STRATEGIC MANAGEMENT

Chapter 2

The External Environment (Opportunities, Threats, Industry Competition, and Competitor Analysis)

• The external environment (includes industry in which firm competes as well as those against whom it competes) affects competitive
actions and responses firms take to outperform competitors and earn above-average returns.

o Characteristics of today’s external environment differ from historical concerns.

o Firms understand external environment by acquiring info about competitors, customers, and other stakeholders to build their own
base of knowledge and capabilities.

▪ On basis of new info, firms take actions in hope of buffering themselves from any negative environmental effects and to
pursue opportunities as basis for better serving their stakeholders’ needs.

o Firm’s competitive actions and responses are influenced by conditions in three parts (general, industry, and competitor) of its
external environment and its understanding of those conditions.

2.1 The General, Industry, and Competitor Environments

• General environment: composed of dimensions in broader society that influences industry and firms within it.

o Group dimensions into seven environmental segments: demographic, economic, political/legal, sociocultural, technological,
global and sustainable physical.

o Firms can’t directly control general environment’s segments.

▪ What company seeks to do is recognize trends in each segment of general environment and then predict each trend’s
effect on it.

▪ No firm can control where growth in potential customers may take place in next decade or two. Firms must study
anticipated trend as foundation for predicting its effects on their ability to identify strategies to use that will allow them
to remain successful as market conditions change.

• Industry environment: set of factors that directly influences a firm and its competitive actions/responses: threat of new entrants, power of
suppliers, power of buyers, and threat of product substitutes, and intensity of rivalry among competing firms.

o Interactions among these five factors determine industry’s profitability potential; industry’s profitability potential influences
choices each firm makes about its competitive actions/response

▪ Challenge for firm is to locate position within industry where it can favorably influence the five factors or where it can
successfully defend itself against their influence.

• The greater a firm’s capacity to favorably influence its industry environment, the greater the likelihood it will
earn above-average returns.

• Competitor analysis: how companies gather and interpret info about their competitors

o Understanding firm’s competitor environment complements insights provided by studying general and industry environments.

• Analysis of general environment focuses on environment trends and their implications, an analysis of industry environment focuses on
factors and conditions influencing an industry’s profitability potential, and an analysis of competitors is focused on predicting competitors’
actions, responses, and intentions.

o Results of the three analyses influences firm’s vision, mission, choice of strategies, and competitive actions/responses it takes to
implement strategies.
 ▪ Firm can develop and implement a more effective strategy when it effectively integrates insights provided by analyses of
general environment, industry environment, and competitor environment.

External Environmental Analysis

To cope with often ambiguous and incomplete environmental data and to increase understanding of the general environment, firms complete an external
environmental analysis. This analysis has four parts: scanning, monitoring, forecasting, and assessing

An opportunity is a condition in the general environment that, if exploited effectively, helps a company reach strategic competitiveness.

A threat is a condition in the general environment that may hinder a company’s efforts to achieve strategic competitiveness

Scanning

• Identifying early signals of environmental changes and trends

entails the study of all segments in the general environment

Monitoring

• Detecting meaning through ongoing observations of environmental changes and trends

Forecasting

• Developing projections of anticipated outcomes based on monitored changes and trends

Assessing

• Determining the timing and importance of environmental changes and trends for firms’ strategies and their management.

2.3 Segments of General Environment

Composed of segments that are external to firm. Although degree of impact varies, these environmental segments affect all industries and firms
competing in them.

o Challenge of each firm is to scan, monitor, forecast, and assess elements in each segment to predict their effects on it. (to recognize
opportunities and threats)

2. The Demographic Segment

o concerned with population’s size, age structure, geographic distribution, ethnic mix, and income distribution.

o Commonly analyzed on global basis b/c of potential effects across countries’ borders and b/c many firms compete in global
markets.

o Population Size

▪ Firms seeking to find growing markets in which to sell goods/services want to recognize market potential that exists for
them in top five nations.

