The Five Competitive Forces That Shape Strategy

>> THOMAS STEWART: I am Tom Stewart, Editor
and Managing Director of the Harvard Business Review. Our guest today is Michael Porter, Professor
at Harvard University and Head of the Institute for Strategy and Competitiveness. He is the author of the forthcoming HBR article,
“The Five Competitive Forces That Shape Strategy”. A reaffirmation, update, and extension of
his groundbreaking 1979 article "How Competitive Forces Shape Strategy". Mike, thanks for joining the program. To start, let us remind our viewers of what
the five competitive forces are. >> MICHAEL PORTER: Well Tom, the basic idea
of the competitive forces starts with the notion that competition is often looked at
too narrowly by managers, and the five forces say that, yes you are competing with your
direct competitors, but you are also in a fight for profits with a broader extended
set of competitors, customers who have bargaining powers, suppliers who can have bargaining
power, new entrants who might come in and kind of grab a piece of the action, and substitute
products or services that essentially place a constraint or a cap on your profitability
and growth.

So the five forces is kind of a holistic way
of looking at any industry and understanding the structural underlying drivers of profitability
and competence. >> STEWART: So I use this to think about my
rival makes it difficult for me. The threat of substitutes means I cannot overcharge. The threat of new entrants’ means I cannot
overcharge. >> PORTER: Right. >> STEWART: The same thing with the buyers
and suppliers. >> PORTER: The buyers and suppliers, and there
is underlying drivers of each of those forces that the model really sort of unveils and
then you can actually apply this. Every industry is different. Every industry will have a different set of
economic fundamentals, but the five forces help you hone in on, first of all, what is
really causing profitability in the industry. What are the trends that are most likely to
be significant in changing the game in the industry? Where are the constraints, which if you can
relax, it might allow you to find a really strong competitive position? >> STEWART: So how would you apply this analysis
to an industry? Airlines for example. >> PORTER: Airlines is a great industry.

Actually you will see in the article or you
have seen in the article that there is a chart that compares profitability of industries,
and airlines, I think has been on the bottom of that list for decades. It is among the least profitable industries
known to man, and the five forces really allow you very quickly to understand why. I mean, let us just go around the chart. The nature of rivalry is incredibly intense
and it is almost exclusively unpriced. It has been very hard to differentiate, get
the customer to wait even an extra two or three minutes for another flight if they can
get on the flight with a cheaper price. So there has been a very intense price competition,
low barriers to entry. Constant stream of new airlines coming into
the industry despite the fact that probability is low.

It always puzzles me. >> STEWART: Low barriers to entry because
you can rent a plane, you do not have to buy them. >> PORTER: You can rent a plane. You can lease a gate. It is all generic technology. You can start with one flight between two
city pairs. There is no real need to have a whole network
in the beginning, and yet, people keep coming in. I think it is just one of those "sexy" industries. It is a great example of how sexiness or coolness
or hotness or cheapness has nothing to do with industry profitability. The underlying structure is what drives profitability. Yeah, the customer is very fickle and price
sensitive. Suppliers of aircraft and aircraft engines
and even aircraft gates at airports now have a lot of clout. They can bargain away most of the profits. GE, and Rolls-Royce, and Airbus, and Boeing
make a lot more money than Airlines. They get most of the profit. And then of course, there is always the substitute
of getting on the train or driving your car or shipping your goods by air and that sets
kind of kept the consumer.

>> STEWART: You have powerful suppliers of
labor too. That is another powerful supplier. >> PORTER: Right, exactly. There is a great case where you have unionized
labor. Unlike other industries, in this industry
particularly with the pilots, the labor can literally shut you down, and there is no way
around them. So, it is an industry where there are spurts
of what you might call mediocre profitability punctuated by long periods of terrible profitability. >> STEWART: So everyone of the five forces
is very strong in that industry and you could take another industry where the five forces
are relatively benign. >> PORTER: Right, like soft drinks. I mean, soft drinks have been a license to
mint money and again, it is the opposite kind of analysis. When I talk with students, we kind of joke
around, there are five-star industries where all the forces are attractive like soft drinks.

There are zero-star industries where all the
forces are unfavorable like airlines and we are always trying to understand, okay, what
is the configuration of underlying economic drivers that is going to really shape the
profit potential of this industry and then armed with that insight, what do I do about
it? How do I try to relax the constraint that
is holding back industry profitability? How can I position myself to kind of insulate
from some of the gales, gale winds of those forces? Those implications of the five forces are
something that this new article has developed in much more detail.

>> STEWART: You conceived this framework nearly
three decades ago and it has been the most extensively used both in management scholarship
and management practice of any strategy framework, and it changed the definition of strategy
in a lot of ways. In these three decades, what have you learned? What have you learned about the application
of these ideas in the real world of business? >> PORTER: Well, the wonderful thing of course
we learned is that these concepts can be applied to literally any, any industry, to product,
to service, high-tech, low-tech, emerging economies, developed economies. Indeed, what one of the powers of the framework
is it helps you get avoid getting trapped or tricked by the latest trend or the latest
technological sensation, and really allows you to focus on the underlying fundamentals. The internet is a good example. We got very, very confused by the internet
because people saw the internet as a force as supposed to really enabling technology
that might or might not impact the underlying structure of the industry.

