Chapter 3
Evaluating a Company’s
External Environment

Competitive strategy must grow out a sophisticated
understanding of the rules of competition that determine
industry attractiveness.
Michael Porter
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When an industry with a reputation for bad economics
meets a manager with a reputation for excellence, it’s
usually the industry that leaves with its reputation intact.
Warren Buffett
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Skate to where the puck is going, not to where the puck
has been.
Wayne Gretsky
External Analysis
 It’s
not recognizing that change will
occur that is the problem, it’s
figuring out:
 what
will happen?
 how it will affect us?
 what to do about it?
Therefore, forecasting is necessary to predict
direction and the effect of change
External Analysis

1) Analyze the environment
macroenvironment
 industry environment
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3) Competitive analysis
4) Identification of key success factors
Environment of the Firm
Macro Environment
Industry Environment
Potential
Entrants
Technology
Competitive
Rivalry
Substitute
Products
Political
& Legal
Economic
Bargaining Power
of Suppliers
Bargaining Power
of Buyers
Demographic
Sociocultural
Macroenvironment
1)
2)
3)
4)
5)
Technology
Demographics
Socioculture
Demographic
Economic
1) Technological Forces

Changes in technology that affect the workplace,
and the products and services consumers expect

e.g., Information technologies, entertainment
technologies, product technologies.
2) Political/Legal Forces

Tax laws, minimum wages, environmental laws,
labor laws, consumer protection, product
liability, etc.
3) Sociocultural Forces

Attitudes of society towards work, careers,
products, services and consumer activism.

e.g., concern for quality of life, birth rates, woman in
the work force, low-carb dieting, health
consciousness, respect for intellectual property,
desire for “green retailing”
4) Demographic Forces

Characteristics of the population
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e.g., age, race, gender, sexual orientation and social
classes
Domestically - falling birth rates, falling death
rates, increase in minority populations
Internationally – birth rates are increasing in
some of the poorest (and most underserved)
populations of the world.
5) Economic Forces

General health/wellbeing of the local, regional,
national or global economy.

e.g., Interest rates, unemployment rates, consumer
spending, confidence and savings, energy costs,
personal disposable income, inflation rates, housing
costs
Macroenvironment

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Firms can not influence them, but they can have
a significant influence on the firm, its industry,
its strategy, and its performance
Cast a wide net and to identify the emerging
trends
Then determine which factors are relevant, and
how these changes will have an effect upon the
firm.
Environment of the Firm
Macro Environment
Industry Environment
Potential
Entrants
Technology
Competitive
Rivalry
Substitute
Products
Political
& Legal
Economic
Bargaining Power
of Suppliers
Bargaining Power
of Buyers
Demographic
Sociocultural
Porter’s Five Forces

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Competitive Rivalry
Power of Buyers
Power of Suppliers
Potential Entrants
Substitute Products
Each of these forces affect costs/prices,
therefore, profitability
Substitute
Products
(of firms in
other industries)
Suppliers of
Key Inputs
Rivalry
Among
Competing
Sellers
Potential
New
Entrants
Buyers
Porter’s 5-forces is all about margins
Price
What factors
increase/decrease margins
within an industry, thus
affecting profitability.
Profits
Costs
{
When industry structural variables are weak…...
Prices can be kept high
Profits can soar
Costs can be kept low
{
When industry structural variables are strong
Prices will be pushed down
Profits shrink
Costs will rise
{
Potential New Entrants

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Firms enter when industries are attractive, unless
they find themselves at an immediate
disadvantage relative to incumbents.
Firms can create “barriers to enter”
Barriers of entry are desirable for entrenched
firms
Barriers to Entry
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Substitutes

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Product/service which fulfills similar need
Price cap
3 Questions
1)
2)
3)
Are they available?
Can we switch?
Price-performance relationship?
Substitutes and Business Definition

How we define our business defines our
substitutes and our rivals
Carbonated Soft Drink
Many Substitutes
Few Rivals
Soft Drinks
Beverages
Few Substitutes
Many Rivals
Buyers


