Manufacturing

Strategy

Unit 2

Porters Model
and the Value
Chain

Manufacturing Strategy: Unit 2 –Porters Model and the Value Chain 2-1
November 2013
Contents

Overview
Learning Outcomes

Manufacturing as a Value Adding Process

The Value Chain
Value Chain Linkages
How the Value Chain can help a company’s competitive
advantage
The Value System
E-Commerce and the Value Chain

Porter’s Model and the Nature of Industrial Competition

The Five Forces Model
Use of Five Forces Analysis
Influencing the Power of the Five Forces
Critique of the Five Forces Model

Porter’s Diamond Model of National Competition

Factor Conditions
Demand Conditions
Related and Supporting Industries
Firm Strategy, Structure and Rivalry
The Diamond as a System
Implications for Governments

Conclusion

2-2 Manufacturing Strategy:Unit 2- Porters Model and the Value Chain

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Overview
This Unit starts with a description of the Value Chain, a concept developed
by Michael Porter, a Professor at Harvard Business School, for use in the
analysis of how individual activities in an organisation can add to (or
subtract from) a company’s competitive advantage. Individual activities are
classified in a number of ways, and the importance of linkages between
activities is stressed, as is the need to take a systems-wide perspective of
activities along the whole length of a supply chain. The extension of the
Value Chain concept from physical materials to information is also
examined.

Porter's Five Forces model is next examined. This provides a framework for
analysing the forces that determine the nature of industrial competition, for
analysing the attractiveness or otherwise of getting into a new industry and
how a company can best manage the forces for competitive advantage.
Since the Five Forces model was conceptualised over 20 years ago, current
criticisms of the model in the light of today’s changing environment are
examined.

Finally an extension of Porter’s thinking is examined in terms of a

framework he has developed for analysing the competitive advantage of
nations, and the steps that governments can take to ensure that a particular
country can become globally competitive.

Learning outcomes
After studying this unit you should be able to:

 explain manufacturing as a value adding process, and how the concept

of the value chain is useful for classifying the various activities which
are part of this process
 understand how that Value Chain concept can be extended to cover the
flow and value of information and information processes as opposed to
mere physical materials
 apply Porter's model to industry of your choice to understand the nature
of the forces that determine industry profitability
 discuss the main criticisms that have been recently raised in terms of the
validity of Porter’s model in today’s environment, and the extent to
which they are justified
 understand the concept of Porter’s Diamond Model for analysing the
competitive advantage of nations

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Manufacturing as a value
adding process

Manufacturing is concerned with the process of adding value to raw

materials by converting them to finished products which are worth more to
customers than the unprocessed materials, and which can therefore be sold
at a higher price. The profit to the manufacturer is the revenue from goods
sold, less the cost of raw materials and the cost of adding value to these raw
materials through the conversion process.

The Value Chain

Figure 2.1 The value chain

Within any manufacturing company, there will be many different types of

activity that add value to the product, either directly or indirectly. The
company is a collection of activities that are performed to design, produce,
market, deliver and support the product. These activities may be represented
by a construct called the 'value chain', first formulated by Harvard Business
School academic Michael Porter in his book “Competitive Advantage”
(Porter, 1985). Figure 2.1 shows the basic value chain for a typical firm.
The diagram shows the steps in the value adding process and how they are
linked together.

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The goal of these activities is to offer the customer a level of value that
exceeds the cost of the activities, thereby resulting in a profit margin.
The primary value chain activities are:

 Inbound Logistics: the receiving and warehousing of raw materials

and their distribution to manufacturing as they are required.
 Operations: the processes of transforming inputs into finished
products and services.
 Outbound Logistics: the warehousing and distribution of finished
goods.
 Marketing & Sales: the identification of customer needs and the
generation of sales.
 Service: the support of customers after the products and services are
sold to them.

The primary activities are the most obvious value adding activities because
they are part of the physical process of converting raw materials into
saleable product, the physical logistics of ensuring a flow of materials
through the factory and out to customers, and the sales and marketing
activities involved in making customers aware of the products the firm is
selling.

These primary activities are supported by:

 The infrastructure of the firm: organizational structure, control

systems, company culture, etc.
 Human resource management: employee recruiting, hiring, training,
development, and compensation.
 Technology development: technologies to support value-creating
activities.
 Procurement: purchasing inputs such as materials, supplies, and
equipment.
The support activities are those remaining organisational activities that do
not add value to the product, but which nevertheless are important because
they provide the necessary reinforcement or assistance which allow the
primary activities to function smoothly over time and to increase the degree
of competitiveness of the operation. Typical support activities are the
procurement of purchased materials or other resources, the development of
new technologies or new information systems, payroll administration,
maintenance of the companies’ buildings etc

The firm's margin or profit then depends on its effectiveness in performing

these activities efficiently, so that the amount that the customer is willing to
pay for the products exceeds the cost of the activities in the value chain. It is
in these activities that a firm has the opportunity to generate superior value.

