Assessing the attractiveness of your industry and strategically positioning your company.
How to assess the attractiveness of your industry and your company's position in it
I have often heard it said that big companies, the corporate giants, are the ones that need to think about their business strategically. Smaller, more entrepreneurial companies, by contrast, do not need strategy -- they can pursue other routes to business success. In my view, that is exactly backward.
Unlike the giants, small businesses cannot rely on the inertia of the marketplace for their survival. Nor can they succeed on brute force, throwing resources at problems. On the contrary, they have to see their competitive environment with particular clarity, and they have to stake out and protect a position they can defend. That is what strategy is all about -- making choices about how you position your company in its competitive environment.
At its root, strategic thinking involves asking two critical questions. First, what is the structure of your industry, and how is it likely to evolve over time? If the business you are in is not very attractive -- and we will see in a moment how to measure its attractiveness -- then you may want to get out of it or find a way of redefining it.
Second, what is your own company's relative position in the industry? No matter how attractive the game is, you will not do well if you do not hold a good position in it. Conversely, you can be in a lackluster industry with low average profitability -- yet if you occupy exactly the right niche, you can perform very well. Strategic thinking shows you how to establish and defend such a position.
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Analyzing Your Industry
In every industry, no matter what product or service it provides, there are five basic forces of competition. Taken together they determine the industry's attractiveness and its long-term profitability.
First, and maybe most obvious, is the character of the rivalry among the competitors. Competition can be gentlemanly and subdued, or it can be vicious and warlike. If competition in your industry is like a guerrilla war, if someone is always attacking your position, that makes the industry less attractive and less profitable. If the competition is more focused on image and service than on price cutting, the whole industry will be more profitable.
Then there is the threat of new entrants. If it is easy for someone else to get into the business, to add new capacity and erode prices, that too will cut into profits. But if there are effective barriers to entry, all the companies in the business will do better.
Another factor: the threat of substitute products or services. Whatever your business does, customers nearly always have other ways of satisfying their needs. If you make aluminum windows, you have to worry about makers of vinyl windows. If you are a traditional full-service stockbroker, you have to worry about discount brokers. If customers have plenty of alternatives to choose from, that too will eat into your profitability.
Then too, your profits may be constrained by suppliers, on the one hand, or by customers, on the other.
The bargaining power of suppliers determines how much they can force up the price of what you have to buy. If you are buying mostly commodities and can switch suppliers easily, they will not have much leverage. But if you are dependent on specialty suppliers or on one or two dominant vendors, you will have to pay whatever they ask.
The bargaining power of buyers similarly determines how much leeway you have in your own pricing. If your customers are a lot more powerful than you, they may beat you down on price, force you to provide many free services, or make you hold inventory and thus bear cost and risk. That can drive the return right out of your business.
The fundamental profit potential in any industry is determined by the balance of those five forces. At one end of the spectrum is an enormously attractive industry such as pharmaceuticals. It is hard for new companies to get into this business. The product -- effective therapeutic drugs -- has no real substitute. Most of the raw materials are commodities, so the suppliers are unimportant. Customers historically have not exercised much bargaining power -- indeed, they have been willing to pay top dollar for anything that made patients feel better. Finally, the rivalry has been extremely gentlemanly. Nobody competes on price, because every company knows it does not have to. That is why major pharmaceutical companies make a 20% return on investment every year.
At the other end of the spectrum is a business such as aluminum-window manufacturing. It is an industry that new competitors can easily enter. There are plenty of substitute products, such as wood and plastic windows. The suppliers are giant aluminum companies with a great deal of clout; the buyers are likely to be big retail or wholesale chains that beat up companies on price. And the rivalry is cutthroat because everyone is always trying to shave a little on price to cover overhead. If the pharmaceutical business gets five stars as an industry, aluminum windows gets zero. If you make a 10% return in any year, you're a hero.
To be sure, those are extreme cases. But your industry fits somewhere; it has a structure, and you can analyze it in terms of the five forces.
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Reshaping Your Industry
If this were the end of the story, it would be a bit depressing: your success would depend on how well you had chosen your industry. But the story does not end here. In fact, the real insight for strategy is that industry structure can be changed. You, by the way you choose to compete, can influence every one of the five forces.
Some companies, for example, get around customers' bargaining power by giving them computer terminals and letting them order directly on-line. Suddenly, it's harder for the customer to order from another supplier. Similarly, companies can raise barriers to entry. A manufacturer might forge exclusive relationships with its retailers, preventing them from taking on competing lines. A company could offer speedier delivery to its customers, requiring more inventory and overhead, which would-be competitors would be hard-pressed to match. The point here is simple: if you think strategically, you can influence the structure of your industry in a positive way.
