ACCA BT Syllabus A. The Business Organisation And Its External Environment - Porter's Five Forces Model - Notes ^{3 / 3}

Michael Porter

stated that a firm wishing to obtain a competitive advantage over its rivals is faced with two choices:

• Cost Leadership

• vs

• Differentiation OR Degree of Focus

Cost Leadership

• With this strategy, the objective is to become the lowest-cost producer in the industry. 

  Many market segments in the industry are supplied with the emphasis placed minimising costs.

• If the achieved selling price can at least equal (or near) the average for the market, then the lowest-cost producer will (in theory) enjoy the best profits.

• This strategy is usually associated with large-scale businesses offering "standard" products with relatively little differentiation that are perfectly acceptable to the majority of customers.

• Occasionally, a low-cost leader will also discount its product to maximise sales, particularly if it has a significant cost advantage over the competition and, in doing so, it can further increase its market share.

• Example from the car industry – Nissan, Ford, Honda

Differentiation

• In a differentiation strategy a firm looks for ways to be unique along some dimensions that are widely valued by buyers. 

  It selects one or more attributes that buyers perceive as important and uniquely positions itself to meet those needs and it is rewarded for its uniqueness with a premium price.

• One can differentiate in design, brand image, customer service.

• Example from the car industry – BMW, Jaguar, Mercedes

Focus

• A focused strategy chooses a segment or group of segments in the industry and tailors its strategy to serving them at the exclusion of others. 

  This segment can be a particular buyer group, segment of the product line or geographic market.

• There are two variations to this strategy - a cost focus where a firm seeks a cost advantage in its target segment and a differentiation focus where a firm seeks differentiation in its target segment.

• The target segments must either have buyers with unusual needs (differentiation focus) or the production and delivery system that best serves the target segment must differ from that of others industry segments. 

  A cost focus exploits differences in cost behaviour in some segments.

• Example from the car industry – Ferrari and Rolls Royce

Porter's 5 forces approach looks in detail at the firm's competitive environment by analysing five forces.

Together these forces determine the overall profit potential of the industry.  

Looking at an individual firm, its ability to earn higher profit margins will be determined by whether or not it can manage the 5 forces more effectively than competitors.

1. The threat of new entrants (and barriers to keep them out)

   A new entrant into an industry will bring extra capacity and more competition. 

   The strength of the threat and the new entrant will depend on two things:

   • Strength of the barriers of entry

   • The response of existing competitors in the marketplace

2. The threat from substitute products

   A substitute product is a good product or service from another industry that satisfies that customer need.

3. The bargaining power of customers

   Customers require better quality products and service at a lower price. 

   By satisfying these, an organisation or industry may force down the profitability of suppliers in the industry. 

   How strong the customer’s position is, depends on a number of factors:

   • How much the customer buys

   • How critical the product is to the customers business

   • Switching costs (switching from one supplier to another)

   • Are the products standard items (easily copied?)

   • The customers own profitability (low customer profits = lower prices from suppliers)

   • Awareness of customers purchasing staff/price awareness

   • When the quality of the product is more important to the customer, the customer is less likely to be price sensitive

4. The bargaining power of suppliers

   Suppliers are able to exert pressure for higher prices however this depends on several other factors:

   1. Are they more than one or two dominant suppliers (charge monopoly prices)

   2. The threat of new entrants

   3. Whether the supplier has other customers or substitute products

   4. Importance of the suppliers product to the customers business

   5. Has the suppliers got a differentiated product

   6. Are the switching costs too high

5. The rivalry amongst current competitors

   The intensity of competition within the industry will affect the profitability of the industry. 

   Competitive actions could be:

   • Price competition

   • Advertising battles

   • Sales promotion campaigns

   • Introducing new products

   • Improving sales aftercare

   • Providing guarantees or warrants