1. what are some strategies leveling up might use to deal with the threat of new entrants?
Editor'southward notation (2022): To marking our 100th anniversary, we're highlighting 12 of our very favorite manufactures. Subscribers can access all 12 at any time and, for nonsubscribers, we're unlocking i per month this year. For February, we're sharing Harvard Business School professor Michael Eastward. Porter'south 1979 article that beginning introduced his groundbreaking 5 forces framework.
The essence of strategy formulation is coping with contest. Yet it is easy to view competition too narrowly and too pessimistically. While one sometimes hears executives complaining to the contrary, intense competition in an industry is neither coincidence nor bad luck.
Moreover, in the fight for market place share, competition is not manifested simply in the other players. Rather, contest in an manufacture is rooted in its underlying economics, and competitive forces exist that go well beyond the established combatants in a item industry. Customers, suppliers, potential entrants, and substitute products are all competitors that may be more or less prominent or active depending on the manufacture.
The state of contest in an manufacture depends on five basic forces, which are diagrammed beneath. The collective strength of these forces determines the ultimate turn a profit potential of an industry. Information technology ranges from intense in industries like tires, metal cans, and steel, where no visitor earns spectacular returns on investment, to mild in industries similar oil field services and equipment, soft drinks, and toiletries, where there is room for quite high returns.
In the economists' "perfectly competitive" manufacture, jockeying for position is unbridled and entry to the manufacture very easy. This kind of industry structure, of course, offers the worst prospect for long-run profitability. The weaker the forces collectively, all the same, the greater the opportunity for superior performance.
Whatever their commonage forcefulness, the corporate strategist's goal is to observe a position in the manufacture where his or her company can best defend itself against these forces or can influence them in its favor. The commonage strength of the forces may exist painfully apparent to all the antagonists; only to cope with them, the strategist must delve beneath the surface and analyze the sources of each. For instance, what makes the manufacture vulnerable to entry? What determines the bargaining power of suppliers?
Noesis of these underlying sources of competitive pressure provides the background for a strategic agenda of action. They highlight the critical strengths and weaknesses of the company, animate the positioning of the company in its manufacture, clarify the areas where strategic changes may yield the greatest payoff, and highlight the places where manufacture trends promise to hold the greatest significance as either opportunities or threats. Agreement these sources also proves to be of help in because areas for diversification.
Contending Forces
The strongest competitive force or forces determine the profitability of an industry and and so are of greatest importance in strategy formulation. For case, fifty-fifty a company with a strong position in an industry unthreatened past potential entrants will earn low returns if it faces a superior or a lower-toll substitute production—every bit the leading manufacturers of vacuum tubes and coffee percolators have learned to their sorrow. In such a situation, coping with the substitute product becomes the number 1 strategic priority.
Different forces take on prominence, of course, in shaping competition in each manufacture. In the ocean-going tanker industry the key force is probably the buyers (the major oil companies), while in tires it is powerful OEM buyers coupled with tough competitors. In the steel manufacture the central forces are foreign competitors and substitute materials.
Every industry has an underlying structure, or a ready of fundamental economical and technical characteristics, that gives rise to these competitive forces. The strategist, wanting to position his or her company to cope best with its industry environment or to influence that surroundings in the visitor's favor, must learn what makes the environment tick.
This view of competition pertains equally to industries dealing in services and to those selling products. To avoid monotony in this article, I refer to both products and services equally "products." The aforementioned general principles apply to all types of business organization.
A few characteristics are disquisitional to the strength of each competitive force. I shall discuss them in this section.
Threat of entry.
New entrants to an industry bring new capacity, the desire to gain market share, and ofttimes substantial resources. Companies diversifying through acquisition into the manufacture from other markets often leverage their resource to cause a shake-upwardly, as Philip Morris did with Miller beer.
The seriousness of the threat of entry depends on the barriers nowadays and on the reaction from existing competitors that entrants can await. If barriers to entry are high and newcomers can expect precipitous retaliation from the entrenched competitors, obviously the newcomers will not pose a serious threat of entering.
