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Analyzing the

External
Environment
of the Firm:
Creating
Competitive
Advantages

chapter 2
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Learning Objectives
2-2

After reading this chapter, you should have a good


understanding of:
LO2.1 The importance of developing forecasts of the
business environment.
LO2.2 Why environmental scanning, environmental
monitoring, and collecting competitive intelligence are
critical inputs to forecasting.
LO2.3 Why scenario planning is a useful technique for
firms competing in industries characterized by
unpredictability and change.

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This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Learning Objectives
2-3

After reading this chapter, you should have a good


understanding of:
LO2.4 How forces in the competitive environment can
affect profitability, and how a firm can improve its
competitive position by increasing its power vis-à-vis
these forces.
LO2.5 How the Internet and digitally based capabilities
are affecting the five competitive forces and industry
profitability.
LO2.6 The concept of strategic groups and their
strategy and performance implications.

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The Importance of External
Environment
2-4

Consider. . .
The best CEOs are always aware of what’s going on
outside their company. Their perceptual acuity
allows them to sense what’s coming. Detecting
anomalies, keeping pace with changes in the external
environment can sustain a competitive advantage.

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This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Creating the Environmentally
Aware Organization
2-5

Exhibit 2.1 Inputs to


Forecasting
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Environmental Scanning &
2-6
Monitoring
▪ Environmental scanning involves surveillance
of a firm’s external environment
▪ Predicts environmental changes to come
▪ Detects changes already under way
▪ Allows firm to be proactive
▪ Environmental monitoring tracks evolution of
environmental trends
▪ Sequences of measurable facts/events
▪ Streams of activities or trends from outside the
organization

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This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Competitive Intelligence
2-7

▪Competitive intelligence
▪ Helps firms define & understand their industry
▪ Identifies rivals’ strengths & weaknesses
▪ Collect data on competitors
▪ Interpret intelligence data
▪ Helps firms avoid surprises
▪ Anticipate competitors’ moves
▪ Decrease response time
▪ Beware of the potential for unethical behavior while
gathering intelligence

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Example:
Using Competitive Intelligence
2-8

▪ Startups have a disadvantage – it takes a lot of time to be


ready for the market – someone else can get there first.
▪ How to find out if your competitor will beat you to launch?
▪ Do competitive intelligence:
▪ Monitor the competitor’s blog posts, e-mail blasts, the
CEO's Twitter messages, changes to the LinkedIn profile.
▪ Track the dates of each dispatch on a spreadsheet and look
for patterns.
▪ When the company’s chatter becomes more frequent,
broadcasting more and more positive messages about its
new product, "It led me to believe they were entering
launch mode” so “we put together a limited version of our
software and released it to get the Qworky name out first.”

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Environmental Forecasting
2-9

▪ Environmental forecasting predicts change


▪ Plausible projections about
▪ Direction of environmental change?
▪ Scope of environmental change?
▪ Speed of environmental change?
▪ Intensity of environmental change?
▪ Scenario analysis involves detailed assessments
of the ways trends may affect an issue &
development of alternative futures based on these
assessments

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Question?
2-10

A danger of forecasting discussed in the text is that


A. in most cases, the expense of collecting the
necessary data exceeds the benefit.
B. forecasting’s retrospective nature provides little
information about the future.
C. managers may view uncertainty as “black and
white” while ignoring important “gray areas.”
D. it can create legal problems for the firm if
regulators discover the company is making
forecasts.

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SWOT Analysis
2-11

▪ SWOT analysis is a basic technique for


analyzing firm and industry conditions
▪ Firm or internal conditions = Strengths &
Weaknesses
▪ Where the firm excels or where it may be lacking
▪ Environmental or external conditions =
Opportunities & Threats
▪ Developments that exist in the general environment
▪ Activities among firms competing for the same
customers

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SWOT Analysis
2-12

▪ SWOT analysis
▪ Forces managers to consider both internal &
external factors simultaneously
▪ Makes firms act proactively
▪ Raises awareness about role of strategy
▪ A firm’s strategy must build on its strengths
▪ Remedy the weaknesses or work around them
▪ Take advantage of the opportunities presented by
the environment
▪ Protect the firm from the threats

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The General Environment
2-13

The general environment is composed of factors


that are both hard to predict and difficult to
control:
▪ Demographic ▪ Technological
▪ Sociocultural ▪ Economic
▪ Political/Legal ▪ Global

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The Demographic Segment
2-14

▪ Demographics are easily understandable &


quantifiable:
▪ Aging population
▪ Rising affluence
▪ Changes in ethnic composition
▪ Geographic distribution of population
▪ Greater disparities in income levels

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Insights from Research:
Demographic factors make a difference
2-15

▪ Compared to younger workers, older workers are


less motivated, less healthy, resist change, are
less trusting, have more trouble balancing work &
family.
▪ How many of you believe this?
▪ What does the research say, and what
implications might this have for a firm’s human
resource strategy?

