Essentials of Strategic Management - Literature review Example

TOPIC: CORPORATE MANAGEMENT (NAME) (COURSE NAME) (INSTITUTIONS NAME) 4th NOVEMBER 2008 Porter’s five forces analysis is an industry’s framework analysis used in the development of business strategies. Michael Porter developed it in 1979. The analysis makes use of industrial organization concepts to derive the five forces that determines the intensity of competition and the market attractiveness. (Porter, 1979).Attractiveness in this context refers to the profitability of the industry. This means that an unattractive industry is the one where the forces combination works negatively to bring down the profitability of the industry. An attractive industrial environment would therefore be the one that tends to approach pure competition. In order to contrast the above forces from the more general term macro environment, Porter decided to call the above forces as microenvironment, which means forces close to the company that affects the business ability to make profit and serve its customers. (Porter, 1980) Organizations are always busy competing for customers, for access to new markets, for access to raw materials as well as the right to come up with new products. Non-profit making organizations compete for grants and donations, government agencies compete for general funding from general fund budgets while the political parties compete for votes. In everyday existence of profit making and non profit making organizations competition is part and parcel of the organizational activities and it is a fact of life if viewed from the long-term perspective. (Thomson, 1997). Many organizations in this competitive environment therefore come up with various ways through which they ensure that they remain competitive in the market such as the use of information technology to fast track each and every activity in the organization as well as the activities of the close and distant competitors. (Jerry, 2006), The purpose of this report is to establish the implication of Porter’s Five Forces Model in understating the competitive strategic analysis of an organization. To amicably establish the implications of the above model and foster understanding of the concepts used a randomly Literature review The fives forces used by Porter in understanding the competitive strategic analysis of an organization include , the buyers bargaining power, the suppliers bargaining power, the threat of substitutes and the thereat of new entrants. Threat of new Entrants Bargaining Power of Existing rivalry of competitors bargaining Suppliers’ power of buyers Threat of substitute products The threat of entry reduces an industry’s potential profitability because firms compete for customers which reduce the revenue of the firms. When the threat of entry is high the, incumbents do not have any other option but to hold their prices down or carry out investment boost in order to bar new competitors. For example, in coffee retailing comparatively low barriers to entry means that a company like Starbucks must aggressively invest in modernizing menus and stores. (Visil, 2005) Powerful suppliers who include suppliers of labour can squeeze out an industry’s profitability. For example according to Porter, Microsoft has really contributed to profitability erosion among makers of personal computers by raising operating systems prices. PC makers have limited freedom to raise their prices when competing fiercely for customers who can easily move between them. The powerful customers captures more value by demanding better quality or more service, force down prices or they generally play industry participants off against each other all at the expense of the profitability of the industry. The power of the buyers is really noticed when they have negotiating leverage relative to the participants in the industry especially if they are sensitive to prices using their thump to primarily bring about reductions in prices. A substitute performs a similar or the same function as a product of an industry by a rather dissimilar means. For example, travel can be substituted by videoconferencing. Aluminum can be substituted by plastic. Express mail is a substitute for email. Quite often the substitution threat is sometimes indirect or down stream especially when a buyer’s industry product is replaced by a substitute. For example, lawn care services and products face threat when single family homes in the suburb are substituted by multifamily homes in the urban areas. Software that is sold to agents face threat when travel agents substitute the airline and travel websites. Competitor’s rivalry takes many forms which include introduction of new products, price discounting, service improvements and advertising campaigns. If the rivalry is high the profitability of an industry is limited and when rivalry is low then the profitability of the industry is also high. The degree to which an industry’s potential profitability is driven down by rivalry is depended up on the basis on which the companies compete and the intensity with which such companies compete. Re-assessment of the marketplace is therefore fundamental when a change in any of the above mentioned forces occur. The attractiveness of the industry does not necessarily mean that every firm in the industry has the same profitability return. Firms apply their business model or network as well as uniqueness in resource to achieve a profit above the average of the industry. For example, the