Theory and Research in Strategic Management: Swings of a Pendulum - Dissertation Example

Theory and Research in Strategic Management: Swings of a Pendulum Introduction Porter’s five forces analysis is essentially a framework applied in industry analysis, as well as development of business strategy. The framework employs industrial organization economics to determine five forces, which influence industrial competitive intensity and the overall attractiveness of a market in terms of industry profitability. Among the five forces, which essentially determine the micro environment of an industry, three forces focus on external competition while the remainder focus on internal threats (McDonald & Dunbar 2004, p. 111). This paper aims at providing a succinct portrayal of Porter’s five forces at play within the airline industry. This essay is a three-part essay that begins with the application of Porter’s five forces analysis in the airline industry; the second part of the essay discusses the most critical forces for organizations in the industry and the final segment critically evaluates the outside-in strategy of strategy formation. Industry Porter’s Five Forces Analysis Air travel has revolutionised how people live and how they experience the world in the modern age. Consequently, the airline industry strategically plays a key function in globalizing other industries, for instance, since it enhances international trade, foreign investment and tourism thereby enhancing global economic growth. However, airlines in the industry function within an extremely dynamic environment in which a number of social, legal, economic and technological forces interrelate, thereby influencing organizational actions and decisions. Within the airline industry, airlines are susceptible to harsh financial distress as a consequence of oil crises, terror attacks and recessions. Therefore, in order to succeed and guarantee their survival airlines must constantly assess their competitive situation and pinpoint key factors, which may influence their decisions and actions (Porter 1998, p. 45). The airline industry is extremely competitive thus Porter’s five forces model is suitable for analysing the extent and intensity of such competition and profitability within the industry (Pfeffer & Salancik 1978, p. 104). This analysis takes place through the identification of five key competitive forces. These forces include the following: Threat of new entrants Porter’s threat of new entrants determines the prospect of new competitors entering the airline industry. This force also considers the likelihood of new industry entrants underscoring the profits enjoyed by established businesses within the industry (Rothwell & Kazanas 2003, p. 85). In the modern world, the airline industry is extremely saturated to the extent that there is a rather minimal space for new comers to enter the airline market. The greatest huddle is the cost of entering the industry. The airline industry is perhaps one of the most expensive industries because of the cost implications of security and safety measures, manpower, customer service and leasing and purchasing aircrafts. Other entry huddles include stringent government restrictions and intense capital costs for new airline development. While the deregulation of a majority of domestic airlines in the 20th century significantly lowered the entry barriers into the airline industry, this move has not made a substantive difference in reducing entry costs. There is profound competitiveness within the industry, particularly in the EU. The entry of new airlines has profoundly reduced the market share of established airlines coupled with increased competition, pricing freedom, which constrains the industry’s profitability. In the event of cheap borrowing, it is extremely likely that the prospect of new airlines entering the industry increases. In essence, the threat of new entrants in the airline industry is relatively low since costs involved in establishing and managing airlines deter entry. Bargaining Power of Buyers Porter (1998, p. 48) identified buyers’ purchasing power as a prominent influence of a company’s competitive position in an industry. Buyers’ bargaining power is the extent of pressure consumers place on an organization thereby affecting its prices, profit and volume potential. Airlines flying from the country’s airports are essentially competing for similar customers resulting in enhanced buyer power. People travelling in and out of the country have varied choices when selecting a suitable airline although price is often the most critical element, particularly for families and students. Therefore, the bargaining power of buyers in the airline industry is relatively high because they are extremely sensitive to prices and seek the best deals available. Certain airlines, for instance, Ryanair UK attract travellers who are price sensitive by offering low fares coupled with the convenience of frequent flights. Other airlines create frequent flyer programs to provide for switching costs, which is also a significant factor to most travellers Bargaining Power of Suppliers Suppliers also exert immense pressure on companies by increasing prices or reducing the quality of products primarily supplied by Airbus and Boeing. Suppliers’ bargaining power is dependent on supplier concentration, buyer information, switching costs, substitute supplies and threat posed by forward integration. Nonetheless, other suppliers that work with airline companies include the providers of on-board snacks. These suppliers do not possess a similar bargaining power to aircraft suppliers since the snack industry is relatively large allowing for airlines to have a vast array of choices regarding from which snack company