The Five Competitive Forces That Shape Strategy

THOMAS STEWART: I'm Tom Stewart, editor and CEO of Harvard Business Review. Our guest today is Michael Porter, professor at Harvard University and director of the Institute for Strategy and Competitiveness. He is the author of the upcoming HBR article, “The Five Competitive Forces That Shape Strategy.” A restatement, update and expansion of his groundbreaking 1979 article "How Competitive Forces Shape Strategy." Mike, thanks for joining the show. To start, let's remind our viewers what the

five

competitive

forces

are. MICHAEL PORTER: Well, Tom, the basic idea of ​​

competitive

forces

starts with the notion that managers often look at competition too narrowly, and the

five

forces say that, yes, you are competing with your direct competitors, but also in a struggle for profits with a broader set of competitors, customers who have bargaining power, suppliers who may have bargaining power, new entrants who could enter and take a piece of the action, and substitute products or services that They essentially place a restriction or limit on your profitability and growth.

Therefore, the five forces are a holistic way to look at any industry and understand the underlying structural drivers of profitability and competition. STEWART: So I use this to think that my rival makes it difficult for me. The threat of substitutes means I can't overcharge. The threat of new entrants means I can't overcharge. GOALKEEPER: Correct. STEWART: The same goes for buyers and suppliers. PORTER: Buyers and suppliers, and there are underlying drivers of each of those forces that the model really reveals and then you can apply this. Every industry is different. Each industry will have a different set of economic fundamentals, but the five forces will help you focus on what is really driving profitability in the industry in the first place.

What are the trends that are most likely to be significant game-changers in the industry? Where are the constraints that, if they can be relaxed, could 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 are a big industry. In fact, you will see in the article or you will have seen in the article that there is a graph that compares the profitability of industries and airlines; I think it's been at the bottom of that list for decades. It is among the least profitable industries known to man, and the five forces really make it very easy to understand why.

I mean, let's go over the graph. The nature of the rivalry is incredibly intense and almost exclusively priceless. It has been very difficult to differentiate, to get the customer to wait even two or three minutes longer for another flight if he can take the flight with a cheaper price. So there has been very intense price competition and few barriers to entry. A constant stream of new airlines entering the industry even though the probability is low. It always baffles me. STEWART: Low barriers to entry because you can rent a plane, you don't have to buy them. PORTER: You can rent a plane.

You can rent a door. It's all generic technology. You can start with a flight between two city pairs. There's no real need to have a full network at the beginning, and yet people keep coming. I think it's just one of those "hot" industries. It's a great example of how sexy, attractive, hot or cheap has nothing to do with the profitability of the industry. The underlying structure is what drives profitability. Yes, the customer is very fickle and price sensitive. Suppliers of aircraft and aircraft engines and even airport gates now have a lot of influence. They can negotiate and keep most of the profits.

GE, Rolls-Royce, Airbus and Boeing make much more money than the airlines. They get most of the profits. And then of course there is always the substitute of getting on the train, driving a car or shipping your products by air and that keeps the consumer going. STEWART: You also have powerful labor suppliers. That's another powerful provider. PORTER: Right, exactly. There is a great case in which there is unionized labor. Unlike other industries, in this industry, particularly with pilots, the workforce can literally paralyze you and there is no way around it. So it's an industry in which there are streaks of what you might call mediocre profitability punctuated by long periods of terrible profitability.

STEWART: So each 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, I eat soda. I mean, soft drinks have been a license to mint money and, again, it's the opposite kind of analysis. When I talk to students, we joke, there are five-star industries where all 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, well, what is the configuration of the underlying economic drivers that will really

shape

the profit potential of this industry and then armed with that information.

What do I do about it? How do I try to relax the restriction that is holding back the profitability of the industry? How can I position myself to insulate myself from some of the gales and gale force winds from 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 almost three decades ago and it has been the most widely used in both management studies and management practice of any strategic framework, and it changed the definition of

strategy

in many ways. In these three decades, what have you learned?

What have you learned about applying these ideas in the real world of business? PORTER: Well, the wonderful thing we learned, of course, is that these concepts can be applied to literally any industry, product, service, high tech, low tech, emerging economies or developed economies. In fact, one of the powers of the framework is that it helps you avoid getting caught up in or fooled by the latest trend or technological sensation, and really allows you to focus on the underlying fundamentals. The Internet is a good example. The Internet confused us very, very much, because people saw the Internet as a force that supposedly actually enabled a technology that may or may not affect the underlying structure of the industry.

