The Criticisms of the Porters 5 Forces Model - Term Paper Example

 “The Porter’s 5 forces model is totally inadequate for attempting international environmental analysis as it totally ignores important aspects like culture & history. Above all, it is based on the Marshallian premise of constant returns to scale- if this assumption were to be changed to increasing returns to scale; the viability of the model falls through.” Introduction: The model created by Michael Porter, the 5 forces analysis to understand industry structure, and thereby to understand how competition is shaped, by has been one of the most widely used management tool in strategy planning. Porter described these five forces as:- Rivalry among existing players Bargaining Power of Suppliers Bargaining power of Buyers Threat of new entrants Threat of substitutes His model, that explains how competition is shaped through the action of five forces, gave insight to industries and business on how to devise a strategy that will enable a business to get a more than industry average return on investment. This model provides an analytical framework for business to better understand the micro-environment in which it operates by understanding the forces that influence the way in which firms compete. The model has been criticized for being deficient and ineffective in analyzing competitiveness under different conditions. One it is said that it fails to take into account historical and cultural factors. Second it is also said that it fails to account for industries, the new knowledge based ones, where returns are not as defined by classical economics, namely constant rate of returns, but increasing rate of returns. There are also other views on questioning the relevance of this analysis in developing and emerging economies, where factors like role of government can render the model unsuitable for predictions on industry behavior. This essay analysis the criticisms raised and try to present a view on how relevant these criticisms are and relevance of this model in international environmental analysis. Five Forces and Increasing rate of return: Constant rate of returns concept is applicable to business as defined in the classical economics theory. Here the resources (raw material, land, labour) available to the business to exploit are finite and the market, that is the consumers and demand, is also finite. When there is a gap between the two, there will be scope for business industry to step in and increase their profit. But this will being in other players and because of the finiteness of resources and demand, there will be, at some point of time, stability and equilibrium achieved. Indeed in case of perfect competition which would arise if all players were equally efficient in accessing, exploiting and utilizing the opportunities and resources, profits should disappear. But in reality this will be otherwise, and over a period of time the industry will operate in equilibrium with its profitability defined by the influence of factors of five forces by Porter. This is the reality even today, what Arthur (1996) describes as the processing and bulk industry. These are industries characterized by tangible, physical inputs and outputs. According to Arthur (1983), there is the other new emerging business and industries with modern complex technologies, which often display increasing returns. Here when the product or usage of a product is adopted, a multiplier effect is generated through the experience of usage. Due to unpredictable and even insignificant historical event it will grow at an increasing rate and ultimately corner the market. This may happen despite the fact that it being an inferior product or technology compared to an existing one at that point of time. These insignificant historical events are very often “beneath the lens resolution of an analyst”, and therefore will impose theoretical and practical limits to predictability of economic future thus rendering Porter’s model useless. Arthur makes it clear that this type of industry also co-exist with the other traditional industries differentiated as one’s that do bulk processing such as grains, livestock, heavy chemicals, metals and ores, foodstuffs, retail goods; those that process resources as against information, knowledge, in the new generation of industries. In the former constant or diminishing rate of return is still the norm. Typically the new generations of industries which Arthur is referring to are industries which have knowledge, technology and the power of IT as their raw material. Relatively there are no limits to their availability and they are relatively infinite. The products and services that these create, along with a market and consumer base that it will have, is also very huge with the characteristics of increasing rate of return. Arthur elaborates this further in his later writings (1996) by quoting the example of how Microsoft’s operating system Dos, (now Windows) got the better of contemporary products. The author uses the word lock-in by which once a technology or product captures a significant market, it grows in a geometric progression and shuts out effectively other alternatives. Arthur further gives reasons as to why these industries have the increasing returns phenomenon. These have up-front high costs and are heavy on know-how and light on (physical) resources. They exhibit a network effect that is they build a web of products around them that offers a bundle of products and services to users and therefore increase the chances of their usage further. The more they become prevalent, the more the chances that they will become