B301A - W5

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B301A

Making Sense of Strategy I

Week Five

16-3-2013 Copyright Material © Arab Open University – Egypt Branch_B301A

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Course materials to be discussed in tutorialsReadings for Block 1&2: Reading 4: Analyzing the industry environment : pp69-81

Block 3: Unit 1: Sections 1.1, 1.2, 1.3 & 1.4

Presentation Agenda


Applying industry analysis• Once we understand how industry structure drives

competition which, in turn, determines industry profitability, then we can apply this analysis:

1. to forecasting industry profitability in the future and,

2. to devising strategies to change industry structure.

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Applying industry analysisForecasting industry profitability

• Decisions to commit resources to a particular industry must be based on anticipated returns/profits five to ten years in the future.

• Over these periods, profitability cannot be accurately forecast by projecting current industry profitability.

• However, we can predict changes in the underlying structure of an industry with some accuracy.

• Structural changes are driven by (i) current changes in product and process technology, (ii) the current strategies of the leading players, (iii) the changes occurring in infrastructure and in related industries, and by (iv) government policies.

• If we understand how industry structure affects competition and profitability, we can use our projections of structural change to forecast the likely changes in industry profitability.


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Applying industry analysisFirst; Forecasting industry profitability

• The first stage is to understand how past changes in industry structure have influenced competition and profitability.

• The next stage is to identify current structural trends and determine how these will impact the five forces of competition and resulting industry profitability.

• While it is not possible to predict with any confidence the quantitative impact of structural changes, their qualitative impact is easier to assess.

• The main problem is the difficulty of appraising the aggregate effect of multiple structural changes where some are beneficial to profitability, others are detrimental.16-3-2013 Copyright Material © Arab Open University – Egypt Branch_B301A 5

Applying industry analysis Second ; Strategies to alter industry structure

• How the structural characteristics of an industry determine the intensity of competition and the level of profitability?

• The answer for this question provides a basis for identifying opportunities for changing industry structure in order to alleviate (lessen) competitive pressures.

• The first issue is to identify the key structural features of an industry that are responsible for depressing profitability.

• The second is to consider which of these structural features are amenable (responsive) to change through appropriate strategic initiatives. 16-3-2013 Copyright Material © Arab Open University

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Applying industry analysisStrategies to alter industry structure (example)

• Suppliers of leading brands (e.g. Sony and Pioneer) have sought to limit the buying power of discount chains by refusing to supply those chains that advertise cut prices or that do not display their products within ‘an appropriate retailing environment’.

• Efforts to improve industry profitability include mergers and attempts at product differentiation.

• Excess capacity has also been a major problem. Through a series of bilateral plant exchanges, the number of companies producing each product group has been reduced and capacity rationalization has been facilitated.

• Building entry barriers is a vital strategy for preserving high profitability in the long run (American Medical Association)16-3-2013 Copyright Material © Arab Open University

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Defining industries: identifying the relevant market• One of the most difficult problems in industry analysis is defining the

relevant industry.

• The first issue is clarifying what we mean by the term ‘industry’.

• Economists define an industry as a group of firms that supplies a market.

• Hence, the key to defining industry boundaries is identifying the relevant market.

• By focusing on the relevant market, we do not lose sight of the critical relationship among firms within an industry: competition.

• A market’s boundaries are defined by substitutability, both on the demand side and on the supply side.


Beyond the Five Forces model: dynamics, game theory, and cooperation

• Porter’s Five Forces of Competition framework is not without its critics.

• Economists criticize its theoretical foundations. Its basis is the structure–conduct–performance approach to industrial organization economics.

• Researchers have identified a number of assumptions in the structure–conduct–performance approach which do not hold in practice.

• For example, business relationships are not always arm’s-length.

• Many relationships are characterized by privilege through affection or trust; others are co-dependent systems formed by networks (webs) of companies, where competition exists between webs and within webs.16-3-2013

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• The Five Forces model is also limited by its static nature: it views industry structure as stable and externally determined.