There are six major sources of barriers to entry:
ane. Economies of scale. These economies deter entry by forcing the entrant either to come in on a large scale or to take a toll disadvantage. Scale economies in production, research, marketing, and service are probably the cardinal barriers to entry in the mainframe computer industry, as Xerox and GE sadly discovered. Economies of calibration can as well deed as hurdles in distribution, utilization of the sales forcefulness, financing, and most any other part of a business organization.
two. Product differentiation. Brand identification creates a barrier by forcing entrants to spend heavily to overcome customer loyalty. Ad, client service, being first in the industry, and product differences are amidst the factors fostering brand identification. It is perhaps the almost of import entry barrier in soft drinks, over-the-counter drugs, cosmetics, investment banking, and public bookkeeping. To create high fences around their businesses, brewers couple brand identification with economies of scale in production, distribution, and marketing.
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3. Capital requirements. The demand to invest large financial resources in order to compete creates a bulwark to entry, particularly if the uppercase is required for unrecoverable expenditures in up-front advertising or R&D. Capital is necessary not only for stock-still facilities just also for customer credit, inventories, and absorbing beginning-upwardly losses. While major corporations have the financial resources to invade about whatever manufacture, the huge capital requirements in certain fields, such as reckoner manufacturing and mineral extraction, limit the pool of likely entrants.
iv. Cost disadvantages independent of size. Entrenched companies may have cost advantages not available to potential rivals, no matter what their size and accessible economies of scale. These advantages can stem from the effects of the learning curve (and of its first cousin, the experience curve), proprietary technology, access to the best raw materials sources, assets purchased at preinflation prices, government subsidies, or favorable locations. Sometimes price advantages are legally enforceable, as they are through patents. (For an analysis of the much-discussed feel curve equally a barrier to entry, see the sidebar "The Feel Bend as an Entry Barrier.")
5. Admission to distribution channels. The newcomer on the block must, of course, secure distribution of its product or service. A new food production, for instance, must displace others from the supermarket shelf via cost breaks, promotions, intense selling efforts, or some other means. The more limited the wholesale or retail channels are and the more that existing competitors have these tied up, plainly the tougher that entry into the manufacture will be. Sometimes this barrier is and then high that, to surmount it, a new contestant must create its ain distribution channels, as Timex did in the picket industry in the 1950s.
half dozen. Government policy. The government can limit or even prevent entry to industries with such controls as license requirements and limits on access to raw materials. Regulated industries like trucking, liquor retailing, and freight forwarding are noticeable examples; more-subtle government restrictions operate in fields similar ski-surface area evolution and coal mining. The authorities also can play a major indirect role past affecting entry barriers through controls such as air and h2o pollution standards and safety regulations.
The potential rival's expectations about the reaction of existing competitors also will influence its decision on whether to enter. The company is likely to have 2d thoughts if incumbents have previously lashed out at new entrants or if:
- The incumbents possess substantial resources to fight back, including backlog greenbacks and unused borrowing power, productive chapters, or clout with distribution channels and customers.
- The incumbents seem likely to cut prices considering of a desire to proceed market shares or because of industrywide excess chapters.
- Industry growth is slow, affecting its ability to absorb the new inflow and probably causing the financial operation of all the parties involved to decline.
Changing conditions.
From a strategic standpoint there are two of import additional points to note about the threat of entry.
Offset, it changes, of grade, as these conditions alter. The expiration of Polaroid's basic patents on instant photography, for instance, greatly reduced its absolute price entry bulwark built by proprietary technology. It is not surprising that Kodak plunged into the marketplace. Production differentiation in printing has all but disappeared. Conversely, in the auto industry economies of scale increased enormously with post–World War II automation and vertical integration—nearly stopping successful new entry.
Second, strategic decisions involving a large segment of an industry can take a major impact on the weather condition determining the threat of entry. For example, the deportment of many U.S. vino producers in the 1960s to stride up product introductions, raise advertising levels, and aggrandize distribution nationally surely strengthened the entry roadblocks by raising economies of scale and making access to distribution channels more difficult. Similarly, decisions by members of the recreational vehicle industry to vertically integrate in lodge to lower costs accept profoundly increased the economies of scale and raised the majuscule cost barriers.
