Michael Porter’sFive Competitive Forces

Three Generic Strategies

&

Value Chain

BY

Mangesh Pawar

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About Michael Porter …

1. Born 1947 in United states2. Received bachelor degree in

aerospace and Mechanical engineering in 1969.

3. MBA from Harvard University in 1971.

4. PhD in Business Economics from Harvard in 1973.

5. He is currently Bishop Williams Lawrence University Professor based at Harvard Business school where he leads “The Institute for Strategy and Competitiveness.

Porter’s five Competitive forces

1. Five interactive competitive forces determines an industry’s long term attractiveness: present competitors ,potential competitors, the bargaining power of suppliers, the bargaining power of buyers and threat of substitute products.

2. The strength of individual forces varies from industry to industry, or within same industry.

For e.g. In the fast food industry in India, KFC versus McDonald's versus Pizza hut versus

Jumbo king.

Potential entrants

Threat of new entrants

New capacity to gain market share

Suppliers/Sub-cons

Bargaining power of suppliers

To rise Prices or reduce the quality

Industry competitorsIndustry competitors

Rivalry among Rivalry among existing firmsexisting firms

Customers / Buyers

Bargaining power of buyers

To force down price,Bargain for high quality

Substitutes

threat of substitute products or services

Appear to be different, satisfy the same needs

Porter’s Model

Rivalry among the present Competitors

1. Rivalry is between the firms that produce products which are close substitutes for each other.

2. Firms are mutually dependent.3. Profitability decreases as rivalry

increases.

Rivalry is greater under following conditions:-

1. There is a high investment intensity- the amount of fixed and working capital required to produce a dollar of sales is large. High intensity require firm to operate at or near capacity as much as possible, putting strong downward pressure on prices when demand slackens.

Such firms are less profitable than those with lower level of investment

2. There are many small firms in an industry or no dominant firms exist-

In recent years, hundreds of pharmaceutical companies have started up, all hoping to produce new wonder drugs. In such crowded segments as neurosciences, inflammatory diseases and drug delivery, competition is keen, and some companies are considering preemptive steps in an effort to dominate the niches.

3. There is little product differentiation- e.g. Major appliances, TV sets.

4. There is high cost to changing suppliers (switching costs)

5. Players applying same strategies.6. Low market growth rates (growth of a particular

company is possible only at the expense of a competitor).

7. Barriers for exit are high (e.g. expensive and highly specialized equipment-manufacturing industry.).

Threats of New Entrants:-

1. It is a second force affecting industry attractiveness.

2. New competitors add capacity to the industry and bring with them the need to gain market share , thereby making competition more intense.

3. The greater the threat of new entrants, the less will be an industry’s attractiveness.

Entry is more difficult under the following conditions:-

1. When strong economies of scale(minimum size required for profitable operations) and learning effects are present, it takes time to obtain the volume and learning required to yield a low relative cost per unit. If firms already present are vertically integrated , entry becomes even more expensive.

2. If the industry has strong capital requirements at the outset.

3.When strong product differentiation exists4.If gaining distribution is particularly

difficult.5.If a buyer incurs switching costs in moving

from one supplier to another.

6. Brand loyalty of customers.7. Protected intellectual property like

patents, licenses etc.8. Scarcity of important resources, e.g.

qualified expert staff 9. Access to raw materials is

controlled by existing players .10. Legislation and government action 

Example

1. The sector in which entry barriers are low is IT Sector.

2. The sector in which entry barriers high, and where the player has to start from scratch is in power, energy plants.

Determinants of supplier power The supplier industry is dominated by a few companies but it sells to

many (e.g., the petroleum industry)

It’s product or service is unique and/or it has built up switching cost (e.g., word processing software)

Substitutes are not readily available (e.g., electricity)

Suppliers are able to integrate forward (e.g., Intel can make PCs)

Determinants of buyer power A buyer purchase a large portion of the seller’s product of service (e.g., oil filters purchased by a major auto maker)

A buyer has the potential to integrate backward industries

Alternative suppliers are plentiful because the product is standard or

undifferentiated (e.g., gas station for motorist)

Changing suppliers costs very little (e.g., office supplies)

A buyer earns low profits and is very sensitive to cost (e.g., grocery store)

The purchased product is unimportant to the final quality or price of a

buyers product or service (e.g., electric wire brought for use in lamp)

Threats of Substitutes

A threat from substitutes exists if there are alternative products with lower prices of better performance parameters for the same purpose. They could potentially attract a significant proportion of market volume and hence reduce the potential sales volume for existing players. This category also relates to complementary products.

