Competitive Strategy

Abstract

This article focuses on strategic analysis and strategic development for companies operating in today's dynamic, competitive business environment. This article will introduce tools for analyzing the external and internal factors that a firm faces. We will then apply that insight to the formulation of a competitive strategy.

In the dynamic environment of the business world, a firm needs to constantly focus on improving its competitive strategy. Competitive strategy refers to the way a firm can gain advantage over others operating in a similar market. Rivalry drives improvement and innovation. Without competition, strategy would be irrelevant.

Strategy goes beyond operational improvement. Tactics that are easily imitated do not constitute a strategy. Simply improving operations or quality cannot lead to a competitive strategy. A competitive strategy utilizes analysis of the structure of an industry and its competitors in order to identify an optimal position. A competitive strategy will also integrate the strengths and resources of the firm to develop a competitive advantage. A sustainable competitive strategy involves continuous improvement with strategic continuity.

This article will focus on the process by which a successful competitive strategy can be developed. The first step to creating a competitive strategy is to analyze the structure of the industry and the nature of competition. Next, we will discuss how to assess the firm's internal environment. Once a clear picture of the industry structure and firm attributes are identified, we can consider the options for achieving goals and sustaining a competitive advantage.

Industry Analysis

In 1979, Michael Porter introduced the business world to a framework for analyzing the structure of an industry. His model, commonly referred to as Porter's Five Forces, takes a broad approach to competitive analysis. He moves beyond focusing on direct competitors in the market and expands his scope to all players in the value chain. Customers, suppliers, potential new entrants and substitute products are all taken into account in shaping the competition of an industry. Porter's Five Forces model is internationally recognized as the foundation for a thorough competitive analysis. This framework can assess the attractiveness of an industry and help clarify how value is divided among different players in the value chain. According to Porter, the nature and degree of competition is influenced by the five major forces that will be discussed in detail below.

Threat of New Entry

New entrants into a market can really shake up an industry. A firm can lose market share, enter a costly battle to defend territory or lose leverage with customers and suppliers. When assessing the attractiveness of an industry with respect to new entrants, we look to mitigating factors called barriers to entry. These characteristics can help protect an industry from new entrants. There are nine major barriers to entry that we will discuss:

1. Economies of scale -- Economic efficiencies are vital to successfully competition in many industries. In many cases, the higher the production volume, the lower the unit cost of production. This increased efficiency provides an advantage to firms that can produce large volumes. If economies of scale come into play in the industry, then a new entrant would either have to match the scale of the large producers or accept a cost disadvantage.
2. Brand Identity -- Recognition in the marketplace can be hard for a new entrant to overcome. Brand loyalty takes time and money to build. A new entrant may need to spend heavily on advertising and in other areas such as customer service to displace the entrenched players.
3. Proprietary Product Differences -- Companies which have patents or other proprietary knowledge can hamper a new entrant's success in the marketplace.
4. Capital Requirements -- The requirement to invest significant financial resources to enter an industry can also inhibit new entrants. Whether it is manufacturing equipment, research and development, or advertising expenditures, any large capital outlay will make a new firm think twice about market entry.
5. Absolute Cost Advantages -- Independent of the size of a company, there are some advantages that come with a track record in the industry. These advantages can arise from the effects of the experience curve, access to a superior supplier, favorable location, etc. New entrants may not be able to match established firms when it comes to these advantages.
6. Switching Costs -- In some cases, consumers will incur additional expenses for switching from a product or service. Monetary penalties, such as an exit fee for breaking a contractual obligation, are employed in many industries. There can also be psychological switching costs that must be overcome to get consumers to change from the status quo.
7. Government Policy -- The government can curb competition in an industry through policies and regulations. The government may have a limited number of licenses that can be given out to set up operations in a certain industry. Environmental regulations and granting of monopolies can also prevent a new firm from entering the market.
8. Access to Distribution -- In many industries, there is a finite number of products that can be offered to consumers. Wholesalers and retailers do not have unlimited capacity. Therefore, there will always be a fight for shelf space. Existing players can lock up the distribution, making it hard for new entrants to get their products to the market. The more constrained the distribution outlet, the more limited the pool of players.
9. Expected Retaliation -- The threat of new entrants can also be influenced by the expected reaction of existing players. If the existing players possess substantial resources to mount a fight or cut prices, new entrants are less likely.

Bargaining Power of Suppliers

The relationship between a supplier and buyer is one of the most important aspects in business. Procurement of raw materials, labor and other supplies is vital to ongoing operations. Profits of a firm can be squeezed by suppliers exerting their power. Suppliers can raise prices, reduce quality, limit supply or even sign exclusive contracts with competitors. In general, powerful supplier groups possess one or several of the following characteristics.

