Lecture 3

Evaluating a Companys External EnvironmentChapter 3

Chapter RoadmapThe Strategically Relevant Components of a Companys External EnvironmentThinking Strategically About a Companys Industry and Competitive EnvironmentQuestion 1: What Are the Industrys 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 OccupyWho 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

Understanding the Factors that Determine a Companys SituationDiagnosing a companys situation has two facetsAssessing the companys external or macro-environment Industry and competitive conditions Forces acting to reshape this environmentAssessing the companys internal or micro-environment Market position and competitiveness Competencies, capabilities, resource strengths and weaknesses, and competitiveness

Figure 3.1: From Thinking Strategically About the Companys Situation to Choosing a Strategy 3-*

Figure 3.2: The Components of a Companys Macro-environment3-*

Thinking Strategically About a Companys Macro-environment

A companys macro-environment includes all relevant factors and influences outside its boundariesDiagnosing a companys external situation involves assessing strategically important factors that have a bearing on the decisions a companys makes about itsDirectionObjectivesStrategyBusiness modelRequires that company managers scan the external environment toIdentify potentially important external developmentsAssess their impact and influenceAdapt a companys direction and strategy as needed

Environmental ScanningGeneral Environment/ Societal environmentEconomic forces that regulate exchange of materials, money, energy, and informationTechnological forces that generate problem solvingPolitical legal forces that allocate power and provide constraining and protecting laws and regulationsSocio-cultural forces that regulate the values, mores, and customs of society

Prentice Hall, 2000Chapter 3*Some Important Variables in the Societal EnvironmentEconomicGDP trendsInterest ratesMoney supplyInflation ratesUnemployment levelsWage/price controlsDevaluation/revaluationEnergy availability and costDisposable and discretionary incomeTechnologicalTotal government spending for R&DTotal industry spending for R&DFocus of technological effortsPatent protectionNew productsNew developments in technology transfer from lab to marketplaceProductivity improvements through automationPolitical-LegalAntitrust regulationsEnvironmental protection lawsTax lawsSpecial incentivesForeign trade regulationsAttitudes toward foreign companiesLaws on hiring and promotionStability of governmentSocioculturalLifestyle changesCareer expectationsConsumer activismRate of family formationGrowth rate of population Age distribution of populationRegional shifts in populationLife expectanciesBirth rates

Important variables in international Societal Environment

EconomicTechnologicalPolitical-legalSocio-culturalEconomic DevelopmentPer capita incomeGDP tendsMonetary and Fiscal policiesEmployment levelCurrency convertibilityNature of competitionRegulation 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 systemCustoms, norms, valuesLanguageDemographicsLife-styleReligious beliefsAttitude towards foreigners Literacy levelHuman rightsEnvironmentism

Key Questions Regarding the Industry and Competitive Environment

Question 1: What are the Industrys Dominant Economic Traits?Analyzing a companys industry and competitive environment begins with identifying an industrys dominant economic features and forming a picture of what the industry landscape is likeIt 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 rateNumber of rivalsScope of competitive rivalryBuyer needs and requirementsDegree of product differentiationProduct innovationSupply/demand conditionsPace of technological changeVertical integrationEconomies of scaleLearning and experience curve effectsQuestion 1: What are the Industrys Dominant Economic Traits?

What to Consider in Identifying an Industrys Dominant FeaturesFeaturesQuestions to answerMarket size and growth rateHow big is the industry and how fast it is growing? What does the industrys position in the business life cycle (early development, rapid growth, early maturity, maturity, stagnation, decline) reveal about the industrys growth position? Scope of competitive rivalryIs the geographic area over which the most companies compete local, regional, national, multinational, or global? Is having a presence in foreign markets becoming more important to a companys long-term competitive success?

Number of RivalsIs the industry fragmented into many small companies or dominated by a few large firms? Is the industry going through a period of consolidation to a smaller number of competitors?Buyer needs and requirementsWhat are the final buyers( as well middlemen) looking for what attributes prompt to choose one brand over another? Are buyers needs or requirements changing? If so what is driving such changes?Production CapacityIs a surplus capacity pushing prices and profits down? Is the industry overcrowded with to many competitors?

Production CapacityIs a surplus capacity pushing the prices and profit margins down? Is the industry over crowded with too many competitors?Pace of Technological ChangeWhat role does the advancing technology play in this industry? Are ongoing upgrades of facilities/ equipment essential because of rapidly advancing production process technologies? Do most industry members have a need or need strong technological capabilities? Why?Degree of Product DifferentiationAre the products of rivals becoming differentiated or less differentiated? Are increasing look alike products of rivals causing heightened price competition?