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A competitive advantage may be achieved by reconfiguring the value chain
to provide lower cost or better differentiation.

Porter also identifies three activity sub-types that may be present in either
primary or support activities. These are:

1. Direct activities which are directly concerned with the performance

of a particular function that directly adds value to the product (e.g.
product design, fabrication, assembly etc.)

2. Indirect activities that make it possible to perform direct activities on

a continuing basis, such as production scheduling, financial
administration etc.

3. Quality Assurance activities which ensure the quality and

conformance to standards of other activities and may include
inspection, testing and rework.

These three types of activity are present in both primary and support
activities.

Example: The physical machining of a part is a direct primary activity as it

adds value directly to the product, whereas the setting up of a machine is an
indirect primary activity as it does not directly add value. Similarly, product
design is a direct support activity which directly adds value to the product,
whereas the administration of the design department is an indirect support
activity.

Exercise 2.1

List some specific primary and support activities within your organisation or
one that is familiar to you and categorise them into the types listed above by
ticking the appropriate box:

Activity Primary Support Direct Indirect QA

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Value chain linkages
A company can only remain in business by developing and maintaining
some sort of advantage over its competitors, and an effective form of
advantage can often come from so-called value chain linkages, particularly
since these usually tend to be hidden from competitors.

The value chain is not a set of independent activities but rather a system of
linked interdependent activities. The way in which one activity is performed
can affect the cost or efficiency of other activities. For example, purchase of
superior raw materials can result in reduced scrap in fabrication.
Advertising and promotional campaigns can be timed to link with periods of
spare production capacity. Purchasing of raw materials should be linked to
the requirements for them, generated by the production plan, so as not to
result in shortages or excess stocks. Effective linkages in the value chain
are the result of good co-ordination and communication between different
activities.

How the value chain can help a

company's competitive advantage
While firms within a particular industry will have similar value chains, there
will be important differences reflecting the individual firm's history,
strategy, its management style and so on. These differences can represent
important sources of competitive advantage, and an analysis of an
organisation's value chain can assist in identifying them. For example, firms
placing emphasis on improving the 'service' section of the value chain will
be competing differently to those emphasising the 'operations' section.
Depending on the nature of the industry, any one of the value chain
activities may provide an advantage if it can be carried out more cost
effectively or in a superior manner compared with competitors. For example
outbound logistics is important for consumer products (product has to be
available at as many outlets as possible), less so for mainframe computers.

To achieve effective coordination across linkages requires effective

information flow. In fact, information systems are frequently the basis on
which competitive advantage is achieved from linkage. For example, within
a particular company's value chain, competitive advantage can be gained by
effectively integrating the design and manufacturing systems through the
development and installation of a CAD/CAM system. In fact, the effort to
achieve an integrated CAD/CAM systems is a recognition of the value of
exploiting the linkage between design and manufacturing to reduce time to
market, and to facilitate better product design and manufacturing

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Support activities are also a potential source of competitive advantage.
Organisational policies that emphasise flexibility, teamwork and lateral
communication should generally ensure that an organisation can adapt to
changes in the market place faster than its competitors. However the
implementation of these policies may require continuous effort by the
human resources department – a support activity. Developing new products
based on new technology is an obvious source of competitive advantage, but
so is less obvious applications such as the use of information technology for
sales order placement on the customer's premises.

The Value System

Competitive advantage depends not only on the value chain of your
organisation but also on the value chain of your customers. An
understanding of your customer's value chain allows you to ensure a proper
fit with your own value chain and to identify unique customer requirements
and how they can be better satisfied by appropriate inter-organisational
linkages with your own value chain, in a way that will enable your company
to differentiate itself from your competitors.
A firm's value chain is part of a larger system that includes the value chains
of upstream suppliers and downstream channels and customers. Porter calls
this series of value chains the value system, shown conceptually below:

Supplier Firm Channel Buyer

... > > > >
Value Chain Value Chain Value Chain Value Chain

Figure 2.2 The Value System

Linkages exist not only in a firm's value chain, but also between value
chains. While a firm exhibiting a high degree of integration with customers
and suppliers is poised to better coordinate upstream and downstream
activities, a firm having a lesser degree of such integration nonetheless can
forge agreements with suppliers and channel partners to achieve better
coordination. For example, an auto manufacturer may have its suppliers set
up facilities in close proximity in order to minimize transport costs and
reduce parts inventories. Clearly, a firm's success in developing and
sustaining a competitive advantage depends not only on its own value chain,
but on its ability to manage the value system of which it is a part

