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Chapter 3

The External Environment

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Chapter Topics

• Remote Environment• International Environment• Industry Environment• Industry Analysis and Competitive

Analysis• Operating Environment• Emphasis on Environmental Factors

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Ex. 3-1: The Firm’s ExternalEnvironment

THE FIRM

Operating Environment (Global and Domestic)

•Competitors •Labor•Suppliers•Customers

Industry Environment (Global and Domestic)•Entry barriers•Supplier power

•Buyer power•Substitute availability

•Competitiverivalry

•Creditors

Remote Environment (Global and Domestic)•Economic•Social•Political

•Technological•Ecological

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Economic Factors

• Concern the nature and direction of economy in which a firm operates

• Types of factors• General availability of credit• Level of disposable income• Propensity of people to spend• Prime interest rates• Inflation rates• Trends in growth of gross national

product

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Social Factors

• Beliefs, values, opinions, and lifestyles of people

• Recent social trends• Entry of large numbers of women into

labor market

• Accelerating interest of consumers and employees in quality-of-life issues

• Shift in age distribution of population

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Political Factors

• Define legal and regulatory parameters within which firms must operate

• Types of factors– Fair-trade decisions– Antitrust laws– Tax programs– Minimum wage legislation– Pollution and pricing policies– Administrative jawboning

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Technological Factors

• Focus on technological changes affecting industry

• Types of changes• New products• Improvements in existing products• Manufacturing and marketing techniques

• Role of technological forecasting• Foresees advancements and estimating

their impact on organization’s operations• Alerts managers to impending challenges

and promising opportunities

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Ecological Factors

• Ecology refers to the relationships among human beings and other living things and air, soil, and water

• Current concerns• Global warming• Loss of habitat and biodiversity• Air, water, and land pollution

• Responsibilities of firms• Eliminating toxic by-products of current

manufacturing processes• Cleaning up prior environmental damage

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Ex. 3-7: Federal Ecological Legislation

Centerpiece Legislation

National Environmental Policy Act, 1969

Established Environmental Protection Agency; consolidated federal environmental activities under it. Established Council on Environmental Quality to advise president on environmental policy and to review environmental impact statements

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Ex. 3-7: Federal Ecological Legislation(contd.)

Air Pollution• Clean Air Act,

1963• Clean Air Act,

Amendments, 1965

• Air Quality Act, 1967

• Clean Air Act, Amendments, 1970 and 1977

Solid Waste Pollution

• Solid Waste Disposal Act, 1965

• Resource Recovery Act, 1970

• Resource Conservation and Recovery Act, 1976

• Surface Mining and Reclamation Act, 1976

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Ex. 3-7: Federal Ecological Legislation(contd.)

Water Pollution

• Refuse Act, 1899

• Federal Water Pollution Control Act, 1956

• Water Quality Act, 1965

• Water Quality Improvement Act, 1970

• Federal Water Pollution Control Act Amendments, 1972

• Safe Drinking Water Act, 1974

• Clean Water Act, 1977

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Concept of Eco-Efficiency

• Definition• Firms producing more useful products while

continuously reducing resource consumption and pollution

• Benefits – why should firms implement an environmental policy?• Increasing demand for cleaner products by

customers• More stringent environmental regulations• Attracting employees who prefer to work for

environmentally conscious firms• Availability of financing• Governmental incentives

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Characteristics of Eco-EfficientCompanies

Proactive, not reactive

Design in, not add on

Flexibility

Encompassing, not insular

Encompassing, not insular

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Ex. 3-8: Factors Used to Assessthe International Environment

Economic Environment• Level of economic

development• Population• GNP• Per capita income• Literacy level• Social infrastructure• Natural resources• Climate• Membership in economic

blocs• Monetary and fiscal policies• Wage and salary levels• Nature of competition• Currency convertibility• Inflation and interest rates• Taxation systems

Political System

• Form of government

• Political ideology

• Stability of government

• Strength of opposition parties

• Social unrest

• Political strife and insurgency

• Governmental attitude toward foreign firms

• Foreign policy

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Ex. 3-8: Factors Used to Assess theInternational Environment (contd.)

Legal Environment

• Legal tradition• Effectiveness of

legal system• Treaties with

foreign nations• Patent trademark

laws• Laws affecting

business firms

Cultural Environment

• Customs, norms, values, beliefs

• Language• Attitudes• Motivations• Social institutions• Status symbols• Religious beliefs

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Ex. 3-9: Forces Driving IndustryCompetition

SuppliersSuppliers

SubstitutesSubstitutes

Industry Competitors

Rivalry Among Existing Firms

NewEntrants

Buyers

Bargaining powerof suppliers

Threat of substituteproducts or services

Bargaining powerof buyers

Threat of new entrants

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Competitive Force: Threat of Entry

• Seriousness of threat depends on• Barriers to entry

• Reaction of existing firms

• Barriers to entry• Economies of scale

• Product differentiation

• Capital requirements

• Cost advantages independent of size

• Access to distribution channels

• Government policy

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Competitive Force: Suppliers

• A supplier group is powerful if:• It is dominated by a few companies and is

more concentrated than industry it sells to• Its product is unique, or differentiated, or

has built up switching costs• It is not obliged to contend with other

products for sale to industry• It poses a threat of integrating forward

into industry’s business• Industry is not an important customer of

supplier group

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Competitive Force: Buyers

• A buyer group is powerful if:• It is concentrated or purchases in large volume• Products purchased from industry are standard or

undifferentiated• Products purchased from industry form a

component of its product, representing a significant fraction of its cost

• It earns low profits, creating incentives to lower its costs

• Industry’s product is unimportant to quality of buyers’ products or services

• Industry’s product does not save buyer money• Buyer poses credible threat of integrating

backward

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Competitive Force: Substitute Products

• Relevance of substitutes• By placing a ceiling on prices charged,

they limit profit potential of an industry

• Substitutes deserving the most attention are those• Subject to trends improving their price-

performance trade-off with the industry’s product

• Produced by industries earning high profit

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Competitive Force: Jockeying For Position

• Tactics of competitive rivalry

• Price competition

• Product introduction

• Advertising slugfests

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What Causes Rivalry to be Intense?

