We've been talking about the Five Forces Analysis.
Remember, this is a tool that helps us think carefully about these five different
competitive forces that can have a big negative impact on
the likelihood of profits and margins in a particular industry or market segment.
So the point of this analysis is to tell us something about how the industry is
structured and what the competitive dynamics are within that industry.
There's lots of things the five forces analysis doesn't tell us.
It doesn't tell us much about the differences between individual firms and
things of that nature, but it tells us something really important and
therefore it's a really important part of any more full strategic analysis.
We need to really understand how is an industry structured.
What's its makeup?
What are the competitive dynamics of the industry, so we can have a sense of
what the likelihood is of good profits and good margins in that industry.
As we know, industries differ in how profitable they are on average.
And this five forces tool helps us understand the dynamics of that.
So we've talked about the thread of new entrance into an industry.
Now, what's the threat of new firms entering the industry to compete with us?
We've talked about the threat of substitutes, the threat that our customers
or buyers will leave us to go to some sort of substitute product or service.
We've talked about the bargaining power in our value chain,
with both suppliers and buyers.
And we've talked finally about the intensity of rivalry
with our direct competitors.
And this is what people think of most readily when they
think about competitive strategy and competition.
There are certain things that are probably part of the structure of an industry,
the dynamics of an industry that we haven't explicitly talked about.
We might think about the role of complements.
Complementary products or services and how that might come into play.
We might think about the role of the institution that we're operating within,
the institutional environment.
That will certainly have an impact on the dynamics of an industry.
So there's certain things that we haven't talked about, but
the point of all of this is that we're trying to understand the dynamics and
structure of an industry or market segment.
So what are a few takeaways as we've gone through and
talked about each of these five forces?
First of all, we've determined that the threat of new entrants into a new industry
is less likely when incumbent firms have a strong competitive advantage and
when they can credibly retaliate against those potential new entrants.
We've learned that the threat of substitutes is also lower
when switching costs are high, and when cross price elasticity is low.
We've got to think about buyer and supplier power.
We've learned that those depend on things like the relative concentration.
Are there a lot of buyers and suppliers, or just a few?
It's determined by the viability of alternatives and
is information free flowing?
Are we able to see pricing information for example and is it transparent?
We've also learned that rivalry is more intense when there are more competitors
in an industry or a market segment.
Rivalry is more intense when the incentives to fight are larger, and
rivalry is more intense when the possibility for
sort of tacit coordination and playing nice with one another is more difficult.
All of these are insights from the Five Forces analysis.
Michael LenoxSenior Associate Dean and Chief Strategy Officer
Jared HarrisSamuel L. Slover Research Chair in Business Administration