So I think one thing I have learned is the
framework is very, very robust, but I have also learned that there is a lot of confusion
and complexity in actually applying the framework in actual practice and we tried to clear as
many of those areas up as we could in this new article. For example, how to think about rivalry? How do we understand when rivalry is really
positive-sum, which allows many companies to do well? When does rivalry become really zero-sum,
where everybody is kind of dragged down into a destructive battle that you cannot win. >> STEWART: Well, I can understand zero-sum. I mean, if we get in a price war, the only
one who wins is the consumer, which is nice if you are a consumer.

>> PORTER: Yeah. >> STEWART: But what do you mean by positive-sum
competition? >> PORTER: Well, the trouble with the zero-sum
competition is then the consumer gets a little price, but they really got no choice, and
a positive-sum competition is where companies can compete on different attributes, services,
features, customer support, that is actually relevant to particular groups of customers. The most really positive-sum competition is
where companies are really competing on different things in order to meet the needs of different
segment. >> STEWART: So we are growing the pie and
there is a piece for each of us. >> PORTER: There is a piece for each of us.

pexels photo 4350218

In fact, one of the things we talked about
in the new article, one of the things I did in the new article that we really probably
did not have the experience to do so many years ago was really talk a lot about the
implications. If this is the way competition works, what
do you do about it? One of them is might be in some industries
rather than go for market share against your rivals, you might be much better off just
really expanding the pie, expanding the whole profit pool of the industry.

That may be the best way for a market leader
to actually improve their circumstances rather than to trigger a destructive battle with
their head-to-head rival. >> STEWART: How should a company get started
using the five forces framework? You are working your strategy and you decide,
"This really works for me." How do you begin? >> PORTER: Well, I think industry analysis
and looking at the competitive environment is of course, probably the starting basic
discipline of any strategy formulation process. If you do not know what your industry looks
like, if you do not know how it is changing, if you do not know what the drivers or competition
are, strategy is going to be marginally useful, if not destructive.

So we got to start with industry analysis
figuring out what your industry is and drawing the right boundaries. >> STEWART: That is not always easy. >> PORTER: It is not always easy. We have added a box in this new article, which
really addresses that question because I encountered so many companies that struggled with industry
definition, identifying really what the industry structure is in your particular industry. And then there is another thing that a lot
of managers do. They kind of go through the industry analysis
and they say, "Okay. This is good, this is bad. This is good, this is bad." So this is an attractive industry or unattractive
industry, but of course the real question is how is that industry changing? Some have believed and taken the five forces
as really a static snapshot, but of course the five forces give you the tools for understanding
the dynamics and where is that industry structure changing? How are buyers and suppliers and substitutes
and potential entry evolving? And then what implications does that hold
for your strategy? How do you position yourself to find that
spot within the industry where you can command a really good profit given the five forces? How can you maybe reshape the nature of the
industry structure? We have got some great new examples that are
very, very contemporary in this article that I think will help the manager community and
the investor community really understand the application of this.

>> STEWART: Sometimes when people think about
strategy, they think about a group of people, maybe from a management consulting firm or
maybe on the 33rd floor of the building, whatever it is, but it is sort of elite strategy priesthood
that goes in and does this. They are almost divorced from the rest of
the management of the company, the 99% of the other people working in the company. How can a strategy become part of the day-to-day
life of a working stiff manager in a company? How do you apply this framework, this thinking? How do you use it? >> PORTER: Well, we think that this way of
looking at an industry needs to be very, very broadly understood in the organization. The thing about it is that managers, even
rank and file employees, it is intuitive.

People understand. We have these customers, we have these suppliers,
we are struggling with them everyday. They are trying to get a better deal, we are
trying to get a better deal. So intuitively, I think this is a way of helping
people sort of step back from all the excruciating little details that characterize any business
and say, “What is really important here?” And then of course we have learned that strategy
is completely useless, again, unless the results of the strategy process, the position that
you choose to occupy, the way you are going to drive your company is well understood quite
broadly because the number one purpose of strategy is alignment. It is really to get all the people in the
organization, making good choices, reinforcing each other's choices because everybody is
pursuing a common value proposition or common way of gaining competitive advantage.

I remember when I wrote this article, there
were many people who believed that strategy documents should be locked in the safe at
night and should not be made available to the rank and file. There was a concern that some competitor would
find some secret. Well, we have actually learned now that it
is the opposite. Your employees got to know your strategy,
your channels have to know your strategy, your suppliers have to know your strategy. >> STEWART: Your competitors probably knew
it already.

>> PORTER: Well, and frankly, again the competition
is not zero-sum. If every company finds a unique need that
it can set out to meet, if it tries to deliver something different than its rivals, multiple
rivals can be successful. If your competitors can understand what you
stand for and what you are committed to, maybe they will make a different choice, rather
than get dragged into this kind of mindless price wars that we see in so many industries.

>> STEWART: The five forces that shape strategy
have been around for 30 years, they are going to be around for, well, they have been around
long before you wrote about it. >> PORTER: That is right. >> STEWART: They have been around as long
as business has been around. They are going to be around as long as business
is around. The new article is just fabulous.

Thank you so much. >> PORTER: Thank you. Well, I am looking forward to kind of getting
another surge of feedback from the practitioners and we will keep learning. >> STEWART: Thanks. >> PORTER: Thanks Tom..

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