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How Competitive Forces Shape Strategy
In 1979, a young Harvard Business School associate professor published his first article for HBR, How competitive forces shape it to strategy? In subsequent years, the explanation of Michael Porter's five forces that determine the long-term profitability of any sector formed the basis of a generation of academic research and business practices. In this article, Porter reaffirms and extends its rigorously classic work on strategy development, and includes substantial new sections that show how to implement the Five Forces analysis.
The five forces define the structure of profit from one sector to determine how the economic value created is distributed. That value could be undermined by the rivalry between existing competitors, of course, but also may weaken because of the power providers and power buyers, or may be limited by the threat of new entrants or the threat of substitutes. The strategy can be seen as the practice of building defenses against the competitive forces or as finding a position in an industry where the forces are weakest. Changes in the strength of the forces indicate changes in the competitive landscape that are key to the continued development of the strategy.
Although at first glance may seem industries very different from each other, the underlying drivers of profitability are the same. The global automotive industry, for example, seems to have nothing in common with the world market for works of art or the heavily regulated European health sector. However, if we want to understand industry competition and profitability in each of these three cases, we must first analyze the five forces that shape their common underlying structure: the threat of new entrants, the influence of the suppliers, the influence buyers, the threat of substitutes and rivalry among existing competitors.
If these forces are intense, as in sectors such as aviation, textiles or the hotel, almost no company gets returns on investment. If the forces are benign, as in industries such as software, the soft drinks or toilet articles, many companies are profitable. What drives competition and profitability is the structure of the industry, manifested in the competitive forces, and not the fact if it produces a product or service if emerging or mature, if it is high or low tech, or is regulated or not.
The article states that understand the competitive forces and their underlying causes; it reveals the origins of the current profitability of an industry while providing us with a framework for anticipating and influencing competition and profitability over time. The healthy structure of an industry should be a competitive aspect to be considered by strategists, like the position of your company. This understanding of the structure of an industry is also essential for effective strategic positioning as defend against competitive forces and to mold them for the benefit of the company are crucial aspects of the strategy.
Threat of new applicants: Applicants to enter an industry bring new capacity and a desire to obtain a market share that puts pressure on prices, costs and the rate of investment needed to compete. Especially when new aspirants come from other industries and decide to diversify, they can influence the existing capacity and cash flows to stimulate competitiveness, which is what Pepsi, did when he entered the bottled water industry, Microsoft when it started offer Internet browsers or Apple when he joined the music distribution business.
As per my understanding, the threat of entry marks therefore a limit to the potential benefits of an industry. When the threat is real, members must reduce prices or increase the investment to stop new competitors. Sales of coffee consumption, for example, the relatively low entry barriers forced Starbucks to invest aggressively to modernize their cafes and menus.
The influence of suppliers: The influential suppliers hold more value for themselves by charging a high price, limit the quality or services or to transfer their costs to industry participants. Powerful suppliers, including those who provide labor, can get the maximum return of an industry that cannot pass increased costs to the final price. So, Microsoft has contributed to the erosion of profitability among producers of personal computers rising prices for operating systems.
The influence of buyers: The influential customers, providers can capture more value to force prices down, demanding better quality and more features (which drives up costs) and facing generally the various participants in an industry. Buyers are powerful if they have negotiating leverage on the participants in an industry, especially if they are sensitive to price, because they use that weight to put pressure on the price reduction.
The threat of substitutes: A substitute performs the same or similar to the product of an industry function, but in different ways. Videoconferencing is a substitute for travel. Plastic is a substitute for aluminum, etc. We have a substitute when we can do without a product, when prefer to buy a used one instead of buying a new one or when the consumer makes.
When the threat of substitutes is high, industry profitability suffers for it. As per my understanding, the substitute products or services limit the performance potential of an industry by placing a ceiling on prices. If an industry does not distance itself from substitute through the services offered by the product, marketing campaigns or other means, it will suffer in terms of profitability and often inhibit its growth capacity.
Rivalry among existing competitors: The rivalry between existing competitors takes many familiar forms, including discounts on prices, new product enhancements, advertising campaigns and service improvements are included. The degree of competition that lowers the profit potential of an industry depends, first, on the intensity with which companies compete and, second, of the basis on which they are competing.
To explore the implications of the framework of the five forces Porter explains why a rapidly growing sector is not always profitable; how to eliminate competitors through mergers and acquisitions can reduce the potential profitability of a sector; how government policies play a role by changing the relative strength of the forces; and how to use the forces to understand the ins. Then it shows how a company can influence the key forces in the sector to create a more favorable to them or expand the pie for all structure. The five forces reveal why profitability of the sector is making it. Only a firm understanding them can incorporate industry conditions in the strategy.
Managers must clearly distinguish operational effectiveness of the strategy. Both are essential, but their agendas are different. The article also states that the operational agenda deals with the continuous improvement in all dimensions in which we must not give up something to get something else. It is the right place for constant change, flexibility and tireless efforts to optimize practices. By contrast, the strategic agenda is the right place for defining a unique position to opt for certain things to the exclusion of others and increase the lace. The strategic agenda demands discipline and continuity; His enemies are scattering and compromise.
In my opinion, maintain a strategic continuity does not mean having a static view of competition. A company must continually improve its operational effectiveness and should actively seek to change the productivity frontier. At the same time, people have to try to extend its field of uniqueness and to improve the fit between their activities. The strategic continuity should make continuous improvement of the company to be more effective.