Lecture 2

External Environmental Analysis

Strategic Management

• Diagnosing a company’s situation has two facets

– Assessing the company’s external ormacro-environment (Societal or General Environment)

• General environment conditions

• Forces acting to reshape this environment

– Assessing the company’s internal ormicro-environment (Specific or task Environment)

• Market position and competitiveness

• Competencies, capabilities, resource strengthsand weaknesses, and competitiveness

Understanding the Factors that Determine a Company’s Situation

From Thinking Strategically about theCompany’s Situation to Choosing a Strategy

The Components of a Company’s Macro-environment

Thinking Strategically about aCompany’s Macro-environment• A company’s macro-environment includes all relevant factors and

influences outside its domain• 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

Environmental Scanning• General Environment/ Societal environment1. Economic forces that regulate exchange of

materials, money, energy, and information2. Technological forces that generate problem solving3. Political –legal forces that allocate power and

provide constraining and protecting laws and regulations

4. Socio-cultural forces that regulate the values, mores, and customs of society

Prentice Hall, 2000 Chapter 3 7

Some Important Variables in the Societal Environment

EconomicGDP trendsInterest ratesMoney supplyInflation ratesUnemployment levels

Wage/price controls

Devaluation/revaluation

Energy availability and cost

Disposable and discretionary income

Technological

Total government spending for R&D

Total industry spending for R&D

Focus of technological efforts

Patent protectionNew productsNew developments in technology transfer from lab to marketplace

Productivity improvements through automation

Political-Legal

Antitrust regulations

Environmental protection laws

Tax lawsSpecial incentivesForeign trade regulations

Attitudes toward foreign companies

Laws on hiring and promotion

Stability of government

Socio-cultural

Lifestyle changesCareer expectations

Consumer activism

Rate of family formation

Growth rate of population

Age distribution of population

Regional shifts in population

Life expectanciesBirth rates

Important variables in International Societal Environment

Economic Technological Political-legal Socio-cultural

Economic DevelopmentPer capita incomeGDP tendsMonetary and Fiscal policiesEmployment levelCurrency convertibilityNature of competition

Regulation in technology transferEnergy availabilityNatural resource availabilitySkill level of workforcePatent-trademark protectionInternet availabilityTelecommunicationinfrastructure

Form of governmentPolitical ideologyTax lawsStability of governmentRegulation of foreign ownership Trade regulationsForeign policiesTerrorist activityLegal system

Customs, norms, valuesLanguageDemographicsLife-stylesReligious beliefsAttitude towards foreigners Literacy levelHuman rightsEnvironmentalism

Key Questions Regarding theIndustry and Competitive Environment

What are the industry’s dominant 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?

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

• Analyzing a company’s industry and competitive environment begins with identifying an industry’s dominant economic features and forming a picture of what the industry landscape is like

• It not only sets the stage for the analysis to come but also promotes understanding of the kind of strategic moves that industry members are likely to employ

• 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?

What to Consider in Identifying an Industry’s Dominant FeaturesWhat to Consider in Identifying an Industry’s Dominant Features

FeaturesFeatures Questions to answerQuestions to answer

Market size and Market size and growth rategrowth rate

How big is the industry and how fast it is growing? How big is the industry and how fast it is growing? What does the industry’s position in the business What does the industry’s position in the business life cycle (early development, rapid growth, early life cycle (early development, rapid growth, early maturity, maturity, stagnation, decline) reveal maturity, maturity, stagnation, decline) reveal about the industry’s growth position? about the industry’s growth position?

Scope of Scope of competitive competitive

rivalryrivalry

Is the geographic area over which most companies Is the geographic area over which most companies compete local, regional, national, multinational, or compete local, regional, national, multinational, or global? Is having a presence in foreign markets global? Is having a presence in foreign markets becoming more important to a company’s long-becoming more important to a company’s long-term competitive success?term competitive success?

