The works of the American management-guru and Harvard-Professor Michael E-Porter are considered to be among the most significant of their subject. Porter had a lasting influence on strategic management with his books about competitive advantages on industry level and on global level, which were written in the eighties. Porter’s models like the Five Competitive Forces, the Value Chain or Porters Diamond have become standard equipment of the manager’s toolbox. His work was more critiqued because economic conditions have changed fundamentally since that time. The rise of the Internet and of various e-business applications has strongly influenced nearly all industries.
In fact, Porters theories base on the economic situation in the eighties. This period was characterized by cyclical developments, strong competition, and relatively stable market structures.
Porter’s 5 forces
The model of the Five Competitive Forces was developed by Michael E. Porter in his book “Competitive Strategy: Techniques for Analyzing Industries and Competitors “in 1980. Since that time it has become an important tool for analyzing an organizations industry structure in strategic processes. Porters model is based on the insight that a corporate strategy should meet the opportunities and threats in the organizations external environment. Especially, competitive strategy should base on and understanding of industry structures and the way they change. Porter has identified five competitive forces that shape every industry and every market. These forces determine the intensity of competition and hence the profitability and attractiveness of an industry. The objective of corporate strategy should be to modify these competitive forces in a way that improves the position of the organization. Porters model supports analysis of the driving forces in an industry. Based on the information derived from the Five Forces Analysis, management can decide how to influence or to exploit particular characteristics of their industry.
Porter claims, “The ultimate aim of competitive strategy is to cope with and, ideally, to change those rules in the firm’s behavior.” (1985, p. 4)
Porter’s 5 Forces – Elements of Industry Structure (source: Porter, 1985, p.6)
I have done the Porters 5 forces analysis of Tesco to understand the way Porters 5 forces work.
Threat of New Entrants:
The UK grocery market is primary dominated by few competitors, including three major brands of Tesco, Asda, and Sainsbury’s that possess a market share of 70% and small chains of Waitrose and Budgens with a further 10%. Over the last 30 years, according to Ritz (2005), the grocery market has been transformed into the supermarket-dominated business. All the major chains have been in power due to their supremacy in operating systems and marketing mix expenditure. This influential force had a great effect on the small traditional shops, such as butchers, bakers, grocery stores etc. Nowadays it possesses a rigid barrier for new companies to enter the grocery market. Other barriers include economies of scale and differentiation achieved by Tesco and Asda seen in their belligerent operational tactics in product development, promotional activity and superior distribution.
Bargaining Power of Suppliers
This force represents power of suppliers which can be influenced by major grocery chains. This consolidates further positions of stores like Tesco and Asda in negotiating better promotional prices from suppliers that small individual chains are unable to match Ritz (2005). In return, UK based suppliers are also endangered by the growing ability of large retailers to source their products from abroad at cheaper deals. The relationship with sellers can affect the strategic freedom of the company and in influencing its margins. The forces of competitive rivalry have reduced the profit margins for supermarket chains and suppliers.
Bargaining Power of Customers
Porter theorised that the more products that become standardized or undifferentiated, the lower the switching cost, and hence, more power is yielded to buyers Porter M. (1980). Tesco’s famous loyalty card – Clubcard remains the most successful customer retention strategy that considerably increases the profitability of Tesco’s business. In meeting customer needs, ensuring low prices, better choices, in-store promotions empowers Tesco to control and retain their customer base. Consumers have become more conscious of the issues like fair trade. Ecologically benign and ethically sound production of consumer produce such as tea, coffee and cocoa is viable, and such products are now widely available at the majority of large chains.
Threat of Substitutes
General substitution is able to reduce demand for a particular product, as there is a threat of consumers switching to the alternatives Porter M. (1980). In grocery industry this is the form of product-for-product or the substitute of need and is further weakened by new trends, such as the way small chains of convenience stores are emerging in the industry. In this case Tesco, Asda and Sainsbury’s are trying to procure existing small-scale operations and opening Metro and Express stores in local towns and city centres Ritz (2005).
Bargaining Power of Competitors
As it was mentioned above, the purchasing power of the food-retailing industry is concentrated in the hands of small number of retail buyers. Operating in a established flat market where growth is difficult, and consumers are increasingly sophisticated, large chains as Tesco are accumulating large amounts of consumer information that can be used to communicate with the consumer Ritz (2005). This competitive market has fostered an augmented level of development, resulting in a situation in which UK grocery retailers have had to be innovative to maintain and build market share. The dominant market leaders have responded by refocusing on price and value, whereas reinforcing the value added elements of their service.
Use of the Information form Five Forces Analysis
Five Forces Analysis can provide valuable information for three aspects of corporate planning:
It allows determining the attractiveness of an industry, and provides insights on profitability. It also supports the decision of entering and exiting the industry or a market. The model can be used to compare the impact of competitive forces on the own organization with their impact on competitors.
Along with PEST- Analysis, this reveals drivers for change in an industry. Five forces actually reveal insights of the potential attractiveness of the industry. Expected political, economical, sociodemographical and technological changes can influence the five competitive forces and thus have impact on industry structures. Useful tools to determine potential changes of competitive forces are scenarios.