• This determines the intensity of competition, which in turn influences the level of industry profitability.

• But competition is not some constrained process that determines prices and profits and leaves industry structure unchanged.

• Competition is a dynamic process through which industry structure itself changes through evolution and transformation.

• Porter’s model does not take these features into account16-3-2013 Copyright Material © Arab Open University – Egypt Branch_B301A 10


• Thus, Porter’s model fails to recognize that competition changes industry structure both

a. consciously by firms’ strategic decisions and

b. as an outcome of the resulting competitive interaction

• The essence of competition, then, is a dynamic process in which equilibrium is never reached and in the course of which industry structures are continually reformed.

• This is evident in the structural transformation of deregulated industries16-3-2013 Copyright Material © Arab Open University



Schumpeterian competition: creative destruction

• Joseph Schumpeter was the first to recognize and analyze the dynamic interaction between competition and industry structure.

• Schumpeter focused on innovation as the central component of competition and the driving force behind industry evolution.

• Innovation represents a ‘perennial gale (recurrent wind ) of creative destruction’ through which favorable industry structures (monopoly in particular) contain the seeds of their own destruction by providing incentives for firms to attack established positions through new approaches to competing.

• The key issue raised by Schumpeter is whether we can use current industry structures as a reliable guide to the nature of competition and industry performance in the future. 16-3-2013 Copyright Material © Arab Open University




• The relevant consideration is the speed of structural change in industry:

• If the pace of transformation is rapid,

• If entry rapidly undermines the market power of dominant firms,

• If innovation speedily transforms industry structure by changing process technology, by creating new substitutes, and by shifting the basis on which firms compete,

then there is little merit in using industry structure as a basis for analyzing competition and profit. 16-3-2013 Copyright Material © Arab Open University




• However, many empirical studies of changes over time in industry structure and profitability do not support Schumpeter’s process of ‘creative destruction’.

• Overall, these studies show a fairly consistent picture of the rate of change of profitability and structure.

• Both at the firm and at the industry level, profits tend to be highly persistent in the long run.

• Structural change – notably concentration, entry, and the identity of leading firms – also appears to be, on average, slow.

• Some industries, however, conform closely to Schumpeter’s model ‘Schumpeterian industries’.

– In computers, telecommunication services, Internet access, and electronic games, using current trends in industry structure to forecast profitability several years ahead is unreliable16-3-2013


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The contribution of game theory

• Central to the criticisms of Porter’s Five Forces as a static framework is its failure to take full account of competitive interactions among firms

• The essence of strategic competition is the interaction among players such that the decisions made by any one player are dependent on the actual and anticipated decisions of the other players.

• The Five Forces analysis offers little insight into firms’ choices of whether to compete or to cooperate; sequential competitive moves; and the role of threats, promises, and commitments.

• Game theory has two especially valuable contributions to make to strategic management.16-3-2013 Copyright Material © Arab Open University




1. It permits the framing of strategic decisions: Apart from any theoretical value of the theory of games, the description of the game in terms of:

a. Identifying the players

b. Specifying each player’s options

c. Establishing the payoffs from every combination of options

d. Defining sequences of decisions using game trees permits us to understand the structure of the competitive situation and facilitates a systematic, rational approach to decision making.16-3-2013 Copyright Material © Arab Open University




2. Through the insight it offers into situations of competition and bargaining, game theory can predict the equilibrium outcomes of competitive situations and the consequences of strategic moves by any one player.

• One of the greatest benefits of game theory is its ability to view business interactions as comprising both competition and cooperation.

• A key deficiency of the Five Forces framework is in viewing rivalry and bargaining as competitive in nature.16-3-2013 Copyright Material © Arab Open University




• Whereas Coca-Cola’s relationship with Pepsi-Cola is essentially competitive, that between Intel and Microsoft is primarily complementary. Thus,

– A player is your complementor if customers value your product more when they have the other player’s product than when they have your product alone.

