Video Transcript: 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 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  

Michael Porter - 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 underlying drivers of profitability  and competition. So  

Tom Stewart - 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, the same thing with the  virus  

Michael Porter - supplies. 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. Where are the constraints,  which, if you can relax and 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, airlines  

Michael Porter - 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 and the five forces really allows you very quickly to understand why. I mean, let's just, let's just go around the 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 the  flight at a cheaper price. So there's been a very intense price competition, low  bearish to entry, a constant stream of new airlines coming into the industry,  despite the fact that the probability is low. It's always puzzling the low barriers to  entry, because you can rent a plane, you can rent a plane, you can lease a gate. You know, it's all generic technology. You can, you can start with one flight  between two city pairs. You don't have to, you know, 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 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 and  even aircraft gates at airports now have a lot of clout. They can bargain away  Mark most of the profits. You know, GE and rolls, Royce and and, 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 or shipping your goods by by by air, and that's that's kind of kept a  

Tom Stewart - concern. You have powerful suppliers of labor too. That's  powerful, right exactly here.  

Michael Porter - There's a great case where you have where you have  unionized labor. And unlike other industries in this 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, like  soft drinks.  

Michael Porter - 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 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 and we're always trying to understand, Okay,  what's the configuration of underlying. The economic drivers that's going to  really shape the potential of this industry. And then, armed with that insight, what do I do about it? You know, 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 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  

Tom Stewart - this framework nearly three decades ago, and it has been the  most extensively used, both in management, scholarship and management  practice, of any of any strategy framework. And it really has changed. 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 Porter - Well, the wonderful thing, of course, we learned is that these,  these concepts, can be applied to literally any, any industry, to 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 that might, might or might  not impact the underlying structure of the industry. So So I think one thing I've  learned is, is, is the framework is, is very, very robust, but I've also learned that  there's a lot of confusion and complexity, and 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 to think about rivalry, what? 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, where, everybody's kind of dragged down into  kind of a destructive battle that you can't win. That's understand zero  

Tom Stewart - 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's, what do you  mean by positive sum competition? Well,  

Michael Porter - you know, the trouble with the zero sum competition is then the consumer gets a low price, but they really get no choice. And, and, 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, and the most really positive sum  competition is where companies are really competing on different things in order to meet the needs of different high and there's a piece for each of us. There'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 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 than to go for market share against your rivals, you might be much better off just really expanding the pie, expanding the whole  profit pool 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  

Tom Stewart - use, or get started using the five forces framework. You're  working your strategy up. You decide this really works for me. How  

Michael Porter - 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 Well, you know, strategy is going to be, you know, marginally  useful, if not destructive. So, so we got to start with industry analysis, you know,  figuring out what your industry is and drawing the right boundaries. And that's  not always 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 an  unattractive industry. But of course, the real question is, how's that industry  changing? Some have believed 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's 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, in the investor community,  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 this sort of elite strategy priesthood  that goes and does this, and they're almost divorced from the from the rest of  the management of the company, the 99% of the other people working in the  company. How can, 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  

Michael Porter - 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, is  that that managers, even rank and file employees, it's intuitive people  understand, yeah, we have these customers, we have these suppliers. We're  struggling with them every day, trying to 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. 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's pursuing a common value proposition, a problem, a common way of gaining competitive advantage. So, you know, I remember when I wrote this  article, there are 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.  There was a concern that some competitor would find some secret. Well, we've  actually learned now that it's the opposite. You know you've got your employees  got to 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, if you know again, there's the competition is not zero  sum. If every company finds a unique need that it can set out to meet, if it tries  to differ, 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. The  

Tom Stewart - five forces that shape strategy have been around for 30 years.  They're going to be around for Well, they've been around. They've been around  for long. They were around long before you wrote about That's right, they've  been around as long as business has been around, they're going to be a lot  around as long as business is around. The new article is just fabulous. And  thank you.  

Michael Porter - So 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,