Evaluating a Firm’s External
Environment
Chapter 2
Objectives
• Understand the import role that the
competitive environment plays on firms
• Gain an understanding of Porter’s Five
Forces and how the tool is applied as part of
an industry analysis.
• Have fun learning!
Questions
1. Name some of the participants in a external
environment.
2. Name the external forces that managers
must be aware of.
3. What are the names Porter’s Forces (Hint:
There are 5)?
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.
The Competitive Environment
• The competitive environment is also called
the task or industry environment.
• The CE consists of competitors (existing or
potential), customers, and suppliers.
General External Environment
Technological
Change
Specific
International
Events
Demographic
Trends
Entry
Complementors
Rivalry
Focal
Firm
Buyers
Legal/Political
Conditions
Industry
Suppliers
Economic
Climate
Substitutes
Cultural
Trends
General External Environment
Technological
Change
Specific
International
Events
PDA’s &
Cell 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
Rising
Interest
Rates
Economic
Climate
Cultural
Trends
Porter’s Five Forces
• Competition tends to be more intense among
firms within a strategic group than between
strategic groups.
• The competitive forces determine:
– The state of competition in an industry and
– The degree to which the firms in an industry are
constrained in raising prices.
The Five Force’s Model
• Helps to analyze the firms competitive
environment for a specific industry.
• Should the firm remain in or exit an industry?
• Provides rational for increasing/decreasing
resource commitments.
• Helps to assess how to improve the firm’s
competitive position.
Porter’s Five Forces
• The stronger the competitive force, the greater the
threat.
• A weak force is an opportunity for the firms in the
industry.
• The collective strength of these forces determines
the ultimate profit potential of an industry.
• Strong competitive forces limit the profitability of the
overall industry.
Porter’s Five Forces Model
Entry
Buyers
Industry
Rivalry
Focal
Firm
Threat
Suppliers
If all threats are high
If all threats are low
Substitutes
expect normal profits
expect above normal profits
Most industries are somewhere between the extremes
Threat of Entrants
• New competitors may enter the industry and
erode profits for established firms.
• Existing barriers to entry and firms’ reactions
determine the extent of the threat. Therefore:
– If barriers are low & the threat from existing
competitors is low than the threat of new
entrants is high.
Sources of Entry Barriers
•
Economies of Scale – High production costs
spread over a large number of units.
•
Product Differentiation – Strong brand
identification and customer loyalty.
•
Capital Requirements – Need to make a
large investment to compete.
Sources of Entry Barriers
•
Switching Costs – One-time costs that the
buyer faces when switching to a new
manufacturer.
•
Distribution Channels – Difficulty in
securing distribution for product.
•
Cost Disadvantages Independent of Scale
– Advantages derived from having: a
proprietary product, favorable access to raw
materials, & gov’t subsidies/policies.
Buyer’s Bargaining Power
• Concentrated or Large Sales from Single
Purchaser – As a buyer’s purchases a
greater percent of a suppliers output the
buyer’s power increases.
• Products are Standard / Undifferentiated –
There are few differences in the product.
• Buyer Faces Few Switching Costs – No or
little cost to switch from one supplier to
another.
Buyer’s Bargaining Power
• Product Earns Low Profits – Low profits
create incentives to lower purchasing costs.
• Buyer Can Produce Product – Buy has the
capability to backward integrate it’s product.
• Quality is Unimportant to Buyer’s Product –
Quality of the product does not greatly affect
the buyer’s product.
Supplier’s Bargaining Power
• There are Few Suppliers
• There are Few Substitute Products
• The Industry is Not an Important Customer
• The Supplier’s Product is Important
• The Supplier’s Product Has Switching
Costs
• The Supplier Group Poses a Threat of
Forward Integration
Threat of Substitute Products
• Substitutes limit the potential returns of an
Industry by placing a ceiling on prices.
• Identifying substitutes involves searching for
other products/services that can perform the
same function as the industry’s offering.
• May have to look outside the industry for a
substitute.
Industry Rivalry
•
•
•
•
•
•
Numerous or Equally Balanced Competitors
Slow Industry Growth
High Fixed or Storage Costs
Lack of Differentiation/Switching Costs
Capacity Augmented in Large Increments
High Exit Barriers
High Rivalry
• What does high rivalry look like?
• Firms are jockeying for position via price
and/or non-price competition through:
• Frequent Price Cutting
• Frequent Product Introductions
• Intense Advertising
• Rapid Competitive Actions & Reactions
Five Forces Weaknesses
 It assumes a zero sum game, i.e. one firm
wins at the others expense. This analysis
therefore down plays the potential for win-win
relationships through partnering with
customers/suppliers. An example of this is
JIT inventory systems.
 It is static in that it looks at a dynamic
environment at a single moment.
Relationships can quickly change.
Exploiting Industry Structure Opportunities
Generic Industry Structures:
• 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.
Exploiting Industry Structure Opportunities
Fragmented Industry Structure
Industry Characteristics
• Large number of small
firms.
• No dominant firms.
• No dominant technology.
• Commodity type
products.
• Low barriers to entry.
• Few, if any, economies
of scale.
Opportunity Consolidation:
• buy competitors
• build market power
• exploit economies of
scale
Exploiting Industry Structure Opportunities
Emerging Industry Structure
Industry Characteristics:
Opportunity:
• New industry based on
break through
technology or product.
• No product standard
has been reached.
• No dominant firm has
emerged.
• New customers come
from non-consumption
not from competitors.
•
•
•
•
First mover advantages
Technology
Locking-up assets
Creating switching costs
Exploiting Industry Structure Opportunities
Mature Industry Structure
Industry Characteristics:
Opportunities:
• Slowing growth in demand.
• Technology standard exists.
• Increasing international
competition.
• Industry-wide profits
declining.
• Industry exit is beginning.
• Refine current
products
• Improve service
• Process innovation
Exploiting Industry Structure Opportunities
Declining Industry Structure
Industry Characteristics:
Opportunities:
• Industry sales have
sustained pattern of
decline.
• Some well-established
firms have exited.
• Firms have stopped
investing in
maintenance.
•
•
•
•
Market leadership
Niche
Harvest
Divest
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.
Strategic Groups
• Factors that might be relevant in identifying
strategic groups:
• Leaders (innovators) and Followers
• Market Segments Served
• Pricing
• Quality
• Distribution Channels
• No two firms are totally different.
• No two firms are exactly the same.