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CHAPTER

External Analysis: Industry Structure, Competitive Forces, and Strategic Groups

McGraw-Hill/Irwin

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Part 1 Strategy Analysis

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LO 3-1 Apply the PESTEL model to organize and assess the impact of external forces on the firm. LO 3-2 Apply the structure-conduct-performance (SCP) model to explain the effect of industry structure on firm profitability. LO 3-3 Apply the five forces model to understand the profit potential of the firms industry. LO 3-4 Describe the strategic role of complements in creating positivesum co-opetition. LO 3-5 Understand the role of industry dynamics and industry convergence in shaping the firms external environment. LO 3-6 Apply the strategic group model to reveal performance differences between clusters of firms in the same industry.

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ChapterCase 3

Build Your Dreams to Sidestep Entry Barriers

Changing U.S. car market


More competition from outside the U.S. However, NO new entry firms in the last 2 decades High barriers to entry

BYD in China is entering the car market Batteries to carsbypassing many hurdles
Electric cars have fewer parts BYD has the battery technology Selling in China, Africa, & S. America
Hybrid Car Video
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BYD Electric Vehicles What are their chances of success?

Warren Buffet invested for 10% equity.


Sticker price that of a Chevy Volt. Many obstacles lay ahead

Which PESTEL factors will be most important for electric vehicles in the 21st century?
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THE PESTEL FRAMEWORK


Key forces in the external environment
Simple way to categorize & analyze external forces
Forces embedded in global environment Creates BOTH opportunities and threats

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EXHIBIT 3.1 The Firm Embedded in Its External Environment

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Political Variables
Governments influence behavior of firms
Subsidies for renewable energy High-mileage automobiles Investments in R&D

Campaigns by candidates for office Taxation at local, state, federal levels Political pressure on firms
Negotiations on pharmaceutical prices Modify home loans

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STRATEGY HIGHLIGHT 3.1

UBS Relents to Pressure by U.S. Government

Large Swiss bank in trouble


U.S. government accused UBS of aiding in tax evasion

Billions of $ moved offshore Names of 52,000 U.S. citizens sought Eventually over 4,000 names were released

Imperils Swiss Bank secrecy

Historically, a competitive advantage

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Economic Variables
Growth Rates
GDP Trends

Interest Rates Employment Levels Inflation Rates Currency & Money Supply Disposable & Discretionary Income

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Socio-Cultural Variables
Lifestyle Changes Career Expectations Demographics
Life expectancies Aging population Rising affluence Changes in ethnic composition More women in workforce globally

Increase in temporary workers Geographic distribution of global population

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Technological Variables
Productivity Improvements Focus of Technological Efforts Industrial Spending for R&D Patent Protection Digital Communications
E-tailers
Mobile devices

Biotechnology
Genetic engineering

Nanotechnology
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Ecological Variables
Global Warming Sustainable Economic Growth Carbon Footprint Fossil Fuel Consumption Pollution of air & water Toxins in food and products

Business Sustainability Video 3-13

Legal Variables
Antitrust Regulations Tort Reform Environmental Protection Laws
CARB zero-emission regulation passed in 1990.

GM, Toyota, & Honda all had EVs by 1997.


Regulation was revoked & EVs withdrawn in 2002.

Hiring and Promotion Laws Americans with Disabilities Act of 1990 Sarbanes-Oxley Act of 2002
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PESTEL Framework
Political
Govt pressures Subsidies & incentives Differences in countries, states,

Technological
Innovation Diffusion Research & development

Countries & regions

Economic
Growth rates Interest rates Employment levels Currency exchange

Environmental
Global warming Sustainability Pollution

Sociocultural
Norms, culture, values
Demographics Lifestyle changes

Legal
Court system
Legislation Hiring laws, ADA, SBOX

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LO 3-1 Apply the PESTEL model to organize and assess the impact of external forces on the firm. LO 3-2 Apply the structure-conduct-performance (SCP) model to explain the effect of industry structure on firm profitability. LO 3-3 Apply the five forces model to understand the profit potential of the firms industry. LO 3-4 Describe the strategic role of complements in creating positivesum co-opetition. LO 3-5 Understand the role of industry dynamics and industry convergence in shaping the firms external environment. LO 3-6 Apply the strategic group model to reveal performance differences between clusters of firms in the same industry.

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THE STRUCTURE-CONDUCT PERFORMANCE (SCP) Perfect Competition


Many small firms commodity products Ex. Pet supply stores

Monopolistic Competition
Many firms differentiated products Ex. Computer hardware, organic foods

Oligopoly
Few large firms interdependent Ex. Express mail, soft drinks

Monopoly
One supplier often government approved Ex. Utilities for electricity, gas, and water

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EXHIBIT 3.2 Industry Structures along the Continuum

Bank Oligopolies Video 3-18

LO 3-1 Apply the PESTEL model to organize and assess the impact of external forces on the firm. LO 3-2 Apply the structure-conduct-performance (SCP) model to explain the effect of industry structure on firm profitability. LO 3-3 Apply the five forces model to understand the profit potential of the firms industry.

