Lectures Notes Importance of Small Businesses

Small businesses are a pillar of the U.S. economy, forming the largest group of exporters

and importers while serving as the largest source of employment (Office of the United States

Trade Representative, 2009). In the state of Louisiana, small businesses comprise the majority of

all employers, employing over half of the state’s private workforce (U.S. Small Business

Administration, 2014), and are key contributors to state export revenues (World Trade Center,

New Orleans, 2015). In the U.S. as a whole, approximately 50% of small businesses survive

more than five years and only a third survive more than 10 (SBA Frequently Asked Questions,

2012). In Louisiana, approximately 50% of small businesses survive more than five years, and

about 40% survive more than 10 years (U.S. Small Business Administration, 2014).

Absence of Strategic Planning and Failure of Small Businesses

Early research on the failure of small businesses identified the absence of strategic planning as a

primary cause (Ibrahim & Goodwin, 1985; Mayer & Goldstein, 1961; Mintzberg, 1979;

Crawford & Lefebvre, 1984; Crawford & Ibrahim, 1985; Nerone, 1997). Excessive optimism, a

failure to monitor results, and the absence of balanced growth also were identified as key factors

(Mayer & Goldstein, 1961; Mintzberg, 1979; Crawford & Lefebvre, 1984; Crawford & Ibrahim,

1985). In their 1982 study, Sexton and Van Auken found that small business owners and manager

often thought of strategic planning, but rarely took action. Several other studies determined that

not only was systematic strategic planning largely absent in small businesses, but also that what

little did take place was reactive, incremental, disorganized, sporadic, and inadequate (Still,

1974; Cooper, 1977; Crawford, R. L., & Ibrahim, A. B., 1985). As Nerone observed, "Most

entrepreneurs [small business owners] are doing their strategy on the back of a napkin, as they

sweat out making the Friday payroll” (Nerone, 1997, p. 9).

In a more recent article, Kraus, Harms, and Schwarz argue that strategic planning does

occur in small businesses, but that it is often performed intuitively without the use of planning

instruments (2006). In practice, small businesses plan in the short term, rather than focusing on

long-term objectives, and are typically reactive rather than proactive (Wang, Walker, &

Redmond, 2007). Small businesses that claim to plan for the future typically develop those plans

ad hoc and rarely write them down formally. Furthermore, the plans provide little guidance for

measuring or analyzing the performance of the small business (Wang et al., 2007). The literature

also indicates that strategic planning in small businesses is unstructured, informal, and irregular,

lacking in information (Gibb & Scott, 1985; Flavel, 1991; Balasundaram, 2009).

Correspondingly, small businesses have been described as shortsighted and strategically

narrowminded (Wang et al., 2007).

Benefits of Strategic Planning

This absence of strategic planning certainly counters much of the literature, which

indicates that small businesses should plan for the long term in order to effectively compete

(Wang et al., 2007). Small businesses that disregard strategic planning risk, at a minimum,

growth and performance and, at worst, their very survival (Wang et al., 2007). Understandably,

small business success is not determined by strategic planning alone; however, there are more

benefits to planning versus not planning (Wang et al., 2007).

Problem Statement

Strategic planning has been studied since the 1950's, but research has focused primarily

on larger organizations (Mazzarol, 2004). Research on strategic planning in small businesses is

still in the early stages (Kraus, Reiche, & Reschke, 2007). Furthermore, although small

businesses are vital to the Louisiana economy, little, if any, research on strategic planning in

Louisiana small businesses has been undertaken. While the existing literature suggests that

strategic planning is positively related to the performance of small businesses (Kraus, Harms, &

Schwarz, 2006; Balasundaram, 2009), most of them do not plan, for as yet unknown reasons

(Wang et al., 2007). Thus, Robinson and Pearce argue that “Research needs to provide specific

reasons why planning is not practiced in firms” (Robinson & Pearce, 1984, p. 135).

Understanding why small businesses do not engage in strategic planning, and how that omission

affects small business mortality, would enable consultants to better serve the small business

sector and public officials to improve public policy.

