Five Competitive Forces That Shape Strategy

Since 1922, The Harvard Business Review has been published as a monthly digest of research-based articles written specifically for high ranking business practitioners.

It is an esteemed publication and is revered by the icons of global business management and is highly regarded as being quite authoritative in scope by the leaders in the fields of academic research as well as upper level managers, executives, and management consultants of a wide array of major industries.

Its worldwide English-language circulation is 240,000, and there are 11 licensed editions of the magazine, including two Chinese-language editions, a German edition, a Brazilian (Portuguese-language) edition, and an English-language South Asia edition.

In its January 2008 Special Edition issue, which I had the pleasure of reading on a long flight recently, there is an article that speaks of how a business, any business, can increase profitability if they understand the role of competition in its strategic approach. The article, The Five Competitive Forces That Shape Strategy,is written by renowned Harvard business expert, Professor Michael E. Porter. Dr. Porter's credentials are unsurpassed and is widely recognized as a leading authority on competitive strategy and the competitiveness and economic development .

Real Estate, being a business industry, most assuredly can benefit from the understanding and implementation of the precepts Porter details in the article.

Porter's basis for the article is that a business that is aware of the "five forces" will be much better suited to understand the structure of its industry and can create a position for itself that is more profitable and less vulnerable to attack.

In looking at the Five Competitive Forces That Shape Strategy we can see how appropriate these strategies are from the perspective of a real estate professional.

In understanding his theory, it can be concluded that the National Association of Realtors may not be working in the best interest of the real estate industry. As the NAR is NOT the real estate industry, it is quite odd that a trade association or lobbying unit of an industry is defining the national policy and procedural strategy of the real estate business. In its ongoing attempt to fulfill its stated core purpose of helping its "members become more profitable and successful", NAR seems to believe that the best course of action for establishing its mission is to stifle or eliminate competition for its rank and file members.

This may prove to not be the best plan. The job of the business strategist is to understand and cope with competition, not seek to eliminate it.

Eliminating rivals is a risky strategy. A profit windfall from removing today's competitors often attracts new competitors and backlash from customers and suppliers. The competition in the real estate industry that is sparked by new arrivals like Zillow, Redfin, Trulia and the like can actually help profitability for all involved.

The strongest competitive force or forces determine the profitability of an industry and become the most important to strategy formulation. The most salient force, however, is not always obvious

Let's take a look at how the Five Competitive Forces That Shape Strategy can impact the real estate industry as we know it today.

Threat of Entry

Porter makes an excellent point relative to how competition can increase the success and profitability of an industry. If you have to become better at what you do to stave off being overtaken by competition, the consumer truly benefits. The diversification and implementation of technologies forces you to up your game. New entrants to an industry bring new capacity and a desire to gain market share that puts pressure on prices, costs, and the rate of investment necessary to compete. Particularly when new entrants are diversifying from other markets, they can leverage existing capabilities and cash flows to shake up competition, as Pepsi did when it entered the bottled water industry, Microsoft did when it began to offer internet browsers, and Apple did when it entered the music distribution business.

The Power of Suppliers

Renamed in our business to read the Power of Sellers, details how the entity that is in control of the "product" is not reliant on the industry to drive its revenue. This is very important when you realize in an up or down market, it is the Seller who has the sole power to set market prices and to set the level of inventory of a product.

The Power of Buyers

As can be expected, the Buyer is the antithesis of the Seller. There is no such thing as a low ball offer. No reason for anyone to think that. The Buyer is exerting their power in the transaction just as the Seller exerts theirs by setting the price. It's business people!! Buyers can capture more value by forcing down prices, demanding better quality or more service (thereby driving up costs), and generally playing industry participants off against one another, all at the expense of industry profitability. Buyers are powerful if they have negotiating leverage relative to industry participants, especially if they are price sensitive, using their clout primarily to pressure price reductions.

The Threat of Substitutes

When the threat of substitutes is high, industry profitability suffers. Substitute products or services limit an industry's profit potential by placing a ceiling on prices. If an industry does not distance itself from substitutes through product performance, marketing, or other means, it will suffer in terms of profitability, and often growth potential. It's not competition that hurts business but rather the perceived threat. If you find Redfin or any of a number of newcomers to the industry to be a threat then you are looking at things the wrong way. What you must realize is that the obsolescence and perceived antiquity of the current real estate industry business model has made the industry ripe for the invasion of substitution and of course, advancement. A substitute performs the same or a similar function as an industry's product by a different or better means.

Rivalry Among Existing Competitors

Rivalry is especially destructive to profitability if it gravitates solely to price because price competition transfers profits directly from an industry to its customers. If it were just a matter of offering a cheaper service or product then perhaps the Redfin's of the world would indeed be a problem for the existing real estate industry business model. However in reviewing what Redfin, Zillow and many new entrants to the business offer the consumer, there are many features, and amenities afforded a consumer that are valuable far in excess of just price.

Competition on dimensions other than price, on product features, support services, delivery time, or brand image, for instance, is less likely to erode profitability because it improves customer value. Rivalry can be positive sum, or actually increase the average profitability of an industry, when each competitor aims to serve the needs of different customer segments, with different mixes of price, products, services, features, or brand identities. Such competition can not only support higher average profitability but also expand the industry, as the needs of more customer groups are better met. Since the entry of new competitors or substitutes is not solely based upon price, then their entry should be applauded and heralded, not met with disquietude.

You are licensed by the state, you are an independent contractor under a broker, or you may be a broker. Why is the NAR running your business and telling you how to conduct your affairs? They are a lobbying organization whose interests may not necessarily mirror your own.

If the NAR does not have your business plan, should you be managing your affairs according to what they say?

I often get responses wherein agents across the Country want to debate substantiated fact with rhetoric opinion. This time, the facts may be hard to debate. They definitely can not be refuted.

The subject of this post, Dr. Porter's article the Five Competitive Forces That Shape Strategy, deserves much more study and attention than I can write here. I urge you to read his article in its entirety and try your best to comprehend and implement the precepts he describes to meet the challenge of today's real estate business model.

It may very well be the catalyst that allows you to turn from conventional wisdom and embrace the future of real estate.