Executive Summary
The oil industry of Saudi Arabia forms a practical situation to which the paper analyses Porter’s Five Forces model. For any industry, the magnitude of each of the Five Forces varies with the industry structure. This paper presents the barriers of entry as a significant force that dictates the market structure in a capitalist economy. The threat of new entrants as a force shapes up the market structure as a monopoly or pure competition. However, the threat of new entrants only forms one consideration for a firm’s strategy to profitability.
Other forces come into play with varied effects on profitability. In the oil industry of Saudi Arabia, the threat of substitutes and the power of suppliers pose a significant threat to firms’ profitability. The Porter’s model explains competition and how strategists should tackle it. Apart from the Five Forces model, Porter also contributes to the strategy field through the ‘value chain’ and ‘generic strategies’ strategic frameworks. Unfortunately, Porter’s contributions are not perfect. They suffer greatly from the dynamic nature of the industry that, in some way, renders the strategies obsolete.
Five Forces Analysis for the Saudi Arabian Oil Industry
Porter’s Five Forces model is a tool used to gauge the profitability of an industry necessary for a business to understand to form its strategy of getting into the industry (Porter 2008). Moreover, existing businesses in the industry also use Porter’s model to remain strategic in the industry (Dyck & Neubert 2009). The oil industry in the world is large. This essay focuses on the oil industry within the Saudi Arabian geographical region. The oil industry incorporates oil and drilling services and oil refining services (Anon n.d.). This essay will use Porter’s Five Forces Analysis model in order to determine the competitiveness of the oil industry in the Saudi Arabian region. An analysis of the Five Forces model looks at how the five key competitive forces influence the industry’s profits (Ahlstrom & Bruton 2010).
Ahlstrom and Bruton (2010) explain that when the five forces are all strong in their influence, then the industry is less profitable for new entrants. On the other hand, the presence of a weak force makes the industry profitable for new entrants. Therefore, a good indication for an attractive industry would be the presence of weak forces within the Five Forces model.
Some exceptional industries or companies still manage to enjoy above-average profits when all Five Forces are strong (Hoskisson et al. 1999). In this essay, we examine critically the oil industry in Saudi Arabia based on the Five Forces model. This analysis will indicate the competitiveness of the industry for the existing players. Also, it will offer insights to new entrant companies on the correct strategy to use in entering the oil industry (White 1986).
The Five Forces model is a tool designed by Porter who defined strategy as the distinction between goals and the instruments companies use to achieve the goals (Roy 2009). The main company’s goals will be how the business is to compete. Secondly, the company will look at its objectives on being profitable, growth, market share and social responsibility among other objectives (Anon 2009). The instruments to be considered include marketing, distribution, finance and control, research and development, and mining capacity (Roy 2009). Porter’s Five Forces are the threat of new entrants, bargaining power of suppliers, the bargaining power of buyers, threats posed by substitutes and the rivalry existing in the industry (Roy 2009). The chart below graphically describes Porter’s Five Force model.
Threat of new entrants
According to Porter, the best position for a firm is that it enables it to influence the Five Forces in its favor. To make the firm’s product a monopoly, a firm uses any aid such as patents and specialized services that raise the barriers to entry for other firms. Another way of raising barriers to entry would be for the firm to sell its products at a very low price such that potential competitors find it hard to enter the market profitably. Competition strategy, in this case, would be a balancing of the total value of the company product and market share (Chen, Chong & Chen 2001).
The reality of firms in any industry is to try to compete by being innovative. They create new technologies that essentially alter the competitive advantage of existing firms. It is not adequate to only use a quantitative measure such as Porter’s to evaluate the threats posed by new entrants. A qualitative approach would consider the intangible aspects of competition. For example, a behavioral approach would consider a firm being superior to a market (Hoskisson et al. 1999).
Therefore, it would count to extend arguments beyond economic rationality and use the theory of organizational knowledge in its humanistic form (Nonaka 1994). In this regard, a threat of new entrants will also matter on grounds of a need to have a voluntary community action within organized structures that extend beyond individuals (Nonaka 1994). Thus unless firms are aware of their social complexity, their strategy against the entry of new firms cannot be sufficient in the long term (Hoskisson et al. 1999).
