Strategy development is the key element that defines the future of the company. Managers create strategies to outline what they want to achieve and how this can be done; however, these plans cannot be created without an outlook of the environment in which the business operates. Porter’s theory of strategy involves examining the five forces, such as customers, suppliers, competitors, and new entrants when creating the strategy to determine what position the firm currently holds and how the profits can be increased considering these five elements. Another approach is choosing one of the two-differentiation or lowering the costs, which are the generic approaches to creating the strategy. At XYZ, the current strategy of the business is lower costs that allow them to attract buyers. However, this company lacks focus on innovation and should adopt a focus strategy to offer a niche service to the clients due to the high competition in the market and strong power of suppliers. This paper will present an analysis of the theories of strategy and evaluate XYZ’s approach to it.
Strategy
The development of the strategy is among the core tasks that business managers undertake because it defines the targets for performance and the approach that the company will take towards product positioning and obtaining profits. There are several theories pertaining to strategy development, the most prominent ones being the Porter’s Fiver Forces and the Generic Strategies. This paper will review the core theories of strategy development and present the author’s critical discussion of them.
Theories of Strategy Development
The most prominent theory of the strategy development process was developed by Michael Porter, and it is titled “The Five Forces.” The basis of this approach is that by analyzing the environment of the industry in which the company operates, the management can select a proper strategic positioning for it. Porter (2008) argues that these competitive forces shape the firms’ strategies because the goal of a business strategy is to create a plan on how to overcome competition. Additionally, the five forces show how the profits are distributed within the industry since a company receives its portion of profits, which can be drained away by the existing competitors or the new entrants. On the other hand, the organization can increase its profit margin by bargaining with the suppliers or depending on the power that the customer has. Porter’s theory of the five forces and their impact on strategy development is shown in Diagram 1.
Evidently, Porter’s approach implies that business managers look at the environment where they operate when developing their strategies and base their decisions on the behaviors of the competitors, customers, and suppliers. This approach allows seeing where the firm can gain a strategic advantage, for example, by offering a better price to the customer, which would result in lower profit margins but more sales, or by bargaining with the suppliers to receive a better deal. Therefore, the basis of Porter’s approach is that the development of the strategy begins with examining the company’s properties and evaluating the behaviors of external players, with an end goal of finding the approach that will allow the firm to gain maximum profits.
In Diagram 1, there are the four elements that shape the competitive strategy under Porter’s views. The first element is the Power of Buyer, which is the availability of other options for the customer or the industry situation where there is a multitude of sellers and only a few buyers. In essence, if the buyer can select from a multitude of substitute products, which differ in price and quality, then the Power of the Buyer is high, and the firm must develop an offer that will differentiate them from the competition; otherwise, the chance of gaining a profit is very low. Another important consideration in this domain is the value of each customer since some can account for a large proportion of the profits in that particular market. Moreover, the cost of attracting new customers is another point for consideration since it determines whether the company should invest effort into attracting new buyers. Hence, by examining the power that the buyers have, the firm can determine whether it is feasible to lower the prices, invest in marketing to attract new buyers, develop a niche product to target a set of specific needs, or whether this market will not be profitable for the business.
The Treat of Substitutes determines the effect that the products that are not directly competing with the firm in the same market but can be selected by buyers as a close substitute to the firm’s offer. If such a threat is high, the company has a lesser strategic advantage, which means that the prices for its products should remain at the current level to maintain the number of customers; however, in a different scenario, where a firm’s prices can be increased, which will result in more profits, since the buyers who need the product will not have other options to choose from. Hence, the Threat of Substitutes is an important point of consideration for the business because it allows the management to determine how much power they have in this particular market.
The Threat of New Entrants element from Diagram 1 relates to the potential intensification of the competition in the market. Evidently, the development of a strategy has to consider the existing competition; however, this is a self-evident element. More importantly, the management has to assess how easy it is to enter this industry because, especially in cases when the profitability is high, the new entrants may significantly hinder the profits of the business. If the threat is high, the management has to develop alternative strategies for overcoming the competition, such as differentiation or lowering the costs, among others. However, if the threat is low, the firm has an advantage and can focus on procuring its current approach. The Threat of the New Entrant element is evaluated by examining the cost and money needed to enter this market (Johnson, Scholes, and Whittington, 2008). For instance, in industries such as metalworking, the investment required to purchase equipment and initiate the work is high, and therefore, the management of the firms that already work in this industry do not have to worry about new competitors emerging and obtaining their share of the market’s profits. From this perspective, markets, where there are strong barriers to entry are ideal for businesses.
