This week’s podcast is on the well-known Five Forces framework by Michael Porter. I go through some of its limitations and where I think it works best.
You can listen to this podcast here or at iTunes, Google Podcasts and Himalaya.
Michael Porter’s five forces:
- Bargaining power of suppliers
- Bargaining power of buyers
- Threat of Substitutes
- Barriers to entry / threat of potential entrants
- Degree of existing competitive rivalry
- Role of complements?
My 4 problems with this are:
- It doesn’t work for dynamic and non-classical strategy terrains.
- It doesn’t work for platforms and ecosystems.
- It doesn’t work with SMILE marathon dimensions, particularly innovation.
- The addition of complements doesn’t really cover the emergence of a connected, digital world.
I also cited the 4 terrains from BCG:
Related podcasts and articles are:
From the Concept Library, concepts for this article are:
- 5 Forces
- 4 Terrains and Strategies (BCG): Predictable vs. Malleable
- SMILE Marathon
From the Company Library, companies for this article are:
- 37: Five Forces
Photo by Mahir Uysal on Unsplash
I write, speak and consult about how to win (and not lose) in digital strategy and transformation.
I am the founder of TechMoat Consulting, a boutique consulting firm that helps retailers, brands, and technology companies exploit digital change to grow faster, innovate better and build digital moats. Get in touch here.
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Welcome welcome everybody. My name is Jeff Towson and this is Tech Strategy and the topic for today four problems with Michael Porter’s five forces although technically I think it is now officially six forces because Compliments has been added. I’ll talk about that in a bit But this is gonna be a bit of theory today not too long This will be a shorter one because it’s you know first of the year and I just want to sort of touch on this very well-known idea, which I think people are pretty familiar with. If you’re not, I’ll go through it somewhat. But really, I want to focus on where it starts to break down. Knowing where a framework works is very important, very useful, especially a good one like this. But also knowing where it doesn’t work and where it gives you the wrong answer is just as important. So that’s kind of the approach I’m going to take on this. Now, for those of you who are subscribers, this is all going to go under Learning Goal 37 and the main ideas for today, just the things to remember, which will be in the show notes. Five forces, obviously. Talk about innovation and we’ll sort of talk about four terrains and strategies, which I spoke about in podcast 62, but I’m going to sort of repeat that and go into it because that is related. And for those of you who aren’t members, feel free to go over to jeffthousen.com. You can sign up there. There’s a free 30-day trial. Try it out. See what you think. and join the group, we’re having a lot of fun. Okay, let’s get into the content. Now, I wanna come at this whole subject from really an investor’s mindset and investor’s approach. And for me at least, the starting point for everything is checklists. I’m a huge believer in checklists. Every company I look at, every investment scenario I look at, I have very… detailed checklists I’ve developed over really 10 years and I go through them one by one and I don’t let myself skip them I I force myself to do it and that’s you know a couple reasons for that one you know, I I can’t keep all of it in my brain my thinking in my checklist, which is kind of like my It’s almost like my recipe book or it’s like my spell book, you know, it’s sort of the accumulation of knowledge over time that grows It’s far more detailed than I could ever keep in my head. That’s one reason. It’s a store of knowledge that grows and improves over time. And second is it hopefully prevents me from making mistakes. The same reason that pilots run checklists, right? Before they get in the plane, before they do, they always run their checklist. And I’m sure they’re very tempted to ignore that. And it just turns out it’s a really good mechanism is to have checklists. So when I think about sort of looking at companies, being investors, I really think about three assets I’m building over time. And the first asset is my checklist. I’m always editing them. I’m always adding other people’s thinking to them. Most of my checklist, 60% are just from great investors like Buffett and Gabelli and Klarman and all this. And I’ve reverse engineered their thinking. And I’m pretty common, basically copying their stuff. And then the rest is mine. So that’s kind of asset number one. I’m always building asset number two. Evaluation models, which I have a big stash of those, which I’m always updating and thinking about. And then asset number three is sort of my network. People I know, because a lot of the best information comes from that. And that tends to be sort of my three assets overall. Okay, but within that, checklists are very powerful. So I’m gonna talk about these things today. Five forces, innovation, smile marathon, the four terrains. These are all things that are in my checklist when I go through companies. I’m always asking myself these questions. So that’s kind of why I’m approaching it this way. Number two, frameworks. I’m a huge believer in frameworks. I’ve said this I don’t know how many times on this podcast. I’m a huge believer in sort of the Richard Feynman, the famous Nobel laureate physicist from Caltech. uh… you know his approach which is he has a famous quote that pretty much any physicists worth their salt can explain the exact same phenomenon with you know five or six different physics models the ideas you know we’re in the business of studying things that exist in the real world physical phenomena not unlike a scientist or a physicist they may study a volcano or a planet you know you’re studying a company these are economic societal business phenomenon, the same way scientists study physical phenomenon. And I try and have frameworks I can use to describe the same phenomenon five or six different ways. So I may well look at a company with, you know, I’ll take a five forces framework and then I’ll take a psychological framework and then I’ll take a consumer behavior framework. I might take a unit economics one. I might take a competitive dynamics one. I’ll come at it. really 10 to 20 different ways. And between all of those, I hopefully capture all the important aspects. So that’s kind of the idea with frameworks is to apply multiple models to small phenomenon that you can get your brain around. And within that, you wanna understand the models, and I’m gonna go through five forces today. But as I said, you have to understand when the model starts to give you the wrong answer. Because every model, I don’t care