The power of suppliers
By Porter’s strategy of positioning the firm at an advantaged position, firms intend to have the power to discriminate their markets and retain a considerable bargain power with their suppliers. As a result, they organize their supplier relations so that many suppliers are pitting against each other (Chen, Chong & Chen 2001). Under ideal Porter’s conditions, firms would strive to make their suppliers market a pure competition so that they enjoy the freedom to choose the lowest prices. Unfortunately, in the oil industry, mining and refining firms have a limited influence on the equipment supply industry. This mainly results from the fact that there are a limited number of suppliers already enjoying the benefits of Porter’s Five Forces model (Porter 1985).
Porter assumes that economic fundamentals hold for every principle influences all industrial organizations equally (Hoskisson et al. 1999). In this manner, his strategy proposal for dealing with suppliers’ power uses a structure-conduct-performance paradigm by Bain (Bain 1956). Thus porters theory focuses on the economic concepts for a whole economy, which fails to account for the intricate differences that exist in specific industries (Hoskisson et al. 1999).
Power of buyers
There exists no significant buyer power in the Saudi Arabian oil industry. Most of the crude oil mined in Saudi Arabia is heavy when compared with international standards. Crude oil mined in Saudi Arabia mainly exported before. According to Porter’s five forces, the players in the oil industry have no option of product differentiation to influence oil prices (Porter 2008). However, new research points out the increasing number of ways in which technology is assisting in product and service delivery thus creating differentiation among firms (D’Aveni 1994). The use of Porter’s five models in analyzing buyer power is insufficient because, in a global market, positions and competitive forces for firms are more complex for a single theoretical framework fit (Hoskisson et al. 1999).
Availability of Substitutes
This Force looks at the potential of a different product taking up the market share of a firm by offering the same utility. Substitutes to the oil industry include alternative fuels used in the region that traditionally import oil from the country (Hordeski 2008). These alternatives include coal, gas, hydroelectricity and even nuclear energy. Oil drilling companies directly feel the effects of oil substitutes because they reduce the overall demand for oil. Meanwhile, oilfield service companies can substantially absorb shocks posed by oil substitutes because their immediate market is the oil drilling companies. When the substitutes lead to the abandonment of oil drilling, the oilfield service companies then feel the effect as their primary market disappears (Investopedia n.d.).
Voices against global warming linked to the emission of greenhouse gases have laid the blame squarely on fossil fuels such as oil and coal. To remedy the situation, most countries in the world are looking into alternative fuel sources as primary energy sources. The increase in the rate of development of alternative fuels such as biofuels lowers the global demand for oil and threatens the existence of oil industries; the Saudi Arabian oil industry in not exempted (Schyndel 2007).
Competitive rivalry
Competitive rivalry happens as firms within the industry enhance their competitive advantages in order to increase their market share. The government of Saudi Arabia has significant stakes in the oil companies in the country and controls the total oil production of the industry. In this regard, there is little rivalry between the oil drilling companies and oilfield service companies in the country. Each company acts according to the government’s directive on oil production (Schyndel 2007).
Porter’s strategic analysis of competition uses the analogy that firms only act as administrative units whose behavior is predictable with changes in their industry (Hoskisson et al. 1999). Another theory on the growth of the firm views firms as collections of disposable productive resources (Penrose 1959). According to Penrose (1959), the originator of the theory of the firm, each firm is heterogeneous and has unique ways of interacting with material and human resources in affecting firm performance. Thus, even though within an industry there may only be a few firms, this does not provide a conclusive indication of the degree of rivalry present. Each firm’s administrative strategy to handle resources affects the overall rivalry of the industry.
The Most Important Forces for Organisations in the Saudi Arabian Oil Industry to Consider
In any industry, Porter’s Five Forces do not have an equal power of influence on a firm’s profitability. Organizations operating in the oil industry of Saudi Arabia have to consider the power of suppliers and the threat of substitutes. The main reason for the increased importance of the two forces is that a change in one or both can lead to the wiping out of existing firms by rendering them uncompetitive (Hoskisson et al. 1999). Suppliers hold the power of fixing their prices at a level that renders the cost of the purchase to high for any profit margin; on the other hand, substitutes present the threat of making firm’s products irrelevant in the market (D’Aveni 1994).
