CORPORATE STRATEGIES: THE MICHAEL PORTER'S VISION

Por María Victoria Retondaro Costaguta

In the previous post we discussed the issue of corporate strategies. In this post: "Corporate Strategies II," Michael Porter's ideas on strategy in general are presented, describing three aspects:

-          The Five Forces model, in order to make the diagnosis

-          The Three Generic Strategies of the Competitive Advantages and

-          The importance of Activity Concept so as to implement the value chain

There are other prominent authors, from the offensive and defensive strategies Philip Kotler, the dynamics capabilities by Teece and Pisano, nevertheless, the reason why the vision of M. Porter is chosen is due to an extensive use of Porter's ideas specially related to the Competitives Advantages strategy, both in companies and in regions and nations.

Porter’s five forces model.

The five forces analysis provides a framework for determining the degree of competition in the productive sector, and therefore what their expected profitability. From this study the most suitable for the company and its activities chains generic strategy will be established. Dynamic processes must be continuously review and implement systemic and flexible manner.

It is expected that the profit in the commodities sector goods - v.g: wheat or iron - is substantially lower than that obtained in sectors with high barriers to entry or high differentiation, -v.g. the pharmaceutical industry or luxury cars -.

The study of the degree of competition in an industry emerges from the traditional microeconomic principles of partial equilibrium analysis, where the rate of profit would be inversely proportional to the degree of market competition.

Porter's five forces can be divided into two groups:

Three forces horizontal competition: Threat of substitution; Threat of new entry; and Competitive rivalry.

Two forces vertical competition: Supplier power; and Buyer power.

 

1.    Threat of substitution: 

In many cases the risk of a company does not reside in its market competitors, but in the appearance of a substitute good spawned within another productive sector. Some broadly known examples would be the fax against the telex, and afterwards the e-mail versus the fax.

Although there are segments of products more difficult to be replaced, either because of legal protection - patents or legal monopoly – or due to technological reasons, the increasing development of innovation processes make the potential appearance of substitute products more accessible. Apart from technical feasibilities, social factors that favor or not fidelity to a product type will be discovered thereafter.

2.    Threat of new entry:

The easier to enter as a supplier to a sector, the harder would be the threat to their current participants. Some industries have high entry barriers such as: high sunk costs, high optimal yields levels of scale, use of unique resources or access to specific distribution channels.

3.    Competitive rivalry:

Even though a high rivalry between competitors is expected, this type of scenario is more expectable in oligopolistic markets. Markets in which suppliers have comparable levels of sales and, public bodies which severely control possible price agreements. The price war situations are an example of high rivalry and decreasing profit rates of participants.

4.    Supplier power:

It is related with the degree of concentration of raw materials supply involved in production processes; the difficulty of replacing; and its impact on the cost structure of the industry. The bargaining power of suppliers should be contrasted with the power of the demanding industry. An example would be the big supermarket chains that hold a greater negotiation capability to impose trading conditions to their suppliers.

5.    Buyer power:

Similarly to the previous point, if the organization is facing few customers, well organized and with a high participation in the procurement industry, the negotiation capacity of the sellers - and thus profitability - would tend to be lower.

In points 4 and 5, another pressure element on the negotiations of the industry, it is given by the capability - technical and competitive - that may have suppliers to link up forward and customers to link up backward, becoming direct competitors in the market to which the company belongs.

Competitive Advantages, Generic strategies.

According to Michael Porter, there are three generic strategies:

• Leader in costs, by offering, sustainably, products or services at lower prices than the competition. The sources of advantage may include preferential access to raw materials, superior technology, experience curve, economies of scale and the like.

• Leader in differentiation, introducing products or services which are perceived by customers as exclusive; and therefore capable to justify a higher price. This differentiation can be obtained through various ways; thanks to a continuing policy of product innovation, due to providing excellent levels of quality, because the core product incorporates new circles of value services, or to distinguish the buyer with the use of a brand of accredited prestige.

Before moving on to the third strategy, there is a point to be considered: if a company does not lead in costs or differentiation in an industry, tends to fall into an intermediate zone. The company will fall into a halfway point; demanders would not be able to clearly position it as a result of not having a clear strategy.

• Leader in a particular segment. The organization focuses on meeting the needs of a very specific target. Like any other segmentation, this can be made according to age range, gender, socioeconomic status, region or lifestyle.

Activity Concept.

