Theme 2.1.

1 Firms and Strategies

Strategies to Develop Competitive Advantage – Porter’s Five Forces

Framework
1. Background

In theory of the firm, it is assumed that the traditional objective of the firm is to maximise profits. As firms
make decisions, these decisions will invariably affect the firms’ profitability and efficiency as well as
societal welfare. Firms often use competitive strategic analysis in marketing and strategic
management to assess strengths and weaknesses of competitors within the market.

One key method of analysing the competition within an industry is by using the Porter’s Five
Forces framework. It was originally developed by Michael E. Porter in 1979. The five forces model
helps to explain if a firm can be profitable in comparison to other firms in the industry. As such,
the framework allows one to understand where a firm lies in the industry landscape and the sources
of profitability in the industry by examining the competitive forces and their underlying causes.
The model also helps one to anticipate and influence competition, and hence profitability over
time. This encourages firms to look beyond the strategies and actions of their rivals, and examine the
other external forces that influence their profits.

Consequently, firms can implement strategies that will provide them with a distinct advantage
over their competitors and enact barriers to prevent competition from entering the market. This
analysis provides a framework for thinking and decision-making for the firm. According to the Michael
Porter’s framework, markets are classified into four categories:

Michael Porter classifies the markets into 4 general cases:

• High barrier to entry and high exit barrier – eg telecommunications, energy
• High barrier to entry and low exit barrier – eg consulting, education
• Low barrier to entry and high exit barrier – eg hotels, ironworks
• Low barrier to entry and low exit barrier – eg retail, electronics, commerce

In general, markets with high entry barriers have few players, and hence enjoy very high
profit margins. Meanwhile, markets with low entry barriers that have many players tend
to enjoy low profits.

Note: It should be noted that many of the elements of the Five Forces model would have been learnt in Firms& Decisions of H2
Economics/H3 Theme 2.1 Part I. As such, the focus in H3 would essentially be about deepening and reframing of what you have
learnt to allow for a richer application of decision-making by firms.

2. Determinants of Competitive Advantage: Porter’s Fives Forces Strategic Framework

In a popular article in the Harvard Business Review (1979), Michael Porter proposed a conceptual
framework (the Five Forces model) for identifying the threats from competition in a relevant market.
Incumbent firms attempt to secure competitive advantages through their choice of management
strategy. This framework provides a basic structure that highlights the relationships between
competitors within an industry, potential competitors, suppliers and buyers.

According to Porter (1979), the state of competition in an industry depends on the five basic forces
as listed below and the collective strength of these forces determines the profit of an industry
and hence its attractiveness. The level of competition ranges from intense in industries like tires, metal
cans, and steel, where no firm earns spectacular returns on investments, to mild in industries like oil
field services and equipment, soft drinks, and toiletries, where there is room for substantial returns.

Competitive advantage is a function of either providing comparable buyer value more efficiently than
competitors (low cost), or performing activities at comparable cost but in unique ways that create more
buyer value than competitors and, hence, command a premium price (differentiation). These strategies
will be analysed in detail in subsequent parts on achieving competitive advantage.
First, let us take a closer look at how the Porter’s Five Forces model serves as a useful starting point
for firms to determine the degree of competitive advantage. According to Porter, there are five
forces that represent the key sources of competitive pressure within an industry and hence shape
industry competition are:

Porter’s Five Forces Model

Threat of Substitutes

According Porter (1979), by placing a ceiling on prices it can charge, substitute products or
services limit the potential of an entry into the industry. If a product or service has significant brand
loyalty such as those observed for brands like Mc Donald’s, Coca-Cola, Apple, then the threat of
substitutes is likely to be lower due to the higher degree of brand loyalty. Hence, in such
industries, these firms can continue to earn high profitability. Further, the greater the distance of
the substitutes outside of the relevant market, the less price inelastic demand will be, and hence
larger the mark-up and profit margins for the incumbent firms. However, the closeness or distance of
substitutes depends on consumer perception of the product or the service created by advertising,
branding and the segmentation of customers into separate distribution channels (third degree price
discrimination or freemium strategies).

