3. Evaluating a company's external environment.

This chapter presents the concepts and analytical tools of the external
environment that should be considered in making strategic choices about where and
how to compete. There's special attention for the competitive arena in which the
company operates, the drivers of market change, the market positions of rivals and
other factors that determine the external environment.

3.1. The strategically relevant components of a company's macro-environment

A company's macro-environment are the external factors that influence a

business.

Every organization operates in a so called macro-environment, the external elements

that exist outside of a company's control that can significantly impact its performance and
ability to compete in its marketplace. The macro-environment includes seven principal
components:

1. Population demographics
2. Societal values and lifestyles
3. General economic conditions
4. Political, legal and regulatory factors
5. Natural environment
6. Technological factors
7. Global forces

All these components have the potential to affect the company's industry and
competitive environment. These factors affect different industries in different ways and
degrees. That's why it's important for managers to determine which factors are the most
strategically relevant. Factors are strategically relevant when they could have an effect on the
company's direction, objectives, strategy and business model. You can take a company that
produces cigarettes as an example. Political and regulatory factors against smoking and the
growing cultural stigma attached to smoking reduce the strategic opportunities to grow the
business.

Macro-environmental factors may occur rapidly or slowly, with or without warning.

Managers must be alert for potential developments, assess the impact and influence of these
developments, and have to adapt the company's direction and strategy as needed. However,
the factors that have the biggest strategy-shaping impact typically pertain to the company's
immediate industry and competitive environment. You can think about competitive pressure,
buyer behavior, actions of rivals and so on. Our main attention goes out to these factors that
lie 'closer to the company'.

3.2. Thinking strategically about a company's industry and competitive environment

Company managers must think strategically about their company's industry and
the competitive environment they operate in.

Managers must focus on using well-defined concepts and analytical tools to gain
understanding of the company's industry and competitive environment and to get clear
answers on the following seven questions:

1. Does the industry offer attractive opportunities for growth?

2. What kinds of competitive forces are industry members facing, and how strong is
each force?
3. What factors are driving changes in the industry, and what impact will these changes
have on competitive intensity and industry profitability?
4. What market positions do industry rivals occupy-who is strongly positioned and who
is not?
5. What strategic moves are rivals likely to make next?
6. What are the key factors for competitive success in the industry?
7. Does the industry offer good prospects for attractive profits?

Answers that are based on analysis provide managers with the understanding needed
to craft a strategy that fits with the external environment.
3.2.1. Does the industry offer attractive opportunities for growth?

Managers must assess whether an industry offers attractive opportunities for

growth before they decide to enter an industry, ot

Answering this question will require us to find out if this industry offers good
opportunities for growth. Growth can't guarantee profitability, but it's a good indicator of how
much customers value the industry's products and whether the industry demand is strong
enough to support profitable sales growth. You can determine the growth by looking at key
economic indicators, like the market size in terms of overall unit sales and the industry's
growth rate. Assessing the market size and growth rate will depend on whether the industry is
defined broadly or narrowed, in terms of its product characteristics. For example, the freight
industry is far more inclusive than the air freight industry, and market size will vary
accordingly. But the growth rate and market size also depends on where the geographic
boundary lines are drawn (local vs global). They often also vary by demographic market
segments (Gen Y vs. baby boomers). Looking at markets in a variety of ways can help
managers assess the various opportunities for growth and its limits. The size of market and
the growth also depends on the industry life cycle, a pattern that industries commonly follow.
The pattern consist of the following four phases: emergence, rapid growth, maturity and
decline.

3.2.2. What kinds of competitive forces are industry members facing, and how strong is each
force?

Porter five forces analysis is a framework to analyze level of competition within

an industry and business strategy development and draws upon industrial organization
economics to derive five forces that determine the competitive intensity and therefore
attractiveness of a market.

The character and strength of competitive forces differ per industry. The most
powerful and widely used tool for diagnosing the competitive pressures in the market is the
five-force model of competition. This model assumes that there are more factors that
influence the competitive pressure than solely rivalry among competing sellers. The five
competitive forces, are shown in the graphic below, and include:
1. Threat of new entrants
2. Bargaining power of suppliers
3. Threat of substitute products/services
4. Bargaining power of buyers
5. Rivalry among existing competitors

The five forces model is being used to identify who (the different parties involved)
brings competitive pressure and to identify the strength of each of the five forces. Each of the
five forces will be explained more in depth.

3.2.2.1. Rivalry among existing competitors

Rivalry among existing competitors refers to the extent to which firms within an
industry put pressure on one another and limit each other’s profit potential.