• Numerous competitors or they are roughly equal in size and power

• Slow growth in industry• Product lacks differentiation or switching

costs• High fixed costs or perishable product• Capacity normally augmented in large

increments• High exit barriers• Rivals are diverse in strategies, origins, and

“personalities”

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Industry and Competitive Analysis

Questionsinvolved

in designing

viablestrategies

1. What are the boundaries of the industry?

2. What is the structure of the industry?

3. Which firms are our competitors?

4. What are the major determinants of competition?

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Why a Definition of Industry Boundaries is Important

• Helps executives determine arena in which their firm competes

• Focuses attention on firm’s competitors

• Helps executives determine key factors for success

• Gives executives another basis on which to evaluate their firm’s goals

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Sources of Difficulty in DefiningIndustry Boundaries

Evolution of industries over time creates new

opportunities and threats

Industry evolution creates industries within

industries

Industries are becoming global in scope

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Issues in Defining an Industry

• What part of the industry corresponds to our firm’s goals?

• What are the key ingredients of success in that part of the industry?

• Does our firm have the skills needed to compete in that part of the industry?

• Will the skills enable us to seize emerging opportunities and deal with future threats?

• Is our definition of the industry flexible enough to allow necessary adjustments to our business concept as the industry grows?

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Characteristics of Industry Structure

• Structural attributes – Enduring characteristics giving an industry its distinctive character

• Variations among industries involves examining• Concentration – Extent to which industry sales are

dominated by only a few firms• Economies of Scale – Savings firms within an

industry achieve due to increased volume• Product Differentiation – Extent to which

customers perceive products of firms in industry as different

• Barriers to Entry – Obstacles a firm must overcome to enter an industry

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Variables in Identifying Competitors• How do other firms define the scope of their

market?• The more similar the definitions of firms, the more

likely the firms will view each other as competitors

• How similar are the benefits the customers derive from the products and services other firms offer?• The more similar the benefits, the higher the level

of substitutability between them

• How committed are other firms to the industry?• To size up commitment of potential competitors to

industry, reliable intelligence data are needed concerning potential resource commitments

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Common Mistakes in IdentifyingCompetitors

• Overemphasizing current and known competitors while ignoring potential entrants

• Overemphasizing large competitors while ignoring small ones

• Overlooking potential international competitors

• Assuming competitors will continue to behave in same way

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Common Mistakes in IdentifyingCompetitors (contd.)

• Misreading signals indicating a shift in focus of competitors

• Overemphasizing competitors’ financial resources, market position, and strategies while ignoring their intangible assets

• Assuming all firms in industry are subject to same constraints or are open to same opportunities

• Believing purpose of strategy is to outsmart competition, rather than satisfy customer needs

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Operating Environment

The operating environment, also called the competitive or task environment, comprises factors in the competitive situation that affect a firm’s success in acquiring needed resources or in profitably marketing its goods and services

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Factors in the OperatingEnvironment

• Firm’s competitive position• The composition of its customers• Its reputation among suppliers and

creditors• Its ability to attract capable employees

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Criteria Used in ConstructingCompetitor Profiles

• Market share

• Breadth of product line

• Effectiveness of sales distribution

• Proprietary and key-account advantages

• Price competitiveness

• Advertising and promotion effectiveness

• Location and age of facility

• Capacity and productivity

• Experience

• Raw material costs

• Financial position

• Relative product quality

• R&D advantages position

• Caliber of personnel

• General images

• Customer profile

• Patents and copyrights

• Union relations

• Technological position

• Community reputation

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Customer Profiles

• Improves ability of managers to• Plan strategic operations• Anticipate changes in size of markets• Reallocate resources to support forecasted

shifts in demand patterns

• Segmenting customers• Geographic• Demographic• Psychographic• Buyer behavior

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Ex. 3-12: Major SegmentationVariables for Industrial Markets

Demographic • Industry• Company size• Location

Operating• Technology• User-nonuser status• Customer

capabilities

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Ex. 3-12: Major SegmentationVariables for Industrial Markets (contd.)

Purchasing Approaches• Purchasing-function organization

• Power structure

• Nature of existing relationships

• General purchase policies

• Purchasing criteria

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Ex. 3-12: Major SegmentationVariables for Industrial Markets (contd.)

Situational Factors• Urgency• Specific application• Size of order

Perfect Characteristics• Buyer-seller

similarity• Attitudes toward risk• Loyalty

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Factors Related to AssessingRelationship With Suppliers

How costly are shipping charges? Are suppliers competitive in terms

of production standards?

Are suppliers’ prices competitive? Do they offer

quantity discounts?

Are suppliers’ prices competitive? Do they offer

quantity discounts?

In terms of deficiency rates, are suppliers’ abilities, reputations, and

services competitive?

Are suppliers reciprocally dependent on the firm?

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Factors Related to AssessingRelationship with Creditors

• Do creditors fairly value and willingly accept firm’s stock as collateral?

• Do creditors perceive firm as having an acceptable record of past payment?

• A strong working capital position? Little or no leverage?

• Are creditors’ loan terms compatible with firm’s profitability objectives?

• Are creditors able to extend necessary lines of credit?

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Factors Related to Acquiring NeededHuman Resources

A firm’s access to neededpersonnel is affected by

Reputation as anemployer

Local employmentrates

Availability of people with needed skills