Analysis of Michael Porters strategic models

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1st Jan 1970 Marketing Reference this

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This report explains about analysis of Porters strategic models. Michael E Porter identified the methods to be applied to an organization to gain competitive advantage. He also identified the value chain that can be applied to increase value at each stage of a business. The value chain has been described in detail so as to explain how a company gains competitive advantage when followed correctly. The strategy is quite simple but possesses great strength.

The principles have been applied to an engineering based industry-3M, to determine and analyse their competitive advantage. The organization managed to sustain in the competitive environment.3M has been selected because the organization has achieved a strong position in the market and possesses competitive advantage in terms of Porter’s strategic models.

Introduction

A competitive industry has got its own strategy to hold a competitive position. To have a competitive advantage, one must create and edge over competitors. An organization requires strategic planning and extensive research to gain competitive advantage.The idea of strategy formulation is to understand and cope with competition. Depending on its competitive advantage, the company leads to failure or success. Hence it is very important to work with strategic planning and does not matter if the company produces product or provides service.

The plan involves consideration of four primary areas. Areas that include the product or service to be sold, the ways of output to be promoted, pricing of goods or services and place strategy. Structure of an industry drives competition and hence results to profitability. It is very important for one to analyze the industries underlying structure in terms of Porter’s five forces in order to get into competition.

One step to include in strategic planning is to analyze the group of consumers at which a company aims its products and services, then identify competition. A company with high profile of strategic planning will have the ability to attract the consumers or customers. The company must acquire the common characteristics or be aware of the needs of customers so that the company holds a strong position.

There are mechanisms in which an organization can obtain competitive advantage. The competition within a market will reflect its performance and its competitive position. It is very important for a competitive company to differentiate themselves from other competitors and plan accordingly, discover competitors’ strengths and weaknesses – learn their strengths and imitate them, use their weaknesses to the company’s advantage.

Competitive Strategy

The intensity of competition for any industry depends on five basic forces. Porter’s five forces is a framework that is used for industry analysis and business strategy development. Analysis of these five forces can be used to determine the competitiveness in an organization and therefore find out the overall profitability of a market.Applying the five forces results in good industries structure and therefore lead to competitive interaction within an industry. The work on strong calculation of an organization in terms of the five forces will determine the potentiality of the industry. The framework below shows the forces that shape industry.

Porter’s five forces that shape strategy

Competitive Rivalry

NEW ENTRANTS

SUPPLIERS

BUYERS

Threat of New Entrants

Bargaining Power

of Buyers

SUBSTITUTES

Bargaining Power

of Suppliers

Threat of Substitutes

It is useful to use Porter’s five forces for strengths, weakness, opportunities and threat analysis, in other words known as the SWOT analysis.

Threat of substitute products, established rivals and new entrants are considered as the three forces from horizontal competition, therefore, offering a product for the same price, whereas bargaining power of suppliers and customers are considered as the two forces from vertical competition, therefore offering the same product but for different price.

This analysis of five forces is a part of the complete Porter strategic models. The other parts are value chain and the generic strategies.

Value Chain

The value chain is a concept from business management and is defined as the chain of activities operating in a specific industry. Value Chain Analysis describes the activities that take place within a business and accordingly relate them to the competitive strength of the business.

The value chain has been identified by Michael E Porter and is used to increase value to business. A company will lead to success if analysed properly until the company has competitors that are financially strong and have competitive advantage in the market share.In order to do the value chain analysis, all costs are evaluated to find a value of profit. This is the difference between the price that customer pays and the total costs incurred with the production and delivery of the product.

A value chain analysis can be performed by analyzing the value chain itself, the customer’s value chains, identifying cost advantages in comparison to competitors and identifying the potential value added for a customer.

http://enduragement.wordpress.com/2008/06/17/value-chain-as-a-basis-of-critical-success-factor-analysis/

Concept of Value Chain

Products pass through all activities of the chain and gains value at each stage. The end product tends to have good cost as an activity may have low cost but the activity adds much value to the end product.

The value chain framework is used as a tool for strategic planning and for defining company’s competencies. The concept of value streams comes into account. The process of using and producing goods, services or information may be shared by the two parties to reach to the primary end, followed by the delivery of a product to a customer and is known as end to end business process

Value chain is part of a system. A value system is the link between other value chains, including the supplier, firm, channel and buyer value chain. Thus it is necessary to manage the whole value system.

    …    

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Supplier

Value Chain

>

Firm

Value Chain

>

Channel

Value Chain

>

Buyer

Value Chain

Porter’s Value System

http://www.netmba.com/strategy/value-chain/

Activities within the Value Chain

This includes the primary activities, the Support activities and gross sales.

Primary Activities: There are five activities involved in it .The activities start from creating a product to delivering the product.