This can be seen as competitive pressure coming from other firms in the industry and
is the strongest of the five competitive forces. Companies try to produce a competitive edge
over rivals. This results in rivals that respond with offensive or defensive countermoves and
produces a continually evolving competitive landscape. Companies can change the
competitive landscape by using competitive weapons. Below are some common examples:

 Price discounting (lowers price and profit margin and increases the sales)
 Couponing (lowers the profit margin and increases sales)
 Advertising (boost buyers demand, increases product differentiation, perceived value
and sales, may increase costs)
 Innovating the product or introducing new/improved features (increases buyers
demand, product differentiation, perceived value and sales, increases costs)
 Customization (Increases switching costs, value, product differentiation and sales,
increases costs)
 Building a bigger, better dealer network (increases access to buyers and sales,
increases costs)
  Improving warranties, offering low-interest financing (increases product
differentiation, switching costs, value and sales)

The intensity of rivalry varies from industry to industry and depends on a number of
factors:

 Rivalry is stronger in markets where buyer demand is growing slowly or is declining

than in markets that are fast growing. Rapidly expanding buyer demand produces
enough new business for all industry members, while a slow growing buyer demand
will result in price discounts, sales promotions and other tactics to boost sales
volumes. With low buyer demand growth, companies have to work harder to reach
customers. Slow growing or declining buyer demand therefore leads to higher rivalry
in the industry.
 Rivalry increases as it becomes less costly for buyers to switch brands. The less
expensive it is for customers to switch to competitors, the easier sellers can steal away
customers. Switching costs not only include monetary costs, but also include the time,
inconvenience and psychological costs involved in switching brands. For example,
many cellular phone carriers charge very high cancelation fees for canceling a
contract. Cell phone carriers do this in hopes that the costs involved with switching to
another carrier will be high enough to prevent their customers from doing so.
 Rivalry increases as the products of rival sellers become more alike, and it diminishes
as the products of industry rivals become more strongly differentiated. Customers are
less brand loyal when the products of rivals are weakly differentiated (identical). This
condition makes it easier for rivals to convince buyers to switch to their products and
leads to higher rivalry. Highly differentiated products will lead to high brand loyalty,
because buyers view the attributes of certain brands as more appealing. It is therefore
hard to convince buyers to switch to another brand and leads to lower rivalry. A
highly differentiated product will also lead to higher switching costs, as it is harder
and more expensive to switch to another brand. Higher switching costs will increase
the rivalry and lower switching costs will decrease the rivalry in the industry.
 Rivalry is more intense when there is unused production capacity, especially if the
industry's product has high fixed or high storage costs. A market that has unused
production capacity is an oversupplied market. The high amount of supply and the
aggressive price cutting to get rid of products will lead to high rivalry in the market.
 The same holds for products that are seasonally, perishable or costly to hold in
inventory. Companies engage in aggressive price cutting to ensure that they're not left
with unwanted inventories. Rivalry will therefore increase. Companies that have high
fixed costs have to produce at full capacity to produce the lowest costs per unit. The
company has to sell this large quantity of product and has to fight for market share,
which results in increased rivalry.
 Rivalry often becomes more intense and unpredictable as the diversity of competitors
increases (in terms of long-term direction, objectives and strategy). A diverse group
of competitors exists of competitors that are willing to try novel rule-breaking market
approaches. This results in a livelier and less predictable environment.
 Rivalry intensifies as the numbers of competitors increase and as competitors become
more equal in size and strength. More companies have to fight over the same amount
of customers. Companies are more likely to engage in a strategic offensive intended to
enhance their market standings, when the number of competitors becomes bigger.
This will heat up competition and puts pressure on competitors to respond with
offensive/defensive moves. Companies that are equal in size (have the same resources
and capabilities) and strength can compete on a fairly equal footing. It is therefore
more likely that the rivalry between equally-sized companies is bigger than between
companies that differ in size.
 Rivalry is stronger when high exit barriers keep unprofitable firms from leaving the
industry. Failing firms tend to hold on longer in industries where the assets can't be
sold easily or where owners are committed to remaining in business for personal
reasons. The firm MUST compete. High exit barriers leads to an overcrowded market
that boosts rivalry (see the earlier explanation above) and forces the weakest firms to
make desperate moves to win sufficient sales. These firms that are mostly losing
ground or are in financial trouble, often engage in price cutting, which can result in
price wars and a destabilized market with more rivalry.

