Analyzing the external environment of the firm

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Who cares?

• Overemphasis on internal characteristics– Product obsolescence– Missed opportunities for new product

development– Sears’ internal operating manual

• Neglect of external analysis– Assumptions about external environment may

become outdated

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Creating environmental awareness at organizational level

• Scanning

• Monitoring

• Competitive intelligence

• Forecasting

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Scanning

• Surveillance of environment– Anticipate future changes and detect changes

under way– Recognize patterns before competitors– Act before changes occur (proactive) rather

than responding afterwards (reactive)– General top of the mind awareness of societal

behaviors and business practices

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Monitoring

• Tracking movement or changes in specific trends, sequences of events, or streams of activities

• Watching specific formal and informal indicators of future events– Index of economic indicators– Shipments by FedEx, UPS, DHL– NAPM index

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Competitive intelligence

• Define and understand industry and identify rivals’ strengths and weaknesses

• Anticipate competitors’ moves and decrease own response time

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Competitive intelligence

• Sources of competitive intelligence– Business press– Competitor pricing– Competitors’ management backgrounds– Open to seemingly unrelated bits of information that

form patterns (Fuld & Co.’s client p. 46)– Awareness of technological changes that threaten

status quo (e.g., Encyclopaedia Brittanica)

• Avoid unethical and illegal behavior

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Environmental forecasting

• “plausible projections about direction, scope, speed, and intensity of environmental change” (p. 42)

• Scenario analysis: human judgment combined with quantitative analysis

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SWOT analysis

• Framework for identifying key elements of strategic context– External elements

• Environmental opportunities for value creation• Environmental threats to competitive position

– Internal elements• Firm strengths: conditions in which firm excels• Firm weaknesses: characteristics which firm may

lack in comparison to competitors

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The general environment

• External factors have profound influence on firm outcomes and entire industries

• Affects different industries differently

• Six segments of general environment: demographic, sociocultural, political/legal/, technological, economic, global

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Demographic segment

• Numerical measurement of characteristics of a population

• Literally: description of people

• Age, income, ethnic composition, geographic distribution, etc.

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Sociocultural segment

• Values, beliefs, attitudes of a society

• Distinct from, but related to, demographics

• Examples of values, beliefs, attitudes– Concern over greenhouse gases– Health consciousness (fitness, diets, etc.)

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Political/legal segment

• Political processes, elections, legislation, regulation, adjudication

• Competition among individuals and groups for “voice” in public policy

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Technological segment

• Growth in knowledge leading to new products and services and improvements in production and distribution

• Examples of technologies: genetic engineering, information technology, CAD/CAM, artificial intelligence, nanotechnology, mass production, assembly line production

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Economic segment

• General economic conditions facing a firm and its industry

• General economic indicators– Key economic indicators– Stock market indices– Other formal and informal indicators

• Describe effects on firm strategic direction

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Global segment

• Relevant (and changing) new global markets• International political events (e.g., changes in

power, fall of Soviet rule, newly industrializing countries, terrorism)

• Cultural and institutional characteristics of global markets

• International organizations promote global economic integration (e.g., WTO, Transatlantic Business Dialogue)

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Relationships among segments

• Segments are not totally distinct

• Segments are interrelated and mutually influencing

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Competitive environment

• More direct influence on industry competition and firm profitability than general environment

• Consists of factors relevant to firm’s strategy – customers, suppliers, and competitors (both existing and potential)

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Porter’s five forces model of industry competition

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Threat of new entrants

• Expands industry capacity and increases competition for market share

• May include start ups as well as existing firms expanding into new business– Phillip Morris’ purchase of Miller Brewing

• Influenced by barriers to entry and anticipated reactions from existing competitors

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Threat of new entrants

• High barriers to entry reduce threat1) Economies of scale

2) Brand identity and product differentiation

3) Capital requirements

4) Switching costs

5) Access to distribution channels

6) Cost disadvantages independent of size

7) Government policyS V Horner 2009

Threat of new entrants

• Expected retaliation of existing competitors– Deterrent to new entrants– Opportunity for entrepreneurs in underserved

niches

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Bargaining power of buyers

• Bargaining power of buyers of industry output

• Motivated to negotiate for lower prices, quality, service, etc.