For example, in the airline industry, the general product that is being sold is “traveling”. There are many
alternatives/substitutes available for this purpose and one can use alternative mode of transport such
as car or train to travel to their destination.

Threat of Entry

A second force determining the likely profitability of an industry or product line is the threat of potential
entrants, which students would have learnt in some detail in H2 Economics. New entrants to an
industry bring new capacity, the desire to gain market share, and often substantial resources
(Porter, 1979). The strength of the threat of entry depends on the barriers present and on the reaction
from existing competitors that entrants can expect. The higher the barriers of entry, the stronger
will be the retaliation faced by potential entrants and the more profitable an incumbent firm will
be. Barriers to entry can arise from several factors, such as the consideration of high capital costs,
economies of scale and absolute cost advantages, brand loyalty, access to distribution channels,
product differentiation and government policy. The government can limit or even foreclose entry to
industries using license requirements and limits on access to raw materials. Regulated industries such
as trucking, liquor retailing and freight forwarding are examples of such industries.

In other words, one can say that this force measures the relative ease with which consumers may
be willing to switch from using the product offered by the incumbent to that of the entrant, hence
measuring the ease with which a potential entrant can enter the market. The easier it is for a potential
entrant to enter the market is, the greater the risk is to the profitability of the incumbent.

For example, the threat of new entry in the airline industry can be considered as low to medium. This is
because it takes a substantial amount of upfront investments or capital to start an airline company,
ranging from purchasing aircrafts, licenses to operate, insurances, distribution channels that are not
easy to obtain for an entrant. Additionally, incumbents have built up a strong consumer base over years
and knowledge of cutting costs through various expertise. As a new entrant into this industry, they are
unlikely to have such expertise to compete with the incumbents, therefore, creating a competitive
disadvantage from the start for themselves. Nonetheless, with the liberalisation of the airline industry,
with access and availability of leasing options to the new firms, along with capital from banks, the
barriers to entry has lowered for potential new entrants. Low cost carriers like Southwest Airlines,
RyanAir, AirAsia and Easy Jet have successfully entered the industry over the years by adopting
innovative cost cutting strategies, threatening the traditional business models of incumbents like
Singapore Air, KLM, and American Airlines.

Bargaining Power of Buyers

The third force determining the profitability of incumbent firms is the bargaining power of buyers. If the
number of buyers in an industry is relatively lower compared to the number of suppliers, the
buyers are likely to have a greater bargaining power known as "buyer power". This means that
they are likely to find it easy to switch to new products offered by the potential entrants due to
the relatively lower switching costs, lower prices offered by rivals due to cost advantages enjoyed by
them. Consumers are more price sensitive if they are purchasing products that are undifferentiated,
expensive relative to their incomes and of a sort where quality is not particularly important (Porter,
1979). Hence, the market power of firms decreases when they have a smaller consumer base but
greater competition – in other words, the number of sellers is higher than the number of buyers. Most
of the sources of buyer power can be attributed to consumers as a group as well as to industrial and
commercial buyers (Porter, 1979).

Buyers may be highly concentrated in industries that manufacture aircraft engines such as Boeing and
Airbus, or extremely fragmented like restaurants. If industry capacity equals or exceeds demand,
concentrated buyers can force price concessions that reduce profits of incumbent firms. On the
other hand, fragmented buyers have little bargaining power. Buyers will have more bargaining
power and reduce firm profitability when they possess more alternatives.

As a result, firms need to consider how to set prices to attract consumers they wants and protect their
branding. According to Philip Kotler (1960), there are five types of products, core product, generic
product, expected product, augmented product, and potential product. In his Five Product Levels Model
(1960), Kotler argued that customers have five levels of need, ranging from emotional needs to
functional needs. The model recognises that consumers view a product more than simply a physical
object and consider various factors before making their purchase. Consequently, a consumer will
purchase product based on his or her perceived value for the product itself.
Based on Kotler’s pricing strategies, he argued that the right price for a product is one of the most
significant factor that determines the firm’s performance. If the price of a product is lower than a
consumer’s perception of the value of the product, less people may actually buy it. If the price of
the product is too high, the firm will run into a similar problem. An individual’s satisfaction of using a
product tends to increase when the actual value of owning the product matches the perceived
value of the product. If a consumer perceives the value of a product to be very high, for example an
iPhone due to its various functionality, they form an emotional bond with the product. This will eventually
affect the firm’s profitability.

