There is quite a number of business models that are often employed by business practitioners in an attempt to undertake the competitive analysis of either a firm, or the industry as a whole. Key among these is the Porter’s five forces on the one hand, and the value chain on the other hand.
The Porter’s model, usually attributed to Michael Porter, is specifically applicable at an industry level, in the assessment of the level of competition within such an industry. As such, it finds wide application is various firms where the strategic managers utilize it to assess the current as well as he potential competitors. In addition, the model finds use in the evaluation of the attractiveness of such an industry.
However there are still some limitations that are associated with this model, such as a lack of dynamism and technological innovations. There is thus a need to integrate the model with such other frameworks as the PESTLE and SWOT analysis for effectiveness. Key aspects of the Porter’s model include the treats of new entrants’ substitute threats, customer bargaining power, supplier bargaining power, and rivalry within the existing competitors.
On the other hand, the value chain, another brainchild of Michael Porter, is a firm-level strategic framework that assesses the increase in competitive advantage. The concept of the value chain has now become comprehensive, and is no longer just restricted to an individual firm. It now finds application in the entire supply chain, as well as the distribution network.
A value chain includes the suppliers of a firm, channels of distribution, buyers of the firm, as well as the actual firm in question. Value chains are limited by their complexities, thus hindering their adaptability by the management. It is also difficult to apply the value chain to a service firm. Nevertheless, value chain models in a firm help management recognize the link between various activities in a firm, thus facilitating in its optimization. Value chain is made up of both primary activities and support activities.
The porter’s five point’s model
Origin and history
The origin of the porter’s five point’s model is attributed to Michael E. Porter’s book that was published in 1980 titled “competitive strategy: techniques for analyzing industries and competitors.” from that point on, this model has proved to be a useful tool for the analysis of the structure of an industry, as well as the strategies that a company would employ to face competitors.
The ideas of Porter’s model are based on the premise that for a company to have a competitive advantage relative to competitors, then the ensuing return on investment for such a company ought to exceed the average figure of such n industry (Thurlby, 1998).
Key applications and uses in competitive analysis and decision making
According to Porter (1998), the “five forces model” ought to be applied at the level of an industry. Porter (1998) further opines that this model has not been devised for application at either the level of an industry sector, or the industry group. In this regard, an industry has been defined as that market where buyers acquire related services and products.
The Porter’s five points model finds useful application in the identification of both the current as well as the potential competitors in a given market moreover, the model aid in a better understanding of how attractive a market maybe, in terms of profitability. In the event that an industry is “unattractive”, what this means is that the combined elements or forces of this model acts to plummet the industry’s overall profitability.
At the very extreme case, such an industry would be viewed at as approaching “pure competition”. Conversely, the fact that an industry has recorded an overall attractiveness is not a guarantee that all the form within such an industry shall post similar profits. In order for individual firms to attain a level of profitability way above the average figure in the industry, then there is a need for such a firm to apply business models and core competencies.
For example, in the airline industry, the level of profitability tends to be relatively low. Nevertheless, there are individual airline companies that are able to post remarkable levels of profits after employing unique business models and core competencies such as low pricing strategies. Porter’s “five forces framework” has often been used by strategy consultants when they are undertaking a qualitative assessment of the strategic position that a firm has assumed.
For example, an assessment of the supermarket industry in the United Kingdom has revealed that the industry is complex owing to high barriers of entry (Dess et al, 2005). Moreover, there is also a lack of own brands by major supermarket companies. In addition, the supermarket industry in the UK seems to have reached an advanced stage, and this has meant that global brands have not been able to adequately duplicate in the UK market.
Although Porter’s “five point model” is a pointer to the profitability of an industry, the model still has its limitations in view of the market environment of today. This is because Porter’s model tends to assume somewhat fixed market structures. Porter’s model was originally based on the prevailing economic situations of the early eighties.
The markets then were characterized by market structures that were relatively stable, as well as high levels of competition. To this end, this model fails to consider novel business models as well as the level of dynamism within industries that has evolved over the years. Such would include the entry into the market of dynamic start-ups, and also technological innovations that are a characteristic of many industries in the current age (Porter, 1998).
