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Chapter 3: Evaluating a Chapter 3: Evaluating a Company’s External Company’s External

EnvironmentEnvironment

Screen graphics created by:Jana F. Kuzmicki, Ph.D.

Troy University

““Analysis is the critical starting Analysis is the critical starting

point ofpoint of

strategic thinking.”strategic thinking.”

Kenichi OhmaeKenichi OhmaeConsultant and AuthorConsultant and Author

““Things are always different –Things are always different –

the art is figuring out which the art is figuring out which

differences matter.” differences matter.”

Laszlo BirinyiLaszlo BirinyiInvestments ManagerInvestments Manager

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Chapter Learning Objectives

1. To gain command of the basic concepts and analytical tools widely used to diagnose a company’s industry and competitive conditions.

2. To become adept in recognizing the factors that cause competition in an industry to be fierce, more or less normal, or relatively weak.

3. To learn how to determine whether an industry’s outlook presents a company with sufficiently attractive opportunities for growth and profitability.

4. To understand why in-depth evaluation of specific industry and competitive conditions is a prerequisite to crafting a strategy well matched to a company’s situation.

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Chapter Roadmap

The Strategically Relevant Components of a Company’s External Environment

Thinking Strategically About a Company’s Industry and Competitive Environment

Question 1: What Are the Industry’s Dominant Economic Features?

Question 2: How Strong Are Competitive Forces? Question 3: What Forces Are Driving Industry Change and

What Impacts Will They Have? Question 4: What Market Positions Do Rivals Occupy—

Who Is Strongly Positioned and Who Is Not? Question 5: What Strategic Moves Are Rivals Likely to

Make Next? Question 6: What Are the Key Factors for Future

Competitive Success? Question 7: Does the Outlook for the Industry Offer the

Company a Good Opportunity to Earn Attractive Profits?

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Diagnosing a company’s situation has two facetsAssessing the company’s external or macro-

environment

Industry and competitive conditions

Forces acting to reshape this environment

Assessing the company’s internal ormicro-environment

Market position and competitiveness

Competencies, capabilities,resource strengths andweaknesses, and competitiveness

Understanding the Factors that Determine a Company’s Situation

Figure 3.1: From Thinking Strategically About theCompany’s Situation to Choosing a Strategy

Figure 3.2: The Components of a Company’s Macro-environment

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Thinking Strategically About aCompany’s Macro-environment

A company’s macro-environment includes all relevant factors and influences outside its boundaries

Diagnosing a company’s external situation involves assessing strategically important factors that have a bearing on the decisions a company’s makes about its

Direction Objectives Strategy Business model

Requires that company managers scanthe external environment to

Identify potentially important external developments Assess their impact and influence Adapt a company’s direction and strategy as needed

Key Questions Regarding theIndustry and Competitive Environment

What are the industry’s dominant economic traits?

How strong are competitive forces?

What forces are driving change in the industry?

What market positions do rivals occupy? What moves will they make next?

What are the key factors for competitive success?

How attractive is the industry from a profit perspective?

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Market size and growth rate Number of rivals Scope of competitive rivalry Buyer needs and requirements Degree of product differentiation Product innovation Supply/demand conditions Pace of technological change Vertical integration Economies of scale Learning and experience curve effects

Question 1: What are the Industry’sDominant Economic Traits?

Table 3.1: What to Consider in Identifyingan Industry’s Dominant Economic Features

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Learning/Experience Effects

Learning/experience effects exist when a company’s unit costs decline as its cumulative production volume increases because of

Accumulating production know-how

Growing mastery of the technology

The bigger the learning or experience curve effect, the bigger the cost advantage of the firm with the largest cumulative production volume

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Question 2: How Strong Are Competitive Forces?

Objectives are to identify

Main sources of competitive forces

Strength of these forces

Key analytical tool

Five Forces Model of Competition

Figure 3.3: The Five Forces Model of Competition

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Analyzing the Five Competitive Forces: How to Do It

Step 1: Identify the specific competitivepressures associated with each ofthe five forces

Step 2: Evaluate the strength of eachcompetitive force – fierce, strong,moderate to normal, or weak?

Step 3: Determine whether the collectivestrength of the five competitive forcesis conducive to earning attractive profits

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Usually the strongest of the five forces

Key factor in determining strength of rivalry

How aggressively are rivals using various weapons of competition to improve their market positions and performance?