Powerful suppliers and buyers.
Suppliers tin exert bargaining power on participants in an industry by raising prices or reducing the quality of purchased goods and services. Powerful suppliers can thereby squeeze profitability out of an manufacture unable to recover cost increases in its own prices. By raising their prices, soft drink concentrate producers have contributed to the erosion of profitability of bottling companies considering the bottlers, facing intense competition from powdered mixes, fruit drinks, and other beverages, have limited freedom to raise their prices appropriately. Customers likewise can force down prices, demand higher quality or more service, and play competitors off against each other—all at the expense of industry profits.
The power of each important supplier or buyer group depends on a number of characteristics of its market state of affairs and on the relative importance of its sales or purchases to the manufacture compared with its overall business concern.
A supplier group is powerful if:
- It is dominated by a few companies and is more full-bodied than the manufacture it sells to.
- Its product is unique or at least differentiated, or if it has built up switching costs. Switching costs are fixed costs buyers confront in changing suppliers. These arise because, amongst other things, a buyer's product specifications tie information technology to particular suppliers, it has invested heavily in specialized ancillary equipment or in learning how to operate a supplier's equipment (as in reckoner software), or its product lines are connected to the supplier'south manufacturing facilities (as in some manufacture of beverage containers).
- It is not obliged to fence with other products for sale to the industry. For instance, the competition betwixt the steel companies and the aluminum companies to sell to the tin industry checks the power of each supplier.
- It poses a credible threat of integrating forward into the industry's business organization. This provides a cheque against the industry's ability to improve the terms on which it purchases.
- The manufacture is not an important customer of the supplier group. If the industry is an important client, suppliers' fortunes will exist closely tied to the manufacture, and they will want to protect the industry through reasonable pricing and assistance in activities like R&D and lobbying.
A buyer group is powerful if:
- Information technology is concentrated or purchases in large volumes. Big-volume buyers are especially strong forces if heavy stock-still costs characterize the manufacture—as they do in metallic containers, corn refining, and majority chemicals, for instance—which enhance the stakes to keep capacity filled.
- The products it purchases from the manufacture are standard or undifferentiated. The buyers, sure that they can always find culling suppliers, may play i visitor against some other, equally they practise in aluminum extrusion.
- The products information technology purchases from the industry form a component of its product and stand for a significant fraction of its cost. The buyers are probable to shop for a favorable price and purchase selectively. Where the product sold by the industry in question is a small fraction of buyers' costs, buyers are ordinarily much less toll sensitive.
- It earns low profits, which create dandy incentive to lower its purchasing costs. Highly assisting buyers, however, are more often than not less price sensitive (that is, of course, if the detail does not represent a large fraction of their costs).
- The manufacture's production is unimportant to the quality of the buyers' products or services. Where the quality of the buyers' products is very much afflicted by the industry's production, buyers are generally less price sensitive. Industries in which this situation obtains include oil field equipment, where a malfunction tin lead to large losses, and enclosures for electronic medical and examination instruments, where the quality of the enclosure tin influence the user'south impression virtually the quality of the equipment within.
- The industry'southward product does not save the heir-apparent money. Where the industry'southward product or service tin can pay for itself many times over, the buyer is rarely price sensitive; rather, he is interested in quality. This is truthful in services like investment cyberbanking and public bookkeeping, where errors in judgment tin be costly and embarrassing, and in businesses similar the logging of oil wells, where an accurate survey tin salve thousands of dollars in drilling costs.
- The buyers pose a credible threat of integrating backward to make the industry's production. The Big Three automobile producers and major buyers of cars accept often used the threat of self-manufacture every bit a bargaining lever. Just sometimes an industry engenders a threat to buyers that its members may integrate forward.
Well-nigh of these sources of buyer power can be attributed to consumers as a grouping equally well as to industrial and commercial buyers; merely a modification of the frame of reference is necessary. Consumers tend to be more toll sensitive if they are purchasing products that are undifferentiated, expensive relative to their incomes, and of a sort where quality is not peculiarly important.
