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For this task, you will assess your organization and how it is impacted by Porter’s diamond factors by researching key external, political, legal, technical, and environmental factors. Bro, please read the requirement again.."For this task, you will assess your organization and how it is impacted by Porter’s diamond factors by researching key external, political, legal, technical, and environmental factors". Note: we are working with JPMorgan Chase. MBA 520 Module Four Short Paper Guidelines and Rubric Overview: For this task, you will assess your organization and how it is impacted by Porter’s diamond factors by researching key external, political, legal, technical, and environmental factors. Prompt: First, review the module resources, especially the Michael Porter article The Competitive Advantage of Nations, and then examine and answer the following questions based on your chosen organization for the final project:  Factor Endowments: How is your organization impacted by factor endowments? In other words, does your organization have a competitive edge based on such things as land, labor, capital, and entrepreneurship that can be exploited for production?  Demand Conditions: How is your organization impacted by demand conditions? In other words, how is your company developed compared to other competitors?  Related and Supporting Industries: Are the related and supporting industries located close to your organization in order to create a competitive edge?  Strategy, Structure, and Rivalry: Is the organization’s strategy, structure, and rivalry providing the company with competitive advantage?  Government and Chance: How do government and chance support the competitive advantage of the organization? Refer to the case study, your textbook, and other course materials to support your responses. Rubric Guidelines for Submission: This short paper should be 2–3 pages in length, double spaced, with 12-point Times New Roman font, one-inch margins, and citations in APA style. Critical Elements Exemplary (100%) Proficient (90%) Needs Improvement (70%) Not Evident (0%) Value Factor Endowments Meets “Proficient” criteria and demonstrates a nuanced understanding of the relationship between factor endowments and competitive advantage Provides a complete, clear analysis of how the chosen company is impacted by factor endowments, including whether factor endowments provide the company with a competitive advantage that is well-supported by information from course resources and research Provides an analysis of how the chosen company is impacted by factor endowments, including whether factor endowments provide the company with a competitive advantage, but the analysis is incomplete, unclear, or not well-supported by information from course resources and research Does not provide an analysis of how the company is impacted by factor endowments and whether factor endowments provide the company with a competitive advantage 18 Critical Elements Exemplary (100%) Proficient (90%) Needs Improvement (70%) Not Evident (0%) Value Demand Conditions Meets “Proficient” criteria and demonstrates a nuanced understanding of the relationship between demand conditions and competitive advantage Provides a complete, clear analysis of how the chosen company is impacted by demand conditions, including how the company is developed compared to other companies and whether demand conditions provide the chosen company with a competitive advantage, and analysis is well- supported by information from course resources and research Provides an analysis of how the chosen company is impacted by demand conditions, including how the company is developed compared to other companies and whether the demand conditions provide the company with a competitive advantage, but the analysis is incomplete, unclear, or not well-supported by information from resources and research Does not provided an analysis of how the chosen company is impacted by demand conditions, including how the company is developed compared to other companies and whether the demand conditions provide the company with a competitive advantage 18 Related and Supporting Industries Meets “Proficient” criteria and demonstrates a nuanced understanding of how related and supporting industries can provide a company with a competitive advantage Provides a clear, complete analysis of whether related and supporting industries are located close to the chosen company in order to create a competitive advantage, and analysis is well-supported by information from course resources and research Provides an analysis of whether related and supporting industries are located close to the chosen company in order to create a competitive advantage, but the analysis is unclear, incomplete, or not well-supported by information from course resources and research Does not provide an analysis of whether related and supporting industries are located close to the chosen company in order to create a competitive advantage 18 Strategy, Structure, and