Transcript Slide 1

Final Lecture
· Brief look at Porter’s Five Forces Model (Basically an
overview of the course)
· Assignments and Exam
Porter’s 5 Forces Model
Aim: To develop a framework within which we can understand how
economics helps businessmen understand their environment and aid
their strategic-decision making
In particular, we want to answer questions:
1). How do I tell how profitable a particular industry is?
2). What are the key factors affecting profitability?
3). How might projected changes in the business environment affect firm
performance?
• Business Unit Strategy: The choice of strategy at the
level of individual business units
• Focus lies in making appropriate strategic decisions given the
market environment faced by the business unit
• Decisions like Pricing, Advertising, Product Characteristics/Features
are generally made by firms on a market by market basis
• Corporate Strategy: The choice of strategy at the level of
the Corporation
• Decisions relating to the set of business units which make up the
corporation (These decisions affect all the corporations business units)
• The decision to Diversify, Vertically Integrate, engage in International
Business
• Broad strategic decisions relating to HR policy and practices, culture
etc
• KEY POINT: We're going to concentrate on Business Unit
Strategy
Average Industry Profitability for 29 UK manufacturing industries.
(Averages for 1993-98 incl.)
Rate of
Rank
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
Industry
Water
Cement
Pharmaceuticals
Publishing
Glass
Clothing
Footwear
Aerospace
Rubber and Plastic
Textile Manuf.
Electricity Generation
Paper
Concrete
Vegetable Processing
Electrical equipment
Gas
Construction
Basic Chemicals
Soap & Detergents
Iron & Steel
Beverages
Domestic Apps.
Sawmilling
Cars
Computers
Dairy Products
Tobacco
Oils & Fats
Petrol Refining
Gross
Profit
70.2%
50.1%
45.3%
43.9%
42.1%
41.5%
39.1%
38.3%
37.9%
37.7%
34.1%
33.9%
33.9%
33.8%
32.6%
30.3%
29.8%
28.4%
28.1%
27.6%
26.8%
24.2%
22.4%
21.7%
20.7%
18.8%
17.3%
11.1%
7.3%
Average Firm Profitability for some large UK listed firms
for 1993-8.
Firm
Wessex Water
National Grid Group
Southern Electric
Glaxo Wellcome
Pennon Group
Severn Trent
Shire Pharmaceuticals
AWG
Kelda Group
British-Borneo Oil & Gas
Rio Tinto
Cable & Wireless
Reuters Group
Reed International
Monument Oil & Gas
PowerGen
Sage Group
Scot. & Southern Energy
Diageo
SmithKline Beecham
Thames Water
AstraZeneca
Scottish Power
Reckitt Benckiser
Smiths Industries
Smith & Nephew
Blue Circle Industries
Corus Group
Greene King
Hanson
Nycomed Amersham
Uniq
Bass
Wetherspoon J.D.
Psion
The Boots Company
Rate of Gross
Profit
55.6%
41.5%
39.1%
35.5%
34.7%
32.2%
32.0%
30.8%
28.0%
26.8%
24.5%
24.3%
24.1%
23.8%
23.6%
23.4%
22.1%
22.0%
20.6%
19.5%
19.2%
18.2%
17.8%
17.8%
16.9%
16.7%
16.4%
15.6%
15.0%
14.5%
14.5%
14.0%
13.1%
13.0%
12.9%
12.3%
Firm
United News & Media
BAT Industries
Fuller Smith & Turner
Cadbury Schweppes
BPB
Whitbread
Shell
Burmah Castrol
Unilever
Assd. British Foods
BAE Systems
Avon Rubber
BP Amoco
Glynwed International
Scottish & Newcastle
Allied Domecq
Imperial Chemical Inds.
Rate of Gross
Profit
11.7%
11.6%
11.6%
11.6%
11.3%
10.4%
9.5%
8.9%
7.9%
7.5%
6.6%
6.2%
6.2%
5.3%
5.3%
4.9%
4.7%
• Our data provide some support for three important
empirical stylized facts:
• Some industries are inherently more profitable than others
• Some firms are consistently more profitable than others
because they operate in these favourable environments
• Firms with similar activities have widely different rates of profit
• These empirical "facts" are a key part of the genesis of the
discipline of Business Strategy
• They imply that:
-
A firm's operating environment is important
-
At the corporate strategic level firms should try to be involved
in "good games“
-
At the business unit level firms should try to alter those
fundamental characteristics - try to improve their "game“
-
There is still scope for firms to do well in relatively poor
environments if they have a good enough strategy to out
perform their rivals
-
Firms should try to choose a strategy that is best given their
operating environment
• Porter's framework relates directly to these empirical
observations
• His framework consists of two parts:
• Industry Analysis - develop a tool that helps us determine what
makes a market tick
• Generic Strategy Formulation - offers strategic prescriptions that
are based on industry analysis
• Some basic issues for industry analysis:
• Arriving at a sensible definition of the market/industry is
a precursor to conducting industry analysis
• This can be quite difficult!
• By defining the market you define a set of competing
products, a geographical area, a set of competitors etc
Too Narrow a Focus can
lead to Strategic Myopia Some important competitive
threats are overlooked
Too Broad a Focus can lead
to irrelevant analysis - the
firm may consider nonexistent threats or lead to the
really important detail being
lost in the larger picture
• Using a number of alternative definitions of a market can
be a useful way of generating a range of strategic
options and perspectives
• What characteristics of a market significantly affect the
performance potential of the firms operating within them?
