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Evaluating a

Companys External
Environment
Chapter 3

Chapter Roadmap
The Strategically Relevant Components of a
Companys External Environment
Thinking Strategically About a Companys
Industry and Competitive Environment
Question 1: What Are the Industrys Dominant
Economic Features?
Question 2: How Strong Are Competitive Forces?
Question 3: What Forces Are Driving Industry Change
and What Impacts Will They Have?
Question 4: What Market Positions Do Rivals Occupy
Who Is Strongly Positioned and Who Is Not?
Question 5: What Strategic Moves Are Rivals Likely to
Make Next?
Question 6: What Are the Key Factors for Future
Competitive Success?
Question 7: Does the Outlook for the Industry Offer the

Understanding the Factors


that Determine a Companys
Situation

Diagnosing a companys situation has


two facets

Assessing the companys external or macroenvironment


Industry and competitive conditions
Forces acting to reshape this environment

Assessing the companys internal or


micro-environment
Market position and competitiveness

Competencies, capabilities,
resource strengths and
weaknesses, and competitiveness

Figure 3.1: From Thinking Strategically About the


Companys Situation to Choosing a Strategy

3-4

Figure 3.2: The Components of a Companys Macro-environment

3-5

Thinking Strategically About


a
Companys Macroenvironment

A companys macro-environment includes all


relevant factors and influences outside its
boundaries
Diagnosing a companys external situation
involves assessing strategically important
factors that have a bearing on the decisions a
companys makes about its

Direction
Objectives
Strategy
Business model

Requires that company managers scan


the external environment to
Identify potentially important external
developments
Assess their impact and influence

Environmental Scanning
General Environment/ Societal
environment
1. Economic forces that regulate
exchange of materials, money, energy,
and information
2. Technological forces that generate
problem solving
3. Political legal forces that allocate
power and provide constraining and
protecting laws and regulations
4. Socio-cultural forces that regulate the
values, mores, and customs of society

Some Important Variables in the


Societal Environment
Economic
GDP trends
Interest rates
Money supply
Inflation rates
Unemployment
levels
Wage/price
controls

Technologica
l
Total government
spending for
R&D
Total industry
spending for
R&D

Lifestyle changes

Special incentives

Focus of
technological
efforts

Foreign trade
regulations
Attitudes toward
foreign
companies

Energy
availability and

New
developments in
technology
transfer from lab
to marketplace

New products

Productivity

Antitrust
regulations

Tax laws

Patent protection

Disposable and
discretionary
Prentice Hall, 2000
income

Sociocultural

Environmental
protection laws

Devaluation/reval
uation

cost

Political-Legal

Career
expectations
Consumer
activism
Rate of family
formation
Growth rate of
population
Age distribution of
population

Laws on hiring
and promotion

Regional shifts in
population

Stability of
government

Life expectancies

Chapter 3

Birth rates
8

Key Questions Regarding the


Industry and Competitive
Environment
What are the
industrys
dominant
traits?

How strong
are
competitive
forces?
What market
positions do
rivals occupy?
What moves
will they make
next?

What forces
are driving
change in
the
industry? How
What are
attractive is
the key
the industry
factors for
from a profit
competitive
perspective?
success?

Question 1: What are the Industrys


Dominant Economic Traits?
Analyzing a companys industry and
competitive environment begins with
identifying an industrys dominant
economic features and forming a
picture of what the industry
landscape is like
It not only sets the stage for the
analysis to come but also promotes
understanding of the kind of
strategic moves that industry
members are likely to employ

Question 1: What are the Industrys


Dominant Economic Traits?

Market size and growth rate


Number of rivals
Scope of competitive rivalry
Buyer needs and requirements
Degree of product differentiation
Product innovation
Supply/demand conditions
Pace of technological change
Vertical integration
Economies of scale
Learning and experience curve effects

What to Consider in Identifying an Industrys Dominant Features

Features

Questions to answer

Market size and


growth rate

How big is the industry and how fast it is growing?


What does the industrys position in the business
life cycle (early development, rapid growth, early
maturity, maturity, stagnation, decline) reveal
about the industrys growth position?

Scope of
competitive
rivalry

Is the geographic area over which the most


companies compete local, regional, national,
multinational, or global?
Is having a presence in foreign markets becoming
more important to a companys long-term
competitive success?

