External Environmental Analysis

Input for Strategy Formulation

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Link to overall strategic management

• “Strategic management includes

understanding the strategic position of an
organisation, strategic choices for the future
and managing strategy in action (Johnson et
al., 2008:12).”

• Strategic position identifies the impact of

– External environment
– Strategic capability
– Expectation and influence of stakeholders on
strategy
Strategic management starts with
the situation/position

Social, Industry Other

political, attractiveness, opportunities
External regulatory, industry and threats --
& community dynamics, & like new
Factors considerations competitive technologies
conditions

Company’s Strategic Situation/position

Firm’s Ambitions, Shared vision,

strengths, philosophies, values
Internal weaknesses, & ethical and company
& competitive principles culture
Factors market position of key
executives
Analysing the external environment

• Firms study the external environment in order

to:
– Identify opportunities and threats in the
marketplace
• we will centre on this when formulating
strategies, as well as the internal strengths and
weaknesses to be discussed in a while
– Avoid surprises
– Respond appropriately to competitors’ moves

• A major challenge is to gather accurate

market intelligence in a timely fashion, and
transform it into usable knowledge to gain a
competitive advantage over other firms
Why do we care about the external environment?

• Strategy needs to be adaptive and dynamic

– Need to know what to adapt to
– Need to understand dynamics

• Impact on organisation
– On growth and scope for growth
– On level and nature of competition
– On “rules of the game”
– On costs
– On profit
The Firm’s External Environment

Comprised of following Components:

• Remote environment
• Industry environment
• Operating environment
The Firm Embedded in Its External Environment
 Environmental influences

Lets look at
the general

(macro)
environme
nt

Environmental influences on the organisation

Source: Adapted from Dobson et al.(2004), See Boddy (2010)
External analysis stages
Analysing the external environment involves breaking a complex inter-related
reality into sets of issues to make the analysis manageable. The main sets of
issues are usually:
 Macro-environment – these are broad trends shaping the national
and international environment in terms of political, economic, social
and technological trends (i.e. PESTEL factors, key drivers ).
 Micro-environment – this is the operating environment or industry
sector in which the firm competes. It addresses a range of issues
such as suppliers, customers, competitive intensity, threat of new
entry and of substitute products arising (i.e. the ‘five-forces’ analysis).
 Competitor analysis – seeks to understand the rival offers from
other firms seeking to serve the same customers and to out
manoeuvre their managers with our innovation and competitive
moves.
 Market analysis seeks to evaluate the current needs of today’s
customers and the emerging needs of tomorrow’s customers so new
products can be anticipated. These will be different in different market
segments.
Firm’s External Environment

• Economic • Competitor
Factors positions
• Social Factors • Customer
• Political Factors profiling
• Suppliers
• Technological
Factors • Creditors
• Ecological • HRM
Factors
The Macro-Environment (Remote)
• Difficult for the firm to influence
• Changes can be far-reaching
• The media: rich source of both information and
speculation
• Tools for analysing the macro-environment
– The PESTEL (Variants PEST/DEEPLIST)
framework
– Key drivers
– Scenarios
 The PESTEL Framework
• The PESTEL framework categorises environmental
influences into six main types:
– Political -
– Economic
– Socio-cultural
– Technological
– Environmental
– Legal

• PESTEL analysis evaluates the broad societal trends

that affect many industries. It identifies current and
future developments that will shape the micro-
environments of each industry sector.
Macro environment –
The PESTLE framework
• Economic Forces –
regulate the exchange of
materials, money, energy
and information
• Technological Forces –
generate problem-solving
inventions
• Political-legal Forces -
allocate power and provide
constraining and protecting
laws and regulations
• Socio – cultural Forces –
regulate the values,
morals, and customs of
society

Johnson, Scholes, and Whittington (2011)

 Identifying environmental influences – PESTEL
analysis

Source: Boddy (2010)

Good PESTEL Analysis

• Focuses on society wide.

