A critical review of Porter’s competitive strategy
Title: A critical review of Porter’s competitive strategy in relation to his five forces model in comparison to other perspectives.
“All men can see these tactics whereby I conquer, but what none can see is the strategy out of which victory is evolved.” Sun Tzu, Chinese General
Introduction
Strategy originates from military and warfare and according to Stephen Cummings; the word itself has its origins from the Greek word ‘stratos’ which meant ‘army’ (Cummings, 1993, pp 133 – 135). A number of ancient generals and scholars have defined the character of strategy. Some famous ones are Sun Tzu, the Chinese general in the 2nd century BC and Sextus Frontinus, the Roman general in the first century AD. Frontinus has defined strategy as “everything achieved by a commander, be it characterised by foresight, advantage, enterprise or resolution” (Cummings, 1993, pp 133 – 135). Another Greek military commander Xenophon very aptly defined strategy as “knowing the business which you propose to carry out” (Cummings, 1993, pp 133 – 135).
The importance of clear intent, seeking advantage over adversaries, objectives of survival and expansion, and utilisation of given resources with inherent strengths and weaknesses in a manner that successfully leverages the advantage, are as relevant to a business organisation as to military. Aligning resources to objectives to gain advantage to maximum limits requires strategic thinking. This process can be either logical or creative. Strategy formation itself can be deliberate or emergent.
Strategy operates at various levels and contexts. It can operate in a combination of business level, corporate level or network level in industry context, organisational context or international context (Wit and Meyer, 2004, p.14). There are diverse models on strategy and strategic management. However all models focus on the importance of aligning the dynamics of a business system to the dynamics of its environment for meeting its long-term objectives. The goal of strategic management is to gain competitive advantage.
According to Wit and Meyer, a business system is the configuration of resources (inputs), activities (throughput) and product/service offering (output) and this configuration is the cornerstone of gaining competitive advantage (Wit and Meyer, 2004 p. 231).
There are two broad models on business level strategy. One involves market orientation and the other is focussed on resources. One revolves around the outside-in perspective, while the other is inside-out perspective. Both deal with the ability of a form to acquire competitive advantage (See Appendix I and II).
One such prominent strategy model is Michael Porter’s Five Forces model. This assignment critically evaluates Porter’s Five Forces model and compares it with alternative models.
Sustainable Competitive Advantage
It is important for competitive advantage to be sustainable. But what exactly is competitive advantage and what makes it sustainable?
According to Wits and Meyer, “a firm’s has a competitive advantage when it has the means to edge out rivals when vying for the favour of customers” (Wit and Meyer, 2004 p. 244). Michael Porter argues that competitive advantage is sustainable “if it cannot be copied, substituted or eroded by the actions of rivals, and is not made redundant by developments in the environment” (Porter, 1980). Wits and Meyer interpret that sustainability is determined by competitive defendability and environmental consonance.
Porter’s Five Forces Model
The five forces model involves market orientation and is an outside-in perspective. The model proposes that the starting point in determining an appropriate competitive strategy is to understand two dynamic factors, (1) the long-term profitability that determines the attractiveness of the industry in which the firm operates; and (2) the position that a firm occupies within an industry vis-a-vis its competitors.
Porter concludes that neither all industries are equal in attractiveness, nor are all firms equal in achieving levels of profitability with in their respective industry. But these positions change and therefore cannot fully determine competitive strategy. On the other hand, a firm can actually shape both (1) the industry attractiveness as well as (2) its competitive position. By understanding of what he calls as the “rules of competition” a firm can create an effective competitive strategy that can alter the balance in its favour.
According to Porter, five competitive forces determine the rules of competition. These are:
The barriers to entry for new competitors
The threat of substitutes
The bargaining power of suppliers
The bargaining power of buyers
The magnitude of existing competition
As can be understood that all the above forces have a direct or an indirect impact upon how the prices and the cost that make up business operations within the industry. What’s more, the level of investment required by a new comer to get into the industry is also portrayed by these forces. The intensity as well as the importance of these forces varies from industry to industry. But irrespective of the nature of industry the collective strength of these forces “determines the ability of firms in an industry to earn, on average, rates of return on investment in excess of cost of capital” (Porter, 1985). For example, for an industry with low entry barriers, the magnitude of competition will be higher. Similarly, availability of substitutes deflates the price within the industry. Bargaining power of buyers brings down prices and as a consequence the margins for firms within the industry. Bargaining power of the suppliers has a direct impact on cost and availability of raw materials. For an industry, which is intensely competitive, the margins once again come under pressure. The UK supermarkets are clearly operating in an intensely competitive industry albeit with a certain degree of control over their suppliers. However, this is not entirely true for the airlines industry, which is not only highly competitive, but also has a low control over its suppliers, especially for its most important raw material – the petrol prices. Therefore the pressure is on both ends – the cost as well as the price.
