Contemporary relevance of Porter’s Five Forces to corporate strategy
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Porter's Five Forces introduced back in 1979 by Michael E. Porter from Harvard University in his first book "Competitive Strategy". It becomes international best seller, and considered by many to be a definitive work on corporate strategy. The book itself had been published in nineteen languages and re-printed almost sixty times, changes the way business leaders thought and remains a guide of choice for strategic managers the world over. It has become an important tool for analyzing an industry structure and strategy process [Morrison M., 2008]. Porter's work has had a greater influence on business strategy than any other theory in the last half of the twentieth century [referenceforbusiness.com]. The tool provides a simple perspective for assessing the position and competitiveness of a corporation or business organization within the industry. Porter points out five forces which the upturn and downturn, will affect the profitability and existence for a corporation or business organization.
Business leaders and managers might be interested in this paper for the purpose of this paper is to discuss the contemporary relevance of Porter's Five Forces to corporate strategy. An attempt also being made to find what is missing from this model related to corporate strategy in current business environment. In so doing, a comparison will be made between Porter's Five Forces and another tool for corporate strategy. Another assessment made concerning the business environment in Porter's era and current business environment.
Porter's Five Forceshttp://wiki.telfer.uottawa.ca/ci-wiki/images/e/e4/Porters.gif
The development of this framework is based on the idea of attractiveness of an industry. As for the attractiveness itself, is determined by the profitability within the industry. More profit means the industry is more attractive and low profitability means a low attractive industry. The way of thinking in the model is to achieve a better competitive position against other players. The competitive advantages developed from strengthening the own position within this Five Forces. The Five Forces framework is based on microeconomics. It considers supply and demand, substitutes and complementary product, and the relationship between production volume and cost of production; also the market structures such as monopoly, oligopoly, or perfect competition.
Threat of new entry
The chances in which new competitors can enter the market and drive the current players' price down. The threat to entry depends on six major forces of barriers which Porters describes as: economics of scale, product differentiation, capital requirements, cost disadvantages independent of size, access to distribution channel, and government policy. The decision of the new-comer also pretty much influenced by their expectation on the existing player. If the incumbents known for previously fought vigorously to new entrants, or possess such substantial resources to fight back (such as excess cash, unused borrowing power, available productive capacity, or clout with distribution channel and customers), the new entrants will likely to have second thought on entering the market. This also happened if they know that the incumbents seem likely to cut the prices. New entrants fear more also when the industry growth is so slow so that newcomers can gain volume only if they take it from the incumbents.
Bargaining power of supplier
Another force Porter mention in the model is how powerful the supplier to drive up the prices of is corporate input. The term supplier includes all sources of input that are needed to provide the product. A supplier of group is powerful when it is dominated by few companies and more concentrated than the industry it sells to. The products are also differentiated or unique - means relatively no substitutes for the particular input - so that it built up the switching cost. The power of supplier also increase when there is a possibility for the supplier for integrating forwards in order to obtain high prices or so. Also when the industry is not an important customer of the supplier group or when it is not obliged to contend with other products for sale to the industry.
Bargaining power of customer
Similarly, bargaining power of customer settle on how powerful is the customer can impose pressure on margins and demands. Buyer are powerful if it is purchase in large volumes and/or the product it purchases is standard or undifferentiated, means they can always find alternative suppliers. Customer will also become more powerful if the products it purchases from the industry form a component of its product and represent an significant fraction of its cost, in other words, the customer become more price sensitive. Furthermore when they know that the company earns low profits, which create great incentives to lower its purchasing cost; and when the industry's product is unimportant to the quality of the buyers' product or services, then the bargaining of customer increase. More threat comes from the possibility of the customer to integrating backward and has the ability to produce the product themselves. Another factor mentioned by Porter is that customer will be more prices sensitive when they recognize that the industry's product does not save the buyer money. He gave an example of logging of oil wells, where an accurate survey can save thousands of dollars in drilling costs, therefore affect the market price.
The extent of which substitute product can be used in place of one product. Porter highlighted the characteristics of substitute products that deserve the most attention as those products that are subjects to trends improving their price-performance trade-off with the industry product or are produced by industries earning high profit. Porter also said that substitutes come into play when the competition within industry increases which lead to price reduction or performance improvement.