Inbound Logistics

In this activity, the goods, such as the raw materials are received from the suppliers and are stored on the production line till they are ready to be used. These goods are then moved around the organization which are then distributed and ready for manufacturing process.

Operations

This is process of the manufacture of goods, to transform the inputs into finished products and services. Individual operations can have specific places for operation.

Outbound Logistics

This is the activity in which the finished goods are passed along the supply chain to the consumer.

Marketing and Sales

This is an activity where an organization focuses on identifying and meeting the customers’ needs to get sales. Marketing communication stands as an important factor in this process.

Service

The activity includes installation, after-sales service, handling complains, training and many more. Therefore, the support provided to customers after sales.

Support Activities: These activities are related to support. They are not directly involved in production but help to increase efficiency.

Procurement

This activity is referred to the responsibility for the purchase of highest possible quality of goods and services at the lowest possible price. They are responsible for outsourcing.

Technology Development

Technology is an important factor for gaining competitive advantage. Costs can be reduced to sustain competitive advantage and this includes production technology, online marketing and all other technologies that support value creating activities.

Human Resource Management

Employees are expensive resources. An organization would manage recruitment, training and development, and rewarding workforce of a business.

Firm Infrastructure

This activity is done by strategic planning to control systems such as Management Information System and other mechanisms that control the organizational structure.

There are linkages between the value chain activities, whether we refer to the primary activities itself or the primary and support activities.Changes in one activity of the value chain will lead to changes in cost or changes in performance for other activitites.These linkages are important for corporate success. If marketing and sales functions properly, procurement will take place in time and forward information’s to inbound logistics leading to correct time of delivery of production via operations.

Competitive Advantage and their Strategies

The company’s profit depends on the efficiency of a company, such that the cost the customer pays is more than the total costs incurred in the value chain.

On analysing the competitive forces in an industry, it is found that there are three generic strategies to gain competitive advantage to achieve good performance in an industry. They are cost leadership, differentiation, and focus which is sub-divided into cost focus and differentiation focus

Porter says that a company must acquire at least one of the generic strategies to gain competitive advantage, otherwise it is considered as below average competitive.

The differentiation and cost leadership strategies seek for competitive advantage in a broad range of market where as the differentiations focus and cost focus are based on narrow market or industries.

Source: http://tutor2u.net/business/strategy/competitive_advantage.htm

Strategy – Cost Leadership/Cost Advantage

This strategy involves in being the lowest cost producer in the industry, and having their selling price equal or average when compared to the market in order to have the best profits. This strategy offers products with little differentiation so that they are acceptable to the majority of the customers. At times, the low cost leader offers discounts to maximise its sales to have significant cost advantage and ultimately increase its market share.

Competitive advantage can also be achieved by reconfiguring the value chain, that is by reducing the cost of individual value chain activities to provide lower cost.Reconfiguration can also be done by changing the structure, such as production process or having a different sales approach and thus restructuring the firm’s cost.

Thus a cost advantage is achieved by offering lower prices on products or by giving better services to customers. It is important to understand cost dynamics to possess cost leadership strategy.

A firm gains cost advantage by controlling 10 Cost Drivers for value chain activities:

‘Economies of Scale’: This refers to the firms with low costs per unit to perform activities more efficiently at large production volumes.

‘Learning’

‘Capacity Utilization’: This refers to the pattern of capacity utilization.

‘Linkages among activities’: How other activities are performed. This refers to the linkages within the value chain and vertical linkages.

‘Interrelations among business units’: Refers to the relationships with other business units within a firm.

‘Degree of vertical integration’: This refers to the degree of performance of upstream and downstream activities,that is, the firm being specialized in some activities and outsourcing the rest of the activities.

‘Timing of Market Entry’

‘Firm’s policy of cost or differentiation’: These policies reflect the firm’s strategy.

‘Geographic Location’

‘Institutional factors’: Examples are government regulations, financial incentives, unionization.

http://www.netmba.com/strategy/value-chain/

Strategy-Differentiation

Differentiation is referred to working in a unique way on criteria’s that are used by buyers and charging a premium price for the product. This would include the additional production costs and highlight on reasons to why the customer should choose the differentiated product.

Differentiation is done by focusing on activities to perform better than competitors,either by procuring inputs that are not easily available to competitors or by increasing service levels.

Likewise, differentiation can improve Buyer’s value. This is done by lowering buyer cost and raising buyer performance. The firm can also choose the activities that create the most valuable differentiation for the buyer relative to cost of differentiation and accordingly select the strategy for sustainability.

Focus on drivers related to differentiation:

‘Policies and Decisions’

‘Linkages among activities’: This refers to linkages within the value chain, supplier and channel linkages.

‘Timing’

‘Location’

‘Interrelations’: Sharing activities with sister business units.

‘Learning’

‘Integration’: This refers to integration of online systems to current ordering systems.

