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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.

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.

Once in a great while companies can effectively reshape an entire industry. American Airlines has done it, for example, in air transportation. After deregulation, air travel was a pretty unattractive business. It was easy to get into -- all you needed was a couple of planes, which could be heavily financed. Buyers had a lot of bargaining power because they viewed airline seats as commodities. And the rivalry was cutthroat. Airlines had high fixed costs and would do anything to fill their empty seats. So there were massive price wars, and the industry as a whole lost money.

American effectively changed the industry's structure. The company introduced a computer reservations system that cost more than $1 billion. Pretty soon anyone who wanted to be a serious competitor needed such a system -- and suddenly an upstart airline with a few planes could not play the game the same way anymore. American also aggressively pursued the hub-and-spoke concept, meaning that it had dozens of flights going in and out of one city. Now would-be competitors needed 10 or 20 flights going to a city, not just 2 or 3. And American set up the first frequent-flyer program. Even though it was quickly imitated, the program created brand loyalty, giving customers a big incentive to stick with the airline they flew on most. Taken together, those moves fundamentally changed the airline business. Except during the Gulf crisis and its aftermath, the industry's profitability has soared, and American has done better than most.

Positioning strategically

Most small companies, of course, cannot change an industry's structure. What they can do, however, is establish a good position in the industry -- a position based on sustainable competitive advantage.

What constitutes a competitive advantage? Well, advantage comes in only two basic varieties. You can have consistently lower costs than your rivals. As long as your product maintains an acceptable quality level, that will lead to higher margins. Alternatively, you can differentiate your product or service from your competitors', in effect making yourself unique at delivering something your customers think is important. That allows you to command a premium price. And provided you keep your costs under control, the premium price will translate into a superior return.

There is one other crucial variable in strategic positioning: what I call competitive scope. Some companies seek advantage in what might be called a broad scope: they serve more or less all types of customers in an industry, offering a wide product line and operating in many geographic areas. Companies with a narrow scope, alternatively, focus on a narrow range of customers or product varieties, or in one geographic region, and dedicate all their efforts to that one small niche or market segment.

These crucial choices in strategy lead to some different combinations, depending on the breadth of the target and the type of advantage sought. In cars, for example, Toyota is the broad, low-cost competitor, BMW and Mercedes-Benz the differentiators in the premium segment, and Hyundai the low-cost player in the price-sensitive segment.

There is room for several successful strategies, as long as each company makes a different choice from its rivals'. The worst error, however, is not to choose, to try a little bit of everything and therefore not have any advantage at all. That is what I call ``stuck in the middle.'' It does not work, because all good strategies involve trade-offs. You cannot be both low cost and differentiated at the same time, because being unique at quality or service usually involves higher costs. A sustainable competitive advantage comes from choosing an appropriate strategy and appropriate scope. For small companies, the operable choice is normally what is known as focus: narrowing the strategic target and dedicating every action to serving that target. Take the hotel business as an example. Nationally, it is dominated by big, full-service chains -- Marriott, Hilton, and so on. Each of them seems to offer everything a traveler could want: Comfortable accommodations. Bars, restaurants, room service. Meeting rooms, suites, health clubs, game rooms for the kids. You might think an upstart company would have no chance of finding, let alone defending, a profitable niche in the industry.

How, then, to explain the success of La Quinta Motor Inns, a company that grew from $61.8 million in 1980 revenues to $226.5 million in 1990?

La Quinta's success lies in strategy: in narrowing its target to the regular, middle-level business customer, the kind of traveler who visits a city over and over, and who does not have an unlimited expense account at his or her disposal.

What do those particular customers want? Mostly, a nice, comfortable room to sleep in. They do not want suites -- they cannot afford them. They do not want a lounge -- if they are going to drink, they know the city and have a car; they will go out. They do not even need a restaurant. La Quintas are always built next door to a Denny's or a Howard Johnson's, something open 24 hours a day, so guests can go get breakfast anytime.

The list goes on. Meeting rooms? No need. Room service? Too expensive. Recreation facilities? No time. Transportation? Already have it.

By not providing all those extras -- extras the La Quinta customer does not want anyway -- the hotel chain is able to lower dramatically the cost of providing a room. So even if it sells the rooms for $38 a night, as compared with $80 or $100 or even $120 at a Marriott, it can make a lot of money. That is focus.

Note one thing, however: if the typical hotel customer wandered into a La Quinta, there would be a lot of dissatisfaction. Room service? ``Sorry, we don't have it.'' How about a playground for the kids? ``Sorry.'' A good focused strategy inevitably makes many customers unhappy. But it is going to make a certain group of customers very, very happy, and that is the logic. You target all your efforts on those customers, and you achieve either lower costs or uniqueness in meeting their needs.