standard. Once the customer falls in to the groove of using it, the more it will become difficult for him to try anything else, as further progression on using add-ons, additional products will be far more easier with this product, than trying out something new. This mechanism of lock-in will give advantage to those who initially gain a foot-hold and reinforce the advantage manifold, effectively shutting out other products. Let us look at the industry sector Microsoft (MS) was operating and see the way in which the five forces would affect MS: Rivalry among firms: Having gained the initial advantage MS will cut the prices of his product. By virtue of the fact that he has an expanding sale because of the network effect, he will be able to cut prices to overcome rivalry, far more than his rivals. The product will sell further and due to customer groove-in, they will be far more comfortable using product that has this OS as the platform. Bargaining power of suppliers: Other vendors (suppliers) will find it more profitable to use MS as platform for writing their own software, because they will now understand that they would be able to reach far more users by working with a leader, than otherwise. This will increase the bargaining power of MS over its suppliers far more than its rivals. Bargaining power of Buyers: Buyers of the products of MS, the PC manufacturers, would find incorporating this OS is favoured by its customers because of the bundle of services and products that they (its customers) would have. They would find incorporating operating system of MS a better option. This therefore will increase the bargaining power of MS with their buyers more than that of its rivals. Barriers to entry: The increasing returns will enable MS to invest far more in research and upgrade its product much faster and far more frequently. Rivals and new entrants will find it difficult to match the investments of MS in research and hence MS will be able to raise the barriers to its potential competitors. All these factors do not operate in isolation and are not sequential, but act simultaneously reinforcing each other till the returns increase in a crescendo effectively shutting out competition. In a conventional industry model Microsoft would have never been able to leverage the initial foot-hold or the advantage they obtained, to such extent because the rate of returns would have been constant or diminishing. Porter’s model therefore seems no longer be applicable to these industries. For one the events take place very rapidly in this kind of industry, it is very dynamic and constantly evolving. Industry structure argues Downes (1998) is changing so rapidly that it is simply not possible to use the five forces model to develop a sustainable competitive advantage. Globalisation, digitalization and deregulation have made it possible for industry structures to change very rapidly he argues. One that is adaptive, with deep pockets, absolutely brilliant product is the one who is most likely to succeed (Arthur 1996). It is argued that Porters model would be more relevant to industries with a structure that is fairly simple and relatively static in time. Another reason given for the “failure” of Porters model in such cases is the inability of the model to differentiate between the industry sector (which is the focus of the analysis of the model) and the ‘ecosystem in which the industry is. For instance Pharmaceutical industry is no longer an isolated industry, but lives in a sector that may be called Life sciences, or biotech sector. This approach of focus is on industry rather than the larger sector in which it operates, “may miss the emergent properties of the sector i.e. the whole may be greater than the sum of the parts.” (Lever R, 2008). Technologies, industries no longer exist alone but live in ecologies (Arthur 96). The value of Porters model is limited to the extent that it more that it enables managers to think about the current situation of their industry in a structured, easy-to-understand way – as a starting point for further analysis. Tikkanen and Halinen (2003) also argue how network and partnerships are going to be the key strategic factors that will help new industries to succeed in the new global business scenario. They also criticize Porters five forces tool as one that does not allow recognition of the fact that organisations could strategically increase their resources by networking and therefore increase their competitive capability. This is typical of organisations operating in increasing returns industries. Microsoft for example, provided many of its network partners a platform to develop utility programmes which benefit both, by putting them in the increasing returns market. Non-Market Influences Porter’s model has been developed in the context of the North American economy, and that too in the eighties, before the advent of the new technologies. Many factors typical of the time and geography are taken for granted. Examples are well developed institutions for finance, Intellectual property protection, legal resolution mechanisms to swiftly resolve buyer seller conflicts, contract laws and anti-trust laws. State intervention in business and markets was minimal. How relevant would this be in an emerging economy is one question raised. Narayanan (2003) considers just one factor, the level of development of institutions in emerging economies. This means just not the existence of such institutions, but how effectively they perform. He examines this with respect to specific financial institutions, legal institutions to resolve business disputes and institutions to protect intellectual