Strategic Management: Analysis of Porter’s five forces model


Introduction

Strategic management is an important process in today’s organizations and requires a good devotion of time and money to make strategic decisions (Harrison and St. John 2009). There are several academic models that are framed for assisting the firms for analysing the marketing condition and situation both at the micro and at the macro level. The essay analyses the importance of academic models for managers in terms of facing challenges and making decisions. Further, Porter’s five force model is selected for analysing its strengths and weaknesses and how the weaknesses can be overcome.

Use in strategic management

In the current business scenario it can be seen that the society is evolving rapidly. There are drastic changes in the lifestyles and habits of people in all around the world, as seen 50 years ago. People and businesses are highly influenced by the rapid changes in the technologies. So, strategic management represents that creative part of management that results into the creative thinking. Strategic management is associated with the aims and directions of the organizations which they adopt in order to face the competition. Strategic management takes into account the choice, analysis and implementation of the elements which are termed as the strategic models. Models can be said to be as the simplification of the facts and figures associated with reality and removal of the unnecessary details, which leads to the proper evaluation of the fundamental information’s. There are several varieties of models associated with the strategic management which aids the managers in facing challenges and taking decisions (Kossowski 2007).

Some models aids the managers in effective planning and some helps in analyzing the strategies, some are used for tactics and also organizing of the company’s activities in terms of people and resources and also their models for the effective implementation and execution of the company practices and operations. Managers at the top level are mostly faced with several challenges, and this challenge can be the success of some new item or product, the utilization or implementation of new technology or decision related to the adoption of new materials or aspects related to the growth of new products and services. Each firm can have different objectives, this can be to generate increased profits or develop market share and so on. In order to attain these different objectives the managers needs to take several vital decisions which are mostly influenced by the models adopted at the strategic management level (Narayan 2000).

In this era of internationalization organizations and companies and their managers are faced with the more and more complex challenges like international competition, new emerging markets, technological improvements, economic and political changes and so on. For the purpose of facing such problems and challenges the managers and organizations need to use the models related to strategic management and gather potential information which aids them in effective decision making. Models are also commonly used because the strategic management decisions needs to be highly successful otherwise they may lead to failures and losses and may also affect the organizations in terms of their reputations and long term profitability (Harding, Harding and Long 1998).

Senior managers need to utilize several conceptual models like BCG matrix, Porters Five Force model etc., in order to be efficient particularly in the decision making processes. Strategic management models can be said to be as the mode of the strategic management. As per the strategic models several steps needs to be taken in order to attain the organizational objectives, and different models are adopted by different organizations as per their convenience and usability. So it can be said that the strategic models are commonly used in the strategic management in order to take appropriate decisions which will make the organization to attain its goals (Orcullo 2008).

Deal with the challenges

There are several factors that can help to explain how the models in the strategic management help the managers in facing challenges. There are several goals of the models and each model has a different goal to provide specific information to the managers when used in some specific business condition. The factors have been explained below:

Provide Framework: The main goal of the strategic models is to provide framework to the business which helps in improving the performance of the business. Models are commonly used in the strategic management because they help the managers by providing several important information and data (external and internal) which helps them to analyze and think more strategically and face challenges in an effective and efficient manner. Looking at the external point of view the organizations can use the PESTEL framework model, as this helps the organization in analyzing the external environmental factors associated with the organization and its environment (Davenport, Leibold and Voelpel 2007).

Prediction of future: Strategic management models can be used to predict the future of the industry and the corporate environment the firm is working in and can help the senior managers to take important decisions related to the strategic management. The future can be predicted through use of several models of strategic management such as, SWOT analysis, balanced scorecard, BCG etc. The models can tell the present position of the firm in the industrial market so as to decide which direction it has to take in future, thus facing the challenges presented by the changing flexible and dyna,ic market of the firm (Henry 2008).