– A player is your competitor if customers value your product less when they have other player’s product than when they have your product alone.

• The value net recognizes these two types of relationship.

• It is important to recognize that a player may occupy multiple roles.– Microscope and Netscape compete on the market for Internet browsers– cooperate in establishing security protocols for protecting privacy and guarding

against credit card fraud on the Internet16-3-2013 Copyright Material © Arab Open University – Egypt Branch_B301A18



• The most important insights that game theory provides are its ability to identify opportunities for a player to change the structure of a game in order to improve payoffs. Consider the following examples:

• The benefits of repeated games

• Deterrence (Discouragement) The payoffs in a game can be changed through increasing the costs to other players of choices that are undesirable to the firm.

• Bringing in competitors establishing alliances and agreements with

• competitors can increase the value of the game by increasing the size of the market and building strength against other competitors.

– The key is converting win–lose (or even lose–lose) games into win–win games.16-3-2013 Copyright Material © Arab Open University




• Game theory permits considerable insight into the nature of situations involving interactions among multiple players. – It clarifies the structure of relationships and nature of

interactions among players, and – it identifies the alternative actions available to different

players and relates these to possible outcomes. • Game theory has provided valuable decision

support in negotiations and in simulating competitive patterns of action and reaction.

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Opportunities for competitive advantage: identifying Key Success factors

• Our discussion of hyper competition and game theory has taken us well beyond the confines of the Five Forces framework

• Remember that the primary purpose of the Five Forces framework is to analyze industry attractiveness in order to forecast industry profitability.

• Hyper-competition explicitly recognizes that competition is a battle for competitive advantage.

• Game theory also focuses on positioning and maneuvering for advantage.

• The purpose of this section is to look explicitly at the analysis of competitive advantage … to identify the potential for competitive advantage within an industry in terms of the factors that determine a firm’s ability to survive and prosper – its Key Success Factors

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To survive and prosper in an industry, a firm must meet two criteria:

1. it must supply what customers want to buy,

2. it must survive competition.

• Hence, we may start by asking two questions:

• What do our customers want?• What does the firm need to do to survive competition?

See Table 3 pp; 7916-3-2013 Copyright Material © Arab Open University – Egypt Branch_B301A 22


• To answer the first question we need to look more closely at customers of the industry and to view them

– (i) as the basic rationale for the existence of the industry and

– (ii) as the underlying source of profit.

• This implies that the firm must

– identify who its customers are,

– identify their needs, and

– establish the basis on which they select the offerings of one supplier in preference to those of another16-3-2013 Copyright Material © Arab Open University – Egypt Branch_B301A

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• The second question requires that the firm examine the basis of competition in the industry.

• How intense is competition and what are its key dimensions?

• If competition in an industry is intense, then, even though the product may be highly differentiated and customers may choose on the basis of design and quality rather than price, low cost may be essential for survival.

• A basic framework for identifying Key Success Factors is presented in Figure 5.16-3-2013 Copyright Material © Arab Open University


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Identifying Key Success Factors for CA

Prerequisites for successPrerequisites for success

What do customers want?

What do customers want?

How does the firm survive competition?

How does the firm survive competition?

• Who are our customers?• What do they want?

• Who are our customers?• What do they want?

• What drives competition?• What are the main dimensions of competition?• How intense is competition?• How can we obtain a superior competitive position?

• What drives competition?• What are the main dimensions of competition?• How intense is competition?• How can we obtain a superior competitive position?

Analysis of competitionAnalysis of competitionAnalysis of demandAnalysis of demand

Key Success FactorsKey Success Factors


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Figure 5: Identifying Key Success Factors (P80)



• There is no universal blueprint for a successful strategy, and even in individual industries, there is no ‘generic strategy’ that can guarantee superior profitability.

• However, each market is different in terms of what motivates customers and how competition works.

• Understanding these aspects of the industry environment is a prerequisite for an effective business strategy.

