Understanding the five forces of competition

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Understanding Michael Porter

By Joan Magretta

(Harvard Business School Press, 236 pages, $24.95)

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Harvard Business School Professor Michael Porter's writings on strategy are classics, but too few people have actually read them. The concepts are complex and interrelated, making it hard for busy managers to use his wisdom in their strategic endeavours.

Now there's a handy solution, distilling his work into a book-length executive summary. It's written by Joan Magretta, who has worked with Prof. Porter for almost two decades and who is a senior associate at the Institute for Strategy and Competitiveness at Harvard Business School.

She begins, naturally enough, with competition and strategy, and the argument that most of what we conventionally think of as strategy is not strategy.

We hear executives saying their strategy is to grow, or to make key acquisitions. General Electric's legendary CEO Jack Welch, for example, once said the company's strategy was to be No. 1 or No. 2 in each marketplace it served.

But none of that is strategy, according to Prof. Porter. Strategy must explain how an organization will achieve superior performance. He is particularly caustic about companies whose leaders say their strategy is to be the best in their industry (despite the fact that seems deceptively similar to how he defines strategy); for most managers, the competition to be best is reinforced by the many business metaphors drawn from warfare and sports.

In war, the aim is to cripple the enemy, since there can only be one winner. In business, there can be multiple winners. Wal-Mart is a leader in discount retailing, but so is Target and both can thrive. And whereas in sports there is one competition, with distinct rules, in business there are multiple contests, based on customer needs that must be met. So McDonald's is a winner in fast foods, but In-n-Out Burgers does well selling slow burgers.

"In the vast majority of businesses, there is simply no such thing as 'the best,'" Ms. Magretta writes. "Is there a best car? A best hamburger?" A best mobile phone?"

The competition, according to Prof. Porter, must be to be unique – and to create unique value. Strategic competition means choosing a path different from that of others, rather than getting into the mug's game of just trying to be more efficient than your competitors at doing the same thing.

"The real point of competition is not to beat your rivals. It's not about winning a sale. The point is to earn profits," she writes.

"Competition for profits is more complex. It's a struggle involving multiple players, not just rivals, over who will capture the value an industry creates. It's true, of course, that companies compete for profits with their rivals. But they are also engaged in a struggle for profits with their customers, who would always be happier to pay less and get more," Ms. Magretta notes.

"They compete with their suppliers, who would always be happier to be paid more and deliver less. They compete with producers who make products that could, in a pinch, be substituted for their own. And they compete with potential rivals as well as existing ones, because even the threat of new entrants places limits on how much they can charge their customers."

That long quote sums up Prof. Porter's five forces that influence an industry, creating the structure under which competition takes place:

–The rivalry among existing competitors;

–The bargaining power of suppliers;

–The bargaining power of buyers;

–The threat of new entrants to the market; and

–The threat of substitute products or services that can replace your offering.

These five forces apply in every industry – and they determine profitability. Most of us assume that profitability comes from whether the industry is high growth or low, regulated or not, manufacturing or not. But as Ms. Magretta notes: "Structure trumps these other, more intuitive categories."

Every strategy, she explains, must pass five tests:

First, it must include a distinct value proposition, answering three fundamental questions: Which customers are you going to serve? Which needs of those customers are you going to meet? What relative price will provide acceptable value for customers and acceptable profitability for the company?

Second, to deliver that value proposition, there must be a tailored series of activities, or value chain.

Next, the strategy will involve making choices that are different from that of your rivals, so your value proposition and value chain are different and you aren't competing directly to be the best.

The fourth test is that the value chain must fit together neatly and efficiently, all the parts harmonizing. Walk into any IKEA outlet and you see a distinct value chain, with everything fitting together: huge display stores, warehouses attached to stores, suburban locations with easy road access, ample free parking, no sales associates on the showroom floor, items in flat packs (thus outsourcing assembly and delivery to customers, while making delivery to the warehouse hugely efficient), and in-store cafeterias and child care that reflect the long time customers tend spend there.

The fifth test is that there must be enough stability in the strategy for it to continue over time.

Ms. Magretta does a superb job of clearly and logically explaining Prof. Porter's concepts, with lots of helpful examples. This is a distillation, but it never feels sparse, with ample time for the reader to learn a concept and sufficient reinforcement of the ideas as you are guided through the Porter oeuvre. Reading it brings you up-to-date on his ideas and, more importantly, helps you to understand your own business and the strategic elements you may have missed.

Special to The Globe and Mail