Number of RivalsNumber of Rivals Is the industry fragmented into many small Is the industry fragmented into many small companies or dominated by a few large firms? companies or dominated by a few large firms? Is the industry going through a period of Is the industry going through a period of consolidation to a smaller number of competitors?consolidation to a smaller number of competitors?

Buyer needs and Buyer needs and requirementsrequirements

What are the final buyers (as well middlemen) What are the final buyers (as well middlemen) looking for – what attributes prompt to choose one looking for – what attributes prompt to choose one brand over another? brand over another? Are buyers needs or requirements Are buyers needs or requirements changing? If so what is driving such changes?changing? If so what is driving such changes?

Production Production CapacityCapacity

Is a surplus capacity pushing prices and profits Is a surplus capacity pushing prices and profits down? down? Is the industry overcrowded with too many Is the industry overcrowded with too many competitors?competitors?

Production Production CapacityCapacity

Is a surplus capacity pushing the prices and profit Is a surplus capacity pushing the prices and profit margins down? margins down? Is the industry over crowded with too many Is the industry over crowded with too many competitors?competitors?

Pace of Pace of Technological Technological

ChangeChange

What role does technology play in this industry? What role does technology play in this industry? Are ongoing Are ongoing upgrades of facilities/ equipment essential because of upgrades of facilities/ equipment essential because of rapidly advancing production process technologies? rapidly advancing production process technologies? Do most industry Do most industry members have a need for strong technological members have a need for strong technological capabilities? Why?capabilities? Why?

Degree of Degree of Product Product

DifferentiationDifferentiation

Are the products of rivals becoming differentiated or Are the products of rivals becoming differentiated or less differentiated? less differentiated? Are increasing look alike products of rivals causing Are increasing look alike products of rivals causing heightened price competition?heightened price competition?

Product Product InnovationInnovation

Is the industry characterized by rapid product innovation and Is the industry characterized by rapid product innovation and short product life cycle? How important is R&D and product short product life cycle? How important is R&D and product innovation? Are there opportunities to overtake key rivals by innovation? Are there opportunities to overtake key rivals by being first-to-market with next generation products?being first-to-market with next generation products?

Vertical Vertical IntegrationIntegration

Are some competitors in the industry partially or fully Are some competitors in the industry partially or fully integrated? Are there any important cost differences among fully integrated? Are there any important cost differences among fully versus partially versus non-integrated firms? Is there any versus partially versus non-integrated firms? Is there any competitive advantage or disadvantage associated with being competitive advantage or disadvantage associated with being fully or partially integrated?fully or partially integrated?

Economies of Economies of ScaleScale

Is industry characterized by economies of scale in purchasing, Is industry characterized by economies of scale in purchasing, manufacturing, and other activities? Do companies with high manufacturing, and other activities? Do companies with high scale operations have an important cost advantage over small scale operations have an important cost advantage over small scale firmsscale firms

Learning and Learning and experience experience curve effectscurve effects

Do some companies have a significant cost advantage Do some companies have a significant cost advantage because of their experience in performing particular because of their experience in performing particular activities?activities?

Question 2: What Kind of CompetitiveForces are Industry Members Facing?

• Objectives are to identify:

– Main sources of competitive forces

– Strength of these forces

• Key analytical tool

– Five Forces Modelof Competition

Fig. 3.3: The Five Forces Model of Competition

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

Factors Affecting Threat of Entry

Threat of New Entrants/ Entry BarriersThreat of New Entrants/ Entry BarriersFactors HUF MUF Neutral MF HF comment

Economies of scaleCapital requiredAccess to distribution channelsExpected retaliationDifferentiationBrand LoyaltyExperience CurveGovt. Action

Low

Low

Ample

LowLow

Low

InsignificantLow

High

High

Restricted

High High

High

Significanthigh

Exit Barriers• Exit BarriersFactors HUF MUF Neutral MF HF Comments

Specialized AssetsFixed Cost of ExitStrategic interrelationshipGovernment Barriers