how good it is, it only applies within a certain set of parameters and assumptions. And when you move beyond that, you’ll get the wrong answer and it’s very easy to think you’re still getting the right answer. So the example of I’ve given at this before is I talked about the upper atmosphere problem that, you know, Newtonian physics works very well on the ground on the earth. Balls rolling down hills, billiard balls, springs, apples falling off trees, things like that. But once you move to the upper atmosphere, it gives you the wrong answer. Even those equations are amazing, right? The whole Newtonian physics thing is amazing. My favorite one is actually, this is another physics example. My favorite one is actually not that one. My favorite one is how they discovered, this is like, god, this is 140 years ago, this is how they discovered that the speed of light is a constant. The speed of sound, it increases if you have a, a siren and you’re standing still it will sound one way because the sound waves move at a certain speed but if you put that same siren on an ambulance going 50 miles an hour the sound waves move at a certain speed plus the fact that the car is moving at a certain miles and it sounds higher. So you know it goes faster when you do it. Well it turns out light’s not like that. If you shine a flashlight standing still and if you shine a flashlight. you know, on the top of a, standing on the top of a speeding train, it arrives at the distant location at the exact same moment. Turns out light is a constant. It doesn’t increase. It’s always the same speed. And this was discovered back by Michelson Morley, for those of you who are of the physics variety, a very famous physicist, and they basically tried to study the speed of light. perpendicular versus parallel to the Earth’s axis. So in theory, if the Earth is spinning on its axis and you shine a light sort of along the axis, and then you compare that to shining light sort of perpendicular to the axis, one should be faster than the other because the Earth is spinning. And that was what they expected to find, and they did their experiments, and it kept coming back with no change. And. That’s a great example of when you have a very good model that you think makes sense, and it doesn’t give you the answer you thought you were gonna get. And rather than accepting it, what happened was the physics community for decades assumed it was a mistake. They said, this has gotta be a mistake. It doesn’t make any sense. And they tried to, oh, we gotta fix the experiment. It was bad, we know. And they kept repeating the experiment and it kept getting the right, basically the same wrong answer. that they thought couldn’t be wrong or couldn’t be right, but it was. And that was because their model for how to think about light didn’t work anymore. It was breaking down. And that’s kind of the point here. Frameworks are very good within a set of parameters. At a certain point, they give you the wrong answer and people generally reject it, which is why it’s very important for people who do investment, because that’s what you’re looking for. You make your money, not when everyone gets the same answer. and believes the answer is right, you make your money when everyone else is wrong and you’re right. So you want these scenarios where things start to be wrong, but everyone thinks it’s right. That’s kind of an investor sweet spot. Anyways, and the end of that story, which I’m paraphrasing badly, is Einstein. And Einstein eventually came along and said something very obvious but crazy, which was, okay, if speed is distance divided by time. that’s the equation, and the speed is the same, but the light is appearing at the same distance, then we know we’re changing the distance, and the speed is the same, so therefore, the only answer must be that time is changing. Which if you look at it, velocity equals distance divided by time. If velocity’s constant and you change the distance, but you keep getting the light at the same location, then time must be changing. And that was his answer and it turns out it blew everybody’s mind. And it was right, it turns out time changes when you speed up. And that was kind of crazy, but that’s why he’s, you know, Einstein. Anyways, that’s a bit of a tangent, but it’s kind of a fun story, I think. You’ve heard me sort of rail along this lines quite a bit, like Metcalfe’s law. Usually what happens is someone comes up with a rule, a framework, in science you would call it a law. Sometimes in business they try and call it a law like Metcalfe’s law, which is a mistake. There’s no laws in business. And then you sort of start getting the wrong answer or you realize your model doesn’t work in certain scenarios and they try and extend the law. They try and tack something onto the side or they try and say, well, here’s an exception. And that’s usually what a mistake looks like. And so Metcalfe’s law, this idea that the value of a network goes up to the square of the number of nodes. and they called it a law, which is a mistake. That thing barely works anywhere. I mean, it has more exceptions to when it gives you the right answer than situations where it does give you the right answer. So the exceptions sort of compound and add up, that’s usually the sign of a law breaking down. And I think that’s what we’re seeing with Michael Porter’s Five Forces. I think he has tacked on from five forces to six forces, this idea of compliments. I think this is trying to extend a very good business idea beyond the scenarios where it actually works. And that’s the point of today. Understand the frameworks, build out your checklist, but for each framework you use, understand where it doesn’t work anymore. It’s as important as understanding where it does work. Okay, so here’s the basics of Michael Porter for those of you who aren’t familiar with this. And even if you are, there are subtleties here that people tend not to talk about very much. I’m going to point those out. I do these all the time. I look at this for companies all the time. And the idea is we’re gonna look at the industry structure. We have major retailers and we have just one or two key distributors. And you’re generally looking at how many people are you dealing with as a company? How many buyers do you have? How strong are they? That would be the power of buyers. How many suppliers do you use? How much power do they have? And generally, if you’re in the part of an industry… where let’s say you’re a local restaurant and you’ve got thousands of competitors and thousands of suppliers, that’s generally considered a structurally unattractive space. And that’s what Michael Porter’s Five Forces is about. It’s about structural, that’s sort of the structures of industries and the way an industry ends up appearing over the long term