Rivalry Meets “Proficient” criteria and demonstrates a nuanced understanding of the relationship of a company’s strategy, structure, and rivalry to competitive advantage Provides a complete, clear analysis of whether the chosen company’s strategy, structure, and rivalry create a competitive advantage, and analysis is well-supported by information from course resources and research Provides an analysis of whether the chosen company’s strategy, structure, and rivalry create a competitive advantage, but the analysis is unclear, incomplete, or not well-supported by information from course resources and research Does not provide an analysis of whether the chosen company’s strategy, structure, and rivalry create a competitive advantage 18 Government and Chance Meets “Proficient” criteria and demonstrates a nuanced understanding of the relationship between government and chance and competitive advantage Provides a clear, complete analysis of how government and chance impact the chosen company’s competitive advantage, and analysis is well-supported by course resources and research Provides analysis of how government and chance contribute to the chosen company’s competitive advantage, but the analysis is unclear, incomplete, or not well-supported by information from course resources and research Does not provide an analysis of how government and chance support the chosen organization’s competitive advantage 18 Critical Elements Exemplary (100%) Proficient (90%) Needs Improvement (70%) Not Evident (0%) Value Articulation of Response Submission is free of errors related to citations, grammar, spelling, syntax, and organization and is presented in a professional and easy-to- read format Submission has no major errors related to citations, grammar, spelling, syntax, or organization Submission has major errors related to citations, grammar, spelling, syntax, or organization that negatively impact readability and articulation of main ideas Submission has critical errors related to citations, grammar, spelling, syntax, or organization that prevent understanding of ideas 10 Total 100% Awareness of the fi ve forces can help a company understand the structure of its industry and stake out a position that is more profi table and less vulnerable to attack. 78 Harvard Business Review | January 2008 | hbr.org 1808 Porter.indd 781808 Porter.indd 78 12/5/07 5:33:57 PM12/5/07 5:33:57 PM P e te r C ro w th e r Editor’s Note: In 1979, Harvard Business Review published “How Competitive Forces Shape Strat- egy” by a young economist and associate professor, Michael E. Porter. It was his fi rst HBR article, and it started a revolution in the strategy fi eld. In subsequent decades, Porter has brought his signature economic rigor to the study of competitive strategy for corpora- tions, regions, nations, and, more recently, health care and philanthropy. “Porter’s fi ve forces” have shaped a generation of academic research and business practice. With prodding and assistance from Harvard Business School Professor Jan Rivkin and longtime colleague Joan Magretta, Porter here reaffi rms, updates, and extends the classic work. He also addresses common misunderstandings, provides practical guidance for users of the framework, and offers a deeper view of its implications for strategy today. THE FIVE COMPETITIVE FORCES THAT by Michael E. Porter hbr.org | January 2008 | Harvard Business Review 79 SHAPE IN ESSENCE, the job of the strategist is to under- STRATEGYSTRATEGY stand and cope with competition. Often, however, managers defi ne competition too narrowly, as if it occurred only among today’s direct competi- tors. Yet competition for profi ts goes beyond es- tablished industry rivals to include four other competitive forces as well: customers, suppliers, potential entrants, and substitute products. The extended rivalry that results from all fi ve forces defi nes an industry’s structure and shapes the nature of competitive interaction within an industry. As different from one another as industries might appear on the surface, the underlying driv- ers of profi tability are the same. The global auto industry, for instance, appears to have nothing in common with the worldwide market for art masterpieces or the heavily regulated health-care 1808 Porter.indd 791808 Porter.indd 79 12/5/07 5:34:06 PM12/5/07 5:34:06 PM LEADERSHIP AND STRATEGY | The Five Competitive Forces That Shape Strategy 80 Harvard Business Review | January 2008 | hbr.org delivery industry in Europe. But to under- stand industry competition and profi tabil- ity in each of those three cases, one must analyze the industry’s underlying struc- ture in terms of the fi ve forces. (See the ex- hibit “The Five Forces That Shape Industry Competition.”) If the forces are intense, as they are in such industries as airlines, textiles, and ho- tels, almost no company earns attractive re- turns on investment. If the forces are benign, as they are in industries such as software, soft drinks, and toiletries, many companies are profi table. Industry structure drives