LO 3-4 Describe the strategic role of complements in creating positivesum co-opetition. LO 3-5 Understand the role of industry dynamics and industry convergence in shaping the firms external environment. LO 3-6 Apply the strategic group model to reveal performance differences between clusters of firms in the same industry.

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COMPETITIVE FORCES AND FIRM STRATEGY The Five Forces Model


The classic industry analysis model

Threat of Entry Power of Suppliers Power of Buyers Threat of Substitutes Rivalry Among Existing Competitors
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EXHIBIT 3.3 Porters Five Forces Model

5 forces video- M. Porter


Source: Porter, M. E. (2008), The five competitive forces that shape strategy, Harvard Business Review

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Threat of Entry HIGH IF:


Customer Switching Costs are Low Capital Needs are Low Retaliation is Not Expected Incumbents dont have:
Proprietary technology Established brands Closed distribution channels

BYD entrance??
Electric vehicles level the auto field BYD has strength working multinational firms
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Power of Suppliers HIGH IF:


Forward Integration is a credible threat
Suppliers exert power in the industry by: threatening to raise prices or to reduce quality. Powerful suppliers can squeeze industry profitability.

No substitutes for supplier products


Suppliers products are differentiated Incumbents face high switching costs Product is important input to buyer

BYD suppliers??
They make the batteries Chevy, Ford are buying

from suppliers!
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Power of Buyers HIGH IF:


A few large buyers Large buyers relative to a seller Products are standardized Buyers face few switching costs Backward Integration is credible Buyer has full information
Buyers compete with the supplying industry by: Bargaining down prices Forcing higher quality

Playing firms off of each other

BYD Buyers??
Product is differentiated Switching costs from

gas to electric
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Threat of Substitutes HIGH IF:


Substitute is good priceperformance trade-off Buyers switching costs to substitute is low
Products with similar functions limit the prices firms can charge

BYD Substitutes??
Electric vs. gas cars
Bus, train, bikes

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Incumbent Rivalry HIGH IF:


Many competitors in the industry Firms are equal size Industry growth is slow or shrinking Exit barriers are high
Contractual obligations Geographic or historical attachments

Products and services are direct substitutes BYD rivals??


Entrance of BYD (& Tesla) increases rivalry
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Five Forces in Airlines vs. Soft Drinks Airlines low profits for decades
Entry threats small airlines popping up Suppliers few & large: aircraft, engines, unions Buyers no switching costs, perfect info now Subs drive for shorter flights

Rivalry intense and low profit

ZERO star industry, each force is strong


Yieldinginferior profits

5 forces video- M. Porter


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Five Forces in Airlines vs. Soft Drinks Soft Drinks high profits for decades
Entry threats strong brands (Coke & Pepsi) Suppliers mostly commodities Buyers bottlers lock into long-term contracts Subs other drinks (water, coffee, etc.)

Rivalry advertizing-based

FIVE star industry, each force is weak


Yieldingstrong profits

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LO 3-1 Apply the PESTEL model to organize and assess the impact of external forces on the firm. LO 3-2 Apply the structure-conduct-performance (SCP) model to explain the effect of industry structure on firm profitability. LO 3-3 Apply the five forces model to understand the profit potential of the firms industry. LO 3-4 Describe the strategic role of complements in creating positive-sum co-opetition. LO 3-5 Understand the role of industry dynamics and industry convergence in shaping the firms external environment. LO 3-6 Apply the strategic group model to reveal performance differences between clusters of firms in the same industry.

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Substitutes and Complements


Substitute: An alternative from outside the given industry for its product or service. When its performance increases or its price falls, industry demand decreases.
Plastic vs. aluminium containers Video conference vs. business travel

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Substitutes and Complements


Complement: A product or service or competency that adds value to original product. When its performance increases or its price falls, industry demand increases.
Paper for Xerox copiers iTunes for iPod music players

Complementor: If customers value your product more when combined with another firms product or service.
Michelin tires for Ford & GM
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EXHIBIT 3.5 Determining Industry Attractiveness

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STRATEGY HIGHLIGHT 3.2

Microsofts Business

Microsoft has 90% share of PC operating systems


They shaped the industry structure

Long-term relations with Dell, HP (OEMs)


Wintel standard has power over OEMs

Customer switching costs high


Intel chip great complement for OS A virtuous cycle Microsoft & Intel

BUT Linux & Cloud ComputingWhat is the future?


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Small Group Exercise 2 - Textbook vs. iPad


Traditional textbook publishing industry consider the impact new electronic devices on this industry.
Kindles, iPads, & $200 Netbooks all enabling e-readers

Use the Porters 5 forces or the 6 force industry attractiveness model to consider the impacts of this technology shift on the textbook publishing industry. 1. How should managers in the textbook industry respond to these developments? 2. Is it likely to raise or lower the industry-level profits?
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CHANGES OVER TIME: INDUSTRY DYNAMICS Industry Growth Rates Highly Variable (Exh. 3.6)
Metals & Internet at the top Retailers and food at the bottom

Structures Change too


U.S. banking industry major consolidations Big 8 accountants are now Big FOUR Stock brokerage firms have grown Internet catalyst

Industry Convergence
Formerly unrelated industries collide Media newspapers, TV, movies

Online business model?

