Analyzing the External

Environment of the Firm

Chapter Two

McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
Creating the Environmentally
Aware Organization

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Environmental Scanning & Monitoring

• External Scanning
 Surveillance of a firm’s external environment:
 Predict environmental changes to come
 Detect changes already under way
 Proactive mode
• Alerts the firm to critical trends before changes
have developed a discernible pattern and before
competitors recognize them

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Environmental Scanning & Monitoring

• External Monitoring
 Track evolution of environmental trends, sequence of
events or streams of activities

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 How to Spot Hot Trends
• Listen
• Pay attention
• Follow trends online
• Go old school

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 Virgin Mobile and Crowdsourcing
• Virgin Mobile USA • The Insider
relies on 2,000 community—a very
carefully selected hip focus group—
online customers, provides input on
referred to as everything from
“Insiders” to keep it designing phones to
aware of trends and coming up with
promising names for service
opportunities. plans.

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 Competitive Intelligence

• Define and understand a firm’s industry

• Identify rivals’ strengths and weaknesses
 Intelligence gathering (data)
 Interpretation of intelligence data
• Helps a firm avoid surprises

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 Environmental Forecasting
• Environmental forecasting
 Plausible projections about direction, scope,
speed and intensity of environmental change

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 Environmental Forecasting
• Scenario analysis
 involves experts’ detailed assessments of
societal trends, economics, politics,
technology, or other dimensions of the
external environment

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 SWOT Analysis

Firm’s strategy must:

• Build on its strengths
• Remedy the weaknesses or work around them
• Take advantage of the opportunities presented
by the environment
• Protect the firm from threats

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 SWOT Analysis
• Strengths and
weaknesses
• Internal conditions of
the firm
• Opportunities and
threats environmental
conditions external to
the firm

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 The General Environment
Factors external to an industry, usually beyond a
firm’s control

• Demographic • Technological
• Sociocultural • Economic
• Legal/Political • Global

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 Demographic Segment

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

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 Sociocultural Segment

• More women in the workforce

• Dual-income families
• Increase in temporary workers
• Greater concern for healthy diets and physical
fitness
• Greater interest in the environment
• Postponement of having children

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 Political/Legal Segment

• Tort reform
• Americans with Disabilities Act (ADA)
• Repeal of Glass-Steagall Act in 1999
• Deregulation of utility and other industries
• Increases in federally mandated minimum
wages
• Taxation at local, state, federal levels
• Legislation on corporate governance reforms
(Sarbanes-Oxley Act)
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 Technological Segment

• Genetic engineering
• Emergence of Internet technology
• Computer-aided design/computer-aided
manufacturing systems (CAD/CAM)
• Wireless communication
• Nanotechnology

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 Economic Segment

• Interest rates
• Unemployment
• Consumer Price index
• Trends in GDP
• Changes in stock market valuations

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 Global Segment

• Increasing global trade

• Currency exchange rates
• Emergence of the Indian and Chinese
economies
• Trade agreements (NAFTA, EU, ASEAN)
• Creation of WTO (decreasing tariffs/free trade in
services)

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 The Competitive Environment

• Competitive environment factors that

pertain to an industry and affect a firm’s
strategies
• Competitors, customers, and suppliers

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Porter’s Five Forces Model
of Industry Competition

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 The Threat of New Entrants

• Profits of established firms in the industry

may be eroded by new competitors
• Sources of entry barriers
 Economies of scale
 Product differentiation
 Capital requirements
 Switching costs
 Access to distribution channels
 Cost disadvantages independent of scale

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 QUESTION

If you are considering opening a new pizza

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

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 The Bargaining Power of Buyers
• Buyers threaten an industry by:
 Forcing down prices
 Bargaining for higher quality or more services
 Playing competitors against each other

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 The Bargaining Power of Buyers
• A buyer group is powerful when
 It is concentrated or purchases large volumes
relative to seller sales
 The products it purchases from the industry are
standard or undifferentiated
 The buyer faces few switching costs
 It earns low profits
 The buyers pose a credible threat of backward
integration
 The industry’s product is unimportant to the
quality of the buyer’s products or services

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The Bargaining Power of Suppliers
• Suppliers can exert power by threatening
to raise prices or reduce the quality of
purchased goods and services

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 The Bargaining Power of Suppliers

• A supplier group will be powerful when

 The supplier group is dominated by a few
companies and is more concentrated than
the industry it sells to
 The supplier group is not obliged to contend
with substitute products for sale to the
industry
 The industry is not an important customer of
the supplier group

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 The Bargaining Power of Suppliers
• A supplier group will be powerful when (cont.)
 The supplier’s product is an important input
to the buyer’s business
 The supplier group’s products are
differentiated or it has built up switching costs
for the buyer
 The supplier group poses a credible threat of
forward integration

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 The Threat of Substitute
Products and Services
• Substitutes limit the potential returns of an
industry
 Ceiling on the prices that firms in that
industry can profitably charge
 Price/performance ratio

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 The Intensity of Rivalry among
Competitors in an Industry
• Price competition
• Advertising battles
• Product introductions
• Increased customer service or warranties

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 The Intensity of Rivalry among
Competitors in an Industry
Interacting factors lead to intense rivalry
• Numerous or equally • Lack of differentiation or
balanced competitors switching costs
• Slow industry growth • Capacity augmented in
• High fixed or shortage large increments
costs • High exit barriers

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How the Internet and Digital Technologies
Influences Industry

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Using Industry Analysis: A Few Caveats

• Managers must not always avoid low profit

industries
 Can still yield high returns for players with sound
strategies
• Implicitly assumes a zero-sum game,
determining how a firm can enhance its position
relative to the forces
• Five Forces analysis is essentially a static
analysis

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 Using Industry Analysis: A Few Caveats
(cont.)
• Good industry analysis looks rigorously at the
structural underpinnings of profitability.
 A first step is to understand the time horizon
• The point of industry analysis is not to declare
the industry attractive or unattractive but to
understand the underpinnings of competition
and the root causes of profitability.

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The Value Net

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 Strategic Groups within Industries

• Two unassailable assumptions in industry

analysis
 No two firms are totally different
 No two firms are exactly the same
• Strategic groups
• Cluster of firms that share similar strategies
 Breadth of product and geographic scope
 Price/quality
 Degree of vertical integration
 Type of distribution system

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 Strategic Groups within Industries

• Value of strategic groups as an analytical tool

 Identify barriers to mobility that protect a group from
attacks by other groups
 Identify groups whose competitive position may be
marginal or tenuous
 Chart the future direction of firms’ strategies
 Thinking through the implications of each industry
trend for the strategic group as a whole

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