakes
Access to necessaryinputs
to necessary inputs competitors stakes
Low-cost Exit
Exitbarriers
Low-costproduct
productdesign
design barriers
Government
Governmentpolicy
policy
Expected
Expectedretaliation
retaliation

Buyers
Buyers
Bargaining
BargainingPower
Powerof
ofBuyers:
Buyers:
Buyer
Buyerconcentration
concentration Buyer
Buyervolume
volume
Switching
Switchingcosts
costs Buyer
Buyerinformation
information
Buyer
Buyerprofits
profits Substitute
Substituteproducts
products
Pull-through
Pull-through Price
Pricesensitivity
sensitivity
Price/total
Price/totalpurchases
purchases Product
Productdifferences
differences
Brand
Brandidentity
identity Ability
Abilityto
tobackward
backwardintegrate
integrate
Impact
Impactononquality/performance
quality/performance Decision
Decisionmakers’
makers’incentives
incentives
The Value Net
Customers

Competitors Company Complementors

Suppliers

Source: Adam Brandenburger and Barry Nalebuff, Co-opetition

(New York: Currency Doubleday, 1996), p. 17
Public Sources of Information
about the Business Government
 Industry studies Landscape sources
Books Antitrust, legal, or tax documents
Investment analysts Census or IRS data
Market research Regulatory bodies
Business school cases
 Industry and company
 Trade associations directories
Thomas’ Register
Dun & Bradstreet
 Business press
General publications (e.g., Wall
 Company sources
Street Journal, Fortune)
Annual reports
Specialized industry trade journals
SEC filings
Local newspapers
Public relations/promotional material
Online services (e.g., Bloomberg,
Internet sites
OneSource, Compustat)
Company histories
Some Common Long-Run
Dynamics Threat of New Entry
• Decline in economies of scale + customer heterogeneity
 fragmentation of market into niches
• Escalation of sunk costs concentration
• Emergence of switching costs entry deterred Bargaining Power
of Customers
Bargaining
Bargaining Power
Power • Concentration or fragmentation of
ofofSuppliers
Suppliers buyers
• Concentration or • Backward integration
• Concentration or
fragmentation of suppliers • Improvement in buyer information
fragmentation of suppliers
• Forward integration Rivalry Among Existing Competitors • Surge or decline in demand
• Forward integration
• Improvement in supplier • Shift in industry growth • Emergence of new distribution
• Improvement in supplier
information • Change in mix between fixed and variable costs channels
information
• Surge or decline in supply • Emergence of dominant design or product • New means for coordinating with
• Surge or decline in supply
• Emergence of substitute inputs • Consolidation customers
• Emergence of substitute inputs
• New means for coordinating • Fragmentation / new entry • Shifts in customer tastes
• New means for coordinating
with suppliers
with suppliers

Threat
ThreatofofSubstitutes
Substitutes
• • Emergence
Emergenceofofnewnewsubstitute
substitute
• • Improvement
Improvement ordecline
or declineininrelative
relativeprice
priceperformance
performance Availability of Complements
ofofsubstitute
substitute • Emergence of new complements
• • Increase
Increaseininbuyer
buyercomfort
comfortwith
withsubstitute
substitute • Change in barriers to entry in
• • Change
Change in barriers to entry insubstitute
in barriers to entry in substitutemarket
market complement market

Source: Jan W. Rivkin

 Profitability Differences Across
Selected Industries
Pharmaceuticals
Prepackaged software
Semiconductors
Women's clothing stores
Dental equipment
Eating places
Drug stores
Petroleum / natural gas
Race track operations
Trucking except local
Engineering services
Computer system design
Cable TV service
Motor vehicles
Scheduled airlines

0 5 10 15 20 25
Operating Income / Assets, 1988-95 (%) Source: Jan W. Rivkin
based on Compustat
The Managerial Problem
 To craft an effective strategy, you must take account of the
external environment (the landscape)
 To decide whether to put your firm in an environment (entry)
 To decide whether to extricate your firm from an environment (exit)
 To position your firm to succeed in a given environment
 To assess the effect of a major change (e.g., deregulation)
 To shape the environment
 But the environment is enormously complex