Competitive rivalry is a combativecontest involving

Offensive actions

Defensive countermoves

Competitive PressuresAmong Rival Sellers

Figure 3.4: Weapons for Competing and Factors Affecting Strength of Rivalry

What Are the TypicalWeapons for Competing?

Lower prices

More or different performance features

Better product performance

Higher quality

Stronger brand image and appeal

Wider selection of models and styles

Bigger/better dealer network

Low interest rate financing

Better or more ads

Stronger product innovation capabilities

Better customer service

Stronger capabilities to provide buyers with custom-made products

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Competitors are active in making fresh moves to improve market standing and business performance

Slow market growth Number of rivals increases and rivals are ofequal

size and competitive capability Buyer costs to switch brands are low Industry conditions tempt rivals to use price cuts or

other competitive weapons to boost volume A successful strategic move carries a big payoff Diversity of rivals increases in terms

of visions, objectives, strategies,resources, and countries of origin

Outsiders acquire weak firms in theindustry and use their resources to transformnew firms into major market contenders

What Causes Rivalry to be Stronger?

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Industry rivals move only infrequently or in a non-aggressive manner to draw sales from rivals

Rapid market growth

Products of rivals are stronglydifferentiated and customer loyalty is high

Buyer costs to switch brands are high

There are fewer than 5 rivals or there are numerous rivals so any one firm’s actions has minimal impact on rivals’ business

What Causes Rivalry to be Weaker?

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Test Your Knowledge

The rivalry among competing sellers in an industry intensifies

A. when buyer demand for the product is growing rapidly.

B. when customers are brand loyal and their costs to switch to competing brands or substitute products are relatively high.

C. when buyer demand is strong and sellers have little or no excess capacity and only minimal inventories.

D. as the number of rivals increases and as they become more equal in size and competitive capability.

E. when the products of rival sellers are highly differentiated products and the industry consists of so many rivals that any one company’s actions have little direct impact on rivals’ business.

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Seriousness of threat depends on

Size of pool of entry candidatesand available resources

Barriers to entry

Reaction of existing firms

Evaluating threat of entry involves assessing

How formidable entry barriers are for each type of potential entrant and

Attractiveness of growth and profit prospects

Competitive PressuresAssociated With Potential Entry

Figure 3.5: Factors Affecting Threat of Entry

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Sizable economies of scale

Cost and resource disadvantages independent of size

Brand preferences and customer loyalty

Capital requirements and/or otherspecialized resource requirements

Access to distribution channels

Regulatory policies

Tariffs and international trade restrictions

Ability of industry incumbents to launch vigorous initiatives to block a newcomer’s entry

Common Barriers to Entry

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There’s a sizable pool of entry candidates

Entry barriers are low

Industry growth is rapid and profit potential is high

Incumbents are unwilling or unable to contest a newcomer’s entry efforts

When existing industry members have a strong incentive to expand into new geographic areas or new product segments where they currently do not have a market presence

When Is the Threat of Entry Stronger?

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There’s only a small pool of entry candidates

Entry barriers are high

Existing competitors are struggling to earn good profits

Industry’s outlook is risky

Industry growth is slow or stagnant

Industry members will strongly contestefforts of new entrants to gain a market foothold

When Is the Threat of Entry Weaker?

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Competitive Pressures from Substitute Products

Substitutes matter when customersare attracted to the products of

firms in other industries

Sugar vs. artificial sweeteners

Eyeglasses and contact lensvs. laser surgery

Newspapers vs. TV vs. Internet

ConceptConcept

ExamplesExamples

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How to Tell Whether SubstituteProducts Are a Strong Force

Whether substitutes are readilyavailable and attractively priced

Whether buyers view substitutesas being comparable or better

How much it costs end usersto switch to substitutes

Figure 3.6: Factors Affecting Competition From Substitute Products

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There are many good substitutes readily available

Substitutes are attractively priced

The higher the quality and performance of substitutes

The lower the end user’s switching costs

End users grow more comfortable with using substitutes

When Is the CompetitionFrom Substitutes Stronger?

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Good substitutes are not readily available or do not exist

Substitutes are higher priced relative to performance they deliver

End users incur high costsin switching to substitutes

When Is the CompetitionFrom Substitutes Weaker?