Analysis of Options:
Porters 5 forces allow a systematic and structured analysis of market structure and competitive situation. The model can be applied to companies, industries, market segments, or regions. Therefore, it is necessary to determine the scope of the market to be analyzed in a first step. Following, all relevant forces for this market are identified and analyzed. Hence, it is not necessary to analyze all elements of all competitive forces with the same depth. The Five Forces Model is based on microeconomics. It takes into account supply and demand, complementary products and substitutes, the relationship between volume of production and cost of production, and market structures like monopoly, oligopoly or perfect competition.
Porter’s model of Five Competitive Forces main weakness results from the historical context in which it was developed. In the early eighties, cyclical growth had taken the centre stage the global economy. Thus, primary corporate objectives consisted of profitability and survival. A major prerequisite for achieving these objectives has been optimization of strategy in relation to the external environment. At that time, development in most industries was stable and predictable, as compared with today’s dynamics. In general, the meaningfulness of this model is reduced by the following factors:
· The model assumes a classic perfect market. The more an industry is regulated, the less meaningful insights it will deliver.
· The model is best applicable for analysis of simple market structures. Comprehensive analysis for a complex industry with multiple product groups, Sub businesses and segments is very difficult using Porter’s 5 forces. A narrow focus of such industries, however, has the risk of missing some important details.
· The model is based on the idea of competition. It assumes that companies try to achieve competitive advantages over other players in the markets as well as over suppliers or customers. Whereas, It does not really take into consideration strategies like strategic alliances, electronic linking of information systems, virtual enterprise-networks.
Generally, Porters Five Forces Model has some major limitations in today’s market. It is not able to take into account the dynamics of markets and new business models like in case of Amazon and Ebay. The value of Porters model is more that it empowers managers to think about the current situation of their industry in a structured, easy-to-understand way – as a starting point for further analysis.
Porters value chain
The value chain approach was developed by Michael Porter in the 1980s in his book “Competitive Advantage: Creating and Sustaining Superior Performance” (Porter, 1985). The concept of value added, in the form of the value chain, can be utilized to develop an organisation’s sustainable competitive advantage in the business arena of the 21st Century. All organisations consist of activities that link together to develop the value of the business, and together these activities form the organisation’s value chain. Such activities may include purchasing activities, manufacturing the products, distribution and marketing of the company’s products and activities (Lynch, 2003). The value chain framework has been used as a powerful analysis tool for the strategic planning of an organisation for nearly two decades. The aim of the value chain framework is to maximise value creation while minimising costs.
Main aspects of Value Chain Analysis
Value chain analysis is a powerful tool for managers to identify the key activities within the firm which form the value chain for that organisation, and have the potential of a sustainable competitive advantage for a company. Therein, competitive advantage of an organisation lies in its ability to perform crucial activities along the value chain better than its competitors.
The value chain framework of Porter (1990) is “an interdependent system or network of activities, connected by linkages” (p. 41). When the system is managed carefully, the linkages can be a vital source of competitive advantage (Pathania-Jain, 2001).
The value chain links the value of the organisations’ activities with its main functional parts. Then the assessment of the contribution of each part in the overall added value of the business is made (Lynch, 2003). In order to conduct the value chain analysis, the company is split into primary and support activities. Primary activities are those that are related with production, while support activities are those that provide the background necessary for the effectiveness and efficiency of the firm, such as human resource management.
The primary activities (Porter, 1985) of the company include the following:
â€¢ Inbound logistics
These are the activities concerned with receiving the materials from suppliers, storing these externally sourced materials, and handling them within the firm.
These are the activities related to the production of products and services. This area can be split into more departments in certain companies. For example, the operations in case of a would include reception, room service etc.
â€¢ Outbound logistics
These are all the activities concerned with distributing the final product and/or service to the customers. For example, in case of a hotel this activity would entail the ways of bringing customers to the hotel.
â€¢ Marketing and sales:
This functional area essentially analyses the needs and wants of customers and is responsible for creating awareness among the target audience of the company about the firm’s products and services. Companies make use of marketing communications tools like advertising, sales promotions etc. to attract customers to their products.
There is often a need to provide services like pre-installation or after-sales service before or after the sale of the product or service.
The support activities of a company include the following:
This function is responsible for purchasing the materials that are necessary for the company’s operations. An efficient procurement department should be able to obtain the highest quality goods at the lowest prices.
â€¢ Human Resource Management
This is a function concerned with recruiting, training, motivating and rewarding the workforce of the company. Human resources are increasingly becoming an important way of attaining sustainable competitive advantage.
â€¢ Technology Development
This is an area that is concerned with technological innovation, training and knowledge that is crucial for most companies today in order to survive.
â€¢ Firm Infrastructure
This includes planning and control systems, such as finance, accounting, and corporate strategy etc.(Lynch,2003).