▪ Firms also want to study changes occurring within populations of different nations/regions of world to assess their
strategic implication

• Aging populations are significant problem for countries b/c of need of workers and burden of supporting
retirement programs.

o Age Structure

▪ World’s population is rapidly aging, with significant implications for availability of qualified labor, healthcare retirement
policies, and business opportunities for others.

• Delayed retirements help companies avoid/defer baby-boomer brain drain that has been looming.
Organizations now have fresh opportunity to address talent gap created by shortage of critical skills in
marketplace and experience gap created by multiple waves of downsizing.

• Firms can use older more experienced workers to transfer their knowledge to younger employees, helping
them to quickly gain valuable skills.
 o Opportunity for firms to more effectively use talent available in workforce.

o Geographic Distribution

▪ How population is distributed within countries and regions is subjected to change over time (differ throughout the
world).

▪ Firms want to carefully study patterns of population distributions in countries and regions to identify
opportunities/threats.

o Ethnic Mix

▪ Ethnic mix of countries’ populations continues to change, creating opportunities and threats for many countries as result.

• Ethnic diversity of population is important not only b/c of consumer needs but also b/c of labor force
composition.

o Firms with greater ethnic diversity in their managerial team are likely to enjoy higher performance.

▪ “New World” countries tend to be pretty diverse (histories of relatively open immigration).

o Income Distribution

▪ Understanding how income is distributed within and across populations informs firms of different groups’ purchasing
power and discretionary income.

• Of interest to firms are average incomes of households and individuals.

• It is important for firms to identify economic systems that are more likely to produce most income growth and
market opportunities.

3. The Economic Segment

o Economic environment: nature/direction of economy in which firm competes or may compete.

▪ Firms seek to compete in relatively stable economics with strong growth potential.

▪ Challenging for firms studying economic environment to predict economic trends that may occur and their effects on
them. (Two reasons for this):

• Global recession in 2008 created numerous problems for companies throughout world like reduced consumer
demands, increases in firms’ inventory levels, development of govt regulations, and tightening of access to
financial resources.

• Global recovery from economic shock continues to be persistently slow and relatively weak.

o Firms need to adjust not only to economic shock and try to recover from it, they have to respond to
what appears to be unpredictable recovery.

▪ When facing economic uncertainty, firms want to be certain to study economic

environment in multiple regions and countries throughout world.

▪ Historically, high degrees of economic uncertainty coincide with periods of lower growth.

• Firms will be able to pursue growth opportunities in regions and nations where they exist while avoiding the
threats of slow growth periods in other settings.

4. The Political/Legal Segment

o *arena in which organizations and interest groups compete for attention, resources, and voice in overseeing the body of
laws/regulations guiding interactions among nations and b/w firms and various govt agencies.
 ▪ This segment is concerned with how organizations try to influence govts and how they try to understand influences
(current/projected) of those govt. on their competitive actions and responses.

• Firms develop political strategy to specify how they will study this segment and approaches they might take to
successfully deal with opportunities/threats that surface within this segment at different points in time.

▪ Regulations formed in response to new national, regional, state and/or local laws that are legislated often influence firm’s
competitive actions and responses.

5. The Sociocultural Segment

o *concerned with society’s attitudes and cultural values (cornerstone of society)

▪ Drives demographic, economic, political/legal, and technological conditions and changes.

o Successful firms must have awareness of changes taking places in societies and their associated cultures in which they are
competing.

▪ Societal and cultural changes challenge firms to find ways to “adapt to stay ahead of their competitors and stay relevant
in minds of their consumers.”

• Sociocultural factors influence entry into new markets and development of new firms in country.

o Attitudes about and approaches to health care are being evaluated in nations/regions in world.

o Greater diversity in workforce creates challenges and opportunities, including combining best of both men’s and women’s
traditional leadership styles.

▪ Diversity initiatives must be successfully managed to reap these organizational benefits.

▪ Each country is unique with respect to sociocultural indicators.

• National cultural values affect behavior in organizations and influence organizational outcomes. National
culture influences to a large extent the internationalization strategy that firms pursue relative to one’s home
country.

o Knowledge sharing is vital for dispersing new knowledge in organizations and increasing speed in
implementing innovations.