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Whether supplier-seller relationships represent a weak or strong competitive force depends on

Whether suppliers can exercisesufficient bargaining leverage toinfluence terms of supply in their favor

Nature and extent of supplier-sellercollaboration in the industry

Competitive Pressures From Suppliersand Supplier-Seller Collaboration

Figure 3.7: Factors Affecting Bargaining Power of Suppliers

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Industry members incur highcosts in switching their purchasesto alternative suppliers

Needed inputs are in short supply Supplier provides a differentiated input

that enhances the quality of performanceof sellers’ products or is a valuablepart of sellers’ production process

There are only a few suppliers of a specific input

Some suppliers threaten to integrate forward

When Is the BargainingPower of Suppliers Stronger?

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Item being supplied is a commodity

Seller switching costs to alternative suppliers are low

Good substitutes exist or new ones emerge

Surge in availability of supplies occurs

Industry members account for a bigfraction of suppliers’ total sales

Industry members threatento integrate backward

Seller collaboration with selected suppliers provides attractive win-win opportunities

When Is the Bargaining Power of Suppliers Weaker?

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Industry members often forge strategic partnerships with select suppliers to

Reduce inventory and logistics costs

Speed availability ofnext-generation components

Enhance quality of parts being supplied

Squeeze out cost savings for both parties

Competitive advantage potential may accrue to those industry members (sellers) doing the best job of managing supply-chain relationships

Competitive Pressures: Collaboration Between Sellers and Suppliers

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Whether the relationships between industry members and buyers represent a weak or strong competitive force depends on

Whether buyers have sufficientbargaining leverage to influenceterms of sale in their favor

Extent and competitive importance ofstrategic partnerships between certain industry members and the buyers

Competitive Pressures From Buyersand Seller-Buyer Collaboration

Figure 3.8: Factors Affecting Bargaining Power of Buyers

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Buyer switching costs to competing brands or substitutes are low

Buyers are large and can demand concessions Large-volume purchases by buyers are important to

sellers Buyer demand is weak or declining Only a few buyers exists Identity of buyer adds prestige

to seller’s list of customers Quantity and quality of information

available to buyers improves Buyers have ability to postpone purchases until later Buyers threaten to integrate backward

When Is the BargainingPower of Buyers Stronger?

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Buyers purchase item infrequently or in small quantities

Buyer switching costs tocompeting brands are high

Surge in buyer demandcreates a “sellers’ market”

Seller’s brand reputation is important to buyer

A specific seller’s product delivers qualityor performance that is very important to buyer

Buyer collaboration with selected sellers provides attractive win-win opportunities

When Is the BargainingPower of Buyers Weaker?

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Partnerships between industry members and some/many of their customers can impact competitive pressures

Collaboration may result inmutual benefits regarding Just-in-time deliveries Order processing Electronic invoice payments Data sharing

Competitive advantage may accrue to those industry members doing the best job of partnering with their customers

Competitive Pressures: CollaborationBetween Sellers and Buyers

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For Discussion: Your Opinion

Explain why low switching costs and weakly

differentiated products tend to give buyers a

high degree of bargaining power.

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Competitive environment isunattractive from the standpointof earning good profits when

Rivalry is vigorous

Entry barriers are lowand entry is likely

Competition from substitutes is strong

Suppliers and customers haveconsiderable bargaining power

Strategic Implications ofthe Five Competitive Forces

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Competitive environment is ideal froma profit-making standpoint when

Rivalry is moderate

Entry barriers are highand no firm is likely to enter

Good substitutesdo not exist

Suppliers and customers arein a weak bargaining position

Strategic Implications ofthe Five Competitive Forces

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Objective is to craft a strategy to

Insulate firm fromcompetitive pressures

Initiate actions to producesustainable competitive advantage

Allow firm to be the industry’s “mover and shaker” with the “most powerful” strategy that defines the business model for the industry

Coping With theFive Competitive Forces

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Question 3: What Forces Are Driving Industry Change and What Impacts Will They Have?

