Wednesday, November 11, 2015

My understanding of Porter's five forces that drive strategy

While intuitively Porter’s five forces that drive strategy make sense, I would argue each of these does not always affect the industry in the same manner.

Porter mentions new entrants can affect the cost and profit of an incumbent in the industry and how industries try to prevent new entrants by increasing the barriers to entry. This does hold true for a lot of the markets but does not hold true for the oil industry. In the oil industry there is an obvious high entry cost, natural resources. Porter mentions how the companies use the economies of scale to prevent new entrants. The oil industry does not use this strategy. The government policies and regulations have increased the barriers of entry. Porter spoke about pricing stating that these prices are dictated by powerful buyers and consumers. Although OPEC does not set oil prices its decisions impact the prices heavily. OPEC accounts for 40% of the world’s oil production. This demonstrates the power such cartels have over the commodities.

Another interesting example of increasing barriers to entry is Amazon. Amazon’s success is attributed by its impeccable process and supply chain management. But another point to consider is Amazon’s share of the market. It has managed to block new entrants by using Porter’s supply-side economies of scale principle. Amazon drove out its competitors by reducing its prices so much so that the company was in a loss until recently. This strategy has allowed Amazon to be the major market player in its industry.

Porter mentions briefly how substitutes can negatively impact the profit of an incumbent. While this holds true for the oil industry. This principle does not stand when disruption occurs. While reading the Encarta and Britannica case. I realized that despite high barriers to entry substitutes can take over the market. In the Britannica case, Encarta was a substitute but through careful marketing and precise disruption it managed to impact Britannica’s profits in a major way.  Therefore, I believe Christensen’s model to disruption is an exception to Porters rule.

The other point where I don’t completely agree with Porter is his approach on rivalry. In my perspective rivalry does not limit a company’s potential. The Cola war case clearly showed how Pepsi and Coke’s competition forced them to innovate in order to sustain themselves in the industry. It was this rivalry led to the creation of Diet Coke which was the “most successful consumer product launch of the eighties”. In my opinion healthy competition not only improves the incumbent’s strategy it forces them to innovate and create. Not only this but it’s also beneficial for the consumers. 
This rivalry prevents a monopoly and gives consumers the multiple options to choose from.

Without this rivalry we would have a monopoly or cartel like OPEC. We can look at the airline industry in this context, they can form a cartel and dictate prices for the consumer. Since this isn’t beneficial to the customer or the industry the government usually steps in to regulate these companies. Therefore in my opinion rivalry or competition can be beneficial to both the industries and the consumers. 

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