Chapter 2
Evaluating a
Firm’s
External
Environment
2-1
After we complete this chapter you should have an
understanding of the following:
1) why external analysis is a critical element of the strategic
management process,
2) how to do an effective external analysis, and
3) what to do in response to external analysis.
2-2
Why External Analysis?
External analysis allows firms to:
• discover threats and opportunities
• see if above normal profits are likely in an industry
• better understand the nature of competition in
an industry
• make more informed strategic choices
2-3
General External Environment
Technological
Change
Specific
International
Events
Demographic
Trends
Entry
Complementors
Rivalry
Focal
Firm
Buyers
Legal/Political
Conditions
Industry
Suppliers
Substitutes
Cultural
Trends
Economic
Climate
2-4
General External Environment
Technological
Change
Specific
International
Events
Shift to
Smart Phones
European Union Ban on
Hormone-Treated U.S. Beef
Demographic
Trends
Hispanic Population Growth
Focal
Firm
Changing Policy toward Oil
Exploration on Public Lands
Legal/Political
Conditions
Changing Image of SUV’s
Falling
Interest
Rates
Cultural
Trends
Economic
Climate
2-5
Industry Analysis
Model of Environmental Threats (aka Porter’s 5 Forces)
Entry/New Competition
Buyer Influence
Industry
Rivalry/Existing Competition
Focal
Firm
Threat
Supplier Leverage
Substitute Products
Higher Threat
Lower Average Profits
2-6
Model of Environmental Threats
Threat of Entry/New Competition
• if firms can easily enter the industry, any above
normal profits will be bid away quickly
• barriers to entry lower the threat of entry
• barriers to entry make an industry more attractive
2-7
Model of Environmental Threats
Threat of Entry/New Competition
Barriers to Entry:
• economies of scale
• product differentiation
• cost advantages independent of scale
• government policies
2-8
Model of Environmental Threats
Threat of Rivalry/Existing Competition
• high rivalry means firms compete vigorously—and
compete away above average profits
Industry conditions that facilitate rivalry:
• large numbers of competitors
• slow or declining growth
• high fixed costs and/or high storage costs
• low product differentiation
• industry capacity can only be added in
large increments
2-9
Model of Environmental Threats
Threat of Substitute Products
• substitutes fill the same need but in a different way
2-10
Model of Environmental Threats
Threat of Supplier Leverage
• powerful suppliers can ‘squeeze’, lower the profits
of the focal firm
Industry conditions that facilitate supplier power:
• small number of firms in supplier’s industry
• highly differentiated product
• lack of close substitutes for suppliers’ products
• supplier could integrate forward
• focal firm is an insignificant customer of supplier
2-11
Model of Environmental Threats
Threat of Buyer Influence
• powerful buyers can ‘squeeze’ (lower profits)
the focal firm by demanding lower prices and/or
higher levels of quality and service
Industry conditions that facilitate buyer power:
• small number of buyers for focal firm’s output
• lack of a differentiated product
• the product is significant to the buyer
2-12
Model of Environmental Threats
Threat of Buyer Influence
Industry conditions that facilitate buyer power:
• buyers operate in a competitive market—they are
not earning above normal profits
• buyers can vertically integrate backwards
• many small buyers can be united around an issue
to act as a block
2-13
Model of Environmental Threats
Entry/New Competition
Buyer Influence
Industry
Rivalry/Existing Competition
Focal
Firm
Threat
Supplier Leverage
If all threats are high
If all threats are low
Substitute Products
expect normal profits
expect above normal profits
Most industries are somewhere between the extremes
2-14
Complementors As Another Force
Complementors Increase the Value of
the Focal Firms Product
• customers perceive more value in the focal firm’s
product when it is combined with the complementor’s
product
• complementors may be found outside the focal firm’s
industry
Example: iPhone & Apps
2-15
Responding to Environmental Threats
Neutralizing Threats
• most firms cannot unilaterally change the
threats in an industry
• by altering relationships in an industry, firms
may reduce threats and/or create opportunities,
thereby increasing profits
Examples: Regional Healthcare System, and a Building
Contractor
2-16
Exploiting Industry Structure Opportunities
Generic Industry Structures
• at any point in time, the structure of most
industries fits into one of four generic categories
• each industry structure presents opportunities
that may be exploited
• firms can choose to exploit an industry structure,
continue business as usual, or exit the industry
2-17
Exploiting Industry Structure Opportunities
Fragmented Industry Structure
Industry Characteristics
• large number of small firms
• no dominant firms
Opportunity
Consolidation
• buy competitors
• no dominant technology
• build market power
• commodity type products
• exploit economies
of scale
• low barriers to entry
• few, if any, economies of scale
2-18
Exploiting Industry Structure Opportunities
Emerging Industry Structure
Industry Characteristics
Opportunity
• new industry based on break
through technology or product
First mover advantages
• no product standard has
been reached
• locking-up assets
• no dominant firm has emerged
• creating switching
costs
• technology standard
• new customers come from nonconsumption not from competitors
2-19
Exploiting Industry Structure Opportunities
Mature Industry Structure
Industry Characteristics
• slowing growth in demand
Opportunities
Refine current products
• technology standard exists
• improve service
• increasing international
competition
• process innovation
• industry-wide profits declining
• industry exit is beginning
2-20
Exploiting Industry Structure Opportunities
Declining Industry Structure
Industry Characteristics
• industry sales have sustained
pattern of decline
• some well-established
firms have exited
• firms have stopped investing
in maintenance
Opportunities
• Market leadership
• Niche
• Harvest
• Divest
2-21
Some Final Thoughts on External Analysis
• External analysis is a necessary precursor to
making informed strategic choices
• External analysis helps firms recognize threats
and opportunities
• External analysis helps firms avoid making
poor resource commitments and increases the
probability of enjoying competitive advantage
2-22