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Porter’s Five Forces: Value Chain and Balanced Score Card

Critically evaluation of Porter’s five forces, Value Chain Analysis, Balanced Scored Card

Given the demands of today’s competitive and dynamic environment, it is quite challenging to understand strategic issues facing organizations and develop the capability for long term organizational success. This report aims to present a critical analysis of three frameworks across organizations: Porter’s Five Forces, Value Chain and Balanced Scorecard. Such critical evaluation includes identifying the benefits and limitations of three frameworks and considering some implementation issues within organizations.

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As powerful strategic management tools, Porter’s Five Forces, Value Chain and Balanced Scorecard frameworks are linked and interacted with each other in a wide circle of business in context. Porter’s Five Forces and Value Chain both help strategic managers to make decisions on the basis of the organization’s external environment and internal analysis. The two frameworks are especially valuable for managers to develop and implement a long-term strategy for organizations so as to build and maintain competitive advantages in the long run. And Balanced Scorecard can ensure and monitor the executions of strategy made by managers in a set of well-structured measures.

However, beyond the linkage between them, these three respective frameworks do have its own particular emphasis which is applied in different directions among organizations. Porter’s Five Forces mainly focuses on the industry structure analysis in the organizations external environment. It reveals the source of competition in an industry and external influence including the threats and opportunities of the industry that an organization has to face to obtain competitive advantage. Value Chain highlights the explorations of internal analysis of a chain of business activities.

It explores the role and contribution of an organization’s resources corresponding to primary and support activities in a cost-effective way to gain a cost advantage. As for the Balanced Scorecard, it emphasizes the evaluation of organizational overall performance by integrating financial measures with other key performance indicators. And measuring overall performance in an organization’s balanced scorecard is directly linked to its strategy to make profits in the long run.

All in all, it is important to be aware of their benefits and weakness as well as the potential problems of three approaches when applying them real business operations, and it largely relies on successful implementation by senior managers in organizations.

Introduction In today’s dynamic and competitive business environment, survival, growth and profitability are the essential goals of all industries. Nowadays, Porter’s Five Forces, Value Chain and Balanced Scorecard frameworks are currently being adopted as the powerful management tools of choice by many organizations.

The essence of these three frameworks is that they can help senior managers to make the right decision and build and sustain competitive advantages in the organization level. This report presents the overview approach of these three frameworks across organizations. And critical evaluation of three frameworks mainly focused on identifying the benefits and limitations of three frameworks and exploring some perceived issues or problems regarding implementation. Finally, the linkage and dissimilarities between the three frameworks are concluded in the last section of this report.

Porter’s five forces, as a powerful analysis tool, enables managers in corporations to analyze the current situation of their industry in a structured, easy-to-understand way. From a strategic management perspective, it is useful for managers in any organization in the same industry or sectors to understand the five competitive forces acting on and between organizations in the same industry and or sector since this will determine the attractiveness of that industry and the way in which individual organizations might choose to compete( Johnso and Scholes, P.116).

2.1 Claimed benefits

First of all, Porter’s five forces framework provides one simple approach to analyze industry structure. The five forces analysis helps in identifying and determining the attractiveness of an industry, the source of competition. And because Porter’s five forces reveal insights on profitability, it can inform important decision decisions about whether to leave or enter industries or sectors.

Moreover, the model can be used to compare the impact of competitive forces on the own organization with their impact on competitors. Competitors may have different options to react to changes in competitive forces from their different resources and competencies (Pearce and Robinson, P.92). This may influence the structure of the whole industry.

The five forces framework can be used to gain insight into the forces at the work in the business environment of a strategic business unit which needs particular attention in the development of the strategy. Porter’s five forces framework is of great importance in developing strategic options to improve relative performance in the industry or influence relative position in the industry. (Johnson and Scholes,P.119). Because strategic choices need to take account of the external environment especially pay attention on Porter’s Five Forces in which the organization operates: competitive advantage may be eroded as substitute products due to technology changes or as new competitors enter the market.( Porter, 2001)

For example, a leading manufacturer of vacuum tubes with a strong position in the electronic product industry unthreatened by potential entrants will gain low returns if it competes with silicon chip or new semiconductors. In this circumstance, how to compete with the substitute product becomes the first strategic priority for the leading manufacturer of vacuum tube to maintain a competitive advantage.

