The Five Competitive Forces That Shape Strategy

A Youtube video where Harvard Strategy professor Michael Porter discusses his (then) upcoming article entitled "The Five Competitive Forces that Shape Strategy." It is billed as an update, extension, and reaffirmation of his enormously influential "Five Forces" framework first articulated over 30 years ago. Even if know this framework by heart, watching this video will remind you of why Porter's insights have stood the test of time.

Business Concept Innovation, Auto Industry, Goodyear

"Business Concept Innovation" is the title of the third chapter of strategist Gary Hamel's book "Leading the Revolution: How to Survive in Turbulent Times by Making Innovation a Way of Life." In that chapter he explains why and how radically different business models can contribute to competitive advantage. A key insight in the chapter is the distinction drawn between incremental and innovative change to a business model. That distinction is underscored by a very well organized conceptual vocabularly and analytical framework, the key elements of which are:

• Core Strategy: the essence of how the firm chooses to compete
• Strategic Resources: unique, firm-specific, and upon which advantage rests
• Customer Interface: How the producer and consumer reach one another
• Value Network: what surrounds the firm and complements its own resources

Each of these four areas has another three to four sub-categories and are linked to each other by another three. Hamel does not provide specific guidelines as to which or how many of the 19 factors  must be implicated in order for a business model or concept to be considered innovative. That said, it is harder to make that case for changes that focus only on one or two of the major elements or a small number of the minor.

A recent article in the Akron Beacon Journal describes tire maker Goodyear's embrace of innovation:

Speaking at the start of the 28th Conference on Tire Science and Technology in Akron on Tuesday, Goodyear Chief Executive Officer Robert Keegan said embracing innovation helped his company survive one of the most challenging times of its existence.He used Goodyear's newest consumer tire, the Assurance Fuel Max, to illustrate how supporting a new product line with everything from improvements in processes to development of personnel can reinvent a business.

Groundwork for the new tire, introduced this year, was laid in 2002, when Goodyear began designing its Assurance line of premium tires. ''We found ourselves in one of those times we had to change simply to survive, but as we did that, we changed the way we worked, and from that point on there was no looking back,'' Keegan said.

'So we decided we clearly needed a new tire, and what we created was a new company.'' ... 'We began thinking less like a traditional manufacturing-based company, like we had been, and more like a fast-moving consumer products company,'' he said. ''More importantly, we began acting like an innovative company.''

The last paragraph above may relates to "Mission", the first sub-category within Hamel's first major category, "Core Strategy." Hamel defines "Mission" as "the overall objective of the strategy--what the business model is designed to accomplish of deliver." Of particular note is the idea of the shift in mindset from "traditional manufacturing" to a "fast-moving consumer products" company. But of course such things are easy to say and harder to do. A little further on we get some indication of what Goodyear actually did.

One year later — in a pace Keegan believes is unprecedented in the industry — the Assurance Fuel Max was designed, developed and introduced, thanks to a ''totally committed cross-functional effort.''

''Every aspect of the proposed product, from fundamental technology to product development, from quality and manufacturing to supply chain, was addressed concurrently,'' Keegan said.

''The result: Exponential acceleration of time to market, a critical factor in driving prosperous innovation,'' he said.

''I'm proud of that because the technology that we develop and the products that we develop have to be also economically relevant,'' he said.

Keegan encouraged his peers to respond to market needs with a ''sense of urgency'' and using ''cross-functional teamwork.''

"Configuration" is one of the three linking or bridging concepts in Hamel's theory. It is the link between "Strategic Resources" and "Core Strategy." Specifically it concerns how the three categories of Strategic Resources--Core Competencies, Strategic Assets, and Core Processes--are arrayed to support the Core Strategy. This distinction between competencies, assests, and processes is a vital and straight-forward one: there are things that a firm does (processes), that it has (assets) and what it knows (competences). 

The reliance on "cross functional teamwork" in the development of the Assurance Fuel Max belongs to the "Configuration" category. It is what is traditionally known as organizational design or structure change.  As a bridge it links " fundamental technology" (assets), as well as product development, manufacturing, and supply chain (processes) to the "Mission" of responding to "market needs" like a "fast-moving consumer products company." 

Finally, although the results are impressive, there is far too little information provided to determine the full extent of the business concept changes. We would need to know a lot more before classifying this as a business concept innovation.

Airline Industry, Rivalry, Barriers to Entry

Today's Boston Herald describes the rapid growth in both performance (sales) and capacity (# of planes) of Canada-based Porter Airlines.  The article contains much information relevant to to two of the "Five Forces" described in the industry analysis framework of Harvard Business School Professor Michael Porter (no relation).  Most notable are references to the determinants of the two forces labeled "industry rivalry" and "barriers to entry." The 5-forces framework identifies several factors that influence the intensity of rivalry, e.g.  the tendency for capacity to be augmented in large increments, the degree of product and service differentiation,  and the diversity of competitors. Though rather short, the article manages to touch upon each of these. 