competition and profi tability, not whether an industry produces a product or service, is emerging or mature, high tech or low tech, regulated or unregulated. While a myriad of factors can affect industry profi tability in the short run – including the weather and the business cycle – industry structure, manifested in the competitive forces, sets industry profi tability in the medium and long run. (See the exhibit “Differences in Industry Profi tability.”) Understanding the competitive forces, and their under- lying causes, reveals the roots of an industry’s current profi t- ability while providing a framework for anticipating and infl uencing competition (and profi tability) over time. A healthy industry structure should be as much a competitive concern to strategists as their company’s own position. Un- derstanding industry structure is also essential to effective strategic positioning. As we will see, defending against the competitive forces and shaping them in a company’s favor are crucial to strategy. Forces That Shape Competition The confi guration of the fi ve forces differs by industry. In the market for commercial aircraft, fi erce rivalry between dominant producers Airbus and Boeing and the bargain- ing power of the airlines that place huge orders for aircraft are strong, while the threat of entry, the threat of substi- tutes, and the power of suppliers are more benign. In the movie theater industry, the proliferation of substitute forms of entertainment and the power of the movie producers and distributors who supply movies, the critical input, are important. The strongest competitive force or forces determine the profi tability of an industry and become the most important to strategy formulation. The most salient force, however, is not always obvious. For example, even though rivalry is often fi erce in com- modity industries, it may not be the factor limiting profi t- ability. Low returns in the photographic fi lm industry, for instance, are the result of a superior substitute product – as Kodak and Fuji, the world’s leading producers of photo- graphic fi lm, learned with the advent of digital photography. In such a situation, coping with the substitute product be- comes the number one strategic priority. Industry structure grows out of a set of economic and technical characteristics that determine the strength of each competitive force. We will examine these drivers in the pages that follow, taking the perspective of an incumbent, or a company already present in the industry. The analysis can be readily extended to understand the challenges facing a potential entrant. THREAT OF ENTRY. New entrants to an industry bring new capacity and a desire to gain market share that puts pressure on prices, costs, and the rate of investment nec- essary to compete. Particularly when new entrants are diversifying from other markets, they can leverage exist- ing capabilities and cash fl ows to shake up competition, as Pepsi did when it entered the bottled water industry, Micro- soft did when it began to offer internet browsers, and Apple did when it entered the music distribution business. Michael E. Porter is the Bishop William Lawrence University Pro- fessor at Harvard University, based at Harvard Business School in Boston. He is a six-time McKinsey Award winner, including for his most recent HBR article, “Strategy and Society,” coauthored with Mark R. Kramer (December 2006). The Five Forces That Shape Industry Competition Bargaining Power of Suppliers Threat of New Entrants Bargaining Power of Buyers Threat of Substitute Products or Services Rivalry Among Existing Competitors 1808 Porter.indd 801808 Porter.indd 80 12/5/07 5:34:13 PM12/5/07 5:34:13 PM hbr.org | January 2008 | Harvard Business Review 81 The threat of entry, therefore, puts a cap on the profi t po- tential of an industry. When the threat is high, incumbents must hold down their prices or boost investment to deter new competitors. In specialty coffee retailing, for example, relatively low entry barriers mean that Starbucks must in- vest aggressively in modernizing stores and menus. The threat of entry in an industry depends on the height of entry barriers that are present and on the reaction en- trants can expect from incumbents. If entry barriers are low and newcomers expect little retaliation from the entrenched competitors, the threat of entry is high and industry profi t- ability is moderated. It is the threat of entry, not whether entry actually occurs, that holds down profi tability. Barriers to entry. Entry barriers are advantages that incum- bents have relative to new entrants. There are seven major sources: 1. Supply-side economies of scale. These economies arise when fi rms that produce at larger volumes enjoy lower costs per unit because they can spread fi xed costs over more units, employ more effi cient technology, or command better terms from suppliers. Supply-side scale economies deter entry by forcing the aspiring entrant either to come into the industry on a large scale, which requires dislodging entrenched com- petitors, or to accept a cost disadvantage. Scale economies can be found in virtually every activity in the value chain; which ones are most important varies by industry. 