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Porter’s Five Forces Model for Industry Analysis

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This essay is an attempt to apply the Five Forces Model for industry analysis and business strategy development formed by Michael E. Porter of Harvard Business School in 1979 that draws upon industrial organization (IO) economics to derive five forces that determine the competitive intensity and therefore attractiveness of a market. Within the ambit of Porter’s typology, this essay aims to analyze the attractiveness of industries for investment and seeks to identify their potential for change or adaptability within the context of the inherent constraints and opportunities which exist in any given organizational environment.

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To achieve the above, a thorough introductory outline of the Five Forces Model will be laid out, citing its content and its pros and cons as a tool for analysis and business strategy in the organizational environment. Concomitantly, relevant concepts shall be defined in order to generate more understanding of the subject matter. A case study of the mobile telecommunications sector will be carried out in order to contextualize the topic and put issues into perspective.

A conclusion will then be drawn from the discourse. To begin with, any attempt to define a concept requires an investigation into its characteristics.

For the term ‘organization’, it is perhaps easier to say what it is not rather than what it is. However, according to Porter, Lawler and Hackman (1975) (quoted in ABE (2010:10), organizations have the following attributes: they are composed of individuals and groups; they have some degree of permanence (they are going concerns); they exist in order to achieve certain goals; and they involve specialization and require rational control and co-ordination. In other words, therefore, organizations are social entities that involve two or more people.

Secondly, they are permanent in the sense that their existence is not usually tied to the achievement of one goal. However, some organizations such as pressure groups cease to exist after the attainment of one particular objective. An example is the Red Card Campaign orchestrated by Father Frank Bwalya, a catholic priest, that was bent on de-campaigning the then ruling Movement for Multi-party Democracy (MMD). On the other hand, some organizations that may have started out with similar limited objectives continue to exist after they have achieved their objectives as they develop new ones.

An example is the Oasis Forum, whose aim was to garner opposition to President Chiluba’s attempt to stand for a third term. Thirdly, organizations are distinguished from other social entities by virtue of the fact that they exist to achieve certain goals. However, this is a matter of degree in that not all members may know or agree on what the goals are. The more explicit and specific the goals of a social grouping are, the more likely it is considered to be an organization. The fourth characteristic of an organization is that it involves specialization and requires coordination.

Labor is divided up in ways that are believed likely to positively contribute to the realization of organizational goals. Nonetheless, specialization requires that mechanisms for coordinating the various specialized activities are put in place. It must be noted that the degree of specialization and coordination varies between organizations with small ones (in terms of the number of people involved) having a less simpler form of specialization and coordination , usually by the owner, while large ones have a more sophisticated form.

In view of the above, therefore, organizations may be defined as social entities engaged in a systematic and coordinated effort, persistently over a period of time, in pursuit of goals which convert resources into goods and services which are needed by the consumers. Sufficed to say this, organizations do not exist in isolation. They are part of the wider fabric of society in general and as such are influenced by, and to some extent may influence, the environment within which they operate. There are two distinct categories of the organizational environment termed as the macro and micro environment. he latter consists of those forces close to the organization that affect its ability to serve its customers while the former includes larger forces of politics, economics, technology, and social forces and it is these we will deal with first. Most scholars of organizational behavior usually consider this external or ‘macro’ environment through a form of analysis known as PEST, an abbreviation of political, economic, social, and technological factors (Rollinson, Broadfield, Edwards, 1988; Handy, 1993).

These can be best viewed as factors beyond the control of the organization and are termed as uncontrollable variables. One way of illustrating the relationship between an organization and its macro environment is to consider the former as a system, which takes inputs from the latter (such as raw materials, labor, etcetera) and uses them to produce outputs in the form of goods and services that are in turn fed back into the environment. Therefore, an understanding of the macro environment is very crucial to the functions of he organization. To start with, according to Lancaster and Reynolds (1998), the political environment can be influenced by three factors namely: the ideology of the government towards business activity, the legal controls on business and the ethics of business practice. Ideology of government is very important as it affects the profitability of many organizations. Policies on corporate taxes and privatization have an impact on most business operations.

The local political landscape and the political attributes of countries a country does business with are also very important. For example, dictatorships can be very unpredictable and civil wars may flare up and this may reap havoc in business. According to anecdotal evidence, a case in point is the Libyan conflict which saw Lapgreen, a Libyan company that had taken over the Zambian telecommunications company Zamtel under MMD rule; lose its stake in the firm as a result of regime changes in both countries.