For example, the information technology industry is usually considered to be quite competitive. For this reason, the structure of the industry keeps on being revolutionised, thanks to innovations. This is thus an indication that Porter’s “five forces model” to be somewhat limited in value, with respect to innovations and dynamism.
Kippenberger (1998) has argued that one should not bank just on the Porter’s model when they are developing an industry strategy. Haberrberg and Rieple (2001) have recommended that additional industry frameworks such as PEST and SWOT analysis be considered as well. Nonetheless, this is not an implication that he Porter’s model is invalid. What this means is that there I a need to implement the model with the full knowledge of its limitations.
In an industry, the Porter’s model as a strategic technique could be useful in he identification of if at all services, products, or even businesses for that matter, have a potential for being profitable. Additionally, the model could also prove to be quite enlightening when applied in an industry with a view to better understand the power balance in such an industry (Porter, 1985).
Key issues in influencing its overall applicability
Substitute products threat
In the event that a product has a substitute, this seeks to increase the probability that customers may have to switch to such an alternative product, in case the price of such a product increases. In other words, the demand elasticity for such a product becomes high. Apparently, substitute products tend to be produced by a limited number of industries.
Nevertheless, the substitute products seek to satisfy similar needs of customers. For example, commuters from say, London to Paris should use the Eurostar rail services as an option rater than drive there. Depending on the degree to which certain products can be substituted, this will often determine the industry price of such products.
Customer bargaining power
Customers usually have an advantage of influencing suppliers to either offer more desirable features to a product, or even to reduce prices. Should this happen, an industry’s profitability tends to plummet. This often happens if the switching costs are low, of a customer has recorded dismal profits. It could also happen in a case whereby a customer makes a large purchase, or is at a better position to solicit for a better supplier.
Suppliers bargaining power
This refers to the ease with which suppliers are able to find customers. Additionally, it is also a pointer to the level of importance that is attached to the products of a supplier.
Rivalry within the existing competitors
This tends to impact on the entire industry. In this case, it is important to know the number of competitors that exists at the moment in an industry, as well as the dominant one amongst these. The overall market growth is also analyzed, or the decline of it for that matter. Moreover, the level of switching of customers from one supplier to the next is also explored. It is also worth noting that the barriers to exit levels are also explored.
New entrant threats
Entry barriers to an industry are often assessed here such entry barrier could be economies of scale. Is small beautiful, or does size matters in an industry? The aspect of product differentiation also comes in, and this often acts as a leverage point amongst rival firms. Capital requirement, such as investing in information technology could as lobe another entry barrier to firms that are financially challenged, as are the switching costs of suppliers by customers, and the ensuing inconveniences, or lack of it.
Accessibility of channels of distribution is also another entry barrier, as well as the acquiring of patents, subsides by the government, and the achievement technical know-how and experience.
Origin and history
This is a firm-level strategic framework that assesses the increase in competitive advantage. The value chain is the brainchild of Michael E. Porter, and has thus been exhaustively been explored in his 1985 book; “Competitive Advantage: Creating and Sustaining Superior Performance”. As the name suggest, the value chain is “a chain of activities” that products often pass through in order that they may gain value.
For instance, a cut diamond tends to be of a higher value that one that is not cut. As such, the activity of cutting a diamond adds value to the product, in this case diamond. The value chain approach is made up of activity an cycle that creates as well as build value in a firm. As such, a firm is often split into either ‘primary activities’ or ‘support activities’.
Key applications and uses
The concept of the value chain has now become comprehensive, and is no longer just restricted to an individual firm. It now finds application in the entire supply chain, as well as the distribution network. When a product or services mix gets delivered to the ultimate customer, such an undertaking shall often call for the mobilization of a variety of economic factors.
In addition, each of these individual economic factors will also seek to manage their individual value chain. When such local value chains have been harmonized and integrated at an industrial scale, the ensuing value chain also tends to be extended in nature, and could as well assume a global context. Porter (1985) has termed this kind of value chain as the “value system”.
In this regard, such a value chain will often include that value chain that is attributed to the supplier of a firm, channels of distribution, buyers of the firm, as well as the actual firm in question. Management strategists are thus charged with the role of seeking to capture the value that such a chain would often generate. For instance, it could be the desire of a spare parts manufacturer to have their wares located in an area easily accessible by an assembly plant, so that transportation costs become more affordable.
