Every company in the world has a competitive strategy whether they have explicitly set it, or it has implicitly formed over time. Explicitly thinking about a company’s competitive strategy is important because it aligns the individual functional departments of the organisation to a set of common goals and objectives. Thinking about competitive strategy raises many questions for company leaders such as “What is driving competition in my industry?”, “What actions are my competitors likely to take?”, and “How will my industry evolve?”.
Competitive Strategy provides a framework for analysing an industry, predicting the industry’s future evolution, understanding your competitor’s and your position within the industry and how to translate this analysis into a competitive strategy for a particular business or industry.
Competitive Strategy is Michael Porter’s second book and was originally published in 1980. Porter is a professor at Harvard Business School and his work has been highly influential in the fields of business, economics and competitive strategy. Competitive Strategy lead to Porter’s third book Competitive Advantage - Creating and Sustaining Superior Performance (Yes, I read them in the wrong order).
Competitive Strategy is broken up into three main sections.
Part 1 looks at forming a general analytical framework for analysing the structure of an industry and its competitors.
Part 2 looks at specific industries and how the framework can be applied to a wide variety of environments and industries.
Part 3 focuses on making strategic decisions that a company will face and insights into how competitors will make similar decisions.
General Analytical Techniques
Porter’s 5 forces framework forms much of the foundation of competition within a given industry.
These five forces are:
- Threat of new entrants
- Threat of substitute products or services
- Bargaining power of customers (buyers)
- Bargaining power of suppliers
- Intensity of competitive rivalry
The attractiveness of an industry is determined by the resulting pressure of each of these forces. When any one of the forces is exerting intense pressure, the industry will be unattractive.
For example, if the barrier to entry is too low, new entrants will be able to enter the industry. When there are many substitute products, this will put a ceiling on the total amount a company can charge for their product. When the bargaining power of buyers or suppliers becomes too great, each party can put pressure on the company to lower prices or increase investments. And finally the intensity of the rivalry between competitors can mean that one company can drive prices down which has a net negative impact on the industry as a whole.
Understanding these five forces and how they effect an industry forms much of the general analyses of Porter’s competitive strategy framework.
Analysis of specific industry analysis
Section two of Competitive Strategy uses the knowledge gained in section one to analyse specific industry environments.
Porter analyses three different types of industries. First he looks at fragmented industries that have low barriers to entry and no single dominant company.
Second, Porter analyses industries at different states of maturity including emerging industries, fast growing industries and industries that are in decline.
And finally Porter looks at the impact of globalisation. When Porter originally wrote this book during the 1980s, globalisation was emerging as an increasingly common strategic problem.
In each of these sections, Porter looks at industry structure, key strategic issues, characteristic strategic alternatives and he identifies possible strategic pitfalls.
Section three of Competitive Advantage builds upon section one to analyse major strategic decisions that arise with business. These are:
- Vertical integration
- Major capacity expansion
- Entry to an industry
This section also looks at divestment in declining industries as well additional economic theory and administrative considerations of managing and motivating an organisation.
Whilst Part Three does not claim to have all of the answers to these strategic decisions, it does offer insight into how competitors, customers, suppliers and potential new entrants might view them. Interpreting the potential decisions of others will have a big impact on your overall decision making.
Vertical Integration is where an organisation manufactures, distributes and sells a product all through internal processes. This means the organisation must invest in technology and internal processes rather than leveraging external suppliers, distributors or sales organisations.
The decision to vertical integrate has many benefits and drawbacks.
For example, a vertically integrated organisation can completely control it’s product from design, through manufacturing and to the end customer. This often means that the company can differentiate their product and provide a higher quality design and customer service for the customer.
However on the other hand, the company will not benefit from the large economies of scale that can be achieved by dedicated organisations who specialise in manufacturing or distribution.
Major capacity expansion
The decision to increase capacity is difficult because it will usually have massive implications on the industry and the future health of the company. Capacity expansion also usually requires decisions to be made that will have a major impact for years to come and so large commitments have to be made far in advance.
In order to make a major capacity expansion decision, an organisation needs to understand or have insight into the future demand of the market and the potential strategic moves a competitor will make.
Adding capacity at the right time can mean that your organisation has a significant advantage over the market. If you can achieve costs at a more attractive economy of scale than your competitors, you will enjoy a cost advantage.
However if you misjudge the future demand of the market, or your competitors also add capacity, the market will be flooded with excess inventory. Investing in capacity expansion will also increase the exit barriers for companies, meaning there might be no turning back once the decision has been made.
Entry into an industry
Entry in to an industry can take many forms but more often than not it is through the development of a new internal business entity or through acquisition.
The decision to enter a new industry should be balanced on the following costs and benefits:
- the investment costs required to be in the new business, such as investment in manufacturing facilities and inventory;
- the additional investment required to overcome other structural entry barriers, such as brand identification and proprietary technology;
- the expected cost from incumbents’ retaliation against the entry, balanced against
- the expected cash flows from being in the industry
A major part of the decision to enter a new industry must revolve around the likelihood that retaliation will occur. The assumed costs that you make could be made irrelevant if your new competitors decide to substantially slash prices due to your entry.
Identifying industries as attractive opportunities for entry is cause for in-depth analysis. The decision must be made whether this opportunity offers significant sustained revenues after entry, a significant advantage through existing business units or a significant opportunity to benefit existing business units by also participating in this adjacent industry.
Much like Competitive Advantage, Competitive Strategy is very much an academic book and so it often feels dense. As I recommended with Competitive Advantage, these books are not very approachable if you are not used to reading academic business books.
However, despite the density and age of the material, these books do offer a lot of value when thinking in terms of broad industry analysis. Whilst I think certain aspects of the material is dated, a lot of what is taught is still as relevant in the 1980s as it is today.
If you are looking to get in to reading academic business books, this could be the one for you. It’s an easier read than Competitive Advantage and offers a lot of interesting insights and analysis into the opportunities and implications of business strategy.
Buy Competitive Strategy: Techniques for Analyzing Industries and Competitors on Amazon (Affiliate Link).