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ARTICLE:Where Should We Compete? New Thinking About the Five Forces and Industry Attractiveness

Strategists have long argued that where you compete is the starting point for strategic analysis. The traditional answer to this question has been to use the five forces model we just studied to compete in attractive (i.e., profitable) industries or markets characterized by high bargaining power over suppliers and buyers, low threats of substitutes or new entry, and low rivalry. This traditional argument is reflected in the recent best seller Playing to Win, by prominent strategists A. G. Lafley and Roger Martin, who argue, Porters five forces help define the fundamental attractiveness of an industry and its individual segments.²³ We agree that the five forces model describes the kind of industry or market youd like to create or compete in, and it remains an excellent model that firms all over the world use to keep tabs on the industry and markets they compete in and to get guidance about what tactical moves they can make to increase profitability in their industry.

Executives, however, have to choose markets to compete in before they enter. This is where new thinking turns the five forces a bit upside down. Traditionally, you would give executives the advice to enter industries or markets that are rated attractive by the five forces. But the success of their choice to enter is determined almost completely by the unique value the firm hopes to offer and the resources and capabilities (these concepts will be covered extensively in Chapter 3) it has to deliver that unique value. Thus, whether a market is attractive may depend more on what the entrant can offer to that market rather than the structural characteristics of the market. To use a popular idiom: Beauty is in the eye of the beholder. Or, in other words, unattractive markets according to traditional industry analysis may be quite attractive to the right kind of entrant.

By almost any measure of attractiveness, the automobile industry is not an attractive industry to enter. Entry barriers are enormous, bargaining power over customers is minimal, rivalry is high, and average profitability is quite low. No wonder there hasnt been a successful US-based company entrant since Chrysler in 1925. Yet in 2008, during the Great Recession while the US government was bailing out GM and Chrysler to the tune of $80 billion²⁴ Tesla, a California-based firm, entered anyway. They entered an unattractive industry at the depths of its unattractivenesstypically, a foolhardy strategic decision. Tesla entered the automobile market with the Roadster, a pricy, beautifully designed, battery electric (BEV) sports car. They followed with the Model S and Model Xboth targeted at wealthy individuals with a penchant for fast cars and a desire to reduce carbon emissions and US dependence on foreign oil.²⁵ Within nine years of entry, by February 2017, Tesla had generated a market value of more than $44.6 billiondouble that of Chrysler and closing in on the 114-year-old Ford²⁶all in an unattractive industry.

Where successful companies choose to compete doesnt depend so much on the historical profitability or structural attractiveness of the market. Rather, it is fundamentally tied to what unique value they can offer, what capabilities they have, and whether they can prevent imitation (all concepts covered more fully in Chapter 3). For industries that are not attractive from a five-forces perspective, successful entry requires offering a unique value proposition with unique resources and capabilities. If you use an approach that mimics what incumbents are doing, your profits will be poorjust like incumbents. Nucor entered the unattractive steel industry, but did so in a radically different way. It used Mini-Mill technology and sourced scrap steel, rather than the traditional enormous steel production plants using iron and coke as their raw materials. Nucor was, and is still, able to produce steel at a much lower cost and to be highly profitable at a time when many US steel manufacturers have gone out of business.²⁷ Markets that are unattractive from a five-forces perspective can still be attractive to new entrantsbut only when they offer unique value.

On the flip side, it is also important to understand that attractive markets from a five-forces perspective are typically unattractive for new entrants. In an article for Harvard Business Review (see Strategies to Crack Well Guarded Markets), we reported that, on average, new entrants into highly profitable (attractive) markets were 30 percent less profitable than new entrants into unattractive markets (i.e., in general, it is easier for new entrants to make money in unattractive industries than attractive ones).²⁸ The reason? Barriers to entry made it difficult for the new entrant to establish itself. So, on average, an attractive market (from a five-forces perspective) is actually the least attractive market for a new entrant. But wait. We also found that when new entrants did achieve profitability in the most attractive markets, they were four times as profitable as the average profitable entrant elsewhere. For example, the beverage industry has historically been a high-profit industry (indeed one of the most profitable)but one with high barriers to entry. So according to the logic weve been discussing, it should be an unattractive market for new entrants. Walmart, however, decided to enter anywayoffering consistently low prices with its Sams Choice brand. We wont spell out exactly how Walmart did it because those barriers to entry are part of the Coca-Cola and Pepsi case that is a companion to this chapter. Suffice it to say that Walmart was able to overcome each element of the barriers to entry that Coca-Cola and Pepsi had painstakingly erected over decades. By figuring out how to circumvent the entry barriers, Walmart was able to grab almost 5 percent share in an attractive market, indeed in one of the most attractive markets from a five-forces perspective. The point is that if firms figure out how to circumvent the barriers to entry into an attractive market, it can be profitable even if they arent able to enter with a particularly unique value proposition (Sams Choice Cola isnt all that unique).

Finally, weve learned that industries as weve historically defined them (e.g., automobiles, medical equipment, computers, cell phones, etc.think about the NAICS codes we covered at the beginning of this chapter) are becoming somewhat irrelevant as it relates to finding attractive markets to compete in (it is not irrelevant to understanding the dynamics of an industry you are already in). In deciding where to compete (i.e., which markets to enter), it is helpful to be as specific as possible rather than using broad generalities such as industries as they have historically been defined. In fact, as Harvard business professor Clayton Christensen has suggested, you compete at the job to be done level (if you truly understand the functional, emotional, and social needs of your customer segment, the task of offering unique value becomes much easier).²⁹ Tesla started in the automobile industry by targeting wealthy individuals who loved fast cars but also had a desire to be green. Customers purchased a Tesla not just because it solved a functional need (transportation, rapid acceleration/speed) but also an emotional need (I want a green world) and a social need (I want to be part of the Tesla community and want others to know about my social consciousness). Now Tesla has added in-home battery charging stations and roof-mounted solar panels for homes. So from a historical perspective, Tesla is now in the roofing segment of the home construction industry as well as being in the automobile industry. One could say that Tesla is in the energy industry at a very high levelwhich is true. But it has expanded into roof tiles and battery-charging stations to do a particular job for a very specific segment of customers: provide a convenient one-stop shop for clean energy at home and on the road for individuals who want a green world.³⁰ When the industry is defined at the job to be done level, it then makes it easier to identify what other companies are also trying to do at that specific job (competitors) and what substitutes exist for that job.