A proper exploitation of the glow of information within such a supplier chain, whether vertically of horizontally, may facilitate such a firm to bypass go-betweens in the chain. This could also facilitate in the creation of new models of business, as well as improving on the “value system”.
The value chain of an organization revolves around the assessment of its overhead and production costs. For a hospitality industry such as McDonald’s, there is also the aspects of royalties, total costs, service fees, retail markup and the average price payable by consumers.
Limitations of the value chain
The value chain model tends to be complicated, and this often acts as a hindrance to its application by management. Given that the strategic management team may also be responsible for the operations of various divisions within a firm, the team might feel challenged to embrace this model.
The application of the value chain to services is not quite easy, and this is yet another of its limitations. Usually, the value chain tends to be exemplified by a reference to the firms that are characterized by a physical flow of products. Such would include amongst others the retailing and the motor vehicle manufacturing industries.
In this regard, customer service tends to be restricted to the ultimate two main activities. Nonetheless, customer service in such industries as education, banking and hospitality occupies a central position. In addition, it is also the largest generators of both revenues and costs. Furthermore, the value system not only tends to be linear, it also disregards the value networks.
The framework of a value chain could offer a multitude of benefits to a firm when applied correctly. First, the analysis would assist the managers of a firm to recognize the link between value activities that exist in a company, as well as to approach the firm from a process perspective, as opposed to from a department or functional point or view.
A value chain analysis also enables managers to assess strategic partnerships with the various industrial players in the value system.
When linkages and cost drivers of a firm have been identified by the management, thanks to the value chain, the management is thus able to lay more emphasis ways of reducing costs. At the same time, the management is in a position to optimize returns of such a value chain. Managers are also better placed to comprehend cost management-related problems in a firm.
These include the inbound and outbound logistics, operations, sales, marketing and services. Inbound logistics is where goods of a firm’s supplier are often received, and stored to await shipment into the assembly/production line. As such, good gets moved around a firm. On the other hand, the outbound logistics is used in reference to the already manufactured goods.
These are often in the supply chain to either the wholesalers or retailers, and eventually to the ultimate customers. Before goods can be shipped to suppliers, goods are either assembled or manufactured in the operations section of the value chain there could also be individualized operations such as a final engine tuning of say, the engine of a car, or the offering of room service in the hospitality industry. It is not just enough to ship goods to the final customer.
There is a need to offer a promotional mix and of the product or the service in order to appeal to the customers. This is often accomplished by the sales and marketing activities. To avoid cognitive dissonance, that is having dissatisfied customers upon a purchase, many firms offer after- sales services. In addition, firms also handle the complaints lodged by customers, as well as the installations.
Such includes procurement, development in technology, human resource and the infrastructure of the firm. Procurement is concerned with the purchase of materials, goods and services within a firm. Firms always aspire to make a high quality purchase or these at the lowest possible price in the market.
For this reason, the issue of outsourcing comes in. In terms of technology development, this tends to give a firm a competitive advantage relative to the competitors. Such development technology would include among others marketing online, technology in production, management of customer relationship, and lean marketing.
In terms of human resources, these tend to be a vital and expensing asset of a firm. For this reason, firms always wish to recruit, train and then develop the best manpower that are then remunerated and rewarded competitively in order that the firm may achieve its objectives. Another support activity of the firm is the infrastructure such as the accounts department, control and planning mechanisms, as well as the implementation of management and information systems.
- Dess, G., Lumpkin, G, & Eisner, A. (2005). Strategic Management (3rd edition). New York: McGraw-Hill.
- Grant, R, M. (2008). Contemporary Strategy Analysis (6th ed.) Oxford: Blackwell
- Haberberg, A, & Rieple, A. (2001). The Strategic Management of Organizations, Essex: Pearson Education Limited.
- Kippenberger, T. (1998) Strategy according to Michael Porter, The Antidote, 3(6): 24-25.
- Porter, M. E. (1985). Competitive advantage. New York: The free press.
- Porter, M. (1998). Competitive Strategy: Techniques for Analyzing Industries and Competitors, New York: Free Press.
- Thurlby, B. (1998) “Competitive forces are also subject to change”, Management Decision, London.