Analyzing the External Environment of the Firm

Chapter Two

Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

After reading this chapter, you should have a good understanding of:

LO1 The importance of developing forecasts of the business environment.

LO2 Why environmental scanning, environmental monitoring, and collecting competitive intelligence are critical inputs to forecasting.

LO3 Why scenario planning is a useful technique for firms competing in industries characterized by unpredictability and change.

LO4 The impact of the general environment on a firm’s strategies and performance.

Learning Objectives

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Learning Objectives (cont.)

LO5 How forces in the competitive environment can affect profitability and how a firm can improve its competitive position by increasing its power vis-à-vis these forces.

LO6 How the Internet and digitally based compatibilities are affecting the five competitive forces and industry profitability.

LO7 The concept of strategic groups and their strategy and performance implications.

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Creating the Environmentally Aware Organization

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Environmental Scanning & Monitoring

• External Scanning Surveillance of a firm’s external environment:

Predict environmental changes to come Detect changes already under way Proactive mode

• Alerts the firm to critical trends before changes have developed a discernible pattern and before competitors recognize them

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Environmental Scanning & Monitoring

• External Monitoring Track evolution of environmental trends, sequence of

events or streams of activities

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How to Spot Hot Trends

• Listen• Pay attention• Follow trends online• Go old school

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Virgin Mobile and Crowdsourcing

• Virgin Mobile USA relies on 2,000 carefully selected online customers, referred to as “Insiders” to keep it aware of trends and promising opportunities.

• The Insider community—a very hip focus group—provides input on everything from designing phones to coming up with names for service plans.

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Competitive Intelligence

• Define and understand a firm’s industry• Identify rivals’ strengths and weaknesses

Intelligence gathering (data) Interpretation of intelligence data

• Helps a firm avoid surprises

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Environmental Forecasting

• Environmental forecasting Plausible projections about direction, scope,

speed and intensity of environmental change

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Environmental Forecasting

• Scenario analysis involves experts’ detailed assessments of

societal trends, economics, politics, technology, or other dimensions of the external environment

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QUESTION

Which of the following is a danger of forecasting?

A. Managers assume that the world is not open to precise predictions.

B. Managers may view uncertainty as black and white and ignore grey areas.

C. Managers assume that the world is uncertain.

D. Managers view the world as completely unpredictable.

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SWOT Analysis

Firm’s strategy must:• Build on its strengths• Remedy the weaknesses or work around them• Take advantage of the opportunities presented

by the environment• Protect the firm from threats

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SWOT Analysis

• Strengths and weaknesses

• Internal conditions of the firm

• Opportunities and threats environmental conditions external to the firm

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Example: Harley-Davidson

• Strengths Strong & adaptable brand image

• Weaknesses Limited ability to develop new non-traditional

products

• Opportunities Growing leisure interest in motorcycles worldwide

• Threats Differing foreign policies governing motorcycles

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The General Environment

Factors external to an industry, usually beyond a firm’s control

• Demographic

• Sociocultural

• Legal/Political

• Technological

• Economic

• Global

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Demographic Segment

• Aging population• Rising or declining affluence• Changes in ethnic composition• Geographic distribution of population• Greater disparities in income levels

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Sociocultural Segment

• More women in the workforce• Dual-income families• Increase in temporary workers• Greater concern for healthy diets and physical

fitness• Greater interest in the environment• Postponement of having children

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Political/Legal Segment

• Tort reform• Americans with Disabilities Act (ADA)• Repeal of Glass-Steagall Act in 1999• Deregulation of utility and other industries• Increases in federally mandated minimum

wages• Taxation at local, state, federal levels• Legislation on corporate governance reforms

(Sarbanes-Oxley Act)

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Technological Segment

• Genetic engineering• Emergence of Internet technology• Computer-aided design/computer-aided

manufacturing systems (CAD/CAM)• Wireless communication• Nanotechnology

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Economic Segment

• Interest rates• Unemployment• Consumer Price index• Trends in GDP• Changes in stock market valuations

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Global Segment

• Increasing global trade• Currency exchange rates• Emergence of the Indian and Chinese

economies• Trade agreements (NAFTA, EU, ASEAN)• Creation of WTO (decreasing tariffs/free trade in

services)

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The Competitive Environment

• Competitive environment factors that pertain to an industry and affect a firm’s strategies

• Competitors, customers, and suppliers

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Porter’s Five Forces Model of Industry Competition

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The Threat of New Entrants

• Profits of established firms in the industry may be eroded by new competitors

• Sources of entry barriers Economies of scale Product differentiation Capital requirements Switching costs Access to distribution channels Cost disadvantages independent of scale

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QUESTION

If you are considering opening a new pizza restaurant in your community, what would be the threat of new entrants? How would you evaluate Porter’s other forces for this industry? Explain.

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The Bargaining Power of Buyers

• Buyers threaten an industry by: Forcing down prices Bargaining for higher quality or more services Playing competitors against each other

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The Bargaining Power of Buyers• A buyer group is powerful when

It is concentrated or purchases large volumes relative to seller sales

The products it purchases from the industry are standard or undifferentiated

The buyer faces few switching costs It earns low profits The buyers pose a credible threat of backward

integration The industry’s product is unimportant to the

quality of the buyer’s products or services

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The Bargaining Power of Suppliers

• Suppliers can exert power by threatening to raise prices or reduce the quality of purchased goods and services

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The Bargaining Power of Suppliers

• A supplier group will be powerful when The supplier group is dominated by a few

companies and is more concentrated than the industry it sells to

The supplier group is not obliged to contend with substitute products for sale to the industry

The industry is not an important customer of the supplier group

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The Bargaining Power of Suppliers

• A supplier group will be powerful when (cont.) The supplier’s product is an important input

to the buyer’s business The supplier group’s products are

differentiated or it has built up switching costs for the buyer

The supplier group poses a credible threat of forward integration

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The Threat of Substitute Products and Services

• Substitutes limit the potential returns of an industry Ceiling on the prices that firms in that

industry can profitably charge Price/performance ratio

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The Intensity of Rivalry among Competitors in an Industry

• Price competition

• Advertising battles

• Product introductions

• Increased customer service or warranties

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The Intensity of Rivalry among Competitors in an Industry

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

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How the Internet and Digital Technologies Influences Industry

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Using Industry Analysis: A Few Caveats

• Managers must not always avoid low profit industries Can still yield high returns for players with sound

strategies

• Implicitly assumes a zero-sum game, determining how a firm can enhance its position relative to the forces

• Five Forces analysis is essentially a static analysis

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Using Industry Analysis: A Few Caveats (cont.)

• Good industry analysis looks rigorously at the structural underpinnings of profitability. A first step is to understand the time horizon

• The point of industry analysis is not to declare the industry attractive or unattractive but to understand the underpinnings of competition and the root causes of profitability.

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The Value Net

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Strategic Groups within Industries

• Two unassailable assumptions in industry analysis No two firms are totally different No two firms are exactly the same

• Strategic groups• Cluster of firms that share similar strategies

Breadth of product and geographic scope Price/quality Degree of vertical integration Type of distribution system

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Strategic Groups within Industries

• Value of strategic groups as an analytical tool Identify barriers to mobility that protect a group from

attacks by other groups Identify groups whose competitive position may be

marginal or tenuous Chart the future direction of firms’ strategies Thinking through the implications of each industry

trend for the strategic group as a whole

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