External Analysis: The Identification of Industry Opportunities and Threats

I. Overview A. For a company to succeed, its strategy must either fit the industry environment in which it operates, or the company must be able to reshape the industry environment in which it operates to its advantage through its choice of strategy. Companies typically fail when their strategy no longer fits the environment in which they operate. B. To achieve a good fit, managers must understand the forces that shape competition in their external environment. This understanding enables them to identify strategic opportunities and threats. Opportunities arise when a company can take advantage of conditions in its environment to formulate and implement strategies that enable it to become more profitable. Threats arise when conditions in the external environment endanger the integrity and profitability of the company’s business. II. Defining an Industry A. An industry can be defined as a group of companies offering products or services that are close substitutes for each other. Close substitutes are products or services that satisfy the same basic consumer need. Firms within the same industry are rivals, also called competitors. 1. A correct industry definition can be the difference between success and failure. 2. Managers must define industries based on the customer need (the demand side of the market) and not the products the industry offers (the supply side of the market). B. Several industries combine to create a sector. For example, the PC industry, the handheld industry, and the mainframe industry together create the computer sector. C. Within industries, customers with a common need group together to form a market segment. For example, the soft drink industry contains regular, diet, and caffeine-free market segments. D. Industry boundaries are not fixed, but can change over time. Industries may fragment into a set of smaller industries, such as when the auto industry fragmented into the car and SUV industries. Industries may also consolidate, such as the blurring of the boundary between the handheld computer and cell phone industries. III. Porter’s Five Forces Model A. This model was devised by Michael Porter to describe forces that shape competition within an industry and help to identify strategic opportunities and threats. The stronger each of these forces is, the more established companies are limited in their ability to raise prices and earn greater profits. A strong competitive force is a threat because it depresses profits. A weak competitive force is an opportunity because it allows the company to earn greater returns. B. One of Porter’s Five Forces is the risk of entry by potential competitors. Potential competitors are companies that are currently not competing in the industry but have the capability to do so. New entry into an industry expands supply. This in turn depresses prices and profits. Thus a high risk of new entry constitutes a strategic threat. A low risk of new entry allows established companies to raise their prices, so it constitutes an opportunity. The risk of entry by potential competitors is a function of the height of barriers to entry. The height of barriers to entry is determined by several factors.

Declining demand results in more competition as companies fight to maintain revenues and market share. especially when demand is declining. Growing demand moderates competition by providing room for expansion. Exit barriers are a serious competitive threat. When customer switching costs. the more vicious will be the price war. Thus interdependence is a major threat. The more commodity-like an industry’s product. These characteristics tend to result in boom-and-bust cycles. Potential competitors are also discouraged when established companies have economies of scale.and medium-sized companies) to consolidated (dominated by a small number of large companies). at which point prices may stabilize again. The extent of rivalry among established firms depends on several factors. When industrie s are deregulated. investments in specialized assets b. tends to protect established firms. Exit barriers include: a. Many fragmented industries are characterized by low entry barriers and commodity-type-products that are hard to differentiate. 4. that is. which constitutes a threat to established companies. 2. are high. high fixed costs of exit such as severance pay c. Economic. and price wars. This in turn leads to excess capacity and price wars. 3. C. Cost advantages might include factors such as patents. economic dependence on a single industry e. emotional attachments to an industry d. when established companies are able to produce at a lower cost than the new entrants due to their larger size and greater experience. 3. . 1. Structures vary from fragmented (made up of many small. 2. the need to maintain expensive assets in order to compete effectively in that industry. whereas weak rivalry creates an opportunity to earn greater returns. and emotional factors can keep companies competing in an industry even when returns are low. new entrants usually proliferate. The “bust” part of the cycle will continue until overall industry capacity is brought into line with demand (through bankruptcies). excess capacity. control of a specific raw material. 5. Loyal customers would discourage potential competitors. with a flood of new entrants. Strong rivalry tends to lower prices and raise costs. Government regulation. The extent to which established companies have brand loyalty from their customers is one factor. b. potential new entrants are discouraged. or access to cheaper funds. such as establishing a protected monopoly. The consequence can be price wars like those the airline industry has experienced. Demand conditions also determine the intensity of rivalry among established companies. a. This threat can be reduced when tacit price-leadership agreements exist within the industry and when companies are successful in emphasizing nonprice competition. One factor is industry competitive structure. Another of Porter’s Five Forces is rivalry among established companies. which refers to the number and size distribution of companies within an industry. so that the competitive actions of one company directly affect the profitability of competitors. leading to low industry profits and exit from the industry. strategic.1. Consolidated industries are interdependent. forcing a response from them. and thus to constitute a barrier to entry. that is costs that accrue to a consumer that intends to switch from the product offering of an established company to the product offering of a new entrant. Different competitive structures have different implications for rivalry. Potential competitors are also discouraged when established companies enjoy an absolute cost advantage over potential entrants.