Each industry has certain economic and technical features that make up its structure. Industry structure is susceptible to change over a period of time. It is important for a firm to understand the factors that could change the industry structure. It is this understanding that can enable a firm to build an effective competitive strategy that can alter the structure of an industry. Porter argues that a successful strategy is the one that can alter the rules of competition to create a position of advantage for the firm. He states that the merit of the five-forces framework lies in the fact that it “allows a firm to see through the complexity and pinpoint those factors that are critical to competition in its industry, as well as to identify those strategic innovations that would improve the industry’s – and its own – profitability” (Porter, 1985).
A strategy has a potential of altering the industry structure in a negative manner as well. It can bring about price sensitivity, competitive backlash or lowering of barriers that protect the industry and ensure its profitability. A good example of this is the low-cost airlines where pricing is treated as the strategy.
‘Smart’ companies take a long-term perspective while making strategic choices, so as not to destroy the industry structure. Industry leaders whose strategic choices can easily alter the industry structure, due to their size and bargaining power, are sensitive to the fact that an altered structure can have a negative impact on the firm’s own growth therefore a leader needs to show an approach that protects the industry structure, rather than destroy it.
The importance of industry structure
Two key areas are touched by industry structure. These are:
Buyer needs, and
Supply/demand balance
Buyer needs: Serious firms treat the task of satisfying buyer needs as their core objective. The effort is always to create value for their customers. However, industry structure determines how profitable this effort turns out to be. For instance, two industries that create an equally high value for their customers may have different returns. Entry barriers, threat of substitutes, bargaining power of buyers and suppliers as well as intensity of competition, all these forces influence industry profitability vis-a-vis customer value creation.
Supply/demand balance: This also has an impact on the industry profitability and at the same time is influenced by industry structure in the long term. Entry and exit barriers exert influence as also capacities. For example, in some industries, even a little excess capacity can lead to price wars and therefore lower the profitability. This is being witnessed in the airlines industry.
Competitive strategies
The objective of understanding industry structure lies in the need to build a sustainable competitive strategy which results in a position of advantage relative to its competitors. The starting point is in value chain analysis that helps a firm to determine the activities which contribute to creating superior value. The goal is to achieve profitability higher than the industry average.
Porter argues that based on this analysis, a firm can have one of the three competitive strategies:
Cost leadership – by which a firm leverages its scale to bring down the cost of doing business and then passes the benefit to its customers. This is achievable only for firms that display one or more of such features – (1) they operate on a large scale, serving multiple segments and perhaps even operating in complementary industries; (2) have proprietary technology; (3) have “preferential access to raw materials” (Porter, 1985). What’s more, cost leadership advantage is not at the expense of differentiation and is pursued by seeking cost advantage from multiple operational areas such as marketing, finance, human resources, in addition to production and supply-chain. Porter states that “a cost leader must achieve parity or proximity in the basis of differentiation relative to its competitors o be an above-average performer, even though it relies on cost-leadership for its competitive advantage” (Porter, 1985). An example is Tesco.
Differentiation: This strategy is aimed at achieving uniqueness on attributes that determine consumer preference. According to Porter, this strategy can emerge from product differentiation, distribution system, and/or marketing approach. This allows a firm to charge premium price and can result in a loyal customer base. However care must be taken that the premium price is more than the cost of differentiation as well as is sustainable in long run. Once again, pursuing this strategy does not mean that a firm can ignore the cost element, which is a vital contributor to its bottom-line. An example of this could be Waitrose.
Focus strategies – cost focus / differentiation focus: These strategic choices are for firms with narrow target segment. These are achievable only if the “target segments “either have buyers with unusual needs or else the production and delivery system that best serves the target segment must differ from that of other industry segments” (Porter, 1985).
These are generic strategies across industries and the manner in which these are executed also varies for different industries.
Internet and the Industry Structure
In recent times, Michael Porter’s five forces model has expanded in scope to include internet and its influence industries. In his article “Strategy and the Internet” published in Harvard Business Review in 2001, Porter argues that Internet “tends to influence and alter industry structures in ways to dampen overall profitability, and it has a levelling effect on business practices, reducing the ability of any company to establish an operational advantage that can be sustained.” He states that the seemingly low cost of doing online business is actually artificially depressed as it does not account for many key activities such as inventory and warehousing which are needed to deliver value to the customer. But he also determines that internet has increased the possibilities for firms “to establish distinctive strategic positionings” that traditional information technology tools could not offer. He concludes that including internet offers a new dimension to a firm’s operations and is unavoidable as a tool in carrying out business. But if real economic value is to be created then internet initiatives must be integrated with the traditional competitive strategy as “internet per se will rarely be a competitive advantage” (Porter, 2001).
Alternative model: Strategy from inside-out
This perspective is exactly opposite to Michael Porter’s Five Forces model. Models based on this perspective are focussed on internal strengths and capabilities for devising a competitive strategy rather than scouring external opportunities. The starting point is an assessment of firm’s resources or competences that have been acquired over a period of time. What’s more, if one such resource is not existing within, then how to acquire it? Market positioning is sought in alignment with a firm’s resource based strategy. “Selected market positions must leverage the existing resource base, not ignore it….for success resources should be leading and markets following” (Wit and Meyer, 2004, p. 252).