And another value of five forces is as a thought provoking theory to help strategic managers arrive at a shared understanding of the threats and opportunities facing the firm to gain competitive advantage (Porter, 2001). Within Porter’s framework, a strong competitive force can be viewed as a threat since it depresses profits. And a weak competitive force can be regarded as an opportunity for organizations to earn great profits. The strength of the five forces may change through time because of factors beyond a company’s direct control. In such circumstances, it is crucial for managers to recognize opportunities and threats when they arise and formulate appropriate strategies to alter the strength of one or more of the five forces to its advantage (Hill and Jones, 1995).

The Porter Five Forces Analysis offers a good explanation for the profitability of an industry, and the firms within it. That’s why the framework becomes a useful analysis tool to analyze a company is able, or unable, to make a decent profit. The collective strength of the five forces determines the ultimate profit potential of an industry (Pearce and Robinson, P.92) It arranges from intense in the industry like steel metal cans, where no company gain considerable returns on investment, to mild in industries like oil-field services and equipment, soft drinks, and toiletries, where large spacious room exists for quite high return.

2.2 Potential limitations

It is important to be aware that this model, though a powerful structure for discussion, Porter’s Five Forces Model has some major limitations in today’s market environment. One of the criticisms of the five forces is that it assumes relatively static market structures. In fact, Porter’s Five Forces Model mainly base on the economic situation in the eighties characterized by strong competition and relatively stable market structures. It is not able to take into account new business models and the dynamics of markets which implies that this model is hardly still applicable in the current rapid change market (Prahalad and Gary, 1990). Nowadays competition is dynamic and hence industry structure changes.

Today’s markets are highly influenced by technological progress, especially in information technology. Technological innovations and dynamic market entrants from start-ups will completely change business models within short times. For example, the computer industry is often considered a highly competitive industry. Such industry structure is constantly being revolutionized by innovation. It this case, the five forces model is of limited value since it represents no more than snapshots of a moving picture. Therefore, it is not advisable to develop a strategy solely on the basis of Porter’s models (Prahala and Gary, 1990).

Another limitation of the five forces is that it provides a good framework for analysis but does not really consider issues around implementing changes to reposition for strategic advantage. Partly because of five force’s simplification of complex relationship such as in the structure of networks and cluster, new strategies such as strategic alliances, electronic linking of information systems of all companies along a value chain, virtual enterprise-networks, to some extent, impair the applicability of the five forces as it used to be(Prahalad and Garyl, 1990).

What’s more, this model also overemphasizes the importance of industry structure as a determinant of company performance and underemphasizes the importance of differences between companies within an industry (Hill and Jones, 1995). The model focuses on an industry as a whole, not on individual firms. Actually, there can be vast variance in the profit rate of individual companies within an industry. Recent research shows that industry structure explains only about 10 percent of the variance in profit rates across companies, suggest that individual resources and capabilities of a company are far more important determinants of its profitability than is the industry.

A company will not be profitable just because it is based in an attractive industry. (Hill and Jones, 1995) 2.3Implementation issues within organizations Some issues during the implementation of these five forces are crucially important for organizations to build long-term business strategies and sustaining competitive advantages rather than simply list the forces.

Successful use of the Porter Model Analysis includes identifying the sources of competition, the strength and likelihood of that competition existing, and strategic recommendations for the action a company should take to develop barriers to the various forms of competition (Prahalad and Gary, 1990). With the realization of the intensity and power of competitive forces, organizations can develop options to influence them in a way that improves their own competitive position. The result could be a new strategic option, e.g. a new positioning; differentiation for competitive products of strategic partnerships.

Porter’s Five Forces can be applied to particular companies, market segments and industries with the step-by-step analysis of the market structure and competitive situation. First of all, when implementing this module in organizations, it is necessary to determine the scope of the market to be analyzed. Following, all relevant forces for this market analyzed and key forces are identified (Gerry and Kevan, P.117). Actually, some organizational strategies and longer-term goals are mainly based on or consistent with the key forces.

Hence, it is not necessary to analyze all elements of all competitive forces with the same depth. Moreover, the key forces in the competitive environment will vary in different industries. Different forces take on prominence in shaping competition in each industry (Porter, 1980).In the oceangoing tanker industry, the key forces are the buyer, while in the steel industry the key forces are foreign competitors and substitute materials. That is also an important consideration when applying Porter’s Five Force into organizations.