Purpose of Study

The primary purpose of this study is to determine the influence of selected factors that

influence small business owners’ perceived obstacles to strategic planning in Louisiana small

businesses.

Research Objectives

The dependent variable of this study is the propensity of Louisiana small businesses to

strategically plan. The independent variable of this study is Louisiana small business owners’

perceived obstacles to strategic planning.

The following specific objectives were formulated to guide this research study:

1. To describe small businesses in Louisiana on the following characteristics:

a) Years the organization has been in business;

b) Industry in which the small business is positioned;

c) Current number of full time and part time employees on the organization's

payroll;

d) Structure of the organization i.e. Limited Liability Corporation,

Subchapter S

Corporation, Partnership, etc.:

e) Existence of a written long term plan.

2. To describe small businesses in Louisiana on the perceived degree to which the

organization conducts strategic planning.

3. To describe small businesses in Louisiana perception regarding the following perceived

obstacles to strategic planning:

a) The perceived quality of the organization’s employees;

b) The perceived degree to which the organization’s leadership has

knowledge of the

planning process;

c) The perceived available time the organization has to strategically plan.

4. To determine if a relationship exists between Louisiana small business owners' perceived

obstacles to strategic planning and the following variables:

a) Industry in which the small business is positioned in;

b) Structure of the organization i.e. Limited Liability Corporation,

Subchapter S

Corporation, Partnership, etc.;

c) Years the organization has been in business;

d) Current number of full time and part time employees on the organization's

payroll;

e) The perceived degree to which the organization conducts strategic

planning;

f) Possession of a written long term plan.

5. To determine if a model exists explaining a significant portion of the variance in

Louisiana small business owners' perceived degree to which the small business conducts

strategic planning using the following characteristics:

a) Years the organization has been in business;

b) Industry in which the small business is positioned;

c) Current number of full time and part time employees on the organization's

payroll;

d) Structure of the organization i.e. Limited Liability Corporation,

Subchapter S

Corporation, Partnership, etc.;

e) The perceived degree to which the organization conducts strategic

planning;

f) The perceived quality of the organization’s employees;

g) The perceived degree to which the organization’s leadership has

knowledge of the

planning process;

h) The perceived available time the organization has to strategically plan;

i) Possession of a written long term plan.

Summary

Small businesses play an important role in the Louisiana economy. Prior research on

strategic planning has focused primarily on large businesses (Mazzarol, 2004); however, little

literature exists that focuses on Louisiana small business strategic planning. While the existing

literature implies that strategic planning is positively related to the performance of small

businesses (Kraus, Harms, & Schwarz, 2006; Balasundaram, 2009), most of them do not plan,

for as yet unknown reasons (Wang et al., 2007). Therefore, this study will explore the obstacles

to strategic planning as perceived by Louisiana small business owners. The results of this study

will benefit small business owners when employing strategic planning within their organizations,

consultants when advising small businesses during the strategic planning process, and public

officials when establishing public policy affecting small businesses.

CHAPTER II: REVIEW OF LITERATURE

Given how important small businesses are to the U.S. economy, many studies have

focused on what causes them to fail. The principal cause of small business failure has been

identified as a lack of strategic planning. Other key factors contributing to small business failures

are excessive optimism, lack of balanced growth, and failure to monitor results (Ibrahim &

Goodwin, 1985; Mayer & Goldstein, 1961; Mintzberg, 1979; Crawford & Lefebvre, 1984;

Crawford & Ibrahim, 1985).

The literature suggests that small businesses owners tend to not engage in systematic

strategic planning (Perry, 2001), even though they often consider it (Sexton & Van Auken,

1982). Furthermore, any planning that small businesses do undertake tends to be reactive,

unstructured, incremental, and sporadic (Still, 1974; Cooper, 1977; Crawford & Ibrahim, 1985).