they purchase their on-board snacks. For instance, British Airways is likely to purchase its on-board snacks from suppliers that are the most economic to ensure that the airline makes a high profit margin from the snacks (McDonald & Dunbar 2004, p. 91). Since there are few suppliers, particularly of aircrafts, the power of supplier is quite high in this industry. Threat of Substitutes The accessibility and threat of substitutes is another notable factor, which affects competition in the airline industry. The threat of substitutes essentially defines the prospect of customers switching to other products or services, which perform the same function (Pfeffer & Salancik 1978, p. 145). Substitutes for services offered by the airline industry include bus, car and train travel to desired destinations. The scope of this threat is largely dependent on a variety of factors, which include convenience, travellers’ personal preferences, time and money. The ease with which buyers can shift their choice over to another substitute profoundly affects the competition from substitutes within the airline industry. A prominent consideration is often the travellers switching costs; however, as a consequence of their low fare and non-stop flights, airlines such as Ryanair UK and British Airways often lure convenience oriented, as well as price sensitive travellers away from substitutes. The threat posed by substitutes is substantially low since air travel is in a class of its own in terms of speed, efficiency in covering massive geographic regions. Competitive Rivalry The airline industry is extremely competitive; competitive industries typically earn loss returns, as well as low profits because of high competition. The airline industry is primarily characterised by the incidence of cut-throat competition, which exists amongst rival industries as a consequence of their low cost nature. Because most carriers are constantly involved in struggles to take away their rivals’ market share, industry growth is relatively average and since it is quite easy for travellers to switch between airlines on the basis of price, the rivalry increases rather substantially. Competitive rivalry is also quite high within the airline industry as a result of high fixed costs since a majority of flight costs are fixed. This means that there is a high chance for airlines to put up for sale all their unsold seats rather cheaply. This, in turn, resolves the pricing wars that exist among airlines (Porter 2008, p. 38). Airlines are constantly in competition against each other, particularly with regard to on-flight entertainment, prices, customer services, technology and in other areas. The net consequence of this competition between airlines is the overall slow market growth rate within the airline industry; therefore, the threat of competitive rivalry in the industry is quite substantial. The most important forces for organisations in this industry The appreciation of the competitive forces that affect industries, as well as their essential causes, exposes the causes of an industry’s current profitability and simultaneously provides a framework for foreseeing and persuading competition, as well as profitability over time. A strong industry configuration should be as much a competitive point of focus to strategists as the organisation’s overall position. As a consequence, understanding the most salient forces that affect industry structure is also critical to effective company strategic positioning (Porter 1996, p. 95). This is because defending an organisation against adverse competitive forces, as well as shaping these forces in favour of the organisation, is a vital part of business strategy development. Configuration of Porter’s five forces differs significantly from one industry to another. As a consequence, the airline industry presents a myriad of unique forces, which impose a significant effect on airlines. Within the airline industry, a number of forces play the most salient role in the industry, and as a consequence, organisations in this industry must play close attention to these forces. With regard to the market for commercial aircrafts, ferocious rivalry between prominent producers such as Boeing and Airbus, as well as the bargaining power of vast majority of airlines, which place massive aircraft orders are quite strong. Consequently, the power of suppliers is also significantly high. The strongest competitive forces essentially determine an industry’s profitability and become the most pertinent in strategy formation within the industry. Another critical force in the airline industry is suppliers’ bargaining power. Certain factors that relate to suppliers’ bargaining power are quite significant in the airline industry. These factors include supplier concentration in the industry, as well as threat posed by forward integration. Suppliers are relatively few in the airline industry with Airbus and Boeing supplying a majority of commercial fixed-wing carriers. Supplier concentration in the airline industry makes it profoundly difficult for organisations in the industry to exercise leverage over industry suppliers and pay low prices or play a supplier against another (Roberts & Berry 1985, p. 9). However, the industry boosts of a low rate of forward integration. Consequently, it is rather unlikely that Boeing or Airbus would staff commercial pilots, maintenance crew or flight attendants to operate flights across the nation. Supplier power also reduces the capacity of competing firms within the industry to earn high profit margins. Another crucial force in an airline industry is competitive rivalry. This is because an intensely competitive industry typically earns low returns since the net cost of competition is high, particularly