The Five Competitive Forces That Shape Strategy

Summary

In this insightful discussion, Harvard Business Review's Tom Stewart interviews Michael Porter, renowned professor and author of 'The Five Competitive Forces That Shape Strategy'. Porter revisits his influential 1979 article, explaining how these forces—rivalry, threat of substitutes, new entrants, bargaining power of buyers and suppliers—holistically assess industry competition and profitability. Using the airline industry as an example, Porter illustrates the framework's application, emphasizing its robustness and relevance across various sectors. He also highlights the importance of strategy alignment within an organization and the potential for positive-sum competition to benefit all players.

Takeaways

• 📚 Michael Porter's 'Five Competitive Forces' framework is a holistic approach to understanding the structural drivers of profitability and competitive advantage within an industry.
• 🤝 The framework considers not only direct competitors but also the broader set of competitors, including customers, suppliers, new entrants, and substitute products or services.
• 💡 The five forces help identify what causes profitability in an industry and the trends that could significantly change the competitive landscape.
• ✈️ The airline industry serves as a clear example where all five forces are strong, leading to intense rivalry, low barriers to entry, and low profitability.
• 🥤 In contrast, the soft drink industry is characterized by benign forces, making it a 'five-star' industry with high profitability and less intense competition.
• 🔍 Porter emphasizes the importance of understanding the underlying economic fundamentals of an industry rather than being misled by temporary trends or technological fads.
• 🛠 The framework is robust and applicable to any industry, including high-tech and low-tech sectors, as well as emerging and developed economies.
• 🔄 The five forces provide insights into the dynamics of industry change, helping to identify evolving trends and strategic opportunities.
• 💼 Strategy should be a widely understood concept within an organization, with all employees aligned towards a common value proposition or competitive advantage.
• 📈 The framework encourages companies to consider expanding the industry's profit pool rather than engaging in destructive battles for market share.
• 🔑 The five forces analysis is a foundational step in strategy formulation, essential for understanding the competitive environment and making informed strategic decisions.
• 🌐 The internet, while often misunderstood as a standalone force, is an enabling technology that may or may not impact the underlying structure of an industry, according to Porter.

Q & A

Who is the guest in the discussion about the five competitive forces?

The guest is Michael Porter, a Professor at Harvard University and Head of the Institute for Strategy and Competitiveness.

What is the main topic of Michael Porter's forthcoming HBR article?

The main topic is 'The Five Competitive Forces That Shape Strategy', which is a reaffirmation, update, and extension of his 1979 article 'How Competitive Forces Shape Strategy'.

What is the fundamental idea behind the five competitive forces framework?

The fundamental idea is that competition is not just with direct competitors but also with a broader set of competitors including customers, suppliers, new entrants, and substitute products or services that affect profitability.

How does the framework of the five competitive forces help in understanding an industry?

The framework provides a holistic way to look at any industry, helping to identify the structural underlying drivers of profitability and competitive advantage.

What are the implications of the threat of substitutes in an industry?

The threat of substitutes places a constraint or cap on profitability and growth, preventing companies from overcharging for their products or services.

Why is the airline industry considered to be among the least profitable?

The airline industry is considered least profitable due to intense rivalry, low barriers to entry, powerful suppliers, fickle customers, and the availability of substitutes like trains or cars.

What does Michael Porter suggest as a potential strategy for industries with intense rivalry?

Porter suggests that rather than focusing on market share, companies might be better off expanding the whole profit pool of the industry, thus growing the pie for everyone.

What is the difference between positive-sum and zero-sum competition according to the discussion?

Positive-sum competition allows companies to compete on different attributes, growing the market for everyone, while zero-sum competition leads to destructive battles that benefit only the consumers in the short term.

How can the five forces framework be applied to strategy formulation?

The framework should be used as the starting point for industry analysis, understanding the competitive environment, and identifying how the industry is changing to inform strategic decisions.

Why is it important for a company's strategy to be understood by all employees?

It is important for alignment; strategy should guide all employees in making choices that reinforce each other, pursuing a common value proposition or competitive advantage.

What has Michael Porter learned about the application of the five forces framework in the real world?

Porter has learned that the framework is robust and can be applied to any industry, but there is often confusion and complexity in its application, which he aims to clear up in his new article.

Outlines

00:00

📚 Introduction to the Five Competitive Forces

In this introductory paragraph, Thomas Stewart interviews Michael Porter, a Harvard Professor and the mind behind the Five Competitive Forces framework. Porter's new HBR article revisits and extends his original 1979 work, emphasizing the importance of understanding not just direct competitors but also the broader set of competitive forces including bargaining power of customers and suppliers, threat of new entrants, and substitute products. The discussion clarifies the holistic approach of the framework in analyzing industry structure and profitability.

05:00

🛫 Applying the Five Forces to the Airline Industry

This paragraph delves into the application of Porter's Five Forces framework to the airline industry, an example of a consistently low-profitability sector. The conversation highlights the intense rivalry, low barriers to entry, significant bargaining power of suppliers, and the prevalence of substitutes as key factors contributing to the industry's lack of profitability. Porter and Stewart discuss the challenges of differentiation and the impact of powerful suppliers like GE, Rolls-Royce, Airbus, and Boeing on industry profits.