For example, the bargaining power of buyers in the airline industry is very high. Consumers are able to
check prices of different airline companies quickly and compare prices using the various online services
such as Skyscanner and Expedia. Furthermore, there are no switching costs in this process involved.
Consumers also tend to fly to different destinations using different carriers to cut their expenditures. As
such, the brand loyalty in this industry tends to be relatively lower than other industries even though
airline companies constantly try to strengthen this using the frequent flyer programs that is aimed at
rewarding consumers that fly with them more frequently.

Bargaining Power of Sellers

Suppliers can exert bargaining power on participants in an industry by raising prices or reducing the
quality of purchased goods and services (Porter, 1979). As such, suppliers with significant
bargaining power can therefore, earn higher profitability in an industry. For example, by raising
their prices, producers of soft drink concentrates have reduced the profitability of bottling companies
because now they face intense competition from powdered mixes, fruit drinks and other beverages.
Hence, bottlers are unable to raise their prices accordingly. The power of each important supplier or
buyer group depends on the number of characteristics of its market situation and on the relative
importance of its sales or purchases to the industry compared with its overall business (Porter, 1979).
A supplier is considered to have a high bargaining power if the market is dominated by few sellers
and is more concentrated than the industry it sells to, or if the product that it is selling is unique
or differentiated, or if the switching costs is high.

This force, therefore, analyses the power and control a firm’s supplier (also known as the market of
inputs or intermediate goods) has over the potential to raise its prices or to reduce the quality of
purchased goods and services, which in turn would lower the profitability of firms in the industry. The
concentration of suppliers and the availability of substitute suppliers are important in determining the
supplier bargaining power. The fewer suppliers there are, the more bargaining power the sellers
have. The source of the bargaining power is determined by the ease with which firms can raise prices
of their products, depending on the number of sellers in the market, uniqueness of their product or
service offered for sale, and the switching cost.

For example, the bargaining power of suppliers in the airline industry can be considered very high. For
example, when firms look at the major inputs that airline companies need, one thinks of fuel and
aircrafts. These inputs are very much affected by external environment over which the airline companies
have little control over. The price of airline fuel is subject to fluctuations in the global market for fuel as
we can see from the Russia-Ukraine crisis. Meanwhile, there are only two major suppliers of aircraft
such as Boeing and Airbus. Therefore, the suppliers in this industry has a substantial bargaining power
on the prices they charge.

Competitive Rivalry in the Industry

The final force examines the intensity of the current competition in the industry. It considers the number
of existing competitors in the industry and what each of the firm can do. Competition is high when
there are lot of competitors that are roughly equal in size and power, when the industry is growing slowly
and the when consumers can easily switch to competitors at a low cost. A good indicator of competitive
rivalry is the concentration ratio of an industry. The lower the concentration ratio is, the more
intense the competition will be and the more likely competitors to actively engage in advertising and
price wars, which can adversely affect their profitability. Furthermore, such behaviour increases the
amount of information available to both the rivals, consumers as well as suppliers of intermediate goods.
This can adversely influence profitability of a firm by negatively affecting the perception of the
consumers and suppliers. Meanwhile, by cutting back on competition and degree of rivalry, firms may
continue to enjoy a healthy level of profits.

For example, in the airline industry, competition tends to be very intense – can be seen by the entry of
low cost carriers, the high exit costs, and the fact that the industry is very stagnant in terms of growth
today. The switching cost of consumers are also very low and there are many firms in the industry that
are similar in size, leading to fierce competition between those firms.

McGuigan et al. (2005, p. 437) offer an alternate viewpoint, saying that instead of engaging in fierce
rivalries where firms may employ strategies that incur high costs without a resultant gain in market
share, firms may go out of their way to avoid intense competition. This is a refreshing take on the effect
of mutual interdependence on firms’ behaviour as it does diverges the traditional way of looking at
competition by suggesting that a fewer number of firms may not lead to greater degree of competition.