is a balance of these five forces. So you have a force that comes from the buyers, you have one that’s sort of competitive rivalry and so on. The net result of those forces over time gives you a somewhat stable industry structure. So this is a longer term framework. It doesn’t help you in terms of changes in two to three months or one to a few years, but it can give you a good sort of a longer term structure. And his original five, the first one would be, you know, the bargaining power of suppliers. So you’re dealing with suppliers, you’re a company, you’re buying stuff. You’re a restaurant, you’re buying tables, you’re buying food, I don’t know. If you’re a bank, you’re getting capital. If you’re a consulting firm, well, I don’t really have a lot of suppliers for consulting firms. I guess they probably buy some information and stuff, not very much. But, you know, how much do you have to rely? Are you dealing with two suppliers or are you dealing with 20? You know, are there lots of options or is there just one? and that’s gonna influence how much you can buy, what the terms are gonna be, are you gonna get paid in one week, are you gonna pay them in one week, or can you delay your payments for six months, which helps your working capital. And generally speaking, an attractive scenario where you have a lot of power related to your suppliers is one when there’s a ton of suppliers and their commodities. So there’s two factors there. because then I can sort of swap around. The scenario where the buyers, I’m sorry, the suppliers are gonna have a lot of power over you is usually if there’s a few suppliers and if they, and or if they are highly differentiated. Those are kind of the words to think about. Few versus many, differentiated versus commodity. And that kind of tells you how much leverage you’re gonna have when you negotiate price, delivery, payment terms, all of that. Walmart is kind of the king of this scenario in terms of being powerful against suppliers. To a large extent, that is their business. They squeeze suppliers to an unbelievable degree. They get low, low prices. That’s why Walmart’s whole strategy is everyday low prices. That’s why they demand certain payment terms. That’s why they literally, I think for a lot of their goods, they demand that the inventory stays on the books. of the suppliers and the suppliers I think have to stock their shelves or at least their warehouses. I mean they really squeeze those folks mercilessly. So you can think about that, how many suppliers, how differentiated, how much are you buying, how big of a buyer are you? So I just gave you the scenario on how big are they. Well, how big are you as a buyer of these suppliers? Walmart is a very, very big buyer. Are you buying in bulk? Other factors you might think about, are there switching costs? If you’re a business, you’re trying to get your customers. you’re trying to build switching costs, right? That’s what you really want. You want them to sign up and be locked in as, you know, you’re their accountant, it’s very hard for them to switch. Well, the same thing works with your suppliers. They’re trying to lock you in with switching costs. So that’s a thing that’s gonna sort of reduce your power if they have big switching costs. And then there’s always this question of whether the supplier can integrate vertically forward. Could the supplier jump into your business? For example, Amazon would be a big customer of FedEx. So FedEx is the supplier. They’re supplying delivery services to Amazon. One of the risks there is Amazon could vertically integrate into express delivery, which it looks like they may be doing. Now, that’s a big move, but even if you’re not doing it, the threat that you can do it changes their ability to squeeze you. because they know, look, you pushed me too hard, I’m gonna jump into your business. Well, that works both ways. You can have leverage over them. I can vertically integrate into you upstream, and you can vertically maybe integrate into me downstream. Now, FedEx can’t really do that, but a lot of businesses can. So that’s just some factors to think about. There’s a lot in there. I generally ask myself all of these questions when I’m looking at a company, and I force myself to go through them specifically. Few versus many, differentiated versus commodity. How much are you buying? Is there ability to build switching costs? Can you vertically integrate? Those are generally my questions when I’m looking at this. Now that’s sort of one force, bargaining power of suppliers over a company. The flip side to that is the bargaining power of the buyers over the company or vice versa, okay. You know, you may as a company, you’re buying from your suppliers, but your customers are buying from you. So it’s basically the same questions when you look the other way. I’m selling to customers, how much power do they have over me? Can I build switching costs into them? You know, are there a lot of companies like me selling? I mean, you basically do the same type of questions on both sides. People I buy from, people I sell to. And that gets you sort of the first two forces. Now the one I really like. is substitutes. For those of you who are subscribers, I’ve sent you kind of a lot of writing this week. One on how Warren Buffett bought a mapping company in 1958 and he made like 50% on his investment over two years. This is back when he was a 26 year old dude living in Omaha. And why he bought this mapping company and the biggest factor, one of the biggest factors of why this mapping company he was buying, which was basically in terminal decline, he bought a dying company, was a new substitute had emerged on the horizon in terms of technology that basically made their core product non-competitive. I really like substitutes as an idea. I think about this all the time. It’s one of my major questions when I look at companies is, is there a low-cost substitute? And God forbid, is there a free… substitute. And that can really change the dynamics of an industry. So let’s say if you’re you know selling cola, okay fine. What happens if Walmart which is selling your cola, let’s say your Coca-Cola, what if Walmart decides to offer private label soda, private label juice, private label water? Now one, those are all substitutes because they’re not exactly cola and two, they’re being done by this company which can really hurt your ability to price and sell. Substitutes tend to be a big deal in technology. One of the reasons I don’t particularly like media very much is because you’re always fighting for people’s attention and there’s just an endless list of substitutes for people’s attention. They can watch videos, they can play video games, they can read a book, they can just take a walk in the park. It really does impact that type of industry in a way