• Based on sound research of actual issues.
• Provides evidence from the research to
validate points made.
• Future oriented.
• Interpretive and not descriptive
Key aspects of PESTLE analysis
• Not just a list of influences
• Need to understand key drivers of
change
• Drivers of change have differential
impact on industries, markets, and
organisations
• Focus is on future impact of
environmental factors
• Combined effect of some of the factors
likely to be most important
Economic Factors
1. Prime interest rates
2. Inflation rates
3. Trends in the growth of
the gross national
product
4. Unemployment rates
5. Globalization of the
economy
6. Outsourcing
 Social Factors
Present in the external environment:
– Beliefs & Values
– Attitudes & Opinions
– Lifestyles
Developed from:
– Cultural conditioning
– Ecological conditioning
– Demographic makeup
– Religion
– Education
– Ethnic conditioning.
Political Factors

Political constraints on firms:

• Fair-trade Decisions
• Antitrust Laws
• Tax Programs
• Minimum Wage Legislation
• Pollution and Pricing Policies
• Administrative jawboning
Technological Factors
• Technological forecasting helps protect and
improve the profitability of firms in growing
industries.

• It alerts strategic managers to impending

challenges and promising opportunities.

• The key to beneficial forecasting of technological

advancement lies in accurately predicting future
technological capabilities and their probable
impacts.
Technological Changes
New product leading to ancillary, supporting and enriching
products and services
•Mobile phone
–Camera, Hands free, FM, Video, Mobile car charger, e-mail,
internet browsing
•Internet
–Medical transcription, on line teaching, e-bay, on line sales, virtual
showrooms, video conferencing
•Ecological Changes
–Tsunami, Earthquake, Floods
•Low cost pre – fab housing
•Warning Systems
•Rapid Evacuation
•Ozone Layer depletion
–Controlling of Chlorofluorocarbons release
•Industry > air-conditioning, refrigeration, aviation
Ecological Factors
• Ecology refers to the relationships among
human beings and other living things and
the air, soil, and water that supports them.
• Threats to our life-supporting ecology
caused principally by human activities in an
industrial society are commonly referred to
as pollution
• Loss of habitat and biodiversity
• Environmental legislation
• Eco-efficiency
Key Drivers and Scenarios Planning

• Key drivers for change are environmental factors

that are likely to have a high impact on the success
or failure of strategy.

• Scenarios are detailed and plausible views of how

the business environment of an organisation might
develop in the future based on key drivers for
change about which there is a high level of
uncertainty.
International Environment
• Monitoring the international environment
involves assessing each non-domestic
market on the same factors that are
used in a domestic assessment.
• While the importance of factors will differ, the same
set of considerations can be used for each country.
• Economic, political, legal, and social factors are
used to assess international environments.
• One complication to this process is that the interplay
among international markets must be considered.
Industries and Sectors Analysis
• An industry is a group of firms producing the
same principal product or service.

• The industry analysis involves identifying

– Competitive forces
– Industry life cycles
– Competitive cycles
Industries and sectors
Industry – a group of firms producing the same
principal product, e.g. mobile phones

Sector – a group of organisations providing the

same kinds of services, e.g. healthcare

Competitive forces in the industry:

– Determine attractiveness of industry
– Affect the way individual companies compete
– Influence decisions on product/market strategy
Industry Environment
• Harvard professor Michael E. Porter propelled the concept
of industry environment into the foreground of strategic
thought and business planning.

• The cornerstone of Porter’s work first appeared in the

Harvard Business Review, in which he explains the five
forces that shape competition in an industry.

• Porter’s well-defined analytic framework helps strategic

managers to link remote factors to their effects on a firm’s
operating environment.

• Porters five forces framework has two main aims:

– To understand the drivers of competitive behaviour in the sector and;
– To evaluate the long-run profit potential of the sector
Competitive Forces Shape Strategy

• The essence of strategy formulation is coping with

competition.

