The Five Competitive Forces That Mold Strategy

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1:00Michael E. Porter:I'm 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's remind our viewers of what the five competitive forces are. Well, Tom, the basic idea of the competitive forces starts with the notion that competition is often looked at too narrowly by managers.

1:42And the five forces say that, yes, you're competing with your direct competitors, but you're also in a fight for profits with a broader extended set of competitors, customers who have bargaining power, 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 competition.

2:15Michael E. Porter:So I use these to think about 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. Right. And the same thing with the power supply. And there's 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 home in on, first of all, what's really causing profitability in your industry? What are the trends that are most likely to be significant in changing the game in the industry?

2:55Where are the constraints which, if you can relax them, might allow you to find a really strong competitive position?

3:01Michael E. Porter:So how would you apply this analysis to an industry, airlines, for example? Airlines is a great industry. It's actually, you'll see in the article, you've seen in the article, that there's a chart that compares profitability of industries. and airlines, I think, has been on the bottom of that list for decades. It's among the least profitable industries known to man. And the five forces really allows you very quickly to understand why. I mean, let's just go around the chart. The nature of rivalry is incredibly intense, and it's almost exclusively on price. It's been very hard to differentiate, to get the customer to wait even an extra two or three minutes for another flight.

3:44if they can get on the flight at a cheaper price. So there's been a very intense price competition, low bearish entry, constant stream. Chevy is called the heartbeat of America for a reason. With SUVs made to move with your rhythm, the versatile Equinox tackles your entire day, the spacious Traverse fits your crew and your whole weekend, and Trax brings style with value you can count on. All infused with tech that has your back, so your drive always hits the right chord. Chevrolet. Together, let's drive. When you need to build up your team to handle the growing chaos at work, use Indeed Sponsored Jobs.

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4:55Michael E. Porter:Low barriers to entry because you can rent a plane. You don't have to buy them. You can rent a plane. You can lease a gate. It's all generic technology. You can start with one flight between two city pairs. There's no real need to have a whole network in the beginning. And yet people keep coming in. I think it's just one of those sexy industries. It's 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. 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.

5:34They 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's always a substitute of getting on the train or driving your car or shipping your goods by air, and that's kind of kept a concern.

5:54Michael E. Porter:And you have powerful suppliers of labor, too. That's another powerful supplier. Right, exactly. There's a great case where you have unionized labor. And unlike other industries in this industry, particularly with the pilots, the labor can literally shut you down and there's no way around them. So it's an industry where there are spurts of what you might call mediocre profitability punctuated by long periods of terrible profitability. So every one of the five forces is very strong in that industry. And you could take another industry where the five forces are relatively benign in all cases. Like soft drinks.

6:29I mean, soft drinks has been a license to mint money. And again, it's the opposite kind of analysis. When I talk with students, we kind of joke around. There's five-star industries where all the forces are attractive, like soft drinks. There's zero-star industries where all the forces are unfavorable, like airlines. And we're always trying to understand, okay, what's the configuration of underlying economic drivers that's 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's holding back industry profitability?

7:02How can I position myself to kind of insulate from some of the gale winds of those forces? And those implications of the five forces are something that this new article has developed in much more detail.

7:17Michael E. Porter: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 really has 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? Well, the wonderful thing, of course, we learned is that these concepts can be applied to literally any industry. It's a product, a service, high tech, low tech. Experience a membership that backs your business journey with American Express Business Platinum.

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9:07The Internet is a good example. We got very, very confused by the Internet because people saw the Internet as a force as opposed to really enabling technology that might or might not impact the underlying structure for the industry. So I think one thing I've learned is the framework is very, very robust, but I've also learned that there's a lot of confusion and complexity in actually applying the framework in actual practice. And we've tried to clear as many of those areas up as we could in this new article. For example, how do I think about rivalry? What's the really, how do we understand when rivalry is really positive some, which allows companies to, you know, many companies to do well, And when does rivalry become really zero-sum, where everybody's kind of dragged down into kind of a destructive battle that you can't win?