1 In microprocessors, incumbents such as Intel are protected by scale economies in research, chip fabrica- tion, and consumer marketing. For lawn care companies like Scotts Miracle-Gro, the most important scale economies are found in the supply chain and media advertising. In small- package delivery, economies of scale arise in national logisti- cal systems and information technology. 2. Demand-side benefi ts of scale. These benefi ts, also known as network effects, arise in industries where a buyer’s willing- ness to pay for a company’s product increases with the num- ber of other buyers who also patronize the company. Buyers may trust larger companies more for a crucial product: Re- call the old adage that no one ever got fi red for buying from IBM (when it was the dominant computer maker). Buyers may also value being in a “network” with a larger number of fellow customers. For instance, online auction participants are attracted to eBay because it offers the most potential trading partners. Demand-side benefi ts of scale discourage entry by limiting the willingness of customers to buy from a newcomer and by reducing the price the newcomer can com- mand until it builds up a large base of customers. 3. Customer switching costs. Switching costs are fi xed costs that buyers face when they change suppliers. Such costs may arise because a buyer who switches vendors must, for ex- ample, alter product specifi cations, retrain employees to use a new product, or modify processes or information systems. The larger the switching costs, the harder it will be for an en- trant to gain customers. Enterprise resource planning (ERP) software is an example of a product with very high switching costs. Once a company has installed SAP’s ERP system, for ex- ample, the costs of moving to a new vendor are astronomical because of embedded data, the fact that internal processes have been adapted to SAP, major retraining needs, and the mission-critical nature of the applications. 4. Capital requirements. The need to invest large fi nan- cial resources in order to compete can deter new entrants. Capital may be necessary not only for fi xed facilities but also to extend customer credit, build inventories, and fund start- up losses. The barrier is particularly great if the capital is required for unrecoverable and therefore harder-to-fi nance expenditures, such as up-front advertising or research and development. While major corporations have the fi nancial resources to invade almost any industry, the huge capital requirements in certain fi elds limit the pool of likely en- trants. Conversely, in such fi elds as tax preparation services or short-haul trucking, capital requirements are minimal and potential entrants plentiful. It is important not to overstate the degree to which capital requirements alone deter entry. If industry returns are at- tractive and are expected to remain so, and if capital markets are effi cient, investors will provide entrants with the funds they need. For aspiring air carriers, for instance, fi nancing is available to purchase expensive aircraft because of their high resale value, one reason why there have been numer- ous new airlines in almost every region. 5. Incumbency advantages independent of size. No matter what their size, incumbents may have cost or quality advan- tages not available to potential rivals. These advantages can stem from such sources as proprietary technology, preferen- tial access to the best raw material sources, preemption of the most favorable geographic locations, established brand identities, or cumulative experience that has allowed incum- Industry structure drives competition and profi tability, not whether an industry is emerging or mature, high tech or low tech, regulated or unregulated. 1808 Porter.indd 811808 Porter.indd 81 12/5/07 5:34:18 PM12/5/07 5:34:18 PM LEADERSHIP AND STRATEGY | The Five Competitive Forces That Shape Strategy 82 Harvard Business Review | January 2008 | hbr.org bents to learn how to produce more effi ciently. Entrants try to bypass such advantages. Upstart discounters such as Tar- get and Wal-Mart, for example, have located stores in free- standing sites rather than regional shopping centers where established department stores were well entrenched. 6. Unequal access to distribution channels. The new en- trant must, of course, secure distribution of its product or service. A new food item, for example, must displace others from the supermarket shelf via price breaks, promotions, intense selling efforts, or some other means. The more lim- ited the wholesale or retail channels are and the more that existing competitors have tied them up, the tougher entry into an industry will be. Sometimes access to distribution is so high a barrier that new entrants must bypass distribu- tion channels altogether or create their own. Thus, upstart low-cost airlines have avoided distribution through travel agents (who tend to favor established higher-fare carriers) and have encouraged passengers to book their own fl ights on the internet. 