Understanding Strategy

What exactly is strategy?

For those already familiar with this term, might have already heard of Michael E. Porter’s famous 1996 HBR article “What is Strategy?” Before Porter came in to the picture, people were discussing competition based on price. But Porter argued that there are additional forces which heavily influenced strategy and price is just one factor.

Before Porter’s theory, people were discussing competition based solely on price.

But before we delve into Porter’s theory, let us first understand the primary objective of strategy, and what it involves.

What does it involve?

  • Positioning an organisation for competitive advantage
  • Doing things differently
  • Being proactive to market changes
  • Targeting the right markets
  • Choosing the right product offerings
  • Corporate resource allocation

Primary objective of strategy

  • Long term sustainable superior performance
  • Create value for shareholders and stakeholders
  • Increase value for the customer

Porter’s Five Forces

  1. Threat of new entrants

The threat of entry in an industry depends on the height of entry barriers present and on the reaction entrants can expect from incumbents. There are multiple sources of barriers to entry:

(a) supply side economies of scale; (b) demand side benefits of scale; (c.)customer switching costs; (d) capital requirements; (e) incumbency advantages independent of size; (f) unequal access to distribution channels; (g) restrictive government policy.

The challenge is to find ways to surmount the entry to barriers without nullifying, through heavy investment, the profitability of participating in the industry.

For example, when Apple entered the music distribution business, it shook the entire industry and captured the market tackling all the threats mentioned above. It leveraged its existing capabilities to level the competition.

2. Bargaining power of suppliers

Powerful suppliers capture more value for themselves by charging higher prices, limiting quality or services, or shifting costs to industry participants.

Microsoft for instance has contributed to the erosion of profitability among personal computers by raising prices on operating systems.

Suppliers offer products that are differentiated than their competitors. Pharma companies that offer patented drugs with distinctive medical benefits have more power over hospitals, health organisations and other buyers or generic products.

3. Bargaining power of buyers

Powerful customers can capture more value by forcing down prices, demanding better quality or more service.

Columbia University for instance, one of the largest customers (20k approx.) for a health insurance company has the power to negotiate terms according to its own requirements.

4. Threat of substitute products of services

A substitute is something that performs the same of similar function as an industry product by different means.

For example, travel websites are a substitute for travel agents. Lyft is a substitute for Uber for calling a taxi. Long distance telephone providers have suffered with the advent of internet and Wi-Fi calling services like Skype and Viber. Here, the buyer’s cost to substitute is low.

5. Rivalry among existing competitors

Rivalry in business has many forms. Price discounting, new product introductions, advertising campaigns and service improvements. Goals of rival companies might be different.

It all depends on the intensity and basis on which companies compete.

For example, in the hospitality industry, hotels compete on various aspects such as prestige, customer base, facilities, membership/loyalty programs etc. Rivalry can be destructive if it spills out a price war. The recent launch of telecom service — Reliance Jio in India has resulted in a price war to attract/retain customer base.

In conclusion…

According to me, Porter’s five forces give us a fantastic framework to conduct a primary strategy analysis, but fails to consider non-market forces. Porter focuses on gaining business leadership in an industry where you can excel with lower costs and competitive benchmarking.

It is solely based on the idea of profitability and competition.

But there are other non-tangible methods to gain an edge over the competition. I think customers are more likely to pay extra for value and brand. For example, you go to the mall to buy a pair of shoes. You have two pairs with an identical design in front of you. One pair has a Nike label on it and is priced 10% more than the other. Which one will you buy? You are more likely ready to spend that additional 10% knowing that Nike makes quality and reliable products. This decision was mostly based on your knowledge and relationship with the brand.

People today are not only looking for the lowest cost product/service but for the best quality. And they are willing to pay a premium for it.

People today are not only looking for the lowest cost product/service but for the best quality. And they are willing to pay a premium for it.

Markets today are open and dynamic than before when this framework was more relevant and freely applicable. Therefore, I think in addition to Porter’s Five Forces, other non-tangible parameters which significantly influence strategy should be considered when analysing a business to get a well rounded idea.

Was this valuable? click the ❤ and respond below :)
It would mean a lot to me if you recommend it, so others can find it. Thank you!