The following is a review of the Equity Investments principles designed to address the learning outcome statements set forth

by CFA Institute. This topic is also covered in:

thE FivE compEtitivE FoRcEs that shapE stRatEgy

Study Session 11

Exam Focus
in 1979, michael Porter introduced the concept of the five forces that shape competitive strategy. A recent update to this influential work shows how the five forces can be employed for strategic analysis. For the exam, know each of the five forces and how these combine to drive industry profitability. Describe why some factors that are commonly used in industry analysis have only a temporary effect on the forces that determine profitability in the long run. Finally, be prepared to show how the five forces can be used to design strategies that will enable a firm to achieve a competitive advantage.

waRm-up
the primary goal for any for-profit enterprise is to make money. the firms competitive strategy is its battle plan for achieving that goal. two central questions provide the basis for the firms choice of a competitive strategy: Industry attractiveness. is the industry attractive in terms of long-term profit potential? Competitive advantage. how does the firm create value for buyers (in excess of the cost of creating it), relative to other players in the industry? there are five key forces that underlie an industrys long-run profitability and, thus, drive the optimal choice of competitive strategy.

LOS 39.a: Distinguish among the five competitive forces that drive industry profitability in the medium and long run. Porters Five Forces
the attractiveness (long-term profitability) of any industry is determined by the interaction of the following five competitive forces (Porters Five Forces): 1. 2. 3. 4. 5. threat of new entrants in the industry. threat of substitutes. Bargaining power of buyers. Bargaining power of suppliers. rivalry among existing competitors. Professors Note: You should be able to recite these five forces anytime, anywhere!

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Steps in Using the Forces in an Industry Analysis

there are six steps when using Porters Five Forces in analyzing an industry: Step 1: Define the industry: this should be done in terms of the products/services sold and the geographical area over which the products/services are sold. the products should then be examined in the context of the five forces. if two products appear similar but have different industry structure in terms of the five forces (e.g., the basic product is the same, but the buyers are vastly different), they should be considered separate industries. Step 2: identify the participants: competitors. Buyers. Suppliers. Potential entrants. Substitutes. Step 3: Determine strength or weakness of each force, what drives it, and why. Be careful to focus on the more important forces and analyze them thoroughly. Step 4: Determine industry structure using an analytical framework and how the five forces come to bear on matters such as pricing and input cost structure. Distinguish between cause (ease of entry) and effect (price competition). which forces are the most important determinants of profitability? Step 5: Assess current and potential shifts in each force. Distinguish between transient blips and long-term structural changes in the industry and the forces. make sure to incorporate trends and not use static analysis. Step 6: Decide which forces can be altered in ways that will affect the value of the industry or firm.

ExampLE: anaLyzing thE compEtitivE FoRcEs FoR waL-maRt

Synopsis
wal-mart is the worlds largest retailer, selling a wide range of products targeted to consumers and small businesses. the firm serves approximately 150 million customers per week in the Americas, Asia, and the united kingdom. wal-mart is widely viewed as having the lowest prices on a broad variety of frequentlypurchased consumer products. Principal competitors include other broad-based discount stores, grocery stores, as well as small retailers operating in its geographic region. the smaller specialty retailers and single-location boutiques compete with wal-mart in limited product lines. wal-mart has a reputation as a formidable competitor, and many retailers have been forced to change their business models in order to stay profitable once wal-mart enters their markets.

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A major development in recent years at wal-mart has been the deterioration in its market image because of accusations of unfair labor practices. the firm is currently defending several lawsuits involving its employment practices, and these have generated significant and damaging press coverage.

Competitive Forces and Wal-Mart

Threat of new entrants. wal-marts cost advantage arises from a famously efficient distribution system, which requires enormous scale and massive capital investment. the barriers to entry for a broad-based discounter are very high. however, wal-mart competes with a large variety of specialized retailers in specific types of products, where barriers to entry may be quite low. Study Session 11 Threat of substitutes. the threat of substitutes in the retailing industry arises largely from the potential elimination of brick-and-mortar retailers by internet-based retailing. to mitigate this threat, wal-mart has launched its own internet-based sales effort. Bargaining power of buyers. the bargaining power of buyers is virtually non-existent. individual consumers have essentially no bargaining leverage against global corporate retailers, and wal-mart does not target corporate customers. wal-mart is sufficiently large enough that even its biggest customers account for an infinitesimal proportion of its sales. Bargaining power of suppliers. the bargaining power of suppliers has historically been very low. wal-mart is well known for vigorous bargaining with its suppliers of both labor and products. its enormous presence in the retail sales industry makes it the largest purchaser for many of its suppliers, giving them virtually no bargaining leverage against wal-mart. wal-mart has also vigorously resisted efforts to unionize its workers, who have historically had very little bargaining power. that is changing somewhat as accusations of unfair labor practices have cost wal-mart market prestige and position, giving labor more leverage with the firm. even so, the bargaining power of suppliers of labor remains quite low. Rivalry among existing competitors. competition among existing competitors in the retail sales industry is very high. An indication of the competitiveness is in walmarts global market share, which is approximately 3%. the vast majority of other firms have market share too small to be significant on a global basis. competition in retailing is focused on geographic region, and wal-marts market position varies widely. in the united States, wal-mart is the largest retailer of many items it sells and commands 20% of the grocery market. it has a much smaller presence in markets such as Germany, which it eventually abandoned after achieving only 2% share in foods against Aldis 19%.

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Conclusion
wal-mart drives its competitive strategy through its enormous scale, which provides significant barriers to entry, low supplier bargaining power, and low buyer bargaining power. Substitutes are available for all products wal-mart sells but usually at higher prices. wal-marts scale has historically enabled it to enjoy high profits for its industry. A principal threat to wal-marts long-term profitability is the increase in supplier power in the form of the influence of its suppliers of labor on the court system, the press, and public opinion. wal-mart should take action to reduce the impact of these labor difficulties on the firm. in fact, it has made steps to improve its public relations through actions such as increased and more visible charitable giving.

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