Analyzing the

External
Environment
of the Firm:
Creating
Competitive
Advantages
chapter 2
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

Education .
 The Importance of External Environment
2-2

Consider…
If a company does not keep pace
with changes in the external
environment, it becomes difficult to
sustain competitive advantages and
deliver strong financial results.
 Creating the Environmentally Aware
Organization
2-3

Exhibit 2.1 Inputs to Forecasting

 Environmental Scanning &
2-4
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
 Hard trends – measurable facts/events
 Soft trends – estimated, probable events
 Competitive Intelligence
2-5

 Competitive intelligence
 Helps firms define & understand their industry
 Identify 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
 Example: Using Competitive intelligence
2-6

 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.”
 Environmental Forecasting
2-7

 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
 SWOT Analysis
2-8

 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
 SWOT Analysis
2-9

 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, and
 Protect the firm from the threats.
 Example: SWOT Analysis
2-10

 Southwest Airlines SWOT

 Strengths
 Strong culture, employee relationships
 Weaknesses
 Lack of cultural fit with new AirTran employees
 Opportunities
 Consolidation in the airline industry means more
routes or acquisition targets might be available
 Threats
 Economic conditions/jet fuel prices might affect
profitability in the future
 The General Environment
2-11

The general environment is composed of

factors that are both hard to predict and
difficult to control:

 Demographic  Technological
 Sociocultural  Economic
 Political/Legal  Global
 The Demographic Segment
2-12

 Demographics are easily understandable

& quantifiable:
 Aging population
 Rising affluence
 Changes in ethnic composition
 Geographic distribution of population
 Greater disparities in income levels
 The Sociocultural Segment
2-13

 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
 The Political/Legal Segment
2-14

 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
 Taxation at local, state, federal levels
 Legislation on corporate governance reforms
 Affordable Health Care Act
 The Technological Segment
2-15

 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
 Wireless communications
 Nanotechnology
 The Economic Segment
2-16

 Economic forces affect all industries:

 Interest rates
 Unemployment
 Consumer Price Index
 Trends in GDP & net disposable income
 Changes in stock market valuations
 The Global Segment
2-17

 Global forces offer both opportunities &

risks:
 Increasing global trade
 Currency exchange rates
 Emergence of the Indian & Chinese
economies
 Trade agreements among regional blocs
(NAFTA, EU, ASEAN)
 Creation of WTO (leading to decreasing
tariffs/free trade in services)
 Increased risks associated with terrorism
 The Competitive Environment
2-18

 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
 Porter’s Five-Forces Model of Industry
Competition
2-19

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.
 The Threat of New Entrants
2-20

 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
 The Bargaining Power of Buyers
2-21

 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
 Quality is not affected by industry product
 The Bargaining Power of Suppliers
2-22

 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
 The Threat of Substitute Products &
Services
2-23

 Substitute products & services limit the

potential returns of an industry by placing
a ceiling on the prices that firms can
profitably charge.
 Substitutes come from another industry
 Can perform the same function as the
industry’s offerings
 The more attractive the
price/performance ratio, the more the
substitute erodes industry profits.
 The Intensity of Rivalry Among
Competitors in an Industry
2-24

 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
 How the Internet and Digital
Technologies Affect Competitive Forces
2-25
 Using Industry Analysis: A Few Caveats
2-26

 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
 The Value Net
2-27

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.
 Doing a Good Industry Analysis
2-28

 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 cost or sales, actual switching costs
 Strategic Groups Within Industries
2-29

 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
 Strategic Groups Within Industries
2-30

Exhibit 2.7 The World Automobile Industry: Strategic Groups

Note: Members of each strategic group are not exhaustive, only illustrative.
 Strategic Groups Within Industries
2-31

 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