3. Factors that Must be Considered to Achieve Sustained Competitive Advantage

To achieve a sustained competitive advantage, firms must make these three considerations:

Resource-based capabilities
The first element, resource-based capabilities, analyses how firms can secure differential access to
key resources such as patents or distribution channels. As an example, from its humble beginnings as
an Internet bookseller that contracted out its warehousing and book delivery service, Amazon managed
to become the preferred agent for Internet sales in general. That is, Amazon acquired enough regular
customers searching for office products, tools and toys so much so that companies like Toys “R” Us
adopted Amazon as their Internet sales channel.

Business processes
Competitive strategy also designs business processes that are difficult to imitate and capable of
creating unique value for targeted customers. Such business processes may include ways to reduce
inefficiencies within the organisation and customise products for the needs of different customers.

Innovation
Competitive strategy also provides a way for sustaining a firm’s profitability though innovation. Product
innovation involves researching the market and the needs of customers and developing new products
(such as Fitbit or Amazon’s Kindle) and improved products and services (such as an improvement in
the digital camera resolution of the iPhone 13) to meet these needs. This may allow the firm to capture
a larger share of the market and in turn increase its total revenue and ceteris paribus, increase its
profits, since it may be some time before competitors can respond with a similarly improved product.

Innovation can also include activities to develop existing and new business processes known as
process innovation – including changes in the equipment and technology used in manufacturing
(including the software used in product design and development), improvement in the tools, techniques,
and software solutions used to help in supply chain and delivery system, changes in the tools used to
sell and maintain your good, as well as methods used for accounting and customer service. Firms can
automate certain aspect of production processes as well reduce the use of office space to run
their business operations to reduce the average and marginal cost of providing a service or a
good. For example, pharmaceutical and medical device manufacturers have turned to automation to
cut costs, mainly because robots are able to complete repetitive tasks up to 50% faster than current
manual processes, enhances productivity and enabling highly skilled manufacturing, medical and
laboratory staff to undertake more valuable activities.

As industries emerge and evolve into other product spaces, firms must anticipate these changes and
plan how they will sustain their positioning industry and, ultimately, shift their business to new industries.
IBM, the dominant mainframe leasing company in the 1970s, reinvented itself twice – first in the 1980s
as a PC manufacturer and a second time in the 1990s as a systems solution provider. In contrast, some
firms like Kodak became outdated.

4. Strategies to Achieve Sustained Competitive Advantage

A firm's relative position within its industry determines whether a firm's profitability is above or below
the industry average. The fundamental basis of above average profitability in the long
run is sustainable competitive advantage. There are two basic types of competitive
advantage a firm can possess are low cost or differentiation. The two basic types of competitive
advantage combined with the scope of activities for which a firm seeks to achieve them, lead to three
generic strategies for achieving above average performance in an industry.

The strategy used by firms will depend on a firm’s choice of competitive scope – the number and
type of products, market segments, number of geographic locations, network of horizontally and
vertically integrated businesses the firm may choose to invest in. The composition of a firm’s resource
capabilities, business opportunities and a detailed knowledge of its customers contribute to determine
the firm’s competitive scope.

Firms will thus have to find a way to create sustainable competitive advantage, which would include
• establish a differentiation strategy or
• a lowest-delivered-cost strategy or
• an information technology (IT) strategy

Differentiation Strategy

It usually involves competing on capabilities, branding or product endorsements. Production

differentiation from H2 Economics, we learnt that it can take the form of real differentiation when
physical changes to the product itself is made by adding more features to the existing products and
making it different from the products provided by the rivals (quality, taste). On the other hand, imaginary
differentiation can take the form of repackaging and branding. Lastly, unrelated to the product/cost
conditions – service differentiation.

