CHAPTER 2 Analyzing the External Environment of the Firm: Creating Competitive Advantages Copyright Anatoli Styf/Shutterstock Learning Objectives After reading this chapter, you should have a good understanding of: 2-1 The importance of developing forecasts of the business environment. 2-2 Why environmental scanning, environmental monitoring, and collecting competitive intelligence are critical inputs to forecasting. 2-3 Why scenario planning is a useful technique for firms competing in industries characterized by unpredictability and change. 2-4 The impact of the general environment on a firm’s strategies and performance. 2-5 How forces in the competitive environment can affect profitability, and how a firm can improve its competitive position by increasing its power vis-à-vis these forces. 2-6 The concept of strategic groups and their strategy and performance implications. ©McGraw-Hill Education. The Importance of External Environment Consider. . . The best CEOs are always aware of what’s going on outside their company. Their perceptual acuity allows them to sense what’s coming. Detecting early warning signals, keeping pace with changes in the external environment can sustain a competitive advantage. ©McGraw-Hill Education. Enhancing Awareness of the External Environment Exhibit 2.1 Inputs to Forecasting ©McGraw-Hill Education. Environmental Scanning & Monitoring Environmental scanning involves surveillance of a firm’s external environment. • Predicts environmental changes to come • Detects changes already under way • Allows firm to be proactive Environmental monitoring tracks evolution of environmental trends. • Sequences of measurable facts/events • Streams of activities or trends from outside the organization ©McGraw-Hill Education. Competitive Intelligence Competitive intelligence • Helps firms define & understand their industry • Identifies rivals’ strengths & weaknesses • Collect data on competitors • Interpret intelligence data • Helps firms avoid surprises • Anticipate competitors’ moves • Decrease response time • Potential for unethical behavior while gathering intelligence ©McGraw-Hill Education. Environmental Forecasting 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. ©McGraw-Hill Education. Question (1 of 2) A danger of forecasting discussed in the text is that A. in most cases, the expense of collecting the necessary data exceeds the benefit. B. forecasting’s retrospective nature provides little information about the future. C. managers may view uncertainty as “black and white” while ignoring important “gray areas.” D. it can create legal problems for the firm if regulators discover the company is making forecasts. ©McGraw-Hill Education. SWOT Analysis 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 • Must consider both internal & external factors simultaneously ©McGraw-Hill Education. The General Environment The general environment is composed of factors that are both hard to predict and difficult to control. • • • • • • ©McGraw-Hill Education. Demographic Sociocultural Political/Legal Technological Economic Global The Demographic Segment Demographics are easily understandable & quantifiable. • • • • • ©McGraw-Hill Education. Aging population Rising affluence Changes in ethnic composition Geographic distribution of population Greater disparities in income levels The Sociocultural Segment Sociocultural forces influence the values, beliefs, and lifestyles of a society. • More women in the workforce • 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 ©McGraw-Hill Education. The Political/Legal Segment Political/Legal processes & legislation influence environmental regulations with which industries must comply. • • • • • • • ©McGraw-Hill Education. Tort reform Americans with Disabilities Act (ADA) Deregulation of utilities & other industries Increases in minimum wages Taxation Legislation on corporate governance reforms Affordable Health Care Act, Medicare reimbursements The Technological Segment Technological developments lead to new products & services. They can create new industries & alter existing ones. • Genetic engineering • Three-dimensional (3D) printing • Computer-aided design/computer-aided manufacturing systems (CAD/CAM) • Research in synthetic & exotic materials • Pollution/global warming • Miniaturization of computing technologies • Wireless communications • Nanotechnology • Big data/data analysis ©McGraw-Hill Education. The Economic Segment Economic forces affect all industries. • • • • • ©McGraw-Hill Education. Interest rates Unemployment Consumer Price Index Trends in GDP & net disposable income Changes in stock market valuations The Global Segment 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 the WTO (leading to decreasing tariffs/free trade in services) • Increased risks associated with terrorism • • • • ©McGraw-Hill Education. General Environment: Relationships among Elements Elements of the general environment interact with each other. • Demographic trends have implications for economics. • Greater access to information technology affects both economics and global relationships. • Political/legal trends can have very different effects on different industries. • Digital technology has altered the way business is conducted in nearly every business domain. • Data analytics ©McGraw-Hill Education. The Competitive Environment The competitive environment