7. Restrictive government policy. Government policy can hinder or aid new entry directly, as well as amplify (or nul- lify) the other entry barriers. Government directly limits or even forecloses entry into industries through, for instance, licensing requirements and restrictions on foreign invest- ment. Regulated industries like liquor retailing, taxi services, and airlines are visible examples. Government policy can heighten other entry barriers through such means as ex- pansive patenting rules that protect proprietary technol- ogy from imitation or environmental or safety regulations that raise scale economies facing newcomers. Of course, government policies may also make entry easier – directly through subsidies, for instance, or indirectly by funding ba- sic research and making it available to all fi rms, new and old, reducing scale economies. Entry barriers should be assessed relative to the capa- bilities of potential entrants, which may be start-ups, foreign fi rms, or companies in related industries. And, as some of our examples illustrate, the strategist must be mindful of the creative ways newcomers might fi nd to circumvent appar- ent barriers. Expected retaliation. How potential entrants believe in- cumbents may react will also infl uence their decision to enter or stay out of an industry. If reaction is vigorous and protracted enough, the profi t potential of participating in the industry can fall below the cost of capital. Incumbents often use public statements and responses to one entrant to send a message to other prospective entrants about their commitment to defending market share. Newcomers are likely to fear expected retaliation if: Incumbents have previously responded vigorously to new entrants. Incumbents possess substantial resources to fi ght back, including excess cash and unused borrowing power, avail- • • able productive capacity, or clout with distribution channels and customers. Incumbents seem likely to cut prices because they are committed to retaining market share at all costs or because the industry has high fi xed costs, which create a strong mo- tivation to drop prices to fi ll excess capacity. Industry growth is slow so newcomers can gain volume only by taking it from incumbents. An analysis of barriers to entry and expected retaliation is obviously crucial for any company contemplating entry into a new industry. The challenge is to fi nd ways to surmount the entry barriers without nullifying, through heavy invest- ment, the profi tability of participating in the industry. THE POWER OF SUPPLIERS. Powerful suppliers capture more of the value for themselves by charging higher prices, limiting quality or services, or shifting costs to industry par- ticipants. Powerful suppliers, including suppliers of labor, can squeeze profi tability out of an industry that is unable to pass on cost increases in its own prices. Microsoft, for in- stance, has contributed to the erosion of profi tability among personal computer makers by raising prices on operating systems. PC makers, competing fi ercely for customers who can easily switch among them, have limited freedom to raise their prices accordingly. Companies depend on a wide range of different supplier groups for inputs. A supplier group is powerful if: It is more concentrated than the industry it sells to. Microsoft’s near monopoly in operating systems, coupled with the fragmentation of PC assemblers, exemplifi es this situation. The supplier group does not depend heavily on the in- dustry for its revenues. Suppliers serving many industries will not hesitate to extract maximum profi ts from each one. If a particular industry accounts for a large portion of a sup- plier group’s volume or profi t, however, suppliers will want to protect the industry through reasonable pricing and as- sist in activities such as R&D and lobbying. Industry participants face switching costs in changing suppliers. For example, shifting suppliers is diffi cult if com- panies have invested heavily in specialized ancillary equip- • • • • • Differences in Industry Profi tability The average return on invested capital varies markedly from industry to industry. Between 1992 and 2006, for example, average return on invested capital in U.S. industries ranged as low as zero or even negative to more than 50%. At the high end are industries like soft drinks and prepackaged software, which have been almost six times more profi table than the airline industry over the period. 