Strategic Information System - Porter’s Competitive Advantage

Porter’s Competitive Advantage

Dr. Michael E. Porter, Professor of Business Administration, Harvard Business School, has addressed his ideas in two keystone books. Competitive Strategy: Techniques for Analyzing Industries and Competitors, and his newer book, Competitive Advantage, present a framework for helping firms actually create and sustain a competitive advantage in their industry in either cost or differentiation. Dr. Porter’s theories on competitive advantage are not tied to information systems, but are used by others to involve information services technologies._In his book, Dr. Porter says that there are two central questions in competitive strategy:

• How structurally attractive is the industry?
• What is the firm’s relative position in the industry?

Both of these questions are dynamic, and neither is sufficient alone to guide strategic choices. Both can be influenced by competitor behavior, and both can be shaped by a firm’s actions. It is imperative that these questions be answered by analysis, which will be the starting point for good strategic thinking, and will open up possibilities for the role of information systems.Industry profitability is a function of five basic competitive forces:

• the threat of new entrants
• the threat of substitute products or services
• the bargaining power of suppliers
• the bargaining power of buyers and
• the intensity of the rivalry among existing competitors

Porter’s books give techniques for getting a handle on the possible average profitability of an industry over time. The analysis of these forces is the base for estimating a firm’s relative position and competitive advantage. In any industry, the sustained average profitability of competitor’s varies widely. The problem is to determine how a business can outperform the industry average and attain a sustainable competitive advantage. It is possible that the answer lies in information technology together with good management._Porter claims that the principal types of competitive advantage are low cost producer, differentiation, and focus. A firm has a competitive advantage if it is able to deliver its product or service at a lower cost than its competitors. If the quality of its product is satisfactory, this will translate into higher margins and higher returns. Another advantage is gained if the firm is able to differentiate itself in some way. Differentiation leads to offering something that is both unique and is desired, and translates into a premium price. Again, this will lead to higher margins and superior performance._It seems that two types of competitive advantage, lower cost and differentiation, are mutually exclusive. To get lower cost, you sacrifice uniqueness. To get a premium price, there must be extra cost involved in the process. To be a superior performer,_however, you must go for competitive advantage in either cost or differentiation._Another point of Porter’s is that competitive advantage is gained through a strategy bases on scope. It is necessary to look at the breadth of a firm’s activities, and narrow the competitive scope to gain focus in either an industry segment, a geographic area, a customer type, and so on. Competitive advantage is most readily gained by defining the competitive scope in which the firm is operating, and concentrating on it._Based on these ideas of type and scope, Porter gives a useful tool for analysis which he calls The Value Chain (Figure No. 1). This value chain gives a framework on which a useful analysis can be hung. The basic notion is that to understand competitive advantage in any firm, one cannot look at the firm as a whole. It is necessary to identify the specific activities which the firm performs to do business. Each firm is a collection of the things that it does that all add up to the product being delivered to the customer. These activities are numerous and are unique to every industry, but it is only in these activities wherecost advantage or differentiation can be gained._The basic idea is that the firm’s activities can be divided into nine generic types. Five are the primary activities, which are the activities that create the product, market it and deliver it; four are the support activities that cross between the primary activities. The primary activities are:

• Inbound logistics, which includes the receipt and storage of material, and the general management of supplies.
• Operations, which are the manufacturing steps or the service steps.
• Outbound logistics, which are associated with collecting, storing, and physically distributing the product to buyers. In some companies this is a significant cost, and buyers value speed and consistency.
• Marketing and sales includes customer relations, order entry, and price management.
• After-sales services covers the support of the product in the field, installation, customer training, and so on.

The support activities are shown across the top of Figure No. 1 because they are a part of all of the firm’s operations. They are not directed to the customer, but they allow the firm to perform its primary activities. The four generic types of support activities are:

• Procurement, which includes the contracting for and purchase of raw materials, or any items used by the enterprise. Part of procurement is in the purchasing department, but it is also spread throughout the organization.
• Technology development may simply cover operational procedures, or many be involved with the use of complex technology. Today, sophisticated technology is pervasive, and cuts across all activities; it is not just an R&D function.
• Human resource management is the recruiting, training, and development of people. Obviously, the cuts across every other activity.
• Firm infrastructure is a considerable part of the firm, including the accounting department, the legal department, the planning department, government relations, and so on.