9:55I can understand zero-sum.

9:57Michael E. Porter:I mean, if we get in a price war, the only one who wins is the consumer, which is nice if you're a consumer. But what do you mean by positive-sum competition? Well, you know, the trouble with the zero-sum competition is then the consumer gets a low price, but they really get no choice. And a positive sum competition is where companies can compete on different attributes, services, features, customer support, that's actually relevant to particular groups of customers. And the most really positive sum competition is where companies are really competing on different things in order to meet the needs of different segments of customers.

10:30Michael E. Porter:So we're growing a pie and there's a piece for each of us. There's a piece for us. In fact, one of the things we talk about in the new article, One of the things I did in the new article that we really probably didn't 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? And one of them 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 them to trigger a destructive battle with their head-to-head rival.

11:07Michael E. Porter:How should a company get started using the five forces framework? You're working your strategy up, you decide this really works for me, how do you begin? 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 don't know what your industry looks like, if you don't know how it's changing, if you don't know what the drivers of competition are, you might as well, you know, strategy is going to be, you know, marginally useful if not destructive. So we've got to start with industry analysis.

11:40You know, figuring out what your industry is and drawing the right boundaries.

11:44Michael E. Porter:And that's not always easy. It's not always easy. We've added a box in this new article which really addresses that question because I... When it's time to scale your business, it's time for Shopify. Get everything you need to grow the way you want. Like, all the way. Stack more sales with the best converting checkout on the planet. Track your cha-chings from every channel right in one spot. And turn real-time reporting into big-time opportunities. Take your business to a whole new level. Switch to Shopify. Start your free trial today. This episode is brought to you by State Farm. Listening to this podcast instead of doom-scrolling?

12:25Smart move. Another smart move? Getting help from one of State Farm's 19 ,000 local agents when you choose to bundle home and auto. Bundling, just another way to save with the personal price plan. Prices are based on rating plans that vary by state. Coverage options are selected by the customer. Availability, amount of discounts and savings, and eligibility vary by state. I encountered so many companies that struggled with industry definition. Identifying really what the industry structure is in your particular industry, And then there's 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.

13:05So this is an attractive industry or an unattractive industry. But, of course, the real question is, how is that industry changing? Some have believed taking 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?

13:41How can you maybe reshape the nature of the industry structure? And we've 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.

13:56Michael E. Porter: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 this sort of elite strategy priesthood that goes and does this. And they're 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? Well, we think that this way of looking at an industry needs to be very, very broadly understood in the organization.

14:36I mean, and the thing about it is that managers, even rank and file employees, it's intuitive. People understand. You know, we have these customers. We have these suppliers. We're struggling with them every day. They're trying to get a better deal. We're 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's really important here. And then of course we've learned that strategy is completely useless, again, unless the results of the strategy process, the position that you choose to occupy, the way you're going to drive your company is well understood quite broadly.

15:12because the number one purpose of strategy is alignment. It's really to get all the people in the organization making good choices, reinforcing each other's choices, because everybody's pursuing a common value proposition, a common way of gaining competitive advantage. So, you know, 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've actually learned now that it's the opposite. Your employees have to know your strategy.

15:50Your channels have to know your strategy. Your suppliers have to know your strategy. And your competitors probably knew it already. Well, and frankly, again, 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. And if your competitors kind of understand what you stand for and what you're committed to, maybe they'll make a different choice rather than get dragged into these kind of mindless price wars that we see in so many industries.

16:22Michael E. Porter:The five forces that shape strategy have been around for 30 years. They're going to be around for, well, they've been around, but they've been around for long. They were around long before you wrote about this. That's right. They've been around as long as business has been around. They're going to be around as long as business is around. The new article is just fabulous and thank you so much. Thank you. Well, I'm looking forward to kind of getting another surge of feedback from the practitioners and we'll keep learning. Thanks. Thanks, Tom.