6. The Technological Support

o *includes institutions and activities involved in creating new knowledge and translating knowledge into new outputs, products,
processes, and materials.

▪ Early adopters of new tech often achieve higher market shares and earn higher returns.

▪ Both large and small firms should continuously scan general environment to identify potential substitutes for tech that
are in current use and identify newly emerging tech from which their firm could derive competitive advantage.

▪ Internet offers firms remarkable capability in terms of their efforts to scan, monitor, forecast, and assess conditions in
general environment.

• Companies study Internet’s capabilities to anticipate how it allows them to create more value for customers
and anticipate future trends.

• Internet generates significant # of opportunities/threats for firms across world.

o Wireless communication technology is becoming significant technological opportunity for

companies to pursue.

o Use of handheld devices has increased substantially and may become dominant form of
communication/commerce.

7. The Global Segment

 o *relevant new global markets, existing markets that are changing, important international political events, and critical cultural and
institutional characteristics of global markets.

o Firms should recognize that globalization of business markets creates opportunities to enter new markets & threats that new
competitors from other economies may enter market.

• Overcapacity signals the possibility that companies based in markets where this is the case will simultaneously
attempt to increase exports/sales in domestic markets

▪ Some firms take cautious approach to globalization.

• Global-focusing: used by firms with moderate levels of international operations who increase this
internationalization by focusing on global niche markets.

o Allows firms to build on to and use core competencies while limiting risks within niche market.

• Firms can limit risks in international markets by focusing operations and sales in one region of world.

o Success with these efforts finds firms building relationships in and knowledge of its markets.

o As firm builds its strengths, rivals find it more difficult to enter its markets and compete successfully.

▪ Firms competing in global markets should recognize each market’s sociocultural and institutional attributes.

• Important to analyze strategic intent of foreign firms when pursuing alliances and joint ventures abroad,
especially where local partners are receiving tech, which many in long run reduce foreign firms’ advantages.

▪ Informal economy is another aspect of global segment requiring analysis.

• This economy has implications for firms’ competitive actions and responses in that increasingly firms
competing in formal economy will find that they are competing against informal economy companies too.

8. The Sustainable Physical Environment Segment

o *potential and actual changes in physical environment and business practices that are intended to positively respond to changes
with intent of creating sustainable environment.

▪ Firms recognize that ecological, social, and economic systems interactively influence what happens in this segment and
that they are part of interconnected global society.

o Companies across global are concerned about physical environment and many record actions they are taking in reports with names
like sustainability and corporate social responsibility.

▪ Increasing # of companies are interested in sustainable development: the development that meets the needs of present
without compromising the ability of future generations to meet their own needs.

▪ Certification programs have been developed to help firms understand how to be sustainable organizations.

o It is necessary to have top mgmt. team with experience, knowledge, and sensitivity required to effectively analyze conditions in
firm’s general environment and other parts such as industry environment and competitors.

2.4 Industry Environment Analysis

1. Industry: group of firms producing products that are close substitutes that influence one another.

o Companies use rich mix of different competitive strategies to pursue above-average returns when competing in industry.

o An industry’s structural characteristics influences firm’s choice of strategies.

2. Industry environment (measured in form of its characteristics) has more direct effect on competitive actions and responses a firm takes to
succeed.

o To study industry, firm examines five forces that affect ability of all firms to operate profitability within given industry.
 o Five forces: threats posed by new entrants, power of suppliers, power of buyers, product substitutes, and intensity of rivalry
among competitors.

▪ Expands scope of firm’s competitive analysis; must search broadly to recognize current and potential competitors by
identifying potential customers and firms serving them.

▪ Firms must recognize that suppliers can become firm’s competitors (by integrating forward) as can buyers (by
integrating backward).

3. 1) Threat of New Entrants

o They can threaten market share of existing competitors.

o One reason new entrants pose such a threat is that they bring additional production capacity.