Jockeying among competitor for position within industry
This factor describes the strength or the intensity of competitiveness among the existing players within the industry. High rivalry limits the profitability of an industry. Factors that shape the intense rivalry in a industry are: (a) payers are roughly equal in size and power (b) the growth of the industry is slow, precipitating fights for market share (c) lacks of differentiation and switching cost of the products (d) strong willingness to cut the price either because the fixed cost are high or the product is perishable (e) high barriers to exit the industry (f) capacity is normally augmented in large increments, and (g) diversity of strategies, origins, and "personalities" of the rivals. Other than the intensity, the dimension basis in which the rivalry takes place also reflects the strength of the rivalry such as price, products features, support service, delivery time, and brand image. Whether the competition takes place in the same dimension, or the rivals converge to compete on same dimensions.
"What do you want to achieve or avoid? The answers to this question are objectives. How will you go about achieving your desire results? The answer to this you can call strategy."
William E Rothschild, Former General Electric Corporate Strategist, CEO of Rothschild Strategies Unlimited LLC
Corporate strategy is about how a firm or business organization should make a decision of series of steps to achieve the desired goal. To create the best decision, the decision maker must be able to analyze the current and expected factors associated with internal as well as external environment. With strategy, one company can be more prepared and comfortable to operate on the market, because good strategy should have examined all the forces involved in business activities. Strategy planning can be developed in three levels, which are: company level, business unit level, and functional or departmental level [Morrison M., 2008].
Corporate strategy ƒ¨ concerned with overall purpose and scope of the business to meet stakeholder expectations. This level of strategy concerned with the selection of business in which the company should compete and with the development and coordination of the portfolio of business. This is a crucial level since it is heavily influenced by the investors in the business and acts to guide strategic decision making throughout the business. Corporate strategy is often stated explicitly in a "mission statement" along with the formulation of visions and goals. It also decide on how business unit to be governed; through direct corporate intervention (centralization) or through autonomous government (decentralization). Corporate strategy also seeks to developed synergies across the business units.
Business Unit Strategyƒ¨ is concerned more with how a business competes successfully in a particular market. It concerns strategic decision about choice of products, meeting needs of customer, gaining advantage over competitors, exploiting or creating new opportunities or market, etc. The strategic issues is about developing and sustaining a competitive advantage for the product and service that are produced.
Functional or Departmental Strategy ƒ¨ the strategy level of the operating divisions. It is concerned with how each part of the business is organized to deliver the corporate and business unit level strategic directions. The functional units translate them into discrete action plans that each division must accomplished for the strategy to succeed. Operational strategy therefore focuses on issues of resources, processes, people, etc. Functional units involved in higher level strategies by providing input into the business unit level and corporate level strategy, such as providing information on customer feedback.
Business environment in current era
Current business environment much likely to be characterized by more dynamic market situation. The digitalization and globalization contribute to this dynamic movement. The power of information technology (IT) grows more and more each day. And as it grows, all players in the market can have access to more information. "The world is flat", globalization made great improvement in distribution of logistics and communication, enable all business to operate globally. Meanwhile, the customers have the chance to shop also on a global level, and compare the prices globally.
The trends and demand now changed as the increased commoditization in so many areas. Companies now must be able to differentiate themselves by give more value for their products. One way to do that is by improving customer experience, through the improvement in the service area. Customers now want individual service and attention, and have high expectations for the goods and services they buy.
Other tools for corporate strategy
David P. Baron nonmarket approach: 4Is
Business environment consist of market and nonmarket environment. An effective corporate strategy must be able to facilitate both market and non-market goals of the company. In relation to this, Baron introduced his 4Is, with emphasis on non-market environment. This framework together with Porter's Five Forces formed the integrated strategies.
The nonmarket environments are social, political, and legal setting that affects the interaction of the corporation outside and in conjunction with, the market environment. Barons define the characteristics as four I's. The first is Issues, of what nonmarket strategies address. Issues in nonmarket environment cover the regulations, proposed laws, court judgments, etc. Second is set of relevant institutions for the particular industry. Regulators or government is usually always become the relevant official body that affect a corporation decision making process. NGOs are also another example of institutions. Interests are individuals and groups with preferences about the industry. Baron includes this factor to address the identity and goals of those with a stake in the issue. Also information concerning with what the interested parties know or believe about the relation between actions and consequences and about the preferences and capabilities of the interested parties. This factor let us to think, what info needed to reach the goal? what is persuasive for the other parties? Prejudices, rumors, state reports, almost all public relations stuff is included in this factor.