The threat of substitutes is determined by factors like-

1. Brand loyalty of customers

2. Close customer relationships

3. Switching costs for customers

4. The relative price for performance of substitutes

5. Current trends.

 

For example, “a manufacturer of TV sets" might consider as 'substitutes' for TV sets as those things customers could buy instead, in order to satisfy their need for entertainment and news: a home computer to go online or watch DVDs, a radio, theater tickets, movie rentals, newspaper or magazine subscriptions, books, and so on.

Example: Splenda

Johnson and Johnson has done the impossible

How? Attacking sugar directly, not other artificial sweeteners

Timeline: 1976 – sucralose discovered by Tate & Lyle

– accidental discovery Discovered that product is 600 times

sweeter than sugar – yet is not absorbed as a carbohydrate

Splenda

To build Buzz, product was first rolled out to diabetics

On to grocery stores and restaurantsPartnered with many major companies –

now in McDonald’s, Starbucks, Coke etcConsumers are demanding SplendaHas dipped into sugar sales and also

exceeds sales for Equal and Sweet’N’Low combined!

The options for the organizations to get rid of these determinants:-

Reducing competitive rivalrybetween the existing competitors-i. Avoid price competitionii. Differentiate your productiii. Buy out competitioniv. Reduce industry over-capacityv. Focus on different segmentsvi. Communicate with competitors

Reducing Threats of new entrants-1. Increase minimum efficient scales of operations.2. Create marketing/brand image.3. Patents, protection of intellectual property.4. Alliances with link products and services.5. Tie up with suppliers.6. Tie up with distributors.7. Retaliation tactics.

Reducing Bargaining Power of Suppliers:-i. Partneringii. Supply chain managementiii. Supply chain trainingiv. Increase dependencyv. Build knowledge of supplier costs and methodsvi. Take over the supplier

Reducing the bargaining power of customers:-

i. Partneringii. Supply chain managementiii. Increase loyaltyiv. Increase incentives and value added.v. Cut put intermediaries (go directly to the

customer)

Reducing the threats of Substitutes:-i. Legal actionsii. Increase switching costsiii. Alliancesiv. Customer surveys to learn about their

preferencesv. Enter substitute market and influence from

within

A five forces Analysis of the Cellular Phone Services Industry

Five Forces Score Rationale

1. Rivalry among the present competitors

Rivalry is low to moderate: moderately favourable

Products are differentiated through new features and services; customer switching cost are low.

2. Threat of new entrants

Threat of new entrants is high: moderately unfavourable

Rapid pace of technological change may bring new entrants based on new technologies: satellites.

3.Supplier power Supplier power is high: moderately unfavourable.

Governments have raised the price of additional bandwidth through auctions.

Forces Score Rationale

4.Buyer power Buyer power is low: very favourable

Even large customers have little power to set terms and conditions in this oligopolistic industry.

5.Threat of substitutes

Threat of substitutes is high: moderately unfavourable

PDA’S or new multimedia devices could replace cell phones.

Conclusion: Only two of the five forces are favourable, while three are unfavourable. Thus the cellular phone service industry is not attractive at this time according to porter’s model

Example of Industry analysis (Athletic shoe industry)

rating each competitive force as high, medium, or low in strength

Rivalry : High (Nike, Reebok, and Adidas)

Threat of potential entrants: Low (maturity industry, growth rate is slow)

Threat of substitute: Low

Bargaining power of suppliers: Medium but rising (Suppliers increasing

in size and ability)

Bargaining power of buyers: medium, but increasing.,

Based on current trends, the industry appears to be increasing its

competitive intensity, profit margin will be falling for the industry

The

Three

Generic Strategies

Three Generic Strategies

Three generic strategies to overcome the five forces and achieve competitive advantage…

– Overall cost leadership Low-cost-position relative to a firm’s peers Manage relationships throughout the entire value chain

– Differentiation Create products and/or services that are unique and

valued Non-price attributes for which customers will pay a

premium– Focus strategy

Narrow product lines, buyer segments, or targeted geographic markets

Attain advantages either through differentiation or cost leadership

The Generic Strategies

1.Cost Leadership – Offer substitutable products at the lowest price. E.g. LCC.