because buyers receive immense benefits of low prices. Factors, which impact competitive rivalry typically, include fixed costs, which are inherent in the airline industry, industry growth, which is a key part of economic growth, barriers to exit and brand identity, which is quite critical (Rothwell & Kazanas 2003, p. 168). Since the airline industry is extremely competitive, industry growth is mostly moderate and airlines typically struggle to take away shares from other airlines. Notably, grounded planes never earn returns while disposing of fixed assets such as planes is relatively difficult. In most cases, as a consequence of bankruptcy laws, airline companies that suffer financial distress can remain industry competitors for quite a long time. However, not all these elements have the same level of importance in terms of ascertaining an industry’s overall attractiveness. Within the airline industry it is relatively easy to gain entry into the industry, but it is relatively difficult to get out (Porter 2008, p. 51). To most competing companies, this scenario is rather adverse. As a consequence, it is not surprising to note that airlines have proven to be mediocre investments in the past. It is quite critical to realise that a full-fledged analysis of an industry typically requires communication with suppliers, industry experts, suppliers, customers, competitors, as well as other sources that impact the industry directly (Hoskisson, Hitt, Wan & Yiu 1999, p. 433). The threat of new entrants is a critical force since it diminishes returns for companies in the industry. This happens as companies pass along superior value to buyers through low prices, as well as high competition costs. Some of the prominent forces that influence the threat of entry include among others brand value, switching costs, capital needs and economies of scale, all of which are critical to the airline industry. Financial institutions provide credit facilities to airlines while equity and debt markets offer alternatives for fund raising. Since it is rather easy for weak airlines within the industry to acquire credit facilities, the airline industry has now become quite saturated. One of the most critical elements that affect the airline industry is brand identity. Most airlines allocate immense resources to marketing strategies to ensure brand recognition and maintenance. For instance, airlines provide travellers with incentives such as frequent flier programs that successfully entice travellers to travel with certain airlines. The frequent flyer incentive program is often strong enough to sway a customer’s choice from one airline to another even in instances when the other airline offers a relatively low fare. Notably, the hub system used in the airline industry also enhances entry barriers. This is because airlines can provide travellers a massive array of choices while simultaneously employing minimal capital through their hubs. Consequently, the hub system enhances the market power of large airlines. The final force critical to the airline industry is buyers’ bargaining power, which is a vital competitive force in an industry. With significant buyer power in the industry, returns typically accrue to buyers through low prices. Buyer power deals with demand elasticity, product standardisation, volume of purchases, quality of services and brand identity. The airline industry presents buyers with many choices in terms of selecting a desired airline. The Internet also ensures that pricing information is minimally fragmented and relatively easy to compare. Sometimes, travellers find price discrepancies for a similar flight while no seat is better than another since arrival time is uniform for all onboard the flight. Other travellers such as vacation travellers are also prone to seek the best deals. Since air travel is rather expensive, for most travellers, demand is quite elastic, which means that demand increases as prices reduce (Hoskisson, Hitt, Wan & Yiu 1999, p. 429). However, airlines often move their prices alongside other airlines thereby forcing buyers to pay the prevailing market price till price wars break out. Outside-in approach to strategy formulation The area of strategic management has in the recent past received immense emphasis, particularly since it plays a critical role in the attainment of organizational competitive advantage. This emphasis continues to appreciate the alternative focus from the resource based, as well as perceptions towards opinions defined in the inside-out approach to an environmental and market oriented approach defined in the outside-in approach. The outside-in approach essentially suggests that, at a holistic level, the formulation of strategy typically encompasses succinct reflection on four core factors (Porter 1980, p. 69). These factors determine a company’s weaknesses and strengths, particularly with regard to its assets, which include brand identification and patents comparative to competitors. These assets combines with behavioural norms, beliefs and values held by the company offer internal constraints to the competitive strategy the organisation may adopt successfully. The outside-in approach takes into consideration external factors such as environmental uncertainty, societal influences, as well as environmental dynamism coupled with industry threats and opportunities and their related rewards and risks. These elements describe an organisation’s external competitive environment and offer external bounds to the successful strategy a firm may adopt. The detailed combination of external and internal limits found in the outside-in approach continues to provide guidance for business strategy formulation by endeavouring to match a company’s strengths and