I decided to read this book because one of my personal heroes, Bill Gurley, had recommended it. It’s somewhat of a dense read but has valuable takeaways. The central principle of the book can be seen in the image below. These are the 5 forces that drive industry competition. Here’s what each of them means.
Threat of New Entrants: This threat is governed by barriers to entry coupled with the reaction from existing competitors that an entrant can expect. Sources of barriers to entry include economies of scale, product differentiation, capital requirements, switching costs, access to distribution channels, cost disadvantages independent of scale, and government policy.
Expected retaliation from existing competitors also influences the threat of entry. Intense rivalry amongst firms can be the result of many factors such as numerous or equally balanced competitors, slow industry growth, lack of differentiation, high strategic stakes, and high exit barriers.
Threat of Substitutes: All firms in an industry are competing in a broad sense with industries producing substitute products. Substitutes that deserve the most attention:
Bargaining Power of Buyers: Buyers force down prices, bargain for high quality / more service, and can play competitors against each other.
A buyer group is powerful if: it is concentrated or purchases large volumes relative to seller sales, the products it purchases are a significant percentage of its costs, it faces few switching costs, it earns low profits, if it poses a credible threat of backward integration, or if the buyer has full information.
Bargaining Power of Suppliers: Suppliers can threaten to raise prices or reduce the quality of the goods / services they provide. A supplier group is powerful if: it is dominated by a few companies and is more concentrated than the industry it sells to, it has product differentiation, the industry is not an important customer of the supplier group, the supplier’s product is an essential input, the supplier poses the threat of forward integration. Labor is a supplier as well and can be a threat if it is scarce or highly organized.
Generic Competitive Strategies: There are 3 generic strategies to outperforming:
The important thing is to pick a strategy and not get stuck in the middle.
A Framework for Competitive Analysis: In conducting a competitive analysis, components of competitors to assess include future goals, current strategy, assumptions, and capabilities. You want to study existing and potential competitors.
Next, let’s study how a competitor might respond:
In most industries, firms are mutually dependent, i.e. firm A’s move affects firm B. The goal is to outperform your competitors without having them retaliate or engage in warfare. Start by looking for moves that improve your performance without impacting the performance of significant competitors. When making a threatening move, you want to predict and influence retaliation.
Market Signals: A market signal is any action by a competitor that provides a direct or indirect indication of its intentions, motives, goals, or internal situation. Signals can be truthful indicators or bluffs.
Forms of market signals include: prior announcements of moves, announcements of results or actions after the fact, public discussions of the industry, and explanations of moves / tactics.
Strategy Towards Buyers and Suppliers: There are 4 primary criteria to assess when selecting buyers:
You want to seek out and sell to the most favorable buyers. Criteria to assess in regards to the purchasing strategic include:
Structural Analysis Within Industries: When doing this, there are many dimensions to consider including specializtion, brand identification, channel selection, product quality, technological leadership, cost position, and many more.
Step 1 is to categorize all significant competitors against the dimensions that are most relevant, and then bucket the companies into strategic groups. Given this, the underlying determinants of a firms profitability will be common industry characteristics, characteristics of the strategic group, and the firms position within its strategic group.
Industry Evolution: Start by asking how industry trends affect each one of the 5 forces. Examples of evolutionary processes include long run changes in growth, changes in buyer segments served, accumulation of experience, product and marketing innovations, entries and exits, etc. Big firms will often leave it to smaller firms to develop a market and prove that significant demand exists before they enter.
Competitive Strategy in Fragmented Industries: Causes of industry fragmentation include low overall entry barriers, absence of economies of scale, and a strong need for creative content.
To overcome fragmentation, you want to create economies of scale, standardize diverse market needs, make acquisitions to reach a critical mass, and recognize industry trends early. To formulate a strategy for doing this:
Competitive Strategy in Emerging Industries: Structural factors of emerging industries include technological uncertainty, strategic uncertainty, and first-time buyers. The industry development is typically constrained by the inability to obtain resources, the absence of product standardization, customer confusion, and the response of threatened entities.
Transition to Industry Maturity: Indicators of maturity include slowing growth (which means more competition for market share), increase selling to experienced repeat buyers, and competition that is more cost and service-oriented.
Implications of maturity can include scaled-down expectations for financial performance, more discipline, and more attention on the human dimension of the firm.
Competitive Strategy in Declining Industries: A declining industry is one where there is a sustained decline in sales. This decline can be the result of tech innovation, changing demographics, or a shift in needs.
Strategic alternatives in this situation include seeking market leadership, creating a niche position, harvesting (i.e. controlled disinvestment), and divesting quickly. The image below presents a framework for deciding which one of these strategies to pick.
Competition in Global Industries: Strategies to choose from in a global industry include broad line global competition, global focus in a particular segment, national focus, or a protected niche (i.e., protected by governmental restraints). Trends affecting global competition include differences amongst countries, industrial policy, the free flow of technology, and the emergence of new large-scale markets.
Strategic Analysis of Vertical Integration (VI): VI is the combination of technologically distinct product, distribution, selling and / or other economic processes within a firm. Benefits of VI can include better economics, a tap into technology, assurance of supply / demand, ability to offset bargaining power and input cost distortions, an enhanced ability to differentiate, and elevated entry barriers.
Strategic costs can include the costs of overcoming mobility barriers, increased operating leverage, higher exit barriers, and the need for capital investment. There are also two forms of VI that a firm can consider:
Capacity Extensions (CE): When contemplating CE, two expectations are crucial: future demand competitor behavior. Keep in mind that companies often have a tendency towards overbuilding, especially in commodity businesses.
Entry Into New Businesses: Characteristics of good industries to enter include the industry being in disequilibrium, slow or ineffectual retaliation from incumbents expected, the firm has lower entry costs than others, the firm has a unique ability to influence industry structure, or positive effects on existing businesses. You can enter a new business in two ways: