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In the first essay, Michael Porter's five competitive forces were introduced and were used to analyze the environment of the banking industry in Tanzania.
This essay is about examining the five force's viability in today's technological business era. It will look at the three generic strategies introduced by Michael Porter as a solution for the firms to compete in their industries. The essay will then compare on the uses or benefits of the five forces framework and the strategies and also the downside or limitations of these forces. Finally there will be conclusion stating whether the model is applicable to today's business environment.
The essay begins with a brief reminder of the five competitive forces and then explores the viability or feasibility of these forces in today's rapidly changing environment which is the aim of this second essay.
As introduced in essay one, the five competitive forces were introduced by Michael Porter in order to examine the attractiveness and profitability of various industries in the market. In his book Competitive Strategy: Techniques for analyzing industries and competitors (1980), Michael Porter pointed out that any industry is surrounded by five main elements and their collective reaction affects the profitability of that business namely Threats of new entrants, Threats of substitutes, Bargaining power of the buyers, Bargaining power of the suppliers and the overall rivalry or competitiveness.
Once the firms have analyzed their business environment, they could use the generic strategies introduced by Michael Porter to create a competitive advantage and also compete successfully within their respective industry.
Let us now look at these generic strategies and also how banks apply them in their daily operations. The below is a diagram that summarizes these strategies:
Michael Porter's Three Generic Strategies:
Source: Michael.E.Porter, (1980) Competitive Strategy-Techniques for analyzing industries and competitors.
The Cost-Leadership Strategy
This is a business level strategy in which a business is the lowest-cost producer in its industry. It tries and keeps all its overhead expenses at a minimum and the firm does everything to cut down costs. An example of banks, they can apply this strategy and reduce some of their costs by providing services based on charging low premiums like customers opening accounts with minimum deposits and the also by the usage of new technology can reduce other administrative costs like storing all the relevant data in the software used instead of using papers and files. This strategy targets the broad market or all the customers. Various banks like US bank of America, Bankers Trust Corporate, Chemical Bank, Chase Manhattan Bank, Citibank, Morgan Guaranty Trust Corporation and Wells Fargo use this strategy in giving loans to their corporate customers and they compete with one another with the interest rates charged. (Anon, 2011)
A firm differentiates itself from its competitors by providing something unique that is valuable to customers. (Musika et al, 2008) Here the firms give the customers a different product or service than provided by its competitors. For example banks providing different facilities to its various customers like loan, credit or over-draft services which is different from other banking institutions, it might add a little more services that help the customers track their transactions. The banks introduce various innovative and diverse products and services to make themselves different from their fellow banks. Another example could be the introduction of Visa cards. In Tanzania this facility was not there before but just started recently. This also is a business level strategy that is directed at all the customers.
As Michael Porter (1980) pointed out that this generic strategy is focusing on a particular buyer group, segment of the product line or geographic market. In other words it is a combination of a cost-leadership and differentiation strategy. It simply means focusing on a small segment or a niche market or product like banks focusing the retail customers only or corporate customers only. Many banks provide special accounts for students who are studying so that they could save for their education, small children who are growing up and who are taught about savings and also women who have various responsibilities like the Exim bank (T) limited introduced Tumaini account especially for working women to help them save money. Diamond Trust bank (T) limited has a Junior Jumbo account for young children. It can either be a cost-focus strategy or a differentiation-focus strategy targeted on a narrow segment.
All the three strategies are related to business level. The managers or the people holding authority in the business decide on what strategy to pursue so as to create a competitive advantage in the market. According to Michael Porter, most firms use either one of these strategies or combine them together to create a position in the market at large.
Let us now look at the benefits of the five forces and the generic strategies provided to the firms in the industry:
USES OR BENEFITS OF THE FIVE FORCES FRAMEWORK :
The information gathered by the five forces analysis can help the firms in their corporate planning strategies like these forces provide statistical analysis. Using the framework, various firms and their competitors are taken into account and hence the firms conducting the analysis get a good deal of information on the activities taking place in the market. The analysis provides an idea on the attractiveness and profitability of the business. It helps the firms to decide whether to enter or exit from a particular industry. For example the banks use this framework to know the performance of all the financial institutions and see where the customers are more demanding and introduce strategies so as to take advantage of this situation.
