The requirements of the complex and dynamic environment in which companies operate has made it empirical to understand the strategic issues which face organizations today so that they can develop sustainability and long term success for themselves. It has become important for strategic managers to develop their organizational goals and strategies in such a manner that the company is able to create competitive advantages and position itself effectively within the industry that it is operating (Kotler, 2009).A number of strategic tools are present that can be used by companies today such as Porter’s Five Forces Model, Value Chain analysis, SWOT analysis and others (Stimpson, 2002). Using these models helps the companies but also limits them in certain ways. To analyze the limitations and benefits a critical analysis is presented of two strategic frameworks which are used often by companies: Porter’s Five Forces Model and Value chain Analysis.
Porter’s Five Forces model aims to assist companies in determining whether the market they are operating in or are considering to enter is profitable and best suited for the company’s capabilities or not (Kotler, 2009). Therefore, this model finds out the market attractiveness and the competition that exists within it. There are five components or forces that for this particular model. These five forces include: threat of new entrants, threat of rivalry, threat of powerful suppliers, threat of powerful buyers and threat of substitutes (Stimpson, 2002; Appendix A).
The threat of rivalry component of the model helps to analyze the competition that exists, the intensity of the competition and also how many players are operating within the industry. Along with that, it also points out the rate of growth and the lack of differentiation for the company as compared to its competitors. It has been understood that if the companies within any particular industry are unable to differentiate their products, the rivalry within the market tends to be very high (David, 2009). If the cost of setting up the business is low and the profitability of companies operating within the industry is high, there is a strong likelihood that it will attract other companies to enter the market as well (Abrosini, Johnson and Scholes, 1998). If a company has the option of choosing from several suppliers, the supplier power tends to decrease. It also decreases if the company is a monopoly in the industry and powerful enough to impact the workings of the market (Lynch, 2009). However, if a supplier is providing the company with a unique or differentiated product or if the option to switch from one supplier to another is limited, the power of suppliers increases (Kotler, 2009). Threat of buyers depends on the numbers of buyers that exist within a market. If the number of buyers is small, the dependency of the company increases on them and thereby these particular buyers affect the company’s revenues (Pettinger, 2004). The final component that makes up the Porter’s Five Forces model is threat f substitutes. The higher the number of substitutes present in the market, the higher and easier it becomes for buyers to switch to other products (Abrosini et al, 1998).
After understanding how Porter’s Five Forces Model works and the factors that form it, it is easier to critically analyze it. The model is able to provide a simple and straight forward approach to examine the industry structure in which a company is operating and also helps in determining the source of competition as well as the attractiveness of the competition (Capon, 2008). Another benefit of the model is that it is able to compare the impact of competitive forces on the organization itself and on the other competitors since competitors tend to have different options to react differently to any external change that occurs (David, 2009). The model also helps in providing strategic options to a company so that it can improve its performance and strengthen its position in the marker (Johnson, Scholes and Whittington, 2011). The model also helps the companies to evaluate how to create and maintain a competitive advantage for itself within the industry since according to this model strategic option should be developed after taking external environment in regard (Porter, 2004). Furthermore, the model also stresses on the fact that competitive advantage for a company might reduce due to substitute products or new entrants within the market. How the company competes with the substitute products or maintains its position when new companies enter are important for it to consider.
One of the most important advantages of using Porter’s Five Forces is Porter’s Five Forces Model assists the managers to evaluate the threats and opportunities that exist in the external environment and to develop strategies based on them (Lynch, 2009). Additionally the mode also gives a fair explanation regarding the profitability of the industry and the companies operating within it and this information can be used by the company to analyze whether it is able or unable to make a profit if it operates within this particular market (David, 2009). The model is also simple to understand and can be explained easily to different employees working within a company. Such an easy interpretation of the external environment also saves time for the company when coming up with the strategy of how to develop and position its business (Kotler, 2009). This tool can also be used effectively with other strategic tools like SWOT analysis, PESTEL and Marketing mix which enables the company to form a competitive strategy for itself.
