Evaluating a Firm’s External

Environment
Session 4b
Why External Analysis?

External analysis allows firms to:

• discover threats and opportunities

• see if above normal profits are likely in an industry

• better understand the nature of competition in

an industry

• make more informed strategic choices

 General External Environment

Entry

Complementors Rivalry

Focal
Firm

Buyers Industry Substitutes

Suppliers
 General External Environment
Technological
Change
Specific Demographic
International Smart Phones Trends
Events
COP 21 Paris Youth Population

Focal
Firm
Changing Policy toward
Land Acquisitions Changing Image of SUV’s
Rising
Interest
Legal/Political Rates Cultural
Conditions Trends
Economic
Climate
Industry Analysis

The Structure–Conduct–Performance Model

• originally developed to spot anti-competitive conditions

for anti-trust purposes

• came to be used to assess the possibilities for

above normal profits for firms within an industry

• model of environmental threats was developed from

this economic tradition
The Structure–Conduct–Performance Model
Industry Analysis
The Model of Environmental Threats

Entry

Industry
Buyers Rivalry
Focal
Firm

Threat
Suppliers Substitutes

Higher Threat Lower Average Profits

Model of Environmental Threats
Threat from New Competition
• If firms can easily enter the industry, any above
normal profits will be bid away quickly.

• Barriers to entry lower the threat of entry.

• Barriers to entry make an industry more attractive.

• This is true whether the focal firm is

already in the industry or thinking about
entering.
Model of Environmental Threats contd.
Threat of New Competition
Barriers to Entry:
• Economies of scale—firm that can’t produce
the minimum efficient scale will be at a
disadvantage.
• Product differentiation—entrants are forced to
overcome customer loyalties to existing products.
• Cost advantages independent of scale—incumbents
may have proprietary tech, managerial knowhow,
access to resources, learning advantages, etc.
• Government policies—governments may impose
trade restrictions and/or grant monopolies.
Model of Industry Competition
Threat from Existing Competitors
• Attributes of an Industry That Increase the Threat of
Direct Competition:
• large numbers of competitors
• slow or declining growth
• low product differentiation
• industry capacity added in large increments
Model of Industry Competition
Threat of Substitute Products
• Substitutes fill the same need but in a different way.

- Coke and Pepsi are rivals, milk is a

substitute for both.

• Substitutes create a price ceiling because consumers

switch to the substitute if prices rise.

• Substitutes will likely come from outside the

industry.
Model of Industry Competition
Threat of Supplier Leverage
• Powerful suppliers can “squeeze” (lower profits for)
the focal firm.
Industry conditions that facilitate supplier power:
• small number of firms in supplier’s industry
• highly differentiated product
• lack of close substitutes for suppliers’ products
• supplier could integrate forward
• focal firm is an insignificant customer of supplier
Model of Industry Competition
Threat from Buyers Influence
• Powerful buyers can “squeeze” (lower profits for)
the focal firm by demanding lower prices and/or
higher levels of quality and service.
Industry conditions that facilitate buyer power:

• small number of buyers for focal firm’s output

• lack of a differentiated product

• the product is significant to the buyer

Model of Industry Competition
Threat from Buyers Influence

Indicators of the threat of buyers influence:

• Buyers operate in a competitive market—they are
not earning above normal profits.

• Buyers can vertically integrate backward.

• Many small buyers can be united around an issue

to act as a block.
 Model of Industry Competition

Entry

Industry
Buyers Rivalry
Focal
Firm

Threat
Suppliers Substitutes

If all threats are high expect normal profits

If all threats are low expect above normal profits

Most industries are somewhere between the extremes.
Complementors As Another Force
Complementors Increase the Value of
the Focal Firms’ Product
• Customers perceive more value in the focal firm’s
product when it is combined with the complementor’s
product.

• Complementors may be found outside the focal firm’s

industry.
Responding to Environmental Threats

Neutralizing Threats
• Most firms cannot unilaterally change the
threats in an industry.

• By altering relationships in an industry, firms

may reduce threats and/or create opportunities,
thereby increasing profits.
Exercise

External Analysis:
• Consider that TATA is planning to buy Air India
• Do an analysis of the attractiveness of the Indian Aviation Industry
using Porter’s 5 forces Model
• Identify the drivers of each force and rate on 1 to 5 how each driver
can be threat of increasing cost and/or reducing revenue (5=high threat)
• Average the ratings across the drivers and find the mean ratings for
each of the forces
• Based on the above analyses, assess the likely levels of industry
profitability (normal, above, below) and prepare a list of possible
threats and opportunities for the client firm