2. Differentiation – Distinguish products and services in order to charge a premium price. E.g. Mercedes

3.Focus – Follow one of the other strategies in a narrow market

Overall Cost Leadership

1. It is through a set of functional policies aimed at the basic objective

2. It requires aggressive construction of efficient- scale facilities, tight cost, overhead control, cost minimization in the areas like R&D, sales force, advertising etc.

3. Low cost becomes the theme though quality, service and other areas cannot be ignored.

Low cost strategy can defend against…

1. Rivalry from the competitors - as its low cost means that it still can earn returns after its competitors have competed away their profits through rivalry.

2. Powerful buyers – as buyers can exert pressure to reduce price only to the level of the next most efficient competitor.

3. Powerful suppliers - provides flexibility to cope up input cost.

4. Entry Barriers – in terms of cost advantage.5. Substitutes – In favourable position compare

to the competitors.

Things required for Cost Leadership:-

1. High relative market share.2. Access to raw materials.3. Heavy up-front capital investment.4. Aggressive pricing.5. Start-up losses. Firms implementing cost leadership in

U.S. are Texas Instruments, Du Pont Hyundai and South-west airlines …

Case on Cost Leadership:-

1. Harnischfeger revolutionize the rough terrain crane industry.

2. It had market share of 15%.3. Redesigned its cranes, modularized its

components, configured changes, reduce material content, established assembly areas, ordered parts in large volumes to reduce cost.

4. This all reduce its price by 15%5. Market share grown to 25%

Value-Chain Activities

Exhibit 5.3 Value-Chain Activities: Examples of Overall Cost Leadership

Source: Adapted with the permission of The Free Press, a division of Simon & Schuster, Inc., from Competitive Advantage: Creating and Sustaining Superior Performance by Michael E. Porter. Copyright © 1985 by Michael E. Porter.

Shared purchasing operations with other business units

Effective policy guidelines to ensure low cost raw materials (with acceptable quality levels)

Expertise in process engineering to reduce manufacturing costs

Effective use of automated technology to reduce scrappage rates

Effective orientation and training programs to maxi- mize employee productivity

Minimize costs associated with employee turnover through effective policies

Standardized account- ing practices to minimize personnel required

Few management layers to reduce overhead costs

Effective layout of receiving dock operation

Effective use of quality control inspectors to minimize rework on the final product

Effective utilization of delivery fleets

Purchase of media in large blocks

Sales force utilization is maximized by territory management

Thorough service repair guidelines to minimize repeat maintenance calls

Use of single type of repair vehicle to minimize costs

Firm infrastructure

Human resource management

Technology development

Procurement

Inbound logistics

Operations Outbound logistics

Marketing and sales

Service

IN COST LEADERSHIP

Differentiation Strategy

1. Differentiating owns product and service from the other firms in the industry.

2. To provide uniqueness3. It is viable strategy for earning

above average returns in an industry as it creates defensible position for coping with the five competitive forces.

1. It provides insulation against rivalry because of brand loyalty by the customers.

2. The resulting customer loyalty and the need for a competitor to overcome uniqueness provide entry barriers.

3. Buyers lack comparable alternatives and thereby are less price sensitive.

4. Customer loyalty are better positioned for the substitutes.

Things required to achieve differentiation

1. Extensive research2. Product design3. High quality materials4. Intensive customer support5. Higher cost6. Higher prices E.g. Mercedes, Harley Davidson, BMW Caterpillar, Nike…

Value-Chain

Activities:

Exhibit 5.5 Value-Chain Activities: Examples of Differentiation

Source: Adapted with the permission of The Free Press, a division of Simon & Schuster, Inc., from Competitive Advantage: Creating and Sustaining Superior Performance by Michael E. Porter. Copyright © 1985 by Michael E. Porter.

Facilities that promote firm image

Superior MIS—To integrate value-creating activities to improve quality

Widely respected CEO enhances firm reputation

Provide training and incentives to ensure a strong customer service orientation

Programs to attract talented engineers and scientists

Excellent applications engineering support

Superior material handling and sorting technology

Use of most prestigious outletsPurchase of high-quality components to enhance product image

Superior material handling operations to minimize damage

Quick transfer of inputs to manufactur- ing process

Flexibility and speed in responding to changes in manu-facturing specs

Low defect rates to improve quality

Accurate and responsive order processing

Effective product replenish-ment to reduce customer’s inventory

Creative and innovative advertising programs

Fostering of personal relation-ship with key customers

Rapid response to customer service requests

Complete inventory of replacement parts and supplies

Firm infrastructure

Human resource management

Technology development

Procurement

Inbound logistics

Operations Outbound logistics

Marketing and sales

Service

DIFFERENTIATION

Focus

1. It suggest to focus on a particular buyer group, segment of the product line, or geographic market.

2. The strategy base on the premise that the firm is able to serve its narrow strategic target more effectively than the competitors who are competing more broadly.