Even though Porter’s Five forces Model has a number of advantages attached to it, there are some serious limitations of the model as well. One of the limitations that has always been attached to this model is the fact that it has assumed static market structures and is based on the economic conditions of the eighties which was characterized by stale market structures and strong competition (Ambrosini et al, 1998). The competition that exists today is more complex and dynamic in nature and therefore the industry structures have changed. The model hence has not been able to take into regard changing trends in the market and the new business models that exist now. Along with that, the industries which exist today are highly influenced by rapid technological innovations and this particular factor has not been taken into regard by the model since it just represents a snapshot (Johnson et al, 2011). Another major disadvantage that is attached to using the model is that even though it does give a fair picture of the external environment and the competition that exists within it, it does not exactly suggest how to strategize according to these particular market trends (Kotler, 2009). Because the model has simplified the complex relationships that exist within the market, actors such as new innovations, strategic alliances, enterprise networks, electronic linking and others have weakened the use of the model over the time (Capon, 2008).
The model has also stressed a lot on the industry structure and not on the differences that are present amongst the different companies working within the industry which means that the model is taking industry performance cumulatively and has under emphasized the importance of individual companies. The model also talks about strategizing a business based on the strength and extent of the competition, source of competition and the barriers to competition (Lynch, 2009). It therefore fails to talk about the intensity and power of competitive forces which can be used by the company to create competitive advantages for themselves. Adding on, there is a large stress placed on going through all the various components of the model before forming a strategy. However, this is not necessary and it is therefore not feasible to go through the step by step implementation of the model in some industries like the steel industry where substitutes and foreign competitors form basis of developing a strategy and not the other factors of the model (Stimpson, 2002).
Value Chain Analysis
Value chain analysis is another tool created by Michael E. Porter which is aimed to analyze the companies based on the different functions in the value adding process (Porter, 2004). This model has two parts. The first part is focused on the primary activities of the company that is its inbound logistics, operations outbound logistics, marketing and sales and service while the second part comprises of the secondary activities of the company which include the firm’s infrastructure, human resource, management, procurement and technological department (Kotler, 2009; Appendix B). The secondary activities are important for the company since these forms the internal working of the firm. If the human resource is competent, flexible and capable, the organization can achieve its strategic objectives easily. This also holds true for the management of the organization and the level of technological development that exists within the company (Stimpson, 2002). The company should also take into account the importance of inbound logistics since the raw materials that it receives determine the quality of the products and services that it offers (Stimpson, 2002). Choosing the right supplier is therefore important as well as selecting the right distributor since he will be reaching out to potential customers of the company.
The most prominent advantage of Value Chain analysis just like Porter’s Five Forces is the ease with which it can be understood by all the parties involved since it can also be represented visually (Appendix B; Lynch, 2009). Another benefit that is attached to using this model is that it shows clearly all the contributions made by a particular department which helps the company to analyze the short comings and the sources from where it can form its competitive advantage for itself (Porter, 2004; Johnson et al, 2011). It is also a very powerful tool to help the company understand the cost position it currently is standing at to obtain a cost advantage for itself and to invest in those activities which are cost effective and incur low costs for the company (Pettinger, 2004).
Value Chain analysis also outlines the various opportunities that exist for a company while making its outsourcing decisions. Companies also understand the importance of inspection and choosing the right suppliers through value chain analysis since one activity links to another and therefore a delay in a certain activity will affect the whole value chain (Capon, 2008). Furthermore, once a company has understood the various linkages that are present in its value chain, it can easily develop competencies for itself by either cutting down costs or being time effective (Ambrosini et al, 1998). Through the outline that is provided regarding the inner working of a company, it becomes easier to compare the advantages that the company has with those of its competitors and also how to implement its various processes like designing its products, distributing its products and services better than the other companies which exist in the market (Johnson et al, 2011). Lastly, a value chain analysis assists a company to understand the importance of each component which forms the company for instance the advantages of a competent workforce, the disadvantages of not reaching out to customers on time and so on.
The major flaw that is linked with a value chain analysis is creating it. Even though it is a powerful strategic tool and is easier to understand visually; developing it is another story since it requires a detailed analysis of the cost position of the company as well as complex calculations which are most difficult to be applied by small sized firms (Porter, 2004). The company also has to consider various elements before it can develop a value chain for itself such as identifying the linkages which exist, supplier and customer margins and key cost drivers (Ambrosini et al, 1988). The model also fails to take into account the power that information technology can have on the value chain of a company (Johnson et al, 2011). With the emergence of information technology, companies can reduce their costs through various means such as use of e-commerce in reaching out to their customers. Additionally, because there are such rapid changes in the environment, the value chain analysis needs to get amended frequently to take into account all the changes that are taking place which becomes a hassle and time consuming for companies (David, 2009).
