Wednesday, March 08, 2017

5 competitive forces that shape Industry competition

Micheal Porter
My classes on Operations strategies starts with a class on Business Strategies as it helps to get a bigger picture of the operating ecosystem before we go into the specifics of day to day operations. Operational strategies which dealt with day to day operating strategies are different from the operations strategies that were important if the organisation were to survive in a competitive environment. The most basic of these parameters being cost, besides innovation of the product or service use, differentiation of the product or service and the markets.

If the organisation is big enough with diverse products and services, it makes sense to have an organisational strategy above each of the business strategies too. However, the business strategy underlies the basic structure of how businesses or organisations operate and compete with each other.  

Porter's Five Forces Theory ..
The five forces theory due to Micheal Porter of the Harvard Business School, talks of the various forces, threats or challenges any organisation faces in its march to growth. If only organisations are able to analyse each of these factors in a very effective way, can the organisation be sure of sustained presence and growth in the market. 

I can personally quote the story of a close friend of mine who was in the semiconductor industry in beginning of the nineties to help explain these concepts well. He used to import microprocessor chips and mother boards at cheap prices from Singapore in large numbers, get them assembled as personal computers, brand them and sell them in the local market.

He thought by buying from a cheap import source he could beat the competition on prices, But what actually happened was that since he was buying from one major wholesaler in Singapore, supplier power was very high. Supplier's threat to give supplies to a competitor or raise prices, rattled my friend's business prospects. My friend was buying in large numbers, at attractive prices, but the supplier was also supplying to other buyers at the same price.

On the buying front, my friend was one among hundreds of customers from all around South East Asia who was buying from this large supplier, because of which my friend was only a small customer among hundreds of others. Hence he could not influence the supplier to give him any preference on supplies or brands.

On the threat of new entry, as more competitors came to know of purchasing microprocessor chips at low cost in large numbers from Singapore, more players entered the market and saturated it as the entry barriers were very low. If one had a lakh of rupees, one could easily enter the market and be a dominant player.  Barriers for new entry were very low.

The threat of substitute products were very low as the semiconductors were high technology products that could be manufactured only in clean environments. The manufacturing setup costs was very high, though since they were manufacturing in large numbers, the unit cost was quite low.

A valid Porter quote, set limits  first and foremost
..
The last of the five forces, competitive rivalry, it was observed that since the market was dominated by Intel and very less by the other player Advanced Micro Devices (AMD), there was no motivation for customers to move from Intel to AMD at all. Even for all the suppliers of Intel PCs, cost was the only criteria. The buyers started bragging about freebies like printers, monitors, modems etc. The seller found it difficult to survive in a highly competitive market where the barriers of entry were very low.

Intel overcame this to a limited extent by coming up with the concept of having preferred distributors and preferred suppliers over fly-by-night operators who used to assemble and operate from make shift shops. Since the barriers to entry were very low, too many competitors started competing for few customers, resulting in low profits. This finally resulted in thousands of small suppliers closing shop.

Among the many factors for high solvency, the most important were as follows -
   - Technology mortality, tech was changing every six months, to faster processors, the small importers found themselves straddled with high unsold inventory of old products which they had to mark down and sell at cheap prices.
   - Disposal of older PCs became an issue as smaller sellers were not ready to buy older machines at end of life. Small retailers found the going tough.
   - Arrival of powerful tablets and smartphones, made less of less of domestic customers preferr PCs and the market shrunk to only corporate clients.

The purpose of this writeup is to enable the reader to get an idea of how important it is to understand the operating environment for any organisation to begin with, to survive in that environment and finally to thrive. Once the environment is set, then comes cost and differentiation aspects.

If you ask me, do all organisations do such analysis initially before they set shop,
my answer is not a sure Yes. The entrepreneurs who start the enterprise need to have a fairly good idea of the operating environment and the ecosystem before they start the venture. The Five Forces Theory consolidates on this initial awareness and reinforces the different aspects relating to the competition.

george..

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