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Porter’s Five Forces can be used to estimate the overall competitive structure of an industry, and can also be useful in helping understand a company’s position within the industry and in shaping each firm’s competitive strategy. In order to succeed in the long run, a firm must cultivate some sort of sustainable competitive advantage. The three generic strategies that can result in such an advantage are cost leadership, differentiation and focus.

Cost leadership refers to the cost of production, not the price charged to customers. In a market where price is determined by supply and demand, the company with the lowest cost of production will enjoy the highest profits. Cost leaders cannot ignore differentiation – if its products are deemed inferior it will not be able to charge the same price as competitors and the lower cost will not produce sustainable advantage. The key is to maintain approximate parity with regard to differentiating factors while achieving the lowest cost.

Differentiation exploits customer willingness to pay more for something perceived to be of greater value. This can be quality, service, marketing or other factors. Differentiators cannot ignore cost – they must ensure that any additional costs incurred in differentiation are exceeded by the premium customers will pay for the differentiated product.

A focus strategy is based on serving a narrow segment of the overall industry and tailoring its strategy to the unique needs of its focus segment. Typically a focus strategy entails one of the other two strategies – being either a cost leader or a differentiator within the focus niche.

For more information, see all articles on: Fundamental Analysis, Industry Analysis, Investing in Stocks

See also:

Global Industry Analysis

Industry Analysis: Porter’s Five Forces

Conducting an Industry Analysis

Industry Analysis: External Factors

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