Welcome to the Harvard Business School video series in this program Professor Michael Porter of the Harvard Business School introduces industry analysis and discusses how to position a company within its industry and how to create an effective strategic planning process. A leading Authority on strategy, Porter is the author of competitive strategy, competitive advantage and competition in global Industries. For suggestions on how best to use this video cassette and accompanying material please refer to the viewers guide and the user's manual in your video package. I Michael Porter and this is my heart visit school classroom where I teach about competitive strategy. Some of you may be very familiar with my ideas on strategy and others of you maybe just learning about the subject. it's a complicated subject here at Harvard I spend about the 50 sessions covering the strategy with my MBA students and clearly we're not going to be able in a short program like this to cover everything in the subject but we've got on our side a very powerful tool and that's the power of the video medium. Through this medium I hope I'm going to be able to give you some of the essential concepts of developing strategy but more importantly to take you behind the scenes in a series of Industries and important American companies to bring the concepts of strategy to life. And in the course of talking to the executives involved in and seeing strategy in action we can learn some lessons about strategy that are hard to learn of any other way. What is competitive strategy? Competitive strategy is the positioning of a company in its competitive environment. Now positioning means more than just a product positioning or the marketing concept, it’s the total positioning of the company involving all of the functions, production, distribution, logistics, service. The total picture of the Enterprise is placing to the competitive environment. How do we go about developing a strategy? Well in developing strategy there are two fundamental questions that we’ve got addressed. The first is the structure or attractiveness of the industry or Industries in which were competing. Some Industries or a lot more profitable than others here in a year at. And we simply must understand why? because one of the essential parts of developing a strategy is to know how good the game is in which you're trying to compete. The second essential question in a strategy is a company's position within its industry. Again, when if we look at many industries, we see that no matter what are the industries profits are higher or low, Companies in the same business have widely different levels of profitability. Some here in a year at make a lot more money than others. And any strategies must understand what it takes to be a superior performer in the industry and not be one of the ones that the below average. Both of these questions are vital in developing strategy. Now let's turn to the first question industry analysis. In any industry no matter what it produces, whether it's a product or service, or any type, there are five basic forces of competition at work that are Illustrated on this chart. The force in the middle is the one we most commonly think about, the Rivalry among the existing competitors, the jockeying for position price cuts, new product introductions, new capacity that sort of thing. In some industry the rivalry is very gentlemanly and genteel. In other industries rivalry is cuts roads, somebody is always attacking the other gap. This diagram however suggest that industry competition is broader than just a rivalry among existing competitors. There's the threat of new entry. The threat of the new competitors can come into the game and they bring a new capacity and if entry is easy, if it's easy for new players to come into the industry that’s can be a fundamental to the attractiveness of the industry. So, one crucial dimension of Industry structure is the barriers to entry. Industries are also competed with substitute products or services these are other products or services that can do the same thing as the industry's product. So, for example if you're selling steel, you're worried about plastics and other materials because there's substitutes for what your industry produces. If in industry faces close a substitute, this places a cap for a constraint on prices in the industry you can only raise your prices so much or you'll start to erode the volume as the buyer desert you to the substitute. You always buying from suppliers in any industry, you're buying inputs like labor, materials and Machinery. And the suppliers have bargaining power. They can constrain the profitability in the industry because they can buy bidding up their own prices for the industry. They can strip the profitability of an industry and finally of course every industry sales to Buyers and those buyers may or may not have bargaining power. If they have bargaining power and if their price is sensitive they made a bargain away the profitability industry by demanding lower prices by expecting more service that they don't pay for and so what. And so, what we see is it in any business the fundamental long-term profit potential is a function of the strength of these five competitive forces the mix of forces will depend on the industry. every industry is unique. But the overall strength of the five forces is going to determine whether an industry is a profitable one in the long-term or one that's mediocre. Now what determines the strength of each of the competitive forces whether it be rivalry or Firepower or supplier power or whatever. Each of the competitive