consists of factors in the task or industry environment that are particularly relevant to a firm’s strategy. • Competitors (existing or potential) • Including those considering entry into an entirely new industry • Customers (or buyers) • Suppliers • Including those considering forward integration ©McGraw-Hill Education. Porter’s Five Forces Model of Industry Competition Exhibit 2.4 Porter’s Five Forces Model of Industry Competition Source: From Michael E. Porter, “The Five Competitive Forces That Shape Strategy,” Special Issue on HBS Centennial.. Harvard Business Review 86, No. 1 (January 2008), 78-93. Reprinted with permission of Michael E. Porter. ©McGraw-Hill Education. Jump to Appendix 1 for long description. The Threat of New Entrants 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: • • • • • • ©McGraw-Hill Education. Economies of scale Product differentiation Capital requirements Switching costs Access to distribution channels Cost disadvantages independent of scale Question (2 of 2) 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. ©McGraw-Hill Education. The Bargaining Power of Buyers Buyers have bargaining power. Buyers can force down prices, bargain for higher quality or more services, or play competitors against each other. Buyer groups are powerful. • Purchasing standard products are in large volumes. • Profits are low & switching costs are few. • Backward integration is possible. • Buyer’s product quality is not affected by industry product. ©McGraw-Hill Education. The Bargaining Power of Suppliers Suppliers can exert bargaining power by threatening to raise prices or reduce the quality of purchased goods and services. Supplier groups are powerful. • • • • • • ©McGraw-Hill Education. Only a few firms dominate the industry. There is 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 Substitute products & services limit the potential returns of an industry. Substitutes come from another industry. Substitutes can perform the same function as the industry’s offerings. Substitutes place a ceiling on prices that firms in an industry can profitably charge. • The more attractive the price/performance ratio, the more the substitute erodes industry profits. ©McGraw-Hill Education. The Intensity of Rivalry among Competitors in an Industry Rivalry tactics include price competition, advertising battles, new product introductions, increased customer service or warranties. Interacting factors lead to intense rivalry. • • • • • • ©McGraw-Hill Education. 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 How the Internet and Digital Technologies Affect Competitive Forces Competitive Forces Benefits to Industry Threat of New Entrants Disadvantages to Industry • Lower barriers to entry increases number of new entrants. • Many Internet-based capabilities can be easily imitated. Bargaining Power of Buyers Reduces the power of buyer intermediaries in many distribution channels. • Switching costs decrease. • Information availability online empowers and users. Bargaining Power of Suppliers Online procurement methods can increase bargaining power over suppliers. • The Internet gives suppliers access to more customers and makes it easier to reach end users. • Online procurement practices deter competition and reduce differentiating features. Threat of Substitutes Internet-based increases in overall efficiency can expand industry sales. • Internet-based capabilities create more opportunities for substitution. Intensity of Rivalry • Since location is less important, the number of competitors increases. • Differences among competitors are harder to perceive online. • Rivalry tends to focus on price and differentiating features are minimized. Sources: Bodily, S., & Venkataraman, S. 2004. Not walls, windows: Capturing value in the digital age. Journal of Business Strategy. 25(3): 15-25; Lumpkin, G.T. Droege, S.B., & Dess, G.G. 2002. E-commerce strategies: Achieving sustainable competitive advantage and avoiding pitfalls. Organizational Dynamics, 30 (Spring): 1-17. ©McGraw-Hill Education. Using Industry Analysis: A Few Caveats 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 extension of five forces analysis. • Vertical dimension = suppliers & customers • Horizontal dimension = substitutes & complements ©McGraw-Hill Education. The Value Net Exhibit 2.6 The Value Net Source: Adapted from “The Right Game: Use Game Theory Shape Strategy,” by A. Brandenburger and B.J. Nalebuff, July-August 1995 Harvard Business Review. ©McGraw-Hill Education. Jump to Appendix 2 for long description. Doing a Good Industry Analysis 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 total cost or sales accounted for by the industry, actual switching costs ©McGraw-Hill Education. 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 – clusters of firms that share similar strategies: • • • • ©McGraw-Hill Education. Breadth of product & geographic scope Price/quality Degree of vertical integration Type of distribution Strategic Groups as an Analytic Tool Strategic groups can be analytical tools. • 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 ©McGraw-Hill Education. Example: Strategic Groups within Industries Exhibit 2.7 The World Automobile Industry: Strategic Groups Note: Members of each strategic group are not exhaustive, only illustrative. ©McGraw-Hill Education. Jump to Appendix 3 for long description.