Legislation also affects the trading activities of many businesses. Laws on business operating hours, minimum wages, intellectual property, consumer privacy, company ownership and registration, etcetera, have repercussions on the functions of the organization. Lastly, ethics reflect a code of behavior expected of organizations and their leadership by the public. In recent times, pressure groups advancing various interests such as environmental protection, consumer protection, and other themes have increasingly become active players within the business arena.

Therefore, monitoring the activities of pressure groups is one way in which organizations are able to predict future legal constraints that are usually promoted by groups with popular support. Economic factors affect the financial operations of organizations such as the potential for growth or for retrenchment in the economy at large in relation to the market for the organization’s products. Factors such as global economic trends, local inflation, income levels, consumption patterns and income distribution have a direct influence on the organization.

The social environment within which an organization operates is influenced by factors affecting the supply of labor, demographic changes in terms of the age profile of the working population, numbers of people in the job market, changing cultural norms and attitudes which may alter people’s expectations and behavior at work, etcetera. When it comes to the technological aspects of the organizational environment, they are factors that affect the processes of production such as changes in computer technology and communications and the implication of new manufacturing processes.

Perreault and McCarthy (1996) observe that there are a number of characteristics of the organizational environment that are likely to affect organizations and these determine the extent to which investment in a particular industry is attractive. Firstly, they argue that instability brought about by rapid changes in any of the four areas can have dramatic consequences. For example, social changes may give rise to spontaneous changes in tastes and fashion or the political environment may become turbulent when the state actively intervenes in the functioning of the organization.

One may therefore say that an unstable environment makes business operations riskier and investment very unattractive. Secondly, the environment is complex as it includes a lot of actors that make up the market. For instance, the increasing complexity of the politico-economic environment has seen an active role played by international institutions, regional trading blocs, agreements, and etcetera. Lastly, the environment places a number of constraints and accords organizations some business opportunities and these can either discourage or encourage investments in a particular sector. They are the major determinants of the investment climate.

The investment climate is said to be favorable if opportunities have a stronger effect on an organization than constraints (threats) do. According to Stanleigh (2010), opportunities in the business environment are those factors that provide possibilities for a business to expand so as to make more sales and profits. He defines constraints as those factors that limit the ability to grow, and reduce sales and profit potential. A useful way of assessing opportunities and constraints is to carry out what is known as a SWOT analysis, an acronym which stands for strengths, weaknesses, opportunities, and threats.

Strengths and weaknesses are internal to an organization. Typically they relate to the resources of the organization, and its structure and leadership, as well as the impact of its marketing in determining the preferences of customers. Market focused organizations are strong because they know what their customers want (open citation). Opportunities and threats (constraints) exist in the external environment. Opportunities relate to the market, to the development of new technologies, and to external factors such as government policies. Threats relate to what the competition is doing as well as legal and other constraints.

PEST analysis, as mentioned earlier, is used to describe the external environment of an organization. The internal environment, as outlined by Lancaster and Reynolds (1998), includes the consumers, competitors, suppliers, and company resources. However, to avoid duplication of effort by discussing the micro environment at great length, this essay now turns to the analysis of Porter’s framework (which, to some degree, touches on the micro environment). Porter’s competitive strategy theory is based on an analysis of a company’s competitive position within its environment, using the ‘five forces’ that drive competition.

Porter developed his Five Forces analysis in reaction to the then-popular SWOT analysis, which he found less rigorous. Porter’s five forces is based on the Structure-Conduct-Performance paradigm in industrial organizational economics. It has been applied to a diverse range of problems, from helping businesses become more profitable to helping governments stabilize industries (http://en. wipedia. com/wiki/porter_five_forces). The basic argument in Porter’s theory is that it is the industry structure within which organizations compete and how they position themselves against that structure which determines how a profitable a firm will be.

The following is an outline and application of Porter’s five forces model (adapted from Porter, 2008: 86-104) in Zambia’s telecommunications sector: The first force to be discussed is the ‘threat of new competition’. Here, it is very usual for profitable markets that yield high returns to attract new firms. This results in many new entrants, which eventually decreases the profitability for all firms in the industry. For example in Zambia, when TELECEL was the only mobile operator, it enjoyed abnormal profit margins due to a favorable tax regime (tax exemptions, etcetera).

