Economics of Business Strategy and Porter's 5 Forces

Question 1

What are strategic frameworks?

Answer 1

Are used to help work out what areas of economics can help managers to understand the markets they operation and it gives structure to the microenvironment (local economies and markets - supply + demand)

Question 2

What are the themes from the empirics?

Answer 2

Some industries are more profitable than others - industry average profit rates are consistently higher in some markets than in others.
Some firms are consistently more profitable than others because they operate in favourable environments (high profits in ‘good game’ than less profitable industries) e.g. tobacco companies.
Firms with similar activities have widely different rates of profits some firms outperform by taking advantage of environment.

Question 3

What is a economic model?

Answer 3

a model is a description of aspects of the economic world that includes only those features that are needed for the purpose. It simplifies reality to better understand a situation and make predictions for the future - takes real world problems and strip them down to its bare essentials.
Takes the Ceteris Paribus assumption (all things equal, if one feature changes everything should stay the same)

Question 4

What do concepts must we be aware of?

Answer 4

1. Fallacy of composition - generalisation
2. Post Hoc fallacy - causality i.e. one event may cause another
   Multiple models explore the same situations/issues to see it different.

Question 5

What does Porter’s Five Forces Model relate to?

Answer 5

it relates directly to the aforementioned empirical observation (SCP theory)argues that market structure is a determinants of firm conduct, which in turn determines profits in an industry and performance.

Question 6

What does the five forcer framework consist of?

Answer 6

1. Industry Analysis - a tool that helps determine key factors
2. Generic strategy formulation - offers strategic prescriptions that are based on industry analysis

Question 7

What do you need to do to define a market?

Answer 7

must define things such as - set of competitors, set of competing products and geographical area

Question 8

What does too narrow of a market focus lead to?

Answer 8

strategic myopia as some important threats are overlooked.

Question 9

What does too broad of a market focus lead to?

Answer 9

irrelevant analysis - the firm may consider non-existing threats or lead to important detail being lost in larger picture.

Question 10

What are the 5 Forces?

Answer 10

1. Bargaining power of customers
2. Bargaining power of suppliers
3. Competitive rivalry within an industry
4. Threat of new entrants
5. Threat of substitute products

Question 11

What does threat of substitutes involve?

Answer 11

Substitutes do the same job as the industry’s product - they are functionally equivalent to some degree, but substitutes fall outside the initial market definition adopted, they are different but do the same job.
Falls in prices, number and availability of existing substitutes or the introduction of new substitutes threatens the profitability of the industry.

Question 12

What are examples of substitutes?

Answer 12

Tea and coffee
Riding the bus or getting a taxi
using a laptop or a notepad to take notes.
Or the introduction of TV streaming and wider social media services has had a big impact upon the services of traditional TV broadcasters, so if broadcast TV is your chosen industry such as BBC, ITV, Sky all exist within industry definition, those that fall outside the defintion include Netflix, Disney, YouTube, Apple Tv streaming services or another substitute that consumers can do instead of watching broadcast TV includes cinema, restaurants.

Question 13

What does threat of new entrants involve?

Answer 13

when entry is easy, new firms will be attracted into profitable industries, production capacity increases in the industry and it drives down price/profits.
Barriers to entry provides advantages for incumbent firms over entrants as it makes it difficult for new firms to enter the market and compete.
Incumbents can take strategic entry deterring action.

Question 14

What are the main barriers to entry?

Answer 14

brand loyalty, economies of scale, control of inputs or distribution channels and high capital requirements.

Question 15

What is bargaining power of suppliers and buyers involve?

Answer 15

They are TWO independent forces but often taken together as they draw upon the same area of economies.

Question 16

What does supplier power involve?

Answer 16

Supplier power is the relationship between industry and buyer.
If strong suppliers can bid up their prices, then the industry cost rises and its profitability falls e.g. the recent high cost of energy has threatened the profitability of energy intensive businesses.

Question 17

What does buyer power involve?

