Introduction Porters 5 Forces has been an essential and common framework used by managers to examine the industry and

business environment thus develop relevant strategies to target the market. It allows managers to oversee the competitiveness and attractiveness of the market based on the five forces of new entrants, suppliers, buyers, threat of substitution, and competition within the industry. However, the model is often criticised as limited by its static nature. structure stable and externally determined (Grant, 2002, p.g. 132). It views industry If analysed in the Operational Thou,

perspective of an operation manager, many loopholes exist in the model.

manager is responsible for the business function that plans, organizes, coordinates, and control resources needed to produce a companys goods and services (Slack, 2006). industry/market). the framework simply concentrates on analysing the external environment (the It has not considered other core aspects of a firms management and Therefore, Porter 5 Forces lack the command of This paper aims to argue insufficiency strategies such as the internal environment.

applied techniques (qualitative and quantitative) that are needed for the complete implementation of strategies by operation managers. of the Porter 5 Forces model by comparing several applied techniques and models that could compensate the elements Porter Five Forces lack for operation managers.

Over concentration of industry/market environment Criticism: Porters Five Forces are based on the economic situation in the eighties, when strong competition, cyclical developments and relatively stable market structures exist (Recklies). Alfred Chandler highlighted the existence of a visible hand from big business amassing resources such as facilities, raw materials, and marketing systems so as to exploit large national markets (Driver, 2011). This partly explains why Porter only analysed Today, the situation has largely For industry/market environment within his model at his time.

transformed, where instability and uncertainties appear to be extremely common, resulting firms to also be significantly affected by the general market and economic conditions. Sainsbury. example, Henry (2008, p.g. 127) provided a comparison example between Tesco and Both firms are operating in an industry with almost identical conditions. Also, economists often believe economic/policy In that case, Porters Five However, one would see a great divergence in profitability betweens the two supermarkets that Porters Five Forces could not explain. cycles have been shorter and shorter post 2008 financial crisis. inefficient for a dynamic market. Even as a simple checklist of issues for managers, Porters Five Forces does not qualify as it has not mentioned any considerations regarding internal management. management is a requirement for successful strategy. the firm. strategies can still fail. managers as well. Alternative/Supplemental Model: Resource-based View, a comparison with Porters Five Forces Resource-based View (RBV) emphasises the internal capabilities of the organisation in formulating strategy to achieve a sustainable competitive advantage in its markets and industries (Henry, 2008, p.g. 126). The RBV instructs operation manager to view their Resource However, resource alone does not company as a pile of resources and capabilities when implementing strategies. refers to the individual resources of the firm such as land. create value. Therefore, capability is a result when resources co-ordinate. It focuses on drafting strategies to target the five forces, but lack the essential idea that effective internal Say advertising attracted demand for If the manager does not control their products costs and brand management, Hence, Porters Five Forces is an insufficient checklist for operation

Forces only guide managers to implement static market-based strategies, which can be

The RBV circulates two aspects regarding strategies implementation: Selecting strategies that exploit a firms key strengths in resources and capabilities. Selecting strategies to develop a firms resources and capabilities, as resource analysis is not just about developing existing resources. It is also concerned (Grant, 2002, p.g. 138) RBV compensates the weaknesses of Porters model by emphasising that strategies should be a result of efficient exploitations from the internal environment. When the external environment is in a state of flux, the firm itself, in terms of its bundle of resources and capabilities, may be a much more stable basis on which to define its identity (Grant, 2002, p.g. 133). Grant also argued that Porters model is a common knowledge that rivals could Furthermore, Porters model lacks any explanation and consideration Therefore, firms may suffer huge losses if operation managers draft RBV, in contrary, suggests RBV helps easily imitate market-based strategies and eliminates any competitive advantage originally enjoyed by the firm. of product life cycle. with filling resources gap and building capability for the future.

strategies solely based on the five forces within the industry.

managers to fully assess its firms internal environment to create strategies. resources/capabilities.

operation managers to oversee their firms strength and weaknesses based on the idea of They are no longer constrained with the dynamic industry They could target specific divisions in their firm and If environment and their strategies could flexibility adapt or even create changes based on their own resources and capabilities. implement actions to exploit or improve resources to enhance organisational capabilities. firms position in the industry.

