Sunday, November 1, 2009

Porter's Five Forces and Basic Economic Theory

In our strategy class last week, we were discussing Porter's Five Forces by extending the idea beyond just a static analysis of the industry as is, but looking at the trends in movement for each of the five forces.

I suspected that there would be a pattern that industries with forces which have a rating of "low" would naturally have a trend of "increasing" whereas forces with "high" ratings would have trends of "decreasing" assuming efficient markets. While not a perfectly isomorphic, I would expect this relationship to at least have a high correlation coefficient in terms of regression if you had to build a model for prediction.

When it comes to Buyer or Supplier Power (a recursive framework which can be applied forwards or backwards with regards to vertical integration / value add or creation), I've always enjoyed using elasticity as a measure of bargaining power. However, in economics, there is the axiom that over time there is more "flexibility" for substitution which I would suggest directly results in increased elasticity.

In the same way that a buyer might not have flexibility or bargaining power in the short term, the natural inclination would be for substitutes to enter into an industry with low price elasticity in order to capture producer surplus (in the case of inelastic demand).

In more pragmatic terms, while it might be academically sound (and necessary) to look at historic values to understand how we got to where we are, it doesn't really become as useful (and it is hardly sufficient) until we understand not only our position, but where we are going.

2 comments:

Matt CM said...

Excellent points Joshua. The issue over lack of dynamic foresight was also identified by academics in UK business schools interviewed recently by the Strategic Planning Society (lack of inclusion of non-market forces was also a key criticism). The resulting article Are we still feeling the Five Forces? may be of interest - feel free to add your comments.

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