The competition in an industry is a self-evident factor that impacts the strategy since this predetermines the potential profits and the approach that the firm’s leaders can take towards maximizing profitability. The assessment of the competition is based on the evaluation of how many companies there are in the industry, how many similar products they offer, and one can also examine the share of the market that these businesses already have (Johnson, Scholes, and Whittington, 2008). Evidently, a large number of competing firms and similar products provide more freedom to the suppliers and buyers because these competitors can offer a lower price or better deals, and therefore, the firm will lose the customers or will have worse profit margins.
The Power of Suppliers is an element that refers to the businesses’ profit margins and the ability to lower production costs. If the suppliers’ power is high, which happens in cases when there are many competing businesses and a small number of suppliers, they can choose to sell their products at higher prices, which will drive up the production costs simultaneously. Therefore, the evaluation of the strategy begins with examining the number of suppliers and the potential leverage that the business might have when negotiating with these suppliers for future deals. Ideally, the business should have the power of the suppliers, and it is best to work in markets where the supplier power is low as opposed to that of the firm, which is the case when there are many suppliers in a single market. In that case, the business can negotiate lower prices and increase its profit margins without changing the price for its customers and have an advantage over the competition.
The assessment of the five factors that impact the competition presented above shows that the development of the strategy is a complex process where a multitude of factors must be considered. Additionally, it highlights the fact that the strategy is linked to the company’s environment and the interactions between the suppliers, customers, competitions, and potential new competitors. The conclusion that arises on the basis of the five forces assessment is that the company can choose to either offer lower prices or a unique product in cases when the market is saturated.
Porter’s Five Forces allow the strategist to get a better comprehension of how the market operates and of the current market conditions. By using this information, one can find a place where the competitive forces are weaker. Porter (1985) argues that the attractiveness of an industry is the profitability of all the firms competing within it, and the industry itself can be loosely defined as a group of companies that produce products that are substitutes for one another. Therefore, the strategy pertains to the approach that a company takes to overcome its competition within an industry and obtain better profit margins and is based on the assessment of the competitive forces within this industry.
The focus on the firm’s future is the main reason why a strategy is created in the first place. According to Porter (1980), the development of a strategy is based on the assessment of the long-term prospects of the industry’s profitability. Namely, not all industries offer the same prospects of profits in the long run; for example, some fast-growing markets can reach their potential soon, and companies entering it will not be able to gain their share of the profits. The second factor is the determinants of the relative competitive positioning in the market. Essentially, these are the factors that determine the firm’s place within the industry when compared to the competitors and considering the perspectives of the suppliers and customers.
Although a company can adopt any type of approach, there are some common strategies that allow it to overcome competition. Apart from the Five Forces, Porter (1980) also developed the three core strategies that describe the most common approaches that firms use when developing their strategies. These are cost leadership, differentiation, and focus, which are Porter’s Generic Strategies. Cost leadership means that a firm is focused on offering its customers the lowest price in the market while also maintaining its profitability. The approach of differentiation means that the company offers a unique product to the customer and gains a market share due to the fact that the competitors’ substitutes do not offer the same features. The way of achieving differentiation is choosing one or several features that the buyers value and focus on the development of the product around these features. Finally, the focus strategy implies selecting a niche within the market and offering a product there, which allows the business to gain leverage over the firms with a broader focus.
Another important factor is the ability of the firm to sustain its profitability over the long run, since gaining profits in the short-term perspective is insufficient to secure a market position. Hence, although change and innovation are important for the development of the business and for reaching its strategic objectives, the process cannot be facilitated without the proper assessment of the competitive environment. The next section will detail the relationship between change, innovation, and strategy.
Relationship between Strategy, Innovation, and Change
Strategy is linked to change due to the requirements of the modern-day business world. According to Hamel (1998), the companies that will be able to survive and thrive are the ones capable of reinventing themselves and their industries. This means that innovation and change have to be an integral component of the business because this is the only way for them to survive. Moreover, Hamel (1998) argues that “it is the revolutionaries…who are creating the new wealth” (p. 7). The author notes that the current competitive environment is different from that gave birth to the concept of strategy fifty years ago, which means that apart from using the theory of strategy, one has to also understand that competitive advantage is gained through innovation.