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Insights from Research:
Demographic Factors make a difference
2-16

▪ ACTUALLY, compared to younger workers, older


workers can be MORE motivated, more willing to
implement change, are as healthy, as trusting, and
do not have issues with work-family imbalance.
▪ However, older workers ARE less willing to
participate in training & career development.
▪ Implications?
▪ Should YOU question your assumption biases?

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The Sociocultural Segment
2-17

▪ Sociocultural forces influence the values,


beliefs, and lifestyles of a society:
▪ More women in the workforce
▪ Dual-income families
▪ Increase in temporary workers
▪ Greater concern for healthy diets & physical fitness
(increasing levels of obesity)
▪ Greater concern for the environment
▪ Postponement of marriage & family formation,
having children

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The Political/Legal Segment
2-18

▪ Political/Legal processes & legislation influence


environmental regulations with which industries
must comply:
▪ Tort reform
▪ Americans with Disabilities Act (ADA)
▪ Deregulation of utilities & other industries
▪ Increases in minimum wages
▪ Legislation on corporate governance reforms
▪ Immigration & visa reform
▪ Affordable Health Care Act, Medicare
reimbursements

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The Technological Segment
2-19

▪ Technological developments lead to new


products & services; can create new industries &
alter existing ones:
▪ Genetic engineering
▪ Computer-aided design/computer-aided
manufacturing systems (CAD/CAM)
▪ Research in synthetic & exotic materials
▪ Pollution/global warming
▪ Nanotechnology & physiolectics
▪ Digital technology can affect multiple segments of
the General Environment, i.e. crowdsourcing

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The Economic Segment
2-20

▪ Economic forces affect all industries:


▪ Interest rates
▪ Unemployment
▪ Consumer Price Index
▪ Trends in GDP & net disposable income
▪ Changes in stock market valuations

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The Global Segment
2-21

▪ Global forces offer both opportunities & risks:


▪ Currency exchange rates
▪ Increasing global trade
▪ Emergence of the Chinese economy
▪ Trade agreements among regional blocs (NAFTA,
EU, ASEAN)
▪ General Agreement of Tariffs & Trade (GATT) –
leading to decreasing tariffs/free trade in services
▪ Rapid rise of the middle class in emerging
countries

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General Environment:
Relationships among Elements
2-22

▪ Elements of the general environment interact


with each other:
▪ Demographic trends have implications for
economics
▪ Greater access to information technology affects
both economics and global relationships
▪ Political/legal trends can have very different effects
on different industries
▪ The Internet & digital technology has altered the
way business is conducted in nearly every business
domain
▪ For instance, see crowdsourcing

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The Competitive Environment
2-23

▪ The competitive environment consists of


factors in the task or industry environment that
are particularly relevant to a firm’s strategy:
▪ Competitors (existing or potential)
▪ Including those considering entry into an entirely
new industry
▪ Customers (or buyers)
▪ Suppliers
▪ Including those considering forward integration

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Porter’s Five-Forces Model of
Industry Competition
2-24

Exhibit 2.4 Porter’s Five-Forces Model of Industry Competition


Source: Adapted and reprinted with permission of The Free Press, a division of Simon & Schuster Adult
Publishing Group, from Competitive Strategy: Techniques for Analyzing Industries and Competitors by Michael
E. Porter. Copyright © 1980, 1998 by The Free Press. All rights reserved.
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The Threat of New Entrants
2-25

▪ The threat of new entrants – possibility that the


profits of established firms in the industry may be
eroded by new competitors.
▪ Depends on existing barriers to entry:
▪ Economies of scale
▪ Product differentiation
▪ Capital requirements
▪ Switching costs
▪ Access to distribution channels
▪ Cost disadvantages independent of scale

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Question?
2-26

▪ If you are considering opening a new pizza


restaurant in your community, what would be the
threat of new entrants? How would you evaluate
Porter’s other forces for this industry? Explain.