Improving decision-making

Strategic management models help the managers to understand the practical realities that are present behind the decision-making of the organizations. The models are required for answering the question related to strategy, such as what type of products the firm should make, what are the potentially attractive markets that are suitable for the firm to enter, what operations are required to be outsourced and how the competition should be dealt with. Managers have to make critical and crucial decisions regarding the formulation of the strategy and its execution. There are several models in strategic management, such as value chain model, BCG matrix, porter’s fiver forces model, national diamond model, SWOT analysis, etc. (Henry 2008)

With the help of use of these models, the decision making of the firm can be improved. For instance, SWOT is a useful strategic management model that can be used for understanding as well as decision making for all types of situations encountered in business. It can be used for decision making related to the method of sales distribution, opportunities for making an acquisition, decisions related to change of suppliers, outsourcing decision for the service, resource or activity, and analysis of any investment opportunity, taking decisions regarding availability of strategic options such as entering the new market or launching the new product (Karagiannopoulos et al 2005).

The decision making is improved as the evaluation of the position of the company can be done in terms of its range of products and services. Models, such as BCG matrix facilitates the manager to think about the products and services of his company and take decisions related to which investment opportunity to look upon, which product or service should be kept and which should let go. The responsibility of the manager is to search the opportunities that could provide best returns to the company and the company could best allocate its resources so as to maximize the profit in future (Roy 2011).

            As the strategic management process has become more and more complex as well as costly. To ease the purpose of mangers in strategic decision making, models of strategic management are used. All the models are distinct but are related to each other. Use of these models improves decision making of the managers and helps them take crucial strategic decisions for the organizations (Ahlstrom and Bruton 2009).

Porter’s Five Forces Model

Five forces of competitive position model developed by Michael Porter provide a simplified perspective for assessment and analysis of competitive position and strength of the corporation in the industry. It is a model for developing an understanding of where the power lies in the business situation. The model is useful for business managers as it helps in understanding the current competitive position of the company and also the strength of the desired position which the company is considering to move into. When business managers have a clear understanding of where the power lies, they can take the advantage of the situation of strength, can well improve the situation of weakness and avoid taking wrong decisions or steps (Griffin 2010).

The five forces analysis model has five important forces which determine and analyses the competitive power in the business industry and the environment the company is working in. The five forces are as follows:

Entry barriers: The threat of new entrants is driven by certain number of factors in the industry and the market, such as absolute cost advantages, government policy, switching costs, brand identity, the economies of scale, distribution access, access to inputs, proprietary products, etc. The new entrants can quickly weaken the position of the existing players in the market if the factors in entry barriers are favourable for them such as low economies of scale, low switching costs for buyers, etc. (Parnell 2003)

Bargaining power of suppliers: It determines how easy it is for suppliers to drive up the prices. The force is driven by the number of suppliers present in every key input, the factor of uniqueness present in the product and services provided by the suppliers, the strength and control of the suppliers over the company, the cost of switching for suppliers, etc. When the number suppliers are less, and the need for suppliers is more, the bargaining power of suppliers becomes high (Parnell 2003).

Bargaining power of buyers: The power of buyers depend on the number of buyers, the significance of each important buyer to the business, their cost of switching, etc. If the business management has to deal with few but powerful buyers, then the latter has the power to dictate terms to the company (Roy 2011).

Competitive rivalry: The degree of rivalry depends on number of factors, such as exit barriers, fixed costs and value added in the long run, industry concentration, differences in products, growth in the industry, switching costs, diversity of rivals, brand identity, etc. All these factors determine the level of competition rivalry in the industry and the market (Parnell 2003).

Threat of substitutes: The relative price performance of the substitutes is the price for substitutes taken for the output of the company to the price the company is charging. If the substitutes’ price is lower, the price differential increases, and there is an increase in the competitive threat. Low switching costs also lead to lowering of threat of substitutes (Schermerhorn 2009). Porter’s five forces model has shaped the generation of academic research and has come out to be a powerful model for understanding the forces that shape the competition in the industry.

Strengths and weaknesses

Porter’s five forces model has shaped the academic research generation and enhanced the understanding of business practice. The major job of the strategist in the industry is to understand the competition and cope with it in an appropriate and effective manner. However, usually, the manager defines the competition in a much confined and manner considering only the direct competitors of today. But the competition in the industry goes beyond the direct rivals including the four other types of competition in the industry including potential entrants, suppliers, buyers, and the substitute products (Griffin 2010).

The extended rivalry which is the outcome of inclusion of four other competition forces other than the direct competition from rivalries defines and shapes the structure of the industry and the nature of the competitive interaction within the industry. Different industries might appear different from the outside, but the fact is that the underlying drivers for profitability in the business are the same. If the intensity of these forces is high, such as in the industries of textiles, airlines and hotels, almost no company can be able to earn an attractive and profitable return on their investment. But, if the forces are benign, for instance in the industries of soft drinks, software and toiletries, many companies can earn a good return on investment and remain profitable (Rainer and Cegielski 2010).