forces is shaped by a number of underlying structural determinants. In the case of the rivalry it's things like how fast the industry is growing, how high are the fixed cost, how much can you differentiate yourself from your rivals, these underlying determinants of each force or describe in detail in your user guide. They represent in the raw material that you use to conduct industry analysis. To bring these ideas to life let's take a look at a number of specific industry and see if we can use this framework to assess their fundamental potential and how it might be changing. Pharmaceutical industry is an 80 billion dollar industry worldwide and it's one of the most profitable industries of any industry in the economy of any country the average after-tax return on equity in the pharmaceutical industry has been around 20% for the law as long as anybody can remember and very few companies have ever have a bad year now why is the pharmaceutical industry such a profitable business why is this such a terrific game to be in well to answer that question let's go back to our five competitive forces let's start with a buyer there are three different buyers of drugs, but neither the doctor who chooses the drug, the patient who wants to feel better, or the insurance plan that pays most of the cost or price sensitive fire to the barriers to entry into the industry how hard is it to get into the pharmaceutical industry will the answer is it's darn hard for two important reasons the first is that in order to get your drug accepted by the doctor you've got to have a thousands of salespeople they're called detail men in this industry and they call him the doctor until that doctor about new drugs and try to persuade the doctor to try the drug out on his or her patients and it's very.. very expensive to set up one of these organizations and the doctor is very busy in addition to a Salesforce you need to actually come up with a new drug you need something Innovative to sell to that doctor and the average cost of developing a new drug today is about 100 million dollars 100 million dollars just to get into the game and about 60 million of that is the cost of testing the drug to get it approved by the government and that takes years in fact there's not been a significant new entrance into the pharmaceutical industry since the 1950s when syntax answered on the back of their a breakthrough in contraceptive pills suppliers have little power in this industry the cost of purchase ingredients used in making a drug is a small percentage of total cost most ingredients are Commodities where suppliers have little room to raise prices they're also few substitutes once an effective drug is on the market it takes years for another therapy to make Headway against it now well the process is pretty gentlemanly drug companies don't compete on price they don't compete on price because they don't have to the buyer isn't price-sensitive they are able to hold up the prices and compete instead on things like their brand reputation of the quality of their sales force things that don't erode the profitability industry so the pharmaceutical industry is what you might call a five-star industry every one of the five competitive forces is favorable let's turn to another industry the airline industry with a very different level of performance for much of the postworld War II. The airline industry has been regulated both in the United States than in many foreign countries and fundamentally affect the structure of an industry how we think about the role of government in Industry competition it's tempting to view government as the sixth Force to add to the other file from our experience that's not the best way to look at it the best way to look at it is to see how government is affecting the other five and by affecting each of the other five forces government can either be a positive or A negative for industry competition Airlines under regulation government suspended the structure of the airline industry prices were fixed offsetting any power of the customer Airlines were not allowed to enter new roots notifying rivalry and new Airlines were not really allowed into the industry in effect making the barriersto-entry unbelievably High under regulation the airline industry profitability was recently good but deregulation unleashed the fundamental structure of the airline industry and has set in motion a set of forces that have led to a very mediocre returns since deregulation took place all you need is a few cities and you got yourself an airline in fact dozens of Airlines Evander the industry as soon as it was allowed by government the buyer is pretty price sensitive and is not very loyal . how long will you wait for the airline of choice 15 minutes 20 minutes customers are willing to switch from one airline to another based on those convenient who has the best price. Rivalry is intense you have lots and lots of competitors with different cost structures with very high fixed-cost. Once you got an airline fueled and you're going to make the trip anyway you will cut price to get those incremental passengers and suppliers to the airline industry have some Cloud 2. In in an aircraft and some other key inputs to the industry. So once government gets out of the air in the airline industry structure the underlying structure goes to work and that structure is not very favorable. and the prophets reflect that. now we seen how to analyze an industry by looking at the five forces. And we see how some Industries are fundamentally more attractive than others and profitability reflects that. But industries are not static. Industry