There is no doubt that Michael Porter’s Theory of Competitive
Strategy (1980) is a landmark thesis in the domain of strategy, expressing the
relationships between the firm and the environment as well as between the firms
in an industry in a unique manner. Professor Porter identified five forces of
competition, namely the threat of new entrants, threat of substitute products
or services, bargaining power of buyers, bargaining power of suppliers and
intensity of industry rivalry. Porter’s Five Forces theory draws largely on the
structure-conduct-performance theories of industrial economics. Porter held
that the five competitive forces vary based on the nature of the industry, the
state of the industry and the state of the firm. He advocated that firms could
deploy three generic strategies, namely cost leadership, differentiation and
niche, for them to derive sustainable competitive advantage over the competitor
firms.
Michael Porter also held that definition of the industry in
which a firm operates in, and the levels of entry and mobility barriers within
and across the defined industries, also influence the competitive strategy of a
firm. Strategies of integration and diversification within an industry are
proposed to influence, and be influenced by, the five forces. In a manner of
saying, Porter’s theory of competitive strategy represents a domain that is at
the intersection of industrial structure and business performance. Pathbreaking
though Porter’s theory has been, there are certain critical shortcomings,
especially with reference to contemporary industrial development. The first
shortcoming is in viewing buyers, suppliers and competitors as distinct
unrelated entities. The second is in the proposition that the higher the entry
barrier the higher is the value or profit potential. The third is that industry
or environmental volatility is low and predictable enabling firms plan their
competitive strategies based on structural designs. More importantly, it is not
calibrated to address the contemporary economic realities.
New realities
The new realities are that buyers, suppliers and competitors
have multiple overlaps. Firms in the same industry competing at the product
level tend to compete at component or materials level. While they may look for
sourcing advantages or cost savings, brand premiums or sales discounts and
design dependencies or independencies, they also tend to be aligned to maximize
overall throughput individually and collectively. The smart device industry is
an example with multiple layers of collaboration at component level amidst
competition at product level. Secondly,
entry barriers need not necessarily represent value building opportunity. Steel
industry may have the highest investment intensity and hence the highest entry
barriers but typically offers meagre returns relative to low investment
industries such as FMCG. The third is that industry structures are becoming increasingly
impacted by economic trends, even as economic trends are getting increasingly
governed by commodity and liquidity cycles as well as cross-border investments
and exchange rate regimes are becoming increasingly volatile, impacting stability
of strategies.
The new realities could also combine two or more competitive
forces into one and accentuate their combined impact. For example, new firms
could enter the industry with substitute products or services (not just
imitator products) thus increasing the competitive intensity more than
proportionately. Buyers may start dumping their products in the exchange or
used product schemes thus making firms more of substitutional sellers rather
than incremental sellers. The intensity of industry rivalry could be more due
to exit barriers (absence of bankruptcy provisions) rather than due to low
entry barriers. Commodity and other economic cycles may mean that strategies
such as cost leadership at design or manufacturing level may be differently
impacted from time to time. An automotive design strategy developed at great
cost for maximal fuel economy may become less powerful in a protracted phase of
extremely cheap oil prices.
Macro versus micro
For Porter, industry-specific and firm mediated
micro-environment provided for sharper articulation of corporate and business
strategies, compared to woolly SWOT analyses that were in fashion in the 1960’s
and 1970’s. The issue, therefore, is
whether industry level micro-environment as proposed by Porter in the 1980s or
economy level macro-environment as is now emerging in the 2010s is more
appropriate for formulating competitive strategy. The way the global economy is
anticipative of US Fed rate hike or the entire Indian industry is exultant
about RBI rate cut does indicate that macroeconomic factors do have an
increasingly overarching influence these days. Similarly, the way the slowdown
in China causes global demand tremors and stock market blues or how a taxation
issue can fray or calm the nerves of portfolio investors in India are also
proofs of global economic and industrial interconnectivity.