• This does not imply that firms within a industry adopt common strategies.

• Since every firm comprises a unique set of resources and capabilities, every firm must pursue unique key success factors.16-3-2013 Copyright Material © Arab Open University


Summary

• In this chapter, we examined concepts and frameworks to assist us in understanding the business environment of the firm.

• A key assumption is that to understand competition and the determinants of profitability within an industry, we are not restricted to acquiring experience-based, industry- specific learning over a long period of time. Instead, draw on concepts, principles, and theories that can be applied to any industry.

• Although every industry is unique, the patterns of competitive behavior can be explained using common analytical frameworks.

• The underlying premise of this chapter is that the structural characteristics of an industry play a key role in determining the nature and intensity of the competition within it and the rate of profit it earns. 16-3-2013 Copyright Material © Arab Open University


Summary

• Our framework for linking industry structure to competition and profitability is Porter’s Five Forces of Competition model.

• This provides a simple, yet powerful, organizing framework for classifying the relevant features of an industry’s structure and predicting their implications for competitive behavior.

• The framework is particularly useful for:

– Predicting industry profitability

– Indicating how the firm can influence industry structure in order to moderate competition and improve profitability.16-3-2013

Copyright Material © Arab Open University – Egypt Branch_B301A29

Summary

• The Porter framework suffers from some critical limitations. • In particular, It does not take adequate account of the

dynamic character of competition. – Competition is a powerful force that changes industry structure.– In hypercompetitive industries, competing strategies create a

process of ‘creative destruction’ that continually transforms industry structure.

• As for the theoretical weaknesses of the Porter framework, game theory provides a broader theoretical basis for analyzing both competition and cooperation, but, in providing a basis for strategy formulation, its potential has yet to be realized.16-3-2013 Copyright Material © Arab Open University


Summary

• Though the Porter framework permits analysis of competition and profitability at the industry level, our industry analysis is also directed toward understanding the opportunities for competitive advantage.

• Our approach has been to show that by understanding customer demand, the competitive process, and the determinants of firm-level profitability, we can identify Key Success Factors: the prerequisites for survival and success with an industry.16-3-2013 Copyright Material © Arab Open University


B301A

Block Three: The Strategy Toolkit

Introduction

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Introduction

If strategic management is all about managing to achieve outstanding success, then the essentials task of strategy are to identify the sources

of superior business performance and to formulate and implement a strategy that exploits these sources of superior performance.

Johnson (2006) views a strategic process involves three interrelated

stages; • Analysis, where strategies explore the environment where their

organization exists, with resources and capabilities.• Choice, where strategies survey the data gained from

reviewing their operating environment and make rational decisions.

• Implementation, where the organisation sets about seeking to implement that strategic decision…. As follows;

Analysis

Implementing

2

Choosing

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Block 3 – Unit One: External Analysis


Introduction • Understanding the environment in which the organization

operates is the crucial first element of a rational approach to strategy.

• The rational approach suggests that organizations need to appreciate the various factors in their operating environment, AND how they may conceivably impact upon them, as they go about making decisions about the nature and content of organizational strategy.

• This phase of the strategy process has produced some of the most famous – and controversial – tools in frequent use in classrooms and boardrooms across the world.16-3-2013 Copyright Material © Arab Open University


Introduction

The aims of organizations using these tools are twofold:

A. They aim to identify opportunities in their operating environments in order to create strategy to take advantage of those opportunities.

B. They aim to identify threats in their operating environments in order to create strategy which nullifies the challenge such threats pose.



Introduction• In this unit, you will read about three principal tools ;

– (i) Liam Fahey and V. K. Narayanan’s STEP or PEST concept (1986), and – (ii) Michael Porter’s five forces model (1980) and his generic strategy model

(1985)– (iii) Strategic group analysis (McGee and Thomas, 1986).