Product InnovationIs the industry characterized by rapid product innovation and short product life cycle? How important is R&D and product innovation? Are there opportunities to overtake key rivals by being first-to-market with next generation products? Vertical IntegrationAre some competitors in the industry partially or or fully integrated? Are there any important cost differences among fully versus partially versus non integrated firms? Is there any competitive advantages or disadvantages associated with being fully or partially integrated firms?Economies of ScaleIs industry characterized by economies of scale in purchasing, manufacturing, and other activities? Do companies with high scale operations have an important cost advantage over small scale firmLearning and experience curve effectsDo any companies have significant cost advantage because of their experience in performing particular activities?

Learning/Experience EffectsLearning/experience effects exist when a companys unit costs decline as its cumulative production volume increases because ofAccumulating 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

Question 2: What Kinds of Competitive Forces Are Industry Members Facing?Objectives are to identifyMain sources of competitive forcesStrength of these forcesKey analytical toolFive Forces Model of Competition

Figure 3.3: The Five Forces Model of Competition3-*

Analyzing the Five Competitive Forces: How to Do ItStep 1: Identify the specific competitive pressures associated with each of the five forcesStep 2: Evaluate the strength of each competitive force -- fierce, strong, moderate to normal, or weak? Step 3: Determine whether the collective strength of the five competitive forces is conducive to earning attractive profits

Competitive Pressures Associated With Potential EntrySeriousness of threat depends onSize of pool of entry candidates and available resourcesBarriers to entryReaction of existing firmsEvaluating threat of entry involves assessingHow formidable entry barriers are for each type of potential entrant andAttractiveness of growth and profit prospects

Factors Affecting Threat of Entry

Threat of New Entrants/ Entry Barriers

FactorsHUFAMUFANeutralMFAHFAcommentEconomies of scaleCapital require redAccess to distribution channelsExpected retaliationDifferentiationBrand LoyaltyExperience CurveGovt. Actionsmall

Low

Ample

LowLow

Low

InsignificantLowlarge

High

Restricted

High High

High

Significanthigh

Exit BarriersExit Barriers

FactorsHUAMUANeutralMAHACommentsSpecialized AssetsFixed Cost of ExitStrategic interrelationshipGovernment BarriersHi

Hi

Hi

HiLOW

Low

Low

Low

Entry BarriersExit BarrierslowhighhighlowLow, stable returnsLow, risky returnsHigh, stable returnsHigh, risky returns Barriers and profitability

Competitive Pressures Among Rival SellersUsually the strongest of the five forcesKey factor in determining strength of rivalryHow aggressively are rivals using various weapons of competition to improve their market positions and performance?Competitive rivalry is a combative contest involvingOffensive actionsDefensive countermoves

Weapons for Competing and Factors Affecting Strength of Rivalry

Competitive Rivalry

FactorsHUFAMUFANeutralMFAHFACommentComposition of CompetitorsMkt. Growth rateScope of competitionFixed storage CostCapacity Increase

Degree of differentiation

Strategic StakeEqual Size SlowGlobal

High

Large

Commodity

HighUnequal SizeHighDomesticLow

Small

High

Low

Competitive Pressures from Substitute ProductsConceptSubstitutes matter when customers are attracted to the products of firms in other industries ExamplesSugar vs. artificial sweetenersEyeglasses and contact lens vs. laser surgeryNewspapers vs. TV vs. Internet

How to Tell Whether Substitute Products Are a Strong ForceWhether substitutes are readily available and attractively pricedWhether buyers view substitutes as being comparable or betterHow much it costs end users to switch to substitutes

Figure 3.6: Factors Affecting Competition From Substitute Products3-*

Threat Of Substitute Product

FactorsHUFAMUFANMFAHFACommentThreat of Obsolescence of Industrys productAggressiveness of substitute products in promotionSwitching CostPerceived price/ value Hi

Hi

Low

HiLow

Low

High

Low

Competitive Pressures From Suppliers and Supplier-Seller CollaborationWhether supplier-seller relationships represent a weak or strong competitive force depends onWhether suppliers can exercise sufficient bargaining leverage to influence terms of supply in their favorNature and extent of supplier-seller collaboration in the industry