When firms differentiate their products, they are likely to keep in mind the most salient features of
their products to target the salience bias of customers to increase the demand and hence their
revenue. Brands like Apple, Netflix and Starbucks use salience to shape their customers’ decision. For
example, Apple keeps their products clean and simple to avoid confusing their customers with different
options and information. They focus on simple design to get 100% of the consumers’ attention. We
always associate the white minimal design and a “bitten” apple with Apple products. Similarly,
consumers enjoy Netflix because of not only their huge content variety but also the way viewers can
navigate the content into seamless experience. Netflix has managed to establish itself through the most
salient feature, the content personalization algorithm and its opening sound “ta-dum”. By targeting
consumers’ saliency bias, firms like Apple and Netflix have continued to dominate in their respective
product markets by creating strong brands. Netflix has seen an increase in more than 8 million
subscribers during the pandemic, with more than 222 million globally [around 65% of Netflix subscribers
are based outside of the US & Canada].

Product differentiation also increases the opportunity cost of switching by lowering the degree of
substitutability of products sold by firms. Hence, deepening the degree of brand loyalty by
consumers by convincing consumers that the product is different from those offered by the rivals.
Furthermore, service differentiation concentrated on strengthening the relationships with
customers who make regular purchases has an effect of “keeping customers from defecting”. For
example, firms like Tesco and NTUC Fair Price use the loyalty schemes such as Tesco’s Club Card
and NTUC rewards to create loyalty and lock in their customers with the reward programs. This
is effective in increasing customers’ perceptions of switching cost, thus fostering customer retention
and switching may involve forgoing points, expending effort and time in signing up for a new program,
and learning how to redeem rewards.

As a result, firms can increase switching barriers by offering attractive loyalty programs that acts
as a “barrier to entry” to other firms as customers may be unwilling to switch to the alternative providers
such as Giant or Waitrose. This is because consumers are more motivated by the prospects of loss
in the forms of points accumulated, familiarity, convenience and customer-firm relationship
against the promise of gains of better quality and cheaper products due to their aversion to loss.
As such, consumers continue to patronize firms like Tesco and NTUC because they focus on the
amount of points they have already accumulated as they are influenced by the sunk cost fallacy.
Such fallacies prevent consumers from making choices that are likely to maximize their present utility
and not which negates the feeling of loss due to decisions made in the past. Such cognitive biases
thus enable firms to employ product differentiation strategies to create strong brands. As a
result, these firms can command a price premium due to product image and lifestyle associated with
their successful branding.

Differentiation strategy also includes product endorsements and creating branding through advertising.
During a product endorsement, firms may stress the specific qualities or characteristics of their
products over its rivals. This is common when firms use advertisements to create a successful brand
by tapping on individuals’ saliency bias – which refers to the tendency for people to focus on
information that is more prominent and over other less prominent but equally relevant pieces of
information. As consumers, we are less inclined to spend our money on products/brands that we do
not notice and we always remember the first impression an advertisement makes on us instead of
the number of times the ads run. If a specific quality or characteristic of a product is not striking, human
brain tends to blend it into the background. Hence, firms can endorse a product and create brand loyalty
through product differentiation strategy.

For example, when Apple promoted its smartwatch, Tim Cook decided to highlight that the product will
“tap you out of your laziness” and remind “you to get up and move since sitting is the new cancer”. They
focused on the product functionality that would appeal to the consumers such as how it delivers
breakthrough wellness and fitness capabilities. As such, even if there are other similar products in the
market providing similar functionality, consumers will be more inclined to purchase Apple Watch as the
differences in its fitness capabilities may not be perceptible to the naked eyes. Similarly, Google focused
on the salient features that makes the Google’s Pixel 4 unique compared to its rivals. The ads focused
on the camera quality, the secure payment system with Google Pay, Google AI, etc.

A successful and consistent advertising creates brands that consumers aspire to own or shorten the
search process for consumers looking for consistency of quality (brand loyalty). As a result, consumers
will perceive the cost of switching to the rivals’ products to be higher as the strong branding
creates a loyalty that “locks in” existing customers. Hence, firms are able to effectively retain their
consumer base and keep the demand for their products relatively more price inelastic to command a
premium price.