The importance of the Value Chain as a tool is that it shows the contributions from different functions of an organization in the value-adding process. At its simplest, it integrates both the process steps for a customer delivery and the various functions in a company that enables the delivery at different stages (Walters, P.132).

3.1 Claimed benefit

Just as it was helpful to use Porter’s Five Forces model as a framework to analyze industries, Porter’s Value Chain is an effective tool to understand, at a high level, how each of internal business activities adds value to organizations by dividing a business into strategically relevant activities. And it enables senior executive to identify the source of competitive advantage by performing these activities in a cost-effective way or better than its competitors.

As a very powerful cost management tool, the value chain attaches great benefits to making a detailed analysis of a company’s cost position to obtain the cost advantage. It makes a good attempt to understand the behaviour of costs across a chain of activities to determine where low-cost advantages or cost disadvantages exist. Because a series of these activities is to create value that exceeds the cost of providing the product or service, and maximize the profitability of company’s business activities in a sustainable manner(Richard and Ramirez, 1993). Using the value chain to analyze costs to identify firm’s strengths and weaknesses is much more useful than traditional cost accounting protocol that most companies are still utilizing.

The value chain also offers opportunities to reach better outsourcing decisions. A linkage exists if the performance or cost of one activity affects that of another. Competitive advantage may be obtained by optimizing and coordinating linked activities. Understanding the linkages between activities can lead to more optimal make-or-buy decisions that can result in either a cost advantage or a differentiation advantage (Herger and Morris, 1989).

The value chain is also helpful to analyze the inner workings of competitor organizations in order to upgrade organizations’ performance. By understanding an organization’s advantages compared to other competitors, the value chain can aid organizations in designing products and systems that will maintain an advantage within the competitive arena. In general, organizations can then use this framework to identify one of the key competitors and then analyze as many competitors as necessary or appropriate for relevant situations.

3.2 Potential limitations

Although the value chain is a very powerful management tool to identify the source of competitive advantage by performing a chain of activities in a cost-effective way, there has also been some potential weaknesses in using this managerial tool. Such limitation includes calculational difficulties for small-sized corporations, ignoring the importance of information to maximize value.

The value chain is a very powerful cost management tool to make a detailed analysis of a company’s cost position to obtain a competitive advantage. However, it doesn’t imply that constructing a value chain is quite easy process. Complex calculational difficulties between a series of value-adding activities would be a potential problem to apply this framework, especially for small-sized organizations. There are several thorny problems to confront: calculating a value for intermediate products, isolating key cost drivers, identifying linkages across activities, and computing supplier and customer margins (Hwang and Richard, 1999).

Another weakness of value chain is that it ignoring the power of information to maximize value for organizations. In recent years, with the emergence of information technology, recognition that IT can add value for the customer while simultaneously reducing the costs of producing an end product or service has revolutionized the role of technology and information in organizations, (Porter & Millar, 1985).

The application of the physical value chain model to most organizations seems relatively slow and inefficient in such a rapid change environment. While more and more use of information component of any process advances faster than the physical counterpart. Especially in creating added value for customers.

The main reason is the power of information is such that it provides opportunities for organizations to establish a virtual value chain in addition to any pre-existing physical value chains. And new established virtual value chain creates value not only through a physical value chain involving the creation of physical goods but also with analyzing and utilizing information. Therefore, the traditional value chain in the current information systems field may as well take the information into very consideration to meet the requirement of new economics.

3.3 Implementation issues within organizations

The value chain is applicable from a corporate strategic level to the individual managing a project. Because of its inherent logic of the process flow, it can be used to analyze most business processes where there are different inputs, outputs and transactions. One straightforward implementation of the Value Chain is the SIPOC analysis (often used in Six Sigma Quality).

This takes the Value Chain as: Suppliers – Inputs – Process – Outputs – Customers to evaluate how organizations generate revenues and control costs while enhancing customer satisfaction. Once the value chain is established, other business analysis tool such as SWOT analysis, Marketing Mix can be applied to each stage and to each functional group contributing to the value (Walters, P.125) Successfully implementing value chain activity in management undoubtedly would strengthen a company’s competitive advantages.

