TOPIC 9 "The Porter's 5 Forces model"
Several methods have been developed in attempts to forecast the direction of changes in the business environment and their effects on the firm. They include various means for the aggregation of expert opinion, constrained extrapolation of past trends, and scanning or monitoring the environment. Prior probabilities assigned to competing hypotheses about the future are revised. Simulation models that forecast changes in the business environment have been largely exploratory (Acar & Georgantzas1995). Measurement problems and a lack of understanding of the interrelationships among variables do not help either. Often, such models capture the interaction between environmental variables and constraints, but very little substantive or content-oriented theory is ever applied. Prior probabilities assigned to competing hypotheses about the future are revised as more tangible evidence of changes in the business environment becomes available. Rapid changes in information technology, global competition, family structure, and other facets of the global society's culture systems are foisting metamorphoses on the business environment (Acar & Georgantzas1995). The business environment has been important concern of a firm in making or changing its strategy. In the analysis of the business environment one method used is the five forces analysis. This paper will discuss whether it agrees or disagrees on the notion that the five forces analysis is inadequate for attempting international environmental analysis because it totally ignores important aspects like culture & history and above all, it is based on the Marshallian premise of constant returns to scale.
The Internationalization of business and its environment
For many years, expansion outside the home market followed the conventional model of the multinational corporation for which the parent company set subsidiaries to handle its business in foreign markets. Though diverse from industry to industry and from company to company, these unprecedented corporate reorganizations have led to a new form of international business organization: the global corporation characterized by the large size of its organization and the small size of its production operations (Mourdoukoutas 1999). As such, the global corporation is a network of independent subsidiaries, affiliates, and multi corporate alliances formed for the purpose of gaining competitive advantages in global industries: the development of complex products, the distribution and marketing of similar products in mature markets, and entry to emerging markets. Globalization has created a whole new market game for international business that dictates new forms of coordination. To be functional and efficient, the global corporation must be organized as an informal and vague organization, a web, a network of entrepreneurs who pursue the goals of the organization both independently and jointly and who share the risks and rewards of its operations (Mourdoukoutas 1999).
The global corporation's vision should include a sound code of ethics that defines the conduct of its internal and external affairs and ties its members to the corporation's goals. Although the terms multinational corporation and global corporation are often used synonymously in describing a corporation's expansion beyond its home market, they have their own distinct characteristics, making them suitable organizations for different business environments. Over time, the term multinational corporation came to describe an international business organization of corporate colonialism in which the parent company treats each national market as a separate market, setting up subsidiaries to handle its entire product and business lines in each of those markets (Dunning & Mucchielli 2001). In this hierarchical organization, subsidiaries are restricted to trading directly with affiliates other than the parent that makes all major decisions regarding production, marketing, distribution, financing, and new product development. In this sense, the multinational corporation model is suitable for corporations in industries confronting a fractured multinational market. Multinational Enterprise (MNE) is the key actor on the stage of international business. It is the organization which leads globalization and it operates as the flagship firm for sets of regionally based business networks and clusters. The MNE interacts with governments but is not powerful enough to pursue a separate agenda of world economic domination. Instead, the reality of regional triad power is that MNEs need to compete for market share and profits (Dunning & Mucchielli 2001). International business focuses on topics relating to the operations of firms with interests in multiple countries. International business is a primary determinant of international trade. The increasing success of international business ventures is globalization. International businesses have subsidiaries or joint-ventures in each national market. The increase of internationalized business results to a more globalized environment that requires better analytical tools.
The role of the strategist is to match the opportunities of the environment with what the firm is capable of doing at an acceptable level of risk, while safeguarding the weaknesses of the firm from the threats of the same environment. It is readily seen that this involves an assessment of internal phenomena and an external analysis of the environment, most directly, the industry (Foss 1997). There is a need to see the enterprise as a whole and to see how it is transformed as new ways of dealing with a changing environment evolve. The awareness of the needs and opportunities created by the changing environment seems to have depended on the training and personality of individual executives and on their ability to keep their eyes on the more important entrepreneurial problems even in the midst of pressing operational needs. There are fundamentally two possible sources of the informational advantages necessary to develop consistently more accurate insights into the value of strategies: the analysis of a firm's competitive environment and the analysis of organizational skills and capabilities already controlled by a firm (Foss 1997).
Of these two sources of insights into the future value of strategies, environmental analysis seems less likely to systematically generate the expectational advantages needed to obtain expected above normal returns. This is because the methodologies for collecting this information are in the public domain. It will normally be the case that firms applying approximately the same publicly available methodology to the analysis of the same environment will collect about the same information (Paley 2006). And these same firms applying publicly available conceptual frameworks to analyze this information will typically come to similar conclusions about the potential of strategies. Thus, analyzing a firm's competitive environment cannot, on average, be expected to generate the expectational advantages that can lead to expected above normal returns in strategic factor markets. The skills of environmental analysis can be rented from various investment banking and consulting firms, and thus skill advantages in analyzing competitive environments will typically only be temporary. It may be the case that, in the collection of information concerning the value of a strategy from a firm's competitive environment, a firm might stumble onto some information that gives it an expectational advantage over other firms. However, if such information was obtained through the systematic application of environmental analysis techniques, then other firms besides the firm that has this information would have obtained it, and it would no longer give an advantage. Thus, only if the information was obtained through nonsystematic means can it give a firm expectational advantage. However, such information, because it does not result from the systematic application of environmental analysis methodologies, must be stochastic in origin. Any informational advantages obtained in this manner must reflect a firm's good fortune and luck, not their skill in evaluating the return potential of strategies (Paley 2006). There are various means to analyze the environment and how it affects business. This can be in the form of Pest analysis, SWOT analysis and five forces analysis. Each analysis has varying focus that creates different kinds of results.