Example: You discover that a customer's value chain focuses on timely

delivery to that company's own customers as its source of competitive
advantage. Reliability of supply to that particular customer would clearly
represent a better fit to that customer's value chain than would a lower cost
product supplied at unpredictable times.
In summary, every activity that occurs in a firm should be captured and
placed in its appropriate position in the value chain. Questions can then be

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asked such as “in what way is this particular activity adding value to the
product?” or “how could this activity be redefined or redesigned in such a
way as to become a greater source of competitive advantage?”

Exercise 2.2

1. Try and think of two unexploited value chain linkages (or potential
linkages) that exist in your organisation or one that is familiar to
you, and which could be used as a source of competitive advantage.
Pay particular attention to those linkages that relate to companies
(suppliers or customers) that are up or down-stream in the supply
chain. Make notes on these linkages in the space below:

2. Try and think of one way in which the value chain of your own
organisation could better support the value chain of one of your
important customers (you will need to carefully consider the nature
of your customer’s value chain, and the potential points of linkage
with your own value chain). Make notes in the space below:

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E-Commerce and the Value Chain
In recent years, with the emergence of E-Commerce, the application of the
value chain model to the information systems field has been extended to
incorporate the concept of a “virtual” value chain. The virtual value chain
concept underlies many of the changes in business associated with E-
Commerce. In a virtual value chain, value may be created not only through
a physical value chain involving the creation of physical goods, but may
also be created with information. For example, numerous companies
presently use the Internet as a means to provide sales and service
information to their customers and thereby enhance customer relationships.
Ongoing advances in technology have resulted in significant changes to
organizational value chains and have forced businesses to implement new
ways of doing business. For many organizations, success in the age of E-
Commerce depends on management’s ability to recognize the role of
information technology on the value chain and modify their value chain to
exploit the opportunities afforded by technology. The importance of the
value chain concept to E-Commerce was recently underscored by a special
issue of CIO magazine that published a list of companies that were the top
100 practitioners of value chain management.

Reading 2.1

Stop now and read: “Electronic Markets and Virtual Value Chains on the
Information Superhighway” by, Benjamin, Robert, Wigand, Rolf., Sloan
Management Review. Cambridge: Winter 1995. Vol. 36, Iss. 2; pg. 62,

Exercise 2.3

The above reading was written in 1995 before the full implications of the
“information superhighway” and in Internet had become apparent. To what
extent do you think the issues raised in the article, are still valid, and what
(if any) new issues have arisen? Is analysis in terms of the Value Chain still
appropriate? Make notes in the space below.

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Porter’s Model and the nature
of industrial competition
A number of conceptual frameworks have been developed for the systematic
description and analysis of competition and competitiveness, the most well-
known of which is due to Michael Porter and is generally termed “Porter’s
model”. Use of Porter’s model requires an appreciation of the fact that any
particular manufacturing company will only perform a relatively limited
number of the conversion stages between primary raw materials (e.g.
minerals extracted from the ground) and consumer products (e.g. cars or
washing machines). and will in fact be part of a much larger “manufacturing
network” in which each organization in the network act as customers and
suppliers of each other as shown in Figure 2.3

Figure 2.3 A Manufacturing Network

Groups of organisations within this network which deal with similar types
of product or raw material may be grouped together in industries. Within a
particular industry there may thus be many competitors for market share.
Also, the customer-supplier relationships operating between organizations
in different industries means that the activities and performance of any
single organization cannot be analysed in isolation but only in the context of
the organization's position in this network.

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Porter’s model is based on the insight that a corporate strategy should meet
the opportunities and threats in the organizations external environment.
Especially, competitive strategy should base on and understanding of
industry structures and the way they change.

Porter has identified five competitive forces that shape every industry and
every market. These forces determine the intensity of competition and hence
the profitability and attractiveness of an industry. The objective of corporate
strategy should be to modify these competitive forces in a way that
improves the position of the organization. Porter’s model supports analysis
of the driving forces in an industry. Based on the information derived from
the Five Forces Analysis, management can decide how to influence or to
exploit particular characteristics of their industry.

The Five Forces Model

Porter’ five forces are shown diagrammatically in Fig. 2.4.

Figure 2.4 Porter’s Five Forces

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The five forces depicted in the model determine the profitability of the
industry because together they influence prices, costs and the amount of
investment necessary. Their relative influence may vary over time.