that things like medical, which I obviously come from that background, there are very few substitutes in medicine. If you’re sick, you’re sick and you go to the doctor and that’s it. There are no substitutes. Well, I’ll go to this other, you know, no, no, no. I mean, it’s a no substitute business in many regards. Media and entertainment is the act, you know, the opposite. There’s an endless sea of substitutes. and it just keeps growing and growing, which is why I think that space is so difficult. So, you know, substitute would be a product or service that’s not considered a direct competitor, but can fulfill the equivalent role for a customer. So instead of going to Starbucks, you can buy a soda somewhere. Instead of buying a soda, you can buy a water. So I’m always sort of focused on what are the substitutes, and within that, The relative price. I think the relative price is a huge deal. I think this is a big problem for Uber, which I’ve talked about a lot, is Uber has low price substitutes. You know, I could take the Uber, or I’ll just take the BTS. That really does sort of impact an industry. So, threat of substitutes, that’s force number three. Number four, threat of potential entrance. And by the way, I’ve listed all these in the show notes if you are writing these down. Now this one I actually really like as well. Who can move into your business? And you have to sort of think, okay, what is the barrier to jump in? Like, you know, I’ve often talked about competitive dynamics, competitive advantage in two buckets. One would be the ongoing forces, the ongoing advantages like lower cost structure. And the other would be how difficult is it to jump in? And you can see both or you can see one or the other in a business. Ideally, you want both. And that really tracks to two of Porter’s Five Forces. One of them is this idea of a threat of potential entrance. How difficult is it for a well-funded, well-run company to jump into your business? How attractive is it to them? Is it profitable? Is it growing? Is it cool? People like to get into cool businesses. Why everyone jumps into media all the time and people write books like crazy. What is the height of that entry barrier you have to sort of surpass? And the height of the barrier, the general things I look at are cost, difficulty, and timing. Those are my three standard questions. Cost, difficulty, and timing. Is it a matter of I want to get into the hospital business? The barrier to entry is mostly a cost, which is I have to spend a ton of money to build the hospital on day one. I talked about this in the email I just sent out today about Buffett. If you’re going to build a mapping company, there’s actually a big upfront cost where you have to map a whole city before you can sell any maps at all. So there’s a big upfront cost. That’s just a pure cost. Now there’s other types like difficulty, cost difficulty timing. a new TV franchise. I want to compete with the Avengers. Well it’s not really just about making, you know, spending money. It’s not a pure cost. It actually turns out it’s quite difficult to create a quality franchise that people like. That’s actually a very sort of difficult skill, talent, creativity, all of that. So it’s not about the money. It’s about the difficulty. I mean, for literally 60 years, 70 years, people have been trying to be the next Disney. Remember when Sony, back in the 1980s, you know, they wanted to be the next Disney. And they bought a studio in Hollywood and all of that. And it turns out, building a Disney is very, very difficult. And it’s not the money. It’s, you know, it’s how do you make these animated kids that drive little kids crazy? And, you know, it’s a very weird skill. And the other studios have been trying to do this forever. Like all the Hollywood studios have wanted to be the animated children’s family company like Disney and they can’t pull it off. It’s really tough. A couple years ago there was this big argument that Chinese companies were gonna be the next Disney and a bunch of real estate companies were saying this and none of them pulled it off. It turns out it’s hard. So the entry barrier, you can think about cost, you can think about difficulty. Science is like, if you’re gonna make a new pharmaceutical, it’s not about… you know, just spending the money on research, it’s very, very difficult. So cost, difficulty, and then the third one is timing. And I actually think this is the coolest one. A lot of things when you wanna jump into a business, if you wanna be Coca-Cola, the biggest advantage Coca-Cola has is their share of consumer mind, that they are very present in people’s brains. And there’s no way to get that quickly. They’re in people’s brains everywhere because they’ve been advertising to people for 100 years. So there’s no check I can write this year to replicate that. It’s a matter of time. It would take me a decade of consistent advertising for that sort of legacy brand to build up in the world. And there’s a lot of these businesses that are like that where it doesn’t matter how hard you try and how much money you spend. it just takes a certain amount of time to replicate what certain companies have and there’s no way around it. I really like time-based advantages like this. I think they’re really sort of formidable barriers. Anyways, other stuff you could consider within sort of the barrier to entry is government regulations that tends to make things more difficult and expensive. Do you need specific access to suppliers or distributors? Can you get your soda on the shelves of Walmart? the big startup costs I mentioned, brand loyalty. You have to think about the threat of retaliation by current competitors. If you’re trying to jump into certain businesses, like Meituan did this a couple years ago. Meituan said they want to get into ride sharing, and they launched their service in Shanghai, which I think was a mistake. Because the one thing, your big problem is if you want to jump into ride sharing, it’s a two-sided platform. but you had a major incumbent, which was Didi. And if you had done sort of ride sharing in fourth tier cities, just helping with peripheral markets, Didi might have ignored it, or might not have cared too much. If you do a major initiative in ride sharing in Shanghai, you are inviting a massive response from Didi, because that’s the core of their business. And they will fight that forever with everything they have. I mean, they live and die in ride sharing in Beijing and Shanghai. So by opening in that city, they invited this massive response. And that initiative did all right for a while, six months, and it’s pretty much disappeared. So anyways, usually people make a decision on, you know, is there a barrier to entry based on benefit versus barrier? How attractive is this market versus what’s