External analysis:

Conceptual framework and real-world applications

(with case questions)

Dr. Daniel Deneffe

April 2022

(c) 2022 Daniel Deneffe

External analysis

Content

1. Industry structural analysis in Grand Strategy

2. 5/6 forces analysis in Operational Strategy: Real-world case application

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1. Industry structural analysis

We first try to understand when and how to use

external analysis
The Firm The external environment

◼ Internal analysis of
resources and capabilities External analysis of

◼ Understanding of internal Strategic ◼ The industry structure1

constraints (mission, values, Options ◼ Customer needs
culture, capability level)
◼ Competitors

Questions to the class (discuss with your neighbor):

◼ What is the purpose of performing a high level industry analysis (‘five forces’ analysis) and
the PESTEL factors affecting the structural industry forces?
◼ When is it useful/less useful?

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1. Industry structural analysis

It is important to understand when and when not to

apply 5 forces (industry structural) analysis

Industry structural analysis

◼ In reality top managers are PESTELing every day but do not necessarily use the framework explicitly
◼ The extremely broad nature of the framework is in fact its limitation: it covers everything in general but
nothing specific
◼ The same applies to the much heralded ‘Porter’ 5 forces framework which is
– useful to understand future threats to the AVERAGE profitability of the market (e.g. consolidation of
buyers, which decreases profitability for all players)
– relatively useless to understand the drivers of average profitability of an industry. What is the value
thereof? Don’t the average profit figures suffice?
◼ Both frameworks (consider it one framework) are useful to structure our thinking about future trends.
– Threats to the average profitability of the markets we are currently in
– Guide our thinking about which strategies could be effective at structurally improving the average
profitability of these markets (e.g. Mergers, creation of barriers, switching costs, etc)
– Spotting new market opportunities and guesstimating the average profitability of capitalizing on them
◼ Remember, though, that the firm’s position in the industry explains more of the firm’s profitability (about
30-45%) than the average profitability as determined by industry-level effects (10-20%)1
1See Ghemawat, P. and J. Rivkin, Creating Competitive Advantage, HBS note, 2006, p.1.
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1. Industry structural analysis

Industry structural analysis – key applications and

frameworks

◼ Entry/diversification and exit decisions

Key applications
– Everything else constant we want to avoid (exit) markets
that are characterized by strong competitive forces
◼ Product portfolio rationalization decisions
– Everything else constant we want to avoid products
characterized by a weak competitive position in an
unattractive market
◼ Market positioning decisions
– Everything else constant, we want to position ourselves
in the market where the forces of competition are the
weakest

Key framework Some form of 5 (or 6) forces analysis or variation thereof

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1. Industry structural analysis

Market force 1 (but most important one!):

Market/segment size1

◼Note: Make sure to define the market/segment first!

– which product/service/solution
– to which customers (defined geographically, by
application, by channel etc.)

◼What is the size of the market/segment?

◼What is the market/segment growth (typically three year

horizon)?
1The size of the market is affected by many factors, including the availability of complements. This is
therefore not treated as a separate force here
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1. Industry structural analysis

Market force 2: Power of substitutes is high when

◼ There are substitute solutions that can meet the needs of

the customers in the defined market at an attractive total
cost

◼ Switching costs to these substitute solutions are low

◼ Note: thinking in ‘share of wallet’ terms can often be

useful to identify substitutes that may not be so obvious
up front

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1. Industry structural analysis

Market force 3 Entry barriers: a. Factors affecting the

entrants’ beliefs of post-entry competition, including

◼ Scale economies relative to market demand

◼ Product proliferation
◼ Incumbents’ tactical reputation and capability/willingness
to retaliate
◼ Excess capacity
◼ Specificity of the assets of incumbents

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1. Industry structural analysis

Market force 3 Entry barriers: b. Incumbents’ first-

mover advantages

◼ Government intervention/legal barriers

◼ Experience curve effects/learning economies
◼ Innovation advantage
◼ Brand advantages/reputation of incumbents’ for quality
products or services
◼ Customer relationship advantages
◼ Hi customer switching costs
◼ Positive network externalities
◼ Pre-commitment contracts

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1. Industry structural analysis

Market force 3 Entry barriers: c. Other factors

◼ Hispecific capital requirements

◼ Sunk entry costs

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1. Industry structural analysis

Market force 4: Power of buyers is high when:

◼ Few buyers
◼ Concentrated or large purchases (high stakes)
◼ Purchase is large fraction of buyer's costs
◼ Standardized products
◼ Few switching costs for buyers
◼ Low profits for buyers
◼ Backward integration threat by buyers
◼ Buyers have information about supplier’s costs, excess
capacity and alternatives