The information from the framework provides the firms with various choices from which they can know which force is in their favor and which is not and thus they can create a strategy which can give them advantage in having a competitive position in the market. So in simple words, the five forces give the managers different options.
It also provides the firms with a dynamical analysis so as to determine the changes that might take place in the future. They could view the external environment and the five forces together and can get the direction of what might change in the competitive forces.
Also the application of the fives forces helps the firms in getting information on how are different competitors affected by these forces. All the firms within the industry are different and are affected differently. Some firms are of large size and capital while some are small or medium and so their industry structures are not same. Just like in banking industry there are retail banks, corporate banks, and Western unions. The industrial analysis conducted could uncover these affects and so the firms could have strategies to continue to exist in the market.
(Johnson et al, 2009)
Another benefit provided by the five forces is that they provide the firms with an understanding of sense of competition and then to look for a way to develop a strategic position in the market relating to the firms concerned. Hence it will be known what or which force is in favor of whom and solutions could be found to guide the firms accordingly. Again the banking industry can give us a good example, as the banks corporate customers possess some degree of power; the banks offer them various services like temporary loans or overdraft facilities with good rates so as to lessen the power.
USES OR BENEFITS OF THE GENERIC STRATEGIES:
The cost-leadership strategy leads to the firm producing and also offering products at minimum prices and hence increases the market share in the industry. This strategy is widely used by various financial institutions; they open various branches at different locations so that they can reach many people and hence get a good deal of market share.
The firms can also achieve economies of scale as it would be producing in large quantities so as to avoid the unit costs.
The differentiation strategy helps the firms in the industry to produce good quality products that are valued by customers and hence increase customer base.
It also creates awareness among the customers for products which are different from that offered by everyone in the industry and thus creates a good image or reputation.
The Focus strategy helps the firms to identify a niche market from the whole big market and the firm can then specialize to serve that segment creating its own competitive position.
(Musika et al, 2008)
Apart from the benefits it provides, Porter's competitive forces and the strategies have limitations on the other hand. Many scholars have criticized the model as per their research findings. Let us now look at these limitations and see whether the framework is practical or not. The following are the downsides of these competitive forces and strategies:
LIMITATIONS OF THE FIVE FORCES AND GENERIC STRATEGIES:
It does not define the right industry. It takes industries as a whole while there are segments involved to make a whole industry. For example in the banking industry, there are segments like the normal banking services involved in the country and those associated with outside the country and also there are different customer segments like retail customers and corporate customers. So these forces are likely to act differently in these segments and Michael Porter's forces did not consider this.
The Converging industries are also not considered in the framework. Nowadays due to the scientific and technological era, many industries seem to converge or overlap each other where earlier they used to be separate. So when conducting the industrial analysis, this matter is not taken care of in the model. Hence it limits the firms in their proper information gathering. Here again we can take example of the banks, nowadays all the banks have IT systems that help in converging many of its activities like branch communication, customer queries.
The competitive forces model has one force that talks about the substitute goods, but it does not take into account the other category of goods or services called the complementary goods. These goods or services are those that can be used together than separate. Hence when carrying out a competitor analysis, the complementary products should also be considered. The firms in the industry might consider conducting business with those firms providing complementary services like banks and the DHL or FedEx services.
(Johnson et al, 2009)
The basic idea from the model was to create a strategy that helps firms to compete in the industry. According to Michael Porter it seemed that the main aim of the business was competition but this is not true. There are many other objectives of the firms apart from competing with each other. Some business give high attention to customer service, providing quality products, maintaining economic stability by creating job opportunities.
According to Adam Brandenburger and Barry Nalebuff in their 1990's research, they found out that the firms could make use of their concept of game theory to come to create the strategies that will help them in their firms. Unlike the Porter's forces, the game theory includes two main parts of co-operation and competition which are both necessary and desirable in conducting business. The Porter's model just concentrates on competition. (provenmodels.com, 2005). Nowadays many firms join together to form mutual partnerships like they form strategic alliances, joint ventures so as to eliminate unnecessary competition and also benefit from each other's resources.
Another group called Sylloge Corporation, an Indian marketers group criticized the five forces framework saying that they provide the strategic options and not the exact strategies to be followed. (Wikipedia.org,2010) According to this statement, it means that the model tells the industries involved of the activities taking place and their outcomes but it does not show any solution or direction that the firms in these industries might want to follow. In other words, we can simply say that the model tells the concerned parties about the problem but it does not give an answer to that problem.
