Chapter 3: Evaluating a
Company’s External
Environment
Screen graphics created by:
Jana F. Kuzmicki, Ph.D.
Troy University
McGraw-Hill/Irwin
©2009 The McGraw-Hill Companies, All Rights Reserved
“Analysis is the critical starting
point of
strategic thinking.”
Kenichi Ohmae
Consultant and Author
“Things are always different –
the art is figuring out which
differences matter.”
Laszlo Birinyi
Investments Manager
Chapter Learning Objectives
1. To gain command of the basic concepts and
analytical tools widely used to diagnose a
company’s industry and competitive conditions.
2. To become adept in recognizing the factors that
cause competition in an industry to be fierce, more
or less normal, or relatively weak.
3. To learn how to determine whether an industry’s
outlook presents a company with sufficiently
attractive opportunities for growth and profitability.
4. To understand why in-depth evaluation of specific
industry and competitive conditions is a prerequisite
to crafting a strategy well matched to a company’s
situation.
1-4
Chapter Roadmap
 The Strategically Relevant Components of a
Company’s External Environment
 Thinking Strategically About a Company’s Industry
and Competitive Environment
 Question 1: What Are the Industry’s 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
Company a Good Opportunity to Earn Attractive Profits?
1-5
Understanding the Factors that
Determine a Company’s Situation
 Diagnosing a company’s situation has
two facets
 Assessing the company’s external or macroenvironment
 Industry and competitive conditions
 Forces acting to reshape this environment
 Assessing the company’s internal or
micro-environment
 Market position and competitiveness
 Competencies, capabilities,
resource strengths and
weaknesses, and competitiveness
1-6
Figure 3.1: From Thinking Strategically About the
Company’s Situation to Choosing a Strategy
Figure 3.2: The Components of a Company’s Macro-environment
Thinking Strategically About a
Company’s Macro-environment
 A company’s macro-environment includes all
relevant factors and influences outside its
boundaries
 Diagnosing a company’s external situation involves
assessing strategically important factors that have a
bearing on the decisions a company’s 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
 Adapt a company’s direction and strategy as needed
1-9
Key Questions Regarding the
Industry and Competitive Environment
What are the
industry’s
dominant
economic 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?
What are the
key factors for
competitive
success?
How attractive
is the industry
from a profit
perspective?
Question 1: What are the Industry’s
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
1-11
Table 3.1: What to Consider in Identifying
an Industry’s Dominant Economic Features
Learning/Experience Effects
 Learning/experience effects exist when a
company’s 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
1-13
Question 2: How Strong Are
Competitive Forces?
 Objectives are to identify
 Main sources of competitive forces
 Strength of these forces
 Key analytical tool
 Five Forces Model
of Competition
1-14
Figure 3.3: The Five Forces Model of Competition
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
1-16
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
1-17
Figure 3.4: Weapons for Competing and Factors
Affecting Strength of Rivalry
What Are the Typical
Weapons for Competing?
 Lower prices
 More or different
performance features
 Better product
performance
 Higher quality
 Stronger brand image and
appeal
 Wider selection of models
and styles
 Bigger/better dealer
network
 Low interest rate financing
 Better or more ads
 Stronger product
innovation capabilities
 Better customer service
 Stronger capabilities to
provide buyers with
custom-made products
What Causes Rivalry to be Stronger?
 Competitors are active in making fresh moves to







improve market standing and business performance
Slow market growth
Number of rivals increases and rivals are ofequal
size and competitive capability
Buyer costs to switch brands are low
Industry conditions tempt rivals to use price cuts or
other competitive weapons to boost volume
A successful strategic move carries a big payoff
Diversity of rivals increases in terms
of visions, objectives, strategies,
resources, and countries of origin
Outsiders acquire weak firms in the
industry and use their resources to transform
new firms into major market contenders
1-20
What Causes Rivalry to be Weaker?
 Industry rivals move only infrequently or in a
non-aggressive manner to draw sales from
rivals
 Rapid market growth
 Products of rivals are strongly
differentiated and customer loyalty is high
 Buyer costs to switch brands are high
 There are fewer than 5 rivals or there are
numerous rivals so any one firm’s actions
has minimal impact on rivals’ business
1-21
Test Your Knowledge
The rivalry among competing sellers in an industry
intensifies
A. when buyer demand for the product is growing
rapidly.
B. when customers are brand loyal and their costs to
switch to competing brands or substitute products
are relatively high.
C. when buyer demand is strong and sellers have little or
no excess capacity and only minimal inventories.
D. as the number of rivals increases and as they become
more equal in size and competitive capability.
E. when the products of rival sellers are highly
differentiated products and the industry consists of
so many rivals that any one company’s actions have
little direct impact on rivals’ business.
1-22
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
1-23
Figure 3.5: Factors Affecting Threat of Entry
Common Barriers to Entry
 Sizable economies of scale
 Cost and resource disadvantages independent
of size
 Brand preferences and customer loyalty
 Capital requirements and/or other
specialized resource requirements
 Access to distribution channels
 Regulatory policies
 Tariffs and international trade restrictions
 Ability of industry incumbents to launch
vigorous initiatives to block a newcomer’s entry
1-25
When Is the Threat of Entry Stronger?