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1. Industry structural analysis

Market force 5: Power of suppliers is high when

(flipside):

◼ Few sellers
◼ Concentrated or large purchases (high stakes)
◼ Input important to buyer
◼ Differentiated products
◼ High switching costs for buyers
◼ Forward integration threat by suppliers
◼ Have full information about supplier’s costs

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1. Industry structural analysis

Market force 6: Rivalry is high when:

◼ There are many firms

◼ There is no dominant player
◼ Products are standardized AND switching costs are low
◼ Market growth rate is low
◼ Players only have little historical interaction

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2. 5/6 forces in Operational Strategy: Real world case illustration

Background about the case example

◼ The goal of the case example is to think independently and in a ‘blank sheet’ mode
about:
– how to approach a particular real-world strategy issue
– the value of the ‘5/6 forces model’ at a particular time in the strategy process
◼ Specifically, we take the case of a payroll services company serving companies with
200 to 2000 employees. It is the market leader in its home market, with a 40+% share
of the outsourced payroll services market
◼ The company has gone through a Grand Strategy review in 2021, using internal
analysis and high-level external market and needs analysis
◼ The outcome of the Grand Strategy exercise was that its best hypothesized strategic
option for profitable growth is to diversify into ‘Ozland.’
◼ It has hypothesized an entry strategy (target segments, service offering, price, USP,
organizational structure and number of salespeople,.) and now needs to fine-tune this
in Operational Strategy using customer interviews/WTP data)
◼ One of the required deliverables is an evidence-based business plan for 2022-2025
◼ We pick up the case at the beginning of the Operational Strategy exercise

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2. 5/6 forces in Operational Strategy: Real world case illustration

Real-world Operational Strategy case example: Entering

the market for payroll services in neighboring ‘Ozland’1

◼ As part of its international expansion plan, the company acquired two

Situation local software companies in a foreign country (Ozland)
◼ The challenge for the company was to build the business in this foreign
country in line with its overall international strategy

◼ The company has no base in the foreign market and is considering a

number of entry strategies
Complication ◼ The company does not know how to gain adequate penetration in the
new market and turn a positive EBIT 4 years after entry (the company’s
objective)

◼ Which client segments should we target (outsourcers or insourcers)?

◼ How should we adapt our service offering in this market?
Question ◼ What should be our USP?
◼ What commercial, operational, IT and other support resources do we
need to realize the strategy?
◼ What financial performance (EBIT) do we reach by 2025 and what
investments are required?
1Allslides in blue font are adapted from the final presentation to the Board
of Directors (with disguised names and figures) (c) 2022 Daniel Deneffe 15
2. 5/6 forces in Operational Strategy: Real world case illustration

Real-world Operational Strategy case example: Entering

the market for payroll services in neighboring ‘Ozland’1

Key issues addressed in the entry strategy

1. Entry barriers: Are there any barriers that we must overcome before we can enter the Ozland
market as a service provider? If so, how can we overcome these in a most effective manner?
2. Unique selling proposition: With which combination of services can we convince clients to
switch to Payroll inc.,either from an insourced solution or from another service provider?
3. Pricing: What payslip price concession, if any, should we make relative to prevailing market
prices in order to induce switching by clients?
4. Target segments: What is the sequence in which we should target the various market
segments (insourcers vs. outsourcers; local vs. multi-country companies)?
5. Internal resources: What commercial, operational, IT and other support resources do we
need – and how much do they cost – to realize the strategy?
6. Partnerships: How could partnerships with other service providers help us accelerate our
market entry and growth?
7. Financial plan: What financial performance (EBIT) do we reach by 2025 and what
investments are required? What are the major risks and what is the upside potential?
8. Implementation plan: What are the next steps to start implementation of the strategy?
1Allslides in blue font are from the final presentation to the Board
of Directors (with disguised names and figures) (c) 2022 Daniel Deneffe 16
2. 5/6 forces in Operational Strategy: Real world case illustration

Real world case example: Entering the market for

payroll services in a neighboring country (Ozland)

Discussion questions to the class

1. How would you approach this entry strategy problem? What is the sequence of
steps

2. What is the value, if any, of the ‘generic’ 5/6 forces model at this stage? Ie. Why
would we do such analysis, if any?

3. Which of the 6 forces discussed so far are the most important ones to evaluate?

4. What would you think/guess are the most important entry barriers in this case and
is it possible to obtain quantitative measures thereof?

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