• Fundamentally market (and hence firm) performance is
hypothesised to be a function of the strength of 5 forces
• Note the two hypotheses implicit in this view of the world:
- Market performance is a relatively simple function of a
set of underlying market characteristics
- Firm performance is primarily determined by the inherent
profitability of their environment
Porter’s 5 Forces
Threat of exercise
of supplier power
The degree of
threat from
Substitute
Products
The extent and
nature of Industry
Rivalry
Threat of exercise
of buyer power
The Size of
Barriers to Entry
•
Barriers to Entry
•
Provide incumbents with advantages over entrants
(which affect market structure)
Sources of Entry Barriers:
High capital requirements, brand loyalty, economies of
scale, control of inputs or distribution channels, and
strategic actions from incumbents
Where any of these are significant the threat of entry is
reduced and the prosperity of the market is enhanced
•
Threat of Substitutes
•
Substitutes do the same job as the industry's product they are "functionally equivalent" (to some degree)
•
Falls in the prices of existing substitutes or the
introduction of new substitute goods threaten the
profitability of the industry
•
E.g. the introduction of pay-per-view technology has
had a big impact upon the market for home video
rental
•
Bargaining Power of Suppliers & Customers
•
If strong suppliers can bid up their prices then the
industry's costs rise and it's profitability falls
•
E.g. Strong unions threaten the profitability of labour
intensive businesses, oil price rises threaten the
profitability of distributors
•
If powerful buyers can force down the industry's price
then industry profits fall
•
E.g. Supermarkets power over many agricultural
markets
•
Power is enhanced if there are few substitutes or if
switching buyer or supplier is costly
•
Intensity and Form of Industry Rivalry
• Intense rivalry (especially when concentrated on price rivalry)
reduces industry profitability
• Often rivalry is intense when: • The market is mature/ the business cycle is recessionary - firms fight
for a larger piece of a shrinking/static pie
• Fixed costs are large - then firms must sell high volumes to cover
costs and hence reduce prices
• Now we want to move on to looking at what makes some
firms in a market more profitable than others
• Porter argues that this is due to differences in their
business unit strategy
• Furthermore he identifies two fundamental routes to
gaining a long term competitive advantage
• A Low Cost Strategy
• A Differentiation Strategy
The Generic Strategy Framework
Porter suggests that there are two fundamental routes
to gaining long run competitive advantage:
The Differentiation
Strategy
The Cost Leadership
Strategy
KEY POINT: Firms should only try to pursue one
of these strategies - otherwise they "get stuck in the middle
• The Differentiation Strategy
• Pursuing a differentiation strategy involves making your product
different from rivals
• That might involve providing extra benefits to the product
For example:
• Airlines might differentiate themselves from one another by offering
more legroom, better in-flight entertainment or food
• Pharmaceutical companies might seek to offer new drugs that offer new
therapeutic benefits
• Soap Companies differentiate themselves by adding different
moisturising ingredients, scents, antibacterial agents, deodorising
ingredients etc
• KEY POINT: Differentiation often (always?) involves incurring
extra costs
• Differentiation confers improved profitability relative to
average performing rivals if:
• Consumers are willing to pay a price that more than
compensates for the higher costs of achieving differentiation:
PROFIT
PROFIT
COST
COST
• The Low Cost Strategy
• A firm pursuing a low cost strategy tries to improve profitability by
reducing costs to the minimum
• They typically offer a basic product that meets the needs of some
consumers but without the frills of some differentiated goods
• For Example:
• Many supermarket own branded goods offer fundamental product
attributes to consumers in basic packaging
• Hotel chains like Travellodge who avoid costs of having swimming
pools, gyms, and just offer a basic hotel service
• Budget Airlines offer basic economy air travel without fancy in flight
meals, extra space, or entertainment
• Key Point: Reducing costs almost certainly involves reducing
the quality of the product relative to differentiated goods
• Low cost firms usually undercut other firms in the market
(sometimes selling volume is key to the low cost strategy if
there are economies of scale)
• They make higher margins by reducing costs by more than
the price reduction
PROFIT
PROFIT
COST
COST
Implementing a low cost strategy involves making
cost reduction a part of the corporate culture
• Q: How do we decide which generic strategy we
should choose?
A:
By understanding the drivers in our environment
(Understanding the market we are in!)
• Critical perspectives on Porter's framework
• Things to note about Porter:
• It's an "externally oriented", "market driven" or "Outside-In"
perspective on strategy formation
• Firms analyse their environments and position them selves with
respect to the important competitive threats
• As such, it relegates the importance of firm specific resources,
capabilities, competencies etc
• Other problems:
• Are generic strategies really a route to competitive advantage?
• Generic = Standard / General / Available to all
• Is being "stuck in the middle" so bad?
• There's plenty of evidence to show that:
• Firms can successfully pursue strategies involving both cost
reduction and elements of differentiation (E.g. Nissan - low cost and
emphasis on reliability)
• Firms that single mindedly focus on a particular generic strategy can
fail (E.g. Caterpillar - endeavoured to make the best earth moving
equipment in the world (highly differentiated) but the costs of doing so
meant that they were vulnerable to attack by cheaper imports)
• Such Hybrid strategies are commonly accepted as being viable