Business strategy fundamentals and implementation approaches

Business Strategy

A popular tool for managers to analyze their external environments is the five forces analysis that was developed by Michael Porter. The five forces analysis rests on the assumption that a firm's ability to succeed is based largely on its pricing power. Pricing power determines whether a firm is able to earn profits on its activities. In the five forces model, pricing power derives from the structure of the industry, as encapsulated in the five forces: buyer power, supplier power, threat of substitutes, threat of new entrants and intensity of rivalry (QuickMBA.com, 2010). This paper will analyze the five forces model, including the various critiques of the model that complicate the task of using the model to analyze a given industry. For illustrative purposes, the computer games industry will be highlighted.

Five Forces Assumptions and Use

The global five forces analysis focuses on the structure of an industry as a major underlying factor of the ability of firms within the industry to generate profits. When a manager works through the five forces, he or she can evaluate the strength of the different forces on the basis of the different factors that contribute to the intensity of those forces. A video game producer for example would see buyers as having high power because they are moderately price sensitive, have low switching costs, there is a high availability of substitutes and buyers have high information and brand sensitivity. For the manager, the ability to use the five forces analysis is dependent on the manager being able to gather the relevant information and on the ability of the manager to objectively analyze this information. Managers within an industry may struggle with objectivity, but the may also lack access to the information needed to make a definitive determination.

Critiques and Challenges

A base critique of any generic model is that such models tend to lack realism (Speed, 1989). For example a manager can make the five forces model realistic based on the information that goes into the model, but ultimately if there are forces that are not covered in the model, then the model is incomplete. Numerous critics have pointed out aspects of the five forces that they feel are unrealistic and have attempted to rectify these deficiencies. The difficulty for the practitioner is to sort through these critiques and amendments in order to find a variant of the five forces concept that is "more realistic" and therefore more useful in their industry. These critiques themselves are often based on academic viewpoints no more or less proven than the original model.

Oviatt and Miller (1989) argued that the lack of realism in models like the five forces reflects a fundamental lack of communication between academics and practitioners in business. While their concerns about the overly academic nature of business schools -- and therefore the general difficulties in applying business school theory to the real world -- are well-founded, this does not specifically invalid such models, including the five forces model. The argument does point out, however, that care must be taken for managers not to rely too heavily on academic models. There is the risk that they could do this, given that the model provides a relatively easy framework with which to work. That the model does not contain a detailed set of caveats about its limitations -- or that such caveats are likely to be ignored by the practitioner anyway -- does increase the risk of misuse and it is recommended that managers become aware of the limitations of models like the five forces rather than relying on them unconditionally.

One such industry-specific critique -- and one that applies well to the video game industry -- is that the five forces model omits as a factor in profitability the issue of innovation. Many critics argue that the five forces model could not possibly apply to their pet industry, and either offer suggestions for improvement or an outright rejection of the model. For the practitioner, these critiques represent clutter in the debate as often as they offer helpful advice for using the five force model. Karagiannopoulos et al. (2005) argue that innovation is a key driver of profitability in the Internet era, and that this weakens the case for traditional five forces modeling. Yet, product differentiation is a component of buyer power; Porter explained that a higher degree of differentiation weakens the power of buyers by reducing the substitutability of the product. Innovation is an important source of differentiation; the critics have done nothing to diminish the five forces model but have instead laid an intellectual landmine at the feet of the manager trying to understand the model better by obfuscating what is otherwise a message clearly in the original model.

Sheehan (2005) further argues that Porter's models are based on industrial firms and therefore need to be modified in order to better fit the information economy. The argument, however, amounts to little more than a re-phrasing of the model. Suppliers are more likely to be knowledge workers (writers, artists, programmers) than physical commodities. Yet the fundamental principles of managing bargaining power remain the same. The value chain processes function the same as well, just with knowledge as a commodity. For the manager, it is important to understand how the different terminology found within the five forces model translates to his or her own business. Failing to do so could lead to improper use of the model, but ultimately the model still holds its relevance once the shift in terminology is understood.

Narayanan and Fahey (2005) make a similar case for emerging economies, highlighting that in a complex world the model needs to be understood as dealing with such complexity. There is the temptation to oversimplify the analysis, based on the surface-level simplicity of the model. Understanding the different drivers of bargaining power across the global video game industry, for example, is a highly complex task. Bargaining power drivers differ from region to region, adding complexity to the task of mapping these drivers to allow managers to derive meaningful conclusions.

Grundy (2006) argues that the main pitfalls in using the five forces model derive from structural issues within the model itself. Among the issues he identifies are prioritizing the forces, analyzing the sub-drivers of the forces, mapping forces over vastly different industry terrains and exploring key interdependencies. There is some merit to these critiques. In particular, while a business student may become adept at working with the model across a number of different industries, the practitioner tends to use the model only occasionally, and is therefore less adept at its use. Analyzing sub-drivers, prioritizing the forces and mapping the forces are all intuitive activities that are improved with practice. Real world managers often lack the experience in working with the model to do it effectively. Grundy is correct is pointing out that the model does not expressly address the issue of key interdependencies. These are to be understood intuitively by the manager, but without the framework for the manager to explore the issue such exploration may not occur. The learning curve for effective use of the five forces model is steep, and it fails to live up to its reputation among managers specifically because they are not adept at using it.

Taking this idea further, the model does not guard against other types of intellectual mistakes. Managers can base their analysis on assumptions, myopic viewpoints, ideology and a priori conclusions, rather than on objective evidence. As with any other framework for thinking, the five forces model is prone to "garbage in, garbage out" and makes no attempt to correct for user incompetence. This is not the fault of the model itself, but it is something that the manager attempting to use the model must understand. Failure to understand this could lead the manager to rely too heavily on the model, and this again would lead to negative results.