• In each case, – you will be introduced to the author’s original motivations for developing these

tools, – discuss how these tools have been used by academics and businesses, and any

developments or extensions to the original models which have been suggested to improve their performance,

– then discuss any criticisms of these models and their ability to deliver insight for students and business people alike.

• Each framework is an attempt to produce a general understanding of the circumstances facing an organisation, how can one tool work in every situation?16-3-2013 Copyright Material © Arab Open University – Egypt Branch_B301A 37

IntroductionBy the end of this unit, you should be able to:

A. analyze the far environment of an organisation, making observations on the potential effect that macro-environmental factors can have on an organization’s strategy process

B. analyze the near environment of an organisation, making observations on the potential effect that industry factors can have on an organization’s strategy process

C. understand the influence of competitors on an organization’s strategy process

D. start to develop your own perspective on what are the critical issues facing an organisation preparing for a strategic choice, through reflection on your own experience and by reference to the various cases and examples used in this unit.16-3-2013

Copyright Material © Arab Open University – Egypt Branch_B301A 38

1.1 Defining terms: what do we mean by the ‘environment’?

Before we start to introduce the tools, it is probably a good idea to make sure we all understand the terminology used here. External; a simple definition of external implies merely ‘being

outside’. organisation cannot assume it can control that phenomenon, so it needs to understand it and develop responses and contingencies to deal with it.

Environment; there are various environments that are important to an organisation which you may see described as its operating environment or its competitive environment,

Analysis; my favourite definition of ‘an analyst’ comes from the nineteenth-century American gothic author Edgar Allan Poe, The analyst, Poe suggests, makes ‘a host of observations and inferences.



Before we start to introduce the tools, it is probably a good idea to make sure we all understand the terminology used here. Industry; Michael Porter suggests the following definition: ‘the

group of firms producing products that are close substitutes for each other’ (Porter, 1980, p. 5), which is perhaps a good working definition of what we traditionally understand to constitute an

industry. Market; Is a structure enabling goods and services to be bought

and sold. The concept can be used to classify a specific geographic location, or a particular product segment, within a

wider industry. Dynamic; Teece et al.,(1997) Dynamic capabilities analysis

attempts to understand how organisations are able to build competitive advantage in regimes of rapid change.



Some observations on ‘the environment’ One of the roles of strategists is to develop an awareness of the

uncertaintie in the environment so that organisations face up to them and ensure they ar not ignored. Why is this important?

The task of the strategist is complicated by the argument that the environment is becoming increasingly dynamic, and that change is rapid, more frequent and more complex than was

previously the case. This suggests that organisations can take nothing for granted. D’Aveni (1994), provided ‘hypercompetition’ where it is argued

that any advantage an organisation enjoys will inevitably be temporary, due to the rate and pace of change.

Authors suggest that in most industries competitive advantage is necessarily short-lived.



As you progress through Unit 1, you might like to consider Figure 1.1 as your map, providing you with a structure for the analysis you will be asked to undertake.

Figure 1.1(P18): A map of an organisation’s external environment


1.2 analyzing the far environment• The far environment, also macro environment is the environment

that is external to an industry (Fahey and Narayanan, 1986).

• This unit concerns the study of the effect that forces at work within the macro environment will have upon all of the industries and organizations within that macro environment.

• The principal tool for exploring the far environment is the STEP or PEST model, which asks that we consider the far environment in terms of four segments: sociological, technological, economic and political.

• By studying these factor an organisation can understand the potential effect of very high-level shifts in the general operating environment.

• The traditional visualisation of the STEP model is shown in figure 1.2(P19); 16-3-2013 Copyright Material © Arab Open University


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1.2 analyzing the far environment

• These are effects which are felt by all organizations, but their precise relevance may differ depending upon the type and characteristics of the industry you are examining.

• The effects can potentially be felt at both a strategic and an operational level.


1.2 analyzing the far environment

Box 1.2: Features of a STEP analysis

• Sociological factors include: (1) demographics, (2) life styles and (3) the social values of a society. Hence analysis in this segment of the model is interested in understanding shifts in population characteristics, the emergence of new life styles and changing social values.