1. Supplier Concentration -- If the industry is dominated by a few suppliers, this provides little choice for the buyer.

• 2. High Switching Costs -- As discussed in the previous section, switching costs can prevent buyers from taking advantage of alternatives. In the case of a supplier-buyer arrangement, there may also be product specifications that tie a buyer to a particular supplier or the buyer could have invested in expensive equipment to process a particular supplier's raw materials. If the buyer will incur switching costs, then the supplier has more strength.
• 3. Unique Product -- When there are few viable substitutes for the materials a firm is trying to procure, the supplier gains more power in the relationship. For example, the buyer could require a special component that has proprietary technology.
• 4. Viable Forward Integration Threat -- When a supplier has the ability to enter the business themselves, it will prevent the buyer from getting too greedy.
• 5. Serves Multiple Industries -- If a supplier's product can be used for many purposes in several different industries, then the supplier can be picky about whom they do business with.
• 6. Marginal Customer -- A buyer may be an insignificant customer to the supplier because they do not purchase enough volume. In that case, the buyer may be the first to experience price increase, material shortages or lower quality products.

Bargaining Power of Customers

Customers can also negatively impact an industry's profitability. Customers can push price down, require higher service and force competitors into costly battles for their patronage. In general, powerful customer groups possess one or several of the following characteristics.

1. Concentrated or Large-Volume Buyer -- These big customers generally can make or break a company. These buyers are courted by many competitors in the industry and can usually capture concessions because of their power over the firm.

• 2. Standardized Product -- These are undifferentiated products with ample alternatives. Because there is little brand identity and no switching costs, these are the most vulnerable to manipulation by customers.
• 3. High Price to Total Purchase Ratio -- If what the buyer is purchasing constitutes a significant portion of total costs or total budget, the buyer is more likely to scrutinize the product and its price.
• 4. Low Buyer Profits -- If a firm earns low profits, it is much more price sensitive than a firm that has a lot of cushion.
• 5. Viable Backward Integration Threat -- If the buyer has the ability to acquire a similar company or build the product themselves, then they will have significant power over the firm.

Threat of Substitutes

Substitutes can come in many forms. Threats can come from within the industry in the form of technology advances. They can also come from outside of the industry with a product that has a similar application. For example, plastic pallets could be a significant threat to a cardboard box manufacturer. The theory of supply and demand can be applied to this threat. The more viable substitutes there are in the market, the less demand and therefore the lower the price may be. If there are no switching costs and no brand loyalty, the threat of substitutes is considerable.

Rivalry among Existing Competitors

Competition between direct competitors in the marketplace will always be present. Firms can wage intense battles to try to steal market share from one another. Common tactics include price wars, new/improved product introduction, and escalation of advertising campaigns. Intense rivalry is characterized by one or several of the following factors:

1. Slow Industry Growth -- An industry that is not expanding at fast enough rate to accommodate all players' growth ambitions, can set the stage for fierce competition. This is particularly true of mature industries where profits are on the decline. This scenario generally results in a shakeout of competitors with only a few surviving.
2. High Exit Barriers -- Significant investment in customized equipment or assets may make it hard for a firm to exit a business. This may cause a company to continue to compete even after returns have been marginalized. Direct competition with these firms should be avoided because they will have incentive to cut costs to the point of razor thin margins or negative returns.
3. Significant Fixed Costs -- This concept relates back to our discussion of economies of scale. When high volume production is necessary in order to maintain lower per units costs, there is a significant incentive to capture more market share. Market share battles usually involve price slashing and are quite damaging to profits.
4. High Concentration and Balance -- When there are numerous competitors of relatively the same size, competition can be exaggerated. Competition in this kind of fragmented industry is intensified because they are all on relatively equal footing, competing for the same supplies and customers.
5. Product Lacks Differentiation or Switching Costs -- Customers in this case can be very fickle and easily substitute one firm's product for another. The temptation to undercut competitors on price can lead to an unattractive proposition for all in the industry.
6. High Diversity of Competitors -- When rivals differ in their strategies, philosophies and cultures, it is hard to predict what your competitors will do next. This instability can cause irrational, intense competition.

Applications

The five forces will impact every market differently. In some markets, the threat of new entrants is particularly heightened. In others, the bargaining power of suppliers can be disastrous for profits. The weaker these forces are, the greater the opportunity for high returns on investment. An industry that experiences intense threats on all fronts is not very attractive and most likely has diminished profit opportunities.

A competitive strategy can use these forces to find optimal positioning. Analysis of the five forces can indicate where the firm can best defend itself. It can also help anticipate change so that a firm is not caught off guard. Finally, the company should use what it knows about the industry to influence the forces in their favor. Understanding these forces can also highlight whether diversification or integration (vertical or horizontal) makes sense. We will further expand on the applications of Porter's model strategy formulation.