property rights, which as mentioned above are taken for granted in the western world. In such countries capital may not be available to all for setting up industry, and biased towards existing elite industries. Financial institutions may have a cultural bias, based on historic reason to be ultra conservative in lending. Entrepreneurs may also be less risk taking because of cultural reasons, as well as poor protection offered to them as per bankruptcy laws. Legal resolving of problems may be long drawn and involving considerable costs-thus distorting the buyer seller bargaining powers as would be expected in the western markets. Narayanan concludes “The unstated assumptions about the frame’s (Five forces strategic model’s) range of applicability distort its usefulness to corporate practitioners, especially in undeveloped geographies.” Hofstede (2001) work on culture and its influence on organisation behaviour, throws important light on the influence culture can have on strategy formulation of companies across nations. Hofstede categorized behaviour patterns of organisations based on the five dimensions. He called them Power Distance (extent to which members accept unequal distribution of power), Uncertainty avoidance (how members feel threatened by unpredictability of events), Individualism-collectivism (tendency to work only towards once goal, or general good), Masculinity/Femininity (Masculinity associated with aggression, assertiveness as against femininity concern for others, nurturance) and the longtime perspective versus short term perspective. Through his research, Hofstede was able to categorise different countries based on the behaviour pattern along each of this factor. Each of these five factors will influence the way in which affect Porter’s five forces shape industry’s competitive behaviour. Unless one is aware of this, one will not be able to describe the industry structure in that particular cultural context, nor be able to formulate a competitive strategy. Prasad (2006) illustrates what these cultural factors will mean in terms of behaviour of each of Porters five forces as follows: Power Distance: Decision making, relationship between Consumer and Customer, relationship between company and its supply chain members, Bureaucracy within and without organisations, organizational structures etc. Masculinity/ Feminity: Compensation designs, impacts on social costs, litigations, inefficiencies associated with preferential policies, Attitude to customer service, Uncertainty Avoidance: Impact on entrepreneurship, the equation between risk and return, Institutional risk avoidance, Culture of Innovation Individualism vs. collectivism: Impact on buyer behavior, market segmentation, costs of communication; approach to cluster behavior, Trade Unionism, collective bargaining Time Orientation: Buyer behaviour (preference for durable goods), substitute products, long term employment, long term relationships in supply chain. It is therefore obvious that each of the five cultural factors will have its own influence on the five force factors of Porters. The intensity or importance of each of these factors may be different in different countries. It means that industry structure and forces behaviour is culture dependent. Evolving competitive strategies ignoring these would mean poor strategy. Culture evolves through time and history of the country determines cultural behaviour. A country which has a tradition of respecting elders may affect Power distance. A country which has values of thrift and savings will have preference to products which are long lasting, with implications of service availability for the product (Time orientation). Culture and history are therefore intertwined and will influence the industry structure, markets etc. Sudden historical events also render all carefully drafted strategies totally irrelevant, example of the revolution in Iran during the eighties, but in defense of the model, no strategy can account for such disruptions either. To sum the criticism on Porter’s five force model is as follows: 1) The model is applicable to those industries which work under the framework of constant rate of returns. It fails to take into account the new emergent economy which are knowledge based and where chance events in history determine success of product, providing increasing rate of returns. It ignores the effects of synergy in networked industries. 2) Model is applicable for an industry which is static, in a steady state and predictable in all ways, especially state intervention. 3) It ignores the culture and history dimension in shaping industry structure in different countries 4) It will not be applicable in emergent economies where the role of state intervention is high Analysis Porter’s five forces model is clear on the basis of which his model has been built and what it can do. According to this model, industry structure drives competition and profits whatever be the nature of industry, emergent, high technology, mature or so on. It provides a framework for understanding the intensity of the five forces the reasons, causes and roots of its profitability. If properly used, it can also provide insights into how to influence these forces to the advantage of the firm that is to derive higher profits than the industry norm. It does not deny the dynamic nature of change of structure in the emerging industry, nor does it deny the increasing rate of returns that is the norm in such industries. It admits to existence of industries where profit pool expands rapidly to be able to provide returns to many on increasing rate of return. It seems much of the criticism