These two form the most crucial forces that affect the profitability of each organization in the industry (Dyck & Neubert 2009). The market for drilling equipment is a seller’s market (Clancy 1999). When few sellers dominate the market, the buyers suffer severely in the form of high equipment costs that depress their profitability. In the oil industry, organizations of Saudi Arabia make a sample of the global oil industry. They are akin to a parasite whose existence depends on the tolerance of their host and the health of the host. In this case, organizations depend on the capacity of global equipment suppliers to meet the global demand. In addition, the organizations are at the mercy of equipment manufacturers to hasten the response to their equipment order. Clancy (1999) uses the metaphor presented above to explain the power that few dominant suppliers have control over the market of a given industry.
Other than equipment suppliers, the highly skilled oil industry depends on a limited labor supply. Labour supply of the oil industry in Saudi Arabia comes mainly from within the country and from neighboring countries in the Middle East. The main competitors for the required skilled labor in the oil industry are other oil-producing nations within the region. These are Iran and Iraq whose demand for skilled labor for the industry has not been growing (Anon 2007).
The stagnation of the two countries’ skilled labor demand is due to the political uncertainty that has frozen developments on new oil-producing capacity development. On a cultural front, Saudi Arabians have a strong negotiating power that allows them to win over supply contracts at lower prices (Anon 2007). The sums saved on contract negotiations fill the increased cost of skilled labor. The relatively high supply of skilled labor arising out of the suppression of competing industry is not permanent. Iraq and Iran can decide to expand their production capacities at any time. A limited supply of labor would then likely force the existing organizations to increase their compensation terms to avoid a high skilled labor turnover.
In analyzing the threat of substitutes, we consider the driving forces to alternative fuel sources. The main driver is the impending cessation of the global oil reserves. As the global oil reserve diminishes, nations direct more funds to research and development of alternative fuels to sustain their energy demands. Saudi Arabia has one of the largest discovered oil reserves in the world. In 1987, the country had about 80 billion barrels in confirmed reserves. Costs of oil exploration and development of new wells have reduced in recent years (Shavinina 2003).
The reduction in cost has also increased the development of new oil fields to ease the supply concerns of oil. As a result, most of the panic attributed to the ‘end of oil’ has ceased (Hordeski 2008). However, the threat of global warming has surfaced in its place to influence nations on diversification from the use of fossil fuels. As nations move into reliance on substitutes, they reduce the global demand for oil. Thus, organizations in the Saudi Arabian oil industry need to be wary of alternative energy sources because they directly influence the price of oil, hence their profitability. This is a long-term concern; the government of Saudi Arabia has signed purchase contracts that fix prices for the short-run.
To sum up, the organizations operating in the Saudi Arabian oil industry have to consider their ability to withstand the monopolistic powers harbored by equipment and skilled labor suppliers. Also, the threat of substitutes is real; however, its effect exists in a long-term projection.
Wider Contribution of Michael Porter to the Field of Strategic Management
The Five Forces model by Michael Porter on strategic management is his major contribution to the field of strategic management. Porter’s contributions help to advance the strategy theory. He gives a breakdown of how strategists are to work by explaining competition and how to cope with it (Porter 2008). In this section, this essay analyses the value chain as presented by Porter, on competitive strategy. It highlights the inadequacy of Porter’s work in today’s industry structure.
Porter brings economics into strategic planning focusing on industrial analysis as the focus of the strategy. To add on the five forces to consider by strategists, Porter gives insights on how companies can maintain a competitive advantage without altering the industry structure (Porter 1985). His contributions refer to the rational thought that strategists must have in analyzing an industry. He explains that the structure of the industry in more important than other attributes such as its growth rate. Porter’s contribution to the strategy theory falls under the classical theory because he presents a deep influence of economics (Anon 2009).
The value chain, just like the five forces model, is now a standard tool in strategic management. It emphasizes on the actions that an organization should undertake so that it remains competitive in its industry. Falling under the classic theory of strategic management, the value chain model follows the structure-conduct-performance paradigm of industrial organization (Teece, Pisano & Shuen 1997).
In the value chain, the strategist looks at the individual contribution to the organizational value that each activity adds. Since the value chain model have several activities that may appear distinct, Porter presents their relationship by including linkages that allow the organizational system to function smoothly. These linkages include information, goods, services, and the processes used to adjust the primary and secondary activities (Recklies 2001).