• Intense competition in an industry is neither coincidence

nor bad luck.

• Competition in an industry is rooted in its underlying

economics, and competitive forces exist that go well
beyond the established combatants in a particular
industry.

• The corporate strategists’ goal is to find a position in the

industry where his or her company can best defend itself
against these forces or can influence them in its favor.
Key aspects of five forces analysis
• Use at level of strategic business
units (SBU)
• Define the industry/market/sector
• Don’t just list the forces: derive
implications for
industry/organisation
• Note connections between
competitive forces and key drivers
in macro environment
• Establish interconnections
between the five forces
• Competition may disrupt the
forces rather than accommodate
them
?
Adapted from: Porter (1980), Competitive Strategy: Techniques Power of other
for Analyzing Industries and Competitors, Free Press, p. 4. Stakeholders
Threat of new entrants
Fewer new entrants = more profit
• Affected by entry barriers such as
– high costs of equipment and facilities
– lack of distribution facilities
– customers loyal to established
brands
– small companies lack economies of
scale
– subsidies/regulations favor existing
firms

• E.g. Patent-protected drugs,

presentation software
 Bargaining power of suppliers
High power of supplier = less profit to buyer
• Power of supplier is high if:
– Buyer takes small % of sales
– Few alternative products or
suppliers (distinctive product keeps
buyers loyal)
– Product a low % of buyer’s costs,
little incentive to seek alternatives
– Cost of switching suppliers high

E.g. luxury brands, business

software
Powerful Suppliers
A supplier group is powerful if:

• It is dominated by a few companies and is more

concentrated than the industry it sells to
• Its product is unique or at least differentiated, or if
it has built-up switching costs
• It is not obliged to contend with other products for
sale to the industry
• It poses a credible threat of integrating forward
into the industry’s business
• The industry is not an important customer of the
supplier group
Bargaining power of buyers
(customers)
Greater power of buyers = less profit to seller
• Power of buyer increases if:
– Buyer takes high % of supplier’s sales
– Many alternative products or suppliers
– Product a high % of buyers costs,
creating incentive to seek alternatives
– Cost of switching to other suppliers is
low

E.g. online products, major

supermarkets like Wal-Mart, Tesco
Powerful Buyers
A buyer group is powerful if:

• It is concentrated or purchases in large volumes

• The products it purchases from the industry are standard
• The products it purchases from the industry form a
component of its product and represent a significant
fraction of its cost
• It earns low profits
• The industry’s product is unimportant to the quality of the
buyers’ products or services
• The industry’s product does not save the buyer money
• The buyers pose a credible threat of integrating
backward
Substitutes
Easy to substitute = less profit to supplier
• Substitution becomes easier
if:
– Buyers willing to change
habits
– Technological developments
enable new products and
services
– Transport costs falling
– New suppliers entering a
market

E.g. online media, new

materials
Substitute Products
• By placing a ceiling on the prices it can charge,
substitute products or services limit the potential of
an industry

• Substitutes not only limit profits in normal times but

also reduce the bonanza an industry can reap in
boom times

• Substitute products that deserve the most attention

strategically are those that are
– subject to trends improving their price-performance
trade-off with the industry’s product or
– produced by industries earning high profits
Intensity of rivalry amongst
competitors
Greater rivalry = lower profit
• Rivalry increases when:
– many firms, but none dominant
– market growing slowly, so firms fight for
share
– high fixed costs encourages over-
production
– loyalties (family businesses or political
support) prolong over-capacity