the difficulty to get in? And you know, they kind of decide, ah, it’s worth it. It’s not worth it. So that’s number four, threat of potential entrants, barrier to entry. Now the fifth one is degree of existing rivalry. This is the other, sort of the other side of the coin of competition. How hard is it to get into a business? And then when you get into the business, are there structural advantages by certain players? So yes, I can break into Coca-Cola’s business quite easily, but once I get in, I can’t beat them because they have cost and marketing and other advantages. Other businesses, it turns out you could open a hospital in a mountain town and it’s actually not that hard to win. It’s hard to get over that first hurdle. Because it’s a small town with a small market, there’s a lot of upfront costs, you probably need regulatory approval. So in that case, you have the upfront cost, but you don’t have the ongoing structural problems. And then in some businesses, you have both. Telecommunications network. A lot of two-sided platforms. You have to break in, which is difficult, and then the incumbent players have a lot of advantages over you. So that’s sort of the second part, is degree of existing competitive rivalry. And this one, you really have to look company by company. This is very company specific. You look at one company, how strong are they versus another company? And you have to go company by company and see where you fit relative to bigger players and smaller players. So you look at the number and the relative size of competitors, is this industry an oligopoly with three to four players? That can be all right. Is it tons of tiny little companies? Is it giants and dwarves with two or three major companies and then 50 small ones? I mean, what’s the scenario? Now, generally speaking, oligopolies are better. Having three competitors, five competitors, 10 competitors is better than having 200 competitors. Like go into any typical shopping mall and look at how many companies are in the food court, competing for your $4. That’s a tough business. And then look at how many companies provide mobile service in your country, and it’ll be like three. So you wanna think about oligopoly. However, the big caveat on this is, what is management behavior within the oligopoly? You can have oligopolies where everyone gets along, like Coke and Pepsi. and everyone makes money. They compete but they don’t compete that hard. And then you have other oligopolies where they just bash each other forever. And even though you should be making money, you don’t make money. So you got to think of how competitive they are. In China, they tend to be fiercely competitive. Other areas, they tend to sort of get along and they compete a bit, but not that tough. So you want to think about that. Now one aspect within, so there’s sort of two sub aspects in this. One is you have to think about management behavior and then second to that, you want to think about exit barriers. Everyone always talks about entry barriers. How hard is it to get into this business? How hard is it to leave the business? Because that will change how competitive they are. If you’re in a business where you have made a massive amount of fixed investments, like Blockbuster opening all those stores, Walmart, Carrefour, opening all those stores, electricity plants, utilities, it is very, very difficult to exit that business. So if someone comes in, you’re gonna keep fighting basically forever. Where in other businesses, if it gets too difficult, people start to leave and that makes the business better. Or if you are fighting someone, they will sort of give up after a while and go home or go on to something else. But if there’s a high exit barrier, they will tend to fight forever, and it can be a really difficult business. It can really intensify the competitive rivalry if there’s a high exit barrier. So it can be fixed capital costs. It can be emotional attachment. Sometimes people just love being in the business. Sometimes they’ve been in it forever. We’ve been in this business for 100 years. A great-great-grandfather started it, and they will just stay forever. Forbes was kind of like this. Forbes Magazine, which is pretty much gone as a company now. You know, that was a 170 year old company founded in the US, very famous business news publication, Malcolm Forbes. They had, you know, big mansions and yachts and things like that. They owned an island at some point. And, you know, clearly by like 1995, now they handed off ownership to the latest son who was Steve Forbes. And… Clearly in 1995 it was a bad business. Being magazines and such and a digital age was going to get disrupted. The best thing they could have done back 1990 to 1995 is just do anything else. Take all that cash you’re making and buy real estate. Do anything else. And nope, they just kept taking all the cash they were making because it was still a profitable business. They kept putting it back into media. and the ship went all the way down and they just spent all that. If they just put it into stocks or something, you know, they’d be sitting on this massive foundation. But nope, they were too emotionally attached to this business, so they kind of went down with the ship. Okay, so that’s one, two, three, four, five. Bargaining power of suppliers, bargaining power of buyers, threat of substitutes, barriers to entry, threat of potential entrants. degree of existing rivalry, competitive rivalry. That’s one through five. That’s standard Michael Porter. Competitive advantage book, competitive strategy. Kind of a must read in the business world. But in the last couple years, the sixth force has been the role of compliments. And I mean, this is, I think this is a reaction to the digital thing, that when you look at the iPhone, you can’t look at the iPhone as just a product. without looking at the power and the importance of all the compliments, digital compliments, which is basically everything in the App Store. All those hundreds of thousands, millions of functions you can add, that adds so much value to the product, but it doesn’t get captured within these five forces. This is made by other companies. So when they talk about roll of compliments, they’re really talking about platforms. That’s really what we’re doing, innovation platforms, things like that. Now traditionally, and I went through this in the discussion on digital economics, compliments have been around forever, right? Hot dog buns are compliments to hot dogs. So is mustard. You don’t buy just hot dogs. You buy hot dogs, hot dog buns, and mustard. They’re all compliments to each other. And you buy them together. But in a physical world, those things were sold separately by different companies. And there weren’t that many compliments to things. Well, in a digital