More specifically, organizations must perform different activities than competitors or perform similar activities in different ways tailored to their unique value proposition so which makes them difficult for competitors to imitate linkages between value-adding activities. Information on cost distribution, cost allocation bases, and the relationship of value chain costs and degree of cost tracing is essential to manage value chain activities successfully. (Hwang and Richard, 1999)

To succeed in today’s competitive business environment, corporations need to undertake value chain analysis and select an optimal mix of value chain activities (Hergert and Morris, 1989). One problem when applying cost analysis of the value chain into business operation should be avoided. The company’s own value chain should not be considered in isolation because value-creating activities are linked each other inside the organization.

Such linkage exists if the performance or cost of one activity affects that of another. Decreasing the costs of one activity can lead to an increase in costs in other activities. Therefore, the costs of activities should not be reduced independently. To achieve a competitive advantage, organizations should make cost analysis of the value chain and coordinate and optimize linked activities together instead of viewing them as separate and independent cost centers(Walters, P.125).

In addition, it is important to be aware that organizations are just part of a wider system of adding value, involving supply chains, distribution value chains and customer’s value chain. By managing the whole value system and co-operating with suppliers and distributors, the entire process – from raw materials to the end product – can be optimized, thus creating greater value and/or less costs. This way competitive advantage can be achieved (Hergert and Morris, 1989).

All in all, with the recognition of the value chain’s claimed benefits and potential weakness stated above as well as some implementation issues, if the organizations can properly adopted the value chain theory, it may assist organizations to explore the role and contribution of its resources which would maintain sustainable competitive advantage in the long run.

Developed at the Harvard Business School, the Balanced Scorecard is an organizational framework for implementing and managing strategy at all levels of an enterprise by linking objectives, initiatives, and measures to an organization’s strategy. The scorecard provides an enterprise view of an organization’s overall performance by integrating financial measures with other key performance indicators (Walters, 2002). Nowadays Balanced Scorecards have been implemented at corporate, strategic business unit, shared service functions, and even individual levels at hundreds of organizations–in both the private and public sector.

3.3 Claimed benefits

Kaplan and Norton also state: “The scorecard brings together in a single report many of the disparate elements of the company’s competitive agenda, e.g. becoming customer orientated, shortening response time, improving quality, emphasizing team-work, reducing new product launch times and managing for the long term.” (Kaplan and Norton, P.68)

A clear strength of the Balanced Scorecard was that of being an easily understood concept. It summarizes in a single, succinct document, four different perspectives on the company’s performance. Viewing the strategy from the four different perspectives, and identifying by links between them, clearly illustrated the causal relationship between the fulfilments of customers and employees expectations and those of shareholders.

The use of the Balanced Scorecard has been attached of considerable benefit as a strategy implementation system for connecting long-term strategic planning and short-term action and budget planning (Ahn, 2001). In this regard, the strategic programs were translated into individual actions oriented towards the attainment of the objectives pursued.

For example, determination of employee’s need with regard to job satisfaction as the individual actions derived from the encouragement of job rotation as strategic programs of the potential perspective. Moreover, a wider range of participants that greatly outnumber the Balanced Scorecard team members were involved in order to determine individual actions, as they have a significant influence on the company’s daily life and on operational processes.

In reality, a Balanced Scorecard is a useful tool that helps the management to better communicate the strategy, to prioritize and motivate the teams to common and longer-term goals. Its logical structure and the strong tie of actions to the strategic goals enabled the employee to set the mind of longer-term objectives and understand the company’s goals so as to recognize their contribution to achieving them. So the Balanced Scorecard emphasizes teamwork in nurturing employee’s commitment to delivering results that are consistent with longer-term goals and organizational strategy (Mooraj and Oyon and Hostettler, 1999).

Although the Balanced Scorecard doesn’t bring about improvements in long-term competitiveness and profitability incorporation, it gives top managers a fast but comprehensive view of the business which is conducive to the long-term health of the business in a competition context. In fact, setting ambitious long-term objectives or short-term objectives followed by an overall list of initiatives for each measure in organizations has proven to be the key drivers to improve overall performance (Mooraj and Oyon and Hostettler, 1999).