Fig. 3.7: Factors Affecting Bargaining Power of Suppliers

Power of Supplier

FactorsHUFAMUFANMFAHFAcomment# of important SuppliersSwitching cost

Availability of substitutesThreat of forward integrationImportance of Buyer industry to suppliers profitQuantity purchased by the industry of suppliers product Suppliers product an important input to the buyers businessFew

High

low High

small

low

Highly ImportantMany

Low

high Low

large

High

Less important

Competitive Pressures: Collaboration Between Sellers and SuppliersIndustry members often forge strategic partnerships with select suppliers toReduce inventory and logistics costsSpeed availability of next-generation componentsEnhance quality of parts being suppliedSqueeze out cost savings for both partiesCompetitive advantage potential may accrue to those industry members (sellers) doing the best job of managing supply-chain relationships

Competitive Pressures From Buyers and Seller-Buyer CollaborationWhether the relationships between industry members and buyers represent a weak or strong competitive force depends onWhether buyers have sufficient bargaining leverage to influence terms of sale in their favorExtent and competitive importance of strategic partnerships between certain industry members and the buyers

Factors Affecting Bargaining Power of Buyers

Power Of Buyer

FactorsHUFAMUFANMFAHFACommentNumber of Important buyersThreat of Backward integrationProduct suppliedSwitching cost% of buyers costProfit earned by buyerImportance to final quality of buyers Pr.Few

High

Commodity

High

High

Low

HighMany

Low

Specialty

Low

Low

High

low

Competitive Pressures: Collaboration Between Sellers and BuyersPartnerships between industry members and some/many of their customers can impact competitive pressuresCollaboration may result in mutual benefits regardingJust-in-time deliveriesOrder processingElectronic invoice paymentsData sharingCompetitive advantage may accrue to those industry members doing the best job of partnering with their customers

Overall Industry attractiveness

FactorsUnfavorableNeutralFavorableEntry BarriersExit BarriersRivalry among existing firmsPower of buyersPower of SuppliersThreat of substitutes

Strategic Implications of the Five Competitive ForcesCompetitive environment is ideal from a profit-making standpoint whenRivalry is moderateEntry barriers are high and no firm is likely to enter Good substitutes do not existSuppliers and customers are in a weak bargaining position

Coping With the Five Competitive ForcesObjective is to craft a strategy toInsulate firm from competitive pressuresInitiate actions to produce sustainable competitive advantageAllow firm to be the industrys mover and shaker with the most powerful strategy that defines the business model for the industry

Is the Collective Strength of the Five Competitive Forces Conducive to Good Profitability As a rule, the stronger collective impact of the five forces, the lower the combined profitability of industry participantsFierce to strong competitive pressures come from all five forces driving industry profitability to unacceptably low levelsAn industry can be competitively unattractive even when not all five forces are strongIntense 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 conditionsEffectively matching a companys strategy to prevailing competitive conditions have two aspectsPursing avenues that shield the firm from as many of the different competitive pressuresInitiating actions calculated to produce sustainable competitive advantage, thereby shifting competition in the companys favor, putting added competitive pressure on rivals, and perhaps even defining a business model for the industry

Question 3: What Forces Are Driving Industry Change and What Impacts Will They Have?Industries change because forces are driving industry participants to alter their actionsDriving forces are the major underlying causes of changing industry and competitive conditionsWhere do driving forces originate?Outer ring of macroenvironment (general environment)Inner ring of macroenvironment ( specific environment)

Analyzing Driving Forces: Three Key StepsSTEP 1: Identify forces likely to exert greatest influence over next 1 - 3 yearsUsually no more than 3 - 4 factors qualify as real drivers of changeSTEP 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

Table 3.2: The Most Common Driving Forces3-*

Question 4: What Market Positions Do Rivals Occupy?One technique to reveal different competitive positions of industry rivals is strategic group mappingA strategic group is a cluster of firms in an industry with similar competitive approaches and market positions

Strategic Group MappingFirms in same strategic group have two or more competitive characteristics in commonHave comparable product line breadthSell in same price/quality rangeEmphasize same distribution channelsUse same product attributes to appeal to similar types of buyersUse identical technological approachesOffer buyers similar servicesCover same geographic areas

Procedure for Constructing a Strategic Group MapSTEP 1: Identify competitive characteristics that differentiate firms in an industry from one anotherSTEP 2: Plot firms on a two-variable map using pairs of these differentiating characteristicsSTEP 3: Assign firms that fall in about the same strategy space to same strategic groupSTEP 4: Draw circles around each group, making circles proportional to size of groups respective share of total industry sales