1808 Porter.indd 821808 Porter.indd 82 12/5/07 5:34:24 PM12/5/07 5:34:24 PM hbr.org | January 2008 | Harvard Business Review 83 ment or in learning how to operate a supplier’s equipment (as with Bloomberg terminals used by fi nancial profession- als). Or fi rms may have located their production lines adja- cent to a supplier’s manufacturing facilities (as in the case of some beverage companies and container manufacturers). When switching costs are high, industry participants fi nd it hard to play suppliers off against one another. (Note that suppliers may have switching costs as well. This limits their power.) Suppliers offer products that are differentiated. Phar- maceutical companies that offer patented drugs with dis- tinctive medical benefi ts have more power over hospitals, health maintenance organizations, and other drug buyers, for example, than drug companies offering me-too or ge- neric products. There is no substitute for what the supplier group pro- vides. Pilots’ unions, for example, exercise considerable sup- plier power over airlines partly because there is no good alternative to a well-trained pilot in the cockpit. The supplier group can credibly threaten to integrate for- ward into the industry. In that case, if industry participants make too much money relative to suppliers, they will induce suppliers to enter the market. • • • THE POWER OF BUYERS. Powerful customers – the fl ip side of powerful suppliers – can capture more value by forc- ing down prices, demanding better quality or more service (thereby driving up costs), and generally playing industry participants off against one another, all at the expense of industry profi tability. Buyers are powerful if they have nego- tiating leverage relative to industry participants, especially if they are price sensitive, using their clout primarily to pres- sure price reductions. As with suppliers, there may be distinct groups of custom- ers who differ in bargaining power. A customer group has negotiating leverage if: There are few buyers, or each one purchases in volumes that are large relative to the size of a single vendor. Large- volume buyers are particularly powerful in industries with high fi xed costs, such as telecommunications equipment, off- shore drilling, and bulk chemicals. High fi xed costs and low marginal costs amplify the pressure on rivals to keep capac- ity fi lled through discounting. The industry’s products are standardized or undifferenti- ated. If buyers believe they can always fi nd an equivalent product, they tend to play one vendor against another. Buyers face few switching costs in changing vendors. • • • Profi tability of Selected U.S. Industries Average ROIC, 1992–2006 N u m b e r o f In d u st ri e s ROIC 0% 5% 10% 15% 20% 25% 30% 35% 40 50 30 20 10 0 10th percentile 7.0% 25th percentile 10.9% Median: 14.3% 75th percentile 18.6% 90th percentile 25.3% or higheror lower Average Return on Invested Capital in U.S. Industries, 1992–2006 Security Brokers and Dealers Soft Drinks Prepackaged Software Pharmaceuticals Perfume, Cosmetics, Toiletries Advertising Agencies Distilled Spirits Semiconductors Medical Instruments Men’s and Boys’ Clothing Tires Household Appliances Malt Beverages Child Day Care Services Household Furniture Drug Stores Grocery Stores Iron and Steel Foundries Cookies and Crackers Mobile Homes Wine and Brandy Bakery Products Engines and Turbines Book Publishing Laboratory Equipment Oil and Gas Machinery Soft Drink Bottling Knitting Mills Hotels Catalog, Mail-Order Houses Airlines Return on invested capital (ROIC) is the appropriate measure of profi tability for strategy formulation, not to mention for equity investors. Return on sales or the growth rate of profi ts fail to account for the capital required to compete in the industry. Here, we utilize earnings before interest and taxes divided by average invested capital less excess cash as the measure of ROIC. This measure controls for idiosyncratic differences in capital structure and tax rates across companies and industries. Source: Standard & Poor’s, Compustat, and author’s calculations Average industry ROIC in the U.S. 14.9% 40.9% 37.6% 37.6% 31.7% 28.6% 27.3% 26.4% 21.3% 21.0% 19.5% 19.5% 19.2% 19.0% 17.6% 17.0% 16.5% 16.0% 15.6% 15.4% 15.0% 13.9% 13.8% 13.7% 13.4% 13.4% 12.6% 11.7% 10.5% 10.4% 5.9% 5.9% 1808 Porter.indd 831808 Porter.indd 83 12/5/07 5:34:29 PM12/5/07 5:34:29 PM LEADERSHIP AND STRATEGY | The Five Competitive Forces That Shape Strategy 84 Harvard Business Review | January 2008 | hbr.org Buyers can credibly threaten to integrate backward and produce the industry’s product themselves if vendors are too profi table. Producers of soft drinks and beer have long controlled the power of packaging manufacturers by threat- ening to make, and at times actually making, packaging ma- terials themselves. A buyer group is price sensitive if: The product it purchases from the industry represents a signifi cant fraction of its cost structure or procurement budget. Here buyers are likely to shop around and bargain hard, as consumers do for home mortgages. Where the prod- uct sold by an industry is a small fraction of buyers’ costs or expenditures, buyers are usually less price sensitive. The buyer group earns low profi ts, is strapped for cash, or is otherwise under pressure to trim its purchasing costs. Highly profi table or cash-rich customers, in contrast, are gen- erally less