Industries change because forcesare driving industry participantsto alter their actions

Driving forces are themajor underlying causesof changing industry andcompetitive conditions

Where do driving forces originate?Outer ring of macroenvironment

Inner ring of macroenvironment

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STEP 1: Identify forces likely to exert greatest influence over next 1 - 3 years

Usually no more than 3 - 4 factorsqualify as real drivers of change

STEP 2: Assess impactAre driving forces acting to cause market

demand for product to increase or decrease?Are driving forces acting to make competition

more or less intense?Will driving forces lead to higher or lower industry

profitability?

STEP 3: Determine what strategy changes are needed to prepare for impacts of driving forces

Analyzing Driving Forces: Three Key Steps

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Changes in long-term industry growth rate

Increasing globalization of industry

Emerging new Internet capabilitiesand applications

Changes in who buys theproduct and how they use it

Product innovation

Technological change/process innovation

Marketing innovation

Common Types of Driving Forces

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Entry or exit of major firms

Diffusion of technical knowledge

Changes in cost and efficiency

Consumer preferences shiftfrom standardized todifferentiated products (or vice versa)

Changes in degree of uncertainty and risk

Regulatory policies / government legislation

Changing societal concerns, attitudes, and lifestyles

Common Types of Driving Forces (con’t)

Table 3.2: The Most Common Driving Forces

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Question 4: What MarketPositions Do Rivals Occupy?

One technique to reveal different competitive positions of industry rivals isstrategic group mapping

A strategic group is a cluster of firms in an industry with similar competitiveapproaches and market positions

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Firms in same strategic grouphave two or more competitive characteristics in common Have comparable product line breadth

Sell in same price/quality range

Emphasize same distribution channels

Use same product attributes to appealto similar types of buyers

Use identical technological approaches

Offer buyers similar services

Cover same geographic areas

Strategic Group Mapping

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STEP 1: Identify competitive characteristics that differentiate firms in an industry 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, making circles proportional to size of group’s respective share of total industry sales

Procedure for Constructing a Strategic Group Map

Example: Strategic Group Map of Selected Automobile Manufacturers

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Variables selected as axes should not be highly correlated

Variables chosen as axes should expose big differences in how rivals compete

Variables do not have to be either quantitative or continuous

Drawing sizes of circles proportional to combined sales of firms in each strategic group allows map to reflect relative sizes of each strategic group

If more than two good competitive variables can be used, several maps can be drawn

Guidelines: Strategic Group Maps

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Interpreting Strategic Group Maps

The closer strategic groups are on the map, the stronger the cross-group competitive rivalry tends to be

Not all positions on the mapare equally attractive

Driving forces and competitive pressures oftenfavor some strategic groups and hurt others

Profit potential of different strategicgroups varies due to strengths andweaknesses in each group’s market position

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Test Your Knowledge

A strategic group map is a helpful analytical tool for

A. assessing why competitive pressures and driving forces usually impact the biggest strategic groups more so than the smaller groups.

B. determining which companies have how big a competitive advantage and how good their prospects are for increasing their market shares.

C. determining which company is the most profitable in the industry and why it is doing so well.

D. determining who competes most closely with whom; evaluating whether industry driving forces and competitive pressures favor some strategic groups and hurt others; and ascertaining whether the profit potential of different strategic groups varies due to the strengths and weaknesses in each group’s respective market positions.

E. pinpointing which of the five competitive forces is the strongest and which is the weakest.

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A firm’s best strategic movesare affected by Current strategies of competitors

Future actions of competitors

Profiling key rivals involves gatheringcompetitive intelligence about Current strategies

Most recent actions and public announcements

Resource strengths and weaknesses

Efforts being made to improve their situation

Thinking and leadership styles of top executives

Question 5: What Strategic MovesAre Rivals Likely to Make Next?

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Sizing up strategies and competitive strengths and weaknesses of rivals involves assessing Which rival has the best strategy? Which

rivals appear to have weak strategies?

Which firms are poised to gainmarket share, and which onesseen destined to lose ground?

Which rivals are likely to rank among the industry leaders five years from now? Do any up-and-coming rivals have strategies and the resources to overtake the current industry leader?

Competitor Analysis

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Which rivals need to increase their unit sales and market share? What strategies are rivals most likely to pursue?

Which rivals have a strong incentive, along with resources, to make major strategic changes?

Which rivals are good candidates to be acquired? Which rivals have the resources to acquire others?

Which rivals are likely to enter new geographic markets?