So when can you describe rivalry as strong or weak? There are a few degrees of
rivalry. Rivalry can be called cutthroat or brutal when competitors engage in price wars or
undertake other aggressive strategic moves that prove mutually destructive to profitability.
Rivalry can be called fierce or strong when the battle for market-share is so strong, that the
profit margins of the firms are squeezed to bare-bone levels (near zero). Rivalry can be called
moderate or normal when industry members earn acceptable profits. And rivalry is weak
when most companies in the industry are satisfied with their sales growth and market share,
rarely steal customers away from customers and consistently earn good profits.

3.2.2.2. Competitive pressures associated with the threat of new entrants

Threat of new entrants refers to the threat new competitors pose to existing
competitors in an industry.

Every market deals with new firms that try to enter the market and bring new
production capacity. Easyjet and Ryanair once entered the European airline market and are
now major European airlines. The seriousness of the threat of entry in a market depends on
two factors: the barriers to entry and the expected reaction of incumbent firms to new entry.
Incumbent firms that are willing and able to launch strong defensive maneuvers to
maintain their positions can make it hard for new entrants to enter and to gain a sufficient
market foothold to survive. Incumbent companies might have more resources and can give
newcomers a hard time by lowering the price of the product, spending more on advertising or
by providing more services to customers. All these factors raise the entrant's costs and risks
and act as entry barriers for the new entrant.
An entry barrier exists when it's hard for a newcomer to break into the market and
when the newcomer has to deal with disadvantages. The most widely barriers that new
entrants must hurdle include the following:
 Sizable economies of scale in production, distribution, or other areas of operations.
Incumbent companies might enjoy cost advantages that are associated with large-scale
operations. Outsiders must enter on a large scale or have to accept the cost-
disadvantage.
 Significant cost advantages held by existing firms due to experience and learning
curve effects. Many incumbent firms are favored by learning-based cost savings that
accrue from experience. This gives incumbents a first-mover advantage over new
entrants.
 Other cost advantages enjoyed by industry incumbents. Incumbents may have cost
advantages that cannot be replicated by a potential entrant. Factors include low fixed
costs (old buildings that have been depreciated), proprietary product technology or
 patents, access to raw materials, favorable locations and government subsidies. The
bigger the advantage for the incumbent, the more risky it becomes for a new entrant to
enter.
 Strong brand preferences and high degrees of brand loyalty. The stronger the
attachment of buyers to established brands, the harder it is for newcomers to break
into the marketplace. Newcomers have to possess enough resources and have to invest
in advertising and sales promotion to overcome customer loyalties and build its own
clientele.
 Strong network effects in customer demand. “Network effects,” is the theory that the
value of a product is dependent on the others using the same product. Buyers are
attracted to a product when there are many other users of the product. For example, a
competitor to Microsoft’s Excel is highly unlikely to emerge because of the huge
network of business consumers that currently utilize the program. Any spreadsheet
software that aspires to compete with Excel must be widely adopted by the business
community in order to be effective.
 High capital requirements. Some industries require a large financial outlay in order to
enter the industry (before even reaching economies of scale). For example: A new
pharmaceutical or biotech firm must spend millions in research and development
costs to develop a product. On the other hand, a new accounting or investment
banking firm has little capital requirement outlays to compete within their industry.
 The difficulties of building a network of distributors or dealers and securing space on
retailers' shelves. An inability to gain access to distribution channels can be a major
barrier. Existing partnership between retailers and wholesalers can make it difficult
for new entrants. Competition for space on a grocery store shelf is a zero-sum game,
if one product wins access to the shelf, another product lost. Large providers such as
Nabisco (from the well-known Oreo cookie) and Keebler have strong relationships
with the major grocery store chains and a new firm in the cookie market may have
difficulty finding a place to sell the product.
 Restrictive government policies. In certain industries, the government will erect
barriers to protect the industry from competition or to protect consumers from the
industry. Certain industries are called “natural monopolies,” in that it is more efficient
for a monopoly to exist than to allow competition. In this instance the government
will protect the natural monopoly and ban competition (e.g. cable or electricity). In
 other industries, the government protects consumers from the negative industry
effects by introducing barriers. For example, pharmaceutical companies must get
product approval before it is available for sale.

