The Five Forces: Competing for Profits

Excerpt from Understanding Michael Porter by Joan Magretta

  • Most people think competition is a direct contest between rivals to win a sale. It’s not. At least not entirely. It’s more about earning (and competing for) profits, which is more complex.
  • Companies compete for profits against Five Forces:
    • direct competitors
    • customers, who would like to pay less
    • suppliers, who’d like to charge more
    • producers, who could make substitute products
    • potential competitions…threat of new entrants places limits on how much a company could charge
  • Most industries are more similar than they appear on the surface
  • Industry structure determines profitability
  • Industry structures are sticky; they are stable over time…structural change on the other hand takes a long time
  • Porter’s prevailing framework for sizing up an environment is called ‘SWOT’: strengths, weaknesses, opportunities, and threats
    • SWOT is a weak tool. No economic principles inform it….SWOT analysis can lead to arbitrary outputs
    • SWOT is biased toward confirming long-standing beliefs
  • The more powerful the force, the more pressure it will put on costs and prices or both
  • Assessing each Force and how it affects profit…
    • Buyers: powerful buyers push costs down to capture more value
    • Suppliers: powerful suppliers will use negotiating leverage to charge higher prices or get better terms
    • Substitutes: put a cap on industry profitability…erode incumbent sales. Switching costs play a big role in substitution
    • New entrants: incumbents erect barriers to deter newcomers
    • Rivalry: when rivalry is intense, profitability is lower (i.e. price cuts, more advertising, new product roll-outs, and increased customer service)
      • Price competition is the most damaging form of rivalry…erodes profits
  • Why Only Five forces?
    • encompasses all relationships relevant to commerce: buyer and seller, seller and supplier, between rival sellers, and between supply and demand
    • Memorizing the five forces won’t make you a better thinker. You have to get the deeper point. There are a limited number of structural forces at work in every industry that systemically impact profitability in a predictable direction
    • Other factors that are important but are not structural (i.e. a Force) include…
      • Gov’t regulation, technology, and and industry growth rates
  • Sixth Force?
    • ‘Complements’ are sometimes proposed as a sixth force. Complements can affect the demand for a product (i.e. software affects hardware)
      • But dismissed because their effects are not direct enough. They affect profitability in a round about way
  • Implications for strategy?
    • Steps in Industry Analysis
      • Define an industry (by both product and geography)
      • Identify players constituting each of Five Forces
      • Assess drivers of each Force
      • Assess overall industry structure
      • Analyze changes/trends in forces
      • Think about positioning
  • Industry structure is dynamic…changes all the time
    • the more you understand an industry using the five force framework the more you can exploit changes when they happen

Are You Sure You Have a Strategy?

by D. Hambrick and J. Fredrickson

  • Strategy has become a catch-all term to mean whatever you want it to mean
  • Strategy can only be strategy if it’s intentional, integrated, and informed
  • Their framework for strategy design is made up of 5 elements:
    • Arenas: where will we be active?
    • Vehicles: how will we get there?
    • Differentiators: how will we win in the marketplace?
    • Staging: what is our speed/sequence of movement?
    • Economic logic: how to we obtain returns?
  • Choices about internal organizational arrangements are not part of strategy
  • The best strategists are iterative, ‘loop’ thinkers
  • Achieving market advantages doesn’t mean a company has to be extremely differentiated…it could stand out as the the most balanced (re: Honda)
  • Strategic differentiation is about making up-front, deliberate choices; differentiation doesn’t just happen
  • All 5 elements of strategy are necessary and involve deliberate choice, preparation, and investment
  • Strategy is nimble, ever-evolving, and deals with the current conditions as much as it does with future conditions

What Predicts Success? It’s Not Your IQ.

by Daniel Goleman via LinkedIn

  • People assume academic abilities should predict how well you do in life. But they don’t.
  • ‘Grit’ is an attitude students with high grades share; plug away in the face of failure
  • Those children with best Cognitive Control had the greatest financial success in their 30s
  • Cognitive Control is the ability to delay gratification in pursuit of a goal
  • What sets star performers apart? Self-awareness, self-management, empathy, and social effectiveness–EQ
  • The higher up the ladder the more EQ matters; EQ more than expertise/intelligence makes you successful

Introduction to Strategy

by Lenox et al.