Number of Rivals

Buyer needs and


requirements

Production
Capacity

Is the industry fragmented into many small


companies or dominated by a few large firms?
Is the industry going through a period of
consolidation to a smaller number of competitors?
What are the final buyers( as well middlemen)
looking for what attributes prompt to choose one
brand over another?
Are buyers needs or requirements
changing? If so what is driving such changes?
Is a surplus capacity pushing prices and profits
down?
Is the industry overcrowded with to many
competitors?

Production
Capacity

Pace of
Technological
Change

Degree of
Product
Differentiation

Is a surplus capacity pushing the prices and profit


margins down?
Is the industry over crowded with too many
competitors?
What role does the advancing technology play in this
industry?
Are ongoing upgrades of facilities/ equipment
essential because of rapidly advancing production
process technologies?
Do most industry members have a need or need
strong technological capabilities? Why?
Are the products of rivals becoming differentiated or
less differentiated?
Are increasing look alike products of rivals causing
heightened price competition?

Product
Innovation

Vertical
Integration

Economies of
Scale
Learning and
experience
curve effects

Is the industry characterized by rapid product innovation and


short product life cycle? How important is R&D and product
innovation? Are there opportunities to overtake key rivals by
being first-to-market with next generation products?
Are some competitors in the industry partially or or fully
integrated? Are there any important cost differences among fully
versus partially versus non integrated firms? Is there any
competitive advantages or disadvantages associated with being
fully or partially integrated firms?

Is industry characterized by economies of scale in purchasing,


manufacturing, and other activities? Do companies with high
scale operations have an important cost advantage over small
scale firm

Do any companies have significant cost advantage


because of their experience in performing particular
activities?

Learning/Experience Effects
Learning/experience effects exist
when a companys unit costs decline as
its cumulative production volume
increases because of

Accumulating production know-how

Growing mastery of the technology

The bigger the learning or


experience curve effect, the bigger
the cost advantage of the firm with the
largest cumulative production volume

Question 2: What Kinds of


Competitive
Forces Are Industry Members
Facing?

Objectives are to identify

Main sources of competitive forces


Strength of these forces

Key analytical tool


Five Forces Model
of Competition

Figure 3.3: The Five Forces Model of Competition

3-19

Analyzing the Five


Competitive Forces: How to
Do It

Step 1: Identify the specific competitive


pressures associated with each of
the five forces

Step 2: Evaluate the strength of each


competitive force -- fierce, strong,
moderate to normal, or weak?
Step 3: Determine whether the collective
strength of the five competitive forces
is conducive to earning attractive
profits

Competitive Pressures
Associated With Potential
Entry

Seriousness of threat depends on

Size of pool of entry candidates


and available resources
Barriers to entry
Reaction of existing firms

Evaluating threat of entry involves


assessing
How formidable entry barriers are for each type
of potential entrant and
Attractiveness of growth and profit prospects

Factors Affecting Threat of Entry

Threat of New Entrants/ Entry Barriers


Factors
Economies
of scale
Capital
require red
Access to
distribution
channels
Expected
retaliation
Differentiati
on
Brand
Loyalty
Experience
Curve
Govt. Action

HUF MUF
A
A

Neutral

MFA HFA

comment

small

large

Low

High

Ample

Restri
cted

Low
Low

High
High

Low

High

Insignifi
cant
Low

Signifi
cant
high

Exit Barriers
Exit Barriers
Factors

Specialized
Assets
Fixed Cost of
Exit
Strategic
interrelations
hip
Government
Barriers

HUA MUA Neutr MA


al

HA

Comments

Hi

LOW

Hi

Low

Hi

Hi

Low

Low

Barriers and profitability

low

Low, stable
returns

Low, risky
returns

High, stable
returns

High, risky
returns

Entry Barriers

high

low

Exit Barriers

high

Competitive Pressures
Among Rival Sellers
Usually the strongest of the five forces
Key factor in determining strength of
rivalry
How aggressively are rivals using various
weapons of competition to improve their
market positions and performance?