Hi

Hi

Hi

Hi

Low

Low

Low

Low

Weapons for Competing and Factors Affecting Strength of Rivalry

Competitive RivalryCompetitive Rivalry

Factors HUF MUF Neutral MF HF Comment

Composition of CompetitorsMkt. Growth rateScope of competitionFixed storage CostCapacity Increase

Degree of differentiation

Strategic Stake

Equal Size SlowGlobal

High

Large

Commodity

High

Unequal Size

HighDomestic

Low

Small

High

Low

Factors Affecting Bargaining Power of Buyers

Power Of BuyerPower Of BuyerFactors HUF MUF N MF HFA Comment

Number of Important buyersThreat of Backward integrationProduct suppliedSwitching cost% of buyer’s costProfit earned by buyerImportance to final quality of buyers Product.

Few

High

Commodity

High

High

Low

Low

Many

Low

Specialty

Low

Low

High

High

How Seller – Buyer Partnership Can Create Competitive Pressures

• Sellers that provide items to business have found it is in their mutual interest to collaborate closely on matters such as:- just in time inventories- order processing- electronic invoice payments- data sharing

• Dell has partnered with its largest PC customers to create an on line system for over 50,000 corporate customers, providing their employees- information on approved product configurations- paperless purchase orders- real time order tracking, invoicing, purchasing history and other efficiency tools- loading a customer’s software at the factory- installing asset tags so that customer setup time is minimal- helping customers upgrade their PC’s to next generation hardware and software

Fig. 3.7: Factors Affecting Bargaining Power of Suppliers

Power of SupplierPower of Supplier

Factors HUF MUF N MF HF Comment

No, of important SuppliersSwitching cost

Availability of substitutesThreat of forward integrationImportance of Buyer industry to suppliers

Importance of supplier’s product to the buyer’s business

Few

High

Difficult High

Buys small ProportionHigh Importance

Many

Low

Many Low

Buys large proportionLow Importance

How Seller-Buyer Partnership Can Create Competitive Pressures

1. Reduce inventory and logistic costs2. Speed the availability of next generation

components3. Enhance the quality of parts and

components being supplied and reduce defect rates

4. Squeeze the cost savings for both themselves and suppliers

Factors Affecting Competition From Substitute Products

Threat Of Substitute ProductThreat Of Substitute Product

Factors HUF MUF N MF HF CommentThreat of Obsolescence of Industry’s productAggressiveness of substitute products in promotionSwitching CostPerceived price/ value

Hi

Hi

Low

Hi

Low

Low

High

Low

Overall Industry AttractivenessOverall Industry Attractiveness

Factors Unfavorable Neutral FavorableEntry BarriersExit BarriersRivalry among existing firmsPower of buyersPower of SuppliersThreat of substitutes

Is the Collective Strength of the Five Competitive Forces Conducive

to Good Profitability? • As a rule, stronger the collective impact of the five

forces, the lower the combined profitability of industry participants

• Fierce to strong competitive pressures come from all five forces driving industry profitability to unacceptably low levels

• An industry can be competitively unattractive even when not all five forces are strong

• Intense competitive pressure from just two or three forces may suffice to destroy the conditions for good profitability and prompt some companies to exit the business

Matching Company Strategy to Competitive Conditions

• Effectively matching a company’s strategy to prevailing competitive conditions have two aspects:

1. Pursuing avenues that shield the firm from as many of the different competitive pressures as possible

2. Initiating actions calculated to produce sustainable competitive advantage, thereby shifting competition in company’s favor, putting added competitive pressure on rivals, and perhaps even defining a business model for the industry

Question 3: What Factors are Driving Industry Change and what Impact will

they have?• Industries change because forces

are 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 microenvironment ( Most frequent)

Driving Forces of Change The internet and new e-commerce opportunities and

threats in the industry Increasing Globalization:1. Where scale economies are so large that rival firms need

to market their products in many countries to gain enough volume to drive unit cost down

2. Where low cost production is a critical consideration (making it imperative to locate manufacturing facilities in countries where lowest cost could be achieved)

3. Where one or more globally ambitious companies are pushing hard to gain significant competitive position in many attractive markets