Issues

Porter's Five Forces model has been criticized because some believe it does not consider the complete picture. Some academics have argued a sixth or even seventh force should be added. A possible sixth force could be stakeholders such as governments, employees, shareholders, creditors, etc. Another force that is not addressed in Porter's framework is the cooperative effect. The concept of complementors may explain the rationale behind the prevalence of strategic alliances.

Company Analysis

Once the industry and competitors have been analyzed, we move on to looking at the particular firm. The next step in strategy formulation is to take stock of what resources the company has available and what the strengths and weaknesses are.

One tool that can help organize the examination of a firm is the SWOT analysis. This framework was developed by Albert Humphrey, who led research projects on Fortune 500 companies at Stanford University in the 1960s and 1970s. This model considers four key areas; (S) strengths, (W) weaknesses, (O) opportunities and (T) threats. A strategist must perform a comprehensive examination of each one of these categories. Some factors to consider in a SWOT analysis are listed below.

Strengths

1. Brand Identity/Loyalty

• 2. Patents/Proprietary Knowledge
• 3. Exclusive Access to Distribution
• 4. Management

Weaknesses

1. High Cost Structure

• 2. Unstable Suppliers
• 3. Poor Reputation
• 4. Management

Threats

1. Government Regulations

• 2. Substitute Products
• 3. Changing Consumer Tastes
• 4. New Entrants

Opportunities

1. New Technology

• 2. New Customer Segments
• 3. International Expansion
• 4. New Distribution Channels

The firm analysis builds on the industry analysis and helps to explain why the company may be over performing or underperforming. It will also help clarify what strategic direction should be pursued.

Strategic Development

Once a comprehensive analysis has been performed on the industry and the company, we can start to build a strategic plan. This article will discuss two common tools to help formulate a competitive strategy.

Competitive Positioning Matrix The first framework we will look at follows Porter's Five Forces model. This matrix lays out four different strategic positions based on the scope of the target consumer and the level of product differentiation. The theory is built on the assumption that there are four basic ways to provide customers with greater value: either through lower cost, special benefits that justify a higher price, or taking each of these elements and tailoring it to a narrow target. Below is an illustration of the positioning strategies.

Cost Leadership -- This strategy focuses on low-cost production. Often this price advantage can be gained through economies of scale. If too many firms try to pursue this strategy, it can result in price wars and suboptimal profits for all firms in the industry.

Differentiation -- A strategy based on differentiation would highlight a product's unique attributes. It focuses on providing additional value to the customer so that they are willing to pay more. This unique characteristic could be along many different lines (e.g., service, distribution, marketing, image, etc.).

Cost Focus -- This strategy chooses a particular market segment and tailors its product to that narrow target with the lowest costs. This competitive strategy takes the aspects of the Cost Leadership strategy and applies it to a particular target.

Differentiation Focus -- Just as with Cost Focus, this strategy goes after a particular market segment and caters to that niche. The basis of this strategy lies in the differentiated product that can serve the narrow target. It takes the aspects of the Differentiation strategy and applies it to a particular target.

A lack of strategy is seen when a firm attempts to pursue more than one of these positions. The straddling of several positions should be avoided. It can lead to suboptimal profits compared to others in the industry.

SWOT Matrix

After completing the competitive positioning matrix, strategists might use a SWOT analysis to identify strategies. The SWOT matrix takes into account the particular characteristics of the firm to build a strategy that responds to the opportunities and threats in the industry. Below is an illustration of how the factors combine to form strategies.

S/O Strategies -- Uses strengths to exploit opportunities.

S/T Strategies -- Uses strengths to avoid threats or help defend against them.

W/O Strategies -- Highlights weaknesses that must be overcome in order to take advantage of opportunities.

W/T Strategies -- Highlights weaknesses that must be overcome to defend against threats and areas where the company is particularly vulnerable.

Threats

There are four threats to competitive advantage that a firm should guard against. Threats to the industry include substitution and holdup. Threats to a firm include imitation and slack.

Substitution -- As we discussed previously in the article, the threat of substitution can make an industry extremely unattractive. The same holds true for a specific firm. Substitution reduces the demand for what a firm provides and can sometimes be subtle and unexpected. Monitoring the competitive landscape can help a firm anticipate this threat. Responses to substitution could include fighting it directly with either cost reductions, or incorporating the substitute's benefits into the existing product. When the product life cycle is on the decline or the when industry competition is too intense, the appropriate strategy might be to do nothing and harvest.