3.4Potential limitations In spite of the Balanced Scorecard’s great success in measuring the company’s performance, there have also been some potential weaknesses in using this management tool. Such limitations include taking too much time recording and monitoring data for the measures, overlooking the employee’s acceptance, not considering supplier’s contribution etc.

One of the problems which occurred in using the Balanced Scorecard mainly focused on recording and monitoring the overloaded measures (Ahn, 2001). Top management spends a great amount of time energy in gathering and analyzing the respective data rather than on making decisions. Sometimes the costs of such a procedure may well outweigh improvements in organizational performance. Hence, it is quite necessary to plan to substantially cut down the number of measures existing in organizations that are outside the scope of the Balanced Scorecard (Kaplan and Norton, 1992).

The question of whether the employees in organizations would be open and receivable to new measures when the numerous measures have already existed proved to be another problem and consideration had to be given as to which of the measures recorded to date should continue to be recorded in the future. One possibility considered to reduce the effort required was to handle them as ‘diagnostic measures’ in the sense that they are only presented to the management when their values exceed a given range (Ahn, 2001).

Moreover, Kaplan and Norton’s Balanced Scorecard concept does not give sufficient guidelines regarding structure. However, the structure of the Balanced Scorecard can be criticized in that the four perspectives have to be translated into the specific needs of individual companies (Johnson, 1998). Potential shortcomings might include, for example, that suppliers are not adequately taken into account or that the financial goals lose too much importance when competing with three or even more other perspectives.

3.5 Implementation issues within organizations

The scorecard has currently been adopted by many companies and its format and content match to meet several management needs. Examples of users include Intel and Apple computers; BP Chemicals, Milliken, the Nat West Bank, Abbey National.

When implementing the Balanced Scorecard to measure organizational performance, there are some potential problems that should be taken into considerations as followed: Lack of a well-defined strategy: The first problem that many companies encounter is that top management can’t articulate a clear and well-defined strategy (Johnson, 1998). In some cases, the strategy is not clear.

In other cases, the member of the top management team holds a different view on the strategy of the firm or what it should be. However, a Balanced Scorecard relies on a well-defined strategy and an understanding of the linkages between strategic objectives and the metrics. Without this foundation, the implementation of the Balanced Scorecard is unlikely to be successful (Johnson, 1998).

Using only lagging measures: Many managers believe that they will earn the benefits of the Balanced Scorecard by using a wide range of non-financial measures. However, a successful scorecard must be comprised of not only the lagging indicators that describe past performance, but also leading indicators that can be used to drive and improve performance for future plan For example, in a logistics analysis system, ‘customer complaints’ is a lagging indicator, while ‘on-time delivery’ is a leading indicator. A successful balanced scorecard must include metrics that provide both historical and future insights (Ahn, 2001).

The process of building and implementing a Balanced Scorecard must be customized. Applying another successful firm’s Balanced Scorecard development process as a guideline may be helpful, but it also increases the risk of overlooking the company’s own competitive position (Walters, 2002). It is essential to realize that the competitive advantages can only be taken adequately into account by establishing a Balanced Scorecard unique to the company involved.

As Kaplan and Norton (1996) state “the balanced Scorecard is not a template that can apply to a business in general or even industry-wide. In particular, the specific content of the four original perspectives of the Balanced Scorecard must be individually adapted to the circumstances of each organization”. (Kaplan and Norton, 1992) Each firm should put forth the effort to identify the measures that are appropriate for its own strategy and competitive position.

In conclusion, Porter’s Five Forces, Value Chain and Balanced Scorecard framework are all effective and powerful strategic management tools in a current dynamic and competitive environment. The linkage between them is that they are all attached considerable importance for managers in organizations to develop and implement the long-term strategy so that sustainable competitive advantages are built and maintained. And these three frameworks are useful tools to make changes and adjust strategy to face up the intensive competition in the current dynamic marketplace.

However, these three respective frameworks have their own particular emphasis which is applied in different directions among the organization. Porter’s Five Forces mainly focuses on industry structure analysis in the organization’s external environment.

While Value Chain highlights the internal analysis of a chain of business activities. As for the Balanced Scorecard, it emphasizes the evaluation of an organization’s overall performance to gain a cost advantage. All in all, it is important to be aware of the limitations and potential problems as well as the possible benefits of these three approaches, it largely relies on successful implementation by senior managers.

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