[MUSIC] To complete a five forces analysis, the first step is to define your industry, that might sound obvious but companies often make mistakes in this. If you define the industry too broadly, your five forces analysis will become unwieldy and if you define the industry too narrowly, you could miss important aspects of each force. The easiest way to define your industry is to start by considering who is your customer and who are the competitors providing products and services that satisfy those customers saying needs. So before we begin, I recommend opening your workbook and answering the question, in what industry does your company participate in? In a semester long course on strategy, it can take several class periods for students to fully understand the five forces. So for now, I'm going to introduce each one briefly and afterward, you can learn more outside of this course. Two of Porter's books are listed for you as optional, not required reading, they might be old, but they are not outdated. Threat of New Entrants, also referred to as barriers to entry, are the things that make it easy or difficult to enter a market. Be careful which terms someone is using, a high threat of new entrants means that there are low barriers to entry in the industry. Economies of scale means that the more units of a product a firm produces, the lower the costs per unit or that the more customers a firm has, the lower the cost of acquiring a new customer, or the higher the price a firm can charge. For example, when you buy a product or service online, do you look for the number of stars the seller earned or how many customers they have or how many products the seller sold? In some online marketplaces, these numbers could mean enough to keep out a new entrance. This is more difficult a barrier to protect. First, some online sellers use bots to pump up their ratings and customer numbers and second, having deep pockets that is easy access to cash can enable a new player to hang on at a loss for long enough to achieve the needed economies of scale. If it's hard for customers to change from one competitor to another, referred to as switching costs, it will be hard to get into the market as a new competitor. It's easier to sell a new brand of cellphone or cell service in a location where no cell service existed before than in a place where everyone already has a provider. In the early days of cellphones, customers had to change their number when changing cell providers, limiting new competition. When that barrier dropped, cell providers tried to keep customers by requiring long service agreements. New providers overcame that barrier to entry by offering to pay off the contracts. Industries that require extensive capital expenditures, for example, large brick and mortar locations, heavy equipment or extensive research and development are tougher to get into and a high degree of government regulation as a barrier to entry. There's a reason you don't see many nuclear power plants being built in the backyards of people with a voice in their government's decisions. And industries, customers and suppliers might threaten to enter the industry if they have a key competency or resource that smooths their way in or if the industry is not meeting their needs. As mentioned in a previous video, when a supplier enters its buyer's industry, it is forward integrating. When a buyer enters its supplier's industry, it is backward integrating. And, of course, as I mentioned in my story earlier, industry participants can create barriers by reacting swiftly to any intruder. The Threat of New Entrants is always prevalent as new players seek new ways to overcome the barriers. Competitive rivalry refers to the extent that industry participants will fight for every dollar and every customer. Industries that are fragmented are those where there are many small players, industries that are consolidated are those that have a few very big players. Competition tends to be more rational among players. In a consolidated industry, they can see each other and read each other's signals more easily and they tend to set prices such that each player makes a good profit. But that does not encourage new players to join in. Competitors are less likely to fight over every last customer in fast growing industries as there's plenty of space for everyone and business is growing so fast, companies are focused on meeting demand. They may not be paying much attention to other players, but when industry growth is slow, and especially when slow growth is combined with excess capacity in an industry with high economies of scale, competitors fight for every sale. Sometimes it can be hard to get out of an industry. You might have learned that her non-cortes burned his army's boats when they landed at Mexico's shore's, preventing any opportunity to retreat was sure to force the men, many of whom were not loyal to him, to win or die trying. In the 1970s, Johnson and Johnson got into the medical imaging equipment industry and found they could not achieve profitability. But it was difficult to sell the division because they had contracts with large hospitals and medical facilities customers whom they served with other products. They struggled for several years until finally, they sold to GE for a much lower price than they pay to enter the market. Suppliers have higher power over industry participants when these things are true. They are more concentrated than the industry to which they sell when the supplier's industry is comprised of a few very large players while there are numerous small industry participants. They don't depend on you for revenues, but you depend on them as an input for a differentiated product. Industry participants face high switching costs, for example, let's say you want to switch to a new, better supplier for a set of machinery for your production facility, but the new machinery will require your employees to undergo extensive training. If industry participants cannot afford to close down their line or allocate even some of their employees time to non-productive work, your supplier can feel confident you won't leave them. And if those who supply to your industry can forward integrate, they will have greater negotiating leverage over you and your industry rivals. Buyer or customer power is essentially the opposite of supplier power. Customers have greater negotiating leverage if they are in a consolidated industry and you are in a fragmented industry, if it's easy for them to switch from one industry player to another or they can easily produce your product or service themselves. They will be very sensitive to price if they themselves are under intense pressure to cut costs. The industry's product or service represents a large portion of their budget and product quality or differentiation is not important. Like with supplier power, you cannot look at just one thing on the list to determine the level of firepower. For example, there are thousands of people who want to fly and only a few airlines going to their preferred destinations. So in some way, the airline industry has greater power over its customers. However, switching costs are incredibly low. I will take almost any airline going to my destination at the time I would like to go at the best price. Years ago, airlines try to increase customer switching costs by creating frequent flyer memberships, but these did not provide a sustainable advantage because every airline created one. There was no key competency required to implement a frequent flyer program beyond flying to more destinations than others and only those who fly extensively chose their flights based on those memberships. This may have changed over the years as credit card companies and others offered miles and smaller airlines collaborated with large airlines to share points, but you get the idea. Substitutes are hardest to predict. Products and services that substitute for existing industries tend to come from outside the industry. It was not a record company that created digital music. For this reason, you always want to be looking ahead. How is technology changing such that the value your industry provides to customers can be achieved in a completely different way? What innovations in one area, that might be unrelated to your industry, might lead to the need for new products and services? Once you have looked at your industry through the lens of each of the five forces, see if you can predict likely changes, what trends might influence the balance of power with your suppliers? How might you position your product to better meet changing customer needs? Where might there be holes in your industry, spaces where there is a customer base, but few competitors are meeting their specific needs? You might even be able to alter the forces as they relate to your company within the industry. I recommend tasking your employees with investigating different forces. For example, this month, a couple of employees add researching customer needs to their tasks, while another couple of employees research competitors, then switch off next month or add another force, get everyone in the habit of keeping their eye on the industry. You want to continually scan the marketplace because the forces are not static and you'll want to be the first to anticipate and exploit changes. Involving your employees will teach them to think strategically to make decisions that support the organization long term, you cannot be everywhere making every decision your employees can learn to manage upwards. Besides, someone may surprise you with a new idea that enables your company to shape the balance of forces such that they are more favorable to your company compared to your rivals. In the next video, we will learn about internal analysis.