airline industry has low profitability but the airline companies by making use of the unique business models are able to gain returns in excess of the average of the industry. Hence, Porter’s five forces framework is made use of by the strategy consultants in occasional making of qualitative evaluation of the position of the firm in the competitive market. In this sense, Porte’s five forces include three horizontal competitions, which include the threat of established rivals, threat of substitute goods, and the threat of new entrants. The vertical competition forces include customers bargaining power and the suppliers bargaining power. (Hunger, David and Thomas, 2003) (a) Threat of substitute products In response to price increases, the propensity of the customers to switch to alternatives is made possible by the existence of close substitutes or products. In this perspective, there are four aspects of threat of substitute products that arises, which are, the switching costs of the buyer, product differentiation perceived level, relative substitutes price performance and the buyer propensity to substitute. (Grant, 2005) (a) Threat of new competitor’s entry. Firms are drawn by markets that prove to be profitable and which yield high returns. This results into numerous new entrants, which in the long term will decrease the profitability of the industry. Unless the incumbent’s blocks out the entry of new firms the rate of profit will shift towards the competitive level. Several aspects arise due to the threat of competitor’s entry. These include, brand equity, absolute cost advantages, capital requirements, access to distribution, sunk costs or switching costs, economies of product differences, government policies, incumbents expected retaliation, learning curves advantages and the existence of entry barriers such as the copyrights, patents and trademarks. © The competitive rivalry intensity. This determines greatly the competitiveness of the industry. Sometimes aggressive rivals compete and sometimes competition takes place in non-price dimensions such as marketing and innovations. (Porter, 1985). Aspects related to the intensity of competitive rivalry include the following, industrial growth rate, barriers of exit, competitors diversity, the number of competitors, expenses used in advertisement, economies of scale, allocation of fixed cost per value added, improvisation of a sustainable competitive advantage, overcapacity of the intermittent industry and informational asymmetry and complexity. (b) The customers bargaining power This is also called the market of outputs. This is defined as the ability of the customers to put pressure to the firm and it trickles down into significantly affecting the sensitivity of the customers due to changes in prices. Aspects related to customers bargaining power include, firm concentration to buyer concentration ratio, volume of the buyer, availability of buyer information, sensitivity of the price by the buyer, ability to integrate backwards, the switching costs of the buyer relative to the switching costs of the firm, the leverage in bargaining especially in high fixed costs industries, existence or availability of substitute products as well as the uniqueness or differential advantage of industry products. (Clarke, 2006) (c) The suppliers bargaining power This is also called the market of inputs. Suppliers of services, components and raw materials such as expertise are one of the most important sources of power to the firm. The suppliers may charge high prices for unique resources or refuse to work with the firm. The aspects related to the bargaining power of the supplier include degree of inputs differentiation, the switching costs of the supplier relative to the switching costs of the firm, availability of the substitute inputs, firm concentration to supplier concentration level, input costs relative to product selling price and the forward integration threat by suppliers to the backward integration by firms. The starting point for businesses in developing strategies is the understanding of the above forces that shape the competition of the industry. Every company should be aware of the anticipated or the projected industry profitability and how the average profitability of the industry has changed over time. The five forces listed above gives a clear understanding of the industry’s profitability in order to allow the company or businesses incorporate conditions of the industry into the strategy. The above forces give a clear picture of the competitive environment especially the significant aspects related to the competitive environment. In this respect, they offer a baseline for sizing up a company’s weaknesses and strengths. (Brandenburger and Nalebuff, 1995), This shows where the company stands as related to the suppliers, buyers, rivals, entrants and substitutes. Of vital importance is the understanding of the structure of the industry, which offers guidance to the managers towards possibilities that are fruitful for strategic action, which includes company positioning to better cope with the contemporary competitive forces, which helps in exploiting changes in the industry. Strategists understanding of the competitive forces and their underpinnings bring the opportunity to spot and claims strategic positions that are promising. For example, the evolution of the music industry has been necessitated by the advent of the digital music distribution as well as the internet with some analysts