Few thinkers have been so completely associated with one area of thinking as the Harvard University academic Michael Porter has been with strategy.
Porter’s groundbreaking insights, first proposed in 1979 in the Harvard Business Review and then in many best-selling books, came to dominate subsequent thinking about strategy.
In his article “How Competitive Forces Shape Strategy“, Porter posited the idea that industry structures are determined by five forces: threat of new competition, threat of substitute products or services, the bargaining power of buyers, the bargaining power of suppliers, and the intensity of competitive rivalry.
Ironically, when I spoke to Porter some time ago, he commented that he only ever intended his model to be a description of how industries behaved, not a prescription for how to formulate strategy. An economist by training, his interest tended to be more in modelling economic behaviour rather than in identifying how best to run individual firms.
Corporate leaders, however, immediately saw the value of Porter’s ideas as a way of analysing and then strengthening their competitive advantage, ideally to the point of controlling the bargaining power of consumers and suppliers, and dominating a market.
Porter’s model has, to some extent, been superseded, but it is still a useful tool. Consider the example of Google, which has achieved global dominance. In the first phase, the company’s success came from a successful innovation strategy in what was at the time a new market: the internet. Kwanghui Lim, associate professor in strategic management at the Melbourne Business School, says the company achieved a level of technical excellence and did not confuse advertising and content as many of its competitors did.
The second phase, however, was closer to Porter’s model. Google was able to create network effects, locking in consumers and suppliers. “Once you had people on board it was hard to deviate from that,” says Lim.
Google’s reduction of the bargaining power of buyers and suppliers was a classic manipulation of Porter’s third and fourth forces. Initially, when the company was operating in a new type of market, its strategy could not be readily derived from Porter’s model. But as the industry and company became more mature its strategy was more easily identified using Porter’s analytics. “There is nothing wrong with Porter’s five forces,” says Lim. “It is a useful way of starting the analysis.”
One potential weakness is that his approach tends to assume static competitive conditions. Over the past two decades competitive conditions have been anything but static. Influences such as globalisation, rapid technological change and the emergence of the digital economy have profoundly changed the environments in which firms make decisions. The Japanese theorist Kenichi Ohmae puts it this way:
“We can no longer define competitors, the companies and customers in a straightforward way. Because this process depends largely on who does it, it is person-specific. Because we are dealing with the invisible continent in the borderless cyberjungle, the business you carve out is person-specific. It really depends on how the strategist sees it and carves out his business domain as his battleground.”
Ohmae is probably exaggerating. Industry structures have not changed so much as to be unrecognisable and one of the surprise features of the biggest “cyberjungle” – the internet – is that it is producing monopolies such as Google and Facebook.
Still, there is little doubt that competition has become more dynamic. Lim comments that there is a greater interest in innovation as a way to deal with the limitations of Porter’s ideas.
Lim believes two things are missing from Porter’s analysis. First, the nature of competition is not always as straightforward as he assumes. Sometimes competitors, buyers and suppliers can be collaborators. “Coke and Pepsi have collaborated much more than they have competed against each other, in order to keep other soft-drink producers out. Porter provides a mechanism for bargaining, but doesn’t tell you much beyond that,” he says.
Lim says the notion of “co-opetition” – ideas of strategy based on game theory that were first developed by the mathematician John von Neumann – have gained currency.
A second limitation is that Porter’s analysis does not shed much light on a firm’s distinctive capabilities. “Since the time of Porter, strategy scholars have included two main streams of thought into mainstream MBA programs: the first on resources and capabilities and the second on game theory,” says Lim. He notes that a “surprisingly high percentage” of mainstream strategy journals have articles that look at innovation (see chart).
Porter’s model is not well suited to situations where industries are subject to so called “creative destruction” (a term devised by the Austrian economist Joseph Schumpeter to describe how new technologies can destroy entire industries). Robert Wiggins, associate professor at the Fogelman College of Business & Economics writes in a Strategic Management Journal article entitled “Schumpeter’s Ghost” that competitive advantage has become “significantly harder to sustain”, a phenomenon that is limited neither to high-technology industries nor to manufacturing industries but is evident in a broad range of industries. Wiggin argues that sustained competitive advantage is increasingly a matter “not of a single advantage maintained over time but more a matter of concatenating over time a sequence of advantages.”
Firms fall from grace a lot faster, says Peter Moran, senior lecturer at the Australian School of Business, University of New South Wales. He believes that Porter’s model remains “the best framework”, but it has shortcomings. “You are getting a lot of complete destruction of industries and Porter has little to say about it. He doesn’t address the question: ‘Where does new value come from?’”
Moran says strategists are looking at so-called “blue ocean” strategies (such as Google’s), whereby companies look for “blue” waters in which there is no competition rather than continue in waters that are “red” with the blood from competition, forcing combatants into zero-sum games.
However, Porter’s analyses remain highly relevant to the formulation of strategy in Australian corporations. Moran says domestic industries are “primarily oligopolistic in almost every sector.” “It is “so entrenched that it is difficult [to know] how it will change, but when it does change it will come down to a collapse of industry boundaries.”
Three decades ago, says Moran, Porter undertook a comparison of different industries, putting pharmaceuticals as the most profitable and airlines as the least profitable. If the same thing was done today the result would be the same. “It hasn’t changed, even though we have gone through decades of globalisation. That is probably the biggest testament to Porter’s five forces.”