The structure of the industry drives the competition and the underlying profitability and not what the industry produces in terms of services and products, is mature or new, regulated or unregulated, or high or low level of technology. This makes the Porter’s five forces model significant in terms of understanding the structure of the industry.

The configuration of the Porter’s five forces differs by the industry. The strongest force or forces determine the competition and the profitability in the industry and also becomes important in the process of strategy formulation. However, the most salient force is however not so obvious in industries. For instance, the commodity industry witnesses the fierce competition rivalry, but it may not be the factor that limits profitability. For instance, the photographic film industry has low returns because of the presence of the superior substitute products like Fuji and Kodak. Therefore, in this situation, the number one strategic priority transfers to coping with the substitute products. It is the strength of the model that it deeply analyses different forces working in the industry and helps the business strategist to set the strategic priority according to the intensity of the forces and which force drives the industry most (Henry 2008).

The strength of the Porter’s five forces model lies in its ability to determine the competitive environment of the company which significantly affects the profitability of the latter. The bargaining power of buyers and suppliers affect the ability of the company to increase the prices and manage costs. When there are low entry barriers in the company, it attracts new entrants, while high barriers to entry discourage the entry. The model is affective in analyzing the driving force of competition in any industry and proves to be quite helpful for business managers to formulate strategies according to the nature of the business environment in the industry (Karagiannopoulos et al 2005).

The analysis of five forces provides the valuable information on three important aspects of strategic planning and management. These three aspects are:

Statical analysis: The analysis of five forces in the industry facilitates determining of the attractiveness of doing business in the industry. Therefore, the model supports the decisions about the entry of new players in the industry or exit from the industry or the market segment. In addition to this, the five forces model can be used for comparison of the impact of competitive forces on the own company with the impact on competitors. The competitors of the company in the industry can have different resources as well as competencies in order to react to the changes in the industry’s competitive forces, thus leading to availability of different options for reacting to the changes (Phadtare 2011).

Dynamical analysis: Strength of the Porter’s five forces model is its ability to conduct dynamic analysis. When this model is combined with the PEST analysis, which has the function of revealing the drivers for change in the industry, the combined model can enable the strategists in the organization to gain an insight about the future of the industry in terms of its potential attractiveness for investment and profitability. The five competitive forces of the industry are highly influenced by expected changes in the political, technological, social, economical and socio-demographical scenarios, which together influences the structure of the industry (Phadtare 2011).

Analysis of available options: When an organization has the knowledge of the power and intensity of competitive forces, it becomes able to develop options to influence it in such a manner which improves the own competitive forces of the organization. The result of availability of options and their analysis can result in a new strategic direction, for instance, development of new positioning plan, differentiation for competitive products with development of strategic partnerships, etc. (Phadtare 2011).

Therefore, the strength of the five forces model of competition lies in the allowance of the systematic and structured analysis of the structure of the market and its competitive situation. The application of the model is quite wide. It can be applied from smaller units to large segments, ranging from particular and specific companies, segments of the market, industries levels, or regions. However, it necessitates the determining of the scope of the market which is to be analyzed in the very first step. Following this step, all the relevant underlying forces are identified and then analyzed for this identified market. It is not essential to study and analyze all the elements of the five forces of competition with the same level of intensity or depth (Grundy 2006).

The five forces model enables the manager to analyze the current as well as future state or situation of the five forces of completion. With this analysis, the business managers can search for options that can influence these forces and make them favourable to the interest of the organization. The power of the competitive forces can be reduced to make the forces aligned to the interests of the organization. Although, the business models that are industry-specific can limit the options available to the organization, the own strategy of the organization can change the impact of the five forces of competition on the organization. The main objective of the use of this strategic management model is to reduce the power of these forces of competition so that the organization can work in a profitable manner and can sustain well in the industry (Henry 2008).