successful, capabilities would evolve into competitive advantage, which distinguishes the For example, Amazon.com first started as an e-commerce The firm identified their Kindle currently occupies platform that mainly retailed media (books, movies, music). developed the Kindle (e-reader) that utilises all these resources. over half of global e-reader market share. diversify then occupy the e-reader market. managers could lead a firm to fail.

significant book databases, suppliers connections, and brand as its strong resources and Simply using Porters model may maximally In contrary, failure to consider RBV by operation

allow Amazon to survive in the e-commerce industry, but would never have guided it to For example, when typewriters began to be displaced by

microcomputers, Olivetti (office equipment manufacturer) failed from establishing itself in personal computer manufacturing, which has no relation to its possessed resources and

capabilities. Typewriter companies who survived and succeed are those who moved to manufacturing products using similar technical and manufacturing skills: electric shavers and other personal care appliances (Grant, 2002, p.g. 136). declining industry. Porter Five Forces, in this example, is again completely useless as it is unable to guide operation managers to shift In dynamic markets, RBV approach is more effective as operation managers can "focus on those internal factors that organisation can attempt to control, rather than on those external factors (industry environment) that are clearly beyond its control" (Steward Clegg, 2011). Example of RBV practical use: The VRIO framework is a RBV appraisal that guides operation managers to draft corresponding strategies to the firms resources/capacities by assessing their nature using four elements namely Value, Rarity, Imitability, Organisation.

Table 1: VRIO framework by Barney and Hesterly (2006, p.g. 70)

Summary of VRIO, Competitive Implications, and Economic Implications Valuable? No Yes No Rare? Costly Imitate? to Organized Properly? No Competitive Implications Disadvantage Parity Temporary Advantage Yes Sustained Advantage Economic Implications Below Normal Normal Above Normal (at least for some amount of time) Above Normal

Yes

Yes

No

Yes

Yes

Yes

The framework implicates four levels of competitiveness for a firms resource/capacity. Competitive Disadvantage: Using this resource places the firm in a disadvantaged position, as there are no benefits to distinguish the firm while costing the firm. (Barney and Hesterly, 2006, p.g. 71). Competitive Parity: If the firms resource/capacity is valuable but not rare, it does not generate any competitive advantages. However, as rivals are highly likely to possess it as Hence, operation well, this resource/capacity represents a requirement for the firm. managers still have to utilise them to maintain the firms competitiveness. Temporary Competitive Advantage: If the firms resource/capacity is valuable, rare, but not costly to imitate, it represents exploitation creates temporary competitive advantage for the firm. It is a competitive advantage because few rivals in the industry possess the Thou, it is temporary as it is not costly resource/capacity in the short run and the first moving firm can earn above-normal economic performance (Barney and Hesterly, 2006, p.g. 71). to imitate it thus in the long run rivals are likely to possess as well. Sustained Competitive Advantage: If the firms resource/capacity is valuable, rare, and costly to imitate, it suggests exploiting the resource/capacity will create sustained competitive advantage for the firm. Even if rival firms are able to acquire or develop the resource As a result, the /capability, the high costs of doing so put them at a competitive disadvantage compared to the firm that has first mover advantage (Barney and Hesterly, 2006, p.g. 72). able to possess it without bearing significant costs. Porters model believes competitive imperfections exist within the industry, therefore suggesting firms to tackle them for opportunities and superior returns. advantages with resources/capabilities. growth. On the other hand, RBV argued that firms should create market imperfections by establishing competitive Today, Porters Five Forces usefulness is challenged, as business environment is dramatic from factors such as exponential technology It is true that the models simplistic nature provides a snapshot for managers to However, in order to survive and advance, the Five Forces evaluate industry environment. loopholes. firm that utilises the resource/capacity obtains abnormal profit in the long run as no firms are Operation managers will either fix this weakness or avoid using it when selecting and implementing strategies

is completely insufficient for operation managers and RBT is one model to compensate major

Lack of quantitative evidences Criticism Porters Five Forces is a purely qualitative tool without numerical support. environment and implement strategies. Therefore, it will be insufficient for operation manager who require quantitative analysis to manage the internal For example, although one may understand through the Five Forces model that its firm has strong bargaining power with suppliers, he/she must require accounting figures such as Inventory-turnover days to plan supply-chain management. Hence, Porter Five Forces has an over qualitative focus without any balance of quantitative analysis in strategies. The following section presents two models that not only compensate the quantitative element of Porters model, but also fulfil other weaknesses of the model. Alternative/Supplemental Model: Sensitivity Analysis, a comparison with Porters Five Forces Sensitivity Analysis is a way of assessing the risk of an investment project by evaluating how responsive the NPV of the project is to changes in the variables from which it has been calculated (Watson and Head, 2010, p.g. 199). It is a simple yet straightforward method to As Porter Five Forces assess display a risk outlook for operation managers numerically.