▪ Unless demand for good/service is increasing capacity holds consumers’ costs down, resulting in less revenue and lower
returns for competing firms.

▪ New entrants have keen interest in gaining large market share.

• New competitors may force existing firms to be more efficient and to learn how to compete in new
dimensions.

o Likelihood that firms will enter industry is function of two factors: barriers to entry and retaliation expected from current industry
participants.

▪ Entry barriers make it difficult for new firms to enter industry and place them at competitive disadvantage even when
they can enter.

• High entry barriers tend to increase returns for existing firms in industry and may allow some firms to
dominate industry.

• Firms competing successfully in industry want to maintain high entry barriers to discourage potential
competitors from deciding to enter industry.

o Barriers to Entry

▪ Firms competing in industry try to develop entry barriers to thwart potential competitors.

• More is known about entry barriers in industrialized countries

▪ There are different kinds of barriers to entering market to consider when examining industry environment.

• Companies competing within industry study barriers to determine degree to which their competitive position
reduces likelihood of new competitors being able to enter industry to compete against them.

• Firms considering entering industry study entry barriers to determine likelihood of being able to identify
attractive competitive position w/in industry.

▪ Economics of Scale

• Derived from incremental efficiency improvements through experience as firm grows larger.

o Cost of producing each unit declines as quantity of product produced during given period increases.

• New entrant is unlikely to quickly generate level of demand for its product that in turn would allow it to
develop economics of scale.

• Can be developed in most business functions. Firms sometimes form strategic alliances or joint ventures to
gain scale economies.

• Becoming more flexible in terms of being able to meet shifts in customer demand is another benefit for
industry incumbent and possible entry barrier for firms considering entering industry.
 • Some competitive conditions reduce ability of economies of scale to create entry barrier. Many companies
customize products for various, small customer groups.

o Customized products are not manufactured in volumes necessary to achieve economies of scale.
Customization is possible by several factors like flexible manufacturing systems.

o Online ordering enhances customers’ ability to buy customized products. Companies manufacturing
customized products can respond quickly to customers’ needs in lieu of developing scale economies.

▪ Product Differentiation

• Over time, customers may come to believe firm’s product is unique, resulting from firm’s service to customer,
effective advertising campaigns, or being the first to market a good/service.

o Greater levels of perceived product uniqueness create customers who consistently purchase firm’s
products.

o To combat perception of uniqueness, new entrants frequently offer products at lower prices. This
decision might result in lower profits or losses.

▪ Capital Requirements

• Competing in new industry requires firm to have resources to invest.

• Capital is needed for inventories, marketing activities, and other critical business functions. Even when new
industry is attractive, the capital required for successful market entry may not be available to pursue market
opportunity.

▪ Switching Costs: one-time costs customers incur when they buy from different supplier.

• In some cases, switching costs are low and can vary as a function of time.

• A decision made by manufacturing to produce a new, innovative product creates high switching costs for
customers.

o Customer loyalty programs are intended to increase customer’s switching costs. If switching costs
are high, a new entrant must offer either a substantially lower price or much better product to attract
buyers.

▪ The more established the relationships between parties, the greater the switching costs.

▪ Access to Distribution Channels

• Industry participants learn how to effectively distribute their products. After building relationship with
distributors, a firm will nurture it, creating switching costs for distributors.

o Access to distribution channels can be strong entry barrier for new entrants. New entrants have to
persuade distributors to carry their products, either in addition to or in place of those currently
distributed.

▪ Price breaks and cooperative advertising allowances may be used for this purpose however
these practices reduce the new entrant’s profit potential.

▪ Access to distribution is less of barrier for products that are sold on the Internet.

▪ Cost Disadvantages Independent of Sale

• Sometimes, established competitors have cost advantages that new entrants cannot duplicate.

• Successful competition requires new entrants to reduce strategic relevance of factors like favorable access to
raw materials or desirable locations.
 ▪ Government Policy

• Govts can control entry into industry and restrict entry into some industries b/c of need to provide quality
service or desire to protect jobs.

o Deregulating industries results in additional firms choosing to enter and compete within industry.