e.g. airlines, agriculture, Nokia and new

mobile suppliers, current banking
industry?
Jockeying for Position
Intense rivalry occurs when:
• Competitors are numerous or are roughly equal
• Industry growth is slow, precipitating fights for
market share that involve expansion
• The product or service lacks differentiation or
switching costs
• Fixed costs are high or the product is perishable,
creating strong temptation to cut prices
• Capacity normally is augmented in large increments
• Exit barriers are high
• Rivals are diverse in strategy, origin, and personality
The mobile phone industry
Equipment manufacturers
compete for the market share.
Nokia, Motorola, Sony
Ericsson. Consolidation in the
industry.
Suppliers’
Power
Very intense. Numerous
offers, packages. If a
customer threatens to
withdraw , the provider
could offer a new phone,
free line rental.
Market is mature, and
now emphasis is on
price, coverage, customer
service
Convergence of mobile
telephony with PDAs and
with Internet. This could
switch both voice and text
messaging into internet.
Is low due to the enormous
cost in licences (£22bn) and
general investment into new
3G technology. This might
Threat from
become a threat if policy
New Entrants towards heavy regulation is to
change
Rivalry Buyers’
of Power
Firms
Buying power of
consumers is very high,
as there is a lot of
choice. Existence of
independent retailers
CPW, Link,
Threat from
Others differentiated
Substitutes
themselves through
cheap advertising
Evaluation of the Five Force Model
ADVANTAGES DISADVANTAGES
• Firms industry environment is a
• Identifies drivers of small determinant of that firm’s
competitive behaviour. profitability
• Indicates trends in • Suppliers of complementary
profitability. products are ignored
• Highlights the need to
• Highlights strategies to disaggregate broad industry
alter industry structure. groupings and examine
(Lynch 2000) competition at segment or
strategic group level
• Assumes all business
relationships are competitive.
• Assumes industry boundaries
are stable over time, ignoring
innovation and
entrepreneurship. (Grant 2005)
Industry Analysis
& Competitive Analysis
• An industry is a collection of firms that offer
similar products or services.
• Structural attributes are the enduring
characteristics that give an industry its
distinctive character.
• Concentration refers to the extent to which
industry sales are dominated by only a few
firms.
• Barriers to entry are the obstacles that a
firm must overcome to enter an industry.
Industry Structures along the Continuum
The Industry Life Cycle
(Johnson et al. 2008: 68)
 The dynamics of industry structure

Johnson, Scholes and Whittington (2008), pp. 67 - 69

Cycles of Competition
(Johnson et al. 2008: 69)
Competitors analysis
• This involves the analysis of strategic groups,
market segments and strategic customers .

• Strategic groups
– Strategic groups are organisations within an industry with
similar strategic characteristics, following similar
strategies or competing on similar bases.

• Benefits identifying strategic group analysis

– Understanding competition
– Analysis of strategic opportunities
– Analysis of mobility barriers
Strategic groups
Strategic groups are Some characteristics for identifying strategic
groups:
organisations within an
industry with similar
Strategic characteristics,
following similar
strategies or competing
on similar bases

Sources: Based on M.E. Porter, Competitive

Strategy, Free Press, 1980; and J. McGee and
H. Thomas, ‘Strategic groups: theory, research
and taxonomy’, Strategic Management Journal,
vol. 7, no. 2 (1986), pp. 141–160.

See Johnson, Scholes, and Whittington (2008)

 Competitive Environment
• Competitive analysis – in similar industries
– Jet and King Fisher
• What drives the competitor
– As shown by its future objectives
• What competitor is doing and can do
– As revealed by its current strategies
• What competitor believes about the industry
– As shown by its assumptions
• What the competitors capabilities are
– As shown by its strengths and weaknesses
Competitive Analysis
1. How do other firms define the scope of their
market?
2. How similar are the benefits the customers
derive from the products and services that
other firms offer? The more similar the
benefits of products or services, the higher
the level of substitutability between them.
3. How committed are other firms to the
industry?
Use of strategic group analysis
• To understand who are the most direct
competitors of an organisation
• To establish the different bases of competitive
rivalry within and between the strategic groups
• To assess if an organisation could move from one
group to another (Mobility Barriers)
– Depends on barriers to entry
• To identify opportunities and threats
– Changes in the macro-environment may create
strategic space
Dimension of SGA
Strategic groups can be created based on many dimensions:
– Specialization
– Brand identification
– Push vs pull
– Channel selection
– Product quality
– Technological position
– Vertical integration
– Cost position
– Service
– Price policy
– Financial or operating leverage
– Parent company relationship
– Government relationship
• It can often be useful to generically differentiate the groups based on
“How they compete” and “Where they compete.”
 Strategic Group Analysis (SGA)
“A strategic group is the group of firms in an industry following
the same or a similar strategy along the strategic dimensions1.”
Porter (1980), p.129.