risks in a qualitative way such as asking users the threat of new entrants/substitutes, sensitivity analysis additional provides users the numbers to back up the qualitative analysis. For example, a building company may have discovered from the Five Forces model that they have a high threat from suppliers, as materials are scarce. Operation managers could Sensitivity conduct a sensitivity analysis on their projects variable costs to further assess their risks level and implement corresponding actions to monitor and control specific variables. as factors of production fluctuate dramatically. analysis also stands to be an efficient tool in uncertain market situations where variables such While Porter Five Forces do not inform managers any information regarding the internal environment, sensitivity analysis can indicate to managers "variables that turn out to be particularly sensitive thus re-examined them carefully before a strategy is accepted" (Richard Lynch, 2008). existences within departments. The quantitative analysis could also provide a checklist of issues so managers have a precise idea of their Sensitivity analysis exists in numerous forms such as This section will analysing variables' impacts on return on capital employed or cash flow. a project and examine the change needed in them to make NPV 0. rate.

concentrate on the Net Present Value (NPV) sensitivity analysis, which identifies variables of NPV is a common way in accounting/finance to display a project's cash flow over its lifetime taken account of discount

The following section demonstrates the procedures of NPV sensitivity analysis. of 3 years.

Assume a

firms cost of capital is 7% and is planning to invest 5 million pound on a machine with a life The product produced from the machine is sold for 20 pounds each and the cost The demand is expected to be 500 000 units each year. To conduct a is 16 pounds.

sensitivity analysis, the operation manager will first calculate the net present value (NPV). The formula for NPV is:

NPV = Initial Investment + (Profit each unit x Demand x Cumulative Present Value Factor (7% for 3 years)) NPV = -5 000 000 + (4.00 x 500 000 x 2.624) = 248 000
Once the NPV is obtained, operation managers can conduct sensitivity analysis by calculating the change in each variable that could potentially costs NPV to be 0. Initial Investment:

100 x

NPV 248 000 = 100 x = 49.6% Initial Investment 5 000 000

The NPV of the project will become zero if initial investment increases by 49.6%. Sales Price:

100 x

NPV 248 000 248 000 = 100 x = 100 x = 0.945% Total Revenue 20.00 x 500 000 x 2.624 26 240 000

A 0.945% fall in sales price will cause the NPV of the project to become 0, so the selling price that makes NPV zero is 19.811. Variable Cost: A decrease of 0.189 in price has the same effect of an increase of 0.189 in variable costs. Hence, variable costs of 16.189 will cause the NPV of the project to become 0.

Demand (Sales Volume):

100 x

NPV 248 000 248 000 = 100 x = 100 x = 4.726% Total Profit 4.00 x 500 000 x 2.624 5 248 000

A 4.726% fall in demand will cause the NPV of the project to become 0, so the demand that makes NPV zero is 500 000 x (1 0.04726) = 476370 units. Project Discount Rate:

Set NPV = 0 and CPVF as unknown

- 5 000 000 + (4.00 x 500 000 x CPVF) = 0

2000000CPVF = 5000000 CPVF = 2.5
2.5 on the CPVF table corresponds to a discount rate of almost 10%. This means a 42.9%

increase of cost of capital (from 7% to 10%) will cause the NPV of the project zero. After calculations, operation managers should summarise the numbers on a table such as the following.
Variable Selling Price per unit Demand (Sales Volume) Variable Cost per unit Initial Investment Project Discount rate Change to make NPV zero -0.945 -4.726% +1.18% +49.6% +42.9% Sensitivity Very High High Very High Very Low Very Low

As one can see, the variables Selling Price per unit and Variable Cost per unit are extremely sensitive to reduce the projects NPV to 0. Sensitivity analysis provides operation managers the knowledge of risks thus they can monitor these variables closely by attempting to control internal environment such as production efficiency.