Figure 1: The Value Chain
Source: Porter (1985) valuechain
Porter used the word ‘margin’ for the difference between the total value and the cost of performing the value activities (Figure 1). Here, value is referred to as the price that the customer is willing to pay for a certain offering (Macmillan et al, 2000). Other scholars have used the word ‘added value’ instead of margin in order to describe the same (Lynch, 2003). The analysis entails a thorough examination of how each part might contribute towards added value in the company and how this may differ from the competition.
In a study of Saudi companies, Ghamdi (2005) found that 22% of the companies in the study used value chain frequently, while 17% reported that they somewhat used it, and 42% did not use the tool at all. An interesting finding of the study was that the manufacturing firms were frequent users of the tool compared to their service counterparts (Ghamdi, 2005).
The ability of a company to understand its own capabilities and the needs of the customers is crucial for a competitive strategy to be successful. The profitability of a firm depends to a large extent on how effectively it manages the various activities in the value chain, such that the price that the customer is willing to pay for the company’s products and services exceeds the relative costs of the value chain activities. It is important to bear in mind that while the value chain analysis may appear as simple in theory, it is quite time-consuming in practice. The logic and validity of the proven technique of value chain analysis has been rigorously tested, therefore, it does not require the user to have the same in-depth knowledge as the originator of the model (Macmillan et al, 2000).
The value chain should be analysed with the core competence of the company at its very heart (Macmillan et al, 2003). The value chain framework is a handy tool for analysing the activities in which the firm can pursue its distinctive core competencies, in the form of a low cost strategy or a differentiation strategy. It is to be noted that the value chain analysis, when used appropriately, makes the implementation of competitive strategies more systematic overall. Analysts should use the value chain analysis to identify how each business activity contributes to a particular competitive strategy. A company may benefit from cost advantages if it either reduces the cost of individual activities in the value chain or the value chain is essentially reconfigured, through structural changes in the activities. One of the problematic areas of the value chain model, however, is that the costs of the different activities of the value chain need to be attributed to an activity. There are few costing systems that contain detailed activity level costing, unless an Activity Based Costing (ABC) system is in place in the company (Macmillan et al, 2003). It is imperative for analysts to note that the overall differentiation advantage may result from any activity in the value chain. A differentiation advantage may be achieved either by changing individual value chain activities to increase uniqueness in the final product or service of the company, or by reconfiguring the company’s value chain.
Example Ivory Soap, a leading product of P&G, is a broad differentiator that turned into a cost leader. Quality is a strategic concern for managers of Ivory Soap, along with delivering a high value product consistently.
Note that in a company with more than one product area, it is appropriate to conduct the value chain analysis at the product group level, and not at the corporate strategy level. It is crucial for companies to have the ability to control and make most of their capabilities.
The Apple podcasting value chain is comprised of nine steps that essentially move from raw content to the listener. All the steps of the value chain include content, advertising, production, publishing, hosting/bandwidth, promotion, searching, catching, and listening. It is important to note that each step in the value chain adds value to the podcast in distinctive ways, has its own sets of challenges and opportunities.
It is important to note that the nature of value chain activities differs greatly in accordance with the types of companies and industries. For companies with complex systems like IBM, Accenture and Cisco etc., it is not possible for one member of the value chain to provide all the products and services from start to finish. The marketing function in such companies focuses on aligning with key partners and allies that must collaborate with each other. For example, installing SAP’s ERP system requires direct involvement from companies like HP, Oracle, and Accenture, along with indirect involvement of companies like EMC, Cisco, and Microsoft, and collaboration between many departments within the company.
Limitations of Value Chain Analysis
One of the limitations of the value chain model is that it describes an industrial organization which essentially buys raw materials and transforms these into physical products. Notably, at the time when the model was introduced (Porter, 1985), service industries in the western countries employed lesser workforce compared to today’s statistics of the same. Academics and practitioners alike have critiqued the model and its applicability in the context of service organisations. Partnerships, alliances and collaboration along with differentiation and low costs are common drivers of value today.
The limitations of the model include the fact that ‘value’ for the final customer is the value only in its theoretical context (Svensson, 2003), and not practical terms. The real value of the product is assessed when the product reaches the final customer, and any assessment of that value before that moment is only something that is true in theory. Despite this limitation, analysts can effectively use the value chain model to determine the value to the final customers in a theoretical way. Use of other planning tools and techniques like Porter’s generic strategies, analysis of critical success factors etc. is recommended in conjunction with the value chain framework for a more comprehensive analysis of a company’s strategy and planning.
The value chain framework has been used as a powerful analysis tool for organisational strategic planning for nearly two decades now. The value chain framework shows that the value chain of a company may be useful in identifying and understanding crucial aspects to achieve competitive strengths and core competencies in the marketplace. The model also reveals how the value chain activities are tied together to ultimately create value for the consumer. The five primary activities and four support activities form an interdependent system that is connected by linkages. Analysts conducting the value chain analysis should break down the key activities of the company according to the activities entailed in the framework, and assess the potential for adding value through the means of cost advantage or differentiation. Finally, it is important to determine strategies that focus on those activities that would enable the company to attain sustainable competitive advantage.
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