10:03

💡 Strategy Beyond the Five Forces: Positive-Sum Competition

In this segment, Porter expands on the implications of the Five Forces framework for strategic decision-making. He introduces the concept of positive-sum competition, where companies can compete on various attributes to meet different customer needs, thereby growing the industry pie. The conversation also touches on the importance of industry analysis in strategy formulation and the dynamic nature of the five forces, which can indicate changes in industry structure and strategic opportunities.

🔄 Strategy as an Organizational Alignment Tool

The final paragraph discusses the importance of making strategy a part of the day-to-day operations of a company, emphasizing that it should not be the exclusive domain of a select few. Porter argues that strategy should be understood broadly within an organization to ensure alignment and that all employees, from management to rank and file, should be aware of the company's strategic direction. The discussion also addresses the misconception that strategy should be kept secret, with Porter advocating for transparency to avoid destructive competition and to allow for unique positioning in the market.

Keywords

💡Competitive Forces

Competitive forces refer to the collective set of factors that determine the intensity of competition in a particular industry. In the video, Michael Porter explains that these forces include rivalry among existing competitors, the threat of new entrants, the bargaining power of suppliers and buyers, and the threat of substitute products or services. The concept is central to the video's theme, as it is the basis for understanding industry profitability and strategic positioning.

💡Profitability

Profitability is the ability of a business to generate profit. It is a key concern in the video, where Porter discusses how the five competitive forces impact a company's potential to earn profits. For example, intense rivalry and the threat of substitutes can limit an airline's ability to charge high prices, affecting profitability.

💡Bargaining Power

Bargaining power is the influence that buyers or suppliers have over the terms of a transaction. In the context of the video, Porter mentions that the bargaining power of buyers and suppliers can affect profitability by influencing the costs and prices within an industry. For instance, powerful aircraft suppliers like GE and Rolls-Royce can extract a significant share of the industry's profits.

💡Rivalry

Rivalry in the video script denotes the competition among existing firms in an industry. Porter explains that intense rivalry, especially in the airline industry, often results in price wars and a lack of differentiation, which can be detrimental to profitability. The concept is used to illustrate how competition shapes strategy and industry dynamics.

💡New Entrants

New entrants are new companies that enter an industry, potentially disrupting the existing market structure. Porter discusses the ease of entry into the airline industry, which contributes to its low profitability due to the constant influx of new competitors that intensify competition.

💡Substitutes

Substitutes are alternative products or services that can replace the product or service of an industry. In the script, Porter uses the example of transportation modes like trains or cars as substitutes for air travel, which can limit the pricing power of airlines and affect their profitability.

💡Industry Analysis

Industry analysis is the process of evaluating the structure and dynamics of an industry to understand its competitive environment. Porter emphasizes the importance of industry analysis as a foundational step in formulating strategy, as it provides insights into the forces shaping competition and profitability.

💡Positive-Sum Competition

Positive-sum competition refers to a situation where competition can result in overall gains for all parties involved, as opposed to zero-sum competition where one party's gain is another's loss. Porter explains that in positive-sum competition, companies can differentiate themselves and meet the needs of different customer segments, thereby growing the industry's profit pool.

💡Zero-Sum Competition

Zero-sum competition is a scenario where one company's gain in market share or profit comes at the expense of another, resulting in no net gain for the industry as a whole. Porter uses this term to describe destructive battles for market share that can lead to price wars and reduced profitability for all competitors.

💡Strategy Formulation

Strategy formulation is the process of developing a strategic plan to achieve an organization's objectives. In the video, Porter discusses the importance of understanding the competitive forces within an industry as a prerequisite for effective strategy formulation, emphasizing the need for alignment and a common understanding of the strategy across the organization.

💡Alignment

Alignment in the context of the video refers to the coordinated efforts of all members within an organization to pursue a common strategic direction. Porter highlights the importance of strategy alignment to ensure that everyone in the company is working towards the same goals and reinforcing each other's actions.

Highlights

Introduction of Michael Porter, his role, and his upcoming HBR article 'The Five Competitive Forces That Shape Strategy'.

Explanation of the five competitive forces as a holistic approach to understanding industry profitability and competition.

The concept that competition is not just with direct rivals but also includes customers, suppliers, new entrants, and substitutes.

Discussion on how the five forces framework helps identify the structural drivers of profitability in any industry.

Illustration of the application of the five forces with the example of the airline industry, which is among the least profitable due to intense rivalry and low barriers to entry.

Porter's point that the airline industry's profitability is affected by powerful suppliers such as GE, Rolls-Royce, Airbus, and Boeing.

The idea that the 'sexiness' of an industry does not correlate with profitability, and that underlying structure is the key driver.

Porter's insight on the importance of understanding the dynamics of an industry, not just a static snapshot, using the five forces.

The distinction between positive-sum and zero-sum competition and how they affect industry profitability.

The suggestion that in some industries, expanding the profit pool rather than fighting for market share might be more beneficial.

Porter's advice on how to begin using the five forces framework, emphasizing the importance of industry analysis.

The challenge of defining industry boundaries and the importance of understanding the industry structure for effective strategy formulation.

The need for strategy to be broadly understood within an organization to ensure alignment and effective execution.

Porter's view on the importance of making strategy transparent to all stakeholders, including employees and suppliers.

The discussion on the robustness of the five forces framework and its applicability across various industries and economies.

Porter's reflection on the learnings from the application of the five forces framework in the real world of business over the past three decades.

The anticipation of further feedback from practitioners to continue refining the understanding and application of the five forces.

Transcripts

>> 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.

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.