Chapter

Two
External
Analysis:
The
Identification of
Opportunities
and Threats
 External Analysis
The purpose of external analysis is to identify
the strategic opportunities and threats in the
organization’s operating environment that
will affect how it pursues its mission.
External Analysis requires an assessment of:
 Industry environment in which company operates
• Competitive structure of industry
• Competitive position of the company
• Competitiveness and position of major rivals
 The country or national environments
in which company competes
 The wider socioeconomic or macroenvironment
that may affect the company and its industry
• Social • Legal • Technological
• Government • International
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 External Analysis:
Opportunities and Threats
Analyzing the dynamics of the industry in which
an organization competes to help identify:
Opportunities Threats
Conditions in the Conditions in the
environment that a environment that
company can take endanger the integrity
advantage of to and profitability of
become more the company’s
profitable business

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 Industry Analysis:
Defining an Industry
 Industry
• A group of companies offering products or services that are
close substitutes for each other and that satisfy the same
basic customer needs
• Industry boundaries may change as customer needs evolve
and technology changes
 Sector
• A group of closely related industries
 Market Segments
• Distinct groups of customers within an industry
• Can be differentiated from each other with distinct attributes
and specific demands
Industry analysis begins by focusing on
the overall industry – before
considering market segment or sector-level issues
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 The Computer Sector:
Industries and Market Segments
Figure 2.1

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 Porter’s Five Forces Model
Figure 2.2

Source: Adapted and reprinted by permission of Harvard Business Review. From “How Competitive Forces Shape Strategy,” by
Michael E. Porter, Harvard Business Review, March/April 1979 © by the President and Fellows of Harvard College. All rights reserved.

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  Risk of Entry by Potential
Competitors
Potential Competitors are companies that are not
currently competing in an industry but have the capability
to do so if they choose. Barriers to new entrants include:
1. Economies of Scale – as firms expand output unit costs fall via:
 Cost reductions – through mass production
 Discounts on bulk purchases – of raw material and standard parts
 Cost advantages – of spreading fixed and marketing costs over large volume
2. Brand Loyalty
 Achieved by creating well-established customer preferences
 Difficult for new entrants to take market share from established brands
3. Absolute Cost Advantages – relative to new entrants
 Accumulated experience – in production and key business processes
 Control of particular inputs required for production
 Lower financial risks – access to cheaper funds
4. Customer Switching Costs for Buyers – where significant
5. Government Regulation
 May be a barrier to enter certain industries

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  Rivalry Among Established
Companies
Competitive Rivalry refers to the competitive struggle
between companies in the same industry to gain market
share from each other. Intensity of rivalry is a function of:
1. Industry Competitive Structure
 Number and size distribution of companies
 Consolidated versus fragmented industries
2. Demand Conditions
 Growing demand – tends to moderate competition and reduce rivalry
 Declining demand – encourages rivalry for market share and revenue
3. Cost Conditions
 High fixed costs – profitability leveraged by sales volume
 Slow demand and growth – can result in intense rivalry and lower profits
4. Height of Exit Barriers – prevents companies from leaving industry
 Write-off of investment in assets  High fixed costs of exit
 Economic dependence on industry  Emotional attachment to industry
 Maintain assets - to participate  Bankruptcy regulations – allowing
effectively in an industry unprofitable assets to remain

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  Bargaining Power of Buyers
Industry Buyers may be the consumers or end-users who
ultimately use the product or intermediaries that distribute or
retail the products. These buyers are most powerful when:
1. Buyers are dominant.
 Buyers are large and few in number.
 The industry supplying the product is composed of many small companies.
2. Buyers purchase in large quantities.
 Buyers have purchasing power as leverage for price reductions.
3. The industry is dependant on the buyers.
 Buyers purchase a large percentage of a company’s total orders.
4. Switching costs for buyers are low.
 Buyers can play off the supplying companies against each other.
5. Buyers can purchase from several supplying companies at once.
6. Buyers can threaten to enter the industry themselves.
 Buyers produce themselves and supply their own product.
 Buyers can use threat of entry as a tactic to drive prices down.