Small business owners tend to focus on immediate rather than long-term objectives, planning

for the future in an ad hoc manner, and fail to make provisions for measuring performance

(Wang et al., 2007). The approach of small businesses to strategic planning is therefore

counterintuitive: although the literature highlights the benefits of strategic planning, most small

businesses do not plan for reasons that are not fully understood (Wang et al.,

2007).

U.S. Small Businesses

Small businesses play a vital role in the U.S. economy. Collectively, they are the largest

employer, the largest importer, and the largest exporter in the country (Office of the United States

Trade Representative, 2009). Small businesses, which are defined as those employing fewer than

500 individuals, comprise 99.9% of firms in the U.S. Furthermore, businesses employing fewer

than 20 individuals comprise 89.7% of U.S. small businesses. In 2008, small businesses

generated 46% of the private non-farm Gross Domestic Product (GDP) (Small Business Council,

2014).

Small businesses foster the growth of local economies by providing opportunities for

employment to people who otherwise may not be employable by larger organizations (Brown,

2011). During the 18-year period from 1992 to 2010, small business outpaced larger firms in job

creation 75% of the time (Graves, 2013). In general, small businesses generate 60-80% of all

new employment in the U.S. Small businesses also generate 16.5 times more patents per

employee when compared to larger firms (Graves, 2013)

Small businesses traditionally dominate industries such as construction and retail, as well

as form a crucial link in the supply chain for large-scale and capital-intensive manufacturing

industries such as defense, mining, automotive, and marine (Abdullah & bin Baker, 2000;

Robinson & Pearce, 1984; Wang et al., 2007; Wang, Rowe, & Cripps, 2006). Furthermore, small

businesses provide a competitive balance to industries that would otherwise be dominated solely

by larger firms (Wang et al., 2007).

However, despite the critical importance of small businesses in the U.S., only

approximately half survive past five years and roughly a third last for 10 years (SBA

Frequently Asked Questions, 2012).

Louisiana Small Businesses

Small businesses play a vital role in the Louisiana economy as well. In aggregate, they

account for 97.3% of employers in Louisiana and employ more than half, 54.5%, of the state's

private sector workforce. Businesses with 500 or more employees comprise the remaining 45.5%

(U.S. Small Business Administration, 2014). Federal, state, and local governments, as well as the

U.S. Postal Service, employ 321,569 public sector workers, or 6.95% of Louisiana’s population

(Molla, 2014). As noted in Table 1, the Small Business Administration (2014) reported that

414,779 small businesses existed in the state of Louisiana in 2011. Of those businesses, only

78,451 had employees; 68,030 employed less than 20 individuals. The majority of the small

businesses, 336,328 or 80.7%, did not have employees. Overall, Louisiana small businesses

employ 875,974 individuals (U.S. Small Business Administration, 2014). (See Table 1)

Table 1 The Number of Louisiana Small Firms by Industry, 2011 (Ranked by Number Of Small

Employer Firms) Source: (U.S. Small Business Administration, 2014)

Number of Louisiana Small Firms by Industry, 2011 (ranked

by number of small employer firms)

Industry

Employer Firms

with

1-499 Employees

Employer Firms

with

1-19 Employees

Nonemployer

Firms

Professional, scientific, and tech svcs. 10,621 9,853 35,489

Retail trade 10,398 9,302 23,229

Health care & social assistance 9,646 8,060 30,124

Other services (except public admin.) 8,719 8,005 64,016

Construction 7,867 6,984 38,305

Accommodatin & food services 6,469 4,878 7,513

Wholesale trade 3,845 3,012 4,206

Admin., supp., waste mgt., remed.Svcs. 3,754 3,186 36,768

Finance & insurance 3,689 3,334 9,127

Real estate & renal & leasing 3,371 3,103 29,506

Transportation & warehousing 2,733 2,310 15,178

Manufacturing 2,706 2,027 4,251

Arts, entertainment, & recreation 1,272 1,080 13,143

Mining 1,196 935 6,277

Educational services 955 649 6,248

Forestry, etc. & agriculture support 566 525 9,654

Information 558 440 3,041

Management of comp. & enterprises 301 65 -

Utilities 203 182 253

Unclassified 177 177 -

Total 78,451 68,030 336,328

As noted in Table 2, the top four industries most populated by small businesses in

Louisiana are health care, social assistance, accommodation and food service, and retail trade. In

2012, 84.5% of the 4000 companies exporting goods were small firms. Louisiana export

revenues totaled more than $65 billion in 2014 (World Trade Center, New Orleans, 2015). The

small firms generated 34.8%, or $22.6 billion, of Louisiana's total export value (U.S. Small

Business Administration, 2014).