Normally. 3. the substitute is a close one. Some strategic groups are more desirable than others. buyers can easily switch to substitute product or an alternate supplier 4. Different strategic groups can have a different standing with respect to the threats and opportunities they face from each of Porter’s five competitive forces. A fifth factor is the threat of substitute products. Strategic Groups Within Industries A. B. The ability of buyers to make demands on a company depends on their power relative to that of the company. 2. the company cannot readily enter the supplier’s industry. Because all companies in a strategic group are pursuing similar strategies. or retailers. Suppliers are any organization that supplies materials. F. The threat of substitutes tends to be greater when: 1. the existing complementary products are not attractive to customers. The existence of adequate substitute products limit the price that companies in an industry can charge without losing their customers to makers of substitutes. a limited number of strategic groups capture the essence of strategic differences among companies within an industry. and so on. they are in industries that are more highly consolidated than the company’s industry 2. . Strategic groups have several implications for internal analysis. other businesses. Buyers can be individual consumers.A third factor in Porter’s Five Forces Model is the bargaining power of buyers. IV. Suppliers tend to be powerful when: 1. but different strategies fr om companies outside the group. or companies that sell products that are used in addition to and along with the enterprise’s own products. insofar as they are characterized by a lower level of threats and/or by greater opportunities. The threat from a lack of complementors tends to be greater when: 1. consumers tend to view the products of such enterprises as direct substitutes for each other. the supplier’s product has no substitutes or is vital to the company 2. G. Suppliers are a threat when they are able to force up the price the company must pay for inputs or to reduce the quality of goods supplied. and revenues and profits will be low. A strategic group is a group of companies within an industry that are pursuing the same basic strategy as the companies with the group. or labor (such as labor unions) to the company. Buyers can be viewed as a competitive threat when they force down prices or when they raise expenses by demanding higher quality and better service. Buyers tend to be powerful when: 1. the price of the substitute is equal to or less than the company’s products. wholesalers. A fourth factor is the bargaining power of suppliers. the company has a switching cost to change suppliers 4. A company’s immediate competitors are those in its strategic group. the company is not important to the supplier 3. When there is a weak supply of complementary products. D. buyers can readily produce the product themselves. demand in the industry will be weak. They are analogous to industry entry barriers and are based on the same factors: brand loyalty. Mobility barriers are factors that inhibit movement between groups. such as differences in quality. 1. The strategies may be based on a variety of factors. The ability of suppliers to make demands on a company depends on their power relative to that of the company. Intel CEO Andy Grove proposed a sixth force: complementors. equally adequate in filling customer’s needs 2. they purchase in large quantities or constitute a significant buyer for that industry 3. suppliers can readily enter the company’s industry 5. due to high prices. few complementary products exist 2. E. services. or distribution channel utilized. inadequate features. market segment served.