• Technological factors concern the technological progress or advances that are taking place in a society, such as new products, processes and materials, or the general level of scientific advances, and how these affect other STEP factors.16-3-2013


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1.2 analyzing the far environmentBox 1.2: Features of a STEP analysis (cont’d)

• Economic factors include: the general set of economic factors and conditions confronting all industries in a society: a particularly significant concern for for-profit organizations within the macro environment.

• Political factors include: (1) political processes occurring in a society, and (2) the actions of regulatory institutions that shape codes of conduct.16-3-2013 Copyright Material © Arab Open University


1.2 analyzing the far environment• Look carefully at the model of the STEP process shown in

Figure 1.2.• Notice that Fahey and Narayanan have linked various elements of

the STEP model together. • They suggest, for instance, that developments in social expectations

will influence technological factors, and indeed vice versa. – For example, Sony’s development of the Walkman in 1978 created a demand

for music-on-the-go. – This in turn contributed to building and sustaining a lifestyle expectation

which led to further technological developments to respond to this change and to meet this emerging

demand.– Before the Walkman, it is arguable if anyone realised that

they ‘needed’ a portable music player.

– Sony, therefore, in anticipating an emerging lifestyle change, developed a product to satisfy this emerging need and in so doing created a new market segment.


1.2 analyzing the far environment• Fahey and Narayanan suggest, therefore, that we should

view the far environment as a system, in which each factor is (potentially) related to and (potentially) affects every other factor.

• Their model offers a framework of analysis for identifying, tracking, projecting and assessing trends and patterns in the global macro-environment, enabling organizations to assess opportunities and threats that might be emerging from across this far environment.

• They suggest that in order to undertake a STEP analysis, we should follow four stages:16-3-2013 Copyright Material © Arab Open University


1.2 analyzing the far environment1. scanning the environment to detect ongoing and

emerging change

2. monitoring specific environmental trends and patterns to attempt to predict their evolution

3. forecasting the future direction of environmental changes

4. assessing current and future environmental changes for their strategic and organisational implications.16-3-2013


1.2 analyzing the far environment• A final, unstated stage is, then, to use this awareness to

inform strategic choice. • STEP analysis involves some key terms: scanning,

monitoring, forecasting, assessing. • Undertaking a STEP analysis does not mean simply making a list of

what you consider to be relevant factors under each heading• it also involves making a judgement about which of these factors is

significant to the organisation you are studying, and • attempting to understand how these factors can impact upon the

decisions that organisation needs to make. • In short, the STEP analysis requires you to answer the ‘So what?’

question.• The value in conducting a STEP analysis specifically in

order to understand how it macro environmental factors can have a direct impact on organisational it profitability, or on performance for not-for-profit (NFP) organisations 16-3-2013 Copyright Material © Arab Open University


1.2 analyzing the far environment• In recent years the traditional STEP model has been expanded to

directly acknowledge additional factors which were difficult to locate in the original model, or whose importance has increased for organizations.

• Specifically, these factors include legal (L) and environmental (E) considerations.

– In an extended analysis, specific legal considerations are identified as distinct from political factors, and,

– increasingly, important environmental or social responsibility issues are also differentiated from the social or political categories where they may have been categorised under a STEP analysis.

• The most recent extended model is therefore known as the STEEPL or PESTLE framework and should provide a useful overview of truly significant factors facing all organisations.16-3-2013 Copyright Material © Arab Open University


1.3 analysing the near environment

Reading 1, Michael Porter’s model: The five competitive forces that shape strategy


1.3: Analysing the near environment

Michael Porter; continues to be identified as a leading exponent of the ‘market positioning’ school of strategy, basing his views upon

industrial organisation economic (IOE). Porter argues that;

it is critical to understand the position of the firm within its industry, as ‘industry structure has a strong influence in determining the competitive rules of the game as well as the strategies potentially available to the firm.

the economic structure of an industry is a product of five forces whose collective strength determines the ‘ultimate profit potential

in the industry.