There are two additional factors that need to be considered in evaluating whether the
threat of entry is strong or weak. The first concerns the attractiveness (growth and profit
prospects) for new entrants. Rapidly growing markets act as magnets for new entrants.
Certain types of entry barriers are unlikely to provide an effective entry deterrent when
growth and profit opportunities are attractive enough. You can determine whether the threat
of entry is strong or weak by asking if the industry's growth and profit prospects are strongly
attractive to potential entrants with sufficient expertise and resources to hurdle prevailing
entry barriers. If the answer is no, potential entry is a weak competitive force. The second
factor concerns the pool of potential entrants and their capabilities in relation with the entry
barriers. Big companies with sufficient resources, capabilities and a respected brand name
might be able to hurdle entry barriers more easily than start-ups.

So the strength of the entry barriers depends on the resources and capabilities
possessed by the pool of potential entrants. The bigger the pool of potential entrants, the
bigger the threat of entry. So the threat of entry changes as the industry’s prospects grow
brighter or dimmer, as entry barriers rise or fall and when the pool of potential entrants and
their resources/capabilities change. So, high entry barriers and weak entry threats today do
not always translate into high entry barriers and weak entry threats tomorrow as the
conditions may change over time.

3.2.2.3. Competitive pressures from the sellers of substitute products

Porter’s threat of substitute’s definition is the availability of a product that the

consumer can purchase instead of the industry’s product.

Companies in one industry come under competitive pressure from the actions of
companies in a closely adjoining industry whenever buyers view the products of the two
industries as a good substitute. Newspapers struggle to maintain their relevance to subscribers
who can view the news on the TV or internet and CD-producers have to hurdle with music
programs like Spotify and Itunes. The degree of competitive pressure from substitutes
depends on three factors:
 Whether the substitute is readily available. The availability of a substitution threat
creates competition and effects the profitability of an industry because consumers can
choose to purchase the substitute instead of the industry’s product. The availability of
close substitute products can make an industry more competitive and decrease profit
potential for the firms in the industry. On the other hand, the lack of close substitute
products makes an industry less competitive and increases profit potential for the
firms in the industry
 Whether buyers view the substitute as attractively priced in relation to their quality,
performance and other relevant attributes. In deciding whether to switch to a
substitute product, customers compare its features as well as price to see if the
substitute offers more value for the money than the industry's product.
 Whether the switching costs for customers are low or high. Low switching costs make
it easier for the sellers of substitutes to lure buyers to their offerings, while high
switching costs make it harder to lure buyers to their offerings. Although most
prevalent switching costs are monetary in nature, there are also psychological, effort-
and time-based switching costs, like the cost of testing the quality of the substitute.

The company first has to identify the substitutes, before assessing the competitive
pressures coming from the substitutes. The company has to determine where the industry
boundaries lie (1) and has to figure out which other products can address the same basic
customer needs as those produced by industry members (2). Deciding where the industry
boundary lies is necessary to determine which companies are direct rivals. As a rule, the
better the quality of the substitute, the lower the price and the lower the user's switching
costs, the higher the competitive pressure from substitute products.

Other market indicators of the competitive strength of substitute products include:

whether sales of substitute products grow in relevance with the industry's product (1),
whether producers of substitutes add production capacity and whether the profits of the
producers of substitutes are on the rise (3).

3.2.2.4. Competitive pressures stemming from supplier bargaining power

 The degree of competitive pressures stemming from suppliers depends on the
amount to which suppliers have bargaining power to influence the terms and conditions
of supply in their favor.

Suppliers that have strong bargaining power can erode industry profitability by
charging higher prices and passing costs on to industry members. They limit the opportunity
for industry members to find better deals. A variety of factors determine the strength of
suppliers’ bargaining power:
 Whether suppliers’ products are in short supply. These suppliers have pricing power
and bargaining leverage. A large amount of supplies shifts the bargaining power to the
industry member.
 Whether suppliers provide a differential input that enhances the quality or
performance of the product. The more differentiated and valuable a particular input in
terms of enhancing the performance of the product of the industry member, the more
bargaining power the supplier has.
 Whether the item is an item that’s readily available. Suppliers of commodities (like
copper or steel) are in a weak position as buyers can easily switch to other suppliers
that offer the same product for the same price.
 Whether it’s difficult or costly to switch to another supplier. The higher the switching
costs for industry members, the stronger the bargaining power of suppliers. Low
switching costs enable industry members to switch to other suppliers more easily (and
less costly).
 Whether there are good substitutes available for the suppliers’ products. The
availability of a substitute decreases the bargaining power of suppliers. Buyers can
switch more easily to the substitute when the supplier increases the price of his
products or when the quality of the substitute product is better.
 Whether industry members account for a sizable fraction of suppliers’ total sales. The
buyer accounts for a sizable fraction of total sales, so the well-being of the buyer is
closely tied with the well-being of the supplier. Suppliers have a big incentive to
protect and enhance the competitiveness of the buyer. The bargaining power of the
supplier therefore decreases.
  Whether the supplier industry is dominated by a few large companies. Suppliers with
sizable market shares and strong demand for their items have large bargaining power
and can charge high prices.
 Whether it makes good economic sense for industry members to integrate backward.
Industry members can self-manufacture items they have been buying from suppliers.
This will decrease the dependency on suppliers and the bargaining power of suppliers.
Suppliers are safe from the threat of self-manufacture by their customers until the
volume of parts a customer needs becomes large enough for the customer to justify
backward integration into self-manufacture of the component.

