Question

2.impact of Differentiation on each of Porter’s 5 forces. example.

3.define the sources of cost advantages. example

4. define the impact of Cost Advantage on each of Porter’s 5 forces. example for each one.

Answer 1

Porter’s 5 forces

Porter's Five Forces is a business analysis model that helps to explain why various industries are able to sustain different levels of profitability.

The model was published in Michael E. Porter's book, "Competitive Strategy: Techniques for Analyzing Industries and Competitors" in 1980.

The Five Forces model is widely used to analyze the industry structure of a company as well as its corporate strategy. Porter identified five undeniable forces that play a part in shaping every market and industry in the world, with few drawbacks.

The five forces are frequently used to measure competition intensity, attractiveness, and profitability of an industry or market.

Porter's five forces are:

1. Competition in the industry

2. Potential of new entrants into the industry

3. Power of suppliers

4. Power of customers

5. Threat of substitute products

The threat of new entrants to the market. Companies in markets with high barriers to entry – whether through regulation, high fixed and/or start-up costs, protected intellectual property, etc. – face less competition than companies in markets with lower barriers. Oil and gas exploration is an example of a tough market to enter because it requires a lot of capital to be able to spread the risks of an unprofitable drill across multiple leases.

The power of the suppliers. If the number of suppliers for a sector is limited, then those suppliers have a lot of pricing power over their client companies. This can lead to the suppliers doing better than the buyers. Microsoft in the 1990s is nearly a textbook example of this dynamic. Microsoft’s operating system drove huge profits for the company while the margins for the personal computers being sold to the public with Windows grew ever thinner, and PC manufacturers saw their profits erode.

The power of the buyers. If an industry moves product through retailers or distributors, then the buyers can exert the same type of pricing power to eat up the profit margin. When an industry has to deal with the Wal-Marts of the world, they sometimes have to give up more than a simple volume discount to get their goods listed. And if they try to push back, there will be another supplier willing to bend over backward to work with that buyer.

Availability of substitutes. Substitutes are the products or services a customer can use to fill the same need. For example, if a cup of coffee costs too much to buy, a customer can switch to tea or simply start brewing their own at home.

Competitive rivalry. This last force is used to sum up the level of competition within an industry. If there are a multitude of players all trying to undercut each other, then profit margins will reflect that. The airline industry is a great example of this: Carriers are always attacking each other with competing routes and trying to steal customers away. A lot of money has been lost in airlines.

The Five Sources of Cost Advantage

There are five commonly recognized sources of cost advantage – people, material/supplies, processes/systems, facilities, and capital. It is not necessary to focus on all of them in order to experience the benefits of being the lowest cost producer in your industry; any one could be enough. However, by achieving a true cost advantage in more than one source, you further ensure your company’s success.

Now, let’s explore each of these five sources and determine the relationship it has on your business.

People

Many organizations boast that their people are their most important asset. While this may be true, people can also represent the most significant cost to a company when you shift from the balance sheet to the operating statement.

Companies do not become the lowest cost producers by paying their people the lowest wages and benefits possible. They become the lowest cost producers by leading and managing their employees to performance levels that exceed those of their competition. To do this, they continuously focus on enhancing the skills of their people. They create highly flexible employees who are capable of meeting the demands of an ever-changing marketplace.

Lowest cost companies create highly disciplined teams who understand their real competition is outside of their organization, not inside. They:

• tell their people what to do
• support them in their efforts to do it
• measure how well they do it
• reward and/or discipline based on their measurements

Materials/Supplies

All companies use materials and supplies to produce their products or perform the services that their customers buy. Lowest cost companies do not simply focus on the lowest unit price of materials or supplies, they establish purchasing practices that result in the lowest total cost for these materials and supplies.

This distinction is essential because the lowest unit price for a particular purchased product may not be the lowest total cost for the same material. Lowest cost companies identify and separate their strategic purchases from their low-risk purchases. They then align their purchasing resources to ensure that strategic material purchases receive the level of attention they deserve. They understand and track their total purchasing costs and work hard to continuously reduce them.

Processes/Systems

Everything that a company does is a process. From the way it hires to the way it fires, from entering orders to collecting receivables, from manufacturing products or delivering services to the way you ensure their quality, everything that an organization does can be reduced to a series of definable steps. Processes that are linked together become a system. Lowest cost producers design their processes and resulting systems to be highly efficient.

Organizational processes and systems can be classified into four basic categories:

• Sales processes – positioning your company and products, generating leads, converting those leads into orders, and entering those orders into your operations
• Operational processes – engineering and manufacturing your products, and ensuring the quality of your products/services
• Distribution processes – getting your products or services to your customers
• Support processes – human resource activities, management information systems, financial management, administration activities (to name a few). Support processes are essential for your sales, operational, and distribution processes.

As a company grows, these processes and systems tend to evolve with it. Lowest cost companies recognize that evolution does not always yield efficiency, and they constantly evaluate and re-engineer their processes to ensure they are performed in the lowest cost way possible.

Facilities

After people and materials, the most significant cost center for companies is often their facilities. Facilities include physical plant (offices and factories), equipment and technology hardware.

Lowest cost organizations work hard to ensure their offices and/or manufacturing facilities are designed to produce the most cost-efficient performance. They invest in the most effective capital equipment to do the essential work of their business. Increasingly, lowest cost companies look for ways to use technology to increase their productivity and reduce their costs.

Capital

The last (but not least) source of cost advantage is capital. Capital falls into two fundamental categories, money that you have (cash on hand and equity) and money that you don’t have (receivables and credit availability). Lowest cost companies recognize and maximize the advantages that come from effective capital management.

Cost Advantage on each of Porter’s 5 forces

A firm's relative position within its industry determines whether a firm's profitability is above or below the industry average. The fundamental basis of above average profitability in the long run is sustainable competitive advantage. There are two basic types of competitive advantage a firm can possess: low cost or differentiation. The two basic types of competitive advantage combined with the scope of activities for which a firm seeks to achieve them, lead to three generic strategies for achieving above average performance in an industry: cost leadership, differentiation, and focus. The focus strategy has two variants, cost focus and differentiation focus.

1. Cost Leadership

In cost leadership, a firm sets out to become the low cost producer in its industry. The sources of cost advantage are varied and depend on the structure of the industry. They may include the pursuit of economies of scale, proprietary technology, preferential access to raw materials and other factors. A low cost producer must find and exploit all sources of cost advantage. if a firm can achieve and sustain overall cost leadership, then it will be an above average performer in its industry, provided it can command prices at or near the industry average.

2. Differentiation

In a differentiation strategy a firm seeks to be unique in its industry along some dimensions that are widely valued by buyers. It selects one or more attributes that many buyers in an industry perceive as important, and uniquely positions itself to meet those needs. It is rewarded for its uniqueness with a premium price.

3. Focus

The generic strategy of focus rests on the choice of a narrow competitive scope within an industry. The focuser selects a segment or group of segments in the industry and tailors its strategy to serving them to the exclusion of others.

The focus strategy has two variants.

(a) In cost focus a firm seeks a cost advantage in its target segment, while in (b) differentiation focus a firm seeks differentiation in its target segment. Both variants of the focus strategy rest on differences between a focuser's target segment and other segments in the industry. The target segments must either have buyers with unusual needs or else the production and delivery system that best serves the target segment must differ from that of other industry segments. Cost focus exploits differences in cost behaviour in some segments, while differentiation focus exploits the special needs of buyers in certain segments.