weaknesses with its environmental opportunities and threats. The outside-in approach not only encompasses the Porterian (1980, p. 72) position including external and internal factors, but also its related entry prevention approach founded in the game theory. For instance, Firm 1 creates a strategic intervention within the market by reducing cost so as to attract a greater market share. This reduced cost is rather unsustainable in the long run since it does not emerge from profitability improvements or the firm’s cost base. On the other hand, Firm 2, which is a competitor, responds to Firm 1’s intervention by endeavouring to recapture market share by providing an extremely flexible service offering. Therefore, Firm 1 suffers short-term disadvantage and responds appropriately. This means that the logic of the outside-in approach centres on an approach, which to begin with strives to appreciate what the firm is doing at present. The outside-in approach then demands the examination of what is taking place in the environment and then makes use of such an analysis to ascertain the strategic options available to the organisation in light of the existing external threats and opportunities. The outside-in approach further allows the demands of the marketplace and the external environment to govern strategy formulation. However, a resource-based perspective provides an alternative view by solely focusing on strategies aimed at exploiting the company’s unique resources, which are referred to as a firm’s firm-specific assets. This alternative suggests that an organization’s success lies squarely on its capacity to pinpoint or develop a competence, which is genuinely distinctive. An organisation must recognize its unique resources; ascertain in which market these resources can attain the highest revenue levels and eventually determine the means through which these resources are utilised most effectively. Notably, empirical tests dealing with resource-based theory have rapidly increased. Essentially, this resource-picking strategy centres on the inside-out approach whose motive implies that competitive advantage emerges from the manner in which a company takes full advantage of its idiosyncratic and inherently distinctive resources, which competitors find extremely difficult to copy (Rothwell & Kazanas 2003, p. 112). One of the most prominent ways of determining the effectiveness and definition of the outside-in approach to strategy formulation is to contrast it to the inside-out approach to decision making and strategy development. The inside-out approach to strategy formulation primarily begins with the definition of the problem. Strategy formulation approaches are essentially initiated in response to current pain points within the organization while the approaches focus on capabilities, which fix these pains and enhance the company’s performance. The outside-in approach typically starts and culminates with the customer. The strategy formulation decision, in this case is started in response to the strategic needs, which exist outside the organization. On the other hand, the decision making process concentrates on the manner in which it will enable the improvement of customer experience. It is, therefore, evident that the outside-in approach to strategy formulation focuses intently on responding to customer needs while the inside-out approach concentrates on responding to company-based pain points (Kotler 1997, p. 94). In addition, the outside-in approach encompasses a broadly defined selection criterion, for instance, focusing on criteria such as enhancing flexibility, adding strategic competence and responsiveness. Moreover, the outside-in approach to strategy formulation concentrates on adding value through the consideration of risk assessment as more pertinent in organisational effectiveness and competitiveness than a weighted score. The approach also involves the application of a service level agreement, which, in turn concentrates on organisational competence, which includes, among others, total cost to serve, flexibility to provide effective responses, speed and agility. In the current business environment, which is marked by profound globalisation, planning seasons in organizations are always excellent motives to revisit organizational approaches to strategy. In essence, strategy focuses on defining, as well as establishing the long term direction for the organization. In terms of the outside-in approach, numerous organizational processes such as marketing and sales become rather critical since they play a substantive role in the development and execution of strategy. In the past, companies focused intently on internal processes in their strategy formulation, seeking ways to reduce costs and enhance overall productivity and profitability. Although this is critical to the overall survival of an organisation, as well as driving short run earnings, the strategy does not enhance the company’s position in terms of addressing shifting trends with regard to the market, new channels, technologies and entry of new competitors (Pfeffer & Salancik 1978, p. 175). Consequently, successful strategy formulation approaches make use of an outside-in approach, which considers customers as assets. When an organisation undertakes an outside-in approach to strategy development, the organization must be willing to invest constantly in learning about, as well as from the company’s customers and to interpret this information into appropriate initiatives. These initiatives under the outside-in approach aim at enabling an organisation gain competitive advantages, improve the organisation’s market position and ultimately the company’s shareholder value. However, companies can also choose to the inside-out approach