Cost-Based Strategies

Cost based strategies involves raising profitability by reducing costs. This may also be accompanied by
a lower price offered to consumers. As mentioned earlier, the final strategy used by a firm will depend
on a firm’s choice of competitive scope. Competitive scope decisions in turn are especially pivotal
for cost-based strategies. In implementing cost-based strategies, a firm will aim to provide a good or
service at the lowest cost possible. The sources of cost advantages are varied and depends on the
structure of the industry. A low cost producer must find and exploit all sources of cost advantage. If a
firm can achieve and sustain overall cost leadership, then it will be an above average performer in its
industry, provided it can command prices at or near the industry average.

One way to keep cost low is by outsourcing. Offshoring/outsourcing various stages of production
to a country that can produce that respective stage for the lowest cost also allows firms to lower
their average costs, or at least mitigate the rise in costs possibly due to rising costs of research and
development, rentals and advertisement. For example, firms can offshore their customer support to
countries like China and India to cut cost on labour costs where wages are significantly high. Similarly,
American firms like CISCO, Ford and American Express have offshored customer support, back-office,
technical support services, and have shifted their call center operations, and other business processes
to India.

However, there will be difficulties in controlling the quality of services that end up adversely
affecting the demand for a firm’s product. For example, manufacturing offshoring may not guarantee
that a product is strictly built according to the parent company’s standards and may affect quality of the
finished product. Additionally, services may be of poor quality due to communication barriers between
American consumers and those providing the services at the call centers in India. Outsourcing can also
increase risks associated with data sensitivity and loss of confidentiality to external parties. As
such, the reduction in costs may be insufficient/ minimal and ineffective in raising profitability.
Furthermore, if the poor quality of the product and services affects the demand, profits may fall further
if the total revenue falls more than the potential cost reductions.

Another way of delivering a product at the lowest cost possible is by adopting a business model that
has very low fixed costs and overheads relative to the costs incurred by rivals. The adoption of
technology has made it possible for many firms to cut costs and charge low prices to their
consumers. For example, Amazon charges low prices because it does not have to endure the
expenses that “bricks and mortar” retailers such as Walmart and Tesco do in operating many hundreds
of stores. Amazon also offers an unmatched variety of goods at low costs as well. Similarly, Netflix is
also able to offer customers a far greater variety of movies and charge lower prices than video rental
stores by conducting all its business over the Internet and via mail.

In service industries, a high asset utilisation can help firms to cut costs. For example, a restaurant
that turns tables around very quickly, having more customers that stay for shorter periods of time
as opposed to another restaurant in which a table is occupied for hours at a time is able to deliver the
service at a lower cost.

Another way of ensuring lower costs is to have a higher control over the value chain. Firms can
negotiate lower prices with suppliers, applying competitive bidding for contracts, preferential
access to raw materials, and so on to cut the cost of providing a good or service, and hence retaining
profits.

Some examples of cost leadership:

• RyanAir is probably one of the most famous examples when it comes to cost leadership.
Founded in 1984, the Irish based budget airline (with a fleet size of 469 airplanes including
subsidiaries) carries more international passengers than any other airline in the world. The
firm’s competitive advantage strategy is based on their intent to outperform competitors by
providing air travel service at the lowest unit cost possible. This is achieved in a variety of ways,
including considerable bargaining power over suppliers, which helps the company keep its
operating costs low; little aircraft variety (mainly Boeing 737-200), allowing them to purchase
spare parts in large quantities; negotiation power with airport operators, demanding low landing
and handling fees, in addition to flying to less popular airports; lack of differentiation services
such as loyalty schemes, free food, in-flight entertainment, airport lounges, premium cabin, etc.

• Primark is an Irish fast fashion retailer with 370 stores across 12 countries. The company offers
competitive prices that undercut their competitors considerably, which is mainly possible due
 to their low operational costs. Primark is able to achieve a leadership in costs in a highly
competitive industry through the following methods: holding huge quantity of stock – by buying
in bulk for all their stores; little branding and advertising – the firm spends little to no budget on
advertising, relying mainly on their social media accounts and word of mouth; efficient supply
chain – Primark has streamlined its supply chain processes, ensuring that no extra costs occur
through unnecessary activities; outsourcing – Primark outsources the manufacturing of its
clothes to developing countries such as Bangladesh.

