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solidifying relationships with favorable customers,

Exploiting industry change

Industry evolution is important strategically because evolution, of course, brings with it changes in the sources of competition I have identified. In the familiar product life-cycle pattern, for example, growth rates change, product differentiation is said to decline as the business becomes more mature, and the companies tend to integrate vertically.

These trends are not so important in themselves; what is critical is whether they affect the sources of competition. Consider vertical integration. In the maturing minicomputer industry, extensive vertical integration, both in manufacturing and in software development, is taking place. This very significant trend is greatly raising economies of scale as well as the amount of capital necessary to compete in the industry. This in turn is raising barriers to entry and may drive some smaller competitors out of the industry once growth levels off.

Obviously, the trends carrying the highest priority from a strategic standpoint are those that affect the most important sources of competition in the industry and those that elevate new causes to the forefront. In contract aerosol packaging, for example, the trend toward less product differentiation is now dominant. It has increased buyers’ power, lowered the barriers to entry, and intensified competition.

The framework for analyzing competition that I have described can also be used to predict the eventual profitability of an industry. In long-range planning the task is to examine each competitive force, forecast the magnitude of each underlying cause, and then construct a composite picture of the likely profit potential of the industry.

The outcome of such an exercise may differ a great deal from the existing industry structure. Today, for example, the solar heating business is populated by dozens and perhaps hundreds of companies, none with a major market position. Entry is easy, and competitors are battling to establish solar heating as a superior substitute for conventional methods.

The potential of this industry will depend largely on the shape of future barriers to entry, the improvement of the industry’s position relative to substitutes, the ultimate intensity of competition, and the power captured by buyers and suppliers. These characteristics will in turn be influenced by such factors as the establishment of brand identities, significant economies of scale or experience curves in equipment manufacture wrought by technological change, the ultimate capital costs to compete, and the extent of overhead in production facilities.

The framework for analyzing industry competition has direct benefits in setting diversification strategy. It provides a road map for answering the extremely difficult question inherent in diversification decisions: “What is the potential of this business?” Combining the framework with judgment in its application, a company may be able to spot an industry with a good future before this good future is reflected in the prices of acquisition candidates.