predicting the birth of millions of music labels. The pattern that had existed since Edison’s invention of the phonograph would be broken by the advent of the internet and digital music distribution. Internet would therefore be a useful tool in removing entry barrier, which would usher in a flood of new players in the industry. However, using the porter’s five forces of analyses it would be established that physical distribution was not the vital entry barrier. Instead, entry barrier was brought about by the benefits incurred by large music labels. Large labels could cushion the inevitable impact of failures by pooling the risks of new artist’s development over many bets. When the structure of the industry is in flux, promising and new competitive positions appear. Structural changes open up new ways and new needs to serve the existing needs. Leaders who are established may be constrained by past strategies or overlook the past strategies and fail to pursue them. Smaller competitors capitalize on such changes or new entrants may well fill the void. Strategies are viewed as avenues for building defenses for finding an industry position or as a defense against competitive forces in the industry where the weak points of the forces exist. For example, Paccar is a company in the heavy truck market. There are numerous structural challenges in the heavy truck industry. Large fleets are operated by many buyers with both the motivation and the advantage to drive down the price of the largest purchases. (Coyne and Sujit, 1996), Most trucks offer similar features and are built to standards that are regulated, so competition in terms of price is rampart. During the recurring cyclical downturns, capital intensity causes fierce rivalry. The unions considerably exercise supplier power. Although 18-wheelers face few direct substitutes, the truck buyers face important substitutes for their service such as rail cargo delivery. In this respect, Paccar has chosen to direct its focus to a single customer group, that is, owner-operators-drivers who contract directly with the serve or shippers as subcontractors to trucking companies that are larger. Small operators have clout limitation as truck buyers and as a result, they are less sensitive due to their economic dependence on the product and their strong emotional ties. Heavy investment has therefore been directed by Paccar towards the development of array of features with owner-operator objectives, that is, cabins, noise insulated cabins, plush leather seats, luxurious sleeper, sleek exterior styling. All these demonstrate the principle of positioning which is only made possible to achieve through the understanding of the porter’s five forces within a given industry. The company through the eye of the five forces has been able to identify the portion of the market where competitive forces remains weak. At this point, the company is able to avoid the price-based rivalry as well as avoiding the buyer power. The company has also positioned every aspect of value chain to cope with its segment forces. Due to this, the company has been profitable for 68 years consecutively and has above 20% return on equity earnings. (George, 2002), Furthermore, a part from revealing the existing industry positioning opportunities, the framework of the five forces necessitates companies’ rigorous analyzation of exit and entry. Both depend upon offering answers to the question about the potential of the business. Exit is shown when the structure of the industry is declining or poor and the company sees no prospects of a higher positioning. The five forces are however used by the strategist in considering a new entry into a new industry by spotting an industry with a promising future before the good future is shown in the acquisition candidates’ prices. The five forces are also useful as they help in revealing industries that are not necessarily attractive for the entrant of an average company but in which a company believes it can overcome barriers to entry at costs that are lower than other firms or has the ability to cope with competitive forces of the industry. The five forces when used by a firm have the implication of leading an industry towards new competing ways that change the five forces for the better. In structure reshaping, a company or a firm wants its competitors to follow in order to transform the entire industry. While many participants in the industry may benefit in the process of structure reshaping, the innovator of the transformation benefits most especially when it can shift competition in areas where it can excel. The structure of the industry can be reshaped in two ways, that is, by expanding the overall pool of profits or by redividing profitability in incumbents favor. In redividing profitability, the company starts by determining the forces that currently constrain the profitability of the industry and address them. All the competitive forces can be potentially influenced by the company. In this view, the strategists strives to reduce the profit share that leaks to buyers, suppliers and substitutes or are sacrificed to prevent new entrants. In order to neutralize the power of the supplier, the company can standardize parts specifications to make it possible to switch from one supplier to the other. This works to alter technology in order to avoid powerful suppliers from grouping together or cultivate additional vendors. In order to counter the power of the customers, the company carries out expansions