Broad Motor Industry

Global full-line
producers
Regional The key to the strategic
Broad-line group concept is that
Product Luxury differences in profitability
Range producers between groups persists
because of the existence
of mobility barriers that
National Niche- High performance stop firms entering or
specialists sports
moving between groups
Narrow and thus competing away
National Geographic Global profit differentials.
Scope

1. “strategic dimensions” refers to any significant criteria for grouping firms, e.g. segments served,
branding, cost position, etc.
Strategic group analysis
Automotive manufacturers

Broad

Regionally Focused: Global Broad Line

Broad Line Producers Producers
E.g. Fiat, PSA, Renault E.g. GM, Ford, Toyota
Nissan, VW, Honda

Nationally Focused Global Suppliers of

PRODUCT Intermediate Line Limited Range
RANGE Producers E.g. Volvo, Saab,
E.g. Kia, Proton Subaru, Daihatsu

Nationally Focused,
Luxury Manufacturers
Small, Specialist
Eg Jaguar, BMW
Producers
E.g. Morgan (UK)
Performance Car
Narrow Producers
E.g. Porche, Lotus

National GEOGRAPHICAL SCOPE Global

McGee & Thomas, 1986

SW of SGA
Strengths
• Assesses strategic dynamics and shifts in the industry
• Defines the nearest competitors of the company and assists in evaluating
the differences in strategies of these competitors
• Helps assess current and potential strategic movements of the
competitors in the market
• Helps understand the underlying determinants of a firm’s profitability

Weaknesses
• Heavily relies on a thorough understanding of the market and its players
to identify mobility barriers and barriers to entry/exit
• Competitor goals and strategies are often unclear
• May require trial and error to find useful dimensions
• “Wrong” dimensions will not differentiate groups into useful categories
Competitor Analysis

Future objectives
Future Objectives:
 How do our goals compare with our
competitors’ goals?
 Where will the emphasis be placed in
the future?
 What is the attitude toward risk?

67
Competitor Analysis

Future objectives
Current Strategy:

 How are we currently competing?

 Does this strategy support changes in
Current strategy
the competitive structure?

68
Competitor Analysis

Future objectives
Assumptions:

 Do we assume the future will be

volatile?
Current strategy  Are we operating under a status quo?
 What assumptions do our competitors
hold about the industry and
themselves?
Assumptions

69
Competitor Analysis

Future objectives
Capabilities:

 What are our strengths and

weaknesses?
Current strategy
 How do we rate compared to our
competitors?

Assumptions

Capabilities

70
Competitor Analysis

Future objectives Response

Response:
Current strategy
 What will our competitors do in the
future?
 Where do we hold an advantage over
Assumptions
our competitors?
 How will this change our relationship
with our competitors?