Answer 17

Buyer power is the relationship between industry and us consumers.
If powerful buyers can force down an industry price then industry profitability falls e.g. supermarket power over many agricultural markets.

Question 18

What does industry and form of industry rivalry involve?

Answer 18

Firms can compete against each other in many ways and to varying degrees. Intense rivalry, especially when concentrated on price rivalry, increases competition and this reduce industry profitability.
Rivalry may be intense when there are many competing firms, lack of differentiation or switching costs, slow industry growth, high storage costs, barriers to exit, high fixed costs/capital requirements.
Firms may try to collude instead.

Question 19

What is different profitability due to?

Answer 19

differing profitability of firms within a market is due to differences in their market strategy.

Question 20

What are the 2 routes firms can take to gaining a long term competitive advantage?

Answer 20

1. Low cost strategy
2. Differentiation strategy
   firms should only pursue one otherwise they get stuck in the middle.

Question 21

What is the differentiation strategy?

Answer 21

Firms pursue to make their product different from rivals - usually involving extra benefits or features to the product e.g. Airlines offering more legroom, better food etc.
Differentiation involves incurring extra costs, but it can confer improved profitability - if consumer pay more it compensates for the higher costs of achieving differentiation.

Question 22

What should differentiators do?

Answer 22

identify sources of higher value for consumers, care about costs but will typically be willing to incur higher costs if it adds value to their product in the eyes of the consumer.
Will only be successful if firms tell consumers that their products have individual and unique features that they are unable to get from products sold by rival firms.

Question 23

What is the low cost strategy?

Answer 23

firms offers a basic product that meets the needs of some consumers but without the frills or benefits of some differentiated goods allows the firms to have a product that meets the customers satisfaction but it lowers the production costs for a firm e.g. budget airlines or supermarket’s own branded goods

Question 24

What do low cost firms do?

Answer 24

They will undercut other firm in the market , they make higher margins by reducing costs by more than the price reduction. Low unit prices means firms can sell more leading to higher profit margins.
Implementing a low cost strategy involves making cost reduction part of the corporate culture.

Question 25

What is a focus strategy?

Answer 25

Porter suggests a focus strategy which is when firms concentrates on a specific buyer group, segment of the product line or geographic market. Its focused on serving a particular target rather than acting industry wide e.g. IKEA low cost furniture you build yourself. It ca be thought of as adding in an extra element to our analysis by looking at where we are trying to target our perceived source of strategic advantage.

Question 26

How is the choice of generic strategy made?

Answer 26

It is made by understanding the profit drivers in the firms environment - firms use five forces analysis to understand its environment and then it needs to identify strategic choices that lead to above average profitability.

Question 27

What is a cost leadership strategy?

Answer 27

is fundamentally a price strategy that aims to raise sales volumes by lowering prices and enhance margins by lowering costs.

Question 28

When are price strategies viable?

Answer 28

when the market is sensitive to price. Market PED is relatively elastic. Price reductions will attract extra sales volume which help to increase economies of scale and lower costs further.

Question 29

When do price strategies become poor?

Answer 29

when customers are less concerned with price - the good is cheap i.e. a small proportion of income, its addictive/necessary, there are no close substitutes(from rivals firms or firms outside the industry)

Question 30

When is differentiation a good strategy?

Answer 30

when demand is less influenced by price, differentiation is a good way of attracting new customers and holding on to those you have.

Question 31

What are the critiques of porters framework?

Answer 31

- externally orientated, market driven or outside in perspective, overlooks the significance of resources, capabilities/skills of competency based advantages - not all firms will be able to pursue differentiation or low cost strategies. - static frameworks does not account for evolving nature or innovation. - emphasises competition but not collaboration/alliances - qualitative based tool - difficult to quantify impacts on industry profits - generic strategy can be seen as classification of strategies that can be grouped together to achieve lower costs of differentiation. - involves formulaic analytical methods that force you to think of the world in a constrained way. - evidence to show that firms can successfully pursue strategies involving post cost reduces and elements of differentiation e.g. Skoda cars