of services that raises the switching costs of the buyers or neutralize powerful channels by finding alternative means of reaching customers. To fight the rivalry profit-eroding price, a company can heavily invest more on products that are unique as done by pharmaceutical companies or widen supportive services to customers. In order to scare away new entrants, the incumbent company can raise the competing fixed cost, for example, by increasing the marketing or R&D expenditures. (Cummings, 1998). To limit the substitute’s threats, companies offer conducive values through features that are attractive and new in the market or widen the accessibility of the product. For example, the introduction of convenience store channels and vending machines by the soft drink companies dramatically improved the soft drink availability as compared to other beverages. In the food service distribution, Sysco is a good example of how a leader in the industry can bring change in the industry structure for the better. Leaders in the industry carry the responsibility of bringing improvement in the structure of the industry. This requires resources that are only possessed by large players. In addition, an industry that is structurally improved is a public good because it brings benefits to every firm in the industry, not just to the inventor of the improvement. Of great importance is noting that changes that are ill advised in issues concerning competitive positioning as well as operating practices undermines the structure of the industry. The pressure to gain a share of the market triggers new kinds of competition that cannot be won even by the incumbents in an industry. This becomes the dark side of shaping the industry structure through the porter’s five forces. Strategists should then ask themselves whether they have set in motion dynamics that may undermine the long run industry structure if they anticipate taking actions that will improve their companies’ competitive advantage. (McGahan, 2004) In expansion of the profit pool, the industry’s level of quality rises, overall demand grows, waste is eliminated, intrinsic costs are reduced and the pie expands. The total pool of available value to buyers, competitors and suppliers grows. The overall value can expand also and the firms may work in collaboration with the suppliers to limit unnecessary costs encountered in the chain of supply. This brings down the industry’s inherent cost structure, which allows greater demand through lower prices, or higher profits or even both. Agreeing on standards and the quality of goods or products can also significantly bring up the industry’s service quality levels and hence prices which in turn benefits customers, rivals and suppliers.(Kelky, 2006) A win-win opportunity for multiple participants in the industry is created by expanding the overall profit pool. It can also reduce the rivalry destructive risks that arise when attempts by incumbents to capture more market share or shift the bargaining power are designed. However, importance of industry’s structure is not reduced by expanding the pie. The division of the expanded pie is rather determined by the five forces. The successful companies are those that encourage the expansion of the pool of industry’s profit in ways that allow them share benefits disproportionately. Conclusion Porter’s five forces is a useful tool of analyses and it fosters an understanding of the competitive strategic analysis of an organization. It shows the implications of the five forces in shaping the industry competition in order for a company to exploit the change in the industry. It also offers a clear picture of the five forces in shaping the competition in the industry for strategic positioning. In addition, porter’s five forces provide an insight into the competitive forces that shape competition in a particular industry and it provides direction into the changes in the structure of the industry. REFERENCES Brandenburger, A. and Nalebuff, B. (1995), "The Right Game: Use Game Theory to Shape Strategy", Harvard Business Review, (Harvard, Harvard University Press) Coyne, K. and Sujit, B. (1996), "Bringing discipline to strategy", The McKinsey Quarterly Grant, R. (2005), "Contemporary Strategy Analysis", (Oxford, Blackwell Publishing Ltd.) Porter, M. (1979) "How competitive forces shape strategy", Harvard Business Review, (Harvard, Harvard University Press) Porter, M. (1980) "Competitive Strategy", (New York, the Free Press) Porter, M. (1985) "Competitive Advantage", (New York, the Free Press) Hunger, J. David, W. and Thomas, L. (2003) "Essentials of Strategic Management", (New Jersey, Pearson Education Inc.) McGahan, A. (2004) “How Industries Evolve - Principles for Achieving and Sustaining Superior Performance". (Boston, Harvard Business School Press) Clarke, D, (2006), the path of development of strategic management, (New York, New York Press) Thomson, R. (1997), Management strategies and practicality, (New York, McGraw Hill) Jerry, H. (2006), implications of Porte’s five forces on business strategies, (Irwin, McGraw Hill) George, M. (2002), organizational behavior and strategic positions. (New York, McGraw Hill Publishers) Cummings, H. (1998), integration of management systems in the porter’s five forces, (New York, Macmillan Press) Visil, K. (2005), why make use of Porter’s five forces? (New York, New York Press) Kelky, T. (2006), relationship between a firm’s strategies and performance, (Oxford, Oxford University Press) Read More