Another contribution of Porter was the generic strategy concept. Porter explained that firms derive strength from their cost advantage and differentiation. Firms may apply the strengths on a broad or narrow scale. According to Porter, the universality of the strengths makes them strategies since they cannot be limited to a specific firm or industry (Whittington 2001). There exist two strategies that a firm can employ. Cost leadership is one of them while differentiation is the other. Porter implies that they arise out of an impressive analysis of the industry preceding them. Porter relied on the classical theory in advancing his firm’s structure in relation to its industry (White 1986).
Porter provided the foundation for the current research on the competitive dynamics of firms. Moreover, Porter is responsible for the introduction of econometric tools for use in the construction of the firm’s strategy (Hoskisson et al. 1999). Porter’s contributions to the field of strategic management-led its significant realignment from a marketing and administrative behavior to an economic one (Hoskisson et al. 1999). Porter brought a scientific methodology using hypotheses on models. Before Porter, strategic management research used inductive case studies on individual firms and industries (D’Aveni 1994). Porter’s models used large-scale statistical analyses to validate scientific hypotheses (Bain 1956). The models based on the structure-conduct-performance (S-C-P) paradigm (Bain 1956).
Critical Analysis
Shortcomings of Porter’s work arise out of the fact that industrial structure is changing. In the last decade, a new economy structure mainly driven by the internet has emerged (Roy 2009). In this new economic structure, traditional conditions such as barriers to entry cease to exist. Moreover, geographical restrictions no longer form the basis of operational boundaries for organizations (Shavinina 2003). Although some traditional industries still exist, their structure now reflects the various infusions of new technology and social structure (Anon 2009).
Industries are now more dynamic than they were a decade ago because of new technologies and concepts such as globalization (Teece, Pisano & Shuen 1997). Teece, Pisano, and Shuen (1997) agree that today’s industries are too dynamic to fit into the structure of Porter’s industry definition. While Porter focused on the resources at the disposal of an organization, today’s industry competitiveness moves further into how an organization continually innovates on these resources (Anon 2009). Therefore, we may argue that resources are no longer static.
According to Porter, the superior advantage that companies will have in an industry lie in their structure rather than the market environment (Porter 2008). However, Porter falls short of explaining the build-up of the organizational structure to enjoy competitive advantage (Whittington 2001). In the value chain, Porter uses a process view of the organization. In this conception, the organization acts as a system and includes subsystems (Porter 1985).
The overall system has inputs, processes, and outputs. Similarly, subsystems contain inputs, transforming processes and outputs. Porter (1985) presents five primary value chain activities and three major secondary activities. Activities that can be classified as primary include marketing, operations, and sales among others. Secondary activities are procurement, human resource management, technological development and infrastructure (Recklies 2001).
The generic strategies of Porter do not offer a link to the classical economic theory of price and competition (Whittington 2001). The generic strategy is an obvious consideration of the results of enhancing profit using either the cost or the price aspect variation (White, 1986). Thus, it is not appropriate to regard the generic strategy concept as a key contribution to the field of strategic management (Hoskisson et al. 1999).
A firm may follow a single strategy faithfully and end up suffering when another firm enters the market with a more competitive product (Dyck & Neubert 2009). It, therefore, appears that the universal claim of the generic strategies applications does not hold. Firms have to use multiple generic strategies and depend on the maintenance of the status quo of the industry (Shavinina 2003).
Conclusion
This essay has analyzed the Saudi Arabian oil industry using the Porter Five Forces model. It has demonstrated that there are deeper factors that affect the forces defining the competitiveness of a firm. Moreover, this essay has shown how one force may extend to influence another force outlined in the Porter model. For example, labor supply when considered as part of suppliers’ power also extends to become buyers’ power because the political uncertainty of competing nations has left Saudi Arabia with a monopoly labor buying power.
Besides the Five Force model, other notable contributions by Porter were the ‘value chain’ and ‘generic strategies’ frameworks. The essay then offers a critique of other Porter’s contributions to the field of strategic management. It shows how Porter’s contribution, despite being functional in earlier decades, cannot be solely used to form the strategist armor in analyzing industries and firms’ competitive advantages. Porter’s Model plays a significant part in industry analysis and development of a firm’s strategy for profitability. Unfortunately, the dynamic nature of the industry and the emergence of non-traditional forms of trade make the model unreliable.
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