Competitive Strategy: Techniques for Analyzing Industries and Competitors - Essay Example

? Strategic Management Every firm requires formulation of strategies in order to stay competitive in its industry. According to Michael Porter firms face five competitive forces namely bargaining power of suppliers, bargaining power of customers, threat of new entrants, threat of substitute products and rivalry among industry competitors. The magnitude of competition within an industry is driven by these forces; this in turn determines the profitability and attractiveness of an industry. Porter suggested three generic strategies to help firms cope with the five competitive forces namely the cost leadership strategy, differentiation strategy and focus strategy. Keywords: strategy, five forces, entrants, analysis, differentiation, Porter,   focus, competitors, substitutes, buyers, suppliers, cost leadership, competitive, method, framework, bargaining, rivalry The significance of strategy formulation by firms is coping with competition. Every firm competing in an industry has either an explicit or implicit competitive strategy. Strategies may have been developed specifically through a planning process or may have developed inherently through tasks carried out by various functional departments of a firm. Each functional department implements approaches directed by its professional direction and the motivation of those in charge. Developing a competitive strategy involves developing an extensive method for how a business is going to compete in an industry, what the objectives of that business will be and what approaches will be needed to achieve those objectives. According to porter, there are five competitive forces that form every industry and every market. The five forces model analyzes the environment in which a business operates to gain competitive advantage. The five forces include the threat of new entrants, the bargaining power of buyers, the bargaining power of suppliers, the threat of substitute products and services and rivalry among industry competitors. These forces drive the magnitude of competition and hence the profitability and attractiveness of an industry. Corporate strategy aims to modify these forces in a way that promotes the position of a business. Competition within an industry is more intense when new companies have easy means of entering the industry. Several barriers of entry can be implemented to limit the threat of new entrants. These barriers include loyalty to major brands, high fixed costs, and scarcity of resources, incentives for using a specific buyer, government legislation, brand equity, switching costs, patents, economies of product differences, capital requirements, access to distribution, absolute cost advantages, learning curve advantages and anticipated retaliation from incumbents. Higher entry barriers lead to higher profits. Suppliers with large enough impact to affect a company’s margins and volumes hold substantial power. Suppliers can place pressure on a business for a range of reasons. They include existence of few suppliers for a particular product, lack of substitutes, products that buyers cannot do without, supplying industries with higher profitability than buying industries, Supplier switching costs being relative to a firms switching costs, presence of substitute inputs, degree of differentiation of inputs and cost of inputs relative to the selling price of the product. Firms can reduce the power of suppliers by diversifying their range of products, standardizing products and supplying some needs from within. Buyers compete with a firm for added value in the value chain, this drives down the prices obtained by a firm. Buyers have power when there are a small number of them, they purchase in large volumes, they cannot do without the product, switching to another competitive product is simple, they are price sensitive and when their switching costs are relative to a firms switching costs. Buyers can be lesser threats when there is a threat of forward integration from the firm. They are less powerful when a product or service is critical to the quality and success of their business. Selecting buyers also plays a significant role in a firm’s strategy. Presence of alternative products and services negatively affects a firm’s attractiveness especially when the product or service has apparent advantages. When a new substitute has many advantages it may break down the other product. Highly competitive firms get low returns as a result of high competition. Rivals may compete on price and non-price dimensions. A firm should be able to position itself so as to defend it against these competitive forces. Influencing these forces improves a firm’s competitive position. A firm is also able to anticipate changes within the industry and take a better position before its rivals. Analyzing the five competitive forces provides valuable information on three aspects of corporate planning namely; statistical analysis, dynamic analysis and analysis of options. Under statistical analysis, analyzing the five forces gives insight on the profitability of an industry, it helps in making decisions on whether to enter or get out of an industry or market segment. Different options are available to competitors who may react to changes in the competitive forces through their different competences and resources. This influences the structure of an entire industry. Dynamical analysis together with pestle analysis discloses drivers of change in an industry. Analyzing the five forces can give insight on the potential future attractiveness of a particular industry. Anticipated overall changes can influence the five competitive forces and impact industry structures. Under the analysis of options, firms can come up with options to influence them in a way that improves their competitive position. This could consequently lead to a new strategic direction for example new positioning or differentiation for competitive products or services. The five forces model allows systematic analysis of competitive situations and market structures. The model is based on microeconomics and considers demand and supply, complementary products and services and their substitutes, relationships between volumes and costs of production and market structures. The five forces model by Porter makes assumptions that buyers, suppliers and competitors do not interact and collude, source of value is in creating barriers to entry and there is generally low uncertainty allowing market participants to plan and react to competition. Firm managers can look for ways to influence the competitive forces in their firm’s interest after current and potential future state of the forces. Options available to a firm after analysis are determined by its own resources, competences and aims and the external market. In coping with the five competitive strategies, Porter suggested three generic strategies that a firm can undertake to achieve competitive advantage. The three strategies are the cost leadership strategy, differentiation strategy and focus strategy. The Cost Leadership Strategy The cost leadership strategy involves a firm setting out to be the lowest cost producer in its industry by maximizing sources of cost advantage such as economies of scale. The strategy involves targeting a wide segment. In this theory, Porter assumes that the firm that is a cost leader in an industry will also have the lowest prices and there is only room for one cost leader in an industry. A Firm follows the cost leadership strategy by attempting to become a low cost producer in its industry. Firms with the lowest costs earn the highest profits especially when competing products or services are basically undifferentiated and are sold at an average market