So the degree of supplier power in an industry depends on the type of supplier.

Different types of suppliers are likely to have different amounts of bargaining power.
Managers need to identify the type of supplier and have to assess the bargaining power of
each type of supplier separately.

3.2.2.5. Competitive pressures stemming from buyer bargaining power

The degree of competitive pressure from buyers depends on the degree to which
buyers have bargaining power and the extent to which buyers are price-sensitive.

Buyers with bargaining power can limit industry profitability by demanding lower
prices, better terms or additional features. Buyer price sensitivity limits the profit potential of
industry members by restricting the ability of sellers to raise prices without losing revenue.

The strength of buyers as competitive force depends on the price sensitivity and the
degree of bargaining power, which vary according to buyer group (small/large retailers,
consumers, wholesalers etc.). Retailers tend to have greater bargaining power over industry
sellers if they have influence over the purchase decision of the end user or if they are critical
in providing sellers with access to the end user. Walmart, Albert Heijn & REWE can be seen
as these critical retailers that possess a lot of bargaining power. They typically have
negotiating leverage in purchasing products from manufacturers because of manufacturers'
need for broad retail exposure and the most appealing shelf locations. In contrast, individual
customers rarely have any real bargaining power in negotiating price concessions or other
favorable terms with sellers. As a buyer group, however, consumers can limit the profit
potential of an industry for the same reasons that other buyer groups exert competitive
pressure. That's because of the following reasons:
 Buyers' bargaining power is greater when their costs of switching to competing
brands or substitutes are relatively low. Buyers are able to switch more easily when
switching costs are low.
 Buyer power increases when industry goods are standardized or differentiation is
weak. Buyers make their selection based on price, because products are standardized.
 Buyers have more power when they are large and few in number relative to the
number of sellers. The smaller the number of buyers, the more sellers have to compete
for their business and the less easy it is for sellers to find alternative buyers when a
customer is lost to a competitor. The larger the buyer, the more important their
business is to the seller and the more sellers will be willing to grant concessions.
 Buyer power increases when buyer demand is weak and industry members are
scrambling to sell more units. Weak or declining demand creates a buyers’ market, in
which bargain-hunting buyers are able to press for better deals. Conversely, strong
and rapidly growing demand creates a sellers’ market and shifts bargaining power to
sellers.
 Buyers gain leverage if they are well informed about sellers' products, prices and
costs. The more information buyers possess, the higher their bargaining power.
Internet plays an important role in providing buyers with information and has led to
more buyer bargaining power.
 Buyers' bargaining power is greater when they pose a credible threat of integrating
backward into the business of sellers. Companies like Heinz and Coors have
integrated backward into metal can manufacturing to become more independent and
to gain bargaining power. Retailers gain bargaining power by placing their private
label brands next to manufacturers' name brands.
 Buyer leverage increases if buyers have discretion to delay their purchases or
perhaps even not make a purchase at all. Buyers often have the option to delay
purchases of durable goods if they are not happy with the prices offered. This puts
pressure on sellers to provide concessions to buyers so that the sellers can keep their
sales numbers from dropping off.
  Buyer price sensitivity increases when buyers are earning low profits or have low
income. Companies and consumers with a low income are more careful and tend to
spend less money. Their price sensitivity limits the ability of sellers to charge high
prices.
 Buyers are more price-sensitive if the product represents a large fraction of their total
purchases. The buyer cares more about the price when a purchase eats up a large
portion of a buyers' budget. Negotiating is worth the time and trouble.
 Buyers are more price sensitive if product performance has limited consequences.
Customers will therefore make decisions that are based on the price of the product.
The price becomes less important when customers base their purchase decision on
quality and performance.

So the degree of competitive pressure from buyers depends on the degree to which
buyers have bargaining power and the extent to which buyers are price-sensitive. Buyers are
able to exert strong competitive pressures and force industry profitability downward if the
majority of industry member sales are made to buyer groups that have strong bargaining
power or high price sensitivity.