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  Bargaining Power of Suppliers
Suppliers are organizations that provide inputs such as
material and labor into the industry. These suppliers are
most powerful when:

1. The product supplied is vital to the industry and has few

substitutes.
2. The industry is not an important customer to suppliers.
 Suppliers are not significantly affected by the industry.
3. Switching costs for companies in the industry are significant.
 Companies in the industry cannot play suppliers against each other.
4. Suppliers can threaten to enter their customers’ industry.
 Suppliers can use their inputs to produce and compete with
companies already in the industry.
5. Companies in the industry cannot threaten to enter suppliers’
industry.
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  Substitute Products
Substitute Products are the products from
different businesses or industries that can satisfy
similar customer needs.

1. The existence of close substitutes is

a strong competitive threat.
 Substitutes limit the price that companies
can charge for their product.

2. Substitutes are a weak competitive

force if an industry’s products have few
close substitutes.
 Other things being equal, companies in
the industry have the opportunity to raise
prices and earn additional profits.

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 Strategic Groups
Within Industries
Strategic Groups are groups of companies that
follow a business model similar to other companies
within their strategic group – but are different from
that of other companies in other strategic groups.
The basic differences between business models in
different strategic groups can be captured by a
relatively small number of strategic factors.
 Implications of Strategic Groups –
1. The closest competitors are within the same Strategic Group
and may be viewed by customers as substitutes for each other.
2. Each Strategic Group can have different competitive forces
and may face a different set of opportunities and threats.
 Mobility Barriers – factors within an industry that inhibit the
movement of companies between strategic groups
• Include barriers to enter another group or exit existing group
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 Strategic Groups in the
Pharmaceutical Industry
Figure 2.3

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 Industry Life Cycle Analysis
Industry Life Cycle Model analyzes the affects of
industry evolution on competitive forces over time
and is characterized by five distinct life cycle stages:
1. Embryonic – industry just beginning to develop
 Rivalry based on perfecting products, educating customers, and
opening up distribution channels.
2. Growth – first-time demand takes-off with new customers
 Low rivalry as focus is on keeping up with high industry growth.
3. Shakeout – demand approaches saturation, replacements
 Rivalry intensifies with emergence of excess productive capacity.
4. Mature – market totally saturated with low to no growth
 Industry consolidation based on market share, driving down price.
5. Decline – industry growth becomes negative
 Rivalry further intensifies based on rate of decline and exit barriers.

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 Stages in the Industry Life Cycle
Strength and nature of five forces change as industry evolves Figure 2.4

    

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 Growth in Demand and Capacity
Anticipate how forces will change and formulate appropriate strategy Figure 2.5

Industry Shakeout:
Rivalry Intensifies
with growth in
excess capacity

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 Limitations of Models
for Industry Analysis
 Life Cycle Issues
• Industry cycles do not always follow the life cycle generalization.
• In rapid growth situations embryonic stage is sometimes skipped.
• Industry growth revitalized through innovation or social change.
• The time span of the stages can vary from industry to industry.
 Innovation and Change
• Punctuated Equilibrium occurs when an industry’s long term stable
structure is punctuated with periods of rapid change by innovation.
• Hypercompetitive industries are characterized by permanent and
ongoing innovation and competitive change.
 Company Differences
• There can be significant variances in the profit rates of individual
companies within an industry.
• In addition to industry attractiveness, company resources and
capabilities are also important determinants of its profitability.
Models provide useful ways of thinking about competition
within an industry – but be aware of their limitations.
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 Punctuated Equilibrium
and Competitive Structure
Figure 2.6

Industry
Structure
revolutionized
by innovation

Periods of long
term stability
Periods of long
term stability

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The Role of the Macroenvironment
Figure 2.7

Changes in the
forces in the macro-
environment can
directly impact:
• The Five Forces
• Relative Strengths
• Industry
Attractiveness

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