price sensitive (that is, of course, if the item does not represent a large fraction of their costs). The quality of buyers’ products or services is little af- fected by the industry’s product. Where quality is very much affected by the industry’s product, buyers are generally less price sensitive. When purchasing or renting production qual- ity cameras, for instance, makers of major motion pictures opt for highly reliable equipment with the latest features. They pay limited attention to price. The industry’s product has little effect on the buyer’s other costs. Here, buyers focus on price. Conversely, where an industry’s product or service can pay for itself many times over by improving performance or reducing labor, material, or other costs, buyers are usually more interested in quality than in price. Examples include products and services like tax accounting or well logging (which measures below-ground conditions of oil wells) that can save or even make the buyer money. Similarly, buyers tend not to be price sensitive in ser- vices such as investment banking, where poor performance can be costly and embarrassing. Most sources of buyer power apply equally to consum- ers and to business-to-business customers. Like industrial customers, consumers tend to be more price sensitive if they are purchasing products that are undifferentiated, expensive relative to their incomes, and of a sort where product perfor- mance has limited consequences. The major difference with consumers is that their needs can be more intangible and harder to quantify. Intermediate customers, or customers who purchase the product but are not the end user (such as assemblers or distri- bution channels), can be analyzed the same way as other buy- ers, with one important addition. Intermediate customers gain signifi cant bargaining power when they can infl uence the purchasing decisions of customers downstream. Con- sumer electronics retailers, jewelry retailers, and agricultural- equipment distributors are examples of distribution chan- nels that exert a strong infl uence on end customers. • • • • • Producers often attempt to diminish channel clout through exclusive arrangements with particular distributors or retailers or by marketing directly to end users. Compo- nent manufacturers seek to develop power over assemblers by creating preferences for their components with down- stream customers. Such is the case with bicycle parts and with sweeteners. DuPont has created enormous clout by advertising its Stainmaster brand of carpet fi bers not only to the carpet manufacturers that actually buy them but also to downstream consumers. Many consumers request Stainmaster carpet even though DuPont is not a carpet manufacturer. THE THREAT OF SUBSTITUTES. A substitute performs the same or a similar function as an industry’s product by a different means. Videoconferencing is a substitute for travel. Plastic is a substitute for aluminum. E-mail is a substitute for express mail. Sometimes, the threat of substitution is downstream or indirect, when a substitute replaces a buyer industry’s product. For example, lawn-care products and ser- vices are threatened when multifamily homes in urban areas substitute for single-family homes in the suburbs. Software sold to agents is threatened when airline and travel websites substitute for travel agents. Substitutes are always present, but they are easy to over- look because they may appear to be very different from the industry’s product: To someone searching for a Father’s Day gift, neckties and power tools may be substitutes. It is a sub- stitute to do without, to purchase a used product rather than a new one, or to do it yourself (bring the service or product in-house). When the threat of substitutes is high, industry profi tabil- ity suffers. Substitute products or services limit an industry’s profi t potential by placing a ceiling on prices. If an industry does not distance itself from substitutes through product performance, marketing, or other means, it will suffer in terms of profi tability – and often growth potential. Substitutes not only limit profi ts in normal times, they also reduce the bonanza an industry can reap in good times. In emerging economies, for example, the surge in demand for wired telephone lines has been capped as many con- sumers opt to make a mobile telephone their fi rst and only phone line. The threat of a substitute is high if: It offers an attractive price-performance trade-off to the industry’s product. The better the relative value of the sub- stitute, the tighter is the lid on an industry’s profi t poten- tial. For example, conventional providers of long-distance telephone service have suffered from the advent of inex- pensive internet-based phone services such as Vonage and Skype. Similarly, video rental outlets are struggling with the emergence of cable and satellite video-on-demand services, online video rental services such as Netfl ix, and the rise of internet video sites like Google’s YouTube. • 1808 Porter.indd 841808 Porter.indd …