Concerning the former, we are told the following, the CEO states that "We know we can easily add one or more additional flights.” The 3-year-old airline will add a 14th 70-seat Bombardier Q400 aircraft to its fleet Tuesday and will have 18 in service by November and an expected 20 by April."  What we may gather here is that capacity may be augmented in increments of flights of one or more. Those flights are on planes with 70 seats and cover a distance of 431 miles. This translates into just over 30K airline seat miles (ASM). We are further told that Porter Air competes with Air Canada and American Eagle, both large, legacy carriers. While there is no information given about the size of Air Canada's jets, American Eagle flies very small jets on commuter flights as well as those to and from small regional airports. Thus, it is mos likely that capacity can be augmented in single flights for all three airlines, with the largest most likely being Canada's national carrier.

Rivalry is also said to be intensified to the degree that products and services are undifferentiated. One which in which Porter differentiates itself from Air Canada and American Eagle is the airport into which it flies: it's the only of the three that flies into Toronto's City Centre airport. The others fly "into Toronto Pearson International Airport in Mississauga, about 17 miles and a $60 cab ride from downtown..." By contrast, from City Center airport "travelers can take a 1.5-minute free ferry ride to the mainland and then a free six- to seven-minute shuttle bus to downtown." Porter also differentiates itself through in-flight amenities (complimentary beer, wine and “premium” snacks, leather seats) and pre-flight perks ( e.g.,  a business-style lounge in Toronto). 

Concerning barriers to entry, we see one in the form of government policy that may indirectly affect rivalry.  Specifically, as a Canadian carrier Porter is prohibited from flying passengers between cities in the US. That law does not, however, prevent Porter from flying from Boston's Logan to other Canadian destinations. 

Airline Industry, Intensity of Rivarly, Capacity Augmented in Large Increments

The intensity of rivalry is one of the "five forces" described in Michael Porter's framework for industry analysis.  Several factors are said to impact it. Among them are the number, diversity, and relative size of the competitors; the pace of industry growth; the level of fixed and storage costs; the degree of differentiation and switching costs; the height of exit barriers; and increments in which capacity can be augmented. This latter factor is highlighted in a recent AP article entitled "A look at airline capacity cuts."

Most major U.S. airlines plan to offer fewer flights this fall than they did a year ago as they adjust to weak demand. Here's a look at recent announcements from the carriers, who are listed in descending order of size based on capacity in August. The figures include both "mainline" and regional affiliates for each company. Passenger-carrying capacity is measured in "available seat miles" or ASMs — miles flown times seats on the planes. A 150-seat jet flying 100 miles equals 15,000 available seat miles.

What the article goes on to provide statistics for seven major US airlines--Delta, American, United, Contintental, Southwest, US Air, and JetBlue--all but one of which is reducing capacityor augmenting capacity downward. In terms of the absolute size of ASMs, the reductions are very large ranging from 6.7 Billion for US Air to 21.6 Billion for Delta. On a percentage basis these numbers range from a low of 3.2% for Delta to 9.2% for American Airlines. These figures seem much smaller. The only carrier showing an increase in capacity is JetBlue with an additional 3 Billion ASMs or just 0.6% of capacity. 

Clearly what is lacking is an objective standard for measuring capacity. However, it is not entirely clear how one should be formulated. For example,  should it be industry-specific, i.e. a measure for each industry. And on what underlying production or performance measure(s) should it based? 

Airlines, Rivalry, Government Policy, Five Forces

According to Wikipedia "When antitrust agencies are evaluating a potential violation of competition laws, they will typically make a determination of the relevant market and attempt to measure market concentration within the relevant market." A recent article in the Dallas Business Journal notes how and why American Airlines plans to ask the Department of Justice for anti-trust immunity. 

American Airlines Inc. is making its case for antitrust immunity for its oneworld Alliance to push forward with business arrangements with its members by filing a pre-emptive defense to possible objections that the Department of Justice recently raised in relation to an antitrust immunity case filed byContinental Airlines.

Tim Smith, a spokesman for American, said the airline became concerned with some of the issues the DOJ raised when Continental made a similar request to obtain antitrust immunity. He said because they raised those issues, American wanted to submit a filing in advance that responds to those issues. He said the filing basically says “there is no harm to competition” through the alliance.

In other words, American Airlinesrm  plans to argue not only that "you've already let the other guys do it" but also that strategic and code sharing alliances will not hacompetition. That's not quite the same thing as saying that competition will be enhanced, let alone that customers will benefit from any increased competition. 