Holdup -- This danger occurs when value is diverted to a customer or supplier who has some bargaining leverage over the firm. If the firm has invested in assets that are specific to a particular relationship, they can be held up as a result. Cooperation can be an essential element of strategy, but over time it can lead to issues. Firms must constantly consider the impact of cooperative relationships. To guard against holdup, a firm can maintain multiple sources, enter into contractual arrangements or vertically integrate.

Imitation -- One of the biggest risks to a firm's competitive advantage is the threat of imitation. When a company is doing well, others will take notice. For strategies to be sustainable, the firm should make sure its point of differentiation and activities are not easily copied.

Slack -- Threats to competitive advantage can also come from within the company. Slack occurs when there is waste or complacency within a firm. To guard against slack, a firm must take a hard look at itself. Outside board members and management incentives tied to shareholder value creation can help impose discipline on the company.

Conclusion

Competitive strategy should be a constant process for all firms. Before the firm can move in any direction, it should take stock of where it is and how industry factors are shaping the competitive landscape.

When a company decides on a strategic position, all activities in the firm must be consistent with this goal. A competitive strategy is not a single, discrete action, but rather an entire activity system that fits together in chorus. There should be an emphasis on trade-offs. Each decision the firm makes should be tested against the chosen strategies to make sure it fits. When a firm is tightly aligned in this matter, it is harder for competitors to match them. Inconsistencies in activities, image, internal coordination, measurement or controls can cause the firm to be disadvantaged.

As the business world moves to competition on a global level, the concepts discussed in this article become even more important. A firm may need to craft individual strategies for each new market it enters, making the strategist's job more complex. Further challenging modern competitive strategy is the rise in environmental awareness, and how that can impact cost, and the burgeoning use of technology in the global marketplace.

Terms & Concepts

Bargaining Power of Customers: One of Porter's five forces that examines how much leverage the customers in a particular industry wield.

Bargaining Power of Suppliers: One of Porter's five forces that examines how much leverage the suppliers in a particular industry wield.

Barriers to Entry: Obstacles that prevent new players from entering industry.

Cost Leadership: A competitive strategy that concentrates on producing a product at the lowest possible price.

Differentiation: A competitive strategy that concentrates on producing unique products with attributes that improve the value proposition for consumers (e.g., service, technology, image, marketing, etc.)

Porter's Five Forces: Strategic framework developed by Michael Porter for assessing the attractiveness of an industry. Areas of analysis include: 1) New Entrants 2) Suppliers 3) Customers 4) Substitutes and 5) Existing Competitors.

Focus: A competitive strategy that focuses on a very narrow target. A firm can either choose to compete in this niche segment with low costs or with a differentiated product.

Holdup: Bargaining leverage one player has over another that can reduce profits or options the firm can pursue.

Threat of New Entrants: One of Porter's five forces that examines the likelihood of new competition entering the marketplace.

Threat of Substitutes: One of Porter's five forces that examines how easily a product can be replaced.

Rivalry Among Existing Competitors: One of Porter's five forces that examines the intensity of competition among existing players in an industry.

Slack: Waste or complacency within a firm that threatens its competitive advantage.

SWOT Analysis: Strategic assessment framework that outlines a company's strengths (S), weaknesses (W), opportunities (O) and threats (T).

Bibliography

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Suggested Reading

Azadi, S., & Rahimzadeh, E. (2012). Developing marketing strategy for electronic business by using McCarthy's Four Marketing Mix Model and Porter's Five Competitive Forces. EMAJ: Emerging Markets Journal, 2(2), 47–58. Retrieved November 22, 2013 from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=90596367

Birger, J. (2006). Second-mover advantage. Fortune, 153(5), 20–21.

Retrieved April 20, 2007, from EBSCO Online Database Academic Search Premiere. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=20004778&site=ehost-live

Burgers, W. P., & Cromartie, J. S., & Davis, J. R. (1998). Cooperative competition in global industries: The strategic dimension. International Trade Journal,12(4), 421–444. Retrieved April 20, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=1327433&site=ehost-live

Henderson, B. (1989). The origin of strategy. Harvard Business Review, 67(6), 139–143. Retrieved April 20, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=9001080593&site=ehost-live

Henderson, B. (1980). Understanding the forces of strategic and natural competition. Journal of Business Strategy, 1(3), 11–16. Retrieved April 20, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=5701632&site=ehost-live

Kim, B. (2013). Competitive priorities and supply chain strategy in the fashion industry. Qualitative Market Research: An International Journal, 16(2), 214–242. Retrieved November 22, 2013 from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=86655007

Walker, G., & T. L. Madsen. (2016). Modern competitive strategy. 4th ed. New York, NY: McGraw Hill.