Bargaining Power of Suppliers

The term 'suppliers' comprises all sources for inputs that are needed in order
to provide goods or services.
Supplier bargaining power is likely to be high when:

 The market is dominated by a few large suppliers rather than a

fragmented source of supply,
 There are no substitutes for the particular input,
 The suppliers customers are fragmented, so their bargaining power is
low,
 The switching costs from one supplier to another are high,
 There is the possibility of the supplier integrating forwards in order to
obtain higher prices and margins. This threat is especially high when
 The buying industry has a higher profitability than the supplying
industry,
 Forward integration provides economies of scale for the supplier,
 The buying industry hinders the supplying industry in their development
(e.g. reluctance to accept new releases of products),
 The buying industry has low barriers to entry.

In such situations, the buying industry often faces a high pressure on

margins from their suppliers. The relationship to powerful suppliers can
potentially reduce strategic options for the organization.

Bargaining Power of Customers

Similarly, the bargaining power of customers determines how much
customers can impose pressure on margins and volumes.
Customers bargaining power is likely to be high when

 They buy large volumes, there is a concentration of buyers,

 The supplying industry comprises a large number of small operators
 The supplying industry operates with high fixed costs,
 The product is undifferentiated and can be replaces by substitutes,
 Switching to an alternative product is relatively simple and is not related
to high costs,
 Customers have low margins and are price-sensitive,
 Customers could produce the product themselves,
 The product is not of strategical importance for the customer,
 The customer knows about the production costs of the product
 There is the possibility for the customer integrating backwards.

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Threat of New Entrants

The competition in an industry will be the higher, the easier it is for other
companies to enter this industry. In such a situation, new entrants could
change major determinants of the market environment (e.g. market shares,
prices, customer loyalty) at any time. There is always a latent pressure for
reaction and adjustment for existing players in this industry.
The threat of new entries will depend on the extent to which there are
barriers to entry. These are typically

 Economies of scale (minimum size requirements for profitable

operations),
 High initial investments and fixed costs,
 Cost advantages of existing players due to experience curve effects of
operation with fully depreciated assets,
 Brand loyalty of customers
 Protected intellectual property like patents, licenses etc,
 Scarcity of important resources, e.g. qualified expert staff
 Access to raw materials is controlled by existing players,
 Distribution channels are controlled by existing players,
 Existing players have close customer relations, e.g. from long-term
service contracts,
 High switching costs for customers
 Legislation and government action

Threat of Substitutes
A threat from substitutes exists if there are alternative products with lower
prices of better performance parameters for the same purpose. They could
potentially attract a significant proportion of market volume and hence
reduce the potential sales volume for existing players. This category also
relates to complementary products. Similarly to the threat of new entrants,
the treat of substitutes is determined by factors like

 Brand loyalty of customers,

 Close customer relationships,
 Switching costs for customers,
 The relative price for performance of substitutes,
 Current trends.

Competitive Rivalry between Existing Players

This force describes the intensity of competition between existing players
(companies) in an industry. High competitive pressure results in pressure on
prices, margins, and hence, on profitability for every single company in the
industry. Competition between existing players is likely to be high when

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 There are many players of about the same size,
 Players have similar strategies
 There is not much differentiation between players and their products,
hence, there is much price competition
 Low market growth rates (growth of a particular company is possible
only at the expense of a competitor),
 Barriers for exit are high (e.g. expensive and highly specialized
equipment).
Much has been written about Porter’s model since Porter’s 1980 book
“Competitive Advantage” and it has virtually become a universally
employed framework for competitive analysis.

Exercise 2.4

For an industry with which you are familiar, answer the following
questions:

1. Who are the main customer groups (or potential customer groups)
within the industry? In what ways might they use their influence?

2. Who are the major suppliers or supplier groups? In what ways might
they use their influence?

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 3. Who are the principle competitors within the industry?

4. Indicate any current or potential substitute products that might fulfil

the same basic function as the principal products or services of the
industry you are considering, but are (or would be) produced in a
different industry.

5. Indicate any barriers that might exist to companies attempting to

enter the industry.

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 6. From a consideration of your answers to the previous five questions,
indicate what you think that would be the approximate strength on a
scale of zero to ten of each of the five forces of Porter’s model.

