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The Five Forces Model

The “five forces” theory will influence the firm through the structure responsible for “what is done” within the business (see Figure 1.4). Porter’s five competitive forces6 defined one of the most important moments in strategic thinking. This model has a deep adherence to some microeconomics principles, such as the supply and demand theory, cost and production theory, price elasticity, customer behavior, market structures, number of players, market size and growth rates, substitution effects, and market-entry barriers, as cited by Recklies.7

Objectively stated, Porter explained the dynamics of a theory based on five forces that allegedly shaped strategy and industry competition:

  1. The threat of new entrants
  2. The threat of substitute products or services
  3. The bargaining power of customers (buyers)
  4. The bargaining power of suppliers
  5. The intensity of competitive rivalry (as illustrated in the next figure)

In addition, most of the premise implicit in this theory suggest that the imperfect competition model is the basis of the five forces methodology.

Contrary to the imperfect competition theory, the perfect competition model suggests an infinite number of buyers (customers) and sellers (suppliers) mitigating any of the bargaining power presented in the Five Forces Model. Sellers and buyers will dispute and prices be reduced to maximize a firm’s profitability.

Another clear reference to imperfect competition lies in the dimension entitled “threat of new entrants,” which considers eventual barriers to entering the market. In the perfect competition model, there are no barriers to entry and exit, and for this reason, mobility is extremely high; perfect mobility is a premise of the perfect competition theory. Imperfect markets suggest difficulty in entering new markets and facilities to sustain position and retain territory in the market.

Figure 1.9

Figure 1.9 Porter’s forces

Buyers’ and sellers’ bargaining power also lies in privileged information that provides competitive advantage during negotiation and other business cycles. The perfect competition model assumes consumers and producers have a perfect knowledge of price, utility, quality, and production methods of products.8

Other variables also suggest that the Five Forces Model is based on the imperfect competition economic model, except for the influence of externalities, and this is the subject of criticism from other authors. As mentioned earlier, the limitation not to apply this model to industry group or industry sector-level analysis has determined the theory’s obsolescence.

As fluid and complex business environments substituted the traditional dynamics experienced a few decades ago, the management of product or service offered has changed in many ways: Lifecycle, customer satisfaction attributes, profitability, shelf life, value, and volume are some examples. The deep changes have impacted on the relationships within firms in a supply network, including suppliers, customers, service providers, other competitors (allies or not), and other noncompeting firms (allies). These actors, though external to the firm, are now stakeholders of the business—it is a period where there is no winning competitor but a winning supply network.

Given this theory provides a snapshot of the business environment, it does not establish a long-term active connection with factors internal or external to this environment. A few people, typically managers, directors, or even external consultants, access existing knowledge inventories to assess business risks and opportunities, as the theory suggests “new knowledge and skill is dependent on pre-existing knowledge and skill.”9 The Five Forces Model provides a methodology for this assessment. This assessment influences the firm as it connects to the value chain environment through the gate of the business practices, as illustrated in the next figure.

The five forces theory does not address any cultural aspects of the organization that may influence the definition of the competitive strategy its implementation and its execution. The way people do things is disregarded. Even less does it address the culture and behavior of the supply networks, formed by other noncompeting companies, service providers (different from suppliers), government, political groups, and other external elements.

Being based on the imperfect competition, the Five Forces Model suggests that the market winner is the best competitor among all existing in the dynamic and competitive environment. It expects limited volatilities and believes a periodic snapshot of the business environment is sufficient to assess risk and create a consistent strategy for competitiveness. Porter’s model suggests a mechanism to evaluate present knowledge based on the perspective of the firm.

Figure 1.10

Figure 1.10 Traditional value chain, risk assessment

Figure 1.11

Figure 1.11 The traditional value chain attributes

This environment accepts that the strategy developed for the competition of a firm will last long enough to pay back all investment related to the effort required for its implementation. This is only possible if the business scenario assessed by the Five Forces Model is sustained without significant change for a long period, typically periods that vary from a few years (2 or 3) to a decade. No dramatic strategy is acceptable on a yearly basis.

This mechanism creates a period when a firm’s strategy is not adherent to business needs and the substitute strategy has not been implemented yet. The reason why the disruption valley (see Figure 1.12) occurs is the organization’s inability to perceive business environment changes soon enough. The disruption valley is an acceptable collateral damage if it represents a very small period in relation to the strategy’s lifecycle. For instance, a disruption valley of one or two quarters can be absorbed by the business if it occurs every 3 or 4 years. If the strategy lifecycle reduces to a year or less, this disruption period is unacceptable.

Figure 1.12

Figure 1.12 Traditional strategy lifecycle

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