Assess the Usefulness of Porter??™S Theory of Competitive Strategy for Understanding the Competitive Behaviour of Companies, Giving Examples.
Assess the usefulness of Porter??™s theory of competitive strategy for understanding the competitive behaviour of companies, giving examples.
Porter??™s theory of competitive strategy is a very important managerial tool for analyzing companies??™ industry structure in strategic process. The competitive theory of strategy is shaped by five forces which Michael E. Porter has developed in his book ???Competitive Strategy: Techniques for Analyzing Industries and Companies??? in 1980.
These five forces are:
1. The bargaining power of buyers
2. The bargaining power of suppliers
3. The rivalry amongst the existing competitors
4. The threat of substitute products
5. The ability of new competitors to enter the industry.
According to Porter ???is the collective strength of the five forces that determines industry profitability???.
It is undeniable the fact that Porter??™s theory is a fundamental theory which, however, has been develop in the early eighties. So there are different opinions on how this theory is still applicable in today??™s industry markets. Seeing how this theory works in practice we can consider of an example.
Let??™s think of someone who wants to give up his job and start a new career as a farmer. He has always wanted to live and work in the countryside, so he decided to switch to a career where he can be his own boss. He applies Porter??™s Five Forces Model to examine the situation:
The Bargaining Power Of Buyers
* There are few, but very large supermarkets.
* The orders are very large.
* The price is extremely sensitive.
* Buyers??™ power is very high.
* The number of substitute products is big.
Conclusion: Buyers have the power over the farmers and they have a strong influence on the price??™s determination.
The Bargaining Power Of Suppliers
* The number of suppliers is big.
* There are many similar products that suppliers are willing to supply in the market.
* The switching cost for a company is high. (e.g. the company uses a specific product from a supplier)
Conclusion: The number of suppliers is big and the companies depend on them. So they have power.
The Rivalry Amongst The Existing Competitors
* There are many competitors in the market.
* The cost of leaving the market is quite high.
* Products??™ switching costs are low so customers can easily switch to a cheaper product.
Conclusion: This market is extremely competitive. This means that if somebody raises the prices, then they will be reduced quickly. Intense competition exerts downward pressure on prices.
The Threat Of Substitute Products
* Some cross-products substitutes.
* Potential technological changes which will allow to competitors to import food in the market.
* Possibility of buyers to switch their habits.
Conclusion: There is threat of substitution but not too big.
The Ability Of New Competitors To Entry The Industry
* It is not too expensive to entry this industry.
* It is good for companies to have experience before their entrance in the industry but they can be trained easily.
* The entry??™s barriers are low, so the entry it is quite easy.
Conclusion: It very easy for a new company to entry this industry and by doing this they will reduce the profits for the existing companies.
Overall Conclusion: Unless this situation changes, this industry is easy for a new company to entry but very tough survive. If he still wants to entry this market and starts a career as farmer, he has to find a business that exist in this market and have high shares of the market, so he can work for this company. But still he will not be his own boss.
Having considered the previous example, we can see that Porter??™s theory can be applied in simple markets like this one. But this is not enough, because in today??™s industries many things have changed since the eighties when Porter??™s theory for competitive strategy has been developed.
Porter??™s model developed in times where the markets were classic, stable and simple. The competition was strong and the developments were cyclical, in contrast with the industries in the 21st century that are complex, dynamic and with multiple interrelations. Another, very strong, characteristic of today??™s industries is the technological breakthroughs that happen almost every day. This characteristic, combined with the dynamic structure of industries, tends to change the business models that were in the past. Porter??™s model was made to analyze simple situations and predictable developments. So the five forces model could better be used on a later stage on this new situation, where things would be more static and simple than they would be on the start.
According to a financial analyst, Dagmar Recklies, during the last ten years Porter??™s ideas became subject of critique because of the developing ???Internet economies???. The development of Internet and other e-business applications have totally changed the economics conditions that were in effect on Porter??™s time. The analyst supports that ???Porter??™s Five Forces model cannot explain or analyze today??™s dynamic changes that have the power to transform whole industries???.
Another author, Larry Downes, also supports that Porter??™s assumptions are no longer viable in today??™s economies. In his article ???Beyond Porter??? he mentions that especially in our days, where information technology influences on markets, ??? it is not advisable ??“ if not to say impossible ??“ to develop a strategy on the basis of Porter??™s models.???
However Downes himself, in his article continues, saying, ???Michael Porter??™s ideas are not totally obsolete despite all the changes in industry dynamics and business models???. The central idea on Porter??™s theory is that businesses operate in a context where, there are buyers, suppliers, competitors, new companies that wish to entry the industry and of course substitutes. So, as a result his ideas are valid even today, in an economy based on competition, as it was in Porter??™s times. In old economies, companies??™ objective was to produce good and services, and sell them. Let??™s think of an example. Let??™s think of a business that manufactures furniture in an old economy without high competition and Internet??™s existence. Its objective is to produce furniture and sell them directly to buyers. In today??™s economies companies that use online applications have to produce or to buy the goods, to present them, to advertise them and finally to find buyers. Such company in modern market could be the Amazon. It is a company that operates international from the Internet and its sells products that first buys from the enterprises, which produce them. The Amazon Company sells the same products with other businesses but in a much lower price. This is a very important advantage that keeps the Company ???alive??™ and in the competitive market. In order to keep this advantage, Amazon Company operates in a Porter??™s five forces model framework.
To sum up, Downes Larry, characteristically reports, ??? Porter??™s ideas have become just one tool from the manager toolbox???. This tool is not the only one or the most important one. And as comes from the examples above, it is not obsolete either. However, new theories and techniques on how a company can be competitive are known from the managers and they add them too in their toolbox. Managers choose every time which ???tool??? they have to use in order the company to achieve its goals with the sufficient and effective way. To do the best choice they have to examine the micro (competitive) environment where the company belongs to, looking for opportunities and potential threats, as well as the internal environment to identify all the strengths and weaknesses the company has. (Management: An Introduction – David Boddy, fourth edition, Chapter 8, page 250)
Having considered all of the relevant factors, we conclude that Porter??™s model does not have the influence it used to have, anymore. Markets have changed structure and new situations are going on today. But this does not mean that Porter??™s theories are obsolete or invalid. This means that mangers have to know the limitations these theories have and they should use them in combination with new techniques in a context that best fits modern requirements.
i. Management: An Introduction ??“ David Boddy, fourth edition, Chapter 8, page 250
ii. How Competitive Forces Shape Strategy, Michael Porter (1979), Harvard Business Review, Vol. 57, Issue 2, pp 5-8
iii. Strategic Management, Dess & Miller, M c Graw-Hill (1993), pp 55-71
iv. Competitive Strategy: Techniques for Analyzing Industries and Companies, Michael E. Porter, 1980
v. Beyond Porter, Larry Downes , (article)