 You need structured ways of thinking about the environment

– …that capture the richness of the real business world
– …but separate signal from noise
Some (Complementary) Solutions
 Supply / demand diagrams
 Industry structure analysis (Five Forces)
 Value net
 Ecological metaphors
From Supply / Demand to the Five
Forces
 What determines the long-run supply / demand balance?
 Entry barriers and intensity of rivalry affect whether firms will add
capacity in response to excess demand
 Exit barriers affect whether firms will retire capacity in response to
excess supply
 What determines the effect of a supply / demand imbalance on
profitability?
 In industries with intense rivalry or powerful buyers, small amounts
of excess capacity tend to lead to big price wars
 In industries with powerful suppliers, the benefits of excess demand
may accrue to the suppliers

 Supply / demand analyses say little about what determines the position
and shape of the two curves
 Industry Analysis: Factors to
Consider Threat of New Entry
Bargaining Power
of Suppliers
• Differentiation of inputs
• Switching costs
• Presence of substitute
inputs
• Supplier concentration
• Importance of volume to
supplier
• Cost relative to total
purchases
• Impact of inputs on cost or
differentiation
• Threat of forward
integration
• Economies of scale • Capital requirements
• Proprietary product • Access to distribution
differences • Absolute cost advantages
• Brand identity • Government policy
• Switching costs • Expected retaliation
Bargaining Power
of Customers
• Buyer concentration
Rivalry Among • Buyer volume
Existing Competitors • Buyer switching costs
• Industry growth • Switching costs • Buyer information
• Fixed costs / value • Concentration and balance • Ability to integrate
added • Informational complexity backward
• Overcapacity • Diversity of competitors • Substitute products
• Product differences • Corporate stakes • Price / total purchases
• Brand identity • Exit barriers • Product differences
• Brand identity
• Impact of quality /
performance
• Buyer profits
Threat of Substitutes
• Relative price performance of substitutes
• Switching costs
• Buyer propensity to substitute Source: Michael E. Porter,
Competitive Advantage
(New York: Free Press, 1985)
Typical Uses of Industry Analysis
 Understand current profitability levels
 Identify forces that must be countered in order to
achieve superior profitability
 Test decision to enter an industry
 Test decision to exit an industry
 Assess effect of a major change (e.g., deregulation)
 Identify ways to alter industry structure
Other Users
 Entrepreneurs
 Investment bankers
 Financial analysts
 Venture capitalists
 Consultants
 Anyone making a career choice
 The Value Net
A player is your competitor with
respect to customers if customers
value your product less when they
have the other player’s product as
well
Competitors
A player is your competitor with
respect to suppliers if it is less
attractive for a supplier to provide
resources to you when it is also
supplying the other player
Customers A player is your complementor with
respect to customers if customers
value your product more when they
have the other player’s product as
well
Firm Complementors
A player is your complementor with
respect to suppliers if it is more
attractive for a supplier to provide
Suppliers resources to you when it is also
supplying the other player
Source: Adam Brandenburger and Barry Nalebuff,
Co-opetition (New York: Currency Doubleday, 1996)
What the Value Net Adds