Competitive rivalry is a combative


contest involving
Offensive actions
Defensive countermoves

Weapons for Competing and Factors


Affecting Strength of Rivalry

Competitive Rivalry
Factors

HU
FA

Composition of
Competitors
Mkt. Growth rate
Scope of
competition
Fixed storage
Cost
Capacity Increase

Equal
Size
Slow
Global

MU
FA

Neut MFA HF
ral
A

Comment

High

Unequa
l Size
High
Domest
ic
Low

Large

Small

Degree of
differentiation

Comm
odity

High

Strategic Stake

High

Low

Competitive Pressures from


Substitute Products
Concept
Substitutes matter when
customers
are attracted to the products of
firms in other industries

Examples

Sugar vs. artificial


sweeteners
Eyeglasses and
contact lens vs. laser
surgery

How to Tell Whether


Substitute
Products Are a Strong Force

Whether substitutes are readily


available and attractively priced

Whether buyers view substitutes


as being comparable or better
How much it costs end users
to switch to substitutes

Figure 3.6: Factors Affecting Competition From Substitute


Products

3-31

Threat Of Substitute Product


HUF
A

Factors
Threat of
Obsolescence
of Industrys
product
Aggressiveness
of substitute
products in
promotion
Switching Cost
Perceived
price/ value

MUFA N

MFA HFA

Comment

Hi

Low

Hi

Low

Low

High

Hi

Low

Competitive Pressures From


Suppliers
and Supplier-Seller Collaboration

Whether supplier-seller relationships


represent a weak or strong
competitive force depends on
Whether suppliers can exercise
sufficient bargaining leverage to
influence terms of supply in their favor
Nature and extent of supplier-seller
collaboration in the industry

Fig. 3.7: Factors Affecting Bargaining


Power of Suppliers

Power of Supplier
Factors
# of important
Suppliers
Switching cost
Availability of
substitutes
Threat of forward
integration
Importance of
Buyer industry to
suppliers profit
Quantity purchased
by the industry of
suppliers product
Suppliers product
an important input
to the buyers
business

HUF
A

MUFA

N MFA HFA

commen
t

Few

Many

High

Low

low
High

high
Low

small

large

low

High

Highly
Importa
nt

Less
import
ant

Competitive Pressures:
Collaboration Between Sellers
and Suppliers

Industry members often forge strategic


partnerships with select suppliers
to

Reduce inventory and logistics costs


Speed availability of
next-generation components
Enhance quality of parts being supplied
Squeeze out cost savings for both parties
Competitive advantage potential may accrue
to those industry members (sellers) doing the
best job of managing supply-chain relationships

Competitive Pressures From


Buyers
and Seller-Buyer Collaboration
Whether the relationships between
industry members and buyers represent
a weak or strong competitive force
depends on
Whether buyers have sufficient
bargaining leverage to influence
terms of sale in their favor
Extent and competitive importance of
strategic partnerships between certain
industry members and the buyers

Factors Affecting Bargaining Power of


Buyers

Power Of Buyer
Factors
Number of
Important
buyers
Threat of
Backward
integration
Product
supplied
Switching
cost
% of
buyers
cost
Profit
earned by
buyer
Importance
to final
quality of
buyers Pr.

HUFA MUFA

MFA

HFA

Comment

Few

Many

High

Low

Commodit
y

Specialty

High
High
Low

High

Low
Low
High

low

Competitive Pressures:
Collaboration
Between Sellers and Buyers

Partnerships between industry members


and some/many of their customers can
impact competitive pressures
Collaboration may result in
mutual benefits regarding

Just-in-time deliveries
Order processing
Electronic invoice payments
Data sharing

Competitive advantage may accrue to


those industry members doing the best job
of partnering with their customers

Overall Industry attractiveness


Factors
Entry Barriers
Exit Barriers
Rivalry among
existing firms
Power of buyers
Power of
Suppliers
Threat of
substitutes

Unfavora Neutral Favorable


ble

Strategic Implications of
the Five Competitive Forces
Competitive environment is ideal from
a profit-making standpoint when
Rivalry is moderate
Entry barriers are high
and no firm is likely to enter
Good substitutes
do not exist
Suppliers and customers are
in a weak bargaining position

Coping With the


Five Competitive Forces
Objective is to craft a strategy to
Insulate firm from
competitive pressures
Initiate actions to produce
sustainable competitive advantage
Allow firm to be the industrys mover and
shaker with the most powerful strategy that
defines the business model for the industry

