Michael Porter’s five forces model works best for manufacturing firms. With regards to problem-solving and mediating industries we find both poor model fit and overwhelming lack of support for Porter’s original predictions.
KNOWLEDGE @BI: Strategy in Action
As the economy changes so should our models of value creation and profitability. We currently run the risk of drawing the wrong conclusions when applying a manufacturing based model to solve non-manufacturing strategic impediments.
Almost all graduates of BI’s program and business school students around the world have been presented with Porter’s five forces model. It is included in almost all strategic management textbooks and all top 20 Global MBA Financial Times ranked business school teach this model as an integral part of the MBA strategic management course.
A conservative Google search results in 2.6m hits far more than its rival the resource based theory. In academic studies of citations within the strategic management literature it appears more often than any other contribution.
- Read also: In search of Locational Advantage
Influential model of Strategy
In brief, Porter’s widely influential contribution develops a model with “key structural features of industries that determine the strength of the competitive forces and hence industry profitability” (Porter, 1980: 4).
Despite the model’s prevalence in teaching and practice, only a handful of scholars have subjected Porter’s propositions to rigorous empirical testing. D’Aveni et al. (2010) refer to the empirical validity as “somewhat dated” while Ghemawat (2006: 24) referring to Schmalensee (1989) states that “a survey of empirical IO in the late 1980s…revealed that only a few of the influences that Porter flagged commanded strong empirical support.
Much of the earlier work of strategic management was developed within the then widespread form of value creation, namely manufacturing i.e., the transformation of inputs into outputs through a sequentially designed transformation process (Thompson, 1967).
Study of manufacturing firms
From Fordism, Scientific Management, the multidivisional firm (Chandler, 1962) to the five-forces (Porter, 1980), managerial concepts and models are heavily based on insights from the study of manufacturing firms and industries.
Even Porter’s work, which is argued to apply equally to product and service businesses, was developed through anecdotal evidence of primarily manufacturing firms. As Normann & Ramirez (1993: 65) so succinctly explained: ‘Our traditional thinking about value is grounded in the assumptions and the models of an industrial economy. According to this view, every company occupies a position on a value chain. Upstream, suppliers provide inputs. The company then adds value to these inputs, before passing them downstream to the next actor in the chain, the customer (whether another business or the final customer)’.
Value creation is changing
But manufacturing is not the common modus operandi of value creation in the economy today. The share of value added of GDP originating from the manufacturing sector in the world decreased from 19.5% in 1998 to 16.5% in 2010 (World Bank, 2013) with corresponding percentages for the US of 16.9% and 13.1%.
Market evolution and deregulation have made vivid the significance of problem-solving and mediating firms and industries for economic development. The 2012 economic report of President of the United States reveals that the share of value added of problem-solving industries out of GDP increased from 13.5% in 1980 to 23.6% in 2010 and for mediating industries from 25.8 to 29.6%.
Changing our models of value creation
In unison, new economic and managerial theories have explored the economics and organization of mediating and problem-solving firms and industries (e.g., Grant, 1996; Katz & Shapiro, 1985, 1994; Løwendahl, 2000; Powell, Koput, & Smith-Doerr, 1996; Stabell & Fjeldstad, 1998).
Hence, I test the original predictions and their extensions to new economically significant sectors in the context of the U.S. economy. Following a long tradition within economics, management and sociology, I use input-output tables of the U.S. economy in the years 1992, 1997, and 2002 provided by the Bureau of Economic Analysis to examine the relationship between market structure and industry performance.
The findings call into question the previously assumed broad applicability of the model. The model works best for manufacturing firms, although not all of Porter’s original predictions are supported.
The astonishing findings are the poor fit of the model with regards to the problem-solving industries. None of Porter’s predictions warrant any significant empirical support! With some statistical reservations, the same is true for the mediating industries.
In conclusion, as the economy changes so should our models of value creation and profitability. The popularity of the model has distracted academic attention. Now, we know better.
This article is published in BI Strategy Magazine 2013/2014, an English/Norwegian language public outreach magazine published by the Depratment of Startegy and Logistics at BI Norwegian Business School.