world, everything is becoming interconnected. I mean, you can add hundreds of thousands of compliments to a smartphone. There are not hundreds of thousands of compliments to buying hot dogs. There’s a couple. So as the world gets more digital and more connected, platforms and this idea of compliments, digital compliments has really kind of exploded as a powerful force. And, you know, Traditionally, the way compliments would be thought of as these are products that enhance the usefulness or desirability of a good. Gas makes cars better. Frequently, easily available gas stations increases the value of your car. New electrical appliances increases the value of your power bill. Compliments, compliments, compliments. That really does change things. And I think he’s added this, I’m guessing here, I think he’s added this because his approach is really about pipelines, products and services. It doesn’t really work well with platforms and the idea that we are living in a connected world of digital goods or physical goods merged with software and it’s just different. Anyways, that’s his sort of thing, role of compliments. I basically don’t think it works. This is like Metcalfe’s law. I think this is like the speed of light example. I think this is a well established theory not working in certain scenarios. And it’s better just to accept it doesn’t work in this case. This stuff doesn’t work for platforms very well. And I’ll give you four places I think this doesn’t work. Rather than trying to stretch this very good model to something that just doesn’t work. Okay. That said, make sure you have Porter’s Five Forces in your sort of checklist, it’s an important one, but make sure you’re also looking at when it doesn’t work. Now let me tell you, four places I think it doesn’t really work. And sorry so much for this being a short podcast. I’ve been kind of going on and on here in theory. So it looks like it’s not gonna be a short one. All right, problem number one, where does Five Forces I think not work very well? Number one, I don’t think it works well for dynamic and non-strategic terrains. Now, last week in podcast 62, I gave you a framework from BCG, which basically outlined four terrains. You know, what landscape are you on as a business? And this is also one in my checklist. I use this all the time. I think it’s a good framework. I put the link below, and also I put the two by two matrix in the… the show notes. But basically, look, you have to understand what ground you’re standing on, and then that will tell you what the appropriate strategy is. And the two dimensions they talk about, this is Martin Reeves’ BCG, was malleable, I’m sorry, malleable versus non-malleable, and predictable versus unpredictable. So that gets you, if you put that in a two by two matrix, you can see it in the notes, you get four quadrants and four types of terrain. some terrains they’re very malleable which means as a company you can sort of shape and change the industry. People can do this in technology. Elon Musk is changing the auto industry like crazy right now. Other industries you really can’t change much. If you’re in the oil and gas industry you are pretty much at the mercy of the world like whatever the oil prices are doing, whatever the weather is. If you’re in the airline business you really can’t change that. You know if there’s weather. you just have to deal with it. You are sort of at the mercy of the external world. So malleable versus non-malleable. Coke, KFC, they can’t really change the world too much, but people like Netflix, Elon Musk, and I would even say FedEx, they can change things. Ant Financial is changing things. Spotify is changing how people listen to music. Entertainment and media tends to be very shapeable, malleable. That would be one dimension. The other dimension would be predictable versus non-predictable. So certain businesses like soda, Coca-Cola, KFC, very predictable. We know how many people are going to be on the planet. We know human beings have to drink a certain amount of water every three days or they die. We can predict total liquid consumption and we can sort of guess how much of that might be coke. Pretty predictable. Unpredictable things are like fashion. We don’t know what fashions are going to be popular in two years. Very, very hard to predict. Mobile payment, various payment solutions are all over the map. Very unpredictable. So out of those two dimensions, you get a two by two matrix with four quadrants, four types of investment or four types of business terrain. And the phrases that BCG use are classical, adaptive, visionary and shaping. So classical is classical strategy. And this is, I think, where Michael Porter really works well. This is Warren Buffett land. Classical would be the lower left quadrant. This is very predictable, non-malleable businesses. That’s soda and candy bars. Snickers cannot change how people eat. They can change a little, very little things they can change about the world. And it’s a very predictable business. You know, Buffett tends to buy things in this quadrant because he’s a long-term investor trying to capture the wealth generation of certain companies over five to ten years. So he needs predictable industries. And I think this is where Michael Porter’s thing really does work well. I think it’s great for predictable industry structures don’t change. And BCG describes this as sort of the realm of classical strategy, which is, I think, Porter. Okay, if we move to the lower right, we get unpredictable terrain and not malleable. So this is kind of when you’re on the terrain and you’re just sort of reacting to it and you can’t change much. This is fashion. Like fashion, they just have to figure out what people are going to buy every month. They can’t change it very much. They’re always just trying to adapt as fast as they can to whatever the world wants. And they don’t have that much ability to shape anything. Zara, H&M, you know, they’re always changing their inventory. Fast fashion is an adaptive strategy. So that would be bucket number two, adaptive. Upper right quadrant where the terrain is malleable, but unpredictable. This is sort of the land of internet companies. Internet companies, especially in media, entertainment, Spotify, TikTok, things like that, they are very capable in shaping behavior and changing how people. behave and how industries function. I mean Netflix really did change how video rentals happen in this world. They shaped that industry. But it’s a pretty unpredictable world because people always change how they consume entertainment. So you’re kind of at the mercy of a rapidly changing world. TikTok is kind of doing this right now. So that sort of category number three is shaping and then number four is visionary. This is Elon Musk land. You are shaping the terrain. and