The basic idea is that competitive advantage grows out of the firm’s ability to perform these activities either less expensively than its competitors, or in a unique way. Competitive advantage should be linked precisely to these specific activities, and not thought of broadly at a firm-wide level. This is an attractive way of thinking for most information Services people, as it is, fundamentally, the systems analysis approach. Computer people are trained to reduce systems to their components, look for the best application for each component, then put together an interrelated system._Information technology is also pervasive throughout all parts of the value chain. Every activity that the firm performs has the potential to imbed information technology because it involves information processing. As information technology moves away from repetitive transaction processing and permeates all activities in the value chain, it will be in a better position to be useful in gaining competitive advantage. Figure No. 2, Value Chain: Key Activities, gives a brief example of a typical analysis of a value chain for a manufacturing company. It is obvious that information processing plays an important role in all these key activities._Porter emphasizes what he call the linkages between the activities that the firm performs. No activities in a firm are independent, yet each department is managed separately. It is most important to understand the cost linkages that are involved so that the firm may get an overall optimization of the production rather than departmental optimizations. A typical linkage might be that if more is spent in procurement, less is spent in operations. If more testing is done in operations, after-sales service costs will be lower. Multifunctional coordination is crucial to competitive advantage, but it is often difficult to see. Insights into linkages give the ability to have overall optimization. Any strategic information system must be analyzed across all departments in the organization._Cost and Competitive Advantage. Cost leadership is one of Porter’s two types of competitive advantage. The cost leader delivers a product of acceptable quality at the lowest possible cost. It attempts to open up a significant and sustainable cost gap over all other competitors. The cost advantage is achieved through superior position in relation to the key cost drivers._Cost leadership translates into above-average profits if the cost leader can command the average prices in the industry. On the other hand, cost leaders must maintain quality that is close to, or equal to, that of the competition. Achieving cost leadership usually requires trade-offs with differentiation. The two are usually incompatible._Note that a firm’s relative cost position cannot be understood by viewing the firm as a whole. Overall cost grows out of the cost performing discrete activities. Cost position is determined by the cumulative cost of performing all value activities._To sustain cost advantage, Porter gives a number of cost drivers which must be understood in detail because the sustainability of cost advantage in an activity depends on the cost drivers of that activity. Again, this type of detail is best obtained by classical systems analysis methods. Some of the cost drivers which must be analyzed, understood, and controlled are:

• Scale. The appropriate type of scale must be found. Policies must be set to reinforce economies of scale in scale-sensitive activities.
• Learning. The learning curve must be understood and managed. As the organization tries to learn from competitors, it must strive to keep its own learning proprietary.
• Capacity Utilization. Cost can be controlled by the leveling of throughput.
• Linkages. Linkages should be exploited within the value chain. Work with suppliers and channels can reduce costs.
• Interrelationships. Shared activities can reduce costs.
• Integration. The possibilities for integration or de-integration should be examined systematically.
• Timing. If the advantages of being the firs mover or a late mover are understood, they can be exploited.
• Policies. Policies that enhance the low-cost position or differentiation should be emphasized.
• Location. When viewed as a whole, the location of individual activities can be optimized.
• Institutional Factors. Institutional factors should be examined to see whether their change may be helpful.

Care must be taken in the evaluation and perception of cost drivers because there are pitfalls if the thinking is incremental and indirect activities are ignored. Even though the manufacturing activities, for example, are obvious candidates for analyses, they should not have exclusive focus. Linkages must be exploited and cross-subsidies avoided. Porter gives five steps to achieving cost leadership:

• Identify the appropriate value chain and assign costs and assets to it.
• Identify the cost drivers of each value activity and see how they interact.
• Determine the relative costs of competitors and the sources of cost differences.
• Develop a strategy to lower relative cost position through controlling cost drivers or reconfiguring the value chain.
• est the cost reduction strategy for sustainability.