Porter’s five forces model has helped the business management in various aspects. It has simplified the microeconomic theory into just five influences critical to study. It has applied systems thinking before its time. Managers can predict the long run returns on the investment of organizations in the industry. It has enabled the strategic managers to obtain the combination of input-output analysis of the specific industry along-with identification of the boundaries of the industry by understanding barriers and substitutes present in the industry. The model lays emphasis on the importance of searching for the imperfect markets, which has the ability to offer more national opportunities for gaining superior returns (Roy 2011).

Through five forces model, strategic managers have become able to understand the importance of the power of negotiation and the arrangements of bargaining in the determination of the attractiveness of the relative market. The model has also enabled the manager to focus more on the external environment rather than the traditional SWOT analysis.

Other major strength of the model is that the five competitive forces are interdependent with other analytical tools of strategic management that deal with the other forces in the external environment and this interdependence can be developed into a well knit system which is more comprehensive and coherent than the single Porter’s five forces model. The model can be prioritized within the format of force field analysis (Ahlstrom and Bruton 2009).

There can be breaking up of the individual forces at the micro-level. The total framework of Porter’s five forces can be transformed into a more dynamic model at both the levels of analysis i.e. industrial level and the more micro level of transaction. There is need to apply the five forces model from segment to segment and all across the business so that the analytical power of the model is improved and the range of applications can also be improved at the same time (Hill and Jones 2007).

The model has broadened the supply demand analysis of single and individual markets in several aspects. The model has slackened the assumption of presence of only large number of competitors to be the only external environmental force that drive the structure and competition of the industry. There is presence of both horizontal and vertical dimension comprising of suppliers, buyers and rivals, and potential entrants and substitutes respectively. The generalization of the competition in the industry has widened the study and analysis of the structure of the industry for profitability (Schermerhorn 2009).

Challenges in the five forces model

Porter’s five force model has enabled the strategic business managers to deeply analyze the situation of the external market environment and take strategic decisions to reduce the power of the competitive forces and make them suitable to the interests of the company. However, the model has not remained protected from criticisms due to its over-generalization of the industry. The main criticism of the model comes from the historical context in which it was emerged and developed (Rainer and Cegielski 2010). In earlier times during 1980s, the global economy was mainly characterized by the cyclical growth. Therefore, only profitability and survival remained the primary objective of most of the organizations. In order to achieve those primary objectives, it is required to optimize the strategy according to the situation in the external environment. Also at that time, the development of most of the industries was quite predictable and stable. It was not like today’s dynamic business environment (Phadtare 2011).

The relevance and meaningfulness of the model is reduced by certain factors. In terms of the economy, the assumption of the model is the classic perfect market. If there are more regulations on the industry, the model becomes unable to give more useful and meaningful insights. Moreover, the model can be best and most suitably applied to the simple market structure. In complex industries where there are multiple relations, presence of multiple product groups, by-products and multiple segments, the comprehensive description as well as analysis of all the five forces of competition is very difficult. When the focus is too narrow with consideration given only to a few particular segments of various industries, there are chances of occurrence of risk of missing out some important elements (Schermerhorn 2009).

Furthermore, the model’s main assumption is that the market structure is static and in today’s highly dynamic markets, it is hardly the case. In today’s market, technological breakthroughs are common and the entrants in the dynamic market from start-ups or from the other industries can completely change the entry barriers, business models and the relationships with the suppliers within a short period of time. The model can be effectively used for the later analysis of any new situation but in context of knowing some prevention actions, the model can hardly do anything (Grundy 2006).

The main base of the model is competition. The assumption of the model is that organizations try to attain competitive advantages over other key players in the industry and the market along-with getting competitive advantage over customers or supplies. With this emphasis or focus, the model does not take into consideration various strategies like electronic linking of the information systems of the company, strategic alliances and virtual networks for organizations, etc. It is a major limitation considering the dynamic markets of today. It just only acts as the starting point for further and deep analysis of the competitive business environment of today’s era (Orcullo 2008).

There are several other limitations of the Porter’s five forces model that limits its applications and its wider acceptance as a major strategic model. The model gives over stress to the macro analysis which is the analysis of the market at the industry level. This over stress is in opposition to the analysis of the more specific segments of the product market at the micro level. Furthermore, the value chains in the industry are over-simplified, for instance, buyers may need to remain both segmented as well as quite differentiated between intermediate buyers, channels and the end consumers (Orcullo 2008).