• McDonald’s has achieved cost leadership in the quick service restaurant industry by optimizing
the processes of cooking food, making them simple and easy to learn by all employees,
reducing the learning curve as much as possible. Furthermore, it has a clear division of labour
that allows them to recruit and train new recruits as opposed to hiring already trained cooks,
which allows them to pay low wages. In addition, through vertical integration, McDonald’s owns
the facilities that produce the ingredient mixtures for their products compared to its rivals. In
other words, the firm manages to cut costs not only when it comes to raw materials and
optimized human resources, but by high asset utilization as well. It serves more customers as
opposed to their competitors in the same amount of time.

• Amazon achieves its competitive advantage in multiple ways, including economies of scale –
the company has huge warehousing facilities and processing capability, thus being able to cut
on costs through physical economies of scale, advanced technology – by using advanced
computing and networking technologies, Amazon achieves maximum operational efficiency
(and minimized costs), process automation – the company has managed to automate a lot of
operational processes, including purchase processing and delivery scheduling, among others.

Information Technology Strategy

With disruptive technology, the way businesses and firms operate has changed significantly.
Essentially, with information technology strategies, they considerably change the way buyers and
sellers communicate, conduct transactions and firms operate. Information technology, and in
particular, disruptive technology, replaces well-established systems, products or even habits because
it has attributes that are far superior. Social media, mobile, wearables, Internet of Things, real-time —
are some of the technologies that are disrupting markets. Professor Clayton M. Christensen, at the
Harvard Business School, first coined the term “disruptive technology” in his paper in 1995. Recent
disruptive technology examples include blockchain, e-commerce, and ride-sharing apps.

In the face of disruptive technology, firms are undergoing digital transformation and leverage digital
technologies to adapt and innovate, trying out new ways of delivering services. Such
transformation focuses mainly on customer behaviour and is not simply about technology, as it seeks
to improve customer experiences and customer-firm relationship.

Disruptive technology spurs new demand and encourages the creation of new products. Disruptive
technologies also led to the emergence of a larger number of innovation and technological startups.
One prominent example would be of the Singapore-based ecommerce site Lazada. Among a rising
trend of online retail startups, Lazada is leading the Southeast Asian market with more than SGD$1
billion yearly revenue, whereby mobile terminals accounts for more than 60% of its transactions. As the
COVID-19 pandemic reshaped consumer behavior, online retailing saw a sudden boom fueled by
national lockdowns and increasing number of consumers avoiding physical stores.

An acceleration in adoption of disruptive technologies, primarily in emerging countries, can be

driven by economic shocks such as the Covid-19. With such ease of browsing for goods and
services at one’s fingertips, use of disruptive technology can help firms to increase demand for
their goods and services, increasing total revenue and hence profits. Hence, consumers who have
been exposed to online group buying of agricultural products, foods, online price comparison platforms,
ride-hailing and bike sharing services, are expected to increase their demand further. Furthermore,
disruptive technologies enables firms to differentiate their products and services significantly,
reducing the degree of substitutability of their products to that provided by the rivals, hence
increasing market their power and limiting competition, enabling them to command a high price for their
products/services.
For example, e-commerce platforms such as Shopee, Lazada and Amazon that have a large numbers
of users have expanded into e-payments, while online mobility platforms have expanded into online
delivery. Such opportunities will allow these incumbents to acquire start-ups at the early stages,
potentially limiting competition. Moreover, Big Data analytics play a key role in helping firms optimise
revenue strategies in a changing and diverse global economy. Firms can use Big Data analysis to better
cater to the diverse cultural preferences and sensitivities to capitalise on the rapidly growing consumer
market.

Firms can also digitilize their operations to cut costs and use information and communication
technologies to enable remote work, supply chain management, and an online relationship with clients
(World Bank, 2020). Application of disruptive technologies increase competitiveness of existing
industries, like Radio frequency identification (RFID), and the rise of e-commerce can be greatly
beneficial to firms in improving the efficiency of supply chains. Producers can tighten their supply
chains to avoid accumulating inventories and minimise their losses.