Answer 1

In a business environment there are five types of competition the company has to face. The ability of the company to face these types of competition will determine its success in the long term. The ability to cope up with these competitions will determine whether the company will sustain for the long. It will exit within a short frame of time.
1. The first type of competition is like a Gorilla war. In this type of competition the competitors always try to attack each others by cutting their prices. In this type of industry the profit margin is very low.
2. Then there are companies in which the the competition will always focus of image and service rather than the price. In this case all the competitors who are operating in the industry will have the benefit of earning profits.
3. The profitability of an industry is also determined by the entry barrier. If it is difficult to enter into a particular industry then the profit will be high. The entry barrier may be in form of Government rules and regulations. Is government restricts the number of computer in any industry then the the companies operating in those industries will earn profits.
4. The Other type of competition may be in the form of substitute. Substitute can be explained like if the customer has the option to two switch two two other product which will give the same type of usage then that can be set as a substitute. For example aluminum Windows can be substituted by windows Windows, traditional full service broker can be substituted by discount brokers. Type of alternative also affects the profitability in the industry.
5. The bargaining power of suppliers also determine the level of profitability in the industry. If the industry is having Limited number of suppliers then the suppliers will charge more price. On the contrary if the suppliers are more then the the chances of demanding a premium price is very less .
These are the 5 types of forces which are mentioned above that determine the profitability of any industry. Hands anyone entering into new business should analyses the potential by taking into account these five factors.

Companies which deal in pharmaceutical which make a earning of 20 % every year easily. This is because the raw material of the commodities are unimportant in this case and the customers also don't have much bargaining power. On the contrary company such as the aluminum window manufacturing have computers which can substitute products like wood and plastic Window undefined these companies deal with great competition and the hardly make an earning of 10% every year. Rating this companies on a scale of 5 the aluminum industry will get 0 rating and the Pharmaceutical will get a 5 star rating. This is only because of the the competition level in this industry.
The real interesting fact is that the industry structure can also be changed and the way a company completes can also influence one of of the five forces which are mentioned above.
A manufacturing company for example can tie up with retail stores and totally avoid competitions in their industry. The manufacturing company will not allow other manufacturers by giving exclusive rights to retailers for selling their products.
In airline industry in America the competition was cutthroat. This was because it was easy to finance aero planes. Anyone could enter the industry by financing this Plains but the competition was very high as all the companies operating in this industry reduce this price by giving low price to the customers to fill up the vacant seats . So American Airlines introduced the system of online booking. This was the first company which introduced this system. Anyone giving competition to this company required huge amount of investment in the reservation system online. Which was difficult for the competitors. Online reservation system also gave American Airlines and brand loyalty from the customers. Which gradually became it difficult for the competitors to to enter. The company also gained a competitive advantage by introducing the hub-and-spoke concept. In this concept the company had 10 or 20 flights going to a city not just two or three which the competitors had. This gave it a huge competitive advantage over the competitors.
Positioning strategy.
Although it is difficult for all companies to change the industry structure. Companies can also earn profit when they have competitive advantage. The competitive advantage can come in two forms. The price can be lower than the competitors and the competitive advantage can be kept. The other way can be making products acceptable quality level which will lead to higher margins. In this way the product has to be unique from the competitors and it should have a unique selling proposition.
Some companies also sell products which are targeted to all the customers in an industry. They offer a very wide range of products in different geographical locations. Example of such a case can be Toyota which makes cars targeted to all kind of customers. They make cars ranging from the hatchback, Sedan, SUV ,premium. Further there are also companies which target very narrow scope of market. They make products to customers which targets only to a particular group. For example BMW and Mercedes they make cars which are are targeted to the premium customers.
Keeping in mind all the above points necessary for the company to choose the type of competition it is ready to face. The worst part of it could be a company entering into a particular competition and not knowing which type of competition it is willing to face. For example a company offering a unique product cannot keep it product at a low price. On the vice versa a company offering a low quality product cannot charge high price for it.
Hotels like Marriott Hilton charge high price from the customers as they have a wide variety of services to offer for the customers.
The La quinta's motor is a company that revenue went from dollar 61.8 million in 1980 and reach 226.5 million in 1990 . It targeted the regular middle class businessman who traveled to a city again and again and have limited budget. It kept it target to those Businessman who did not need very luxury rooms, restaurant, bars, meeting rooms etc. In spite of not having this the company succeed at this because its target market was to achieve low cost customers and it was offering this in a very unique way in meeting the customers need.
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