The ownership ability of retailers is determined by the same rules, with one important addition. Retailers can proceeds meaning bargaining power over manufacturers when they can influence consumers' purchasing decisions, as they do in audio components, jewelry, appliances, sporting goods, and other goods.
Strategic activeness.
A visitor's choice of suppliers to buy from or heir-apparent groups to sell to should be viewed as a crucial strategic decision. A company can improve its strategic posture past finding suppliers or buyers who possess the least power to influence it adversely.
Further Reading
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Blue Ocean vs. Five Forces
Innovation Magazine Article
- Salvage
About common is the situation of a company being able to cull whom it will sell to—in other words, buyer selection. Rarely practice all the buyer groups a company sells to enjoy equal ability. Even if a visitor sells to a single manufacture, segments usually exist within that manufacture that exercise less ability (and that are therefore less toll sensitive) than others. For instance, the replacement market for almost products is less price sensitive than the overall marketplace.
As a rule, a company can sell to powerful buyers and still come away with above-average profitability only if it is a depression-cost producer in its industry or if its product enjoys some unusual, if not unique, features. In supplying large customers with electric motors, Emerson Electric earns high returns considering its low toll position permits the visitor to meet or undercut competitors' prices.
If the company lacks a low cost position or a unique product, selling to everyone is cocky-defeating because the more than sales information technology achieves, the more vulnerable it becomes. The company may take to muster the courage to turn away concern and sell merely to less potent customers.
Heir-apparent choice has been a key to the success of National Can and Crown Cork & Seal. They focus on the segments of the can manufacture where they can create product differentiation, minimize the threat of backward integration, and otherwise mitigate the awesome ability of their customers. Of course, some industries do non enjoy the luxury of selecting "good" buyers.
As the factors creating supplier and heir-apparent ability change with time or every bit a consequence of a company'southward strategic decisions, naturally the ability of these groups rises or declines. In the ready-to-article of clothing clothing manufacture, as the buyers (section stores and vesture stores) have become more than concentrated and control has passed to large bondage, the industry has come up under increasing force per unit area and suffered falling margins. The industry has been unable to differentiate its product or engender switching costs that lock in its buyers enough to neutralize these trends.
Substitute products.
By placing a ceiling on prices it can charge, substitute products or services limit the potential of an industry. Unless it can upgrade the quality of the product or differentiate it somehow (as via marketing), the industry volition suffer in earnings and possibly in growth.
Manifestly, the more bonny the price-operation trade-off offered by substitute products, the firmer the lid placed on the industry's profit potential. Saccharide producers confronted with the large-scale commercialization of high-fructose corn syrup, a saccharide substitute, are learning this lesson today.
Substitutes not but limit profits in normal times; they too reduce the bonanza an industry tin can reap in smash times. In 1978 the producers of fiberglass insulation enjoyed unprecedented demand as a outcome of high energy costs and severe winter conditions. Only the manufacture'southward power to heighten prices was tempered by the plethora of insulation substitutes, including cellulose, rock wool, and styrofoam. These substitutes are leap to become an even stronger forcefulness once the current round of plant additions by fiberglass insulation producers has boosted chapters enough to meet need (and and so some).
Substitute products that deserve the most attention strategically are those that (a) are subject area to trends improving their price-performance trade-off with the industry's product, or (b) are produced by industries earning high profits. Substitutes frequently come up speedily into play if some development increases competition in their industries and causes toll reduction or performance improvement.
Jockeying for position.
Rivalry amidst existing competitors takes the familiar form of jockeying for position—using tactics like price competition, product introduction, and advertising slugfests. Intense rivalry is related to the presence of a number of factors:
- Competitors are numerous or are roughly equal in size and power. In many U.S. industries in recent years strange contenders, of grade, have get part of the competitive film.
- Industry growth is slow, precipitating fights for market share that involve expansion-minded members.
- The production or service lacks differentiation or switching costs, which lock in buyers and protect one combatant from raids on its customers by another.
- Fixed costs are high or the product is perishable, creating potent temptation to cutting prices. Many basic materials businesses, like newspaper and aluminum, endure from this problem when need slackens.