The competitive forces have many assumptions involved while in today's era, these assumptions no longer apply. It assumes a static market structure. When Michael Porter discovered this framework in the 1980's, the market was stable and one could easily foresee the trends in various industries but today this is not the case. In today's era many new technological development causes the business environment to change and so do these forces. A very good example is how the introduction of internet banking has had an influence in the banking industry; it has changed the degree of power from one force to the other. With technology any player can get into the industry virtually and also reach a large market at the same time. Other changes that the internet seems to have created might be the change from economies of scale to altering rules of competition. With Information technology small players in the market can create a competitive advantage as they possess the knowledge of applying the technology.
With the internet banking, the banks are no longer the gatekeepers but they act as gateways to the financial products. The customers can easily log in to a bank's website and see what products and services are offered. (Siaw I, Yu A, 2004)
The framework sees everything from an outside-in perspective. It doesn't take into account the resource based view of the strategy (inside-out) which is the competitive advantage and superior performance of an organization explained by the distinctiveness of its capabilities. (Johnson et al, 2009) This view includes firm's unique resources that perform the best in the overall industry. They could be the firm's management team, employees or equipment. Michael porter did not see these as acting within the firm's boundary. They help the firms in the industries to build competitive advantage. If a firm does something which is better than all the firms in the industry, then no matter how low the threats of entrants is or how high the bargaining power, this will lower down and act in that firm's favor, hence that firm does not need to worry about the forces within the industry.
A Model of Competitive Advantage by using the Resource based view:
The forces and the strategies mentioned by Porter are more deliberate than emergent. Nowadays the world is changing rapidly and the firms have to be ready to operate in the different environment, like recently there was a big credit crunch or economic crisis that hit all the countries in the world and due to this fact, even the competitive forces would have changed their power in favor of one player to the other. During the eighties era, the firms had a stable environment and there was cyclical developments in the industries but this is not the case in today's dynamic environment.
According to Larry Downes the competitive forces are not applicable in today's period. He identified three analytical tools that would make the Porter's forces to be vulnerable. As per his findings, today's environment is affected by the three elements namely, Digitalization, Globalization and Deregulation. As many firms get influenced by the information technology, all the players within the industry can get access to various information and hence get the knowledge of what is taking place in their respective industry, not like before, the buyers or suppliers had to conduct researches, then only they could get an idea about the general environment of the market.
As Globalization takes place and as many people of different cultures and backgrounds meet with one another, it is likely that there will be many new methods introduced of conducting businesses and hence the competitive forces will not be able to really give a picture of the attractiveness or profitability of a particular industry. An example can be see in the banking industry, long before the banks worked independently on their own but when the western union concept came in, many banks joined hands with the western union outlets and are now operating in providing the transfer of transactions together.
Michael Porter had based his knowledge on the existing businesses. According to his assumptions, if any firms wanted to get into business, they would look at the present industries, He did not give a thought that the firms might consider to go into new markets.
In their book, Blue Ocean Strategy, how to create uncontested market space and make the competition irrelevant, (2005) W. Chan Kim and Renee Mauborgne criticized Porter's framework because it was too narrow, it discussed about low cost or niche players while ignoring the value of the products or services that is more important to the customers. Porter's framework plays around the known industries where the boundaries and competitive rules are well defined. Here the more firms get into the market, the more need arises to outdo the firms and this tends to sometimes create conflicts between the firms, this is termed as the red ocean strategy. While if the firms look around for opportunities and go into new industry, then they could successfully achieve a space in the market and also gain profits, which is called the Blue Ocean strategy, meaning the firms have to search deep and discover the new gaps which had been left out by the existing firms. An example of ING Direct in the 1990s applying this strategy shows how the banks can benefit from it. ING Direct focused more on the savings and mortgages accounts, unlike other banks in the industry focusing on the current accounts. Hence it started serving a different segment which was untapped and it also benefitted from it. (Burt. G, n.d)
The below diagram summarizes what a blue ocean strategy is from the red ocean one which was the focus of the five forces framework.