you can actually see the longer term outcome. That’s why it’s a visionary. You know, he knows what cars are probably gonna look like in 10 years. He kind of knows what his plan to Mars is gonna look like. So it’s malleable, but it’s actually not that unpredictable. So those are the four quadrants. I basically think to get to the point here, I think what Porter’s Five Forces work really well is classic, which is non-malleable, very predictable. and maybe adaptive in some types of adaptive like the terrain is like if you’re Zara and H&M it’s a pretty pretty it is a pretty sort of static field you have to adapt all the time that is what you have to do as an activity you’re always adapting to what people want what they want but within that you can kind of you know figure it out but I think when you move up to shaping or when you move up to visionary. very very hard to use Porter’s situation effectively and I think a lot of those categories are digital and that gets you into compliments, it gets you into platform strategy and as I’ll talk about I don’t think that works terribly well. Another way to explain all of this is The way Porter works, it’s a snapshot in time. Here’s how the competitive landscape looks today. Here’s you versus your buyers versus your rivals versus your new entrants. But it doesn’t explain how you got there and the process that led to this and what it’s gonna look like tomorrow. It’s a sort of frozen moment in time. So this doesn’t work terribly well in industries that change all the time, that are malleable, that are always moving, that are dynamic. So that’s I think part of the problem. This is really a snapshot strategy framework, as opposed to one where you may be looking at core competencies that you build over five years. Okay, as problem number one, I don’t think it works for sort of non-classical strategy terrains, and I don’t think it works for dynamic businesses. Another way to think about this is advantages in scale versus advantages in speed. In certain businesses like Coke and Snickers and whatever, a lot of the advantages come from scale. That you’re bigger, you have greater reach, you have economies of scale, you get learning effects, maybe let’s say your Model T cars or something like that. You’re able to expend a lot of money. There’s a lot of advantages to being big in classically stable industries. But in other industries, your biggest advantage is probably not scale, it’s probably speed. that you are just faster on your feet. And you see a lot of companies really struggling with this. How do we get the advantages of scale and speed at the same time? So a company like Google, they have all this massive scale. They have tons of money, tons of tech, all those advantages of scale. But they also try and do things with very small teams to get the advantages of speed and innovation and creativity and ownership. And that’s a real problem is how do you… capture both of those and can you? Snickers is not a really fast organization. Microsoft and Apple were faster on their feet when they were a handful of people in garages versus IBM, the giant of the age. Okay, IBM had scale, but Steve Jobs had speed and he outran them. So you have to kind of think about those. I think that’s another way of talking about sort of dynamic versus more stable static industries. Okay, problem number two. I don’t think the Five Forces framework, as I’ve said, works with platforms and ecosystems. If you try and map out Five Forces, the whole point of a platform is you’re helping, I mean, as I’ve kind of said from day one in this class, the difference between a pipeline business and a platform business model is you have more than one user group. So you’re always trying to work between merchants and buyers and sellers and… people dating and people looking for dates. You’re always working on those interactions. That’s the point of a platform. Well, that doesn’t really fit into this framework terribly well. I do use it sometimes. And what I end up doing is I end up mapping out the five forces for each user group separately. So I’ll do the five forces for the merchants on Lazada, and then I’ll do the five forces for the buyers on Lazada. And okay, I do do that, but Yeah, it doesn’t really work very well, and that’s platforms. If you move to the more robust, complicated idea of ecosystems, which I’ve said, platforms are a simplified business model, an ecosystem or a network-based business model. They’re a simplified ecosystem. That’s what they are. Ecosystems themselves can be very complicated and robust. Basically, you’ve got lots of parties involved in something. with some degree of collaboration or at least mutual dependence. Everyone in the semiconductor industry works together in some form. They all use the same standards, they use the IP, they coordinate all this because making semiconductors is beyond the ability of any one company. So you get these sort of very complicated ecosystems with lots of parties. You know, the Porter thing, it doesn’t work very well for platforms and it doesn’t work for ecosystems at all. And unfortunately, the world is moving more and more towards an interconnected ecosystem with lots of complements and lots of platforms and, you know, that seems to be what the future is going to look like. So you can see when he tags on the role of complements as a six force, it’s kind of a crude attempt to stretch from the world this framework was developed for, which was in the 1970s and 1980s. to a more digital age. Yeah, I don’t think it works. Okay. Problem number three, two more. I don’t think it works for my smile marathon. You know, this idea that you have to compete, this was the Elon Musk versus Warren Buffett question. Warren Buffett’s all about competitive advantage, structural advantages, Elon Musk’s all about, hey, that’s nonsense, you can’t get structural advantages in this world, the only advantage you can have is how fast you innovate. Right, and I’ve broken. that into two levels on my strategy pyramid. There’s the competitive advantage, which is dark green, and then below that there’s the light green, which is the smile marathon. That’s really, you could, you could, I could relabel those, the Warren Buffett level versus the Elon Musk level. That you have to compete on both of those levels. You have to try and build competitive advantages, structural advantages, which is kind of Warren Buffett, Michael Porter as you can. But you also have to recognize, you just have to run fast along. what I’ve described as one or two of five dimensions. Scale, machine learning, innovation, rate of learning, or ecosystem. I don’t think this really applies to that very well. The interesting thing is, well, I think it’s interesting, these two levels tend to interact with each other. On my Smile Marathon, the S