Capabilities

71
Competitive Profile Matrix (CPM)

Identifies firm’s major competitors

and their strengths and
weaknesses in relation to a
specific firm’s strategic positions
Value Assignment for CPM

Major Strength 4

Minor Strength 3

Minor Weakness 2

Major Weakness 1
 Lenovo Apple Dell
CSF’s Weigh Rating Weighte Rating Weighted Rating Weighted
t d Score Score Score

Market Share 0.15 3 0.45 2 0.30 4 0.60

Inventory System 0.08 2 0.16 2 0.16 4 0.32
Financial Position 0.10 2 0.20 3 0.30 3 0.30
Product Quality 0.08 3 0.24 4 0.32 3 0.24
Consumer Loyalty 0.02 3 0.06 3 0.06 4 0.08
Sales Distribution 0.10 3 0.30 2 0.20 3 0.30
Global Experience 0.15 3 0.45 2 0.30 4 0.60
Org. Structure 0.05 3 0.15 3 0.15 3 0.15
Production Capacity 0.04 3 0.12 3 0.12 3 0.12

E-commerce 0.10 3 0.30 3 0.30 3 0.30

Customer Service 0.10 3 0.30 2 0.20 4 0.40
Price
0.02 4 0.08 1 0.02 3 0.06
Competitiveness
Managerial 0.01 2 0.02 4 0.04 2 0.02
Experience
Total 1.00 2.83 2.47 3.49
Industry Analysis CPM
• Just because one firm receives a 3.49 rating and
another receives a 2.47 rating, it does not follow that
the first firm is 41% better than the second.

• Numbers reveal the relative strengths of firms but

implied precision is an illusion.

• Numbers are not magic.

• The aim is to assimilate and evaluate information in

a meaningful manner so that correct decision -
making may take place.
Operating Environment
• Also called competitive or task environment
• Includes competitor positions and customer
profiling based on the following factors:
– Geographic
– Demographic
– Psychographic
– Buyer Behavior
• Also includes suppliers & creditors and
HRM
Market Analysis
• Determines attractiveness and competitive
advantage

• Key variables to determine:

• Overall size
• Market shares of key competitors
• Growth rates/trends
• Segments (relative growth rates)
• Profitability
• Existing/likely competitors
• Accessibility issues
Strategic customer and critical
success factors
• A strategic customer is the person(s) at whom the strategy is primarily
addressed because they have the most influence over which goods or
services are purchased.
– What do our customers want? (basic source of profit in the industry, who are
they, what are their needs and how do they make decisions?)

• Critical success factors (CSFs) are those product features with which a
organisation must outperform the competition because they are particularly
valued by a group of customers.
– “those factors within the firm’s market environment that determine its ability
to survive and prosper” (Grant 2005, p92)

– What does the firm need to do to survive competition? (how intense is

competition and what are the key dimensions upon which competitors
compete?)

– How then can firms use their resources and capabilities to profit from KSF?
Market segment analysis
• A market segment is a group of customers
who have similar needs that are different from
customer needs in other parts of the market.

• Market segment analysis

– Identify key segmentation variables
– Construct a segmentation matrix
– Analyse segment attractiveness
– Identify KSFs in each segment
– Choose between broad or narrow segment focus.
Some Bases of Market Segmentation
(Johnson et al. 2008:77)
HR: Nature of the Labor Market
Access to personnel is affected by 4 factors:

• Firm’s reputation as an employer

• Local employment rates
• Availability of people with the needed skills
• Its relationship with labor unions.
Emphasis on Environmental Factors

• Differing external elements affect different strategies

at different times and with varying strengths
• Only certainty is that the effect of the remote and
operating environments will be uncertain until a
strategy is implemented
• Many managers, particularly in less powerful firms,
minimize long-term planning
• Instead, they allow managers to adapt to new
pressures from the environment
• Absence of strong resources and psychological
commitment to a proactive strategy effectively bars
a firm from assuming a leadership role in its
environment
Handling Mode or Coping Mode

• Scanning
– Identify early signals of environmental changes and trends
• Monitoring
– Detecting meaning through ongoing observations of
environmental changes and trends
• Forecasting
– Developing projections of anticipated outcomes based on
monitored changes and trends
• Assessing
– Determining timing and importance of environmental
changes and trends for firms’ strategies and their
management
84
Extra – SCP Analysis
Structure – Conduct – Performance