‘Scale’: Large scale results to better service.

‘Institutional factors’

http://www.netmba.com/strategy/value-chain/

Differentiation can also be obtained by reconfiguring the value chain via forward integrate so as to perform functions that have been performed by its customers, backward integrate so as to control inputs, implementing new process technologies and utilizing new distribution channels.

Strategy-Focus

This refers to the narrow competitive scope within an industry. An organization that pursues this strategy tends to focus on one segment or a group of segments that they wish to aim at. An organization that uses this strategy will aim at its target segments only and not on the overall competitive advantage.

Strategy – Differentiation Focus

In this strategy, a business focuses on a small number of target market segments. Via this strategy there are opportunities to provide products that are different from competitors who may be targeting a broader group of customers. It is important to ensure that the product is satisfactory according to the customers needs.

Strategy – Cost Focus

In this strategy, a business seeks a lower-cost advantage in a small number of market segments. The product is similar to the higher priced product but is a basic one and is acceptable to sufficient customers.

General Options

Other ways of gaining competitive advantage are by reducing costs that do not affect the forms of differentiation. Such as, changing the design of a product may reduce manufacturing costs but may have increase in service costs. Thus resulting to net cost increase even though there is cost reduction.

Sometimes, changes in designs may reduce manufacturing costs and this may improve reliability, thus reducing the service costs. A company may increase its competitive advantage through such improvements, thus referring to linkages between the activities.

There are ways to cut down costs in the value chain. One example being sharing of raw materials between business units. Sharing of procurement activities results in cost reduction. However, business units have certain drawbacks such as coordination and some of the organizational practicalities. It is important to analyze the drawbacks when devising or planning a strategy to gain the benefits.

Thus an organization can obtain competitive advantage via value chain.

In order to find the strategic capabilities of 3M, the value chain and Porter’s five forces have to be analyzed. There are a number of reasons why we believe that 3M achieves competitive advantage.

There are five criteria’s that affect the sales in a year.

Performance of End Markets

Creation of New Markets

Transient effects in supply chain

Gain in Market Share

X factors

Recent analysis has shown that 3M gained a positive response in terms of market share gain and new product growth. Transient effect in supply chain is neutral thus resulting the performance of end market to be neutral. X factors are unexplainable but adds a certain value to the Organization.

‘The company posted full-year 2009 sales of $23.1 billion and earnings per share of $4.52, down 8.5 % and 7.6 %, respectively. Excluding special items, 2009 earnings declined 9.3 % to $4.69 per share. While there was obviously a contraction in sales, the full-year EPS of $4.69 per share was well within the original forecast range from one year ago and has been quite remarkable accomplishment’.

http://solutions.3m.com/3MContentRetrievalAPI/BlobServlet?locale=en_US&lmd=1269529672000&assetId=1180611654372&assetType=MMM_Image&blobAttribute=ImageFile

The economic down turn had a negative impact on 3M but achieved the best of sales in the year 2009.As of 2010, 3M has spread its products at all levels in the market, using technology to differentiate their products from the competition, and by using market-led pricing to attract customers and increasing service levels up to maintain even stronger position. 3M has an enduring reputation for customer service that earns them higher returns than competitors.

3M focuses on the state of end markets. They are keen in determining the real buyer. They identify the buyer’s value chain and work accordingly to get into a competitive advantage. They determine the relative cost of competitors and accordingly lower its cost structure and improve its operation.

The concept of environmental technology is a tool for competitive advantage. Environmental technologies offer new management process to minimize ecological impacts of economic production. 3M has a competitive advantage and is differentiation, which is protected by its patents and proprietary technology. The company’s research activity generates number of new and upgraded products that are covered by the patents and believes that this brings competitive advantage to the business. However, the loss of patent does not have any risk on revenue with the associated product as the company’s brand and the manufacturing expertise are significant components of the company’s competitive advantage.

3M not only emphasize on products or markets but also on the source of differentiation. 3M is very optimistic about their creative capabilities, confident in their operational strength and is the philosophy to change products every 3 years so that others cannot copy their products and they tend to remain competitive. 3M ensures that many of its products are genuine and more useful to customers than its competitors. The brand 3M is strongly recognized and signals this value to buyers.

Research and product development has truly been a major driver of sales growth.

3M is conscious of the timing of the release of a new product. Despite of serious pressures from communisation, 3M continues with their creativity of their new product. They reduce the manufacturing costs and work closely with their customers and lead to success.

The government has provided an important competitive advantage to the company. It conferred upon the creator of a new product and given rights to make, use and sell that invention for a certain period of time.

Another advantage is their supply chain management that is linked with the capability of their production and helps them to maintain it because of its position. Their logistics systems are handled by outsourced firms and is why 3M possesses outstanding management process, thus leading to on-time production process.3M has highly efficient network of suppliers.