stands for scale, scope, efficiency, and effectiveness. Okay, that means one of the things you’re trying to do faster than your competitor as a local sushi restaurant is to get scale and speed. Right? Well, okay, that’s your operational dimension you have to come in. At a certain point if you get big enough, if you get enough scale, it becomes a competitive advantage. So if you pull far enough away from others, you can, you know, these smile marathon dimensions can become competitive advantages. I think innovation at a certain point becomes harder and harder for other companies to copy if you’re really good at it. So these things do sort of interrelate. And it’s worth pointing out that like, you know, innovation is an interesting question. I’ve put it as one of my five dimensions under the Smile Marathon, but it’s a massive topic. And one of the things I do think about with innovation a lot is how much innovation is increasingly about linkages. in an ecosystem. The days of I’ve got an R&D department, and here’s the line item on our income statement about how much we’re spending. And that’s how we do innovation in telecommunications. Those days are fading fast. Now it’s about how connected are the people within your organization to other people doing R&D around the world in your industries. It’s innovation appears to be more and more proportional to linkages. within ecosystems. And that’s where you can, I mean, forget the idea of a lone inventor. I mean, that idea is dead. You know, when you can link to others within an ecosystem, you get so many more resources, you get so many more superior products. And this is what ecosystems are really, really good at. And why they’re such a good response to a major tech disruption is they are incredibly good at innovation. They’re not terribly efficient, but they’re very good at innovation. when you bring multiple parties together around, we’ve gotta launch the iPhone. That’s like the Android Open Handset Alliance. We gotta bring everyone together to try and launch this new thing called the iPhone. And we need everybody involved. We need the chip makers, we need the people who make the screens, we need the people who make the apps, we need the software. You know, you have to sort of orchestrate an ecosystem to do these large innovation step changes. So, I mean. There is this idea that innovation is really about linkages between companies and people. Combinatorial innovation, I’ve talked about this before. You could view it as linkages to your customers. How much do you know about what they want every day? Linkages to an external network of firms. Complementers, suppliers, competitors. This list I’m giving you is not mine. This is Melissa Schilling over at NYU. Technology clusters. You know, is it a big surprise that these companies are all in certain geographic locations, so there’s lots of connections between people and companies? New York City and sort of finance Silicon Valley and tech, Shenzhen, Beijing, Hollywood, you know, sort of proximity to knowledge. Now that appears to be a big deal. So anyways, I think about that more and more about how innovation is no longer a firm activity, it’s an ecosystem activity. Okay, that’s number three, which is that I don’t think the sort of Porter Five Four’s really addresses my smile marathon dimension at all. And number four, the last one, is sticking, all of these topics I’ve mentioned, platforms, ecosystems, innovation, multiple dimensions of competition, you don’t really capture much of that by just saying compliments. I mean. Compliments, I don’t even talk about compliments very much anymore. I think it’s, to describe the iPhone as a product with a bunch of compliments, kind of misses 90% of what’s going on. It’s the platform. You know, there’s so much better thinking than, you know, compliments is kind of an old economic term that doesn’t really capture much of this sort of digital connected age very much. I don’t usually use it very much. So I think even if you did want to stretch his five forces to sort of encompass some of this, I don’t think… saying compliments would be the way to do it. Okay, so that’s kind of my four points for today. Four problems, four limitations. Five forces doesn’t work for sort of non-classical strategic terrains and for very dynamic industries, number one. Number two, it doesn’t work for platforms and ecosystems too much. Number three, it doesn’t work with my sort of smile marathon, the Elon Musk approach to competition. And number four, compliments is not really the right way to think about any of these things. So I don’t even put that in my five. I still keep it as five forces. And that is it. I’m sorry that turned into kind of a lot of theory today. For those of you who are subscribers, your main takeaways for today, five forces, innovation, and then my four terrains and strategies, which is the BCG summary. And all of those things are listed in the show notes. And this all goes under learning goal number 37. And that is it for me. I am still here in Bangkok. I ended up canceling my planned trip out of town. I was gonna do a road trip, which I mentioned last week. And then the COVID thing started to flare up here in Thailand and I figured I better sit tight for a couple days and see what’s what. And it looks like things are closing down a little bit more this week, so. Oh well. What I did do is I ended up playing Ghosts of Tsushima. I don’t know, for those of you who like PS4 and this stuff, man, that is the greatest. video game I’ve ever seen. It is such a stunning video game in terms of the visual. It’s artistic. It’s the only video game, for those of you who aren’t familiar, this is an open world where you’re a Japanese samurai and you go across the island of Tsushima and you fight Mongols and it’s absolutely beautiful. It’s the only video game I’ve ever played where you just stop playing the game and you just look around at the scenery because it’s so pretty. I mean it’s very artistically stunning as a game. And so I spent a ridiculous amount of time playing that. I’m getting real good at decapitating people and all those, it’s really violent by the way, but it’s pretty fun. Anyways, so much for my road trip, but I did achieve a lot of skills in Ghost of Tsushima, so I feel pretty good about that. Any other suggestions for games, please let me know. Last time I asked this question. Someone recommended The Last of Us, which I’ve started a little bit. That was pretty awesome. Ghost of Tsushima, amazing. I still like sort of Batman. I’ve been playing that one a lot. But yeah, any more suggestions, please let me know. I’m having a good old time. Otherwise, I hope everyone is doing well. I hope you’re staying safe, having a good week, having a good start to the new year, and I will talk to you next week. Bye-bye.