The most extreme case of a competitive unattractive industry occurs when all five
forces are producing strong competitive pressure. This will drive profitability to unacceptably
low levels and forcing some industry members out of business. But an industry can also be
competitive unattractive without all five competitive forces being strong. Remember, intense
competitive pressures from just one or two of the five forces can drive profitability to low
levels. The strongest competitive forces determine the extent of the competitive pressure on
industry profitability. So managers must look at the strongest forces when they evaluate the
strength of the competitive forces. The ideal competitive environment for earning superior
profits is one in which both suppliers and customers are in weak bargaining positions, there
are no good substitutes, high entry barriers and rivalry among present sellers generate only
limited competitive pressures. The competitive strength in most industries lies in between the
two extremes, somewhere in the middle between very intense competition and very weak
competition.

3.2.3. What factors are driving changes in the industry, and what impact will these changes
have on competitive intensity and industry profitability?
 Assessing what factors are driving changes in the industry and what impact
these changes have on competitive intensity is an important management task.

It's important to understand the nature and intensity of the competitive forces in an
industry, like we just did, but it's also important to understand that the intensity of these
forces are subject to change. Industries are affected by new developments and trends that
alter industry conditions. Since the five competitive forces have such significance for an
industry’s profit potential, it is critical that managers remain alert to the changes most likely
to affect the strength of the five forces. Managers must scan the environments, which will
enable them to forecast any changes. Positive changes may present opportunities for the
company, while negative changes may require a defensive strategic response. Managers can
react more quickly if they have advance notice of the coming changes. Moreover, with early
notice, managers may be able to influence the direction of environmental change and improve
the outlook.

Managing under changing conditions begins with a strategic analysis of the industry
dynamics. This involves the following three steps:
1. Identifying the drivers of change.
2. Assessing the impact of the factors driving industry change.
3. Developing a strategy that takes the changes in industry conditions into account.

3.2.3.1. Identifying the drivers of change.

There are things, events, or situations that occur that affect the way a business
operates, either in a positive or negative way.

These things, situations, or events that occur that affect a business in either a positive
or negative way are called "drivers of change". It is important to focus on the most
powerful agents of change, the ones that have the biggest influence in reshaping the industry
landscape. The following factors are the 12 most common drivers of industry change:
 Changes in an industry's long-term growth rate. Shifts in the industry's growth rate
are a key driver of industry change, affecting the balance between supply and
demand, exit and entry, and the character and strength of competition.
 Increasing globalization. Globalization can be precipitated by the blossoming of
consumer demand in more and more countries and by the actions of government
officials in many countries to reduce trade barriers or open up once closed markets to
foreign competitors. Differences in labor costs give manufacturers incentives to
relocate their labor-intensive plants to low-wage countries. Analyzing globalization
can be a difficult task, because it influences each industry differently and effects all
five forces differently. Globalization increases the diversity and the number of
competitors and the lowering of trade barriers increases the threat of entry, which all
increase the rivalry in the industry. On the other hand, globalization is likely to
weaken supplier power by increasing the number of suppliers and increasing the
possibility of substituting cheap labor for other inputs. The specific effects vary per
industry.
 Changes in who buys the product and how they use it. Shifts in buyer demographics
and the ways products are being used can greatly alter industry and competitive
conditions. Longer life expectancies, for example, are driving demand for health care
and recreational living.
 Technological change. Advances in technology can cause disruptive change in an
industry by introducing substitutes that offer buyers an irresistible price/performance
combination. It can have a big impact on the demand in in the industry, but also on
the manufacturing process, which can lead to greater economies of scale or greater
product differentiation.
 Emerging internet capabilities and applications. Internet can be seen as a special
technological change. Companies can reach customers via the internet instead of
reaching them through brick-and-mortar stores. This increases the diversity and size
of competitors. Internet also makes buyers better informed.
 Product and marketing innovation. An ongoing stream of product innovations tends
to alter the pattern of competition in an industry by attracting more first-time buyers,
rejuvenating industry growth, and/or increasing product differentiation, with
concomitant effects on rivalry, entry threat, and buyer power.
  Entry or exit of major firms. The entry of one or more foreign companies into a
geographic market once dominated by domestic firms nearly always change the
demand between demand and supply and shakes up competitive conditions by adding
diversity.
 Diffusion of technical know-how across more companies and more countries.
Knowledge about how to perform an activity spreads and products tend to be more
commodity like. This increases the intensity of rivalry, buyer power and the threat of
new entry.
 Improvement in cost and efficiency in closely adjoining markets. Big changes in the
costs of substitute producers can alter the state of competition by changing the
price/performance trade-off between an industry's products and that of substitute
goods. Consumers will switch and buy the substitute product.
 Reductions in uncertainty and business risk. Many companies are resistant to enter
industries with uncertain futures or high levels of business risk. Over time,
diminishing risk levels and uncertainty tend to stimulate new entry and capital
investments on the part of growth-minded companies seeking new opportunities. This
can increase rivalry as the numbers of firms and their diversity increases.
 Regulatory influences and government policy changes. Competitive conditions can be
changed by changes in regulations and government policies. They can affect barriers
to entry in some industries, but they can also affect rivalry through antitrust policies.
 Changing societal concerns, attitudes and lifestyles. Social changes can be powerful
instigators of industry change. Growing concerns about global warming, for example,
can lead to growth rates in the green energy market. It can affect the intensity of
industry rivalry and entry conditions.