structure can change it can change either For Better or For Worse. For two basic reasons, first environmental forces. Like new technology can shift the structure of the industry. And Company through their own strategies also have the power to shape industry structure. How do we analyze industry structural change? well once again we use the five forces. And Industry Trend or a competitor development is significant for future industry structure is it affects one or more of the five forces. Now to understand how this works let's go back to the pharmaceutical industry that Goldmine I talked about earlier. In the pharmaceutical industry there are three important changes that threaten to undermine that tremendous profitability of the industry. The first has to do with the buyer who didn't care about price well that's starting to change there's increasing pressure on cost control is coming from the government is coming from the insurance company. Is coming because the cost of drugs has increased twice as fast as Consumer Price Index in the 1980s. Now this increasing pressure for could cost control is leading to the second important change in the industry and that's the emergence of so-called generic drugs. One of these babies are generic drug doesn't have the brand name of the manufacturer but has the identical chemical composition. Its therapeutically equivalent. and once a drug goes off of patent as many have. It legally possible for the drug to be imitated by another manufacturer. Now increasingly the government is legislating that doctors have to prescribe a generic not the brand name of the manufacturer. The third important change in the pharmaceutical industry is the emergence of biotechnology. Now biotechnology is a whole new way doing a research on drugs. But let’s think the impact of biotechnology on the structure of the medical industry. It’s doing a couple of things first of all it's reducing the cost of developing new drugs, lowering the barriers entry and in the process whole new companies like Genentech entirely new skills have an opportunity to enter this industry for the first time in decades. Now these three changes, costcontainment, generic drugs, and biotechnology are all undermining the structure of the pharmaceutical industry. And unless drug companies can react to respond the average property believe that industry is likely to go down. But it doesn't always work that way in some Industries structural change is positive. Now let's return to the airline industry and discuss three important changes that are occurring in that industry that have the promise to fundamentally improve the industry been so difficult and so competitive for the last decade. The first important change is a so-called hub-and-spoke root system. Now by having a lot of flights coming in and out of the same city every day in a very coordinated way an airline can get major efficiencies in operations in marketing and number of other aspects of the business. The effect of the hub-and-spoke system of the airline was started to compete on the basis of hubs not on every individual flight. And this is also raised the barriers to entry into the airline industry to get into a city now you have to offer enough flights to compete with that Airline who has that city is a hub. Another Force changing airline industry is the emergence of sophisticated management information systems. One airline is involved in hundreds of millions of transactions everyday fair schedule tickets and modern computer technology has revolutionized the way all this can be done it's allowed it to be automated. The problem though is it.. it takes millions and if not hundreds of millions of dollars for an airline to develop this kind of sophisticated technology. And this huge investment has substantially raised the barriers to entry into this industry and given a new lever for some Airlines to outdo others. The final change in the airline industry that's going to improve the industry structure is the so-called frequent traveler programs. Where Airlines give free travel to passengers who accumulate miles on their Airline. The programs you remember that one of the crucial problems in the industry is that it was hard to differentiate. One Airline was preceded the same as another will the frequent traveler programs have started to change that equation again rivalry is starting to get less intense and the barriers to entry are going up. Now we’ve seen a number of Industry examples spanning 200 very different types of Industries what should we have learned about industry analysis. First of all, we should have learned that industry analysis is the starting point of any strategy. You simply must understand the structure of each and every industry in which you're competing and the underlying reasons why that structure is what it is. Each industry is going to be different in terms of which competitive force is the most significant sometimes it's the buyer sometimes it's very first entry sometimes it’s rivalry. But whichever force is most significant that's the place where strategic attention really needs to be placed. That's where you should focus your creative energies and trying to improve your environment. Another crucial lesson in Industry analysis is that you must constantly be looking for how your industry might change. Because we’ve seen and Airlines in Pharmaceuticals how important and even revolutionary industry structural change might be. And we've seen how to use the five forces framework to analyze how your industry might indeed be change. We've also seen however that companies have the power to shape their