Bargaining power of customers

0 10
Bargaining power of suppliers
0 10
Intensity of existing competition
0 10
Threat of substitute products
0 10
Threat of new entrants
0 10

7. What useful conclusions (if any) can you draw from this exercise?

You should notice that Porter’s model should generally be applied to

industries rather than to specific organisations, and that industries should
not be defined in terms that are too broad, or the application of Porter’s
model is unlikely to bring any particularly illuminating insights. For
example, in attempting to apply Porter’s model to the automotive industry,
one might identify many different groups of both customers and suppliers,
each with their own different degrees of bargaining power. Intensity of
competition might be very different in different sections of the industry, as
might be the threat of new entrants and substitute products. To apply the
model to the industry as a whole would involve making such broad
generalisations, as to be virtually useless. The correct approach in this case
would be to attempt to identify subgroups of the industry for which each of
the five forces were relatively homogeneous and apply the model for each
of these subgroups separately.

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Exercise 2.5

1. For the case of the automotive industry, identify two sub industries
to which Porter's model might be applied.

2. For each sub industry indicate the relative strengths of the five
forces of Porter's model in the table below

Force Strength - Sub Industry 1 Strength - Sub Industry 2

Power of Customers

Power of Suppliers

Intensity of existing rivalry

Threat of new entrants

Threat of Substitute Products

Use of Five Forces Analysis

Now you have seen how the five forces operate in different industries, you
may be asking "What now? How can we change our situation?' An
organisation often does not usually have unrestricted choice as to the
industry in which it operates. Most firms, particularly those in capital
intensive industries (e.g. steelmaking), have made a big investment in
technology and human expertise. This can mean prohibitively high
'switching costs' if they wish to make a short-term change of industry. Long-
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term industry changes are possible, and in many cases essential, in order to
get out of industries in decline (e.g. a change from manufacture of records to
manufacture of compact discs). However, in the shorter term, most
organisations do not have the option to change.

Porter does not provide any prescriptive advice on what an organisation

should do about the five forces once it has identified them. The model is
descriptive only. The ability to make the best of your company's situation
can be improved, however, by:
 understanding how the five forces work;
 attempting to minimise their effects; or
 managing them to your advantage rather than merely being at their
mercy.
The ability to manage or to protect yourself against these forces more
effectively than your competitors can be an important source of competitive
advantage.
More specifically, Five Forces Analysis can provide valuable information
for three aspects of corporate planning:

Statical Analysis:

The Five Forces Analysis allows determining the attractiveness of an

industry. It provides insights on profitability. Thus, it supports decisions
about entry to or exit from and industry or a market segment. Moreover, the
model can be used to compare the impact of competitive forces on the own
organization with their impact on competitors. Competitors may have
different options to react to changes in competitive forces from their
different resources and competences. This may influence the structure of the
whole industry.

Dynamical Analysis:

Five Forces Analysis can also reveal insights about the potential future
attractiveness of the industry. Expected political, economical, socio-
demographical and technological changes can influence the five competitive
forces and thus have impact on industry structures.
.
Analysis of Options:

With the knowledge about intensity and power of competitive forces,

organizations can develop options to influence them in a way that improves
their own competitive position. The result could be a new strategic
direction, e.g. a new positioning, differentiation for competitive products of
strategic partnerships etc.

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Influencing the Power of Five Forces
After the analysis of current and potential future state of the five
competitive forces, managers can search for options to influence these
forces in their organization’s interest. Although industry-specific business
models will limit options, the own strategy can change the impact of
competitive forces on the organization. The objective is to reduce the power
of competitive forces.

Typical ways in which the five forces may be reduced are:

Reducing the Bargaining Power of Suppliers

 Partnering
 Supply chain management
 Supply chain training
 Increase dependency
 Build knowledge of supplier costs and methods
 Take over a supplier

Reducing the Bargaining Power of Customers

 Partnering
 Supply chain management
 Increase loyalty
 Increase incentives and value added
 Move purchase decision away from price
 Cut out powerful intermediaries (go directly to customer)

Reducing the Treat of New Entrants

 Increase minimum efficient scales of operations

 Create a marketing / brand image (loyalty as a barrier)
 Patents, protection of intellectual property
 Alliances with linked products / services
 Tie up with suppliers
 Tie up with distributors
 Retaliation tactics

Reducing the Threat of Substitutes

 Legal actions
 Increase switching costs
 Alliances

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 Customer surveys to learn about their preferences
 Enter substitute market and influence from within
 Accentuate differences (real or perceived)

Reducing the Competitive Rivalry between Existing Players

 Avoid price competition

 Make your product different
 Buy out competition
 Reduce industry over-capacity
 Focus on different segments
 Communicate with competitors

Example: In the pharmaceutical industry one manufacturer reduced the

power of wholesalers by deciding to distribute direct to many pharmacies -
a decision with significant cost, service and production management
systems implications. Another approach would be to reposition the firm to
defend itself against negative forces by acquiring key supply or distribution
businesses. A further alternative might be to predict or anticipate the
significant shifts in the forces and deliberately exploit them in order to gain
an advantage. Swiss watch makers, having suffered a decline with the
introduction of digital watches have made a comeback through the
introduction of high value added 'dress watches' - a situation made possible
because digital watches became so cheap.