3.2.3.2. Assessing the impact of the factors driving industry change.

The second step in dynamic industry analysis is to determine whether the

prevailing change drivers are acting to make the industry environment more or less
attractive.
 Just identifying the drivers of change isn't enough. You have to check whether the
prevailing change drivers are acting to make the industry environment more or less attractive
after you identified the drivers of change. You therefore need to answer three questions:
1. Are the drivers of change causing demand for the industry's product to increase or
decrease?
2. Is the collective impact of the drivers of change making competition more or less
intense?
3. Will the combined impacts of the change drivers lead to higher or lower industry
profitability?

Getting a good image of the collective factors requires looking at each factor
individually and requires to determine whether the change drivers will have impact on the
demand, competition and industry profitability.
3.2.3.3. Developing a strategy that takes the changes in industry conditions into account.

Strategy adjustments will be needed to deal with the impacts of the earlier
described changes.

Managers need to draw conclusions about what strategy adjustments will be needed to
deal with the impacts of the changes in industry conditions. These changes are based on the
industry dynamics that have been analyzed before (step 1 and 2). Dynamic industry analysis,
when done properly, has practical value and pushes company managers to think about what's
around the corner and what the company needs to be doing to get ready for it.

3.2.4. What market positions do industry rivals occupy-who is strongly positioned and who is
not?

Managers must determine what market positions rivals occupy by mapping

rivals in strategic groups.

Companies commonly sell in different price/quality ranges, have different distribution

channels and so on. Managers have to understand which companies are strongly positioned
and which are weakly positioned. This can be done by using the technique of strategic group
mapping. This technique displays the different competitive positions that rival firms occupy
in the industry.

A strategic group is a management concept which separates companies within the

same industry with similar business models and or a similar strategy combination. These
companies have similar market positions. The procedure for constructing a strategic group
map is straightforward:
 Identify the competitive characteristics that differentiate firms in the industry. Typical
variables are: price/quality range, geographical coverage, product-line breadth, degree
of service offered etc.

 Plot the firms on a two-variable map using pairs of these differentiating

characteristics.

 Assign firms occupying about the same map location to the same strategic group (like
Gap and Banana Republic)

 Draw circles around each strategic group and make them proportional to the size of
the group's share of total industry sales revenues.

An example can be seen below.

The two variables in the strategic group map shouldn't be highly correlated and should
reflect key approaches to offering value to customers and expose big differences in how
rivals position themselves to compete in the marketplace. Analysts must identify the
characteristics that differentiate rival firms and use these differences as variables for the axes
and as the basis for deciding which firm belongs in which strategic group. If more than two
variables can be used as axes for the map. Then it's wise to draw several maps to give
different views of the relationships among the competitive positions present in the industry's
structure.

So why do we use strategic group maps? Strategic group maps reveal which
companies are close competitors and which are distant competitors. Firms in the same
strategic groups are close competitors and the next closest rivals are in the adjacent groups.
It's also good to know that not all positions on the map are equally attractive. That's because
of the following two reasons:

 Prevailing competitive pressures can benefit some strategic groups while it may hurt
others. The impact of competitive pressure differs per group. There’s little reason to
believe that all companies in the industry feel the same degree of competitive
pressure, since their market position and strategy differs from other companies.

 Profit prospects vary from strategic group to strategic group. The profit prospects
differ per group, because of differing growth rates for the principal buyer segments
served by each group, differing degrees of rivalry within groups, differing pressures
from possible new entrants to each group, differing degrees of exposure to
competition from substitute products outside the industry, differing degrees if
supplier/buyer bargaining power from group to group, and differing impacts from the
industry’s drivers of change.