Porter acknowledges that the impact of each force will be clear to each firm operating in that industry;

what is critical is for the firm to delve (investigate) below the surface and analyse the sources of each force,

developing responses which either nullify the potential threats posed by some forces or accentuate the advantages offered by others. The five forces approach can be used to analyse two scenarios; The analysis can be from the perspective of an incumbent. Or it can be from the perspective of a potential new entrant.

Review pp; 28 & 29 VIP

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Figure 1.4a(P32): A five force analysis of the global steel industry


Criticisms and extensions of the five forces approach

• The five forces approach has not been universally acclaimed and a number of significant criticisms have emerged in the three decades since it was first discussed.

• It is important that you understand the nature of these criticisms, and come to your own opinion as to whether they are compelling or otherwise.

• Four (4) criticisms of Porter’s work have identified, which you should read and consider, but

• Michael Porter responded to these criticisms16-3-2013 Copyright Material © Arab Open University – Egypt Branch_B301A 57

1.3: Analysing the near environment Resource-based criticisms• RBV is a central theoretical contribution emphasising the

importance of internal analysis in the strategy process. However, it is important here to note that the RBV represents a significant critique of industrial organisation economic (IOE) approaches to identifying and developing business-level strategy.

• Jay B. Barney (1991) outlines two major assumptions underlying Porter’s work which, explicitly, RBV theorists believe are evidence of its weakness if it is not undertaken alongside an internal analysis of capabilities and competencies.

• These assumptions are that:– Organizations within an industry are identical in terms of their strategic

resources and the strategies they pursue.– If resource heterogeneity is present in an industry then that heterogeneity

will be short-lived (for example if a new entrant arrives, or an incumbent develops new and valuable resources) – i.e., resources tend to be imitable or mobile, and hence the advantages they bring will inevitably only be temporary.


Resource-based criticisms• Jay B. Barney (1991), notes that the RBV, as it seeks to link

internal characteristics with performance, is a challenge to these assumptions. Indeed the RBV adopts contrary assumptions

• First that there will be resource heterogeneity between organizations, and

• Second that there is no inevitability that resource heterogeneity will disappear, along with any advantage that heterogeneity brings

– as competitive advantage is a product of superior resources and capabilities, and occasionally an organization’s resources and capabilities are so superior that competitive advantage becomes sustainable over the longer term.16-3-2013 Copyright Material © Arab Open University


1.3: Analysing the near environment Dynamic criticisms

• Another criticism of Porter’s work suggests that it lacks dynamism – i.e., that it is a static model.

• This criticism is magnified by the increased dynamism of the environment, and the speed with which industry boundaries are seen to shift.

• It may be that industry boundaries are fluid at the best of times. • You may have found it challenging when conducting your own five

forces analysis, for example, to precisely identify the difference between one industry’s product or service and its substitutes.

• Some authors, such as David Teece (2007), suggest that, Porter’s work fails to recognize the effect of rapid innovation on industry boundaries and this undermines the value of its application.

• Teece further uses this criticism to argue in favor of resource-based approaches to strategy-making.


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Dynamic criticisms• Robert Grant (2008) has suggested the addition of a new force – that of

the complement or complementor.

• Grant’s perspective is that the issue of whether organizations can or should cooperate with competitors needs to be acknowledged during a five forces analysis.

• He argues that an organization is often so interconnected with other organizations that they may have merged value chains,

– so that to exclude complementors from a five forces analysis is to risk underestimating their importance to an organization’s understanding of its industry structure.

• To Grant, therefore, a complementor is much more than a simple supplier, as a complementor is the co-creator of an organization’s product or service offering and needs to be acknowledged as such.16-3-2013 Copyright Material © Arab Open University – Egypt Branch_B301A

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1.3: Analysing the near environment Practice-based criticisms

• A considerable critique has recently emerged based upon the argued dangers of assuming that it is possible to generalize about the experiences of organizations – even similar organizations – within an industry.