industry. You're not a passive participant in your industry you can influence how industry structure of all. And an essential part of any company strategy must be an approach to making the industry structure better. Particularly if a company is a leading company. But the final lesson is the third of the outside of all this and that is that companies can unwittingly destroy their industry just as easily as they can make it better. Many companies by not thinking through the implications of their strategic moves will go down as strategic path that undermines the industry structure that makes the five forces worse. Any strategic move of any sort must constantly be tested against its impact on the fundamental structure. Competitive Positioning We looked at how to analyze an industry the first essential question is in strategy. Now let’s turn to the second question. How is a company achieve superior performer within its industry whatever the average industry profitability may be. Now the starting point for understanding why a company is a superior performer is pretty simple. That is that to be a superior performer in your industry you've got to have a sustainable competitive advantage. A company has to have something it can do better than its Rivals that it can protect from imitation. It can keep its competitors from replicating. Now Advantage can be sustained in one of two ways. Either you can be lucky enough to come up with something that your competitors can’t ever copy which is rare. Or more commonly you can improve faster than your competitors can catch up. And continuous Improvement and continuous search for new benefits and edges is really part and parcel to most successful companies of the latest sustained advantage. Now if competitive manage is the key of the superior performer, how do we get one? well to understand that question we must recognize that there are two basic types of competitive advantage that any company can possess. One is low cost, in designing and producing and delivering and marketing its products than its competitors, it has lower-cost and therefore it can earn superior margins and therefore superior performance. Now the other kind of competitive advantage is what I like to call differentiation. A corporate differentiated is enable to provide some kind of unique benefit that customer think it’s important. And because it's unique in an important area its customer is willing to pay at a premium price and that premium price leads to Superior margins and intern Superior performance. Now if we think about it almost any strength or any weakness the company has, can be translated either into something that makes their relative cost position high or low or something that affects their ability to be differentiated relative to their competitors. And if we see later, its very important to understand which one a company is trying to achieve. Now in seeking one of these two types of competitive advantage, any company has another fundamental choice to make in setting its strategy, and that's what I like to call competitive scope. The breath of the target within which is seeking to gain that advantage. Now some companies like General Motors historically the automobile industry have picked a broad competitive scope they offered a wide range of products to a wide range of customers in a wide range of geographic markets. Other companies recognize that they can achieve competitive advantage with a broad range of consumers or in a broad range of product lines and therefore if they pick what I would call a narrow scope of focusing on a particular product line a particular type of customer of a particular type of geographic area perhaps and they seek to gain advantage in this narrow arena even though they can't get over all. Now, these two essential variables to type of advantage and the scope of advantage lead to what I like to call generic strategies some fundamentally different routes to competitive advantage that companies can choose. Now as you see in this chart there are four basic options, a company can seek a broad positioning and to be the low-cost producer, or it can seek a broad positioning and try to differentiate itself with that wide-range consumer segments and so on. Or it can choose a focus strategy by narrowing market to some unusual segment and seeking to be either low-cost or differentiated in that particular area even though it can achieve those advantages over all. What we learn from studying a wide range of industry is that the worst strategic Air is to be stuck in the middle to not be willing to choose which of these routes to competitive advantage the company is going to follow, to worry about quality and differentiation but not achieved uniqueness in anything and I think about segmentation of the market but to not be willing to dedicate themselves to a particular narrow segment. These kind of companies are stuck in the middle and they're going to be the below-average performers in any industry. Cost Leadership Any company seeking to gain a cost advantage must start with a good product. A low-cost strategy starts with a good product. It starts with a product that acceptable in quality and acceptable in the future that meets the basic needs of the consumer. But the low-cost competitor doesn't offer all the Frills and all the bells and all the whistles that they potentially could they seek simply to produce a good basic product. Instead of Frills they’re advantage is going to come from opening up a significant and a sustainable cost gap over all their competitors. And they do this by managing the critical drivers of cost in their business whatever