So I think one thing I've learned is that the framework is very, very solid, but I've also learned that there is a lot of confusion and complexity in applying the framework in real practice and we try to clarify as many of those areas as possible. as we could in this new article. For example, how to think about rivalry? How do we understand when rivalry is truly positive-sum, allowing many companies to succeed? When does rivalry truly become zero-sum, where everyone is drawn into a destructive battle that cannot be won? STEWART: Well, I can understand zero sum. I mean, if we get into a price war, the only one who wins is the consumer, which is a good thing if you're a consumer.

PORTER: Yes. STEWART: But what do you mean by positive sum competition? PORTER: Well, the problem with zero-sum competition is that the consumer gets a small price, but they don't really have a choice, and positive-sum competition is where companies can compete on different attributes, services, features and clients. support, which is really relevant to particular groups of customers. More positive sum competition is when companies actually compete on different things to meet the needs of different segments. STEWART: So we're growing the pie and there's a piece for each of us. PORTER: There's a piece for each of us. 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 probably didn't have the experience to do all those years ago, was talk a lot about the implications.

If this is how competition works, what do you do about it? One of them is that it might be in some industries, rather than chasing market share against your rivals, it might be much better to just expand the pie, expand the entire industry profit pool. That may be the best way for a market leader to actually improve his circumstances rather than triggering a destructive head-to-head battle with his rival. STEWART: How should a company begin using the five forces framework? You're working on your

strategy

and you decide, "This really works for me." How do you start? PORTER: Well, I think industry analysis and observing the competitive environment are, of course, probably the basic initial discipline of any strategy formulation process.

If you don't know what your industry is like, if you don't know how it's changing, if you don't know what the drivers or the competition are, the strategy will be marginally useful, if not destructive. So we start with industry analysis, finding out what your industry is and drawing the right boundaries. STEWART: That's not always easy. PORTER: It's not always easy. We've added a sidebar in this new article, which really addresses that question because I ran into a lot of companies that had a hard time with industry definition, really identifying what the industry structure is in their particular industry.

And then there is another thing that many managers do. They sort of look at the industry analysis and say, "Okay. This is good, this is bad. This is good, this is bad." So this is an attractive industry or an 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 the tools to understand the dynamics and where the structure of the industry is changing? How are buyers, suppliers, substitutes and potential entrants evolving? And what implications does this have for your strategy?

How do you position yourself to find that place within the industry where you can make a really good profit given the five forces? How can the nature of the industry structure be re

shape

d? We have some great new examples that are very, very contemporary in this article that I think will help the manager community and the investment community to really understand the application of this. STEWART: Sometimes when people think about strategy, they think about a group of people, maybe a management consulting firm or maybe the 33rd floor of the building, whatever, but it's kind of a priesthood. elite strategy that comes into play. and does this.

They are almost divorced from the rest of the company's management, 99% of the rest of the people who work in the company. How can a strategy become part of the daily life of a hard-working manager in a company? How do you apply this framework, this thinking? How do you use it? PORTER: Well, we think this way of looking at an industry needs to be understood very, very broadly across the organization. The thing is that managers, even rank-and-file employees, are intuitive. People understand. We have these customers, we have these suppliers, we fight with them every day. They're trying to get a better deal, we're trying to get a better deal.

Intuitively, I think this is a way to help people step back from all the excruciating little details that characterize any business and say, "What's really important here?" And then, of course, we have learned that strategy is completely useless, again, unless the results of the strategic process, the position that you choose to occupy, the way you are going to conduct your business, are well understood in a fairly broad way. because the number one purpose of strategy is alignment. It's really about getting everyone in the organization to make good decisions and reinforce each other's decisions because everyone is pursuing a common value proposition or a common way to gain a competitive advantage.

I remember when I wrote this article, there were many people who believed that strategy documents should be locked in a safe at night and not made available to the rank and file. There was concern that a competitor would discover some secrets. Well, now we have learned that the opposite is true. Your employees should know your strategy, your channels should know your strategy, your suppliers should know your strategy. STEWART: Your competitors probably already knew that. PORTER: Well, and frankly, again competition is not zero-sum. If each company finds a unique need that it can set out to satisfy, if it tries to offer something different from its rivals, multiple rivals can be successful.

If your competitors can understand what you stand for and what you are committed to, they may make a decision.different decision, rather than being dragged into these types of meaningless price wars that we see in so many industries. STEWART: The five forces that shape strategy have been around for 30 years and will continue to exist - well, they've been around long before you wrote about them. GOALKEEPER: That's right. STEWART: They've been around as long as businesses have existed. They will be present as long as businesses exist. The new item is simply fabulous. Thank you so much. GOALKEEPER: Thank you.

Well, I hope to receive another wave of feedback from professionals and we will continue to learn. STEWART: Thank you. PORTER: Thanks Tom.