Table 2 Employment in Louisiana Small Firms by Industry and Firm Size, 2011 (Ranked by

Number of Small Employer Firms) Source: (U.S. Small Business Administration, 2014)

Employment in Louisiana by Industry and Firm Size, 2011

(ranked by small firm employment)

Industry Employment

Small Firms Total Firms

Small Firm Share

of Industry

Employment (%)

Health care & social assistance 156,785 282,985 55

Accommodation & food services 106,250 182,523 58

Retail trade 93,286 226,638 41

Construction 78,986 127,941 62

Professional, scientific, & tech. svcs. 66,888 88,171 76

Other services (except public admin.) 64,979 72,394 90

Manufacturing 50,963 125,820 41

Wholesale trade 46,893 75,009 63

Admin., sup., waste mgt., remed.

svcs. 46,211 100,856 46

Finance & insurance 34,913 66,255 53

Transportation & warehousing 30,771 65,367 47

Educational services

Real estate & rental & leasing 24,014 36,322 66

Mining 19,469 53,185 37

Arts, entertainment, & recreation 14,513 23,477 62

Information 7,340 23,722 31

Management of comp. & enterprises 6,173 20,468 30

Forestry, etc. & agriculture support 3,764 3,951 95

Utilities 2,454 - -

Unclassified - - -

Total 875,974 1,617,229 54

Similar to the national percentages, only 47.6% of Louisiana small businesses survive beyond

five years and roughly 37.4% remain in business more than 10 years (U.S. Small Business

Administration, 2014). Although small businesses are important to the Louisiana economy,

research on strategic planning in small businesses is largely absent from the literature. Instead,

research on strategic planning has focused primarily on larger organizations (Mazzarol, 2004).

Strategic Planning and Its Benefits

Given the risk of failure, small businesses are concerned with establishing a competitive

advantage that will ensure long-term survival (Galán, Monje, & Zúñiga-Vicente, 2009). Wankel

(2007) defined strategy as "an approach to reach corporate goals in order to be successful on a

long-term basis," and as "an attempt to prepare for all eventualities by abstraction and thus to

account for the complexity and the dynamics of the environment" (p. 74). Although businesses

cannot predict the future, they can prepare for it and align accordingly (Kraus, Reiche, &

Reschke, 2011). Strategic planning involves deducing how present developments will look in the

future, providing guiding principles and procedures for achieving specified goals. In other words,

strategic planning is an essential tool for strategic management, allowing businesses to stipulate

basic conditions for their future activities (Kraus et al., 2011).

Given its concern with competitive advantage, strategic planning focuses on establishing

long-term goals, developing plans to reach those goals, and distributing the resources needed to

achieve those goals (Stonehouse & Pemberton, 2002; O'Regan & Ghobadian, 2004; Wang et al.,

2007). As described by Kenichi Ohmae, "the purpose of strategic planning is to enable a business

to gain as efficiently as possible, a sustainable edge over its competitors" (as cited in O'Regan &

Ghobadian, 2004, p. 664; Wang et al., 2007). Businesses grow by acquiring new customers and

thus market share. Strategic planning spawns innovation by constantly seeking to develop new

services and products to bring to the market (Hill, 2011). A strategic business plan pairs the

objectives of a company with the needs of the marketplace. It not only defines company goals,

but also applies those goals to take advantage of available business opportunities by carefully

analyzing a particular company's strengths and weaknesses in meeting industry needs (Scott,

2011). Specifically, strategic planning helps a company identify a market need or customer

problem and create a product or service that efficiently and cost-effectively addresses the need or

solves the problem.