A huge distinguishing factor is to maintain investments in the future. 3M maintained investments of more than a billion dollars at a time in research and development when many companies had to step back.3M managed to achieve about 126% of movement of cash into or out of the business.These investments built confidence into 3M to have the best in the future. They are confident with marketing and sales representatives and stand a good position in the marketplace.

With high cash flow, high margins and a powerful balance sheet ,3M tend to have more opportunities which other companies do not have.3M manages to accelerate key investments and gain market share from other competitors. Unlike some of the companies, they are not dependent on external resources, which can get quite expensive. Thus they have the ability to finance growth with internal funds.

Their planning included reducing structural costs throughout the company and including the factories so as to cut down costs and by adding those expenses that are mandatory. They are aimed to accelerate growth in the various businesses.

3M has been restructuring by reducing structural costs since early 2008 and continued through 2009, reducing about 6,400 positions, another 200 positions in late 2009, 900 positions in the second quarter and 1,200 positions in the first quarter, thus reducing net income by $119 million over the year. 3M also announced reductions of 3,500 positions in 2008, thus reducing $194 million or $0.28 per diluted share for year 2008.

The organization reduced number of employments due to restricting actions. The plan of the organization is very simple. 3M is consistent of controlling costs, generating cash and drive sales.

It is a usual practice for 3M to perform cost analysis to the value chain activities. The organization matches its cost structure to the buyer’s value chain and accordingly reconfigures the cost structure.

The Buyer Bargaining Power is reduced due to the strength of the well-known brands such as Post-it, Nexcare and few more. Buyer concentration may vary depending on who the products are being sold to. The products are genuine and are of great value, thus reducing the bargaining power of buyers.

Inputs such as metal, wood pulp and oil derived raw materials are available from many sources and are used by employees who tend to be very creative.3M has strong bargaining power with the employees but this does not reduce profitability.

3M products are sold through different distribution channels of limited size and hence creating a barrier for a company wanting to enter one of the industries that 3M competes in. They are sold under various trademarks, both directly to users and through distributors or dealers in a wide variety of trades all around the world.3M continues to grow revenue worldwide.

3M continuously develops new products using advanced technology, thus making it difficult for the potential substitutes to compete against their products. For most cases, products with low prices would mean that buyers have low incentive to look for substitutes.

3M possesses good facilities and are highly suitable for the function of their designs that meets the customer’s needs.3M is a global enterprise. Their properties are used by multiple business segments. 3M’s markets grow in line with global GDP and hence leading to moderate rivalry.

‘After conducting a comprehensive study of 100 industries in 10 countries, Michael E Porter found that the success in competition is determined by four broad attributes that determine competitive advantage. Factor conditions, demand conditions, related and supporting industries and the environments in which the firms compete’ and can be compared with that of 3M.

International Business (4th edition),Alan M. Rugman and Simon Collinson

The factor conditions include land, labor and capital.3M tend to have highly educated people and the organization seeks to produce goods and services that highlight the intellectual ability of these people. To maintain this competitive position, 3M continually upgrades or adjusts its factor conditions.3M has strong labor force and the effectiveness is increased by getting some of the personnel to be creative and some to become more market orientated and to sell the product more vigorously throughout the world.

3M focuses on the special needs of people and work locally depending on the areas demand. This provides a number of benefits. It helps 3M to understand what the buyers want. If customer desires to change a product, the local seller has the ability to respond before the distant competitors.

3M possesses global presence in many businesses. Economic conditions vary from country to country.3M observes the real sign of demand increases and set up according to the local demands of specific markets.

There is an advantage to the supplier being located near the producer. The producer can provide low cost inputs. In addition to that, the suppliers know the status of the producer and are in a position to forecast and react to changes. By sharing information’s with 3M, helps to maintain its competitive advantage.

3M is an industry where long term development is valued more.3M emphasizes on development process to satisfy customer needs, after sales service and a highly disciplined management structure. Comparing with some of segments offered round the world by 3M, commercial construction is not popular in the United States. Commercial construction has had to modify its strategy to address this market. This includes driving costs down to make the company more price competitive. However, the presence of this market is not large in the United States.

The company’s approach to both product development and distribution is very consumer-friendly and market-driven and is the reason to achieve a competitive place today.

Conclusion

3M has established a strong position over 2009 and has struggled to overcome economic challenges to help protect the future. It is a very successful, stronger and more innovative company now. Products are being developed and updated every three years and released in time. The products are unique and highly appreciated by their customers. Research and development has helped boost the competition. 3M managed to build confidence within their customer’s, provides market led pricing to attract the customer and also provides good after sales service. It is because of the organization’s capabilities, 3M has achieved such competitive advantage.3M has correctly evaluated and followed the simple strategy that has been identified by Michael E Porter and are in a position they are today.

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