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Analyzing

the External
Environment
of the Firm:
Creating
Competitive
Advantages
chapter 2
Copyright 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education

Learning Objectives
2-2

After reading this chapter, you should have a


good understanding of:
LO1.1 The importance of developing forecasts of
the business environment.

LO1.2 Why environmental scanning, environmental


monitoring, and collecting competitive intelligence
are critical inputs to forecasting.

LO1.3 Why scenario planning is a useful technique


for firms competing in industries characterized by
unpredictability and change.

Learning Objectives
2-3

After reading this chapter, you should have


a good understanding of:
LO1.4 How forces in the competitive environment
can affect profitability, and how a firm can
improve its competitive position by increasing its
power vis--vis these forces.

LO1.5 How the Internet and digitally based


capabilities are affecting the five competitive
forces and industry profitability.

LO1.6 The concept of strategic groups and their


strategy and performance implications.

The Importance of External


Environment
2-4

Consider
If a company does not keep pace
with changes in the external
environment, it becomes difficult
to sustain competitive advantages
and deliver strong financial results.

2-5

Creating the Environmentally


Aware Organization

Exhibit 2.1 Inputs to


Forecasting

2-6

Environmental Scanning &


Monitoring

Environmental scanning involves


surveillance of a firms external
environment

Predicts environmental changes to come


Detects changes already under way
Allows firm to be proactive

Environmental monitoring tracks


evolution of environmental trends

Hard trends measurable facts/events


Soft trends estimated, probable events

Competitive Intelligence
2-7

Competitive intelligence

Helps firms define & understand their industry


Identify rivals strengths & weaknesses
Collect

data on competitors
Interpret intelligence data

Helps firms avoid surprises


Anticipate

competitors moves
Decrease response time

Beware of the potential for unethical behavior


while gathering intelligence

Example: Using Competitive


intelligence
2-8

Startups have a disadvantage it takes a lot of time to be


ready for the market - someone else can get there first.

How to find out if your competitor will beat you to launch?

Do competitive intelligence:

Monitor the competitors blog posts, e-mail blasts, the CEO's


Twitter messages, changes to the LinkedIn profile
Track the dates of each dispatch on a spreadsheet and look for
patterns
When the companys chatter becomes more frequent,
broadcasting more and more positive messages about its new
product, "It led me to believe they were entering launch mode
so we put together a limited version of our software and
released it to get the Qworky name out first.

Environmental Forecasting
2-9

Environmental forecasting predicts


change

Plausible projections about


Direction

of environmental change?
Scope of environmental change?
Speed of environmental change?
Intensity of environmental change?

Scenario analysis involves detailed


assessments of the ways trends may affect
an issue & development of alternative
futures based on these assessments

Question?
2-10

A danger of forecasting discussed in the text


is that
A.
B.
C.
D.

in most cases, the expense of collecting the


necessary data exceeds the benefit.
forecastings retrospective nature provides
little information about the future.
managers may view uncertainty as black and
white while ignoring important gray areas.
it can create legal problems for the firm if
regulators discover the company is making
forecasts.

SWOT Analysis
2-11

SWOT analysis is a basic technique for


analyzing firm and industry conditions

Firm or internal conditions = Strengths &


Weaknesses
Where

the firm excels or where it may be lacking

Environmental or external conditions =


Opportunities & Threats
Developments

that exist in the general

environment
Activities among firms competing for the same
customers

SWOT Analysis
2-12

SWOT analysis

Forces managers to consider both internal


& external factors simultaneously
Makes firms act proactively
Raises awareness about role of strategy
A

firms strategy must build on its strengths,


Remedy the weaknesses or work around them,
Take advantage of the opportunities presented
by the environment, and
Protect the firm from the threats.

Example: SWOT Analysis


2-13

Southwest Airlines SWOT

Strengths
Strong

Weaknesses
Lack

culture, employee relationships

of cultural fit with new AirTran employees

Opportunities
Consolidation

in the airline industry means more


routes or acquisition targets might be available

Threats
Economic

conditions/jet fuel prices might affect


profitability in the future

The General Environment


2-14

The general environment is composed


of factors that are both hard to predict and
difficult to control:

Demographic
Sociocultural
Political/Legal

Technological
Economic
Global

The Demographic
Segment

2-15

Demographics are easily


understandable & quantifiable:

Aging population
Rising affluence
Changes in ethnic composition
Geographic distribution of population
Greater disparities in income levels

The Sociocultural Segment


2-16

Sociocultural forces influence the


values, beliefs, and lifestyles of a society:

More women in the workforce


Dual-income families
Increase in temporary workers
Greater concern for healthy diets & physical
fitness (increasing levels of obesity)
Greater concern for the environment
Postponement of marriage & family
formation, having children

The Political/Legal
Segment

2-17

Political/Legal processes & legislation


influence environmental regulations with
which industries must comply:

Tort reform
Americans with Disabilities Act (ADA)
Deregulation of utilities & other industries
Increases in minimum wages
Taxation at local, state, federal levels
Legislation on corporate governance reforms
Affordable Health Care Act

The Technological
Segment

2-18

Technological developments lead to


new products & services; can create new
industries & alter existing ones:

