1-1

Chapter Two
External Analysis:
The Identification of
Opportunities and Threats
1-2
External Analysis requires an assessment of:
Industry environment
The country or national environments
The wider socioeconomic or macroenvironment
Social
Government
Legal
International
Technological
Macroeconomic
External Analysis
The purpose of external analysis is to identify the
strategic opportunities and threats in the organizations
operating environment.
1-3
External Analysis:
Opportunities and Threats
Opportunities
Conditions in the
environment that a
company can take
advantage of to
become more
profitable
Threats
Conditions in the
environment that
endanger the integrity
and profitability of
the companys
business
1-4
ROIC Across Industries in
the US: 1992-2006
1-5
ROIC Across Industries in
China (2006)
Wind
1-6
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
1-7
The Computer Sector:
Industries and Segments
1-8
Porters Five Forces Model
Risk of entry
by potential
competitors
Rivalry
Among
Established
Firms
Threat of
substitute
products
Bargaining
power of
suppliers
Bargaining
power of
buyers
Source: Adapted and reprinted by permission of
Harvard Business Review. An exhibit from How
Competitive Forces Shape Strategy?by Michael E.
Porter (March-April 1979, Copyright 1979 by the
President and Fellows of Harvard College: all rights
reserved.

1-9
How the Five Forces Shape
Competition within an Industry
The stronger that each of these five forces is, the more
limited is the ability of established companies to raise
prices and earn greater profits within their industry.
A weak competitive force
may be viewed as an opportunity as it allows company to
earn greater profits
A strong competitive force
may be viewed as a threat as it depresses industry profits
Strength of forces may change as industry conditions
change


1-10
Barriers to new entrants include:
C Risk of Entry by
Potential Competitors
Cost reductions
Discounts on bulk
purchases
Cost advantages/savings
Economies of Scale
well-established customer
preferences
Difficult for new entrants to
take market share from
established brands
Brand Loyalty
Accumulated experience
Control of particular
inputs required for
production
Lower financial risks
Absolute Cost Advantage
Customer Switching Costs
Government Regulation
1-11
C Rivalry Among
Established Companies
Intensity of rivalry is a function of:
Cost reductions
Discounts on bulk
purchases
Cost advantages/savings
Industry Competitive
Structure
Growing demand
Declining demand
Demand Conditions
High fixed costs
Slow demand and growth
Cost Conditions
Height of Exit Barriers
Write-off of investment in
assets
Economic dependence on
industry
Maintain assets
High fixed costs of exit
Emotional attachment to
industry
Bankruptcy regulations
1-12
Buyers are most powerful when:
C Bargaining Power of Buyers
Buyers are large and few
in number.
The industry supplying
the product is composed
of many small companies.
Buyers are dominant
Buyers have purchasing
power as leverage for price
reductions
Purchase in large quantities
Buyers purchase a large
percentage of a companys
total orders
The industry is dependant
on the buyers
low switching costs Buyers can play off the
supplying companies against
each other.
Purchase from several
supplying companies at
once
Threaten to enter the
industry themselves
Buyers produce
themselves and supply
their own product.
1-13
Suppliers are most powerful when:
C Bargaining Power of Suppliers
The product is vital to the
industry and has few
substitutes
Suppliers are not significantly
affected by the industry
The industry is not an
important customer to
suppliers
Companies in the industry
cannot play suppliers against
each other
Significant switching costs
Threaten to enter their
customers industry
Suppliers can use their inputs
to produce and compete with
companies already in the
industry
Companies cannot threaten
to enter their suppliers
industry
1-14
C Substitute Products
Substitutes limit the price that
companies can charge for
their product
The existence of close
substitutes is a strong
competitive threat
Other things being equal,
companies in the industry
have the opportunity to raise
prices and earn additional
profits
Substitutes are a weak
competitive force if an
industrys products have few
close substitutes
1-15
Applying the Five Forces ModelThe
China Southern Sky Pearl Club
Three membership levels: Sky Pearl Gold card,
Silver card and Base card.
Elite Qualification: Earning 80k mileages or 40
segments within a year (between Jan. 1 and Dec.
31) for a gold card, 40k mileages or 20 segments for
a silver card
The same standards applying to the case of
retaining the membership level!!!
China Southern Elite benefits - Lounge Access,
Extra baggage allowance, etc.
Any Impact on Competition of the Airline Industry?
1-16
Applying the Five Forces ModelThe
China Southern Sky Pearl Club
Potential Threat to Entry
Harder to steal customers away
from incumbent airlines
Slightly higher barriers to entry
Fewer potential threat to entry
Industry Rivalry
Airlines will compete less
aggressively with others for built
up customers
Decrease in rivalry
Threat of Substitutes
Driving, bus, train
Virtually no change
Buyer Power
Customer decision different after
accumulating miles
Less likely to defect from SC Lock
in
Business travelers value the MOST!
Choices of decision makers and
institutions different
Lower buyer power
Supplier Power
Labor, fuel, aircraft manufacturers,
airports
Virtually no change
1-17
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.
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
1-18
Strategic Group Mapping
Firms in same strategic group have two or more
competitive characteristics in common
Sell in same price/quality range
Cover same geographic areas
Be vertically integrated to same degree
Have comparable product line breadth
Emphasize same types of distribution channels
Offer buyers similar services
Use identical technological approaches
1-19
Procedure for Constructing a
Strategic Group Map
STEP 1: Identify competitive characteristics that
differentiate firms from one another
STEP 2: Plot firms on a two-variable map using pairs
of these differentiating characteristics
STEP 3: Assign firms that fall in about the same
strategy space to same strategic group
STEP 4: Draw circles around each group
1-20
Strategic Groups in the
Pharmaceutical Industry
1-21
Strategic Barriers in the
Pharmaceutical Industry
Strategic Barrier
Lack of R&D Skills
to develop new
proprietary drugs
1-22
Strategic Groups of the
Video Game Industry
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Overall Cost to Players of Video Games
Low
(Coin-operated
equipment)
Medium
(Console players cost
$100-$300)
High
(Use PC)