Exercise 2.6

For one of the examples chosen for the automotive industry in Exercise 5,
identify ways in which the stronger forces might be reduced

Critique of the Five Forces Model

Porter’s model of Five Competitive Forces has been criticised on a number
of counts. Its main weakness results from the historical context in which it
was developed. In the early eighties, the global economy experienced
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cyclical growth and primary corporate objectives consisted of profitability
and survival. A major prerequisite for achieving these objectives was the
optimization of strategy in relation to the external environment. At that
time, development in most industries was fairly stable and predictable,
compared with today’s turbulence.

In general, the meaningfulness of this model is reduced by the following

factors:

1. The model assumes a classic perfect market, in the economic sense. The
more an industry is regulated, the less meaningful insights the model can
deliver.

2. The model is best applicable for analysis of simple market structures. A

comprehensive description and analysis of all five forces gets very
difficult in complex industries with multiple interrelations, product
groups, by-products and segments. A too narrow focus on particular
segments of such industries, however, bears the risk of missing
important elements.

3. The model assumes relatively static market structures. This is hardly the
case in today’s dynamic markets. Technological breakthroughs and
dynamic market entrants from start-ups or other industries may
completely change business models, entry barriers and relationships
along the supply chain within short times. The Five Forces model may
have some use for later analysis of the new situation; but it will hardly
provide much meaningful advice for preventive actions.

4. The model is based on the idea of competition. It assumes that

companies try to achieve competitive advantages over other players in
the markets as well as over suppliers or customers. With this focus, it
does not really take into consideration strategies like strategic alliances,
electronic linking of information systems of all companies along a value
chain, virtual enterprise-networks or others.

5. While Porter's five forces provide an excellent basis for viewing the
internal dynamics of an industry, they do not include environmental
forces external to the industry. External forces are:

Economic: the national economic situation within a particular country

Legal: current or future legislation which might affect the firm's

activities

Technological: this force is particularly potent because new technology

can render a product obsolete within a very short time

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 Social: changes in the way individuals and communities carry out their
activities and the values and beliefs they hold
Global: increasingly significant due to the rise of international trade and
competition

Overall, Porters Five Forces Model has some major limitations in today’s
market environment. It is not able to take into account new business models
and the dynamics of markets. The value of Porters model is more that it
enables managers to think about the current situation of their industry in a
structured, easy-to-understand way – as a starting point for further analysis.

In spite of these criticisms, Porters model of Five Competitive Forces

nevertheless allows a systematic analysis of market structure and
competitive situation. The model can be applied to particular companies,
market segments, industries or regions. It is always necessary to determine
the scope of the market to be analyzed in a first step after which all relevant
forces for this market are identified and analyzed. However it is not
necessary to analyze all elements of all competitive forces with the same
depth.

The five forces govern the 'rules' by which organisations may compete.
Understanding them will help in the development of an appropriate strategy
for a business. The business strategy describes how the organisation will
compete given the realities of the market and the forces affecting it. In turn
this will influence the choice and application of particular systems of
production management. The link between the forces in a particular industry
and the choice of production management system in a given organisation is
the manufacturing strategy. The manufacturing strategy, which should be
designed to support the business strategy, will then provide the framework
on which decisions on which more detailed manufacturing management
systems may be based.

Reading 2.2

Stop now and read: “Beyond Porter” by Larry Downes, Context Magazine,
Fall, 1997
Reading 2.3

Now read: “Beyond Porter – a Critique of the Critique of Porter”, by

Dagmar Recklies

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Porters Diamond Model of
National Competitive
Advantage
According to Porter, a nation attains a competitive advantage if its firms are
competitive. Firms become competitive through innovation. Innovation can
include technical improvements to the product or to the production process.

Four attributes of a nation comprises “Porter’s Diamond” model of national

advantage. They are:

 factor conditions (i.e. the nation's position in factors of production,

such as skilled labour and infrastructure),
 demand conditions (i.e. sophisticated customers in home market),
 related and supporting industries, and
 firm strategy, structure and rivalry (i.e. conditions for organization
of companies, and the nature of domestic rivalry).

