Day 3

External Analysis: Industry Structure,

Competitive Forces, and Strategic Groups
 How External Factors Impact a Firm

General Environment
• Managers have little control
• Macroeconomic factors
• Interest / currency exchange rates

Task Environment
• Managers can influence
• Composition of strategic groups
• Industry structure

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 The Firm Within Its External Environment

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 The PESTEL Model

Groups environmental factors into six segments:

1. Political
2. Economic
3. Sociocultural
4. Technological
5. Ecological
6. Legal
→ Such factors create both opportunities and threats

A straightforward way to scan, monitor, and evaluate

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 Political Factors

Processes & actions of government bodies

Firms traditionally wield little influence.
Companies nevertheless increasingly work to shape
and influence this realm
Can be shaped through nonmarket strategies:
• Lobbying; Public Relations; Contributions; Litigation
• E.g., Airbnb vs. Hotels
Political and legal forces are closely related.
• Political pressure often results in changes in
legislation.

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 Economic Factors

Largely macro-economic
Economy-wide phenomena
Examples include:
• Growth rates
• Levels of employment
• Interest rates
• Price stability
• Currency exchange rates

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 Economic Factors

GROWTH RATES
A measure of the change in the amount of goods and services
produced by a nation’s economy
In periods of economic expansion, consumer and business
demands are rising, and competition among firms frequently
decreases → more profitable
Boom periods can overheat → speculative asset bubbles
In a recessionary period, the reverse is generally true.
Certain companies that focus on low-cost solutions may
benefit from economic contractions because demand for their
products or services rises.
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 Economic Factors

LEVELS OF EMPLOYMENT
Growth rates directly affect the level of employment.
In boom times, unemployment tends to be low, and skilled
human capital becomes a scarce and more expensive
resource.
As the price of labor rises, firms have an incentive to invest
more into capital goods such as cutting-edge equipment or
artificial intelligence (AI).
In economic downturns, unemployment rises.
As more people search for employment, skilled human capital
is more abundant and wages usually fall.
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 Economic Factors

INTEREST RATES
Real interest rates—the amount that creditors are paid for use of their
money and the amount that debtors pay for that use, adjusted for
inflation.
Low real interest rates have a direct bearing on consumer demand.
• Credit is cheap → consumers buy more on credit → economic
growth
• Firms can easily borrow money to finance growth.
• Reduces the cost of capital and enhances a firm’s
competitiveness.
When rising, consumer demand slows → firms difficult to borrow
money to support operations, possibly deferring investments.
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 Economic Factors

PRICE STABILITY
the lack of change in price levels of goods and services
When there is too much money in an economy, we tend to see rising
prices—inflation.
• too much money chasing too few goods and services
Deflation describes a decrease in the overall price level.
• A sudden and pronounced drop in demand generally causes
deflation, which in turn forces sellers to lower prices to motivate
buyers.
• Distorts expectations about the future: Companies will not invest in
new production capacity or innovation because they expect a
further decline in prices.
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 Economic Factors

CURRENCY EXCHANGE RATES

How many dollars one must pay for a unit of foreign currency
A critical variable for any company that buys or sells products and
services across national borders.
• E.g., U.S. dollar appreciation against the Euro

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 Sociocultural Factors

Society’s cultures, norms, and values

• Are constantly in flux
• Differ across groups
Demographic trends
• Population characteristics
• Age, gender, family size, ethnicity, sexual orientation,
religion, and socioeconomic class

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 Technological Factors

Application of knowledge
• New processes and products
Innovations in process technology:
• Lean manufacturing and Six Sigma quality
• E.g., Airbnb
Innovations in product technology:
• E.g., Smartphones and wearable devices
Technological progress is relentless and seems to be
picking up speed → both opportunities and threats
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 Ecological Factors

Broad environmental issues:

• Natural environment
• Global warming
• Sustainable economic growth
Can provide business opportunities
• Tesla cars have zero emissions
• SolarCity providing clean-tech energy services
• Decentralized solar power generation and storage via
Powerwall
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 Legal Factors