The value chain analysis also fails to point out the important linkages that exist between the various components operating in the chain. If a manger or any employee using this model does not understand the linkages that exist, it will result in a loss for the company since one component affects the other (Lynch, 2009). For instance, failure to select good suppliers will affect the operations of the company since raw materials will not be of good quality which will in turn affect the end product being delivered to the customers (Kotler, 2009).
One of the methods of implementing a value chain is through a chain of suppliers to inputs to outputs and finally to customers (Porter, 2004). Once the value chain is developed for a company, different strategic tools can be implemented such as SWOT analysis and Marketing Mix to enhance the functionality of the company (Kotler, 2009). However, it should be recognized by the managers that a company’s value chain should not be considered in isolation since various factors tend to affect it (Capon, 2008) and the linkages that exist between the various elements of the value chain should be comprehended fully. Decreasing the costs of one element might increase the costs of the other element which is linked to it (Lynch, 2009). Therefore to achieve a competitive edge for itself, a firm should understand linkages and should not take each element separately. A company should take into regard that its value chain is in fact a part of the wider system which involves suppliers, distributors, customers’ value channels and the services that competitors provide (Ambrosini et al, 1998). Hence, if the entire process that is from raw materials to end products is managed and co-operated properly, a company can create profits and advantages for itself and eliminate losses from its system.
Another short coming of the value chain that can emerge is when companies compare their value chain systems with their competitors and change theirs to match them thinking that by doing so they will enjoy the same benefits (Johnson et al, 2011). This does not hold true since the capability of every company is different and thus, a company cannot match its operations or any other component of the value chain with its competitors without affecting the whole value chain itself. The value chain analysis has been developed a long time back due to which it is traditional in nature and does not take into regard various changes that have occurred in the environment today (Capon, 2008). Furthermore, companies might not even need to use all the elements of the value chain designed by Porter since different industries have different ways of functioning for instance in the video on demand industry, there is no need of operations department or use of operations in forming the value chain as these companies just transfer the movies that they get from studios to their customers (Kotler, 2009).
Thus, using a value chain is not as simple as it is portrayed and companies need to conduct in depth analysis of various departments to form a value chain analysis for themselves.
Porter’s Five Forces Model and Value chain analysis both have a number of short comings associated to them which include the need to take into regard of new trends in the external environment. However, both these tools are still popular and used by companies all over the world since they can be easily used with a number of other strategic tools (Kotler, 2009; Johnson et al, 2011) as well as the fact that they can be easily understood and visually represented. Furthermore, these tools help the companies to comprehend the external environment and form their strategies based on their understanding. Through these models, firms can easily develop and recognize the competitive advantages that they can create to position themselves in a better way within the industry that they are operating in. Therefore, use of these tools is essential for companies. However, modifying these tools to take into account the various technological and innovative trends that exist in the environment is necessary (Lynch, 2009).
- Ambrosini, V., Johnson, G. and Scholes, K., (1998). Exploring Techniques of Analysis and Evaluation in Strategic Management, Prentice-Hall, pp. 88-92
- Capon, C., (2008). Understanding Strategic Management, Prentice Hall, pp. 66-76
- David, F., (2009). Strategic Management Concepts, 12th Ed.,, Pearson Education International, pp. 65-89
- Johnson, G., Scholes, K. and Whittington, R., (2011). Exploring Corporate Strategy, Prentice-Hall Europe, Prentice-Hall, 9th Ed., pp. 115-118, 175-213
- Kotler, P., (2009). Marketing Management : A South Asian Perceptive, Prentice Hall, U.S.A., pp. ,220-221, 227-230
- Lynch, R., (2009). Strategic Management, 5th Ed., Prentice-Hall, pp. 56-62
- Pettinger, R., (2004). Contemporary Strategic Management, Palgrave, pp. 112-119
- Porter, M., (2004). Competitive Advantage, Free Press Publications, pp. 85-88
- Stimpson, P., (2002). Motivation in Theory and In Practice, Cambridge University Press, pp. 84-89, 91, 255-256
Porter’s Five Forces Model
Value Chain Analysis