Alternative/Supplemental Model: Real Options Valuation, a comparison with Porters Five Forces Real Options Valuation (ROV) originated from financial options valuation. investments by firms that embodied flexibility (Grant, 2002, p.g. 49). predicted cash flow. Thou, researchers showed that the same principles could be used to value real options - capital It requires operation managers to break projects into different parts thereby evaluating it separately based on its Real options models are based on the assumption that there is an underlying source of uncertainty, such as the price of a commodity or the outcome of a research project. Overtime, the outcome of the underlying uncertainty is revealed (Bowmon, 2001), and managers can implement corresponding strategies to execution/abandon/hold in different initial stages. unpredictable climate. Luehrman (1998) proposed an interesting illustration of ROV. Some are edible now but would benefit from more time. Farmers Managing a portfolio of strategic options is like growing a garden of tomatoes in an pick them early only if squirrels/other competitors are likely to get them. be picked. projects. ROV exists to be another quantitative appraisal that operation manager depends upon when implementing strategies. As mentioned above, Porters Five Forces assumes stable markets The model excludes and lacks any consideration on uncertainty in its framework. initiate or not. Others are not yet

edible, but if there is enough time left in the season, many will ripen unharmed and eventually This presentation proves why managers would desire flexibility in their

flexibilities in their strategies, giving an insufficient mono perspective for managers to either In reality, since firms are often faced with uncertainties, it is essential to It may be more explore different options such as time-delay during strategy implementation. equipped with good knowledge.

profitable if the project waits for year until market uncertainties are resolved and manager is Therefore, although ROV does not formulate strategies, it compensates the insufficiency of flexibility and uncertainty in Porters model, guiding managers out a dilemma to execute, abandon, or hold strategies in dynamic market conditions. The core idea of ROV is to compare and select the most profitable decision for the firm out of all options. The following is an example of ROV using the decision tree method. Assume a project requires an initial investment of $5000 with a discount rate of 10%. for the first year (t=0) and expected price of output each year will be $800. Its revenue (p) Thou, for the

following years, revenue have a 50/50 probability to be $500 or $1000 and the manager

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would only know a year ahead.

Since the operation manager is faced with such decision

dilemma with estimations provided, he can apply ROV to guide his decision.

Po = 500 Po = 800 Po = 1000

Po = 500

Po = 1000

The operation manager will make two economic net present value (ENPV) calculations to valuate the options to invest or delay the project. ENPV, in simple, is to estimate the projects potential of best, most likely, and worst case using probabilities of different options. ENPV of the project if invest now Assume the manager invests the project now; the manager knows the firm will obtain $800 for sure in year 1 but prices in the future are unknown. perpetuity term is: Hence, the ENPV for the project in

ENPV = 6454.6
ENPV = 5000 + 800 + 800 0.1

ENPV = 3800

ENPV of the project if delay one year Assume the manager delay the project for a year; there will be flexibility as the operation manager can examine the market condition for a year and determine whether it is possible to earn the maximal profit of $1000. perpetuity term is: Hence, the ENPV for delaying the project one year in

ENPV = probability(initial investment+ + probability (revenue of not investing)

Cash (Revenue) + Known Revenue of Yr 1) Discount Rate

ENPV = 0.5(4545.4 +
ENPV = 6454.6

1000 +1000) + 0.5 (0) 0.1

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Note that the initial investment ($5000) is discounted to $4545.4 because the value of money has decreased over a year. We take probability into account as delaying the project a year allows the operation manager to acknowledge the optimal profitability of the project. Therefore, there is a probability of 50% that he will invest if revenue is $1000 and another 50% that he wont invest if revenue is $500. As shown above, the ENPV of delaying the project a year ($6454.6) is much higher than investing now ($3800). Hence, ROV guides the operation manager to choose the option that is more likely to yield higher revenue. It assists managers in the process of strategy implementation by examining Porter Five Forces, on the other hand, is when and what to do using options valuation. details or guidance regarding time and flexibility.

insufficient alone as it only informs users what strategy to implement without any specific

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Conclusion Porters Five Forces presents itself as a quick and easy tool for one to understand core market environment base on exploring the five forces. is inadequate. However, to be a model that completely informs operation manager regarding issues and strategies formulations/implementations, it Firstly, Porters Five Forces is statically concerned with the external market Secondly, its extreme environment without any guidance on internal management. issue/strategy should be targeted and implemented.

qualitative nature does not inform figures regarding internal management and how each Therefore, in order to enhance the firms efficiency and competitiveness, it is reasonable to conclude that operation managers must require other frameworks such as RBV, sensitivity analysis, and ROV to compensate and fulfil Porters Five Forces weaknesses.

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