Competitive Forces

The dominant strategy paradigm in the 1980s, the competitive forces approach pioneered by Michael Porter views the essence of competitive strategy formulation as relating a company to its industry in which it competes, the strategic group it is part of and its competitors. Five forces- entry barriers, threat of substitutes, buyer bargaining power, supplier bargaining power and rivalry among firms- determine the inherent profit potential of an industry. The focus of the analysis is to find a “holding” location for the firm, or a “resting area” in which the firm can defend itself against competitive forces, influence buyers and suppliers events in its favor and find ways to become and remain profitable.

Assumptions in this strategy model are as follows- economic rents are monopoly rents, firms earn rents when they impede the competitive forces which tend to drive economic returns to zero, industries or subsectors of industries become more attractive if they have structural impediments to competitive forces, rents are created largely at the industry or subsector level rather than at the firm level.

This approach to strategy was incubated inside the field of industrial organization and in particular, the industrial structure school of Mason and Bain. In competitive environments characterized by stable structural barriers, the five forces may become determinants of industry-level profitability. However, competitive advantage is difficult to ascertain where rapid technological change is happening, and where certain firm-assets, such as patents or offshore delivery teams, can be expected to play a larger role in explaining economic rents to a firm.

Strategic Conflict

This approach uses the tools of game theory to analyze the competitive interaction between competing firms to reveal how a firm can influence the behavior and actions of rivals and eventually, the market- prices, quantities, profits, beliefs of customers, rivals, costs or speed of entry into the industry. Examples of game theoretic moves include investments in capacity, the “cross-parry”, online and print advertising, product announcements, preemptive product strategy and oversees market entry. However, to be successful in deterring or derailing competitive response, these strategic moves require irreversible commitments and will fall flat if they can be reversed without incurring substantial financial hardship. The hope remains to increase profits by manipulating the market conditions the firm is a part of.

Strategic moves can also be aimed at influencing competing firm behavior, via signaling techniques that include predatory and limit pricing, launch announcement, capacity addition. Cooperating with firms that are not a direct threat in order to advance market share is another strategic move emanating from this paradigm.

However, game theory is unable to crystallize the strategic options available to a firm in entirety. The game theoretic models admit multiple equilibria, and conclude with a wide range of choices for choosing the appropriate game form to be used. The results of the modeling often depend on the assumptions about what another competitor will do in a particular situation. The externalities not identified in the game specification are assumed to have no effect on the  outcome- the strategy recommendation, while we all know that these very externalities, such as rapid technological, political, social and market changes are usually responsible for the way most firms perform.

This paradigm of strategy formulation is more apt for situations where the competitors are more “alike” than different, and where the competitive positions are more delicately balanced, as with Coke and Pepsi. However, applicability of game theoretic strategy formulation will rapidly decline in industries where there is rapid technological change and fast-shifting market conditions.

Problematic with the game theoretic approach to strategy is the manager’s fascination with Machiavellian tricks that will distract her from seeking to build a sustainable competitive advantage using the firms existing “capabilities”, and from protecting the unique skills and abilities available within the firm.