Tom stewart harvard business review

THE FIVE COMPETITIVE FORCES THAT SHAPE STRATEGY

Tom Stewart 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's the author of the forthcoming HBR article, "The Five Competitive Forces That Shape Strategy," a reaffirmation update and extension of his ground breaking 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?

Michael E. 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'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 underlining drivers of profitability in competitions.

Tom Stewart So I use this to think about my rival makes it difficult for me, the threat of substitutes means I can't over charge, the threat of new entrants means I can't over charge and the same thing with the buyers and suppliers.

Michael E. Porter And there are underlining 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, where are the constraints which if you can relax them might allow you to find a really strong competitive position.

Tom Stewart So how would you apply this analysis to an industry, airlines for example?

Michael E. Porter Airline is a great industry. It's actually -- you'll see in the article -- you've seen in the article that 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 that 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 if they can get on a flight at a cheaper price. So there's been a very intense price competition, low barriers to entry, there's been a constant stream of new airlines coming into the industry despite the fact that the profitability is low. It always puzzled me.

Tom Stewart The low -- because you can rent a plane, you don't have to buy --

Michael E. Porter You can rent a plane, you can lease the gate. It's all generic technology. You can start with one flight between two city pairs, you don't have to -- 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 industry." 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 cloud(ph). 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's always a substitute of getting on the train or driving your car or shipping your goods by air and that sets -- kind of kept to consumer.

Tom Stewart And you have powerful suppliers of labor too, that's another powerful supplier.

Michael E. Porter Right, exactly. There's 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'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.

Tom Stewart 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 case.

Michael E. Porter Right, like soft drinks. I mean soft drinks has been a license to meet money, and again, it's 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'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, how can I position myself to kind of insulate from some of the gales -- gale winds of those forces. And those implications of the five forces are something that this new article has developed in much more detail.

Tom 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. The framework really has -- 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?

Michael E. Porter Well, the wonderful thing of course we learned is that these concepts can be applied to literally 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 opposed to really enabling technology that might or might not impact the underlying structure of the industry.

So, 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. We've tried to clear as many of those areas up as we could in this new article. For example, how to think about rivalry? What's the really -- how do we understand when rivalry is really a positive sum, which allows companies to -- many companies to do well? And when does rivalry become really zero sum where everybody is kind of dragged down into kind of a destructive battle that you can't win? That just --

Tom Stewart Well, I can understand zero sum. I mean if we can get into 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?

Michael E. Porter Well, 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 competitions 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 set --

Tom Stewart So we're growing the pie and there's a piece for each of us.

Michael E. Porter There's a piece for 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 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 is -- might be in some industries rather 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.

Tom Stewart How should a company use or get started using the five forces framework? You're working your strategy up, you decided this really works for me. How do you begin?

Michael E. 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 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 or competition are, you might as well -- 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.

Tom Stewart And that's not always easy.

Michael E. Porter It's not always easy. We've 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'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. So, this is a attractive industry or unattractive industry." But of course, the real question is, how's that industry changing?

Some have believed taking the five forces is 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 that you're -- where you can command a really good profit given the five forces? How 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 to really understand the application of this.

Tom 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 the sort of elite strategy priesthood that goes in and then does this and they're almost divorced from the rest of the management of the company, the 99% or 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?

Michael E. Porter We think that this way of looking at an industry needs to be very, very broadly understood in the organization. And the thing about it is that managers even ranking file employees, it's intuitive. People understand we have these customers, we have these suppliers, we're struggling with them every day trying -- they're trying to get a better deal, we're trying to get a better deal. So intuitively, I think this is the way of helping people sort of step back from all of 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. Because 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 is pursuing a common value proposition, a common way of gaining competitive advantage.

So, I remember when I wrote this article, there are many people who believe that strategy document should be locked in a safe at night and should not be made available to the ranking file. There was a concern that some competitor would find some secret. Well, we've actually learn now that it is the opposite, you've got -- your employees got to know your strategy, your channels have to know your strategy, your suppliers have to know your strategy.

Tom Stewart And your competitors probably knew it already.

Michael E. Porter Well, and frankly if -- 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. And if your competitors kind of understand what you stand for and what your committed to, maybe they'll make a different choice, rather than get dragged into this kind of mindless price(ph) words that we see in some of the industries.

Tom Stewart The five forces that shape strategy have been around for 30 years, they're going to be around for -- well, they've been around for -- they were around long before you wrote about this.

Michael E. Porter That's right.

Tom Stewart 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.

Michael E. Porter Thank you. Well, I'm looking for the kind of getting another surge of feedback from the practitioners and we'll keep learning.

Tom Stewart Thanks.

Michael E. Porter Thanks, Tom.

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