• Bargaining power of buyer groups a function of:– Market situation– Relative importance of purchases from the

industry compared to its overall business

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Bargaining power of buyers: factors

• Buyers are concentrated, or each one purchases a significant percentage of total industry sales.

• The products that the buyers purchase represent a significant percentage of the buyers’ costs.

• The products that the buyers purchase are standard or undifferentiated.

• Buyers face few switching costs and can freely change suppliers.

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Bargaining power of buyers: factors

• Buyers earn low profits, creating pressure for them to reduce their purchasing costs.

• Buyers have the ability to engage in backward integration by becoming their own suppliers.

• The industry’s product is relatively unimportant to the quality of the buyers’ products or services.

• Buyers have complete information.

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Bargaining power of suppliers

• Bargaining power of suppliers of industry inputs to charge higher prices, reduce quality of purchased goods/services

• Factors influencing bargaining of suppliers mirror those of the bargaining power of buyers

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Bargaining power of suppliers : factors

• The supplying industry is dominated by one or a few companies.

• There are no substitute products, weakening industry players in relation to their suppliers.

• The buying industry is not a major customer of the suppliers

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Bargaining power of suppliers : factors

• The suppliers pose a credible threat of forward integration by “becoming their own customers.”

• The suppliers’ products are differentiated or have built-in switching costs, thereby reducing the buyers’ ability to play one supplier against another.

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Intensity of rivalry among existing competitors

• Jockeying for position among producers of industry output

• Tactics:– Price competition– Advertising battles– Product introductions– Customer service levels or warranties

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Intensity of rivalry: structural factors

1) Numerous or equally balanced competitors

2) High fixed or storage costs

3) Slow industry growth

4) Lack of differentiation or low switching costs

5) Capacity increases in large increments (“clumpy”)

6) Diversity of competitors

7) High strategic stakes

8) High exit barriers

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Threat of substitute products and services

• Substitutes perform similar or same functions as existing industry products but have different characteristics– Sugar producers face threats from producers

of high fructose corn syrup– Fiberglass producers face threats from

producers of cellulose, rock wool, and styrofoam

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Threat of substitute products and services

• Distinct from economics definition which defines competing products– In strategic thinking, Coke and Pepsi are

competing products; Coke and Snapple are substitutes

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Limitations of five forces model

• Industry often difficult to identify.• Does not account for the role of strategic

alliances/partnerships• Some firms, most notably large ones, can often

take steps to modify the industry structure• Assumes industry factors, not firm resources,

comprise the primary determinants of firm profit.• Firms compete in many industries and markets

and must be concerned with multiple industry structures.

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Strategic groups

• Two assumptions:1. No two firms are totally identical

2. No two firms are totally different

• Firms more similar to each other than to rest of industry may be identified as a strategic group

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Strategic groups

• Dimensions of similarity– Breadth of product line– Geographic scope– Price/quality– Degree of vertical integration– Type of distribution (e.g., dealer network,

mass merchandisers, private label)– Variety of strategic combinations in an

industryS V Horner 2009

Strategic groups as a tool of industry analysis

• Identifies barriers to mobility protecting one group from competition from another– Barriers to mobility

• Factors deterring entry of firms from one group into another (e.g., Wal-Mart and Nordstrom’s)

• Examples: technology, brand image, dealer network

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Strategic groups as a tool of industry analysis

• Identifies groups whose competitive position may be marginal or tenuous (e.g., JCP and Sears stuck in the middle between Wal-Mart and Nieman Marcus)

• Helps chart future direction of firm’s strategies

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Strategic groups as a tool of industry analysis

• Helps managers think through implications of each industry trend for strategic group as a whole– e.g., variable effect of interest rates on

strategic groups in automobile manufacturing (e.g., Porsche vs. Kia)

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Summary

• Environmental analysis a necessary component of strategic planning

• Environmental awareness occurs through scanning, monitoring, competitive intelligence, environmental forecasting

• Two major components of environment– General environment– Competitive environment

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Summary

• General environmental segments: demographic, sociocultural, political/legal, technological, economic, global

• Competitive environment:– Five competitive forces (Porter’s five forces)

• Threat of new entrants, bargaining power of buyers, bargaining power of suppliers, threat of substitutes, intensity of rivalry

• Strategic groups

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