Which rivals are likely to expand their product offerings and enter new product segments?

Things to Consider inPredicting Moves of Rivals

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For Discussion: Your Opinion

Why does a company need to bother with

studying competitors and trying to predict what

moves rivals will make next? Why can’t it just

choose whatever strategy it wants or make

whatever moves in the marketplace it wishes

without first worrying about what rivals are

going to do?

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Key Success Factors (KSFs) are competitive factors and attributes that affect every industry member’s ability to be competitively and financially successful

KSFs are those particular attributes that are so important that they spell the difference between Profit and loss Competitive success or failure

KSFs can relate to Specific strategy elements Product attributes Resources Competencies Competitive capabilities Market achievements

Question 6: What Are the KeyFactors for Competitive Success?

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The answers to 3 questions often help pinpoint an industry’s KSFs

On what basis do customers choosebetween competing brands of sellers?

What resources and competitive capabilities does a company need to have to be competitively successful?

What shortcomings are likely to place a company at a significant competitive disadvantage?

Rarely are there more than 5 - 6 factors that are truly key to the future financial and competitive success of industry members

Identifying Industry Key Success Factors

Table 3.3: Common Types of Industry Key Success Factors

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Access to distribution – to get a company’s brand stocked andfavorably displayed in retail outlets

Image – to induce consumers tobuy a particular company’s product(brand name and attractiveness of packaging are key deciding factors)

Low-cost production capabilities – to keep selling prices competitive

Sufficient sales volume – to achievescale economies in marketing expenditures

Example: KSFs for Bottled Water Industry

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Example: KSFs forReady-to-Wear Apparel Industry

Appealing designs and color combinations – to create buyer appeal

Low-cost manufacturing efficiency – to keep selling prices competitive

Strong network of retailers/company-owned stores – to allow storesto keep best-selling items in stock

Clever advertising – to effectivelyconvey a specific image to induce consumers to purchase a particular label

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Involves assessing whether the industry and competitive environment presents a company with an attractive or unattractive opportunity for earning good profits

Factors to consider: Industry growth potential Whether competitive forces are growing stronger/weaker Whether driving forces will favorable/unfavorably impact

industry profitability Degree of risk and uncertainty in industry’s future Whether the industry confronts severe problems Firm’s competitive position in industry vis-à-vis rivals Firm’s potential to capitalize on industry opportunities or

the vulnerabilities of weaker rivals Whether a firm has sufficient competitive strength to

defend against unattractive industry factors

Question 7: Does the Outlook for theIndustry Offer an Attractive Opportunity?

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Factors to Consider inAssessing Industry Attractiveness

As a general proposition If an industry’s overall profit prospects are

above average, the industry environment is basically attractive

If an industry’s overall profit prospects are below average, the industry environment is basically unattractive

However

Attractiveness is relative, not absolute

Conclusions about attractiveness have to be drawn from the perspective of a particular company

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An industry is unlikely to be equally attractive or unattractive to all industry members Industry environments attractive to strong

competitors may be unattractive to weak competitorsA favorably positioned company may survey an

industry environment and see opportunities that weak competitors have little or no ability to capture

Industry environments attractive to insiders may be unattractive to potential entrants

Under certain circumstances, a firm uniquely well-situated in an otherwise unattractive industry can still earn good profits by taking sales and market share away from weaker competitors

Factors to Consider inAssessing Industry Attractiveness

Core Concept: AssessingIndustry Attractiveness

The degree to which an industry

is attractive or unattractive is not the

same for all industry participants

or potential entrants.

The opportunities an industry

presents depend partly on a

company’s ability to capture them.

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Test Your Knowledge

Which of the following is not an important factor for company managers to consider in drawing conclusions about whether the industry presents an attractive opportunity?

A. Whether powerful competitive forces are squeezing industry profitability to subpar levels and whether competition appears destined to grow stronger or weaker

B. The industry’s growth potential and the degree of uncertainty and risk in the industry’s future

C. Whether industry profitability will be affected favorably or unfavorably by the prevailing driving forces

D. How many of the industry’s key success factors do companies in the industry typically incorporate into their strategies

E. The company’s ability to capitalize on the vulnerabilities of weakly positioned rivals and whether the company has sufficient competitive strength to defend against or counteract the factors that make the industry unattractive