price. Firms implementing the cost leadership strategy focus on reducing costs at every stage in a product’s value chain. A company being a cost leader does not mean that its products have a low price. A company can charge an average price on its products while following this strategy and reinvest additional profits into the business. Cost leadership requires vigorous development of effective and extensive facilities, active quest of knowledgeably reducing costs, tight control of overheads and costs, avoidance of marginal customer accounts and minimizing costs in areas like research and development, service, sales force and advertising (Porter 35). To achieve these objectives, a lot of managerial focus on cost control is required. The entire strategy implements low costs in comparison to competitors through quality, service and other areas. By having low costs a firm gets above average returns in its industry despite the presence of competitors. This is because the firm still earns returns after competitors compete away a lot of profits through competition. A low-cost stand protects a firm against powerful buyers who can apply power only to cause a reduction of prices to the equivalent of the next most efficient competitor. Low costs also act as protection against competent suppliers by maintaining more resiliencies to cope with increases in costs of inputs. Factors that lead to a low cost position for a firm also present significant entry barriers in terms of cost advantages and scale economies. A low cost stand for a firm places it in a favorable position relative to its competitors within an industry. It is therefore right to say that a low cost position protects a firm against all the five competitive forces because bargaining can only keep reducing profits until those of the next most efficient competitor are eliminated and since less efficient competitors will suffer first from competitive pressures (Porter 36). To achieve an overall low cost position, a high relative market share is required and other factors like available access to raw materials. It may also require designing products that are easy to manufacture, maintenance of a wide range of related products which will allow spreading of costs and focusing an all major customer groups so as to build volume. This strategy may require investing a lot of capital in powerful and modern equipment, aggressive pricing and losses during start-up to build market share. High market share later allows economies in purchasing which further lowers costs. When achieved, a low cost position provides high profits which can be reinstated in new equipment and modern facilities for the purpose of maintaining cost leadership. Reinvestment is essential to maintain a low cost position. Examples of firms that have successfully implemented the cost leadership strategies include Texas Instruments, Emerson Electric, Du Pont and Black and Decker. It has been the key of Brigg’s and Stratton’s success in small horsepower gasoline engines holding fifty percent worldwide share (Porter 36). The cost leadership strategy carries a risk when a firm focuses on reducing costs sometimes at the expense of other key factors, this may become so dominant that the firm loses direction on the reason it focused on such a strategy. Differentiation Strategy The differentiation strategy involves offering many geographic markets and a range of customer divisions products and services that are unique and valuable, for which they are willing to pay more (Haberberg and Rieple 173). The price premium paid by these customers must highly outweigh the extra costs incurred in providing the unique features of the product or service. A firm following the differentiation strategy aims to deliver unique products or services to the market with characteristics that most customers value. Differentiation and uniqueness earns a higher price product or service. A firm that differentiates its products manages to charge a premium price for that product in the market. According to Porter, a company incurs extra costs and investments in employing the differentiation strategy. An example is the cost of advertising a new brand of a differentiated product. A firm gains many advantages by implementing this strategy. A problem in implementing this strategy comes in when it is difficult for a firm to estimate if extra costs incurred in products or services differentiation can be recovered from customers through charging of premium prices. Additionally, a rewarding differentiation strategy of a firm attracts competitors to get into the firm’s market segment and copy the differentiated product or service. Focus Strategy The focus strategy is also referred to as the niche strategy. It involves a firm focusing on a narrow customer segment. This strategy can be further divided into differentiation and cost focus strategies, this depends on whether a firm attempts to achieve differentiation or cost advantage in a particular segment. A firm using the cost focus strategy aims for a cost advantage only in its target segment while a firm using the differentiation focus strategy aims for differentiation only in its target segment. The strategy depends on the existence of substantial differences between a focusing firm target segment and other firms in the industry. If the differences are not very pronounced then a broadly based competitor can also serve the segment and possibly more cheaply (Haberberg and Rieple 174). According to Porter, the focus strategy is a moderator of the cost leadership and differentiation strategies. Firms can implement this strategy by identifying a market niche and offering specialized products or services for that niche. The focus strategy offers a firm the chance to charge a premium price for superior quality products or services or by providing a low price product or service to a specific group of buyers. Examples of niche players in the automobile industry are Rolls-Royce and Ferrari. These firms have a small advantage of worldwide market and offer premium products at a premium price. The disadvantage of this strategy comes in when a market niche is too small and insignificant to justify a firm’s focus. Focusing on costs can be complicated in firms where economies of scale play a significant role. The danger of a niche disappearing over time is inherent since a business environment and preferences of customers change with time. To implement different generic strategies different resources and skills, organizational processes and styles of leadership are required and this means very different cultures. According to Porter, firms should not combine the cost focus and differentiation focus strategies on a business unit level. Combining the two strategies may lead to a firm getting stuck hence not pursuing one of the strategies completely. It might be very complicated to focus on differentiation and low cost at the same time. This analysis has been debated by scholars with some citing examples of successful firms that have implemented more than one generic strategy. References Porter, M. E. (1998). Competitive Strategy: Techniques for Analyzing Industries and Competitors. New York: The Free Press. Porter, M. E. (2008). On Competition. Massachusets: Harvard Business School Publishing. Faulkner, D., & Campbell, A. (2003). The Oxford Handbook of Strategy. New York: Oxford University Press. Haberberg, A., & Rieple, A. (2008). Strategic Management: Theory and Application. New York: Oxford University Press. Drypen. Retrieved April 24, 2012, from http://drypen.in/marketing/porters-generic-strategies.html BusinessMate.Org. Retrieved April 24, 2012, from http://www.businessmate.org/Article.php?ArtikelId=187 RapidBI. Retrieved April 24, 24, 2012, from http://rapidbi.com/porterfiveforces/ Read More