             Another important challenge that the Porter’s five forces model faces is its inability to link to the possible management actions in a direct and straight manner, for instance, if any company has low influence of itself on any of the five competitive forces driving the industry, the model cannot give them the direction to deal with the issue. The model tends to give encouragement to the mindset that the industry is a specific entity and has its specified boundaries. However, in today’s time, boundaries of the industry appear to be more fluid in terms of the nature of the industry than the earlier times. The appearance of the model is such that it looks like self contained. Therefore, it is not specifically related to the factors in PEST analysis or the growth dynamics in the particular market (Norton 2008).

Another challenge faced by the Porter’s five forces model is related to its consideration as being over-branded. Although there are a large number of strategists who subscribe to the model, its theory and assumptions, yet the fact cannot be denied that model lacks the consideration for non-market forces. There is no consideration of the corporate social responsibility and the business ethics. There is a range of other factors that can be considered while studying the external environment, such as government policies, etc. The model is valid until today. There has been a drastic change in the industrial environment since 1980s (Parnell 2003). There are more rapid changes in today’s industrial environment due to the presence of advancements in information system and technology. The value chains have become quite easier than the earlier times as one company can take the role of the wholesaler, producer as well as retailer. The flexibility in the market is not considered by the porter’s five forces model. As there is huge growth of the e-commerce sector in the today’s industrial and business environment, the model has to be repeated continuously for the purpose of analysis because the environment is very flexible and changes rapidly (Parnell 2003).

Although Porter has given some acknowledgment to some types of government restrictions, such as access to raw materials or the government control, there is no consideration given to the direct or indirect influences of the government, such as effect on companies when the government changes tax policies or gives subventions. Sometimes, government itself acts as a company when it buys aircrafts, or need construction firms. The five forces model can be considered just a starting point for analysis and is required to be adjusted so as to fit to the today’s industrial environment (Halawi et al 2006).

The model has missed out the vital stage in the process of assessing the industry or the market. There is no explanation given for how to define the concerned industry. The industries picked up by Porter were easy to identify, but there are a lot many other people who prove wrong in identifying the industry, therefore, the analysis of the industry through the model becomes worthless. It is argued that defining the industry is the most critical part in analysis of the external environment and where the organization stands in the industry (Nemati and Barko 2004). The model has also failed to consider the factors that are less tangible in nature. In strategic management, the strategy is related to both the economic situation of the firm as well as the purpose and identity of the firm. However, Porter’s five forces model deals only with the former part mentioned and does not give due consideration to the latter. Through this model, the manager can analyze the economic stand of the firm, but cannot effectively analyze the other aspects of the firm that are related to its social fabric and related history.

The second dimension of the strategy can tell why some companies tend to stick to the same industry even if it is reflected as highly unattractive according to the five forces model, and why some firms tend to be the rule breakers or are known as innovators. So, the strategy is related to the higher purpose of the firm which is not included in the concerned model for strategic management (Schmidt 2010).

There is a need to take a multi-pronged approach for overcoming the weaknesses or challenges of the firm. The model is quite simple in its analytical approach, but it can be combined with other strategic management models to understand the more complex industrial environment in which organizations work today. Each of the five forces of the model should be understood as a more interacting and a more wide system rather as a single and self contained unit. There is a need to prioritize the forces in terms of favourable, neutral or unfavourable. The traditional Porter’s model is quite static in nature, but it can be given a more dynamic outlook, which can enhance its usefulness making it useful for both macro and micro level analysis (Grundy 2006).

Conclusion

Porter’s five forces model is an important and easy to use strategic management model that is useful in analyzing the structure of the industry and the level of competition. The framework is simple and is used frequently. The strengths of the model lie in its simple perspective, ability to analyze the structure of the industry and the position of the firm in the industry by understanding the impact of the five forces of competition and which force is driving the industry, prediction of long term rates of return, simple focus on market growth rates, and so on. However, there are limitations to the model that limit its scope and application. These limitations include oversimplification of the industry value chain, failure in linking the analysis to the management action, over-stress on macro analysis, specification of the industry as an entity, the historical context in which the model was developed which is very different from what the industrial environment is today, appearance of the model as self-contained, neglect of the other forces such as governmental forces and actions, etc. The limitations of the model can be done away by combining the model with the other analytical models so as to gain insights on the industry both at the macro and the micro level.

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