Planning also helps a company gain a clearer picture of the competition, allowing it to

develop strategies that take advantage of a competitor's weaknesses (Hill, 2011) and create

solutions that are significantly more beneficial to the customer than those provided by the

competition. Strategic planning compels a business to concentrate on specific areas in the

market, allowing for more effective business operations, and enables the business to learn as

much as it can about customer needs and potential opportunities in the market (Scott, 2011).

Correspondingly, a strategic plan includes extensive market research, exploration of industry

trends, and competitor analysis. A strategic plan shares many of the same components as a

business plan, such as an executive summary, marketing analysis, and financial statements, but is

more specific with respect to how the company will achieve its goals. For example, a strategic

business plan will attempt to identify a target market, reduce it to a manageable size, and

establish a strategy for acquiring that market (Scott, 2011).

Strategic planning is, fundamentally, brainstorming at its best. Since strategic planning

relies on creativity, its development involves intuition as much as management science. The more

small business owners understand their companies and industries, the better their strategic plans

will be (Pirraglia, 2011). As expressed by Drucker (1974), "it is necessary in strategic planning to

start separately with, 'What is our business?,' 'What will it be?,' and 'What should it be?'" (p.

122). Strategic planning demarcates where a company is heading (Pirraglia, 2011). The strategic

plan provides a road map for a business in which the management team fashions a longterm

vision for a larger, more profitable organization. In order to encourage company growth, strategic

planning involves envisioning potential activities that must be undertaken and potential expenses

that will have to be made (Hill, 2011). By using strategic planning, small business owners not

only become better positioned in the market, but also become experts in their respective

industries. The strategic plan also serves as an organizational tool, keeping the company on track

to meet its growth and financial objectives (Scott, 2011). Through an appraisal of past growth

and adjustments for further growth, strategic planning is critical for owners to understand the

trajectory of their companies (Scott, 2011).

In general, strategic planning is more common in small businesses that exhibit better

performance. Specifically, small businesses that engage in strategic planning are more likely to

achieve higher sales growth, returns on assets, margins on profit, and employee growth (Wang et

al., 2007). They tend to be more innovative, have more newly patented products, use new process

and management technologies, and achieve international growth (Wang et al., 2007). Most

significantly, small businesses that engage in strategic planning are less likely to fail

(Wang et al., 2007). Empirical studies have linked strategic planning to success (Kraus et al.,

2011), the implication being that strategic planning is essential for the success of a small business

(Pirraglia, 2011).

Perry (2001) found that in 152 failed firms and 152 non-failed firms, very little strategic

planning took place. However, some planning was performed in the non-failed businesses, which

suggests that the degree of planning may be related to whether the business fails. One limitation

of his (2001) study was that the independent variable—planning—and the phenomenon were

only weakly correlated.

Gibson, Cassar, and Wingham (2001) found that, of 2,956 firms for which data were

available, only 16.3% were described as regular planners, while 43.5% were non-planners. The

remaining 40.2% described themselves as irregular planners. Gibson et al. (2001) determined

that planners reported higher performance than non-planners, which indicated that planning and

performance are related.

In a study by Trow (1961), out of 51 companies in which planning occurred, 12 of 19

small firms (defined as up to 1000 employees) generated steady profits. The remaining

companies did not report on profitability. These findings suggest that firms that planned were

more profitable than those that did not.

Kraus et al. (2006) conducted a study of 290 firms with less than 50 employees. The

researchers used employee growth to measure firm performance. They found that a greater

degree of formalization, as indicated by the existence of a written strategic plan, was related to a

higher degree of performance.

The History and Components of a Strategic Plan

Modern strategic planning has taken a page from World War II, in which the U.S., its

allies, and its enemies developed strategies on the battlefield. Military commanders used these

strategies to help determine the strengths and weaknesses of each force. Using these processes,

they were able to observe the battlefield or environment and establish implementation plans and

command and control mechanisms (Nerone, 1997). The process of strategic planning was

successful because it allowed military strategists to follow proven approaches that literally had

been battle tested over centuries of documented warfare (Nerone, 1997). These strategies and the

eventual success of the allied forces were adopted by the private sector as military commanders

returned from Europe and entered the civilian workforce.

