Porter

CHAPTER 1
The Five Competitive Forces That Shape Strategy
Michael E. Porter
IN ESSENCE, THE JOB OF THE STRATEGIST
is to understand and cope with competition. Often, however, managers define competition too narrowly, as if it occurred only among today's direct competitors. Yet competition for profits goes beyond established industry rivals to include four other competitiveforces as well: customers, suppliers, potential entrants, and substitute products. The extended rivalry that results from all five forces defines an industry's structure and shapes the nature of competitive interaction within an industry.
As different from one another as industries might appear on the surface, the underlying drivers of profitability are the same. The globa] auto industry, forinstance, appears to have nothing in common with the worldwide market for art masterpieces or the heavily regulated health-care delivery industry in Europe. But to understand industry competition and profitability in each of those three cases, one must analyze the industry's underlying structure in terms of the five forces. (See figure i.i.)
If the forces are intense, as they are in such industries asairlines, textiles, and hotels, almost no company earns attractive returns on investment. If the forces are benign, as they are in industries such as software, soft drinks, and toiletries, many companies are profitable. Industry structure drives competition and profitability, not whether an industry produces a product or service, is emerging or mature, high tech or low tech, regulated orunregulated. While a myriad of factors can affect industry profitability in the short run—including the weather and the
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io Competition and Strategy: Core Concepts
value chain; which ones are most important varies by industry.' In microprocessors, incumbents such as Intel are protected by scale economies in research, chip fabrication, and consumer marketing. For lawn care companieslike Scotts Miracle-Gro, the most important scale economies are found in the supply chain and media advertising. In small-package delivery, economies of scale arise in national logistical systems and information technology.
i. Demand-side benefits of scale. These benefits, also known as network effects, arise in industries,where a buyer's willingness to pay for a company's product increases with thenumber of other buyers who also patronize the company. Buyers may trust larger companies more for a crucial product: Recall the old adage that no one ever got fired for buying from IBM (when it was the dominant computer maker). Buyers may also value being in a "network" with a larger number of fellow customers. For instance, online auction participants are attracted to eBay because it offers themost potential trading partners. Demand-side benefits of scale discourage entry by limiting the willingness of customers to buy from a newcomer-and by reducing the price the newcomer can command until it builds up a large base of customers.
3. Customer switching costs. Switching costs are fixed costs that buyers face when they change suppliers. Such costs may arise because a buyer whoswitches vendors must, for example, alter product specifications, retrain employees to use a new product, or modify processes or information systems. The larger the switching costs, the harder it will be for an entrant to gain customers. Enterprise resource planning (ERP) software is an example of a product with very high switching costs. Once a company has installed SAP's ERP system, for example, thecosts of moving to a new vendor are astronomical because of embedded data, the fact that internal processes have been adapted to SAP, major retraining needs, and the mission-critical nature of the applications.
4. Capital requirements. The need to invest large financial resources in order to compete can deter new entrants. Capital may be necessary not only for fixed facilities but also to...