Original citation: Kunc, Martin (2010) Revisiting Porter’s generic strategies for competitive environments using system dynamics. In: Computational analysis of firms' organization and strategic behaviour. Routledge Research in Strategic Management. London : Routledge, pp. 152- 170. Permanent WRAP url: http://wrap.warwick.ac.uk/58353 Copyright and reuse: The Warwick Research Archive Portal (WRAP) makes this work by researchers of the University of Warwick available open access under the following conditions. Copyright © and all moral rights to the version of the paper presented here belong to the individual author(s) and/or other copyright owners. To the extent reasonable and practicable the material made available in WRAP has been checked for eligibility before being made available. Copies of this item can be used for personal research only without prior permission or charge. 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For more information, please contact the WRAP Team at: [email protected] http://go.warwick.ac.uk/lib-publications Porter's Generic Strategies for Competitive Environments 153 try to satisfy with the most convenient product at the best possible price. 6 Revisiting Porter's Generic Strategies Firms and customers interact over time through a process of adjustment between consumers' requirements and firms' products. While successful for Competitive Environments Using firms grow when an increasing number of customers accept and adopt their System Dynamics products because their products are either different from or cheaper than other competing products, less successful firms have to abandon the indus- try or react by improving their products or reducing the price of their exist- Martin Kunc ing products. The physical structure of any business is important as it imposes oper- ating constraints (practical rules for how resources work and combine to deliver products and services) on managers. However, the effect of oper- ating policies (managers' decision-making processes related to the level of INTRODUCTION coordination and development of activities related to the value chain of the firm) is more relevant to the dynamic behavior of industries because oper- Porter (1998) suggests that not only do investment decisions make it hard ating policies regulate the competitive behavior of firms and, through the to forecast with certainty the equilibrium of industries, but also industries interconnections existing in the market, of the industry. Porter's generic may evolve following different paths at different speeds depending on these strategies intend to be proposals for managing operating policies in decisions. Managerial decision making significantly affects the dynamics a coherent way; e.g., if a firm follows a cost leadership strategy, operat- of firms. Management decisions to meet their strategic goals affect not only ing policies aimed at minimizing costs are key for this firm to achieve their firms but also the system of resources of competing firms, generating profitability. reactions that will influence their own resources in the future. The external In System Dynamics, we can analyze firms in two areas: managerial environment is not completely exogenous but is in part created by managers decision making, and operating policies to control the system of resources. and their decisions. Consequently, firms have to fit into patterns of resource Management, and managerial decision making, is viewed as the process exchanges and competitive actions with other firms in the industry, form- of converting information into action. This conversion process is decision ing adaptive systems embedded in feedback processes. Porter analyzed this making. As Forrester (1994) notes, aspect of competition through the five forces framework (Porter 1998) and suggested generic strategies (cost leadership and differentiation) as a recipe [I]f management is the process of converting information into action, for competing effectively in industries. This chapter explores the effects of then management success depends primarily on what information is business policies based on Porter's generic strategies on the performance chosen and how the conversion is executed. The difference between a of the firm in a competitive environment. The model portrays managerial good manager and a poor manager lies at this point between informa- decision-making processes using the generic strategies described in Porter's tion and action. (1985) competitive strategy: cost leadership and differentiation. The model formalizes managerial decision-making processes, identifying constructs Therefore, the difference between firms' performance and, as a conse- and relationships existing in each generic strategy and transforming them quence of the feedback structure of the industry, the level of competition of into equations in a process similar to the research methodology employed an industry depends on the managerial decision-making processes. How- by Sastry (1997). ever, we cannot deny that this process is influenced by the lens that manag- ers employ to see their firms. In this aspect, Porter's generic strategies are widespread lenses used by many managers to see the positioning of their A FEEDBACK VIEW OF COMPETITIVE INDUSTRIES firms in a competitive environment. In Porter's words: 'Every firm operates on a set of assumptions about its own situation. These assumptions about The concept of industry describes an environment where firms develop its own situation will guide the way the firm behaves and the way it reacts their business supplying similar products or services to customers. Basi- to events' (1998: 58). cally, an industry is a feedback system comprised of firms and a market. In System Dynamics, operating policies are normally represented as pur- On the one hand, firms provide services or products to satisfy customers' posive adjustment of resources through goal-seeking information feedback requirements. On the other hand, customers have requirements that they (Sterman 2000; Morecroft 2002). It is the essence of the feedback view of 154 Martin Kunc Porter's Generic Strategies for Competitive Environments 155 the firm (Morecroft 2002). This process of resource building is the cor- Table 6.1 Differences in Decision-Making Styles Using the Porter (1985) Generic nerstone for the activities grouped into a value chain. Decisions stemming Strategies from operating policies lead to corrective actions intended to close observed Key Issues Cost Leader Differentiation Leader gaps between desired and actual resources necessary to implement generic What is the expected The expected market size is Market size is based on the strategies. Defining and monitoring the gaps (shortages or excesses) in a market size? based on extrapolations of number of consumers that firm's portfolio of resources is essentially an information-processing activ- past market growth rate. the managers expect to ity subject to the practical constraints of bounded rationality (Morecroft attract with the product. 1985a). While every manager has available a large number of information What are the Broad requirements in terms demandingThe consumers in terms are highly of sources to determine an operating policy, each manager selects and uses requirements of of product characteristics, only a small fraction of all available information that is coherent with the potential but highly sensitive to product characteristics and generic strategy selected. customers? price. less sensitive to price. What is the set of Management expects to build Management believes that resources necessary their competitive advantage customers' requirements Describing Managerial Decision-Making Styles to satisfy customers' by improving the efficiency are mostly related to bet- Based in Porter's Generic Strategies requirements and of the existing operations. ter products rather than maintain a competi- Thus, they allocate most of lower prices. Consequently, While the decision-making styles of managers in an industry vary and there tive advantage? their investment to increase management allocates most is not a clear typology, they can be grouped using Porter (1985) generic the effectiveness of their of the investment in the strategies into two main styles: cost leadership and differentiation. operational resources as a development of new prod- The sources of cost leadership are varied and depend on the structure of means to reduce costs. Mar- uct technology as a means ket share is a key goal for to achieve a competitive the industry, but they are generally economies of scale or highly productive the achievement of econo- advantage. operational processes. If a firm can achieve and sustain overall cost leader- mies of scale. However, ship, then it will achieve above-average profits provided