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Subject 3. Implications for strategy

Once having assessed the forces affecting competition in an industry and their underlying causes, the corporate strategist can identify the company's strengths and weaknesses. The crucial strengths and weaknesses from a strategic standpoint are the company's posture versus the underlying causes of each force. Where does it stand against substitutes? Against the sources of entry barriers?

Then the strategist can devise a plan of action that may include 1. positioning the company so that its capabilities provide the best defense against the competitive force; and 2. anticipating shifts in the factors underlying the forces and responding to them, with the hope of exploiting change by choosing a strategy appropriate for the new competitive balance before opponents recognize it; and 3. shaping industry structure by influencing the balance of the forces, thereby improving the company's position.

Positioning the Company

This approach takes the structure of the industry as given and matches the company's strengths and weaknesses to it. Strategy can be viewed as building defenses against the competitive forces or as finding positions in the industry where the forces are weakest.

Knowledge of the company's capacities and of the causes of the competitive forces will highlight the areas where the company should confront competition and where avoid it. If the company is a low-cost producer, it may choose to confront powerful buyers while it takes care to sell them only products not vulnerable to competition from substitutes.

Exploiting Industry Change

Industry evolution is important strategically because evolution brings with it changes in the five competitive forces. In the familiar product life-cycle pattern, for example, growth rate change, product differentiation is said to decline as the business becomes more mature, and the companies tend to integrate vertically.

These trends are not so important in themselves. What is critical is whether they affect the competitive sources. Consider vertical integration. In the maturing personal computer industry, extensive vertical integration, both in manufacturing and in software development, is taking place. This very significant trend is greatly raising economies of scale as well as the amount of capital necessary to compete in the industry. This in turn is raising entry barriers and may drive some smaller competitors out of the industry once growth levels off.

A strategist can also use the five forces model to predict the eventual profitability of an industry. In long-range planning the task is to examine each competitive force, forecast the magnitude of each underlying cause, and then construct a composite picture of the likely profit potential of the industry.

Shaping Industry Structure

When dealing with the forces that drive industry competition, a company can devise a strategy that takes the offensive. This posture is designed to do more than merely cope with the forces themselves; it is meant to alter their causes.

Innovations in marketing can raise brand identification or otherwise differentiate the product. Capital investments in large-scale facilities or vertical integration affect entry barriers. The balance of forces is partly a result of external factors and partly in the company's control.

Why eliminating rivals is a risky strategy?

The competition in an industry can actually help profitability for all involved. Merger and acquisition strategies merely designed to eliminate rivals (rather than improve cost or quality) are risky. Based on the five forces model, the reduced competition should increase industry profitability in the short term. However, the additional profits often attract new competitors and a backlash from customers and suppliers. The job of the business strategist is to understand and cope with competition, not seek to eliminate it.

Study notes from a previous year's CFA exam:

c. identify changes in industry structure, and forecast their effects on the industry's profit potential;

d. explain how positioning a company, exploiting industry change, and shaping industry structure may be used to achieve a competitive advantage.