Restaruants, New Entrants, Rivalry, Differentiation

Noted management theorist Arthur L. Stinchcombe once wrote that restaurants are the fruit flies of organizational ecology.  Fruit flies are perhaps the world's most studied organism, especially in the field of genetics. Stinchcombe (and others before him) may have made thsi remark because like fruit flies, restaurants require relatively space, equipment, and capital to maintain. Or perhaps it was said because, like fruit flies, they have a short generation span, enabling adaptatiosn and mutations in several generations to be studied in a relatively short period of time.  I'm pretty sure he didn't say it because of the relation both have to food.  In any event, an article in the Albany Business Journal underscores why this organizational form is ideal to study:

Andrew Zheng says his new Asian-fusion restaurant is just the ticket for a vacant Off-Track Betting parlor on North Pearl Street in the Albany’s downtown. Zheng’s plans for the three-story building at 68 N. Pearl St. —situated between Jillian’s and the Bayou Cafe Downtown—start with a 200-seat restaurant on the first floor. Subsequent phases, he says, will include a “virtual” game room on the second floor, and apartments and condos on the third floor. Zheng plans to attract a following of patrons who work and/or socialize downtown and are looking for alternatives to the mainly Italian and American fare offered there. “I think downtown is missing the kind of thing that we’ll offer,” said Zheng, 27, whose family operates South Wok and West Wok in Glenmont, and China Dragon in Schenectady. ... Tai’s American-infused menu will feature traditional Chinese, Japanese, Thai and Malaysian cuisine. Zheng said he’s not concerned about the current down economy because the restaurant will cater to a niche audience.

The experiment here (though not a controlled one) is whether a mixed or multi-use establishment--in an Asian fusion restaurant + virtual game room + apartment/condo block-- will survive its entry into a a downtown restaurant market dominated by traditional Italian and American fare. 

Another way to view this story is as one about barriers to entry and rivalry. In most US cities, it is relatively easy to open a restaurant. That is to say, barriers to entry are low. In order to lessen the intensity of rivalry, differentiation is a strategy that permits firms to compete on a basis other than price. Differentation on type is an obvious dimension. All else equal, an Italian restaurant alongside a American along side a Chinese alongside an Asian Fusion restaurant would not have as intense a rivalry as would four Italian or four Chinese restaurants. 

Insurance Industry, Five Forces, Rivarly, Barriers to Entry

The threat of entry (of new competitors) and Rivarly are two of the "Five Forces" in Michael Porter's framework for industry analysis.  Concerning the former, the basic idea is that "Profitable markets that yield high returns will draw firms. This results in many new entrants, which will effectively decrease profitability. Unless the entry of new firms can be blocked by incumbents, the profit rate will fall towards a competitive level." Among the factors creating barriers to entry are the intellectual property rights, capital requirements, brand equity, cost advantages, expected retaliation by incumbents, and government policy. 

Several other factors are said by Porter to increase the intensity of rivalry in an industry--and thereby lower profitability. The list includes the number of competitors, the rate of industry growth (the slower the growth the higher the rivarly),  intermittent industry overcapacity, exit barriers, diversity of competitors, informational complexity and asymmetry, and economies of scale.

Much of the discussion of late about healthcarere reform in the US concerns the relationship between barriers to entry and rivalry in the insurance industry. Many critics of the administration's plan prefer solutions that would force insurance companies to compete more agressively with one another. A key consideration for them are barriers to entry at the state-level.  For example, in an article entitled "Let Insurance Companies Compete Across the US", University of Chicago political scientist Charles Lipson, makes the case by first noting the presence of laws that prevent healthcare insurers from selling across state lines:

Right now, the U.S. does not have a national market for health insurance. It has 50 separate state markets. Erecting walls around each state means less competition and higher prices for consumers. There's not even one market for the Chicago area. If you live in South Holland or Calumet City, your insurance options could be completely different from your Indiana neighbors in Hammond or Merrillville. What sense does that make?

To help us understand the benefical effect that could arise from removing these laws, Lipson points to a very closely related industry where competition on price, differentiation, and even innovation are the norm--the market for auto-insurance:

The easiest way to see how insurance competition benefits consumers is to look at auto insurance. That's a huge, nationwide market and companies compete intensively for a share of it. Some stress their low prices, others customer service, whatever gives them an edge in the marketplace.Geico and Progressive have been especially aggressive in touting cost savings. State Farm and Allstate certainly compete on price, but they stress service after an accident. That's why Allstate says "you're in good hands," and State Farm says it will be there "like a good neighbor." Other companies, like SafeAuto, focus on drivers who want only minimum coverage to meet state license requirements. In short, auto insurance companies compete vigorously to provide what different consumers want, and they tell them so in national advertisements. Life insurance companies do the same thing. There are even companies that specialize in comparing policies for customers. Competition drives down excess profits and means better, cheaper options for consumers. Ever see an ad touting health insurance? They are rare because the markets are small and companies don't need to compete aggressively on price or service.

This last line is important. According to Lispon,  preventing health insurers from competing across state lines is needless barrier to entry, one that keeps the markets small and reduces the need or incentive for companies in the market to compete on either price or service.  This comports with Porter's model where both the number and the diversity of competitors in an industry increase the intensity of rivalry and by extension, bring many benefits for consumers.