The goal of a business is to provide value and earn more than its cost of capital. In the modern-day environment, replicating the business model or a product is not problematic, considering the amount of information available online and the access to resources. Moreover, Hemmer (1996) states that the policy of cost reduction is obsolete and cannot guarantee the development of the business. More specifically, companies are overly focused on reducing their expenditures and ensuring that their return on the invested money is maximized; however, this approach is finite and cannot be continuously used to ensure that there are adequate profits. Hemmer (1996) states that “squeezing another penny out of costs, getting a product to market a few weeks earlier, responding to customers’ inquiries a little bit faster, ratcheting quality up one more notch, capturing another point of market share—those are the obsessions of managers today” (para. 1). However, this approach is used by managers of most companies, and it does not allow for differentiation between firms, especially in saturated markets. Thus, innovation, or even the ability to incorporate innovation into the strategy as a component of the firm’s target for the future, is essential. Hence, businesses have to continuously develop and offer new products and services that address the needs of the customer in better and more effective ways. In another case, the competitors or new entrants will gain an advantage by either innovating or capturing a market share, which will not allow the business to earn profits that exceed the value of their capital.
From the perspective of strategy as a plan for the future that considers the current environment, innovation allows reaching the objectives beyond those described by Porter in his theories. This is because if the business integrates innovation and change into their strategic plan, they will consistently overcome the competitors and will not have to worry about the new entrants capable of offering the old types of products and services. Hence, a culture of innovation has become essential for the survival of contemporary businesses.
Analysis of Strategic Processes at XYZ
XYZ is a small firm with under 100 employees operating in the metalworking industry, which provides its clients with a set of services linked to the modification of metals. Based on Porter’s theory, the current position of this company in the market requires a change in the strategic direction. This is because the competition n the industry is high; there are several large firms that offer the same services. Hence, the power of the buyer is high because they can choose between the small, middle-sized sized or large companies that provide the metalwork services depending on their needs. The number of suppliers who sell the metal required to facilitate the service is limited, which means that their bargaining power is high, and XUZ cannot negotiate lower prices for itself. One positive aspect is that the threat of new entrants is low because to buy the equipment needed for the provision of services, one would have to make a substantial investment.
Currently, XYZ has selected the lower cost strategy, and the management has reduced its profit margins to offer the clients a better price when compared to the competition. However, this strategy is difficult to sustain in the long run because the company is not obtaining the revenue that it could have. Moreover, the strategy selected for lowering the costs is also not beneficial because it is achieved through reduced profit margins and not by negotiating better prices with suppliers. The rationale for this approach is that XYZ needs to maintain the cooperation with the existing clients to ensure that they do not buy from the larger companies. However, these larger firms have the bargaining power to negotiate a better price with the suppliers and, therefore, can overthrow XYZ’s efforts. From the viewpoint of people’s engagement and contribution, the current strategy is not effective, and therefore, the engagement of the individuals is low, which will be discussed in detail in the recommendations section.
Recommendations
Since XYZ is a small company in an industry where the competitive rivalry is high, the selected strategy should be a focus on differentiation. The basis of this approach is that XYZ selects a niche in the market, for example, a specific set of companies that require a particular type of metalwork and continues to develop in this direction. The rationale for this recommendation is the issue of company size and low costs since XYZ has difficulty competing with the larger businesses, and the lowering of costs affects the profit margin. By selecting a niche, XYZ will be able to offer some exclusive services to these companies while maintaining its profit margin.
In the previous section of this paper, the aspect of the culture of innovation has been discussed, and the importance of it is linked to the people’s aspect of operations. This is because, by definition, innovation involves the application of creativity and thinking beyond what currently exists in an industry (Johnson, Scholes, and Whittington, 2008). This creativity and the focus on developing new products must be an integral part of the values that the employees of the business adhere to and abide by. The second recommendation is for XYZ to reexamine its corporate culture and create an alignment between the vision for innovation and the employees’ views of the strategy and their values. In this way, XYZ will be able to achieve its strategic target of capturing the market share in the niche of the metalwork industry.
Conclusion
In summary, this paper is an assessment of the theories relating to the development of strategy, and it includes recommendations for the XYZ company. Strategy development is an essential component of work for any business, and under Porter’s approach, it requires an assessment of the competition, new entrants, substitutes, and the bargaining power of the suppliers and the customers. There are two common approaches to strategy, which are Porter’s Generic strategies, and these are differentiation or low cost. For XYZ, the existing strategy cannot help this business secure a proper market position, and therefore, it is recommended to change a direction towards differentiation and adopt a culture of innovation.
Reference list
Hamel, G. (1996) ‘Strategy as revolution’, Harvard Business Review, 74(4), pp. 69-82.
Hamel, G. (1998) ‘Strategic innovation and the quest for value’, Sloan Management Review 39(2), pp. 1-10.
Johnson, G., Scholes, K. and Whittington, R. (2008) Exploring corporate strategy text & cases. Prentice Hall.
Nguyen, F. (2018) ‘Reinventing shopping carts.’ Web.
Porter, M. (1980) Competitive strategy. Free Press.
Porter, M. E. (2008) ‘The five competitive forces that shape strategy’, Harvard Business Review, pp. 79-93.
