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The Five Competitive Forces That Shape Strategy Review

Michael Porter is the Bishop Lawrence University Professor at Harvard Business School and a leading expert on strategy and competitiveness. He also chairs the Harvard Business School's program for newly appointed CEOs of multi-billion dollar corporations. "The Five Competitive Forces that Shape Strategy" reaffirms, updates, and extends his original 1979 publication on strategy.

Porter begins by pointing out that the job of the strategist is to understand and cope with competition. Managers, however, often define competition too narrowly, including only today's direct competitors. Competition for profits goes beyond established industry rivals to also include customers, suppliers, potential entrants, and substitute products. When these forces are intense (airlines, textiles, hotels), almost no firm earns attractive returns on investment in the medium- or long-term. (Short-term factors, such as weather, bad publicity for a competitor, etc. may offer temporary respite.) Where weak (soft drinks, pre-packaged software, and security dealers) sustained high profits are possible.

Porter then identifies the five forces that shape competition, along with examples of recent changes in those forces. He begins with potential barriers to entry for new competitors. These include large supply-side economies of scale, large demand-side benefits of scale - eg. IBM's reputation, customer switching costs (particularly for specialized software), large capital requirements, advantages of incumbency that are independent of scale (eg. location, reputation), and advantageous access to distribution channels (eg. supermarket supply systems).

A second, supplier power, is boosted by being more concentrated by the industry it sells to, not relying heavily on sales to a specific industry, product differentiation (key to avoiding price competition, often achieved through advertising - eg. soft drinks, or financing, inventory, advertising, etc. services provided buyers), lack of substitutes (the Internet's rise has severely impact travel agents' ability to extract fees from both travelers and travel vendors - hotels, airlines, ships, etc.; patent expiration has major impacts in the drug industry), posing a credible threat to integrate forward, and high switching costs for existing customers.

Buyer power, is Porter's third force shaping competition, and enhanced by high fixed/low variable cost suppliers, lack of supplier differentiation (again, not limited to the physical product), and lack of credible supplier ability to integrate forwards. Porter also points out that buyers are more price sensitive if the product being purchased represents a significant cost component, or the buyers are earning low profits. Buyer power in the appliance retailing business has recently increased due to the replacement of small locally-owned appliance stores by 'big box' retailers such as Home Depot and Best Buy.

Competitor rivalry, the number four force, is greatest if competitors are numerous or roughly the same size, and/or exit barriers are high.

Finally, price competition is most likely when product differentiation is minimal, fixed costs are high and variable costs low, the product is perishable, or when capacity must be expanded in large increments.

Evaluating the strength of competition should not be done subjectively. Many of the factors can be quantified - examples include the percentage of a buyer's total cost accounted for by the supplying industry's product (indicates price sensitivity), the percentage of industry sales required to load a plant or logistical network to efficient scale (helps assess barriers to entry), the buyer's switching costs (assesses the strength of incentives that a rival must offer customers. Perhaps surprisingly, industry rivalry may not be the determining factor - a lesson learned by Kodak and Fuji Film through the rise of digital photography.

'Product positioning' is a key decision that strategizers must make. Porter's chooses Paccar, maker of Kenworth and Peterbilt heavy trucks to illustrate the point. Most heavy trucks are bought by large trucking companies such as Swift, Knight, Schneider, etc. - buyers who emphasize low costs. However, there is also a sizable smaller market made up of owner-operators that own their own trucks and lease services to others. Those owner-operators typically take pride in their trucks and want more attractive interiors. Paccar markets to them, providing build-to-order trucks (6-8 week waiting times) and a wide network of roadside service and parts availability. Following this positioning strategy, Paccar avoids intense price competition from larger-volume Freightliner and Volvo.

Finally, Porter points out that positioning and operational effectiveness, while necessary, do not suffice as strategy. Today's global markets change too quickly and participants, more often than not, can quickly imitate these components. Thus, strategists should look for a sustainable competitive advantage. But that's another topic.

The Five Competitive Forces That Shape Strategy Overview

In 1979, a young associate professor at Harvard Business School published his first article for HBR, "How Competitive Forces Shape Strategy." In the years that followed, Michael Porter's explication of the five forces that determine the long-run profitability of any industry has shaped a generation of academic research and business practice. In this article, Porter undertakes a thorough reaffirmation and extension of his classic work of strategy formulation, which includes substantial new sections showing how to put the five forces analysis into practice. The five forces govern the profit structure of an industry by determining how the economic value it creates is apportioned. That value may be drained away through the rivalry among existing competitors, of course, but it can also be bargained away through the power of suppliers or the power of customers or be constrained by the threat of new entrants or the threat of substitutes. Strategy can be viewed as building defenses against the competitive forces or as finding a position in an industry where the forces are weaker. Changes in the strength of the forces signal changes in the competitive landscape critical to ongoing strategy formulation. In exploring the implications of the five forces framework, Porter explains why a fast-growing industry is not always a profitable one, how eliminating today's competitors through mergers and acquisitions can reduce an industry's profit potential, how government policies play a role by changing the relative strength of the forces, and how to use the forces to understand complements. He then shows how a company can influence the key forces in its industry to create a more favorable structure for itself or to expand the pie altogether. The five forces reveal why industry profitability is what it is. Only by understanding them can a company incorporate industry conditions into strategy.

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