3. Firms either use low cost or differentiation strategy to achieve the result.

E.g. Johnson & Johnson- focus strategy that achieves differentiation position in baby care products.

Air – Deccan – focus strategy that achieves low cost position.

Focus / Niche Strategiesand Competitive Advantage

Achieve lower costs thanrivals in serving the segment --

A focused low-cost strategy

Offer niche buyers somethingdifferent from rivals --

A focused differentiation strategy

Approach 1

Approach 2Which hat is unique?

Differentiation FocusCost FocusNarrow

target

DifferentiationCost LeadershipBroad target

DifferentiationLower Cost

Competitive Advantage

Com

peti

tive S

cop

e

Source: from Competitive Strategy by Michael E. Porter

1. The firm achieving focus may also potentially earn above average returns for its industry.

2. Focus means that the firm either has a low cost position , high differentiation or both.

For e.g. FEVICOL focused on the specialty markets for fasteners where it can design products according to the buyers need.

Barista and cafe-coffee day focused more on the soft beverages - differentiation

E.g.1. An example of a focus strategy that achieves a low cost

position in serving its particular target is Air-Asia airlines in Malaysia which has provided the most economical fares mainly focusing on cost cutting in various departments.

2. While Singapore Airlines is an example of focus strategy that achieves high differentiation with high cost serving particular target.

Examples of Focus Strategies

eBay Online auctions

Porsche Sports cars

Jiffy Lube International Maintenance for motor vehicles

Pottery Barn Kids Children’s furniture and accessories

OTHER REQUIREMENTS

1. The three generic strategies differ in dimensions.

2. Requires different sources and skills.

3. Sustained commitment to one of the strategies is required to achieve success.

Generic Strategy

Required skills and resources

Common Organizations requirement

Overall Cost Leadership

1. Substantial capital Investment

2.Process engineering skills

3.Intense Supervision of labour4. Low cost distribution system

1. Tight cost control

2.Detail control report

3.Incentive based on meeting strict quantitative targets

Other requirements of the Generic Strategies

Generic Strategies

Required skills and resources

Common Organizational Requirements

Differentiation 1.Strong marketing abilities

2.Product engg.creative flair, strong capability in basic research

3.Strong cooperation from channels

1. Strong coordination among functions in R&D, product development and marketing

2.Amenities to attract highly skilled labour,scientists or creative people.

Focus1. Combination of the above policies directed at the particular strategic target

1. Combination of the above policies directed at the particular strategic target.

Risks of the generic Strategies

Risks of Overall cost Leadership1. Reinvesting in modern equipment2. Scrapping obsolete assets3. Avoiding product line proliferation4. Alert for technological improvements5. Low cost learning by industry

newcomers or followers through imitation

6. Inability to see required product or marketing change because of the attention placed on cost.

Case 1: Ford Motors• Ford Motor company in 1920 achieved unchallenged cost

leadership through limitation of the models and varieties, aggressive backward integration, highly automated facilities.

• As the income rose, the market began to place more of a premium on styling, model changes, comfort .

• Customer willing to pay a price premium to get such features• General motors stood ready to capitalize on this development

with a full line models • Ford faced enormous cost of strategic readjustment given the

rigidities created by heavy investments in cost minimization of an obsolete model.

Case 2: Sharp

• Sharp is in consumer electronics• It has followed a cost leadership strategy• Its ability to undercut Sony’s and

Panasonics was eroded by cost increases and U.S. antidumping legislation and its strategic position was deteriorating through sole concentration on cost leadership.

Risks of Differentiation

1.The cost differential between low cost competitors and the differentiated firm becomes too great for the differentiation to hold brand loyalty. Buyers thus sacrifice some of the features , services or image possessed by the differentiated firm for large cost savings

2.Imitations narrows perceived differentiation , common occurrence as industries mature.

Case

• Kawasaki and other Japanese motorcycle producers have been able to successfully attack differentiated producers such as Harley-Davidson and Triumph in large motorcycles by offering major cost savings to buyers.

This case says that if the differentiated firm gets too far behind in cost due to technological change or simply inattention, the low cost firm may be in a position to make major roads.