on this model not being relevant came out at the time of the rise of this so called emerging industries, the rise of IT, internet where it seemed that once an industry took a lead (the example being Microsoft and others), it precluded growth of other industries, Later on while we move into the early years of this century, such runaway growths have not been the exclusive prerogative of early winners. There has been room enough for other companies to grow in the same industries. Companies like Google, Amazon are late entries relatively, but have not been shut out. The industry structure has changed, expanded and allowed other players to spot opportunities and grow. To say that this is due to chance historical events is to deny the immense hard work done by these companies, the successful strategic insights shown by these, which have been the cause of their success. Porter’s model gives an opportunity to spot changes in industry structure. Porter (2008) warns about not being sensitive to structural changes and not being able to spot potential entry of competitors. For instance, if company like Barnes & Noble had spotted the threat of Amazon early on, they could have acted to counter the threat of a new entrant. . These two companies are examples of companies as a strategy, proactively altered the structure of the industry, creating a new industry out of synthesis of one or two (retail sales plus use of internet) and succeeded. Porter’s model to understand industry structure and what drives competition would have been the basis for emergence of such innovative strategy. Porter’s model also does not rule out the role of cultural and historic factors that influence the five forces. Porter (2008) is careful in defining an industry. He defines it in terms of how uniform the forces are within the boundary. An industry even with similar products and services but where the forces act totally differently, is to be considered a different industry with different boundaries. This often happens geographically, and if understood properly will well be able to cover industry structure across the world, and define the strength of the forces in each of the industries across the world. Thus there is ample scope in the model to accommodate cultural differences. The fault for not accommodating significant differences in the intensity of five forces in similar industries in different countries, would be because of not defining an industry appropriately, not the defect in the model. Similarly level of government intervention, rules and regulations can be studied in term of how they influence each of the five factors when analyzing the industry structure- there is no need to consider it as a separate force. Seen through this perspective Porter’s model seems to cover this objection also. Conclusion: Porter’s five forces model is one which has been studied and critically assessed for its utility as a tool in strategic planning. Criticisms on several points such as, model ignores cultural and historic considerations, not useful when attempting international environmental analysis, inadequate for the analysis of the new emergent industries in the rising returns sector, do not seem to be convincing. What is needed is to have a more rigor of analysis while using the model to ensure their influence on the five forces is understood appropriately, rather than considering them as sixth, seventh or the eight force. References Arthur Brian W, Competing Technologies, Increasing returns and Lock-in by historical events, 1983, http://www.santafe.edu/~wbarthur/Papers/Pdf_files/EJ.pdf, accessed 14th February 2009 Arthur, Brian W, Increasing Returns and the New World of Business, 1996, http://www.santafe.edu/~wbarthur/Papers/Pdf_files/HBR.pdf, accessed 13th Feb. 2009, Arthur, Brian W, Increasing Returns and Path Dependency on economy, 1993, e-book, http://books.google.co.in/books?hl=en&lr=&id=11k- dqHOPcC&oi=fnd&pg=PR9&dq=concept+of+returns+to+scale&ots=H_QjDYR6v_&sig=pLlj-tcq_YmWl8OuRG3Q9YHuueM#PPA7,M1, accessed 14th February 2009 Downes L, Beyond Porter, 1998, Context Magazine http://www.contextmag.com/setFrameRedirect.asp?src=/archives/199712/technosynthesis.asp, accessed 19 Feb 09 Hofstede G, Cultures consequences, Comparing values, behaviours, institutions and organisations across nations, Sage Publication, 2001 Mead R, International Management, 2005, Blackwell publishing Lever R, 2008, Weakness of Porter's Five Forces Model, http://strategic-business-planning.suite101.com/article.cfm/weakness_of_porters_five_forces_model, accessed 19 February 2009 Narayanan V K, The Critical and Developmental Potentiality of Philosophy of Science: An Application of Toulmin Analysis to the Concept of Strategy, 2003 http://www.mngt.waikato.ac.nz/ejrot/cmsconference/2003/proceedings/philosophy/narayanan.pdf, accessed 17 February 2009 Porter M E, How Competitive forces shape strategy, HBR 1979, Porter M E, The Five competitive forces that shape strategy, HBR.org | January 2008 | Harvard Business Review 79 Prasad A, History, Culture & the Five Forces Model understanding global industry attractiveness through the eyes of M E Porter, July 2006, http://www.pdf-search-engine.com/html.php?p=sandiego.strategicmanagement.net/pdf/session_papers/SMS-2007-AC-1126-21_paper.html, accessed 18 Feb. 2009 Recklies D, Beyond Porter – A Critique of the Critique of Porter, 2008 http://www.themanager.org/Strategy/BeyondPorter.htm, accessed 15 Feb 2009 Tikkanen J, Halinen A, Network Approach to Strategic Management – Exploration to the Emerging Perspective 2003, http://www.impgroup.org/uploads/papers/4430.pdf, accessed 15 February 2009 Read More