prices fall with the attainment of economies of scale. 2. companies tend to recognize their interdependence and try to avoid price wars if possible. rather than cost economies or brand loyalty. 1. absolute cost advantages. Managers must learn to anticipate the changes that will occur as the industry develops over time. Growth is slow because of buyer unfamiliarity with the industry’s products. D. Most competitors have exited the industry. reducing the intensity of rivalry and allowing greater profitability. Depending on the speed of the decline and the height of exit barriers. As an industry enters maturity. and distribution channels develop. demand takes off when consumers become familiar with the product. 2. Growth industries provide opportunities for firms to expand their market share and revenues in a relatively low rivalry situation. Virtually all companies exit the industry. Barriers to entry at this stage tend to be based on access to key technological knowhow. especially in an economic downturn. often by acquiring the assets of firms exiting the industry. capitalizing on the lack of rivalry. A growth industry is one where first-time demand is expanding rapidly as new consumers enter the marketplace. During an industry’s growth stage. B. Intense competition for market share can develop. opening up distribution channels. An industry shakeout occurs when the rate of industry growth slows down as demand approaches saturation levels. As an industry enters the shakeout stage. Embryonic industries provide a good opportunity for firms to capture loyal customers. However. rivalry between companies becomes intense. Over time. C. competitive pressures can become as fierce as in the shakeout stage. Many firms exit the industry at this point. An embryonic industry is one that is just beginning to develop. Industry Life Cycle Analysis A. industries pass through a series of well-defined stages with different implications for the nature of competition. there tends to be little rivalry. Porter’s five competitive forces and competitive dynamics change as an industry evolves. growth becomes negative. and economies of scale. In the decline stage. 1. barriers to entry increase and the threat of entry from potential competitors decreases. growth is very low or near zero. . Most of the demand is limited to replacement demand. and high prices stemming from the inability of companies to reap economies of scale. Mobility barriers make it difficult for companies to move into another strategic group. F. 1. creating an oligopoly dominated by a few. and demand is limited to replacement demand. Stable demand gives them the opportunity to enter into price-leadership agreements. 2. large companies. driving down prices. Typically. 1. poor distribution channels. Rivalry in embryonic industries is based on educating customers. Rapid growth in demand enables companies to expand their revenues and profits without taking market share away from competitors. A mature industry is one where the market is totally saturated. A saturated market is one where there are few first -time buyers left. 1. 2. and they also protect group members from entry by companies from other groups. E. with excess productive capacity and severe price discounting. and perfecting the design of the product. In mature industries. the stability of a mature industry is always threatened by further price wars.V. Firms entering at this stage avoid the high expenses of initial product development. Industry shakeout provides an opportunity for those firms that are dedicated to success in this particular industry to consolidate their power.

. innovation in many industries competition leads to new products. Limitations of Models for Industry Analysis A. the attractiveness of an industry. This theory asserts that the Five Forces Model is not a good predictor of the changes that take place in the short time just after an important innovation. D. with industry effects accounting for only 10 to 20 percent of the variance. Innovation can fragment or consolidate an industr y. create new strategic groups or market segments. The macroenvironment refers to the broader economic. the harder it is for companies to reduce capacity and the greater is the threat of severe price competition. these are all major determinants of the overall level of demand. moving slowly or rapidly through the stages or remaining “stuck” at a particular stage. and otherwise disrupt the orderly predictions of all three of the models for industry analysis. these models have limitations. demographic. processes. technological. Adverse changes in any of these can threaten profitability in an industry. One important limitation of the life cycle model is that industry life cycles vary considerably. Richard D’Aveni has argued that many industries are hypercompetitive. interest rates. However. Another limitation of all of these models is the lack of attention paid to the consequenc es of innovation.Falling demand leads to excess capacity. whereas positive changes tend to increase profitability. Michael Porter. industry structure is constantly being revolutionized by innovation. being characterized by permanent and ongoing innovation. However. 2. in spite of limitation. strategic groups. but it is useful in the longer periods of stability that follow the turbulence. There are five important forces in the macroenvironment. Another limitation of the models for internal analysis is the lack of attention paid to firm specific factors. Macroeconomic forces include changes in the growth rate of the economy. there are those who question the validity of the punctuated equilibrium approach. the originator of the Five Forces model. and inflation rates. currency exchange rates. 2. The Five Forces. and industry life cycle models constitute very useful ways of thinking about and analyzing the nature of competition within an industry. there are no periods of equilibrium. VII. It is apparent that changes in this macroenvironment can have a direct impact on any one of the five forces in Porter’s model. Technological forces are characterized by an accelerated pace of innovation and change. However. Over time. The punctuated equilibrium theory allows Porter’s Five Forces Model to continue to be somewhat useful. and political environment within which an industry is embedded. B. has shifted focus to acknowledge the role of innovations as “unfreezing” and “reshaping” industry structure. It does not mean the models are useless. speed or slow an industry’s life cycle. thereby altering the relative strength of these forces and with it. 2. The greater the exit barriers. Thus. In such industries. or strategies that can be very successful and transform the nature of competition within an industry. skipping or repeating stages. it does mean that managers must be aware of the limitations as they apply these models to their firms. in which an innovation triggers a period of turbulence. followed by a period of stability. VI. the three models of internal analysis are not useful. C. social. 1. Technological change can make established products obsolescent overnight. causing companies to engage in price wars. Porter describes a model of punctuated equilibrium. Studies point to enormous variance in the profit rates of individual companies within an industry. The Role of the Macroenvironment A. 1. These studies suggest that the individual resources and capabilities of a company are far more important determinants of that company’s profitability than the industry or the strategic group of which the company is a member. B.