Risks of Focus1. The cost differential between broad range

competitors and the focused firm widens to eliminate the cost advantages of serving narrow target or to offset the differentiation achieved by focus.

2. Competitors find submarkets within the strategic target and out focus the focuser.

Stuck in the middle: No competitive advantage Be doomed to below-average performance

Stuck inthe Middle

Focused, DifferentiatedFirms

Cost LeadershipFirms

Market Share

Return onInvestment

High

LowHigh

STUCK IN MIDDLE

Lessons from the Three Generic StrategiesThe essence of the three strategic choices:

Whether to perform activities differently or to perform different activities relative to competitors.

There are two fundamental strategic dimensions: cost and differentiation The key is to choose one dimension and execute

on it consistently. According to Porter, firms that are “stuck in the middle”

either have no strategy or are drifting strategically.

Three Strategic Groups in the Global Automobile Industry

Figure 2.2

VALUE CHAIN

Value Chain

The value chain represents a set of activities that organizations perform to distribute goods and services. According to porter, the organization can gain competitive advantage by managing the value chain more effectively and efficiently than the competitors.

Michael Porter proposed the value chain as a tool for identifying ways to create more customer value.

The value chain identifies nine strategically relevant activities that create value and cost in specific business.

These nine value- creating activities consist of five primary activities and four support activities.

The primary activities in value chain are- inbound logistics, represent the sequence of

bringing material into the business converting them into the final products-

operations Shipping out final product-outbound logistics Marketing them – marketing and sales Servicing them- service

The support activities are –1. Procurement2. Technology development3. Human resource management4. Firm infrastructure

Primary Activities

Su

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Act

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Technological Development

Human Resource Management

Firm Infrastructure

Procurement

Inb

oun

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Log

isti

cs

Op

erat

ion

s

Ou

tbou

nd

Log

isti

cs

Mar

ket

ing

& S

ales

Ser

vice

MARG

IN

MARGIN

Value Creating ActivitiesValue Creating ActivitiesValue Creating ActivitiesValue Creating Activities

Firm’s objectives:-

1. The firm’s task is to examine its cost and performance in each value creating activity and to look for ways to improve it.

2. Should estimate its competitors costs and performance as benchmarks against its own costs and performance.

3. Its success depends not only on how well each department performs its work, but also on how other departmental activities are coordinated.

Core business processes

Core business processes –It includes1. The market sensing process2. The new offering realization process3. The customer acquisition process4. The customer relationship

management process5. The fulfillment management

process

Strong companies develop superior capabilities in managing their core processes.

For e.g. Wal-Mart It has superior strength in its stock replenishment

process. As Wal-mart sell their goods, sales information flows via

computer not only to Wal-mart headquarters' , but also to Wal-mart suppliers, who ship replacement merchandise to the stores almost at the rate it moves off the shelf. The idea is not to manage stocks of goods, but flow of goods.

The Value Chain System

UpstreamValue Chains

A Company’s Own

Value Chain

DownstreamValue Chains

Activities, Costs, &

Margins ofForwardChannelAllies &

StrategicPartners

InternallyPerformedActivities, Costs, &Margins

Activities, Costs, &

Margins ofSuppliers

Buyer/UserValue

Chains

The value – delivery network

1. Firm should look for competitive advantages beyond it’s operations.

2. Companies today have partnered with specific suppliers and distributors to create a superior value delivery network

E.g. for Value- delivery network Levi Strauss’s Value- Delivery Network

Dupont(fibers)

Milliken

(Fabric)

Levi’s (Apparel)

Sears(retail)

Customer

Delivery

Delivery

Delivery

Delivery

Order

Order

Order

Order

Competition is between networks , not companies .The winner is the company with the better network.

1. In this example of value – delivery network is the one that connects Levi Strauss and company, the famous maker of blue jeans, with its suppliers and distributors .

2. One of Levi’s major retailers is Sears . Every night Levi’s learns the sizes and styles of the jeans sold through sears .

3. Levi’s then electronically orders more fabric for next – day delivery from Milliken and company, its fabric supplier. Milliken in turn relays an order for more fiber to Dupont, its fiber supplier.

4.In this way , the partners in the supply chain 4.In this way , the partners in the supply chain use most current sales information to use most current sales information to manufacture what is selling , rather than manufacture what is selling , rather than forecast that may not match current demandforecast that may not match current demandIn this system, the goods are pulled by In this system, the goods are pulled by demand rather than pushed by supply.demand rather than pushed by supply.

THANK YOU ….