Early management theorists, including H. Igor Ansoff, Philip Selznick, George Steiner,

Peter Drucker, C.H. Hofer, D.E. Schendel, and Henry Mintzberg, are considered pioneers in the

field of strategic thinking (Nerone, 1997). Other notable theorist is Harvard Business School

professor Alfred Chandler, who “insisted that structure must follow strategy” (The Economist,

2007, para. 3), and Albert Humphrey, who created the SWOT Analysis, while working at the

Stanford Research Institute during the 1960’s (Stanford Research Institute Alumni Newsletter,

2005). A later theorist, Harvard Business School Professor Michael Porter, is considered to be the

founder of the modern field of strategy and regarded as the most influential thinker on

competitiveness and management (Harvard Business School, 2014).

H. Igor Ansoff devised one of the earliest strategic planning models, the Ansoff Matrix.

The Ansoff Matrix focused on options for business growth. Ansoff identified four types of

product-market strategies: market penetration, market development, product development

strategy, and diversification (Ansoff, 1957). According to Ansoff, a product-market strategy is a

“joint statement of a product line and the corresponding set of missions which the products are

designed to fulfill” (Ansoff, 1957, p. 114). The first of these, market penetration, he defined as an

“effort to increase company sales without departing from an original product-market strategy.

The company seeks to improve business performance either by increasing the volume of sales to

its present customers or by finding new customers for present products” (Ansoff, 1957, p. 114).

In contrast, market development is “[a] strategy in which the company attempts to adapt

its present product line (generally with some modification in the product characteristics) to new

missions” (Ansoff, 1957, p. 114). A product development strategy “develops products that have

new and different characteristics such as will improve the performance of the mission” (Ansoff,

1957, p. 114). And diversification is “the final alternative. It calls for a simultaneous departure

from the present product line and the present market structure” (Ansoff, 1957, p. 114).

Figure 1 Product-Market Strategies for Business Growth Alternatives

 Represents the product line and  represents the corresponding set of missions. The pair of

 and  is a product-market strategy (Ansoff, 1957, p. 114).

In 1979, The Harvard Business Review published Michael E. Porter’s “How Competitive

Forces Shape Strategy” (Harvard Business Review, 2008). In his article, Porter suggested that

there are five forces that shape an organization's strategy: the threats of new entrants, the

bargaining power of suppliers, the bargaining power of customers, and the threat of substitute

products and services. Porter argued that these four forces interact with the fifth force:

competitors jockeying for position within an industry (Harvard Business Review, 2008).

Porter theorized that the threats to new entrants consisted of six barriers: economies of

scale, product differentiation, capital requirements, cost disadvantages independent of size,

access to distribution channels, and government policy (Porter, 1979). Economies of scale force

market entrants to either enter the market on a large scale or consent to a cost handicap.

Economies of scale can act as barriers to distribution, financing, and utilization of the

organization’s sales force (Porter, 1979). The second barrier, product differentiation, forces

market entrants to spend large amounts of money on customer service and advertising in order to

Markets

Product Line

0

MARKET

Penetration

1

2

3

..

Market Development

DIVERSIFICATION

PRODUCT

DEVELOPMENT

01234..

demonstrate product differentiation and generate a brand identity (Porter, 1979). Capital

requirements force market entrants to spend large sums of non-recoverable funds on facilities,

customer credit, inventory, and research and development, in addition to advertisements. Due to

these constraints, capital requirements limit the pool of potential entrants (Porter, 1979). Cost

disadvantages force market entrants to realize that rivals who are already entrenched in the

market possess the inherent advantage of time. Market entrants must deal with learning and

experience curves, proprietary technologies, access to pre-inflation cost of materials, and

favorable locations (Porter, 1979). The fifth barrier, access to distribution channels, forces market

entrants to acquire channels for distributing products and services. Thus, selling efforts must

attempt to displace other rivals. If wholesale channels are limited and barriers are high, a market

entrant must create its own distribution channels (Porter, 1979). Finally, government policy can

limit market entrants to industries by mandating licensing requirements, regulatory requirements,

environmental standards, or access to raw materials (Porter, 1979). Porter states,