SWOT model ƒ¨ covering external and internal forces
Another tools being used for corporate strategy is SWOT. SWOT models addressing the internal and external forces. The Strength defines what characteristics impose by a company that can be used to keep hold on the market or even expand it. Weakness is really the opposite, this factors is any kind of lack the company has that can affect its existence in a bad way. Both strength and weakness is internal factors. Meanwhile, the external factor is covered by the Opportunity and Threat. Opportunity discuss about all issues or current condition of the environment that can give a better chance for the company to improve the operation. The threat talks about all threatening situation from the environment in which the company operates. More of this are, opportunity and threat, be explored more in Porter's Five Forces model.
Contemporary relevance between Porter's Five Forces and corporate strategy
Any organization, especially ones dealing with corporation or business environment realize that their success depend on both internal and external factors. With his Five Forces, Porter tries to emphasis on the most important or most influencing forces to the business profitability and existence. The competitors, the new entrants, new substitute, also the bargaining power of both supplier and buyer covered most aspects of a business activity. Indeed, Porter's Five Model focuses heavily in competitive strategy, which is essential. To be specific, the Five Forces, mentioning competition, are related more to analysis of external forces from the market environment of the strategy.
Of course, all business organization will always seek the best way to maximize corporate profit and determining the attractiveness of an industry. This is a need that will always be in manager's mind in every industry, from every era. Therefore, through his model, Porters tries to give a framework that can help the decision maker to create a strategy where enable the company to stay in the market, defend their current position, and even grow the market size. It supports the decisions about to enter or to exit from an industry or market.
As a business leader, it is important to understand the competition in the industry. The model can be used to compare the impact of one competitive force on our own company and to the impact on the competitors. With the knowledge of power and intensity of competitive forces, the strategy can be developed in way that gives the company options to influence the forces to improve their own position, such as new positioning or differentiation of product. It also gives the details on how to prevent the new entrants. Not only new entrants, the strategy should be able to cope with the substitute product that is getting more and more accessible now for the customer. Bargaining power of supplier and buyer is more relevant to supply and demand. It is essential to know which side of supply and demand equation our business is referring to. The framework tells us how profitability can be affected, in good way and in bad way from the context of industry rivalry and competition. It creates to position the firm to leverage its strengths and defend against the unfavorable effects from the five forces.
Generally speaking, the model talked about the profitability and survival of a company. Referring to the definition of corporate strategy, Porter's Five Forces seems irrelevant. Corporate strategy designs the grand strategy for the company grand purpose. And almost no company has a mission statement for to be 'the most profitable' or so. Most company longing for sustainability; to be able to hold on success for a long term period. They achieve this by creating more value through their business, managing portfolio business, and developing business units; things that we don't learned through Porter's Five Forces. Profitability is just one way to get to the grand purpose. That is the reason why, for the grandiose strategy of a company, to be based on only Porters that is focus on profitability, is unadvisable. The strategy such as focus and differentiation for competitiveness can be implemented at business unit level strategy to create competitive advantage. It may be relevant in corporate level as for the interest of stakeholder, indirectly. When the business unit strategy is achieved the desired goal, which most likely to be more profit, this is also will considered as favorable by the investors. Corporate strategy also concerned about the development and coordination of portfolio of business. The complexity that portfolio has cannot be found in the Porter's model. Multi-variance product, multi-company in different industries, all this density of current market environment made Porter's Five Forces become less practical.
Other relevance is the dimension of competition. It is something that decided at the corporate level. Porter's mentioning that based on the competitive advantages, we must choose the dimension of competition and it is best to create a battle field in that dimension, not in other dimension. This is about knowing our company competitive advantages and where to compete and win over the rivalry.
What others are missing?
Porter's Five Forces did not describing the other external factor like regulator and social environment of the company. Porter's Five Forces made based on the economic situation on the eighties. During early eighties, the economic situation is more stable and predictable development in industries compared to today dynamics. It is also characterized by cyclical growth and also by strong competition [D. Recklies, website]. Thus, in Porter's era, the main objectives of many business organization or corporation are profitability and survival. Porter's model focuses on analysis of the actual situation of company's customers, supplier, and competitor; and predictable development from new entrants as well as substitutes. Global and networked markets, as mentioned previously, force the business players to think more in the corporate strategies. Now, it is not enough to only position oneself as a price-leader or quality leader. Competitive advantages now comes from the ability of the company to develop a way to maintain the relationship with more mobile customer and also to manage the networks that could be located in other part of the world. Porter's Five Forces treats customer and supplier as third parties, which they no longer are. Corporate, suppliers, and customer now have extended relationship. And how this relationship managed is not less important than competitive advantages, because it creates values which harder to obtained and maintained than profits. This side of Porter's Five Forces, lack of value-adding analysis made Porter's Five Forces is less applicable in corporate strategy.