A company can outperform rivals only if it is able to make a difference that is sustainable in the long-term. To stand out companies must deliver greater value to customers or create a comparable value at a lower cost, or both. By delivering greater value a company is able to charge higher average unit prices, while greater efficiency results in lower average unit costs.

Differentiation occurs both by the choice of activities to be performed and by how they are made. Therefore, the activities are the basic units of competitive advantage. The total advantage or disadvantage is the result of all activities of a company.

Differences in operational effectiveness among companies can be seen everywhere. Some companies are able to get more of their inputs than others because they eliminate wasted efforts to use more advanced technology, motivate best employees or are more astute in managing certain activities or groups of activities. Such differences in operational efficiency are an important source of differences in profitability among competitors, because they directly affect the relationship between their position costs and levels of differentiation.

The productivity boundaries are continuously expanding as new technologies and management approaches are created and new inputs are available.

As companies move towards the boundaries, they can often improve various dimensions of performance simultaneously. The constant improvement of operational efficiency is necessary to achieve outperformance. Nevertheless, it is usually not enough, since it is becoming increasingly difficult to stay ahead of rivals. The obvious reason is the rapid spread of best practices. Competitors can quickly imitate management techniques, new technologies, advances in inputs and better ways to meet customer needs

The competitive strategy consists in being different which means to deliberately select a set of different activities in order to deliver a unique value mix.

The different alternatives of positioning determine not only which activities a company will implement and how to configure them, but also how these activities are related to each other. There are three types of relationship schemas among activities:

-       The first one consists in the consistency between each activity and the overall strategy. Consistency ensures that the competitive advantages of activities get accumulated. It also facilitates communication strategy to customers, employees and shareholders, and improves its implementation thanks to the uniformity of the criteria within the company.

-       The second one occurs when activities are reinforced among each other

-       The third one goes beyond the strengthening of the activities, it consists in optimizing the effort

In the three schemas the whole is more important than any of the parts. The competitive advantage arises from the whole system of activities. The adjustment among the activities diminishes the cost or increases substantially the differentiation.

For a competitor, it is more difficult to match a set of interrelated activities than only imitate a particular approach of the sales force, imitate a process technology or replicate a set of product features. The positions grounded in systems of activities are far more sustainable than the ones grounded in individual activities.

Two alternative visions of ‘strategy’:

The last decade implicit strategic model

■ An ideal competitive position in the sector

■ Benchmarking of all activities and achieving the best practice

■ Outsourcing and aggressive alliances to achieve efficiencies

■ The advantages lie in just a few success factors, crucial resources and core competencies

■ Flexibility and quick responses to all competitive and market changes

The sustainable competitive advantage

■ Unique competitive position of the company

■ Activities adapted to the strategy

■ Clear trade-offs and choices regarding the competitors

■ Competitive advantage arises from the merge of all the activities

■ Sustainability derives from the whole activity system, not from isolated parties

■ Operational efficiency is taken for granted

Source: Michel Porter

It is usually considered that threats against the strategy come from outside the company due to changes in technology or because of the competitors’ behavior. Although external changes may be the problem, the biggest threat for strategy often comes from the same company. A solid strategy is weakened due to a misinformed vision of competitors, organizational errors and, especially, the desire to grow.

Deepen a position implies to differentiate even more the activities of the company, to strengthen the fit among the activities and to communicate better the strategy to clients. But nevertheless, many companies succumb to the temptation to encourage an "easy" growth, adding features, products or services without evaluating if they suit to the strategy. Otherwise, they target new customers or markets to which the company has not many novelties to offer. As usual, a company can grow faster -and more profitably- deepening better in the needs and varieties that differentiate it rather than forcing itself to grow in areas which lack of unique features.

Final Comment

There are some critics against Porter’s Competitive Advantages Strategy:

The Five Forces model that is used in order to make a diagnosis is based on the analysis of the company external situation. Although is fundamental to study the own market characteristics, it is also important to analyze the organization internal capabilities and experience. On one hand, a great part of the knowledge a company handles is tacit (Nonaka Takeuchi, 1995: The Knowledge-Creating Company: How Japanese Companies Create the Dynamics of Innovation, New York, Oxford University Press). The innovations market is imperfect; therefore the reach of new knowledges, productive processes and products is mostly generated within the organization. Hence, in order to define properly the strategies, it is mandatory to know the firm internal potentialities. In relation with this topic, Porter’s point of view is too simple and narrow.