• Among the potential practice-based criticisms is a suggestion that a focus upon the five forces identified by Porter cannot help an organisation to make a judgement about industry attractiveness, because to do so requires an impossible level of abstraction in deciding upon the relative power of each – and their implications.



Practice-based criticisms• Porter’s conclusion (that understanding these forces

enables a firm to make effective strategic choices) is often watered down to simply suggest that undertaking such analysis may help managers to take better decisions.

• A second criticism concerns the tendency of Porter’s model to encourage analysts to group various suppliers, buyers, and so on together, when not all suppliers or buyers are alike.

– An individual and a petroleum refinery may both be customers of an electric utility, but they cannot be said to share many characteristics, so encouraging them to be considered alike is seen as a serious failing of Porter’s approach.16-3-2013


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Sector-based criticisms• The industries studied and referred to in Porter’s original model were

overwhelmingly American organizations and from a manufacturing sector, such as automobiles, or the emerging high-technology industries, such as computing.

• The model was also developed at the end of the 1970s, an era where the certainty of industry boundaries was much greater than the increasingly connected global economy within which we live today;

• while it did acknowledge the convergence of industries such as telecommunications and computing, the model did not anticipate the extent of such convergence and the increasing and rapid blurring of industry boundaries.

• But a valid general question remains: to what extent can a framework developed at a particular time and based upon observations of a particular industry be likely to work in a differing context?16-3-2013


Sector-based criticisms• Public sector criticisms often suggest that there is

a need for a sixth force – government – in any application of the five forces model to a public sector body, in order to enable it to make sense of the context within which it operates.

• Similarly, industries which are largely competitive but heavily regulated, such as utilities, pharmaceuticals and (increasingly) finance, may also need a more explicit recognition of the role of the government actor in order to enable any five forces analysis to meaningfully reflect the structural arrangement of their industry.


Michael Porter response to these criticisms• Despite these criticisms, Porter remains convinced of

the validity of his ideas and has recently responded to these criticisms.

• Porter addresses several of the criticisms leveled at his original work. A summary of his arguments follow.

• Government should not be treated as a sixth force.

• Porter suggests that analysts, while not ignoring government, should refine their understanding of any or all of the five forces that government affects.16-3-2013 Copyright Material © Arab Open University


Michael Porter response to these criticisms• Complements should also not be treated as a sixth force.

• Porter again suggests that complementary products or services should be understood in terms of their effects on the five forces rather than as a separate force in their own right, as they do not in and of their own right influence the availability of profitability in an industry but can change the evaluation of each force within an industry.

• ‘Identifying complements is part of the analyst’s work … the strategic significance of complements will be best understood through the lens of the five forces.’



Michael Porter response to these criticisms• The five forces approach is not, and has never been, a

‘static’ model, but a framework for identifying the most important industry developments and for anticipating their impact on industry attractiveness.

• Porter suggests, through a series of examples, that any failure of the approach to anticipate future trends is a failure of the analyst rather than a failure of the model.

• He argues that to understand the current structure of competition and to establish a baseline from which you can forecast the potential for change, the five forces can be a dynamic predictive model grounded in the structure of competition in any industry.16-3-2013 Copyright Material © Arab Open University


Michael Porter response to these criticisms• Porter argues that changes to industry structure are a fact of

life, and a failure to draw (or amend) an industry structure accordingly is a further failure of the analyst rather than a failure of the model.

• He reiterates (restates) his argument that industries are distinguished by two primary dimensions: the scope of products and services, and the geographic scope.

• If boundaries are shifting or blurring rapidly, it is implied, then this needs to be recognized by redefining industry boundaries

– the principle of the structure of competition and the five forces remains unchallenged.


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HomeworkBlock 3: activities 1.1, 1.3, 1.6, 1.7, 1.8 Case study 1.1

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