However, disruptive technology can lower barriers to entry significantly, smaller firms that have fewer
resources to enter and target segments of the market that have been neglected by the main
industry players, allowing it to compete. Disruptive innovation also reduces exit costs significantly
for potential entrant that no longer need to spend significantly on the set-up cost to sell their goods and
services. For example, with the increase in demand for restaurant-quality meals delivered to one’s
home, there is an emergence of delivery only kitchens known as “cloud kitchens or ghost kitchens”.
These are food preparation operations with no waiters, no dining room and no parking lot. In other
words, these kitchens have no physical presence at all. With minimal entry and exist costs,
disruptive technologies have increased contestability in the F&B industry. Currently, there are
about 7,500 cloud kitchens now operating in China and 3,500 in India.

Hence, disruptive technology removes barriers to entry and lowers entry cost into a market,
weakening the position of established players and giving new firms space to grow. As a result,
with the use of disruptive technology, markets are likely to become more competitive and to a certain
degree contestable, reducing the market power and profitability of big firms such as Amazon and
Lazada. Meanwhile, firms that are slow to respond to disruptive technology or leverage on it are
likely to be phased out over time. For example, Nokia invented its first smartphone in 1996 but failed
to update its software to remain relevant by including apps and ignored the changes that followed.
Similarly, Blackberry failed to respond to changing consumers’ needs and wants. In 2017, it exited the
market for smartphone. Traditional television distribution are also increasingly being driven out by digital
distribution providers such as Netflix and Hulu with more people consumers opting for streaming
services.

Case Study: The Banking and Financial Sector

During the pandemic, the financial and banking sector transformed the way it delivered its services.
Bank leveraged on disruptive technology to remain profitable by introducing digital options to provide
services as well as digital assets. Leveraging on disruptive technology allowed banks to retain or
increase demand for their services and hence total revenue. However, more importantly, it allowed
banks to undertake branch consolidation to cut costs and leverage on their digital channels for running
business since consumer behavior has changed deeply. Furthermore, banking processes that are
repetitive are being replaced by robotic automation and artificial intelligence, known as “smart
automation” or “intelligent automation”. With a fall in average and marginal costs and increase in
demand, firms could see significant rise in their profits by leveraging on disruptive technology.

However, the banking industry face greater competition from other intermediaries, increasingly digital,
in their core business such as payment and advisory services. Disruptive technologies have given rise
to the FinTech sector, which is essentially the use of innovative information and automation technology
in financial services. As such, digital technologies have a large impact in terms of increasing competition
and contestability in the banking industry, forcing older incumbents like POSB, Deutsche Bank,
Santander and Barclays to restructure the way they provide services to their customers. Digital
disruption provides opportunities to potential entrants and rivals opportunity to improve efficiency with
innovation, increasing pressure on the profit margins of the incumbents. Incumbents that are still over
reliant on overextended branches, they will continue to lose their customers, in particular, the younger
generations who prefer to bank with their mobile phones, to those that have adapted well to the digital
revolution.

5. Limitations of the Model

One of the main criticism of the Porter’s Five Forces Model is that it may not be relevant in current
times. According to Isabelle et al (2020), the framework was developed at a different time that was
largely characterised by strong competition, stability in markets and steady technological
changes. Furthermore, the model fails to recognise the possibility of strategic alliances between
firms and relies heavily on traditional approach of assessing competition and viewing competition.

However, today, with technological disruption, the way firms and consumers interact with one another
has completely changes and the speed at which the transactions are made. Firms tends to operate
in a high competitive environment today with low barriers to entry. They are exposed to constant
changes and thus need to be aggressive and dynamic in their responses to survive in an
industry. This leads to high degree of market instability. Hence, with every changing business
environment as observed today, the Porter’s Five Forces framework has limited usefulness in enabling
firms to understand on how to gain competitive edge or measure the degree of competition in an
industry. As such, critics argue that Porter's Five Forces framework is too static, and hence omits
changes in the competitive environment (Thyrlby, 1998; Grundy, 2006) such as the drivers of
internationalization.