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LO 3-1 Apply the PESTEL model to organize and assess the impact of external forces on the firm. LO 3-2 Apply the structure-conduct-performance (SCP) model to explain the effect of industry structure on firm profitability. LO 3-3 Apply the five forces model to understand the profit potential of the firms industry.

LO 3-4 Describe the strategic role of complements in creating positivesum co-opetition. LO 3-5 Understand the role of industry dynamics and industry convergence in shaping the firms external environment. LO 3-6 Apply the strategic group model to reveal performance differences between clusters of firms in the same industry.

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Strategic Groups
Mapping Groups
Auto industry example
Ford, Toyota gas BYD, Tesla electric
GM,

Mobility Barriers
Firms would try to

ID best dimensions Choose two for map

Locate firms on map


Bubble

move to the profit spots BUT Specific factors that separate groups Airlines
International routes Regulations: airport slots

size = market share

Rivalry is strongest in

SAME group Some groups more profitable than others


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EXHIBIT 3.7 Strategic Groups and Mobility Barrier U.S. Airlines

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CHAPTERCASE 3 /Consider This


BYD was China's fastest-growing carmaker!
Sold more the 500,000 in 2010 Shanghai govt subsidy of $9k for EVs

Which PESTEL factors are most salient for the electric vehicle industry? How is your home country auto industry structured? Use Exhibit 3.5 for traditional auto industry.
What changes for electric auto industry?

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Take-Away Concepts
LO 3-1 Apply the PESTEL model for external forces. Macro environment has a wide range of domestic & global forces. The political environment describes the influence government bodies can have on firms. The economic environment is mainly affected by five factors: growth rates, interest rates, levels of employment, price stability (inflation and deflation), and currency exchange rates. Sociocultural factors capture a societys cultures, norms, and values. Technological factors capture the application of knowledge to create new processes and products. Ecological factors concern a firms regard for environmental issues such as the natural environment, global warming, and sustainable economic growth. Legal environment factors capture the official outcomes of the political processes that manifest themselves in laws, mandates, regulations, and court decisions.
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Take-Away Concepts (contd)


LO 3-2 Apply the SCP model for industry structure. Helps explain differences in industry performance. A perfectly competitive industry is characterized by many small firms, a commodity product, low entry barriers, and no pricing power for individual firms. A monopolistic industry is characterized by many firms, a differentiated product, medium entry barriers, and some pricing power. An oligopolistic industry is characterized by few (large) firms, a differentiated product, high entry barriers, and some degree of pricing power. A monopoly exists when there is only one (large) firm supplying the market. The firm may offer a unique product, the barriers to entry are high, and the monopolist has considerable pricing power.

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Take-Away Concepts (contd)


LO 3-3 Apply the five forces model for profit potential of industry. Five competitive forces shape an industrys profit potential: (1) threat of entry, (2) power of suppliers, (3) power of buyers, (4) threat of substitutes, and (5) rivalry among existing competitors. The stronger a competitive force, the greater the threat it represents. The weaker the competitive force, the greater the opportunity it presents. Firm can shape industry structure through its strategy. Industry attractiveness determined by 3 pairs of forces.

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Take-Away Concepts (contd)


LO 3-4 Describe the strategic role of complements in creating positivesum co-opetition. Co-opetition (co-operation among competitors) can create a positivesum game, resulting in a larger pie for everyone involved. Complements increase demand for the primary product, enhancing the profit potential for the industry and the firm. Industry attractiveness can be determined by three pairs of two forces: (1) supplier and buyer power, (2) entry and exit barriers, and (3) available complements and the threat of substitutes. Attractive industries for co-opetition are characterized by high entry barriers, low exit barriers, low buyer and supplier power, a low threat of substitutes, and the availability of complements.

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Take-Away Concepts (contd)


LO 3-5 Understand the role of industry dynamics and industry convergence in shaping the firms external environment. Industries are dynamicthey change over time. Different conditions prevail in different industries, directly affecting the firms competing in these industries and their profitability. In industry convergence, formerly unrelated industries begin to satisfy the same customer need. It is often brought on by technological advances. LO 3-6 Apply the strategic group model for differences between clusters of firms in the same industry. A strategic group is a set of firms within a specific industry that pursue a similar strategy in their quest for competitive advantage.

Rivalry within the same group is more intense than between groups.
Mobility barriers restrict movement between groups.

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Complement Complementor Entry barriers Exit barriers Five forces model Industry Industry convergence

Mobility barriers PESTEL model SCP (structure-conductperformance) model Strategic group Strategic group model

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