Factor Conditions
Factor conditions refers to inputs used as factors of production - such as
labour, land, natural resources, capital and infrastructure. This is similar to
standard economic theory, but Porter argues that the "key" factors of
production (or specialized factors) are created, not inherited. Specialized
factors of production are skilled labour, capital and infrastructure.
"Non-key" factors or general use factors, such as unskilled labour and raw
materials, can be obtained by any company and, hence, do not generate
sustainable competitive advantage. However, specialized factors involve
heavy, sustained investment. They are more difficult to duplicate. This leads
to a competitive advantage, because if other firms cannot easily duplicate
these factors, they are valuable.

Porter argues that a lack of resources often actually helps countries to

become competitive (selected factor disadvantage). Abundance generates
waste and scarcity generates an innovative mindset. Such countries are
forced to innovate to overcome their problem of scarce resources.
Examples are:

 Switzerland was the first country to experience labour shortages.

They abandoned labour-intensive watches and concentrated on
innovative/high-end watches.
 Japan has high priced land and so its factory space is at a premium.
This lead to just-in-time inventory techniques (Japanese firms have

Manufacturing Strategy: Unit 2 – Porters Model and the Value Chain 2-25
November 2013
 insufficient space for high stock levels, so to cope with the risk of
not have goods when required, they innovated new inventory
techniques).
 Sweden has a short building season and high construction costs.
These two things combined created a need for pre-fabricated houses.

Demand Conditions
Porter argues that a sophisticated domestic market is an important element
to producing competitiveness. Firms that face a sophisticated domestic
market are likely to sell superior products because the market demands high
quality and a close proximity to such consumers enables the firm to better
understand the needs and desires of the customers. If the nation’s
discriminating values spread to other countries, then the local firms will be
competitive in the global market. One example is the French wine industry.
The French are sophisticated wine consumers. These consumers force and
help French wineries to produce high quality wines.

Related and Supporting Industries

Porter also argues that a set of strong related and supporting industries is
important to the competitiveness of firms. This includes suppliers and
related industries. This usually occurs at a regional level as opposed to a
national level. Examples include Silicon Valley in the U.S., Detroit (for the
auto industry) and Italy (leather-shoes and other leather goods industries).
The phenomenon of competitors (and upstream and/or downstream
industries) locating in the same area is known as clustering or
agglomeration. Some advantages to locating close to your rivals may be:

 potential technology knowledge spillovers,

 an association of a region on the part of consumers with a product
and high quality and therefore some market power
 an association of a region on the part of applicable labour force.

Some disadvantages to locating close to rivals are:

 potential poaching of employees by rival companies and

 obvious increase in competition possibly decreasing mark-ups.

Firm Strategy, Structure and Rivalry

Strategy

(a) Capital Markets

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Domestic capital markets affect the strategy of firms. Some countries’
capital markets have a long-run outlook, while others have a short-run
outlook. Industries vary in how long the long-run is. Countries with a short-
run outlook (like the U.S.) will tend to be more competitive in industries
where investment is short-term (like the computer industry). Countries with
a long run outlook (like Switzerland) will tend to be more competitive in
industries where investment is long term (like the pharmaceutical industry).

(b) Individuals’ Career Choices

Individuals base their career decisions on opportunities and prestige. A
country will be competitive in an industry whose key personnel hold
positions that are considered prestigious.

Structure

Porter argues that the best management styles vary among industries. Some
countries may be oriented toward a particular style of management. Those
countries will tend to be more competitive in industries for which that style
of management is suited. For example, Germany tends to have hierarchical
management structures composed of managers with strong technical
backgrounds and Italy has smaller, family-run firms.

Rivalry

Porter argues that intense competition spurs innovation. Competition is

particularly fierce in Japan, where many companies compete vigorously in
most industries. International competition is not as intense and motivating.
With international competition, there are enough differences between
companies and their environments to provide handy excuses to managers
who were outperformed by their competitors.

The Diamond as a System

The points on the diamond constitute a system and are self-reinforcing.
Domestic rivalry for final goods stimulates the emergence of an industry
that provides specialized intermediate goods. Keen domestic competition
leads to more sophisticated consumers who come to expect upgrading and
innovation. The diamond promotes clustering. The role of chance in the
model is emphasized. Random events can either benefit or harm a firm’s
competitive position. These can be things such as major technological
breakthroughs or inventions, acts of war and destruction, or dramatic shifts
in exchange rates.