At that time for example, a sim card cost up to K50, 000 but today, with three mobile operators, its cost is ten times less. However, not very long ago, the telecommunications industry in Zambia was comprised of national operators. Over the past decade, the industry has been swept up in rapid deregulation and innovation. This has seen Government monopolies face a plethora of new competitors in telecommunications. Therefore, unless the entry of new firms can be blocked by incumbents, the abnormal profit rate tends towards zero (perfect competition). The existence of barriers to entry (such as patents, rights, nd etcetera) are some of the constraints placed on new entrants (e. g. media reports say Vodacom Zambia, which was supposedly earmarked to possess the fourth mobile license was denied one). The most attractive segment is one in which entry barriers are high and exit barriers are low. Few new firms can enter and non-performing firms can exit easily as a result of being taken over by larger conglomerates (for example, Celtel, Telecel, and Zain where taken over). It comes as no surprise that in the capital-intensive telecommunications industry, the biggest barrier to entry is access to finance.

To cover high fixed costs, serious contenders typically require a lot of cash. When capital markets are generous, the threat of competitive entrants escalates. When financing opportunities are less readily available, the pace of entry slows. Meanwhile, ownership of a telecom license can represent a huge barrier to entry (http://www. telecommagazine. com). In Zambia, for instance, telecom operators must apply to the Zambia Information Communication Technology Agency (ZICTA) and the Patents and Companies Registration agency (PACRA) to receive regulatory approval and licensing.

There is also a limited amount of “good” radio spectrum that lends itself to mobile voice and data applications. In addition, it is important to note that superior operating skills and management experience (that is, qualified manpower) within the telecoms industry is fairly scarce in Zambia, making entry into the industry even more difficult. Such constraints make investment in the sector not very appealing. The second force is the ‘threat of substitute products or services’.

The existence of products outside of the realm of the common product boundaries increases the propensity of customers to switch to alternatives. Note that this should not be confused with competitors’ similar products but entirely different ones instead. Products and services from non-traditional telecom industries pose serious substitution threats. The cable companies such as iConnect and Multichoice, with their own direct lines into homes, offer broadband internet services, and satellite links that can substitute for high-speed business networking needs.

Energy utility companies (ZESCO) are laying miles of high-capacity telecom network (fiber optic cables) alongside their own track and pipeline assets. Just as worrying for telecom operators is the internet which is becoming a viable vehicle for cut-rate voice calls. Delivered by Internet Service Providers (ISPs) – not telecom operators – “internet telephony” could reduce the market share of telecom companies’ core voice revenues. Some software such as Whats Up, which enables mobile phone users to send text messages for free, may reduce talk time sales.

Mobile telecoms firms have had to respond to the above threats by coming up with products and services that at least match their competitors. They have come up with services such as mobile money transfer, high-speed mobile internet, free social networking (such as Facebook), etcetera. Thirdly, the ‘bargaining power of customers (buyers)’ is also described as the market of outputs, that is, the ability of customers to put the firm under pressure, which also affects the customer’s sensitivity to price changes. With increased choice of telecom products and services in Zambia, the bargaining power of buyers is rising.

To avoid losses in market share, mobile operators are now forced to increase customer privileges by tailoring their products and services to the convenience of the customer. For example, sim replacements can now be done remotely at places other than the firm’s offices through agents (e. g. at Airtel). Moreover, telephone and data services are not very different regardless of which companies are selling them. For the most part, basic services are treated as a commodity. This translates into customers seeking low prices from companies that offer a reliable service.

At the same time, buyer power can vary somewhat between market segments. While switching costs are relatively low for residential telecom customers, they can get higher for larger business customers such as post-paid subscribers, especially those that rely more on customized products and services. Fourthly, ‘the bargaining power of suppliers’ is also described as the market of inputs. Suppliers of raw materials, components, labor, and services (such as marketing or technical expertise) to the firm can be a source of power over the firm, when there are few substitutes.

Suppliers may refuse to work with the firm or even charge excessively high prices for unique resources. At first glance, it might look like telecom equipment suppliers have considerable bargaining power over telecom operators. Indeed, without high-tech broadband switching equipment, fiber-optic cables, mobile handsets and billing software, telecom operators would not be able to do the job of transmitting voice and data from place to place. But there are actually a number of large equipment makers around the world. There are enough vendors, arguably, to dilute bargaining power.

In Zambia, like in the rest of the developing world, labor is in surplus. This makes investment very attractive as costs of human resources are generally low despite revising the minimum wage while the job market seems to be saturated. This means that firms have an upper hand in the labor market. Among mobile operators for instance, there has been a lot of casualization of labor. However, the limited pool of talented managers and engineers, especially those well versed in the latest technologies, places the companies in a weak position in terms of hiring and salaries.