they may be. Now in gaining this low-cost position the cost leader translate this into superior margins provided they can command prices that are at or near the industry average. In strategy there's a very important equation. Which determines a fundamentally a company's ability to be a superior performer. And another equation is the comparison of a company's prices relative to its competitors and its cost position relative to competitors. Any company that has superior performer either has higher prices or lower-cost, but there's a balance to be struck. In a cost leadership strategy a company is trying to be the low-cost producer and get a cost advantage that's where it's advantage is going to come from. But it must not let its prices get too low or its cost advantage will be notified or offset by lower prices. Now let's look at two companies that have successfully implemented cost Bay strategies.. Everyone of us uses bar soap hopefully everyday. That's why it's a 1.6 billion dollar industry in the United States when one thinks of soap one thinks of one company Procter & Gamble when one thinks of Procter & Gamble one thinks of oneself Ivory. One might think soap is a mundane business where there's little opportunity for a strategy after all soap is soap in fact so provides an example of competitive positioning. Ivory was introduced many years ago actually in 1879 at the time there were over three hundred companies in the soap industry most of these companies competed with the strategy of producing very crude soaps the other competitor soap in the industry at the time were producers of very expensive luxury soap. Now I freely decided to enter the market with a very different strategy for the time. The basic of the bar soap strategy is introduce and trials bar of soap without the harsh ingredients and alkalis that were characteristic of the other soaps of the time. The Ivory bar also floated. Instantly enough though the floating was an accident. Ivory made some bars up a by accident in the manufacturing process and it turned out that they float. consumers were so interested in that feature that the Procter & Gamble quickly decided that it was a good idea. In addition to the product itself however I recreated some very important symbols of it strategy. The first was whiteness. At the time most soaps were Brown and color various shades of brown. I free instead became quite so I re was the first heavily advertised so in fact one of the first heavily advertised brands in the United States of any kind. in addition to the advertising goal was the advertising message. Charlie Proctor had a very interesting idea he had the problem of communicating Purity and there was no well-established and impurity in the consumer’s mind. So, Harley Proctor designed his own measure of Purity which led to the famous slogan ninetynine and forty-four 100% pure this became the slogan that personify the ivory brand. One Charlie Proctor said a major Purity he aggressively used comparison as with other soaps in fact tables appeared in magazines which to compare diver each other brands. later on he started very early to use endorsements. He had chemist and Physicians a certified to the purity of the ivory brand. the final early innovation in Procter & Gamble advertising was the use of the image of the baby. the baby became one of the early symbols of Ivory. If it’s mild for baby it's got to be mild enough for you the results of the ivory strategy were astounding. Arie behaved the differentiated soap in the United States. It commanded the premium price and it also commanded a leading share of the soap Market dominating all other competitors. I am pursued the differentiation strategy up through the 1940s and 1950s but important changes in the industry in the 1950s and 1960s were threatening and challenging the traditional Ivory strategy. The first was dial. Dial was the first of the so-called deodorant bars in addition to basic cleaning it offers a deodorizing feature as well a number of other deodorant bars follow. the second major development was Dove. Dove was specially formulated to take good care of the skin so-called Beauty Bar was introduced in 1956 and again others followed. Now the introduction of dial and Dove fundamentally threaten the positioning of Ivory as the differentiated so these new products had features that I didn't have. Now Procter & Gamble had a choice at this stage it could have added these new features one or both of them to Ivory, but it chose not to, instead Procter & Gamble decided to strategically the Ivory. Now the basic Ivory bar remain the same is quite it floats it's 99 44 100% pure but I removed from being the differentiated soap to being the good basic soap that represents a good value. It moved from being the differentiator to being the cost leader in the soap industry and in the processes Ivory was able to maintain its leading Market position. Now what is the new Ivory strategy. Well let's start with the bar. The ivory strategy is to have a simple basic, no Frills soap, no unnecessary ingredients, no scents, no perfumes and now how about the packaging was you can see here the Ivory package aims for Simplicity there's no expensive papers, no shiny paper, no garish colors, look at this this bar here, that's pretty garish. Arie goes for Simplicity for simple of four basic bundling. Here's an example of a bundle of soap there are six bars here sold together and what this did was go from having a bunch of bars sitting in the bin in a disarray to unique kind of package and the ID here was an ivory could be used by the whole family so you should buy it in quantity.