According to Porter, an agglomeration becomes self-reinforcing through the

following typical set of events:

Manufacturing Strategy: Unit 2 – Porters Model and the Value Chain 2-27
November 2013
 1. When there is a large industry presence in an area, it will increase
the supply of specific factors (i.e. workers with industry-specific
training) since they will tend to get higher returns and less risk of
losing employment.
2. At the same time, upstream firms (i.e. those who supply intermediate
inputs) will invest in the area. They will also wish to save on
transport costs, tariffs, inter-firm communication costs, inventories,
etc.
3. At the same time, downstream firms (i.e. those use our industry’s
product as an input) will also invest in the area. This causes
additional savings of the type listed before.
4. Finally, attracted by the good set of specific factors, upstream and
downstream firms, producers in related industries (i.e. those who use
similar inputs or whose goods are purchased by the same set of
customers) will also invest. This will trigger subsequent rounds of
investment.

Implications for Governments

The government plays an important role in Porter’s diamond model.
Like everybody else, Porter argues that there are some things that
governments do that they shouldn't, and other things that they do not do
but should. He says, "Government’s proper role is as a catalyst and
challenger; it is to encourage - or even push - companies to raise their
aspirations and move to higher levels of competitive performance …"
Governments can influence all four of Porter’s determinants through a
variety of actions such as

 Subsidies to firms, either directly (money) or indirectly

(through infrastructure).
 Tax codes applicable to corporation, business or property
ownership.
 Educational policies that affect the skill level of workers.
 They should focus on specialized factor creation. (How can
they do this?)
 They should enforce tough standards. (This prescription may
seem counterintuitive. What is his rationale? Maybe to
establish high technical and product standards including
environmental regulations.)

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Exercise 2.7

For a country and industry of your choicen analyse the degree of

competitiveness of the country for that particular industry using Porter’s
Diamond model.

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November 2013
Conclusion
The Value Chain is an important tool for analysing the individual activities
in a manufacturing organisation and how they contribute to profitability. It
also highlights the interrelationship between activities not only within a
single company but also across company boundaries, and the modern supply
chain may be regarded as a “value system”. The advent of E-Commerce is
bringing a new set of dimensions to value chain analysis, in terms of its
application to the flow of information rather than merely materials.

The Five Forces Model examines the forces that will operate in a particular
industry, so that an individual company operating in the industry can
attempt to use them to its competitive advantage. The model is based on
microeconomics and takes into account supply and demand, complementary
products and substitutes, the relationship between volume of production and
cost of production, and market structures like monopoly, oligopoly or
perfect competition.

The most important implication of Porter's model is that firms should

attempt to influence the balance of forces through strategic moves and
thereby strengthen the firm's position.

Finally, in an extension from individual companies or industries to entire

countries as the unit of analysis, Porter’s Diamond Model allows a
systematic analysis of the potential competitive advantage of individual
countries within specific industries by examining the characteristics of the
country in four different areas. This can reveal the types of action that
would need to be taken by governments in order to improve a countries
competitive positioning in increasingly global markets.

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Case Study

CSP Soups
CSP Australia is a wholly US owned manufacturer of canned soups for the
retail market At present it manufactures 6 basic varieties of soups (thin and
thick vegetable soup, tomato soup, ham & pea soup, chicken soup, and
mushroom soup). Each soup is marketed in four different sizes, family (2
litres), large (1 litre), medium (.75 litres) and small (.5 litres) and are
manufactured on a single production line. The market is competitive, and
the company is under severe pressure to make a profit or it will be
threatened with closure by the US parent company. Raw materials are
bought in bulk from a limited number of major suppliers, and the soups are
sold through large supermarket chains.

In an emergency review of its operations, the company is considering taking

advantage of some proprietary technology developed by the parent company
which causes the original flavour of the soup to be sealed into the can for a
much longer period of time without any deterioration thus allowing a one
year old can of soup, when opened to taste as though it had only just been
made from fresh ingredients. To take maximum advantage of this
technology the company is planning to expend its product range into a
series of speciality soups, targeted at the gourmet market. A high variety of
such soups is being planned, with up to fifty different flavours being
anticipated. It is envisaged that local suppliers will be used (to ensure the
flavour is as fresh as possible when the can is sealed). The range of
flavours, together with the blends and mixing conditions of ingredients
required to produce them, will be supplied by the parent company. The
soups are expected to be sold to small restaurants and through more
specialist delicatessens, rather than through large supermarkets.

Analysis Question

You have been called in by the company as an external consultant to make

recommendations on whether the above business/marketing strategy is
likely to be effective in turning the company around. As the first step,
before making a detailed analysis, you have been asked to make a broad
brush analysis using the framework provided by Porter's model and the
Value Chain. The purpose of this is to establish those areas in which more
detailed analysis needs to be performed.

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