Who are your key buyers? - who provides our
revenues?
Can they force:
•
lower prices, higher quality and service – affect the
terms and conditions of the exchange?
Buyers

What affect buyers’ power?
Volume/Frequency of purchase
 Portion of buyer’s costs
 Lack of differentiation
 Low switching costs
 Self-source or backwards integration
 Criticality
 Buyers’ knowledge
 Buyers’ profitability

Suppliers
•
•
Who are you key suppliers?
Suppliers are a strong competitive force when:
Only a few suppliers exist
 Few substitutes
 Buyers not important customers to suppliers
 Suppliers provide a product crucial to production
process, and/or significantly affects product quality
 It is costly to switch suppliers
 Forward integration a credible threat
 They can supply a component at a lower cost

Rivalry and Profitability

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Industry profitability is a collective good.
Collective good is served by coordination
•

Are there industries were pricing is coordinated?
Incentive to violate


Usually the most powerful of the five forces
How actively and aggressively are rivals
employing competitive weapons in jockeying
for a stronger market position and increasing
sales?
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Is price competition vigorous?
Active efforts to improve quality?
Are rivals racing to offer better
performance features? better
customer service?
Lots of advertising/sales promotions?
Active efforts to build a stronger
dealer network?
Active product innovation?
Active use of other weapons of rivalry?
Rivalry – What drives it?
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Industries and Segments
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What is a segment?
Different segments…..
•
•
posses different combinations of 5-forces
therefore:
reward different strategies
 possess different levels of profitability

Porter’s..in conclusion

Attractiveness of industry/segment
current industry
 adjacent segments
 industries you might consider entering

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Which forces possess the greatest influence?

Can we influence them?
Static model & Hypercompetition
•
If the pace of transformation is rapid, if entry rapidly
undermines the market power of dominant firms, if
innovation speedily transforms industry structure by
changing process technology, creating new substitutes,
and by shifting the basis on which firms compete, then
there is little merit in using industry structure as a basis
for analyzing competition and profit.
What Forces Are at
Work to Change Industry Conditions?

Industries change because
forces are driving industry
participants to alter their
actions

Driving forces are the major
underlying causes of changing
industry and competitive
conditions
Common Types of Driving
Forces

Changes in long-term industry growth rate

Changes in who buys the product and how they use it

Product innovation

Technological change/process innovation

Marketing innovation

Entry or exit of major firms

Diffusion of technical knowledge
Common Types of Driving
Forces

Increasing globalization of industry

Changes in cost and efficiency

Market shift from standardized to differentiated
products (or vice versa)

New regulatory policies and/or government legislation

Changing societal concerns, attitudes, and lifestyles

Changes in degree of uncertainty and risk
Competitor Analysis

Strategic group mapping

A strategic group consists of those rivals with
similar competitive approaches in an industry
Price
Cartier
Tiffany
National Jewelry Retailers
Nordstroms
Sachs
Jerrods
Marks & Morgan
Zales
Kay
Pawn Shop
Chain-by-the-Foot Carts
Burdines
Dillards
Sears
JCP
Target
WalMart
Kmart
Breadth of Product Line
Other Dimensions for Strategic
Group Maps
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Vertical integration
Geographic scope
R&D Expenditures
Customer Service
Number of outlets
Reputation
Can even be categorical (e.g., Mexican, Italian,
pizza, subs, chicken)
Four Steps of CA
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Identify their strategy
Identify the objectives
Identify their assumptions
Identity their capabilities
Strategy
Objectives
Assumptions
Capabilities
Strategic
Action
Competitive Analysis

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Important in concentrated industries (few, large
share competitors)
Benefits
forecast future actions, predict reactions
 can we influence rivals’ behavior?

Identification of Key Success Factors?

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KSFs are product attributes, competencies,
competitive capabilities, and market
achievements with the greatest direct bearing on
profitability
opportunities for competitive advantage