Genetic engineering
Computer-aided design/computer-aided
manufacturing systems (CAD/CAM)
Research in synthetic & exotic materials
Pollution/global warming
Wireless communications
Nanotechnology

The Economic Segment


2-19

Economic forces affect all industries:

Interest rates
Unemployment
Consumer Price Index
Trends in GDP & net disposable income
Changes in stock market valuations

The Global Segment


2-20

Global forces offer both opportunities &


risks:

Increasing global trade


Currency exchange rates
Emergence of the Indian & Chinese
economies
Trade agreements among regional blocs
(NAFTA, EU, ASEAN)
Creation of WTO (leading to decreasing
tariffs/free trade in services)
Increased risks associated with terrorism

The Competitive
Environment

2-21

The competitive environment


consists of factors in the task or industry
environment that are particularly
relevant to a firms strategy:

Competitors (existing or potential)


Including

those considering entry into an


entirely new industry

Customers (or buyers)


Suppliers
Including

those considering forward integration

Porters Five-Forces Model of


Industry Competition
2-22

Exhibit 2.4 Porters Five-Forces Model of Industry Competition


Source: Adapted and reprinted with permission of The Free Press, a division of Simon & Schuster Adult
Publishing Group, from Competitive Strategy: Techniques for Analyzing Industries and Competitors by Michael
E. Porter. Copyright 1980, 1998 by The Free Press. All rights reserved.

The Threat of New


Entrants

2-23

The threat of new entrants - possibility


that the profits of established firms in the
industry may be eroded by new competitors.
Depends on existing barriers to entry:

Economies of scale
Product differentiation
Capital requirements
Switching costs
Access to distribution channels
Cost disadvantages independent of scale

Question?
2-24

If you are considering opening a new


pizza restaurant in your community,
what would be the threat of new
entrants? How would you evaluate
Porters other forces for this industry?
Explain.

The Bargaining Power of


Buyers

2-25

Buyers have bargaining power:


Buyers can force down prices, bargain for
higher quality or more services, play
competitors against each other.
Buyer groups are powerful when:

Purchasing standard products in large


volumes
Profits are low & switching costs are few
Backward integration is possible
Quality is not affected by industry product

The Bargaining Power of


Suppliers

2-26

Suppliers can exert bargaining power by


threatening to raise prices or reduce the
quality of purchased goods and services.
Supplier groups are powerful when:

Only a few firms dominate the industry


No competition from substitute products
Suppliers sell to several industries
Buyer quality is affected by industry product
Products are differentiated & have switching
costs
Forward integration is possible

The Threat of Substitute


Products & Services

2-27

Substitute products & services limit


the potential returns of an industry by
placing a ceiling on the prices that firms
can profitably charge.
Substitutes come from another industry
Can perform the same function as the
industrys offerings
The more attractive the
price/performance ratio, the more the
substitute erodes industry profits.

The Intensity of Rivalry


Among Competitors in an
Industry

2-28

Rivalry tactics include price competition,


advertising battles, new product
introductions, increased customer service
or warranties
Interacting factors lead to intense rivalry:

Numerous or equally balanced competitors


Slow industry growth
High fixed or shortage costs
Lack of differentiation or switching costs
Capacity augmented in large increments
High exit barriers

2-29

How the Internet and Digital


Technologies Affect Competitive
Forces

Using Industry Analysis: A


Few Caveats

2-30

Managers must not always avoid low profit


industries these can still yield high returns for
players who pursue sound strategies
Five forces analysis implicitly assumes a zerosum game yet mutually beneficial relationships
can still be established with buyers & suppliers
Five forces analysis is essentially a static analysis
yet external forces can still change the structure
of all industries
See the value net
Vertical dimension = suppliers & customers
Horizontal dimension = substitutes & complements

The Value Net


2-31

Exhibit 2.6 The Value Net


Source: reprinted by permission of Harvard Business Review. Exhibit from The Right Game: Use Game Theory
to Shape Strategy, by A. Brandenburger and B.J. Nalebuff, July-August 1995. Copyright 1995 by the Harvard
Business School Publishing Corporation. All rights reserved.

Doing a Good Industry


Analysis

2-32

Good industry analysis looks rigorously


at the structural underpinnings & root
causes of profitability

Must choose the appropriate time frame


Consider

the industry business life cycle


Average profitability over 3-5 years or longer

Must consider quantitative factors as well


as qualitative
Get

numbers to quantify five forces factors

Percentages of cost or sales, actual switching costs

Strategic Groups Within


Industries

2-33

Two unassailable assumptions in industry


analysis:

No two firms are totally different


No two firms are exactly the same

Strategic groups clusters of firms


that share similar strategies:

Breadth of product & geographic scope


Price/quality
Degree of vertical integration
Type of distribution

2-34

Strategic Groups Within


Industries

Exhibit 2.7 The World Automobile Industry: Strategic


Groups
Note: Members of each strategic group are not exhaustive, only illustrative.

Strategic Groups Within


Industries

2-35

Strategic groups as an analytical tool

Helps identify barriers to mobility that


protect a group from attacks by other
groups
Helps identify groups whose competitive
position may be marginal or tenuous
Helps chart the future direction of firms
strategies
Helps to think through the implications of
each industry trend for the strategic group
as a whole