Is the Collective Strength of the


Five Competitive Forces Conducive
to Good Profitability
As a rule, the stronger collective impact of the
five forces, the lower the combined profitability of
industry participants
Fierce to strong competitive pressures come from
all five forces driving industry profitability to
unacceptably low levels
An industry can be competitively unattractive
even when not all five forces are strong
Intense competitive pressure from just two or
three forces may suffice to destroy the conditions
for good profitability and prompt some companies
to exit the business

Matching Company Strategy to


Competitive conditions

Effectively matching a companys


strategy to prevailing competitive
conditions have two aspects
1. Pursing avenues that shield the firm from
as many of the different competitive
pressures
2. Initiating actions calculated to produce
sustainable competitive advantage,
thereby shifting competition in the
companys favor, putting added
competitive pressure on rivals, and
perhaps even defining a business model
for the industry

Question 3: What Forces Are Driving


Industry Change and What Impacts
Will They Have?
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
Where do driving forces originate?
Outer ring of macroenvironment (general
environment)
Inner ring of macroenvironment ( specific
environment)

Analyzing Driving Forces:


Three Key Steps
STEP 1: Identify forces likely to exert greatest
influence over next 1 - 3 years

Usually no more than 3 - 4 factors


qualify as real drivers of change
STEP 2: Assess impact

Are driving forces acting to cause market


demand for product to increase or
decrease?
Are driving forces acting to make competition
more or less intense?
Will driving forces lead to higher or lower
industry profitability?
STEP 3: Determine what strategy changes are
needed to prepare for impacts of driving forces

Table 3.2: The Most Common Driving Forces

3-48

Question 4: What Market


Positions Do Rivals Occupy?
One technique to reveal different
competitive positions of industry
rivals is
strategic group mapping
A strategic group is a cluster of
firms in an industry with similar
competitive
approaches and market positions

Strategic Group Mapping


Firms in same strategic group
have two or more competitive
characteristics in common

Have comparable product line breadth


Sell in same price/quality range
Emphasize same distribution channels
Use same product attributes to appeal
to similar types of buyers
Use identical technological approaches
Offer buyers similar services
Cover same geographic areas

Procedure for Constructing


a Strategic Group Map
STEP 1: Identify competitive characteristics
that differentiate firms in an industry
from one another
STEP 2: Plot firms on a two-variable map
using pairs of these differentiating
characteristics
STEP 3: Assign firms that fall in about the
same strategy space to same
strategic group
STEP 4: Draw circles around each group,
making circles proportional to size of
groups respective share of total
industry sales

Example: Strategic Group Map of Selected Automobile Manufacturers

3-52

3.10
Mapping Strategic Groups in the U.S. Restaurant Chain Industry (Fig.

Mapping Strategic Groups in the U.S.


Restaurant Chain Industry

3.5)

High
Red Lobster
Olive Garden
ChiChi's

Perkins
International House
of Pancakes

Price

Ponderosa
Bonanza

Shoney's
Denny's
Country Kitchen

Kentucky Fried Chicken


Pizza Hut
Long John Silver's

Arby's Wendy's
Domino's Dairy Queen
Hardee's Taco Bell
Burger King McDonald's
Low
Limited Menu

Full Menu

Product-Line Breadth
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Chapter 3

53

Guidelines: Strategic Group


Maps
Variables selected as axes should not be
highly correlated
Variables chosen as axes should expose big
differences in how rivals compete
Variables do not have to be either
quantitative or continuous
Drawing sizes of circles proportional to
combined sales of firms in each strategic
group allows map to reflect relative sizes of
each strategic group
If more than two good competitive variables
can be used, several maps can be drawn

Interpreting Strategic Group


Maps
The closer strategic groups are
on the map, the stronger the cross-group
competitive rivalry tends to be
Not all positions on the map
are equally attractive
Driving forces and competitive pressures often
favor some strategic groups and hurt others
Profit potential of different strategic
groups varies due to strengths and
weaknesses in each groups market
position

Implications of Strategic
groups
The strategic group a firm should consider
entering
The type and level of entry barriers the firm
will face
The number and type of entry barriers the
firm will face
The strategic dimensions that will make the
firm similar to its strategic group members
and different from members of different
strategic groups
The relative effect of five forces of
competition on its relative profitability

Question 5: What Strategic


Moves
Are Rivals Likely to Make
Nextmoves
A firms best strategic
are affected by

Current strategies of competitors


Future actions of competitors

Profiling key rivals involves gathering


competitive intelligence about

Current strategies
Most recent actions and public announcements
Resource strengths and weaknesses
Efforts being made to improve their situation
Thinking and leadership styles of top
executives

Competitor Analysis
Sizing up strategies and competitive
strengths and weaknesses of rivals
involves assessing
Which rival has the best strategy? Which
rivals appear to have weak strategies?
Which firms are poised to gain
market share, and which ones
seen destined to lose ground?
Which rivals are likely to rank among the
industry leaders five years from now? Do
any up-and-coming rivals have strategies
and the resources to overtake the current
industry leader?