So some strategic groups are more favorable positioned than others because they
confront weaker competitive forces and because they are more favorably impacted by the
drivers of industry change. Thus, part of analyzing the strategic group map is locating the
“best” position on the map.

3.2.5. What strategic moves are rivals likely to make next?

Managers must determine what strategic moves rivals will make by scouting
them and by finding information about these rivals.

As in sports, scouting the opponent is an essential part of game plan development.

That's why companies need to "scout" competitors. They have to find information about
rivals' strategies, their actions, financial performances, strengths and weaknesses, and the
leadership styles of the executives. This is called competitive intelligence. Competitive
intelligence is the action of defining, gathering, analyzing, and distributing intelligence about
products, customers, competitors, and any aspect of the environment needed to support
executives and managers making strategic decisions for an organization. Having good
information about the environment and the competitors allow a company to prepare defensive
countermoves, to craft its own strategy that has taken possible future market maneuvers into
account, and to exploit any openings that arise from competitors missteps. Good competitive
intelligence helps managers avoid any damage to sales and profits that come from sudden
market maneuvers.

So are there some indicators that can forecast the actions of a company? Financial
performance is a good indicator of the likeliness of a strategic move. Companies with good
financial performances will only fine-tune their current strategy, while companies with bad
financial performances will likely change their current strategy. Ambitious rivals also tend to
launch new strategic offensives to pursue emerging market opportunities. The information
that companies release in the press also offers good clues about what actions the company is
going to undertake. Many companies have a competitive intelligence unit that sifts through
the information and creates up-to-date strategic profiles of competitors.

There are several useful questions that managers can use to help predict the likely
actions of rivals:
 Which competitors have good performing strategies and therefore only need to fine-
tune their strategies?

 Which companies are losing ground in the marketplace and are good candidates of
moving to a different part of the strategic group map?

 Which rivals are likely to enter new geographic markets?

 Which rivals badly need to increase their unit sales and market share? What strategic
options are they most likely to pursue?

 Which rivals are strong candidates to enter new product segments?

 Which rivals are good candidates to be acquired?

To succeed in predicting a competitor's next moves, company strategists need to have

a good understanding of each rival's situation, the pattern of behavior in the past, how
managers think and what the rival's best strategic options are. "Scouting" takes time but it
allows managers to prepare effective countermoves and to take rivals' probable actions into
account when crafting their own actions/strategy.

3.2.6. What are the key factors for competitive success in the industry?
 Key success factors are the strategy elements, product attributes, operational
approaches, resources and competitive capabilities with the greatest impact on
competitive success in the marketplace.

Key success factors (KSF's) refer to the combination of important facts that are
required in order to accomplish one or more desirable business goals. When key success
factors are categorized as critical success factors, they are viewed as variables that have direct
impact on effectiveness of a business. They determine key results of a business. KSF's are so
important that all firms must pay close attention to them. The better a company's KSF in
comparison with the industry's KSF, the more competitive successful that company will be.
Identifying KSF's is therefore a critical task.

KSF's vary from industry to industry and from time to time, but can be deduced by
asking the same three questions:
 On what basis do buyers of the industry's product choose between the competing
brands of sellers? So what product attributes are crucial?

 What resources and capabilities must a company have to be competitively successful?

 What shortcomings are almost certain to put a company at a significant competitive

disadvantage?

Correctly diagnosing an industry's KSF's raises a company's chances of crafting a

good strategy. Companies that can't deliver on the KSF's of its industry are unlikely to make
enough profits to stay in business. So you have to deliver on KSF's of the industry to
compete. Companies should aim to be distinctively better than rivals on one or two of the
KSF's to be more competitive. The goal is of strategists is not to meet the KSF's, but to
exceed them.

3.2.7. Does the industry offer good prospects for attractive profits?

Managers must determine whether the industry offers good prospects for
attractive profits, or not.
 The final step in evaluating the industry and its competitive environment is to use the
result of the analysis performed in answering the first 6 questions to determine whether the
industry presents the company with strong prospects for attractive profits. You therefore have
to look whether competitive forces are squeezing profitability, whether profitability will be
favorably or unfavorably affected by drivers of change, whether the company occupies a
stronger position in the market, how well the company's strategy delivers on the industry
KSF's and whether the industry will grow.
If a company can conclude that its overall profitability prospects are above average in
the industry, then the industry environment is attractive for that company. The attractiveness
of an industry is thus not the same for all industry participants and all potential entrants!