▪ It is not uncommon for govts to attempt to regulate entry of foreign firms, especially in
industries considered critical to country’s economy or important markets within it.

o Govt. decisions/policies regarding antitrust issues also affect entry barriers

o Expected Retaliation

▪ Companies seeking to enter industry anticipate reactions of firms in industry. An expectation of swift and vigorous
competitive responses reduces likelihood of entry.

• Can be expected when existing firm has major stake in industry, when it has substantial resources, and when
industry growth is slow or constrained.

▪ Locating market niches not being served by incumbents allows new entrant to avoid entry barriers. Small entrepreneurial
firms are best suited for identifying and serving neglected market segments.

4. Bargaining Power of Suppliers

o Increasing prices and reducing quality of products are potential means suppliers use to exert power over firms competing w/in
industry.

o If firm is unable to recover cost increases by its suppliers through its own pricing structure, its profitability is reduced by suppliers’
actions.

o Supplier group is powerful when:

▪ It’s dominated by few large companies/more concentrated than industry to which it sells.

▪ Satisfactory substitute products aren’t available to industry firms

▪ Industry firms aren’t significant customer for supplier group

▪ Suppliers’ goods are critical to buyers’ marketplace success

▪ Effectiveness of suppliers’ products has created high switching costs for industry firms

▪ Poses credible threat to integrate forward into buyers’ industry. Credibility is enhanced when suppliers have substantial
resources and provide highly differentiated product

o Some buyers attempt to manage/reduce suppliers’ power by developing long-term relationship with them. Although long-term
arrangements reduce buyer power, they increase suppliers’ incentive to be helpful and cooperative in appreciation of longer-term
relationship (guaranteed sales)-true when partners develop trust in one another.

5. Bargaining Power of Buyers

o Firms seek to maximize return on their invested capital.

o Buyers (customers of industry or firm) want to buy products at lowest possible price-point at which industry earns lowest
acceptable rate of return on its invested capital.

▪ To reduce costs, buyers bargain for higher quality, greater levels of service, and lower prices (outcomes achieved by
enhancing competitive battles among industry’s firms.

o Customers (buyer groups) are powerful when:

▪ They purchase large portion of industry’s total output.

▪ The sales of product being purchased account for significant portion of seller’s annual revenues.

▪ They could switch to another product at little, if any, cost.

 ▪ They industry’s products are undifferentiated or standardized, and buyers pose a credible threat if they were to integrate
backward into sellers’ industry.

o Consumers armed with greater among of info about manufacturer’s costs and power of Internet as shopping and distribution
alternative have increased bargaining power in many industries.

6. Threat of Substitute Products

o *goods/services from outside a given industry that performs similar or same functions as product that industry produces.

▪ Present strong threat to firm when customers face few if any switching costs and when substitute product’s price is lower
or its quality and performance capabilities are equal to or greater than those of competing product.

• Differentiating product along dimensions that are valuable to customers reduces substitute’s attractiveness.

7. Intensity of Rivalry among Competitors

o B/c industry’s firms are mutually dependent, actions taken by one company usually invite responses. Competitive rivalry
intensifies when firm is challenged by competitor’s actions or when company recognizes opportunity to improve its market
position.

▪ Firms w/in industry are rarely homogeneous; they differ in resources and capabilities and seek to differentiate
themselves from competitors.

• Firms seek to differentiate their products from competitors’ offerings in ways that customers value and in
which the firms have competitive advantage.

▪ Common dimensions on which rivalry is based include price, service after the sale, and
innovation. Firms have begun to act quickly in order to gain competitive advantage.

o Factors that experience shows affects intensity of rivalries among firms:

▪ Numerous or Equally Balanced Competitors

• Intense rivalries are common in industries with many companies. With multiple competitors, it is common for
few firms to believe they can act without eliciting a response. Evidence suggest that other firms are aware of
competitors’ actions, often choosing to respond to them.

• At extremes, industries with only a few firms of equivalent size and power tend to have strong rivalries.

• The large and often similar-sized resource bases of firms permit vigorous actions/responses.