4. Where local governments are privatizing government-owned monopolies

Driving Forces Changes in long-term industry growth rate1. Upsurge in long-term demand triggers a race for growth

among existing firms and attract new-comers2. A shrinking market heightens competitive pressures for

market share inducing mergers and acquisitions that result in industry consolidation

Changes in who buys the product and how they use it Product innovation Technological change Marketing innovation Entry or exit of a major firm

Drivers of Change

Diffusion of technical know how across more companies and countries

Changes in cost and efficiency Growing preference for differentiated products

instead of commodity or vice versa Regulatory influences and government policy

changes Changing societal concerns, attitudes and life styles

Assessing the Impact of the Driving Forces

• Are the driving forces causing demand for the industry’s product to increase or decrease?

• Are the driving forces acting to make competition more or less intense?

• Will the driving forces lead to higher or lower industry profitability?

Categorizing International Industries

• Multi-domestic Industries: Are specific to each country or group of countries Collection of essentially domestic industries Each subsidiary is essentially independent of the

activities of the MNC’s subsidiaries in other countries• Global Industries: Operate world wide, with MNC making only small

adjustment for country specific circumstances MNC’s produce products or services in various

locations throughout the world and sell them making only small adjustments for country requirements

Prentice Hall, 2000 Chapter 3 41

Continuum of International Industries

3.9 Continuum of International Industries (Fig. 3.4)

Multi-domestic

Industry in which companies tailor their products to the specific needs of consumers in a particular country. E.g.:

• Telecommunication

• Insurance

• Banking

Global

Industry in which companiesmanufacture and sell the same products, with only minor adjustments made for individual countries around the world. E.g.:

Automobiles

• Wrist watches

• Electrical appliances

Factors that Determine whether Industry would be Global or Multi-

domestic1. Pressure for coordination within

multinational corporations operating in that country

2. Pressure for local responsiveness on the part of individual country markets

Strategic Groups• A strategic group is a set of business units or firms

that pursue similar strategies with similar resources• A firm’s competitive domain can be identified with

the concept of strategic group• The strategic group map consists of two sets of

dimensionsI. Business Scope Commitment:(1) The target market segment (2) types of products

offered (3) geographical reachII. Resource Allocation Commitment: Allocation of

resources to functional areas considered central in achieving competitive advantage

Prentice Hall, 2000 Chapter 3 44

Mapping Strategic Groups in the U.S. Restaurant Chain Industry

3.10 Mapping Strategic Groups in the U.S. Restaurant Chain Industry (Fig. 3.5)

Product-Line Breadth

High

LowLimited Menu Full Menu

Arby's Wendy's Domino's Dairy Queen

Hardee's Taco Bell Burger King McDonald's

Shoney's Denny's

Country Kitchen

Kentucky Fried Chicken Pizza Hut

Long John Silver's

Ponderosa Bonanza

Perkins International House

of Pancakes

Red Lobster Olive Garden

ChiChi's

Pric

e

Implications of Strategic Groups

• The strategic group a firm should consider entering

• The number, type and level of entry barriers the firm will face

• The strategic dimensions that will make the firm similar to its strategic group members and different from members of different strategic groups

• The combined effect of five forces of competition on its relative profitability

Key Success Factors• Key success factors affect the ability of

industry members to prosper in market place• On what basis do customers chose between

the competing brands of sellers?• What must a seller do to be competitively

successful- what resources and competitive capabilities does it need?

• What does it take for sellers to achieve a sustainable competitive advantage?