Two main models have been proposed by leading practitioners of management:
Competence based view; and
Capabilities based view
This viewpoint does not consider just physical resources, but also intangible resources or competences that get uniquely composed within an organisation during its operational span. These could vary from competence in Internet-driven supply-chain management to offline quality process. Firms seeking leadership position make sure that its core competences or capabilities are upgraded on a periodic basis so that competitive advantage is maintained. This is termed as the dynamic capabilities view (Teece, Pisano and Shuen, 1997). It is emphasised that a firm needs to take a long-term view of its competences and take all actions to strengthen these competences. This perspective does not advocate an ad-hoc approach that results in building up of unrelated competences.
On the flip side, the challenge is in dismantling of existing competences and building of new competences as market demand changes. One good example of this is the mass-production mastered by American automobile companies could not be transformed swiftly into lean production practiced by Japanese firms such as Toyota, leading to erosion of market share and competitive advantage for giants such as General Motors and Ford. “…companies experience that that their core competences can be their core rigidities, locking them out of new opportunities” (Leonard-Barton, 1995).
The perspective is further refined by Miller, Eisenstat and Foote (2002) as they propose the terms “asymmetries” and “capability configurations.” According to them, a firm’s asymmetries are it’s “skills, knowledge, processes relationships, proper ties, or outputs an organisation possesses or produces that its motivated competitors are unlikely to acquire or copy in a cost or time-effective way” (Miller et al 2002). However these can be of disadvantage to a firm unless “carefully fostered and directed….by leveraging them via an appropriate market focus, companies may be able to aspire realistically to attain competitive advantage” (Miller et al 2002). This is the essence of “capability configuration” which is a system of reinforcing elements incorporating core capabilities and the organisational design infrastructures…” (Miller et al 2002). They argue that the development process of inside-out strategy is emergent and iterative in nature and is characterised by trial and error. Three imperatives suggested by them for deriving sustainable competitive advantage out of an capabilities model are that firms need to: (1) “discover asymmetries and their potential”; (2) “create capability configurations – by design”; and (3) “pursue market opportunities that build on and leverage capabilities” (Miller et al 2002).
Conclusion
Both perspectives have their supporters. It is for a firm to decide the perspective that it wants to take for building its competitive strategy. It is suggested that the inside-out perspective has more depth. The argument is that although market-orientation and ability to capitalise on external opportunities are critical factors in a firm’s success, both (1) market-sensing and (2) customer-linking are distinctive capabilities that get cultivated within a firm over a period of time (Day, 1994). At the same time, Barney (1991) argues that resources become the foundation of competitive advantage only once they meet four conditions. They should be “(1) valuable, (2) rare, (3) difficult to imitate, and (4) difficult to substitute” (Barney, 1991).
Appendix I: Outside-in versus inside-out perspective
Outside-in perspective
Inside-out perspective
Emphasis on
Markets over resources
Resources over markets
Orientation
Opportunity driven (external potential)
Strength driven (internal potential)
Starting point
Market demand and industry structure
Resource base and activity system
Fit through
Adaptation to environment
Adaptation of environment
Strategic focus
Attaining advantageous position
Attaining distinctive resources
Strategic moves
External positioning
Building resource base
Tactical moves
Acquiring necessary resources
External positioning
Competitive weapons
Bargaining power and mobility barriers
Superior resources and imitation barriers
Source: Wit and Meyer, 2004, p.255
Appendix II
References:
Barney, J.B. (1991); Firm Resources and Sustained Competitive Advantage; Journal of Management, Vol. 17, No. 1, 1991, pp.99-120
Cummings, S. (1993); Brief Case: The First Strategists; Long Range Planning, Vol. 26, No. 3, June pp. 133 – 135
Day, George S. (1994); The Capabilities of Market-Driven Organisations; Journal of Marketing, October 1994, Vol. 58, No. 4, pp. 37-52
Leonard-Barton, D. (1995); Wellsprings of Knowledge; Harvard Business School Press, Boston, MA
Miller, Danny; Eisenstat, Russel and Foote, Nathaniel (2002); Strategy from the inside out: building capability-creating organisations; California Management Review, Vol. 33, No. 3
Porter, M.E. (1980); Competitive Strategy: Techniques for Analysing Industries and Competitors; New York: The Free Press
Porter, M.E. (1985); Competitive Advantage: Creating and Sustaining Superior Performance; New York: The Free Press
Porter, M.E. (1996); What is Strategy’; Harvard Business Review, Vol. 74, No. 6, November-December, pp. 61-78
Porter, M.E. (2001); Internet and Strategy’; Harvard Business Review, March; accessed from Harvard Business Publishing online http://www.hbsp.harvard.edu/hbsp/index.jsp
Prahalad, C.K. and Hamel, G. (1990); The Core Competence of the Corporation; Harvard Business Review, Vol. 68, No. 3, May-June, pp. 79-91
Teece, D.J., Pisano, G. and Shuen, A. (1997); Dynamic Capabilities and Strategic Management; Strategic Management Journal, Vol. 18, No. 7, August, pp. 509-533
Wit, Bob De and Meyer, Ron (2008); Strategy: Process, Content, Context – An International Perspective; Thomson, 4th Edition
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