External Analysis – The identification of Opportunities and Threats

External Analysis

• Analyzing the dynamics of the industry in which an organization competes to help identify opportunities and threats

“To assure victory, always carefully survey the field before battle.” - Sun Tzu

Opportunities and Threats

• Opportunities arise when a company can take advantage of conditions in its environment to formulate and implement strategies that enable it to become more profitable.

• Threats arise when conditions in the external environment endanger the integrity and profitability of the company’s business.

Defining industry

• Industry: “…a group of companies offering products or services that are close substitutes for each other… that satisfy the same basic customer need.”– Identifying industry: Consumer-oriented view is better than

product-oriented view– Broader view is better than narrow view– Industry boundary may change

• Sector: “…a group of closely related industries.”

• Market Segments: “…distinct groups of customers within a market that can be differentiated from each other on the basis of their distinct attributes and specific demands..”

The Computer Sector:Industries and Segments

Forces Shape Competition

• Porter's five forces helps • Stronger these forces, limited is the ability of

firms to raise prices and earn profitWeak competitive forces = Opportunity Strong competitive force = Threat (because they depress profit)

• Strength of these forces changes• And are the opportunities and threats – design

appropriate strategic responses

Porter’s Five Forces Model

Risk of Entry by Potential CompetitorsCompetitors: “…companies… not currently competing in an industry but have the capability to do so...” They may not enter if barriers are high1. Economies of Scale – unit costs fall

Cost reductions – mass production of standardized output Bulk purchase discounts Cost savings

2. Brand Loyalty = creating customer preferences3. Absolute Cost Advantages v. New Entrants

Superior production operation and process due to accumulated experience, patents, and secret processes

Control of production inputs Lower financial risks

4. Customer Switching Costs 5. Government Regulation

Rivalry Among Established Companies

Rivalry: “…competitive struggle between companies in same industry to gain market share...” Influenced by1. Industry Competitive Structure- Number/size of

companies, consolidated vs. fragmented 2. Industry Demand Conditions

• Growing demand – reduces rivalry• Declining demand – encourages rivalry

3. Cost Conditions• High fixed costs – profitability leveraged by volume• Slow demand/growth – intense rivalry/lower profits

4. Exit Barriers – lock up firms and reduce profit• Write-off assets High fixed cost• Economic dependence Emotional attachment• Maintain assets Bankruptcy regulations

Bargaining Power of Buyers

Bargaining power here refers to the ability of buyers to bargain down prices charged by companies in the industry or to raise the costs of companies in the industry by demanding better quality and service

High: Threat because they squeeze profit

Buyers are most powerful when:

1. Suppliers = many small companies, buyers large/few2. Purchase in large quantities3. Suppliers depend on buyers for large % of orders4. Buyers switching costs are low 5. Buyer can purchase from several6. Buyers supply own needs

Bargaining Power of Suppliers

Suppliers are most powerful when:1. Few substitutes2. Industry not important to suppliers3. Buyers- purchase large % of orders4. Buyers experience significant switching costs 5. Suppliers can threaten to enter industry

• Produce/supply own product• Buyers cannot threaten to make own inputs

Substitute ProductsThey are “…products from different businesses or industries…can satisfy similar customer needs.”

1. Existence of close substitutes a strong threat - Substitutes limit price that companies can charge for product

2. Substitutes a weak competitive force• Few close substitutes• Companies in industry can raise prices and earn

additional profits.

Sixth Force: Complementors“…sell products that add value to the products.. In an industry… when use together….”

1. Substitutes/complements influence demand2. Important in demand & profitability in many hi-tech

industries

Strategic Groups Within IndustriesThey are“…follow a business model… similar to other companies within… group, but are different from the business model of other companies in other… groups.

Implications 1. Closest competitors in same strategic group viewed as

substitutes for each other2. Different competitive forces and may face different

set of opportunities/threatsMobility Barriers

3. Inhibit movement between strategic groups4. Include barriers to enter another group or exit existing

Industry Life Cycle Analysis• This approach

“…analyzes the effects of industry evolution on competitive forces over time…characterized by five distinct life cycle stages”

To remember:Strength and nature of five forces change as industry evolves

Stages in Industry Life Cycle

Stages1. Embryonic- beginning to develop; perfecting products,

educating customers, opening distribution channels

2. Growth- demand takes-off; focus on keeping up with high industry growth

3. Shakeout- demand approaches saturation, replacements; emergence of excess productive capacity

4. Mature- saturated with low/no growth; consolidation based on market share, driving down price

5. Decline- growth becomes negative; rivalry further intensifies based on rate of decline/exit barriers

Limitations of Models for Industry Analysis1) Life Cycle Issues

a) Cycles not always follow generalizationb) Rapid growth situations may skip embryonicc) Growth revitalized by innovation/social changed) Time span of stages can vary

2) Innovation and Changea) Punctuated Equilibrium- industry’s long term stable

structure punctuated with periods of rapid change/innovation

b) Hypercompetitive industries- permanent, ongoing innovation & competitive change

3) Company Differencesa) Significant variances in profit ratesb) Resources/capabilities determinants of profit

Punctuated Equilibrium& Competitive Structure

The Macro-environment

• Macro-economic Forces: rates of interest, currency exchange, inflation/deflation

• Global Forces: barriers to international trade and investment

• Technological Forces: new technologies• Demographic Forces: changes in characteristics of a

population• Social Forces: social values and mores• Political & Legal Forces: laws/regulations

Role of Macro Environment

The Role of the Macro-environment

Changes in one or more forces in the macro-environment can affect:– Competitiveness of the industry (Porter’s

Five Forces)– Attractiveness of the industry– Relative strengths (or weaknesses) of a

given company

Michael Porter on strategy

“Strategy is a choice on how to compete.”