In addition to that, in spite of always strengthening position within the industry with competitive advantages to compete against the competitor, co-operation with competitor by mergers and acquisition is also one way to maintain the existence and survival of a business organization. Hence, this model cannot keep up with dynamic situation in the current business environment.
Globalization and digitalization
Porters did not include how technology developed and that it is a strong force on competitiveness. Whereas, Porter did not explicitly mention it as a force, but it IS there. New entrant and new substitutes could mean that the competitor could have innovations background. New machines can affect the bargaining power of supplier too, in example. Not to mention how information spread unbelievably fast, and wide, around the internet. Experts coined the term of 'internet economy' for this decades in which internet have been so embedded in everyday life. Various e-business applications have strongly influenced almost all industries. The development of the information system gives new opportunity for players from outside industry to chance the basis of competition in a market. Porter did not mention how technology will affect the competitiveness. The difference is that on Porter's era, technology is something more like a tool to implement the change. But now, with its more rapid growth compare to eighties, technology has become a most important driver to a change.
Needless to say, nonmarket environment, as brought up by Baron, also one important forces that must be considered in crafting the strategy. Any kind of corporation or business organization must dealing with social, politics, and legal arrangement, directly and indirectly. Of course, Baron extended work from Porter's Five Forces expected to be able to give the best model to develop the so-called integrated strategy.
Dynamic market structure
Porter's model assumes relatively static market structure. Yet, today's market is far from static. Dynamic market entrants, supported by more technological breakthrough, may change the entry barriers, the business model within short time. The model also assumes that all companies always try to get competitive advantages and win over other player in the industry. The dynamic market structure have new way of thinking of survival than to compete and kill each other. It is designed to analyze individual business performance. It is not considers strategies such as synergies and strategic alliances (mergers, acquisition), electronic linking of information system of all companies along a value chain, virtual enterprise-networks or others [D. Recklies]. This model also cannot assist the more complex structures of industries. The analysis cannot cope with multiple group products, by-products, and segments. And narrowing the focus only in one industry is too risky in today's corporate strategy. This model also not yet considering that sometimes it may be possible to create new market than compete in the existing market.
Nevertheless, later in his paper on 2008, he includes how technology is one factor that can greatly affect competitiveness and rivalry in an industry. Not only had that, he also included other factors such as government and complementary product that can affect the company's profitability. In this paper, he also mentioned how a change in industry structure shifts each of the five forces.
In general, Porter's Five Model has some limitation in today's market environment application and on its relevance with corporate strategy. In relation to corporate strategy, Porter's model might be a little help for defining in which dimension or market out company wants to operate, although this dimension might be converted again once the strategy derived to business unit level. However, with all the lack Porter's Five Forces had, the model is not completely obsolete to current business. Porter's is an economist, so the model is basically the simple way of how he describes the microeconomics. He describes the attractiveness of the industry that is influenced by the five forces. This is also explains why the model always repeat and focusing more in profitability; for economics talks about profit maximization. Even now, business still operates in five forces framework describes by Porter. The model enable the decision maker, the managers, to think about the environment surrounding their industries in a structured way, easy-to-understand way as a starting point for further analysis.
In summary, while Porter's Five Forces seems less reliable concerning the current competitiveness in the industry (in terms of technology or innovations involvement), it is still manage to help strategic focus of the company in profitability and survival within the industry. The models assist more in business unit level strategy and less applicable in corporate strategy level. Corporate level strategy talks more about value which we hardly find in the Five Forces. Yet, indirectly the success in business unit level strategy supports the achievement of corporate strategy.
Porter's Five Forces is still relevant to current strategy planning, yet today business players must considered more things such as the growth of globalization and technology and how it will affect the other factors, if not creating its own forces. The tremendous growth of technology nowadays can't be separated in any aspects of life, and that including corporate strategy. However it might be, technology leads to innovation which will influence the every step a company have to defend its market and even expand its market. Certainly, a corporate strategy should not be carelessly made without take note of the non-market environment. In addition to that, examination on the nonmarket environment also should be conducted to support the strategy on market environment of a company. Another kind of analysis also may be needed to examine the dynamic state of markets. Porter's framework becomes one of the tools in developing a strategy, maybe as a starting point, but not the most important or the only model being used. A good strategy never should use only one or few model as a basis.