The Five Competitive Forces That Shape Strategy

An Interview with Michael E. Porter, Professor, Harvard University. Porter's five competitive forces is the basis for much of modern business strategy. Understand the framework and how to put it into practice.

(relaxed upbeat music)

- 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.

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 kinda 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 competition.

- So I used these to think about

my rival makes it difficult for me,

the threat of substitutes
means I can't overcharge,

the threat of new entrance
means I can't overcharge.

- Right.

- And the same thing with power supplies.

- Buyers and suppliers.

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 hone in on,

first of all, what's really causing

profitability in your industry?

What are the trends are
the most likely to be

significant in changing
the game in the industry?

Where are the constraints,

which is you can relax, it might allow you

to find a really strong
competitive position?

- 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

if they can get on the
flight at a cheeper price.

So there's been a very
intense price competition.

Low barriers to entry,

constant stream of new airlines
coming into the industry

despite the fact that
the probability is low.

It's always puzzled me.

- The low barriers to entry
because you can rent a plane.

You don't have to buy them.
- You can rent a plane.

You can plane a plane.

You can lease a 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 industries.

It's a great example of how sexiness,

or coolness, or hotness, or chicness,

has nothing to do with
industry profitability.

The underlying structure is
what drives profitability.

Yeah, the customer is very
fickle and price sensitive.

Supplier 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's
always a substitute

of getting on the train,
or driving your car,

or shipping your goods by air.

So that's kinda kept it constrained.

- And you have powerful
suppliers of labor too.

That's powerful suppliers--
- Right, exactly.

There's a great case where
you have unionized labor,

and unlike other industries,

and 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.

- Yeah.

- And you could take
another industry where

the five forces are relatively
benign in all cases.

- Right, like soft drinks.

I 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 gonna 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.

- 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.

I mean, 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,

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's 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.

And we've tried to clear
as many of those area 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 positive sum,

which allows companies to,
many companies to do well?

And when is rivalry become really zero sum

where everybody's kinda dragged down

into kind of a destructive
battle that you can't win?

- 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're a consumer.

- Yeah.

- But what do you mean by
positive sum competition?

- Well, the trouble with
zero sum competition

is then the consumer gets a low price,

but they really get no choice.

And a positive sum competition's

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 customer.

- So we're well enough high,

and there's a piece for each of us.

- And it's a piece of 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 od 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 than to trigger
a destructive battle

with their head-to-head rival.

- How should a company use,

or get started using the
five forces framework?

You're working your strategy up.

You both decide, this really works for me.

- Yep, yep.

- 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, strategy is gonna be

marginally useful if not destructive.

So we gotta start with industry analysis,

figuring out what your industry is

and drawing the right boundaries.

- And that's not always easy.

- It is 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 kinda 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 believe, 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's that industry 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?

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.

- 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, I mean.

And the thing about it is that managers,

even rank and file
employees, it's intuitive.

People understand it.

And 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

sorta 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 gonna 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's pursuing
a common value proposition,

a common way of gaining
competitive advantage.

So, I remember when I wrote this article,

there were many people who
believe that strategy documents

should be locked in the safe at night,

and should not be made
available to the rank and file,

and there was a concern
that some competitor

would find some secret.

Well, we've actually learned
now that it's the opposite.

Your employees gotta know your strategy.

Your channels have to know your strategy.

Your suppliers have to know your strategy.

- And your competitors
probably knew it already.

- 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.

And if your competitors kinda
understand what you stand for

and what you're committed to,

maybe they'll make a different choice

rather than get dragged in
these kinda mindless price wars

that we see in so many industries.

- The five forces that shape strategy

have been around for 30 years.

They're gonna be around for,

well, they've been around for long.

They were around long
before you wrote about them.

- That's right.

- They've been around as long
as business has been around.

They're gonna 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 kinda getting

another surge of feedback
from the practitioners,

and we'll keep learning.

- Thanks.

- Thanks, Tom.