Common Types of Industry Key Success Factors (KSF)Common Types of Industry Key Success Factors (KSF)

Technology Technology RelatedRelated

Expertise in particular technology or in scientific research ( important in Expertise in particular technology or in scientific research ( important in pharmaceuticals, internet applications, mobile communications, and pharmaceuticals, internet applications, mobile communications, and many high tech. industry many high tech. industry Proven ability to improve production processes (important in industries Proven ability to improve production processes (important in industries where advancing technology opens the way for higher manufacturing where advancing technology opens the way for higher manufacturing efficiency and lower production costs)efficiency and lower production costs)

Manufacturing Manufacturing Related KSF’sRelated KSF’s

Ability to achieve scale economies and/or capture learning Ability to achieve scale economies and/or capture learning curve effects (important to achieving low production costs) curve effects (important to achieving low production costs) Quality control know-how Quality control know-how ( important in those industries where customers insists on ( important in those industries where customers insists on product reliability) product reliability) High utilization of fixed assets (important in capital intensive/ High utilization of fixed assets (important in capital intensive/ high fixed cost industries) high fixed cost industries) Access to attractive supplies of skilled labor Access to attractive supplies of skilled labor High labor productivity ( important for items with high labor High labor productivity ( important for items with high labor content) content) Low cost product design and engineering ( reduces Low cost product design and engineering ( reduces manufacturing costs) manufacturing costs) Ability to manufacture or assemble products that are Ability to manufacture or assemble products that are customized to buyer specificationcustomized to buyer specification

Distribution Distribution related related KSF’sKSF’s

A strong network of wholesale distributors/dealers A strong network of wholesale distributors/dealers Strong direct sales capabilities via the internet and or having Strong direct sales capabilities via the internet and or having company owned retail outlets company owned retail outlets Ability to secure favorable display space on retailer shelves Ability to secure favorable display space on retailer shelves

Marketing Marketing Related Related KSF’sKSF’s

A talented workforceA talented workforce

Distribution capabilities Distribution capabilities Product innovation capabilities Product innovation capabilities Short delivery time capability Short delivery time capability Supply chain management capabilities Supply chain management capabilities Strong e-commerce capabilities Strong e-commerce capabilities

Breadth of product line and product selection Breadth of product line and product selection A well known and respected brand name A well known and respected brand name Courteous, personalized customer service Courteous, personalized customer service Customer guarantees and warranties Customer guarantees and warranties Clever advertising Clever advertising

HR HR

Related KSF’sRelated KSF’s

External Factor Analysis Summary( EFAS) / External Factor Evaluation Matrix ( EFE)

• Column 1( External Factors) list 8-10 most important opportunities and threats facing the company

• Column 2 ( Weights) assign a weight to each factor. The higher the weight the more important is this factor to the current and future success of the company. All weights must sum to 1.0 regardless of the number of factors

• Column 3 (Rating) ,assign a rating to each factor from 5.0 ( outstanding) to 1.0 (poor) based on management’s current response to a particular factor

• Column 4 ( weighted score) Multiply the weight in column 2 for each factor in column 3 to obtain each factor’s weighted score.

• Column 5 ( comments), note why a particular factor was selected and how its weight and rating were estimated

• Add the individual weighted score for all external factors in column 4 to determine the total weighted score for that particular company. The weighted score of 3 = average, 4 = above average, less than 2.5 as below average

Prentice Hall, 2000 Chapter 3 50

External Factors Analysis Summary (EFAS)

3.16 External Factor Analysis Summary (EFAS): Blank

ExternalStrategic Factors Weight Rating

Weighted Score Comments

1 2 3 4 5

1.00

Opportunities

Threats

Total Weighted Score

Notes: 1. List opportunities and threats (5–10 each) in column 1. 2. Weight each factor from 1.0 (Most Important) to 0.0 (Not Important) in Column 2 based on that factor’s probable impact on the company’s strategic position. The total weights must sum to 1.00. 3. Rate each factor from 5 (Outstanding) to 1 (Poor) in Column 3 based on the company’s response to that factor. 4. Multiply each factor’s weight times its rating to obtain each factor’s weighted score in Column 4. 5. Use Column 5 (comments) for rationale used for each factor. 6. Add the weighted scores to obtain the total weighted score for the company in Column 4. This tells how well the company is responding to the strategic factors in its external environment.Source: T. L. Wheelen and J. D. Hunger, “External Strategic Factors Analysis Summary (EFAS).” Copyright © 1991 by Wheelen and Hunger Associates. Reprinted by permission.