- Capacity is normally augmented in large increments. Such additions, as in the chlorine and vinyl chloride businesses, disrupt the manufacture'southward supply-demand residue and ofttimes lead to periods of overcapacity and price-cut.
- Exit barriers are high. Exit barriers, similar very specialized assets or management'southward loyalty to a detail business concern, keep companies competing even though they may be earning depression or even negative returns on investment. Excess capacity remains functioning, and the profitability of the healthy competitors suffers as the ill ones hang on. If the entire industry suffers from overcapacity, it may seek government assistance—particularly if foreign competition is present.
- The rivals are diverse in strategies, origins, and "personalities." They have different ideas about how to compete and continually run head-on into each other in the process.
Every bit an manufacture matures, its growth rate changes, resulting in declining profits and (oft) a shakeout. In the booming recreational vehicle industry of the early on 1970s, nearly every producer did well; but slow growth since so has eliminated the high returns, except for the strongest members, not to mention many of the weaker companies. The same profit story has been played out in industry after industry—snowmobiles, droplets packaging, and sports equipment are just a few examples.
An acquisition can introduce a very dissimilar personality to an industry, as has been the case with Blackness & Decker's takeover of McCullough, the producer of chain saws. Technological innovation tin boost the level of stock-still costs in the production procedure, every bit it did in the shift from batch to continuous-line photofinishing in the 1960s.
While a company must live with many of these factors—because they are built into manufacture economics—it may accept some latitude for improving matters through strategic shifts. For example, information technology may try to raise buyers' switching costs or increase product differentiation. A focus on selling efforts in the fastest-growing segments of the industry or on market areas with the lowest fixed costs can reduce the impact of manufacture rivalry. If information technology is feasible, a company tin can endeavor to avoid confrontation with competitors having high exit barriers and can thus sidestep interest in biting price-cutting.
Formulation of Strategy
Once having assessed the forces affecting competition in an manufacture and their underlying causes, the corporate strategist can identify the visitor'south strengths and weaknesses. The crucial strengths and weaknesses from a strategic standpoint are the company's posture vis-à-vis the underlying causes of each forcefulness. Where does it stand against substitutes? Against the sources of entry barriers?
And so the strategist tin devise a program of action that may include (l) positioning the visitor so that its capabilities provide the best defense against the competitive force; and/or (2) influencing the residuum of the forces through strategic moves, thereby improving the company'south position; and/or (3) anticipating shifts in the factors underlying the forces and responding to them, with the hope of exploiting change by choosing a strategy advisable for the new competitive balance before opponents recognize information technology. I shall consider each strategic arroyo in turn.
Positioning the company.
The first approach takes the structure of the manufacture as given and matches the company'due south strengths and weaknesses to information technology. Strategy can exist viewed as building defenses against the competitive forces or as finding positions in the manufacture where the forces are weakest.
Cognition of the company's capabilities and of the causes of the competitive forces will highlight the areas where the company should confront competition and where avoid it. If the company is a low-cost producer, it may choose to face up powerful buyers while information technology takes intendance to sell them only products not vulnerable to competition from substitutes.
The success of Dr Pepper in the soft drink industry illustrates the coupling of realistic knowledge of corporate strengths with sound industry assay to yield a superior strategy. Coca-Cola and PepsiCola boss Dr Pepper's industry, where many small concentrate producers compete for a piece of the activity. Dr Pepper chose a strategy of avoiding the largest-selling drink segment, maintaining a narrow flavor line, forgoing the development of a captive bottler network, and marketing heavily. The company positioned itself and so as to be least vulnerable to its competitive forces while information technology exploited its small size.
In the $11.v billion soft drink industry, barriers to entry in the form of brand identification, big-calibration marketing, and access to a bottler network are enormous. Rather than have the formidable costs and calibration economies in having its own bottler network—that is, following the lead of the Big Ii and of 7-Up—Dr Pepper took advantage of the different flavor of its drink to "piggyback" on Coke and Pepsi bottlers who wanted a total line to sell to customers. Dr Pepper coped with the power of these buyers through boggling service and other efforts to distinguish its treatment of them from that of Coke and Pepsi.