▪ Slow Industry Growth

• When market is growing, firms try to effectively use resources to serve an expanding customer base. Markets
increasing in size reduce pressure to take customers from competitors.

o Rivalry in no-growth or slow-growth markets becomes more intense as firms battle to increase their
market shares by attracting competitors’ customers.

▪ High Fixed Costs or High Storage Costs

• When fixed costs account for large part of total costs, companies try to maximize use of their productive
capacity, allowing firms to spread costs across larger volume of output.

o When many firms attempt to maximize their productive capacity, excess capacity is created on
industry-wide basis.

▪ To reduce inventories, individual companies cut price of their product and offer rebates
and other special discounts to customers. Doing this often intensifies competition.

• Pattern of excess capacity at industry level followed by intense rivalry at firm

level is frequently observed in industries with high storage costs.
 ▪ Lack of Differentiation or Low Switching Costs

• When buyers find differentiated product that satisfies needs, they purchase product loyally over time.
Industries with many companies that have successfully differentiated their products have less rivalry, resulting
in lower competition for individual firms.

o Firms that develop and sustain differentiated product that can’t be easily imitated by competitors
earn higher returns.

▪ When buyers view products as commodities (products w/ few differentiated features or

capabilities), rivalry intensifies.

• Buyers’ purchasing decisions are based primarily on price, and to a lesser degree,
service.

▪ High Strategic Stakes

• Competitive rivalry is likely to be high when it is important for several of competitors to perform well in
market. High strategic stakes exist in terms of geographic locations.

▪ High Exit Barriers

• Companies continue competing in industry even though returns on their invested capital are low/negative,
sometimes. Firms making this choice likely face high exit barriers, which include economic, strategic, and
emotional factors causing them to remain in industry when profitability of doing so is questionable.

• Common exit barriers that firms face include:

o Specialized assets, fixed costs of exit, strategic interrelationships,

emotional barriers, and government/social restrictions.

2.5 Interpreting Industry Analyses

1. Effective industry analyses are products of careful study and interpretation of data and info from multiple sources.

2. A wealth of industry-specific data is available for firms to analyze for purpose of better understanding industry’s competitive realities.

o Due to globalization, international markets and rivalries must be included in firms’ analyses and b/c of development of global
markets, country’s borders no longer restrict industry structures.

▪ Entering international markets enhance chances of success of new ventures as well as more established firms.

3. Analyses of five forces within given industry allows firm to determine industry’s attractiveness in terms of potential to earn average or
above-average returns.

o The stronger the competitive forces, the lower the potential for firms to generate profits by implementing their strategies.

▪ An unattractive industry has low entry barriers, suppliers and buyers with strong bargaining positions, strong competitive
threats from product substitutes, and intense

rivalry among competitors.

• These industry characteristics make it difficult for firms to achieve strategic competitiveness and earn above-
average returns.

▪ An attractive industry has high entry barriers, suppliers and buyers with little bargaining power, few competitive threats
from product substitutes, and relatively moderate rivalry.

Strategic group

A set of firms emphasizing similar strategic dimensions and using a similar strategy
The competition between firms within a strategic group is greater than the competition between a member of a strategic group and compa- nies outside
that strategic group. Therefore, intra-strategic group competition is more intense than is inter-strategic group competition. In fact, more heterogeneity is
evident in the performance of firms within strategic groups than across the groups. The per- formance leaders within groups are able to follow strategies
similar to those of other firms in the group and yet maintain strategic distinctiveness as a foundation for earning above-average returns

Competitor Analysis

competitor environment is the final part of the external environment requiring study

Competitor analysis focuses on each company against which a firm competes directly

Competitor intelligence
is the set of data and information the firm gathers to better understand and anticipate competitors’ objectives, strategies, assumptions, and capabilities

Complementors are companies or networks of companies that sell complementary goods or services that are compatible with the focal firm’s good or
service

Ethical Considerations

Firms must follow relevant laws and regulations as well as carefully articulated ethical guidelines when gathering competitor intelligence
n