  • Strategy is a pattern of decisions in a company that reveal its objectives, purpose, goals, policies…and defines the range of activities that they will pursue to drive value for its shareholders, employees, and customers
    • Strategy is hard to define because it is complex…
  • To assess a firm’s business strategy you have to have a clear picture of what makes the firm unique and differentiated
  • Variety of external forces influence a firm’s strategy:
    • competition
    • technology
    • the economy
    • etc
  • Strategy is integrative; brings finance, marketing, accounting, ops, and hr together
  • Also integrative in the sense that you are driving value for multiple parties: shareholders, customers, employees, suppliers, etc
  • Tradeoffs are critical: companies juggle short-term and long-term investments
  • Analytical frameworks and tools can help create comprehensive understanding of business context and are key to strategy
  • Fundamental Principle of Competition:
    • If everyone can do it, then it’s hard to capture value from it
    • Must consider second order effects
    • A successful strategy requires some barrier to competition that prevents other firms from imitating the strategy
  • Strategic analysis includes:
    • Identifying a companies current positioning and its strengths and weaknesses
    • Consideration of pros/cons of small set of strategic actions to improve position
    • Advancement of recommendations based on analysis
  • Strategy is not merely operational effectiveness; it’s dynamic and involves both content and action…also includes tactical responses to external factors

Tesla Motors – HBR Case

by Eric Van den Steen

  • Car business is 3% of GDP–one of largest industries in US
  • Since WWII, no US firm has successfully entered car market…except Tesla?
  • Cars consist of 3 things: power train, chassis, and body
    • because of this conventional cars are complex and expensive to design; it takes $1 to 6 Billion and between 4-5 years to design
  • Traditional car manufacturing assembly plants need huge volumes to reach minimum efficiency
    • assembly lines expensive, sometimes inefficient, and more expensive to manufacture
    • Manufacturing cost is 80% of final sale price
    • High “experience curve” in 1st year; lot’s of bugs and defects worked out by manufacturers
  • Car producers are among heaviest advertising spenders, occasionally higher than Pepsi, Coke, and Disney
  • Conventional Cars sold through Dealerships
  • Electric vehicles (EV) were popular in 1800s, but were overtaken by technologically more advanced internal combustion cars in 20th century
  • The battery was most expensive and complicated component of EVs
    • battery cost decreased by 90% from 2009-2012
  • Gov’t provide rebates for EVs to push adoption…EVs good for environment
  • Hurdles to EV adoption: uncertainty about resale value, safety, range anxiety, and lack of charging stations.
  • Nissan Leaf was most ambitious EV project ever
    • Nissan saw opportunity to be a leading supplier of EV batteries
    • Joint venture w/NEC
  • Fisker, another EV producer, flopped paving the way for Tesla
  • Elon Musk is Tesla’s co-founder. Originally just funded it; later moved into CEO role
  • None of founding team members were from auto industry
  • Tesla Roadster was first production-grade EV and high-end EV
    • used Lotus body
    • liquid cooling system for battery
  • Model S was Tesla’s first mass-produced EV…won rave reviews
    • wireless software updates
    • 17″ touch screen
    • custom suspension
  • Model S assembly line fully in-house in Fremont, CA…plant was bought at 2/3 discount
  • No dealerships, just company-owned stores w/salaried sales people
  • Marketed Model S speed, comfort, and handling instead of energy benefits
  • Tesla also sold its electric power trains to other car manufacturers
  • Tesla working on Model 3 ($35,000) as a part of Musk’s master plan to build accessible EVs

Case Questions:

  1. Was Gen 3 (Model 3) the logical next step or a bridge too far?
  2. And is Tesla here to stay and to become the first US firm since WWII to enter car industry with a mass-produced car?

My thoughts:

Model 3 is a logical next step given Musk’s stated master plan. His ultimate goal is to make the planet more livable by reducing car emissions. Step one was to build an EV for the rich to subsidizes building a mid-sized car…the mid-sized car would then subsidize building the entry level car. There’s not enough people in the world driving high-end cars to sell enough Tesla’s to, to reduce global emissions. Hence entering entry-level markets that reach more people and thereby reduce more emissions.

Is Tesla here to stay? Hard to say. Tesla is no longer Tesla Motors. It’s now just Tesla after the acquisition of Solar City. This could cause a lack of focus and some issues. (Musk runs OpenAI, Boring Company, and Space X) Also, it’s difficult to predict how well the Model 3 will do. Check back with me after the strenuous experience curve in a year or so. That’s going to be a huge test.

HBR Guide to Better Business Writing

by Bryan A. Garner

  • Write chronologically
  • Be clear
  • Shorter. More varied sentences.
  • The passive voice is to be avoided
  • Eliminate unnecessary words
  • Write in plain English; avoid Bizspeak
  • Rule of 3 numbers: one, two, three, and too many numbers
  • MACJ Framework
    1. Madman: conduct research
    2. Architect: draft outline
    3. Carpenter: write unfiltered
    4. Judge: edit
  • Ask coworkers to edit your work
  • Picture the person you’re writing for as you write
  • Use contractions; they’re not that bad
  • Never use two or three words when one will do
  • Watch your tone
  • Do not draft and edit emails simultaneously
  • Use ‘I,’ ‘we,’ ‘us’ to make writing more personal