Many pocket-size companies in the soft drink business organization offering cola drinks that thrust them into head-to-head competition against the majors. Dr Pepper, still, maximized production differentiation by maintaining a narrow line of beverages built around an unusual flavor.
Finally, Dr Pepper met Coke and Pepsi with an advertising onslaught emphasizing the alleged uniqueness of its single flavor. This campaign congenital strong make identification and dandy client loyalty. Helping its efforts was the fact that Dr Pepper'due south formula involved lower raw materials price, which gave the visitor an absolute cost reward over its major competitors.
There are no economies of scale in soft drink concentrate production, so Dr Pepper could prosper despite its small share of the business (half-dozen%). Thus Dr Pepper confronted contest in marketing simply avoided it in production line and in distribution. This artful positioning combined with good implementation has led to an enviable record in earnings and in the stock market.
Influencing the remainder.
When dealing with the forces that drive manufacture competition, a company tin can devise a strategy that takes the offensive. This posture is designed to practise more than than just cope with the forces themselves; it is meant to alter their causes.
Innovations in marketing tin raise make identification or otherwise differentiate the product. Capital investments in large-scale facilities or vertical integration affect entry barriers. The balance of forces is partly a result of external factors and partly in the company'southward control.
Exploiting manufacture modify.
Industry evolution is important strategically considering development, of class, brings with it changes in the sources of competition I have identified. In the familiar product life-wheel blueprint, for instance, growth rates change, product differentiation is said to pass up as the business becomes more than mature, and the companies tend to integrate vertically.
These trends are not and then important in themselves; what is critical is whether they affect the sources of competition. Consider vertical integration. In the maturing minicomputer industry, all-encompassing vertical integration, both in manufacturing and in software evolution, is taking identify. This very significant trend is profoundly raising economies of calibration likewise as the corporeality of capital necessary to compete in the manufacture. This in turn is raising barriers to entry and may drive some smaller competitors out of the industry in one case growth levels off.
Evidently, 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 drag new causes to the forefront. In contract droplets 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 job is to examine each competitive forcefulness, forecast the magnitude of each underlying cause, and and then construct a composite picture of the likely profit potential of the industry.
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The upshot of such an practice may differ a great deal from the existing industry construction. Today, for example, the solar heating business concern 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 futurity 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 plow exist influenced past such factors as the establishment of make 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 concern?" Combining the framework with judgment in its application, a visitor may be able to spot an industry with a adept time to come before this proficient future is reflected in the prices of acquisition candidates.
Multifaceted Rivalry
Corporate managers accept directed a great deal of attention to defining their businesses equally a crucial stride in strategy formulation. Theodore Levitt, in his classic 1960 article in HBR, argued strongly for fugitive the myopia of narrow, product-oriented industry definition. Numerous other regime have as well stressed the demand to look across production to function in defining a business, beyond national boundaries to potential international competition, and beyond the ranks of one'southward competitors today to those that may get competitors tomorrow. As a result of these urgings, the proper definition of a company's industry or industries has get an endlessly debated field of study.
One motive behind this debate is the want to exploit new markets. Some other, perhaps more important motive is the fear of overlooking latent sources of competition that someday may threaten the industry. Many managers concentrate so single-mindedly on their straight antagonists in the fight for market place share that they fail to realize that they are also competing with their customers and their suppliers for bargaining power. Meanwhile, they too neglect to continue a wary eye out for new entrants to the contest or fail to recognize the subtle threat of substitute products.
The key to growth—even survival—is to stake out a position that is less vulnerable to attack from head-to-head opponents, whether established or new, and less vulnerable to erosion from the management of buyers, suppliers, and substitute goods. Establishing such a position can take many forms—solidifying relationships with favorable customers, differentiating the product either substantively or psychologically through marketing, integrating forward or astern, establishing technological leadership.
This article is too included in the forthcoming book HBR at 100: The Most Influential and Innovative Manufactures from Harvard Business organisation Review's Kickoff Century (Harvard Concern Review Press, 2022).
A version of this article appeared in the March–April 1979 effect of Harvard Business Review.
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Source: https://hbr.org/1979/03/how-competitive-forces-shape-strategy
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