Arcades

Home PCs
Video game
consoles
Online/Internet
Sony, Sega,
Nintendo, several
others
Arcade
operators
Publishers
of games on
CD-ROMs
MSN Gaming Zone,
Pogo.com,
America Online,
HEAT, Engage,
Oceanline, TEN
1-24
Interpreting Strategic Group Maps
Driving forces and competitive pressures often favor
some strategic groups and hurt others
Profit potential of different strategic groups varies
due to strengths and weaknesses in each groups
market position
The closer strategic groups are on map, the stronger
the competitive rivalry among member firms tends to
be
1-25
Industry Life Cycle Model analyzes the affects of industry
evolution on competitive forces over time and is characterized
by five distinct life cycle stages:
Industry Life Cycle Analysis
1. Embryonic industry just beginning to develop
2. Growth first-time demand takes-off with new
customers
3. Shakeout demand approaches saturation,
replacements
4. Mature market totally saturated with low to no
growth
5. Decline industry growth becomes negative
1-26
Stages in the Industry
Life Cycle
O O O O O
Strength and nature of five forces change as industry evolves
Rivalry based on perfecting products,
educating customers, and opening up
distribution channels
Low rivalry as focus is on
keeping up with high industry
growth
Rivalry intensifies with
emergence of excess
productive capacity
Industry consolidation based
on market share, driving
down price
Rivalry further intensifies
based on rate of decline and
exit barriers
1-27
Growth in Demand and
Capacity
Industry Shakeout:
Rivalry Intensifies
with growth in
excess capacity
Anticipate how forces will change and formulate appropriate strategy
1-28
Limitations of Models
for Industry Analysis
Life Cycle Issues
Industry cycles do not always follow the life cycle generalization
In rapid growth situations
Industry growth revitalized through innovation or social change
The time span of the stages
Innovation and Change
Punctuated Equilibrium
Hypercompetitive industries
Company Differences
There can be significant variances in the profit rates of individual companies within
an industry
Company resources and capabilities are also important
1-29
Punctuated Equilibrium
and Competitive Structure
Periods of long
term stability
Periods of long
term stability
Industry
Structure
revolutionized
by innovation
1-30
The Macroenvironment
Macroeconomic Forces: growth rates, interest rates,
currency exchange rates, inflation or deflation rates
Global Forces: barriers to international trade and
investment
Technological Forces: new technologies
Demographic Forces: changes in characteristics of a
population
Social Forces: social values and mores
Political & Legal Forces: laws and regulations
1-31
The Role of the
Macroenvironment
Changes in one or more forces in the
macroenvironment can affect:
The competitiveness of the industry (Porters Five
Forces)
The attractiveness of the industry
Relative strengths (or weaknesses) of a given
company


1-32
The Role of the
Macroenvironment
Political and Legal
Environment
Technological
Environment
Demographic
Environment
Social Environment
Macro-Economic
Environment
Risk of entry
by potential
competitors
Rivalry
Among
Established
Firms
Threat of
substitute
products
Bargaining
power of
suppliers
Bargaining
power of
buyers
1-33
Globalization and Industry
Structure
_Globalization
of Markets
1-34
The Determinants of National
Competitive Advantage



Factor
Conditions
Competitiveness
of Related and
Supporting Industries
Local
Demand
Conditions
Intensity
of
Rivalry
National
Competitive
Advantage
1-35
Strategy is a choice
on how to compete.
- Michael Porter
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