PART 1:

STRATEGIC MANAGEMENT INPUTS

Chapter 2
The External Environment:
Opportunities, threats, industry
competition and competitor analysis
 KNOWLEDGE OBJECTIVES

Explain the importance of analysing and understanding

the firm’s external environment.

Define and describe the general environment and

the industry environment.

Discuss the four activities of the external

environmental analysis process.

Name and describe the general environment’s seven

segments.
 KNOWLEDGE OBJECTIVES
Identify the five competitive forces and explain how they determine an industry’s profit potential.

Define strategic groups and describe their influence on the firm.

Describe what firms need to know about their competitors and different methods (including ethical standards) used to
collect intelligence about them.
 FIGURE 2.1

THE EXTERNAL
ENVIRONMENT
 THE EXTERNAL ENVIRONMENT
• A firm’s external environment creates:
• opportunities (e.g. the opportunity for BP to
enter other global markets)
• threats (e.g. the possibility that additional
regulations in its global markets will reduce
opportunities for BP to extract oil and gas)

• Collectively, opportunities and threats affect a firm’s

strategic actions.
 EXTERNAL ENVIRONMENTAL ANALYSIS
• External environments are:
• turbulent
• complex
• global
• uncertain
• ambiguous
• incomplete
• Firms engage in external environmental analysis to better
understand and cope with their environments.
• This analysis has four parts: scanning, monitoring,
forecasting and assessing.
 TABLE 2.1

THE GENERAL
ENVIRONMENT
 EXTERNAL ENVIRONMENTAL ANALYSIS:
SCANNING

Scanning is the study of all

segments in the general
environment. Through
scanning, firms identify
early signals of potential
changes in the general
environment and detect
changes that are already
underway.
Scanning often Many firms use special
reveals ambiguous, software to reduce the
incomplete or trade-off between an
unconnected data and important missed event
information. and false alarm rates.
 FIGURE 2.2

THE FIVE
FORCES OF
COMPETITION
MODEL
 INDUSTRY ENVIRONMENT ANALYSIS:
THE FIVE FORCES OF COMPETITION MODEL
• Historically, firms concentrated only on direct
competitors
• Focusing on wider industry members highlights
potential opportunities and competitors
• E.g. Suppliers can integrate forward, or buyers
integrate backward and become competitors
• Five forces analysis helps firms understand the
profitability potential of an industry
 INDUSTRY ENVIRONMENT ANALYSIS:
THE FIVE FORCES OF COMPETITION MODEL
1 THREAT OF NEW ENTRANTS: BARRIERS TO ENTRY

• High entry barriers tend to increase the returns for

existing firms in a industry and may allow some firms to
dominate the industry
• Industry incumbents want to maintain high entry
barriers in order to discourage potential competitors
from entering the industry
 INDUSTRY ENVIRONMENT ANALYSIS:
THE FIVE FORCES OF COMPETITION MODEL
2 BARGAINING POWER OF SUPPLIERS

Supplier power increases when:

• Suppliers are large and few in number
• Suitable substitute products are not available
• Industry firms are not a significant customer for the
suppliers
• Suppliers’ goods are critical to buyers’ marketplace
success.
 INDUSTRY ENVIRONMENT ANALYSIS:
THE FIVE FORCES OF COMPETITION MODEL
3 BARGAINING POWER OF BUYERS

Buyer power increases when:

• The industry’s products are undifferentiated or
standardised
• Buyers pose a credible threat to integrate backward into
the sellers’ industry.
 INDUSTRY ENVIRONMENT ANALYSIS:
THE FIVE FORCES OF COMPETITION MODEL
4 THREAT OF SUBSTITUTE PRODUCTS

• The threat of substitute products increases when:

• Buyers face few switching costs
• The substitute product’s price is lower
• Substitute product’s quality and performance are
equal to or greater than the existing product
• Differentiated industry products that are valued by
customers reduce this threat.
 INDUSTRY ENVIRONMENT ANALYSIS:
THE FIVE FORCES OF COMPETITION MODEL
5 RIVALRY AMONG COMPETING FIRMS
Industry rivalry
• Competitors are rarely homogeneous; they differ in resources and
capabilities and seek to differentiate themselves from competitors.
• Firms seek to differentiate their products in ways that customers value
and in ways the firms have a competitive advantage.
• Common rivalry dimensions include:
• Price
• Service after the sale
• Innovation
 INDUSTRY ENVIRONMENT ANALYSIS:
THE FIVE FORCES OF COMPETITION MODEL
INTERPRETING INDUSTRY ANALYSES

Low entry barriers

Strongly positioned
suppliers and buyers Unattractive
Strong threats from industry
substitute products
Intense rivalry among
competitors
LOW PROFIT POTENTIAL
 INDUSTRY ENVIRONMENT ANALYSIS:
THE FIVE FORCES OF COMPETITION MODEL
INTERPRETING INDUSTRY ANALYSES

High entry barriers

Weakly positioned
suppliers and buyers Attractive
Few threats from industry
substitute products
Moderate rivalry
among competitors
HIGH PROFIT POTENTIAL
 INDUSTRY ENVIRONMENT ANALYSIS:
STRATEGIC GROUPS
• A set of firms emphasising similar strategic dimensions and
using similar strategies
• Greater competition within a strategic group than between
strategic groups
• More heterogeneity in the performance of firms within
strategic groups
• Similar market positions
• Similar products
• Similar strategic actions
 INDUSTRY ENVIRONMENT ANALYSIS:
STRATEGIC GROUPS

Strategic Group Dimensions

• Extent of technological leadership
• Product quality
• Pricing policies
• Distribution channels
• Customer service
 INDUSTRY ENVIRONMENT ANALYSIS:
STRATEGIC GROUPS
Implications
• Firms within a strategic group are direct
competitors (offer similar products). Thus, rivalry
can be intense, and the greater the rivalry the
greater the threat to each firm’s profitability.
• The strengths of the five forces differ across
strategic groups.
• The closer the strategic groups are in terms of
strategy, the greater the likelihood of rivalry.
FIGURE 2.3

COMPETITOR
ANALYSIS
COMPONENTS