Official outcomes of political processes:

• Laws
• Mandates
• Regulations
• Court decisions
In fact, regulatory changes tend to affect entire industries at
once.
E.g., EU applies political and legal pressure on U.S. tech
companies.
• Breaking up “digital monopolies” such as Google.
Many industries have been deregulated:
• Airlines, telecom, energy, and trucking
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 Industry vs. Firm Effects

Industry Effects
• The underlying economic structure of the industry
• Elements in common to all
• Entry and exit barriers, number and size of companies,
and types of products and services offered
Firm Effects
• The actions managers take
• Firm heterogeneity
• More important than external effects
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 Superior Firm Performance

→ Strategic leaders’ actions tend to be more important in determining firm

performance than the forces exerted on the firm by its external environment.
→ Although a firm’s industry is not quite as important as the firm’s strategy within
its industry, they jointly determine roughly 75 percent of overall firm
performance.
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 Industry & Industry Analysis

Industry:
• Group of incumbent companies
• Relatively similar suppliers and buyers
• Similar products and services
Industry analysis, a method to:
• Identify an industry’s profit potential
• The level of profitability that can be expected for
the average firm
• Derive implications for a firm’s strategic position
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 Strategic Positioning

A firm’s ability to:

• Create value for customers (V)
• Contain costs (C)
Goal: Generate a large gap between:
• The value the firm’s product or service creates
• The cost required to produce it

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 The Five Forces Model

The Five Forces Model helps strategic leaders

understand:
• The profit potential of different industries.
• How they can position their firms to gain and sustain
competitive advantage.
Two key insights about this model:
• Competition is viewed more broadly in the five forces
model.
• Profit potential is a function of the five competitive
forces.
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 Porter’s Five Forces Model

SOURCE: Michael E. Porter, “The five competitive forces that shape strategy,” Harvard Business Review, January 2008.

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 The Five Forces Model

Competition describes the struggle among these forces to

capture as much of the economic value created in an industry as
possible.
The intensity of rivalry  the strength of the other competitive
forces.
The model enables managers to not only understand their
industry environment but also shape their firm’s strategy.
• The weaker the five forces, the greater the industry’s profit
potential → making the industry more attractive
• The goal of crafting a strategic position is of course to
improve the firm’s ability to achieve and sustain a
competitive advantage.
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 Threat of Entry (1 of 4)

The risk that potential competitors will enter an

industry
What happens when more entrants are coming?
Lowers industry profit potential:
• Incumbents lower prices
Incumbents spend more to satisfy existing customers.
Entry barriers:
• Obstacles blocking others from entering
• A significant predictor of industry profit potential
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 Threat of Entry (2 of 4)

The more profitable an industry, the more attractive

Entry barriers:
Economies of scale
• Larger output
• because they can spread fixed costs over more units,
employ technology more efficiently, benefit from
a more specialized division of labor, and demand
better terms from their suppliers.
Network effects
• One user of a product or service has on the value of
that product or service for other users.
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 Threat of Entry (2 of 4)

Customer switching costs

• Changing vendors may require the buyer to alter
product specifications, retrain employees, and/or
modify existing processes.
Capital requirements
• “price of the entry ticket”
Advantages independent of size
• brand loyalty, proprietary technology, preferential
access to raw materials and distribution channels,
favorable geographic locations, and cumulative
learning and experience effects
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 Threat of Entry (2 of 4)

Government policy
• Regulation
• E.g., China frequently requires foreign companies to
enter joint ventures with domestic ones and to share
technology.
• Deregulation
• airlines, telecommunications, and trucking have
generated significant new entries.
Credible threat of retaliation
• Price wars, product and service innovation,
advertising, sales promotions, and litigation
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 Threat of Entry (3 of 4)

The threat of entry is high when:

✓The minimum efficient scale to compete in an industry
is low.
✓Network effects are not present.
✓Customer switching costs are low.
✓Capital requirements are low.