Industries and firms are impacted not merely by firm and
industry specific competitive forces but also national and international
economic forces. IPOs as well as follow-on offerings and stake sales by Public
Sector Undertakings (PSUs) in India, for example, are affected by dips in
Indian stock market sentiments which are, in turn, caused by dips in global
stock markets. Economic liberalization
may have freed industrial development from public policy (notwithstanding
residual macro regulations) but industrial development is impacted more than
ever by national and international economic factors. There is probably no way
to decouple Indian economy and industry from such vagaries but at least there
must be a model that focuses the attention of firms and industries on such
competitive economic forces. This blog post proposes a theory of five
competitive economic forces as an adjunct to Porter’s theory of competitive
strategy.
Five Economic forces
Five economic forces impact industrial structure and
performance. The first is the threat of inflation. The second is the risk of
global capital flows. The third is the bargaining power of national
technologies. The fourth is the bargaining power of national markets. The fifth
is the intensity of national rivalry. Each of these has an impact on industry
level competitive strategy. They also dictate a preferred drift in the generic competitive
strategies. Competitive threat of inflation, for example, impacts the
bargaining power of suppliers as well as that of buyers. It also supports cost
leadership as a preferred generic competitive strategy. The competitive force
of global flows influences market capitalization levels on bourses, and brings
in or drives out more risk capital for expansion and diversification. Unlimited
capital flows take the focus away from efficiency and promote differentiation
and niche as generic competitive strategies.
Nations play a major role in licensing technologies, and
generate major bargaining power over these. This is countered in part by the
bargaining power of national markets. This interplay is evident usually in
military technologies (eg., Rafale aircraft deal between France and India) but
has extended to high end civilian technologies too (eg., China’s high speed
rail technology for US to connect Los Angeles and Los Vegas). The latter at
industry level was evident when major technology firms of US vied each with
each other during Prime Minister Narendra Modi’s visit to US West Coast to invest
and supply technologies for Indian markets. When nations compete to participate
in emerging markets, rivalry is heightened, but to the benefit of the local
industry. Governments can leverage such rivalry for national benefit. India,
for example, can benefit from generating international interest and rivalry for
building bullet train infrastructure or new capital cities. A firm, before
applying Porter’s Five Forces Theory, must, therefore, apply the Five Economic
Forces Theory to establish the correct perspectives for firm level competitive
strategic analysis.
Model within model
This blog post has proposed, probably for the first time in
the history of strategic management, a theory of competitive economic forces as
an overarching umbrella under which Porter’s theory of competitive strategy
needs to be recalibrated. The big difference between the national economic
forces and the industrial competitive forces is that the former are more
volatile and unpredictable, and are additionally susceptible to public policy
and governmental actions. While industrial competitive forces are more
predictable they are swayed by how the economic policy framework changes. Some
research is clearly needed to understand if and how the economic forces model can
be linked to the industrial forces model. One way could be to choose a time
horizon that starts with a major economic inflexion point and model the
industrial forces until the expected next inflection point, and develop a
calibrated industry and firm level model for the target timeframe. The author
suggests that academia and practitioners of management, as well as economists
and strategists must collaborate to assess the relevance and coupling of both
these models; the new economic and the established industrial!
For India, at this point a combination of competitive economic
forces sets up the five force economic model, the forces being decelerating inflation
(as is presently evident), declining portfolio investments (due to the much
anticipated Fed rate hike), dependence foreign technologies (for next
generation infrastructure), consumerisation of markets (with increased
purchasing power) and increasing national rivalry to enter or expand in India (virtually
every developed country desiring to have a share of India). Such an analytical
framework sets the tone for recalibrating the basic Porter model. In the
ultimate analysis, the issue is not one of choosing between a micro or macro
model. Macro model is the missing piece in current strategy framework and must
be provided for, as suggested herein. In addition, Porter’s micro model
continues to be relevant but with two caveats. Firstly, industrial play is not
only about forces of completion; it should be equally about forces of
collaboration. Secondly, the five forces, and the entities causing them, are
not independent of each other but could have overlaps, and be accentuated or
attenuated based on overlaps.
Posted by Dr CB Rao on October 3, 2015
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