Michael Porter is professor at Harvard Business School. He is well-known for creating the five force’s framework. This helps frame the structure that an industry is operating within. The forces include 1) Rivalry within Industry 2) Threat of New Entrants 3) Bargaining Power of Suppliers 4) Bargaining Power of Buyers and lastly 5) Threat of Substitute services or products.
The basic idea is that people generally view competition in too narrow of an lense and helps helps build a more holistic view of what a business is dealing with. Below i’ve transcribed an video which provides a brief summary on his article “The Five Competitive Forces That Shape Strategy.”
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 ground breaking 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.
THOMAS 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.
MICHAEL PORTER: Right.
THOMAS STEWART: The same thing with the buyers and suppliers.
MICHAEL 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?
THOMAS STEWART: So how would you apply this analysis to an industry? Airlines for example.
MICHAEL 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 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.
THOMAS STEWART: Low barriers to entry because you can rent a plane, you do not have to buy them.
MICHAEL 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.
THOMAS STEWART: You have powerful suppliers of labor too. That is another powerful supplier.
MICHAEL 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.
THOMAS 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.
MICHAEL 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.
THOMAS 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?
MICHAEL 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.
THOMAS 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.
MICHAEL PORTER: Yeah.
THOMAS STEWART: But what do you mean by positive-sum competition?
MICHAEL 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.
THOMAS STEWART: So we are growing the pie and there is a piece for each of us.
MICHAEL 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.
THOMAS 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?
MICHAEL 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.
THOMAS STEWART: That is not always easy.
MICHAEL 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.
THOMAS STEWART: Sometimes when people think about strategy, they think about a group of people, maybe from a management consulting firm or maybe on the 3rd 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 % 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?
MICHAEL 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.
THOMAS STEWART: Your competitors probably knew it already.
MICHAEL 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.
THOMAS STEWART: The five forces that shape strategy have been around for years, they are going to be around for, well, they have been around long before you wrote about it.
MICHAEL PORTER: That is right.
THOMAS 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.
MICHAEL PORTER: Thank you. Well, I am looking forward to kind of getting another surge of feedback from the practitioners and we will keep learning.
THOMAS STEWART: Thanks.
MICHAEL PORTER: Thanks Tom.
Please let me know of any feedback you have.