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 Threat of Entry (3 of 4)
The threat of entry is high when:
✓Incumbents do not possess:
• Brand loyalty.
• Proprietary technology.
• Preferential access to raw materials.
• Preferential access to distribution channels.
• Favorable geographic locations.
• Cumulative learning and experience effects.
✓Restrictive government regulations do not exist.
✓New entrants expect that incumbents will not or cannot retaliate.
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 Power of Suppliers

Pressures that industry suppliers can exert on an

industry’s profit potential
Lowers industry profit potential if:
• Suppliers demand higher prices for their inputs
• Suppliers reduce quality

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 Power of Suppliers

The power of suppliers is high when:

✓Supplier’s industry is more concentrated than the industry it
sells to.
✓Suppliers do not depend heavily on the industry for their
revenues.
✓Incumbent firms face significant switching costs when
changing suppliers.
✓Suppliers offer products that are differentiated.
✓There are no readily available substitutes for the products or
services that the suppliers offer.
✓Suppliers can credibly threaten to forward-integrate into the
industry.
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 Power of Buyers (Customers)

Pressure customers put on an industry

Lowers industry profit potential if:
• Buyers obtain price discounts
• Reduces revenue
• Buyers demand higher quality / service
• Raises production costs

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 Power of Buyers (Customers)

The power of buyers is high when:

✓There are a few buyers and each buyer purchases
large quantities relative to the size of a single seller.
✓The industry’s products are standardized or
undifferentiated commodities.
✓Buyers face low or no switching costs.
✓Buyers can credibly threaten to backwardly integrate
into the industry.
✓Buyers are price-sensitive.
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 Power of Buyers (Customers)

Buyers are especially price sensitive when:

✓The buyer’s purchase represents a significant fraction
of its cost structure or procurement budget.
✓Buyers earn low profits or are strapped for cash.
✓The quality (cost) of the buyers’ products and
services is not affected much by the quality (cost) of
their inputs.

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 Threat of Substitutes

Meet the same basic customer need

• But in a different way
• Available from outside the given industry
Examples:
• Energy drinks vs. coffee
• Videoconferencing vs. business travel
• E-mail vs. express mail

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 Threat of Substitutes

The threat of substitutes is high when:

✓The substitute offers an attractive price-performance
trade-off.
✓The buyer’s cost of switching to the substitute is low.

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 Rivalry Among Competitors

The intensity with which companies in the same

industry jockey for market share and profitability
Other forces pressure this rivalry
Examples of tactics:
• Price discounting
• After sales service

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 Rivalry Among Competitors

The rivalry among existing competitors is high when:

✓There are many competitors in the industry.
✓The competitors are roughly of equal size.
✓Industry growth is slow, zero, or even negative.
✓Exit barriers are high.
✓Incumbent firms are highly committed to the business.
✓Incumbent firms cannot read or understand each other’s strategies well.
✓Products and services are direct substitutes.
✓Fixed costs are high and marginal costs are low.
✓Excess capacity exists in the industry.
✓The product or service is perishable.
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 Competitive Industry Structure

Refers to elements and features common to all

industries.
- Number and size of competitors
- Firm’s degree of pricing power
- Type of product or service
• Commodity or differentiated
- Height of entry barriers

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 4 Main Competitive Industry Structures

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 Industry Growth

Affects intensity of rivalry among competitors

During periods of high growth:
• Consumer demand rises
• Price competition among firms decreases
During periods of negative growth:
• Rivalry is fierce
• Price discounts, frequent new product releases with
minor modifications, intense promotional campaigns,
and fast retaliation by rivals
• Rivals can only gain at the expense of one another
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 Strategic Commitments

Firm actions that are:

• Costly
• Long-term oriented
• Difficult to reverse
Affects intensity of rivalry among competitors
Example: airline industry
• Hub and spoke model requires significant investment
• aircraft, gate leases, hangars, maintenance facilities,
baggage facilities, and ground transportation all
accrue before the airlines sell any tickets.
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 Exit Barriers