Learn | Consult | Research

 Differences in Profitability Across Industries

Average Return on Equity in US Industries, 1982-1993

100

11.7%

13.8%

16.5%
90
80
First Quartile
Fourth Quartile
70 Average
Average
22.2%
60 9.3%
Number
of 50
Industries
40
30 Average = 14.7%
Median = 13.8%
20
10
0
2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

22%

24%

26%

28%

30%

32%
Return on Equity (Percent)
Note: Return on Equity = Net Income / Year End Shareholders’ Equity; Analysis based on sample of 593 industries
Source: Silverman 2000 86
© 2005 Mara Lederman, Rotman School of Management
 Some Industries Are More Profitable Than
Differences in Profitability Across Selected Industries
Others
Pharmaceuticals

Semiconductors
ROE & ROA - Selected Industries, 1989

Dental equipment
30%

Drug stores
25%

Race track operations

20%
Engineering services
ROE
15%
ROA
Cable television service
10%
Scheduled air transport

5% -5 0 5 10 15 20 25
Operating income / assets, 1988-95 (%)
0%
Source: Pankaj Ghemawat and Jan W.Pharmaceuticals Tires / Rubber
Rivkin, “Creating Competitive Advantage” Home Appliances
87
© 2005 Mara Lederman, Rotman School of Management
 DifferencesWithin
in Profitability Within Perform
Industries, Some Competitors Selected Industries
Better than Others.

Semiconductor Industry

IntelROE - Pharmaceutical Industry 1989

60%Texas Instruments

50% Motorola

AMD
40%

Analog Devices
30%
National Semiconductor
20%
-5 0 5 10 15 20 25
10%
Operating income / assets, 1988-95 (%)

0%
Amgen AMP Eli Lilly Merck Mylan Pfizer
Source: Pankaj Ghemawat and Jan W. Rivkin, “Creating Competitive Advantage”
88
© 2005 Mara Lederman, Rotman School of Management
 The U.S. Auto Industry’s Profit Pool

Exhibit 5.7 The U.S. Auto Industry’s Profit Pool

Source: Adapted by permission of Harvard Business Review. Exhibit from “A Fresh Look at Strategy” by O. Gadiesh
and J. L. Gilbert, Harvard Business Review 76, no. 3 (1998), pp. 139-48. Copyright © 1998 by the Harvard Business
School ©Publishing
89
Copyright 2005 by The Corporation, all rights
McGraw-Hill Companies, Inc.reserved.
All rights reserved. 5-22
 Decomposition of Variance in Profitability

Year
2% Industry
18%

Corporate
parent
4%

Transient
46%

Business
segment
30%

Source: Anita M. McGahan and Michael E. Porter, “How Much Does Industry Matter Really?” Strategic Management Journal, 1997

90
© 2005 Mara Lederman, Rotman School of Management
 Three Factors Determining Company
Performance
• Industry Context
– e.g., during the last two decades, companies in
the airlines industry have been persistently less
profitable than those in the pharmaceutical
industry

• National Context
– e.g., world’s most successful consumer
electronics firms are in Japan

• Company Capabilities and Strategies

– e.g., Wal-mart and Southwest Airlines
91
Structure-Conduct-Performance

Industry Structure Firm Conduct Performance

• Number of buyers • Pricing • Econ profits
and sellers • Advertising • Accounting
• Degree of product • R&D profits (ratios)
differentiation • Investment in
• Barriers to entry plant and • NPV/DCF
• Cost structures equipment
• Vertical integration • MVA/EVA
• Alliances • Tobin’s Q

92
The Structure-Conduct-
Performance Paradigm
• The Causal View
Market
Conduct Performance
Structure

The Feedback Critique

 No one-way causal link.
 Conduct can affect market structure.
 Market performance can affect
conduct as well as market structure.

Clarke Modifications of Baye Chapter 7 4

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