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.