 Complementors
 Symmetry
Expanded Industry Analysis

Threat of New Entry

Bargaining Power Rivalry Among Bargaining Power

of Suppliers Existing Competitors of Customers

Threat of Substitutes Availability of

Complements
Degree of Rivalry
 Concentration and balance
 Industry growth
 Fixed (or storage costs)/Value added
 Product differences
 Brand identity
 Switching costs
 Intermittent cover-capacity
 Diverse stakes
 Exit barriers
Entry Barriers
 Economies of scale  Absolute cost advantages
Learning curve
 Product differences
Access to necessary inputs
 Brand identity Low cost product design
 Switching costs  Government policy
 Capital requirements  Expected retaliation
 Access to distribution
Power of Buyers
Intrinsic Strength Price Sensitivity
 Buyer concentration  Price/Total purchase
 Buyer volume  Product differences
 Switching costs  Brand identity
 Buyer information  Impact on
 Ability to backward quality/performance
integrate  Buyer profits
 Substitute products  Decision maker’s
 Pull through incentives
Power of Suppliers
 Supplier concentration
 Substitute suppliers
 Supplier volume
 Product differences
 Brand identity
 Switching costs
 Low buyer information
 Threat of forward integration
 Pull through
Threat of Substitution
 Product function not form
 Entire value added chain
 Thread depends on
 Relative price/performance
 Switching costs
 Often an S-curve process
The Power of Complementors
 Relative concentration
 Relative buyer or supplier switching costs
 Ease of unbundling
 Differences in pull-through
 Asymmetric integration threats
 Rate of growth of the pie
Issues with the Five-Forces
Framework
 Industry definition
 Completeness (e.g., import competition)
 Consistency (e.g., import strategic variety)
 Duplication (e.g., switching costs)
 Symmetry (e.g., buyer substitution vs. supplier substitution,
complements)
 The role of informational conditions
 The need for macroenvironmental analysis
 Long-run focus vs. change
 shocks
 cycles
 trends
 Product rather than resource focus
Landscapes
 Landscape is broader than industry
 Landscape includes firms, institutions, and
other players which often are not viewed as
part of an industry
 Landscape includes networks of firms (from
different industries) whose profits may be
interdependent (e.g. Microsoft-Intel)
Commitment Opportunities and
Structure
 Production scale economies set a lower bound
on concentration
 Many settings are more concentrated than
production scale economies would imply
 Opportunities to commit resources to
advertising and R & D in ways that enhance
willingness-to-pay to some minimal degree are
what lead to “excess” concentration
Steps in Landscape Analysis
 Define the landscape: what is in, what is out
 Identify the players
 e.g., who are the customers, really? Who are the competitors?
 Assess the relationships among players
 See Porter (1979, 1980) for some factors to consider
 Sniff-test
 Is assessment in line with actual profitability?
 Are more profitable players better positioned vis-a-vis
competitive forces?
 Assess recent and future changes
 Steps in Landscape Analysis
(cont.)
Purpose Common steps
 Identify forces that must be  Pinpoint most threatening force and seek ways
countered in order to achieve to counter (e.g., build switching costs, find new
superior profitability sources of supply)

 Consider effect of entry on structure; choose

 Test decision to enter
relative position; select entry vehicle; compare
costs of entry to benefits

 Identify options for improving structure or

 Test decision to exit relative position; select exit vehicle; compare
costs of exit to benefits

 Consider how change will affect each force

 Assess effects of a major change
 Assess consolidation, backward integration,
forward integration, investments that raise entry
 Identify ways to alter structure
costs, entry into substitute market, etc.
Common Pitfalls in Landscape
Analysis
 Failing to define the landscape clearly
 A clear definition is more important that the “right” definition
 Confusing transient effects with structural forces
 Ignoring changes in structural forces
 Assuming that competitive forces cannot be altered
 Confusing evidence of a force with its underlying cause
 e.g., blaming customer power on customer price sensitivity
rather than exploring root causes of price sensitivity
 Ignoring the full range of substitutes
 Paying equal attention to all the forces
Lessons
 Industries or landscapes are neither created equal nor
stay equal
 The concept of “extended competition” provides a
comprehensive framework for assessing structural
attractiveness
 A firm’s strategy can increase or decrease its exposure
to competitive forces
 Other things being equal, a firm should seek to trigger
actions that improve structural attractiveness
 But it isn’t enough to look at just structural attractiveness:
competitive position must also be considered
Conclusion

 Envisioning the business landscape

 Adapting to the business landscape
 Shaping the business landscape