 There’s a sizable pool of entry candidates
 Entry barriers are low
 Industry growth is rapid and profit
potential is high
 Incumbents are unwilling or unable to contest a
newcomer’s entry efforts
 When existing industry members have a strong
incentive to expand into new geographic areas
or new product segments where they currently
do not have a market presence
1-26
When Is the Threat of Entry Weaker?
 There’s only a small pool of entry candidates
 Entry barriers are high
 Existing competitors are struggling to earn good
profits
 Industry’s outlook is risky
 Industry growth is slow or stagnant
 Industry members will strongly contest
efforts of new entrants to gain a market foothold
1-27
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
 Newspapers vs. TV vs. Internet
1-28
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
1-29
Figure 3.6: Factors Affecting Competition From Substitute Products
When Is the Competition
From Substitutes Stronger?
 There are many good substitutes readily
available
 Substitutes are attractively priced
 The higher the quality and
performance of substitutes
 The lower the end user’s switching costs
 End users grow more comfortable with using
substitutes
1-31
When Is the Competition
From Substitutes Weaker?
 Good substitutes are not readily available or
do not exist
 Substitutes are higher priced relative to
performance they deliver
 End users incur high costs
in switching to substitutes
1-32
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
1-33
Figure 3.7: Factors Affecting Bargaining Power of Suppliers
When Is the Bargaining
Power of Suppliers Stronger?
 Industry members incur high
costs in switching their purchases
to alternative suppliers
 Needed inputs are in short supply
 Supplier provides a differentiated input
that enhances the quality of performance
of sellers’ products or is a valuable
part of sellers’ production process
 There are only a few suppliers of a specific
input
 Some suppliers threaten to integrate forward
1-35
When Is the Bargaining
Power of Suppliers Weaker?
 Item being supplied is a commodity
 Seller switching costs to alternative suppliers
are low
 Good substitutes exist or new ones emerge
 Surge in availability of supplies occurs
 Industry members account for a big
fraction of suppliers’ total sales
 Industry members threaten
to integrate backward
 Seller collaboration with selected suppliers
provides attractive win-win opportunities
1-36
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
1-37
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
1-38
Figure 3.8: Factors Affecting Bargaining Power of Buyers
When Is the Bargaining
Power of Buyers Stronger?
 Buyer switching costs to competing brands or
substitutes are low
 Buyers are large and can demand concessions
 Large-volume purchases by buyers are important to
sellers
 Buyer demand is weak or declining
 Only a few buyers exists
 Identity of buyer adds prestige
to seller’s list of customers
 Quantity and quality of information
available to buyers improves
 Buyers have ability to postpone purchases until later
 Buyers threaten to integrate backward
1-40
When Is the Bargaining
Power of Buyers Weaker?
 Buyers purchase item infrequently or in small
quantities
 Buyer switching costs to
competing brands are high
 Surge in buyer demand
creates a “sellers’ market”
 Seller’s brand reputation is important to buyer
 A specific seller’s product delivers quality
or performance that is very important to buyer
 Buyer collaboration with selected sellers
provides attractive win-win opportunities
1-41
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
1-42
For Discussion: Your Opinion
Explain why low switching costs and weakly
differentiated products tend to give buyers a
high degree of bargaining power.
1-43
Strategic Implications of
the Five Competitive Forces
 Competitive environment is
unattractive from the standpoint
of earning good profits when
 Rivalry is vigorous
 Entry barriers are low
and entry is likely
 Competition from
substitutes is strong
 Suppliers and customers have
considerable bargaining power
1-44
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
1-45
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 industry’s “mover and
shaker” with the “most powerful” strategy that
defines the business model for the industry
1-46
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
 Inner ring of macroenvironment
1-47
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
1-48
Common Types of Driving Forces
 Changes in long-term industry growth rate
 Increasing globalization of industry
 Emerging new Internet capabilities
and applications
 Changes in who buys the
product and how they use it
 Product innovation
 Technological change/process innovation
 Marketing innovation
1-49
Common Types of Driving Forces
(con’t)
 Entry or exit of major firms
 Diffusion of technical knowledge
 Changes in cost and efficiency
 Consumer preferences shift
from standardized to
differentiated products (or vice versa)
 Changes in degree of uncertainty and risk
 Regulatory policies / government legislation
 Changing societal concerns, attitudes, and
lifestyles
1-50
Table 3.2: The Most Common Driving Forces
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
1-52
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
1-53
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 group’s
respective share of total industry sales
1-54
Example: Strategic Group Map of Selected Automobile Manufacturers
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
1-56
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 group’s market
position
1-57
Test Your Knowledge
A strategic group map is a helpful analytical tool for
A. assessing why competitive pressures and driving forces
usually impact the biggest strategic groups more so than
the smaller groups.