by reducing their research and development, limit innovation, and deter experiments by placing internal company issues above the need to serve customers. History shows that such companies have also attained growth and longevity in the business environment. One such company is Apple, which chose to steer clear of adopting consumer perspectives to product innovation and development. Steve Jobs constantly poised that consumers were unaware of what they needed and required the input of producers to tell them what they desire and need. In most instances companies that opt for the outside-in approach rather than the inside-out approach perform better since the companies immerse themselves in the marketplace, conducting intense experiments so as to acquire in-depth market insight and arrive at actionable ideas (Kotler 1997, p. 125). However, that is not to say that companies that make use of the inside-out approach are constantly bombarded with bad results. On the contrary companies that adopt the inside-out approach do not necessarily appear out of touch with their customers, but rather seem focused on delivering superior value to their customers by focusing on their internal processes. While companies that take an outside-in approach to strategy formulation typically depend on marketing to enable them maintain their customer-centricity and to enhance direct communication with customers, those that adopt an inside-out approach depend on their internal processes to inform their product and innovation decisions. The inside-out strategy thereby enables the maximisation of company resources in product development. Company chief marketing officers are tasked with determining growth opportunities available to an organization, as well as ensuring organizational positioning is effective to deal with future falls. Therefore, successful chief marketing officers are immensely passionate in terms of advocating for customer value and establishing strong relations with both sales and research and development departments within the organisation. However, despite the clear benefits inherent in adopting an inside-out approach to strategy formulation, the adoption of an outside-in approach is the most effective strategy because of a number of reasons. Firstly, marketing can prove quite effective in the development of strategies, which improve the organisation’s overall capacity to attract, sustain and grow the value of its customers thus not only enhancing its value, but its effectiveness, as well. These are vital components of overall marketing performance, and the outside-in approach to strategy formulation typically facilitates the attainment of these components. Perhaps one of the primary reasons why the outside-in approach is effective is because it considers external and internal issues faced by the organization. The strategy typically derives directly from these issues to establish and implement real solutions and add and enhance real value. The adoption of the outside-in approach to strategy formulation encompasses a variety of steps which begin with the development of a formal strategy formulation process for ensuring the involvement of all necessary executives in the strategy development. Secondly, the process demands the establishment of a formal system for following developments within the business’ external environment as a vital part of the process (Day & Moorman 2010, p. 65). This begins with the presumption that everything that the existing strategy formulation is doing is either nonexistent or wrong. Moreover, the outside-in strategy formulation approach is the most effective strategy since it entails identifying the core business and people templates that determine business success and constantly track and communicate these metrics to the internal company community. Based on the metrics and business issues identified pertinent departments then develop the appropriate strategy, which will optimally enhance performance on the metrics (Day & Moorman 2010, p. 68). However, it is pertinent to appreciate that the outside-in strategy formulation approach is a process rather than an intervention since any strategy is essentially a pattern in decision streams, and as business issues change and new huddles appear, the strategy will also need to change. Conclusion The business environment continues to change with shifting trends that demand a close examination of forces that impact organizations and industries, for instance, Porter’s Five Forces that provide a holistic view of an entire industry. This paper has examined Porter’s Five Forces as related to the modern airline industry, as well as other factors that affect business environments such as the most effective strategies to strategy formulation. It is evident that while both inside-out and outside-in approaches attain success, the outside-in approach is the most effective in terms of meeting customer demands and enhancing company and brand image. References Day, S & Moorman, C 2010, Strategy from the outside in: Profiting from customer value, McGraw-Hill, New York. Hoskisson, RE, Hitt, MA, Wan, WP & Yiu, D 1999, ‘Theory and research in strategic management: Swings of a pendulum’, Journal of Management, vol. 25, pp. 417-456. Kotler, P 1997, Marketing management, Prentice-Hall, Incorporation, New York. McDonald, M & Dunbar, I 2004, Market segmentation: How to do it, how to profit from it, Butterworth-Heinemann, Oxford. Pfeffer, J & Salancik, GR 1978, The external control of organizations: A resource dependence perspective, Harper and Row, New York. Porter, ME 1980, Competitive strategy, Free Press, New York. Porter, ME 1996, ‘What is strategy?’ Harvard Business Review, November-December. 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