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The Bargaining Power of Buyers
2-27

▪ Buyers have bargaining power:


▪ Buyers can force down prices, bargain for higher
quality or more services, play competitors against
each other
▪ Buyer groups are powerful when:
▪ Purchasing standard products in large volumes
▪ Profits are low & switching costs are few
▪ Backward integration is possible
▪ Buyer’s product quality is not affected by industry
product

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The Bargaining Power of Suppliers
2-28

▪ Suppliers can exert bargaining power by


threatening to raise prices or reduce the quality of
purchased goods and services
▪ Supplier groups are powerful when:
▪ Only a few firms dominate the industry
▪ No competition from substitute products
▪ Suppliers sell to several industries
▪ Buyer quality is affected by industry product
▪ Products are differentiated & have switching costs
▪ Forward integration is possible

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The Threat of Substitute Products
& Services
2-29

▪ Substitute products & services limit the


potential returns of an industry
▪ Substitutes come from another industry
▪ Can perform the same function as the industry’s
offerings
▪ Place a ceiling on prices that firms in an industry
can profitably charge
▪ The more attractive the price/performance ratio,
the more the substitute erodes industry profits.

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The Intensity of Rivalry Among
Competitors in an Industry
2-30

▪ Rivalry tactics include price competition,


advertising battles, new product introductions,
increased customer service or warranties
▪ Interacting factors lead to intense rivalry:
▪ Numerous or equally balanced competitors
▪ Slow industry growth
▪ High fixed or shortage costs
▪ Lack of differentiation or switching costs
▪ Capacity augmented in large increments
▪ High exit barriers

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How the Internet and Digital Technologies
Affect Competitive Forces
2-31

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Example: How the Internet
Increases Rivalry
2-32

▪ 2002: Best Buy is the largest seller of PCs to consumers, the largest
seller of music and electronics and the third largest seller of major
appliances in the United States, but facing competition from Internet
sellers such as Amazon.
▪ CEO Dick Schultze realized he had to become an infomediary,
building partnerships with suppliers & customers to head off
rivalry.
▪ 2009: Best Buy drops to 20% of market share for consumer
electronics, with Amazon at #2, new CEO Brian Dunn is struggling.
▪ Showrooming was occurring - customer used physical stores to
check out products, but made purchases online.
▪ 2012: new CEO Hubert Joly faces 7% market share, revives
infomediary strategy, stressing opportunity to try products out in
the store, get immediate support, & immediate delivery -
will this be enough for Best Buy to survive?

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Using Industry Analysis:
A Few Caveats
2-33

▪ Managers must not always avoid low profit


industries – these can still yield high returns for
players who pursue sound strategies
▪ Five forces analysis implicitly assumes a zero-
sum game – yet mutually beneficial relationships
can still be established with buyers & suppliers
▪ Five forces analysis is essentially a static analysis
– yet external forces can still change the structure
of all industries
▪ See the value net
▪ Vertical dimension = suppliers & customers
▪ Horizontal dimension = substitutes & complements
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The Value Net
2-34

Exhibit 2.6 The Value Net


Source: reprinted by permission of Harvard Business Review. Exhibit from “The Right Game: Use Game Theory
to Shape Strategy,” by A. Brandenburger and B.J. Nalebuff, July-August 1995. Copyright © 1995 by the Harvard
Business School Publishing Corporation. All rights reserved.
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The Value Net: Complements
2-35

▪ Complements are typically products or services


that have a potential positive impact on the value of
a firm’s own products or services
▪ Firms that produce complements are referred to as
“complementors”
▪ Savvy firms will offer complementary products or services,
i.e. Apple’s iTunes is a complement to the iPod
▪ Complements help increase the performance and
efficiency of products or services of a particular
industry, improving the competitive situation

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Doing a Good Industry Analysis
2-36

▪ Good industry analysis looks rigorously at the


structural underpinnings & root causes of
profitability
▪ Must choose the appropriate time frame
▪ Consider the industry business life cycle
▪ Average profitability over 3-5 years or longer
▪ Must consider quantitative factors as well as
qualitative
▪ Get numbers to quantify five forces factors
▪ Percentages of total cost or sales accounted for by the
industry, actual switching costs

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Strategic Groups Within
Industries
2-37

▪ Two unassailable assumptions in industry


analysis:
▪ No two firms are totally different
▪ No two firms are exactly the same
▪ Strategic groups – clusters of firms that share
similar strategies:
▪ Breadth of product & geographic scope
▪ Price/quality
▪ Degree of vertical integration
▪ Type of distribution

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Strategic Groups Within
Industries
2-38

▪ Strategic groups as an analytical tool


▪ Helps identify barriers to mobility that protect a
group from attacks by other groups
▪ Helps identify groups whose competitive position
may be marginal or tenuous
▪ Helps chart the future direction of firms’ strategies
▪ Helps to think through the implications of each
industry trend for the strategic group as a whole

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Strategic Groups Within
Industries
2-39

Exhibit 2.7 The World Automobile Industry: Strategic


Groups
Note: Members of each strategic group are not exhaustive, only illustrative.
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