B. determining which companies have how big a competitive
advantage and how good their prospects are for increasing
their market shares.
C. determining which company is the most profitable in the
industry and why it is doing so well.
D. determining who competes most closely with whom;
evaluating whether industry driving forces and competitive
pressures favor some strategic groups and hurt others; and
ascertaining whether the profit potential of different
strategic groups varies due to the strengths and
weaknesses in each group’s respective market positions.
E. pinpointing which of the five competitive forces is the
strongest and which is the weakest.
1-58
Question 5: What Strategic Moves
Are Rivals Likely to Make Next?
 A firm’s best strategic moves
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
1-59
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?
1-60
Things to Consider in
Predicting Moves of Rivals
 Which rivals need to increase their unit sales
and market share? What strategies are rivals
most likely to pursue?
 Which rivals have a strong incentive, along with
resources, to make major strategic changes?
 Which rivals are good candidates to be
acquired? Which rivals have the resources to
acquire others?
 Which rivals are likely to enter new geographic
markets?
 Which rivals are likely to expand their product
offerings and enter new product segments?
1-61
For Discussion: Your Opinion
Why does a company need to bother with
studying competitors and trying to predict what
moves rivals will make next? Why can’t it just
choose whatever strategy it wants or make
whatever moves in the marketplace it wishes
without first worrying about what rivals are
going to do?
1-62
Question 6: What Are the Key
Factors for Competitive Success?
 Key Success Factors (KSFs) are competitive
factors and attributes that affect every industry
member’s 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
1-63
Identifying Industry Key Success Factors
 The answers to 3 questions often help pinpoint
an industry’s 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
1-64
Table 3.3: Common Types of Industry Key Success Factors
Example: KSFs for Bottled Water Industry
 Access to distribution – to get a
company’s brand stocked and
favorably displayed in retail outlets
 Image – to induce consumers to
buy a particular company’s product
(brand name and attractiveness of
packaging are key deciding factors)
 Low-cost production capabilities –
to keep selling prices competitive
 Sufficient sales volume – to achieve
scale economies in marketing expenditures
1-66
Example: KSFs for
Ready-to-Wear Apparel Industry
 Appealing designs and color
combinations – to create buyer appeal
 Low-cost manufacturing efficiency – to
keep selling prices competitive
 Strong network of retailers/company-
owned stores – to allow stores
to keep best-selling items in stock
 Clever advertising – to effectively
convey a specific image to induce
consumers to purchase a particular label
1-67
Question 7: Does the Outlook for the
Industry Offer an Attractive Opportunity?
 Involves assessing whether the industry and
competitive environment presents a company with
an attractive or unattractive opportunity
for earning good profits
 Factors to consider:
 Industry growth potential
 Whether competitive forces are growing stronger/weaker
 Whether driving forces will favorable/unfavorably impact
industry profitability
 Degree of risk and uncertainty in industry’s future
 Whether the industry confronts severe problems
 Firm’s competitive position in industry vis-à-vis rivals
 Firm’s potential to capitalize on industry opportunities or
the vulnerabilities of weaker rivals
 Whether a firm has sufficient competitive strength to
defend against unattractive industry factors
1-68
Factors to Consider in
Assessing Industry Attractiveness
 As a general proposition
 If an industry’s overall profit prospects are
above average, the industry environment is
basically attractive
 If an industry’s overall profit prospects are
below average, the industry environment is
basically unattractive
 However
 Attractiveness is relative, not absolute
 Conclusions about attractiveness have
to be drawn from the perspective of a
particular company
1-69
Factors to Consider in
Assessing Industry Attractiveness
 An industry is unlikely to be equally
attractive or unattractive to all industry
members
 Industry environments attractive to strong
competitors may be unattractive to weak competitors
 A favorably positioned company may survey an
industry environment and see opportunities that
weak competitors have little or no ability to
capture
 Industry environments attractive to insiders may be
unattractive to potential entrants
 Under certain circumstances, a firm uniquely wellsituated in an otherwise unattractive industry can
still earn good profits by taking sales and market
share away from weaker competitors
1-70
Core Concept: Assessing
Industry Attractiveness
The degree to which an industry
is attractive or unattractive is not the
same for all industry participants
or potential entrants.
The opportunities an industry
presents depend partly on a
company’s ability to capture them.
Test Your Knowledge
Which of the following is not an important factor for company
managers to consider in drawing conclusions about whether
the industry presents an attractive opportunity?
A. Whether powerful competitive forces are squeezing industry
profitability to subpar levels and whether competition
appears destined to grow stronger or weaker
B. The industry’s growth potential and the degree of
uncertainty and risk in the industry’s future
C. Whether industry profitability will be affected favorably or
unfavorably by the prevailing driving forces
D. How many of the industry’s key success factors do
companies in the industry typically incorporate into their
strategies
E. The company’s ability to capitalize on the vulnerabilities of
weakly positioned rivals and whether the company has
sufficient competitive strength to defend against or
counteract the factors that make the industry unattractive
1-72