Five forces Analysis
The strength of each of these forces varies from industry to industry, but taken together they determine long-term profitability. They help to shape the prices firms can charge, the costs they must pay for resources and the level of investment that will be needed to compete. The threat of new entrants limits market share and profit; powerful buyers or suppliers, using their superior bargaining power, can drive down prices or push costs up, eroding margins, and so on. The strength of each of the five forces is a function of what Porter calls industry structure, which is also defined as the underlying economic and technical characteristics of an industry. The pressures of the five forces will be the most important determinants in choosing which strategy is the right one for the place and moment, but as circumstances change, strategic options can change as well. Porter argues against excessive concentration on geographical location, pointing out that it is more important (Witzel 2003). The five forces address the question why are some markets more attractive than others?' The collective strength of these five competitive forces determines the ability of firms in an industry to earn, on average, rates of return on investment in excess of the cost of capital (Kermally 2003). The five forces analysis developed by Porter is a framework for the industry analysis and business strategy development. The five forces compose of factors that affect the company’s ability to satisfy clients and gain profit. The five forces help the company in determining the competitive intensity of the market. The essence of Porter’s analysis is that the strategizing business needs to assess the strengths of these separate five forces in its specific industry context and then to position itself/check them/alter them in its favor so as to optimize its own sustainable competitive advantage within the structure. The Five Forces Framework may thus only provide a one-sided or distorted perspective on strategy options that need to be considered by an international business in the contemporary setting. The extended Porter analysis provides a valuable general framework for the analysis of the strategic management of international businesses in the contemporary era, providing an understanding of the growth of international competition and the emergence of global firms in some industries (Mudambi & Ricketts1998). The five forces focus on virus aspects of the firm particularly on potential entrants, competitive rivalry, substitutes, bargaining power of buyers and bargaining power of sellers. The five forces analysis is beneficial because it is one of the models that are easy to learn and understand. It does not require much specialization to understand the model. The five forces analysis helps the company to analyze their current situation in an organized and structured way. This kind of analysis provides the reason for people to be attracted into the company and the industry it belongs to. The five forces play a big part in developing strategic options that can be used to influence the movement of the company into its desired direction. Moreover the five forces provide the leaders of the firm on what can be its opportunities and threats so that they can advance or maintain their competitive advantage. Lastly the five forces provide what aspect of the company or the industry can be profitable and what aspects of the firm should be changed in order to achieve relative success.
The inadequacy of the five forces
Porter with his five-force framework provides a model to assess the long-run average industry profitability. Those forces include the nature and degree of rivalry, the threat of substitution, buyer power, supplier power, and the threat of new entry. As a first approach, the industry's attractiveness, expressed as the long-term average profitability, is an indicator not only of the current profitability, but also of growth potential. Nevertheless, it is not possible to assume that growth opportunities arise only in attractive industries. Many industries are attractive because of the growth potential they have, but there are also growth opportunities in less attractive industries, because of the firm's positioning. Porter's work contributed to underscoring the importance of industries' structural attractiveness when designing and assessing business strategies. Furthermore, his five-forces model offers a concise and rigorous way to explore an industry's features and their impact on the company's strategy. However, concentrating excessively or solely on the industry's features has led in some cases to the conclusion that there are structurally good and bad industries, and that firms cannot grow in the context of unattractive industries. These are not irreversible conditions (Canals 2000).
What is true is that there are industries that are not growing and industries that are growing, and the latter seem to be more attractive from a business viewpoint. However, although growth is one variable that contributes to configuring an industry in one way or another, it is not the only one. A company that actively faces the future and reflects on new ways and paths for growth is a company whose approach is not confined solely to reducing size or cutting costs but also finds new ways to serve its customers, integrate employees, and offer a better return on shareholders' investment. This is the best mentality for reinventing an industry and shaking off the syndrome of so called bad or unattractive industries (Canals 2000). A primary criticism of the Porter Five Forces framework is that it does not directly address cross-border issues. In most cases, but not always, the addition of cross-border possibilities increases the strength of competitive forces. For individual countries, managers need to consider the openness of the market, not just in terms of government barriers such as trade, investment, and regulatory but also in terms of logistical access and customer openness to foreign products. The effect of country openness varies for each of Porter's five forces. Particularly for the threat of new entrants and rivalry among existing firms, increased country openness heightens competition by increasing its geographic scope (Brewer & Rugman 2001).
Increased country openness also increases the pressure from substitutes by increasing the geographic scope of where these substitutes might come from. Country openness reduces the power of suppliers by allowing local subsidiaries to bring in supplies from outside. Conversely, country openness increases the power of buyers by allowing them to seek off-shore providers (Brewer & Rugman 2001). Five forces analysis is not good for international environment analysis because it only focuses on the local setting. The five forces analysis was designed to identify the problems with the local market. The five forces analysis does not take a look at international aspects such as history and culture. History and culture are important in knowing the international environment and what are the probable changes that might happen in the international market. Since the five forces is based on the Marshallian premise of constant returns to scale changing it to increasing returns to scale would render five forces as useless in an international environment. Five forces works much better in a constant environment. Once it shifts to an increasing return to scale such as the international environment; it would cost the reduced scope for the five forces.
The five forces analysis is beneficial because it is one of the models that are easy to learn and understand. It does not require much specialization to understand the model. The five forces analysis helps the company to analyze their current situation in an organized and structured way. It may be good for analyzing a business that needs to change its strategy but it does not provide the information needed in international environmental analysis. Five forces analysis is not good for international environment analysis because it only focuses on the local setting. The five forces analysis was designed to identify the problems with the local market. The five forces analysis does not take a look at international aspects such as history and culture. History and culture are important in knowing the international environment and what are the probable changes that might happen in the international market.
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