A company’s choice of suppliers to buy from or buyer groups to sell to should be viewed

as a crucial strategic decision. A company can improve its strategic posture by finding

suppliers or buyers who possess the least power to influence it adversely. (Porter, 1979,

p. 141)

Porter theorized that suppliers can exercise bargaining forces on market participants by

either reducing or increasing the quality or prices of goods and services. Thus, suppliers can

extract profits from a market and its participants (1979). For example, Porter argues that a group

of suppliers is powerful if it is more concentrated in comparison with the industry that it is

selling to (Porter, 1979). Additionally, suppliers are powerful if their products are highly

differentiated and unique, or if switching costs have developed. Switching costs can occur when

a buyer’s product is highly specified and production lines are coupled with the supplier's

manufacturing facilities. Switching costs then become fixed even when a buyer changes

suppliers (Porter, 1979). Furthermore, if a supplier does not have to compete with other products,

the supplier essentially has no reason to reduce prices or increase the quality of its product

(Porter, 1979). Moreover, if the supplier possesses the ability to integrate further into the market,

the buyer’s ability to improve purchasing terms is highly limited (Porter, 1979). Lastly, if the

buyer is simply not significant to the supplier, the supplier and buyers' interests are not aligned,

and thus the supplier has no real incentive to work with the buyer (Porter, 1979).

Porter theorized that buyers can exercise bargaining forces on market participants if they

purchase in large quantities. This approach would require that capacity remain high consistently,

which would be particularly difficult if fixed costs within the market were high (Porter, 1979).

Additionally, buyers can exercise their will if products are standard or not particularly

differentiated. In this case, buyers are not incentivized to purchase from any one specific

company but instead could pit companies against one another in an attempt to lower market

prices (Porter, 1979). Furthermore, if a particular component for a product represents a large part

of overall costs, buyers are incentivized to shop for more favorable pricing (Porter, 1979). And if

a buyer earns low profits, then the buyer would be incentivized to lower its purchasing costs.

Should a buyer earn higher profits, it is generally less sensitive to prices, assuming that the price

does not signify a large percentage of overall costs (Porter, 1979). Additionally, if the quality of

the product is of significant importance to the buyer, the buyer is typically less price sensitive

(Porter, 1979). In his article, Porter uses an example from the oil field industry, where equipment

failure can lead to huge losses (1979). Furthermore, when the industry’s product can pay for

itself over time, such as accounting or legal services where errors can be costly, the buyer is less

likely to be price sensitive (1979). Lastly, buyers can opt to produce their own materials, thus

removing the need for purchasing from a third party manufacturer. This threat provides leverage

to the buyer (Porter, 1979).

Figure 2 Porter’s Original 1979 Five Force Model, Source: (Porter, 1979).

Albert S. Humphrey created what was eventually dubbed the SWOT Analysis while

working at the Stanford Research Institute during the 1960’s. His research was funded by various

Fortune 500 companies who wished to identify deficiencies in corporate planning and create a

system to manage change. (Stanford Research Institute Newsletter, 2005).

Though Humphrey’s key finding were never published, as they were deemed too

controversial, he wrote them in the December 2005 Newsletter of the Stanford Research

Institutes Alumni Newsletter. They are as follows:

1) A business can be divided into two parts: The base business plus the development

business. The development business turns over every 5 to 7 years, 2) All people

measure what they get from their work and divide it by what they give to the work

and this reward/effort ratio is compared to others. If it perceived as too low, the

person slows down, 3) The introduction of a corporate planner upsets the sense of fair

play at senior level, making the job of the corporate planner impossible, 4) The gap

between what could