and even the political party makeup of the Congress can create opportunities and threats for companies in many industries. it can create new products and processes.S. 4. Political and legal forces are shaped by changing laws and regulations. but at the same time. Thus technological change is both an opportunity and a threat. it is creative and destructive. the impact of the trend toward greater health consciousness has been a boon to the fitness equipment and organic foods industries. Changing demographics create both opportunities and threats. population and the movement of people across national boundaries. For example.3. while it has hurt the beef and cigarette industries. 5. such as the aging of the U. Demographic forces consist of any trends related to population. spawning new industries and products while eliminating others. New social movements also create opportunities and threats. Factors such as deregulation. . insurance reform. Social forces consist of changes in societal preferences and values.

such as land. and raw materials. b. and increased focus on one huge global marketplace. Porter speaks of these four attributes as constituting the diamond. The tastes and preferences of consumers in different nations are beginning to converge at some global norm. compressing product life cycles. as firms are increasingly able to disperse parts of their production operations around the world. in spite of the increased threats due to globalization. reducing the importance of static models of external analysis. Companies gain competitive advantage when their home countries are rich in factor endowments. The globalization of markets has led to decreased emphasis on national markets. In a study of national competitive advantage. a. International trade and foreign direct investment have grown rapidly in the last few years. One attribute is factor endowments.VIII. along with advanced factors. This has led to the globalization of production and markets. reducing costs. and perhaps. railways. The decline in trade barriers has opened up many once-protected markets to companies based outside those markets. There are several implications of the globalization of products and markets that are important to managers. such as Porter’s Five Force Model or strategic groups. and ports). a. Implications of the globalization of production and markets include the need for companies to recognize that industry boundaries do not stop at national borders. Factors of production include basic factors. He argues that firms are most likely to succeed in industries or industry segments where conditions with regard to the four attributes are favorable. B. Michael Porter identified four attributes of a national state that have an important impact upon the global competitiveness of companies located within that nation. A final implication is that. Another implication is that competitive rivalry will increase as relatively protected national markets are transformed into segments of fragmented global industries where a large number of companies battle one another for market share and profits in country after country around the globe. such as technological know-how. Despite the globalization of production and markets. The national context of a country influences the competitiveness of companies based within that nation. b. a. and competitors can be found in other national markets. driven by lower tariffs and non-tariff barriers. Individual companies need to understand the link between national context and competitive advantage in order to identify where their most significant competitors are likely to come from and to identify where they might want to locate certain productive activities. He also argues that the diamond’s attributes form a mutually reinforcing system in which the effect of one attribute is dependent on the state of others. The Globalization of Production and Markets 1. it has also created enormous opportunities. c. National Competitive Advantage 1. A third implication is that the rate of innovation will continue to skyrocket. 2. which include the cost and quality of factors of production. d. many of the most successful companies in certain industries are still clustered in a small number of countries. 2. . managerial sophistication. capital. labor. roads. and physical infrastructure (for example. The Global and National Environments A. The globalization of production has occurred.

Domestic rivalry creates pressures to innovate. to improve quality. . Companies gain competitive advantage if their domestic consumers pressure them to meet high standards of product quality and to produce innovative products. Another attribute is local demand conditions. to reduce costs. Successful industries within a country tend to be grouped into “clusters” of related industries. which in turn makes them better international competitors. thereby helping it achieve a strong competitive position internationally. d. The benefits of investments in advanced factors of production by related and supporting industries can spill over into an industry. Thus the characteristics of home demand are particularly important in shaping the attributes of domestically made products and in creating pressures for innovation and quality. and to invest in upgrading advanced factors. and rivalry of companies within the nation. Companies are typically most sensitive to the needs of their closest customers. A fourth attribute is the strategy. Different nations are characterized by different “management ideologies.” which either help them or do not help them to build national competitive advantage. Also. A third attribute is the presence of related and supporting industries that are internationally competitive. c. structure.b. companies that experience a vigorous domestic rivalry look for ways to improve efficiency.

Sign up to vote on this title
UsefulNot useful