Michael Porter's forces are based on the Red ocean strategy
Furthermore there are still a number of things that Porter's framework doesn't take into account like the non-market forces. Porter had not taken into view the government's influence in the market of a particular industry. Today the Governments play an active role in the economy of their country, there are various rules and regulations that the firms (existing and those planning to enter) must fulfill in order to successfully run their business. In the five forces, there is no mention of this governmental influence. For example as mentioned in essay 1, the governments and the central bank of the country first audit everything, from the capital requirements to the people going to be in the management of the bank.
Also there are other activities like the corporate social responsibilities, some firms might not be performing well in their profitability but they would be on the top when it comes to serving the society and hence these firms could take advantage of this and market their firms and gain a position in the industry. (SPS, 2009)
As found out in the article by Dagmar Recklies (2008), the competitive forces framework is based on the theory of Economics. Michael Porter just based his evaluation on various economic laws and came up with the five forces framework. Now as the time passes by these economic laws also vary with the situations and hence this makes Porter's model to be vulnerable or less applicable in the changed surroundings. The below is the diagram that shows how the Porter's framework came into being by comparing it with the universal economic laws.
Porters Five Forces
Areas of Microeconomics
Bargaining Power of Suppliers
Supply and demand theory, cost and production theory, price elasticity
Bargaining Power of Customers
Supply and demand theory, customer behavior, price elasticity
Rivalry between Existing Players
Market structures, number of players, market size and growth rates
Threat of Substitutes
Threat of New Entrants
Market entry barriers
à Industry attractiveness
à Profitability, supernormal profits
Apart from these limitations of the five forces framework, there are risks involved in the generic strategies introduced by Michael Porter as a solution to deal with competition. In his book (1980), Porter does mention about the risks involved in pursuing the generic strategies. For example: in the cost leadership, the firms might not see an opportunity to invest in new areas as they would have to spend on the research and development, they might alter the quality of their products due to more focus on lowering the costs.
In the differentiation strategy, the firms might alter their products and reduce the customers brand royalty as the customers were more used to the older services provided but the firms would not be aware as their main strategy is to differentiate themselves.
In the focus strategy, the firms narrow their reach of the market as they just target a small segment and that also they are not sure would work because the customers do have a tendency to change their tastes and preferences quite often.
COMPARISON OF THE BENEFITS AND LIMITATIONS OF THE FIVE FORCES FRAMEWORK AND CONCLUSION
The above discussed were the benefits gained from using Michael Porter's five competitive forces framework and the limitations of the model in application of the model in today's era.
The five forces framework helps the firms in analyzing the general environment of the industry. Through conducting a research using these five forces, the trends of the business and the external influences of the industry is pictured. The level of competition gets revealed and the firms create strategies to continue in their respective industries. However the framework is kind of static in its application, it tells the firms on how the competition is but the firms themselves have to find out ways to deal with the competition and continue to survive.
The forces can act or behave differently with the different players in the industry. Many firms within the same industry have different positions within the market and they also differ from each other in their capabilities, one firm might not be good in one area but it would be performing well in another area. As the framework takes the industry as a whole, it is better to disaggregate the industries and then analyze the environment using the framework.
When using the framework, the firms should look at the macro environment as the forces are focused more on the inside (micro) surroundings, it is not advisable to make decisions based on the framework itself. The firm should also consider applying various other tools like the SWOT analysis, PESTEL and BCG matrix so as to gain a broader picture. The firms should reduce the threats and use its strengths to take advantage of the strategic gap, which is the opportunity in the competitive environment that is not being fully exploited by competitors (Johnson et al, 2009, p 50)
The research question of this essay can be concluded that the model introduced by Michael Porter in the 1980's does not have much influence in today's changing environment. It was useful in that period but as today, the situations keep on changing, there are many new discoveries going on, the e-commerce or the information technology has had a greater influence on all the industries, the porter's framework did not see this coming. However the framework is a kind of analytical tool which can be used by the firms in making their decisions based on more research or knowledge. A good and competitive firm does not make decisions based on one analysis; it must use many tools and frameworks to come to the final decision. The competitive forces should be used together with other business frameworks like the SWOT, PESTEL to give a broader view.
Overall the framework is a tool that helps in scrutinizing the business environment in general and provides an idea but it has to be used alongside with other tools as well so as to get a better result and formulate a strategy or business decision based on sound research.