Obstacles that determine how easily a firm can leave

that industry
Mainly economic and social factors
Examples:
• Contractual obligations
• employee health care, retirement benefits, and
severance pay
• Emotional attachments
• Michigan: GM, Ford, and Chrysler
• Ripple effects through the supply chain
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 A Sixth Force

Complements:
• A product, service, or competency
• Adds value when used with the original product
Co-opetition:
• Cooperation by competitors to achieve a strategic
objective
• E.g., Samsung and Google

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 Entry Choices

When?
•Entry Timing
•Stage of industry life
cycle
•Order of entry

Who? How?
•Identify the players: •Leverage existing
•Incumbents, assets
entrants, suppliers, •Reconfigure value
customers, other chains
stakeholders Entry •Establish niches

Choice

Where? What?
•The Space of Entry:
•Type of entry:
•Product positioning
•Scale, commitment,
(high end vs. low
product and/or
end), Pricing
service, business
strategy, Potential
model etc.
partners, etc.

Source: Based on and adapted from Zachary M.A., Gianiodis P.T., Tyge Payne G., and G.D. Markman (2014), Entry timing: enduring lessons and future directions,
Journal of Management, 41: 1409; and Bryce D.J. and J.H. Dyer (2007), Strategies to crack well-guarded markets, Harvard Business Review, May: 84-92.

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 Industry Dynamics

Analysis must repeat over time

• Industry structures aren’t stable
• They are dynamic
Provides insight about:
• Changing speed of an industry
• Rate of innovation
Industry consolidation
• Industry incumbents have an incentive to reduce the number of
competitors in the industry – horizontal mergers and acquisitions
Industry fragmentation
• External shocks such as deregulation, new legislation, technological
innovation, or globalization

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 Industry Convergence

When unrelated industries satisfy the same need

Caused by technological advances
Example: Media Industries
• Content going online
• Newspapers, magazines, TV, movies, radio, music
• Will print media become obsolete?

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 Strategic Groups

Strategic groups:
• A set of companies
• Pursue a similar strategy
• In the same industry
The strategic group model (framework):
• Clusters different firms into groups
• Is based on key strategic dimensions
• expenditures on research and development, technology, product
differentiation, product and service offerings, market segments,
distribution channels, customer service, etc.
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 How to Create a Strategic Group Map

1. Identify the important strategic dimensions

2. Choose two key dimensions
• For horizontal and vertical axes
• Ensure they’re not highly correlated
3. Graph the firms in the strategic group
• Each firm’s market share indicated by the size of the
bubble

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 Strategic Group Map: Domestic Airline Industry

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 Strategic Groups

Tend to follow a similar strategy.

Companies in the same strategic group, therefore, are
direct competitors.
Intra-group rivalry exceeds inter-group rivalry.
The number of different business strategies pursued
within an industry determines the number of strategic
groups in that industry.
• can be identified along a fairly small number of
dimensions.

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 Insights from Strategic Group Mapping

1. Competitive rivalry:
• Strongest between firms in the same strategic group
2. External environment:
• Affects strategic groups differently
• E.g., economic downturn
3. Five competitive forces:
• Affect strategic groups differently
• E.g., Barriers to entry, threat of substitutes, …
4. Profitability:
• Some strategic groups more profitable than others
• E.g., point-to-point: lower costs, high-yield city pairs
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 Mobility Barrier

Restrict movement between strategic groups

Industry-specific factors
Based on hard-to-reverse investments

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 Implications for Strategic Leaders

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 Analysis of the External Environment Is
Key to Strategic Management

First step: PESTEL Analysis

• How external factors affect the industry
Next step: Porter’s Five Forces
• The overall industry environment
Final step: Draw a Strategic Group Map
• Explains performance differences in an industry

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 How to Apply the Five Forces Model

Define the relevant industry

Identify and group the key forces
Identify the drivers of each force
• Are they strong or weak? Why?
Assess overall industry structure
• Profit potential

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 Shortcomings of Models

They are static

• Just a snapshot
• But black swan events can happen suddenly
• Information can become obsolete
• Assess industry dynamics
They don’t explain why performance differences occur
in an industry
• Internal analysis is required (next day material)

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