Question 6: What Are the


Key
Factors for Competitive
Key Success Factors
(KSFs) are competitive factors
Success?

and attributes that affect every industry members


ability to be competitively and financially successful
KSFs are those particular attributes that are so
important that they spell the difference between
Profit and loss
Competitive success or failure

KSFs can relate to

Specific strategy elements


Product attributes
Resources
Competencies
Competitive capabilities
Market achievements

Identifying Industry Key


Success Factors
The answers to 3 questions often help pinpoint an
industrys KSFs
On what basis do customers choose
between competing brands of sellers?
What resources and competitive capabilities does a
company need to have to be competitively successful?
What shortcomings are likely to place a company at a
significant competitive disadvantage?

Rarely are there more than 5 - 6


factors that are truly key to the future financial
and competitive success of industry members

Common Types of Industry Key Success Factors (KSF)


Technology
Related

Manufacturing
Related KSF

Expertise in particular technology or in scientific research ( important in


pharmaceuticals, internet applications, mobile communications, and
many high tech. industry
Proven ability to improve production processes ( important in industries
where advancing technology opens the way for higher manufacturing
efficiency and lower production costs)

Ability to achieve scale economies and/or capture learning


curve effects (important to achieving low production costs)
Quality control know-how
( important in those industries where customers insists on
product reliability)
High utilization of fixed assets (important in capital intensive/
high fixed cost industries)
Access to attractive supplies of skilled labor
High labor productivity ( important for items with high labor
content)
Low cost product design and engineering ( reduces
manufacturing costs)
Ability to manufacture or assemble products that are
customized to buyer specification

Distribution A strong network of wholesale distributors/dealers


Strong direct sales capabilities via the internet and or having
related KSF company owned retail outlets
Ability to secure favorable display space on retailer shelves

Marketing
Related KSF

Breadth of product line and product selection


A well known and respected brand name
Courteous, personalized customer service
Customer guarantees and warranties
Clever advertising
A talented workforce
Distribution capabilities
Product innovation capabilities
Short delivery time capability
Supply chain management capabilities
Strong e-commerce capabilities

Industry Matrix/ Competitive Profile


Matrix ( CPM)
Strategic Factors

Weight
1

Total

Company A
Rating

Company A
Weighted Score

Company B
Rating

Company B
Weighted Score

1.00

Source:T. L. Wheelen and J. D. Hunger, Industry Matrix. Copyright 1997 by Wheelen and Hunger Associates.
Reprinted by permission.
Prentice Hall, 2000

Chapter 3

63

3.16
External Factor Analysis Summary (EFAS): Blank

External Factor Analysis


Summary (EFAS)

External
Strategic Factors
Opportunities

Weight
1

Weighted
Score

Rating
2

Comments
4

Threats

Total Weighted Score

1.00

Notes: 1. List opportunities and threats (510 each) in column 1. 2. Weight each factor from 1.0 (Most Important) to 0.0 (Not
Important) in Column 2 based on that factors probable impact on the companys strategic position. The total weights must sum to
1.00. 3. Rate each factor from 5 (Outstanding) to 1 (Poor) in Column 3 based on the companys response to that factor. 4. Multiply
each factors weight times its rating to obtain each factors weighted score in Column 4. 5. Use Column 5 (comments) for rationale
used for each factor. 6. Add the weighted scores to obtain the total weighted score for the company in Column 4. This tells how well
the company is responding to the strategic factors in its external environment.
Source:T. L. Wheelen and J. D. Hunger, External Strategic Factors Analysis Summary (EFAS). Copyright 1991 by Wheelen and
Hunger Associates. Reprinted by permission.

Prentice Hall, 2000

Chapter 3

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