Example: Strategic Group Map of Selected Automobile Manufacturers 3-*

Prentice Hall, 2000Chapter 3*Mapping Strategic Groups in the U.S. Restaurant Chain IndustryPrice

Guidelines: Strategic Group MapsVariables selected as axes should not be highly correlatedVariables chosen as axes should expose big differences in how rivals competeVariables do not have to be either quantitative or continuousDrawing sizes of circles proportional to combined sales of firms in each strategic group allows map to reflect relative sizes of each strategic groupIf more than two good competitive variables can be used, several maps can be drawn

Interpreting Strategic Group MapsThe closer strategic groups are on the map, the stronger the cross-group competitive rivalry tends to beNot all positions on the map are equally attractiveDriving forces and competitive pressures often favor some strategic groups and hurt othersProfit potential of different strategic groups varies due to strengths and weaknesses in each groups market position

The strategic group a firm should consider enteringThe type and level of entry barriers the firm will faceThe number and type of entry barriers the firm will faceThe strategic dimensions that will make the firm similar to its strategic group members and different from members of different strategic groupsThe relative effect of five forces of competition on its relative profitability

Implications of Strategic groups

Question 5: What Strategic Moves Are Rivals Likely to Make NextA firms best strategic moves are affected byCurrent strategies of competitorsFuture actions of competitors Profiling key rivals involves gathering competitive intelligence aboutCurrent strategiesMost recent actions and public announcementsResource strengths and weaknessesEfforts being made to improve their situationThinking and leadership styles of top executives

Competitor AnalysisSizing up strategies and competitive strengths and weaknesses of rivals involves assessingWhich rival has the best strategy? Which rivals appear to have weak strategies?Which firms are poised to gain market share, and which ones seen 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?

Question 6: What Are the Key Factors for Competitive Success?Key Success Factors (KSFs) are competitive factors and attributes that affect every industry members ability to be competitively and financially successfulKSFs are those particular attributes that are so important that they spell the difference betweenProfit and lossCompetitive success or failure KSFs can relate toSpecific strategy elementsProduct attributesResourcesCompetenciesCompetitive capabilitiesMarket achievements

Identifying Industry Key Success FactorsThe answers to 3 questions often help pinpoint an industrys KSFsOn what basis do customers choose between 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

Common Types of Industry Key Success Factors (KSF)Technology RelatedExpertise in particular technology or in scientific research ( important in pharmaceuticals, internet applications, mobile communications, and many high tech. industry Proven ability to improve production processes ( important in industries where advancing technology opens the way for higher manufacturing efficiency and lower production costs)Manufacturing Related KSFAbility to achieve scale economies and/or capture learning curve effects (important to achieving low production costs) Quality control know-how ( important in those industries where customers insists on product reliability) High utilization of fixed assets (important in capital intensive/ high fixed cost industries) Access to attractive supplies of skilled labor High labor productivity ( important for items with high labor content) Low cost product design and engineering ( reduces manufacturing costs) Ability to manufacture or assemble products that are customized to buyer specification

Distribution related KSFA strong network of wholesale distributors/dealers Strong direct sales capabilities via the internet and or having company owned retail outlets Ability to secure favorable display space on retailer shelves Marketing Related KSF A talented workforceDistribution capabilities Product innovation capabilities Short delivery time capability Supply chain management capabilities Strong e-commerce capabilities Breadth of product line and product selection A well known and respected brand name Courteous, personalized customer service Customer guarantees and warranties Clever advertising

Prentice Hall, 2000Chapter 3*Industry Matrix/ Competitive Profile Matrix ( CPM)Strategic FactorsWeightCompany ARatingCompany AWeighted ScoreCompany BRatingCompany BWeighted Score123456Total1.00Source:T. L. Wheelen and J. D. Hunger, Industry Matrix. Copyright 1997 by Wheelen and Hunger Associates. Reprinted by permission.

Prentice Hall, 2000Chapter 3*External Factor Analysis Summary (EFAS)External Strategic FactorsWeight

RatingWeighted ScoreComments123451.00Opportunities

Threats

Total Weighted ScoreNotes: 1. List opportunities and threats (510 each) in column 1. 2. Weight each factor from 1.0 (Most Important) to 0.0 (Not Important) in Column 2 based on that factors probable impact on the companys 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 companys response to that factor. 4. Multiply each factors weight times its rating to obtain each factors 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.

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