Lastly, for most industries, the intensity of competitive rivalry is the major determinant of the competitiveness of the industry. The wave of industry deregulation together with the receptive capital markets of the late 1990s paved the way for a rush of new entrants. New technology is prompting a host of substitute services. Nearly everybody already pays for phone services, so all competitors now must lure customers with lower prices and more exciting services. This tends to drive industry profitability down.

In addition to low profits, the telecom industry suffers from high exit barriers, mainly due to its specialized equipment. For instance, networks and billing systems cannot really be used for much else, and their swift obsolescence makes liquidation somewhat difficult. In Zambia, anecdotal evidence suggests that the intensity of competition among mobile operators is very high despite the country only having three firms. This can be illustrated by a lot of advertising and the introduction of a plethora of promotional products and innovative services.

For example, Zamtel now has exclusive rights to the Muvi TV ‘more money in your pockets’ game show. All three mobile operators have mobile phones on promotional sale; they offer conditional free calling, international roaming, and etcetera. Porter’s Five Forces model is a simple but powerful tool for understanding where power lies in a business situation. This is useful, because it helps you understand both the strength of your current competitive position, and the strength of a position you are looking to move into.

With a clear understanding of where power lies, an organization can take fair advantage of a situation of strength, improve a situation of weakness, and avoid taking wrong steps. This makes it an important part of any planning toolkit. Conventionally, the tool is used to identify whether new products, services or businesses have the potential to be profitable. However it can be very illuminating when used to understand the balance of power in other situations. The theory can be used to analyze the plausibility of industries as investment avenues and also to identify their potential for change.

However, Porter’s model has been criticized for the following assumptions: that buyers, competitors, and suppliers are unrelated and do not interact and cooperate with each other secretly; that uncertainty is low, allowing participants in a market to plan for and respond to competitive behavior; and that the source of value is structural advantage (creating barriers to entry) (Coyne and Subramaniam, 1996). According to Stanleigh (2010), businesses need to be constantly aware of their environment and how they change over time in order to keep abreast with competition.

They need to take what is termed an anticipatory approach, that is, they need to anticipate changes that are likely to take place in the future in the business environment. By anticipating change businesses are able to adjust the way they operate to be ahead of competitors. He further contends that businesses that take a reactive approach, that is, those which only change when or after the environment changes will be left behind. Studying environmental constraints and opportunities and environmental change is important to businesses that want to plan ahead and achieve their goals.

There are many drivers of change but in Stanleigh’s (2010:8-13) opinion, the most important key driver for change is when 75% of the organization’s leadership is honestly convinced that business as usual is no longer acceptable. He notes that most organizations are probably there right now. They want something that is going to deliver some positive results through this unsettling period of transition. Change, however slow or dramatic has its challenges and these include: firstly, maintaining the energy and enthusiasm of employees throughout the change journey is not an easy task.

Management needs to help employees to accept the need for change and energize them towards achieving it. Secondly, ensuring that the organization adapts to change and does not backslide into old ways of working is also a challenge. It is emphasized that individuals and organizations alike must be resilient enough to adapt to changes occurring in their environment in order to ensure survival. Without resilience to change, extinction occurs (Ibidem, p. 10). Thirdly, understanding the science of quality and implementing it as an art is crucial to managing changes in the organizational environment.

The ‘Art of Quality Management’ as Stanleigh puts it, is fundamentally an ability to best apply the necessary quality tools so as to make a quick, immediate and lasting impact on the process, the staff and the customers (p. 11). Fourth, prioritizing organizational projects and resources may prove cumbersome. To overcome this challenge the management team must identify all projects and other initiatives currently in play throughout the industry so that they can immediately begin a process of project prioritization.

This will present an opportunity to drop low-value projects that are no longer helping the organization to realize its strategic objectives. Lastly, managing the cultural shift that is needed to create and sustain organizational change might be a daunting task. It is usually difficult and somewhat costly for people and organizations to alter their way of doing things in order to keep up with the prevailing trends (keeping up with the Johnseys).

In a nutshell, it is hoped that this essay has achieved its aim of applying Porter’s model of business strategy in analyzing the attractiveness of industries for investment and identifying their potential for change or adaptability within the context of the inherent constraints and opportunities which exist in any given organizational environment. It has drawn examples from the telecommunications industry in Zambia thus due to limitations on the scope of this essay, it may be deduced that organizations need to adapt to their environment for them to survive.

Cite this Porter’s Five Forces Model for Industry Analysis

Porter’s Five Forces Model for Industry Analysis. (2016, Oct 19). Retrieved from https://graduateway.com/porters-five-forces-model-for-industry-analysis/

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