External and Industry Environment Analysis

Dr. K. Rangarajan

31 May 2012

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Objectives - Analysis of Environment

General environment

Focused on the futurefuture

Industry environment

Focused on industryindustry--specificspecific factors influencing firm profitability

Competitor environment

Focused on competitive dynamicscompetitive dynamics

competitors’ capabilities, intentions, actions, responses

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Two Determinants of Profitability

Environmental Attractiveness

CompetitivePosition

Advantage

Disadvantage

Low High

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Business Environment

External & internal conditions effecting the firm

Firm trades & competes within an economy, & an industry

Constant changes require systematic monitoring

Environmental changes destroy & create business opportunities

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External Environmental Analysis

A continuous process which includesA continuous process which includes

l Scanning: Identifying early signals of environmental changes and trends

l Monitoring: Detecting meaning through ongoing observations of environmental changes and trends

l Forecasting: Developing projections of anticipated outcomes based on monitored changes and trends

l Assessing: Determining the timing and importance of environmental changes and trends for firms’ strategies and their management

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Three Component Relationship of the Firm to the Business Environment

Deterministic - Regulatory, legal and market structures taken as givens

Probabilistic – Areas where the firm has the ability to increase its odds of success.

Random – Uncontrollable and uncertain elements from which the firm can attempt to protect itself

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AN ORGANIZATION’S ENVIRONMENT

Industry SectorCompetitors,

Industry size and Characteristics, Related Industries

Raw Materials Sector

Suppliers, Manufacturers, Real Estate

Human Resources Sector

Labor Market, Employment Agencies, Universities, Training Schools, Employees in Other Companies, Unionization Financial Resources Sector

Stock Markets, Banks,

Savings and Loans,

Private InvestorsMarket Sector

Customers, Clients, Potential Users of Products and Services

Technology Sector

Techniques of Production, Science, Research Centers, Automation, New Materials

Economic Conditions

Sector

Recession, Unemployment Rate, Inflation rate, Rate of

Investment, Economics, Growth

Government Sector

City, State, Federal Laws and Regulations, Taxes, Services, Court System, Political Processes

Socio-Cultural sector

Age, Values, Beliefs, Education, Religion, Work Ethic, Urban vs. Rural, Birth Rate

ORGANIZATION

DOMAIN

Task Environment

Macro Environment

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External Environmental Analysis

Strategic IntentStrategic IntentStrategic MissionStrategic Mission

The ExternalThe ExternalEnvironmentEnvironment

Analysis of macro/general environmentAnalysis of macro/general environment

Analysis of task environmentAnalysis of task environment

Analysis of competitor Analysis of competitor environmentenvironment

The ExternalThe ExternalEnvironmentEnvironment

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Environmental Uncertainty

Level of uncertainty depends on 2 dimensions:

Degree of change within the industry

Stable to dynamic

Degree of Homogeneity within industry

Simple to complex

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Stable

Unstable

Simple Complex

1. Small number of external elements

2. Elements remain the same or change slowly or relatively predictably

Examples: Soft drink bottlers, beer distributors, container manufacturers,local utilities

Complex + Stable =LOW MODERATE

UNCERTAINTY

1. Large number of external elements

2. Elements remain the same or change slowly or relatively predictably

Examples: Universities, hospitals, insurance companies

Simple + Unstable =HIGH MODERATE UNCERTAINTY

1. Small number of external elements

2. Elements change frequently, more unpredictably and reactively

Examples: Fashion clothing, music industry, toy

manufacturers

Complex + Unstable =HIGH UNCERTAINTY

1. Large number of external elements

2. Elements change frequently, more unpredictably and reactively

Examples: American airlines, oil companies, electronic firms, aerospace firms, personal computers

Simple + Stable = LOW UNCERTAINTY

Organizational uncertainty

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Key Steps in an External Analysis

1. Determine which questions you are trying to answer.

1. What do you want to know?

2. Why do you need to know it?

2. Determine the Scope and Scale of the Analysis.

1. What is the appropriate level of analysis?

2. What trends do you need to investigate?

3. What segments are involved?

4. How would classify the issues?

5. How important are they to the firm?

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Key Steps Continued.

1. Determine information needs

1. What types and amounts of information are needed?

2. Where is that information located?

3. How can you get the required information?

4. How can we get the data to the people that need it?

2. Understanding the Data

1. What do the data mean?

2. How might the data benefit the firm?

3. What threats do the data represent?

4. How can you use the data to your firm’s advantage?

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Macro-environment – PESTEL (1)

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Macro environment – PESTEL (2)

Political

• Government stability

• Taxation policy

• Foreign trade regulations

• Social welfare policies

Economic

• Business cycles

• GNP trends

• Interest rates

• Money supply

• Inflation

• Unemployment

• Disposable income

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Macroenvironment – PESTEL (3)

Sociocultural

• Population demographics

• Income distribution

• Social mobility

• Lifestyle changes

• Attitudes to work and leisure

• Consumerism

• Levels of education

Technological

• Government spending on research

• Government and industry focus on technological effort

• New discoveries /developments

• Speed of technology transfer

• Rates of obsolescence

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Macroenvironment – PESTEL (4)

Environmental

• Environmental protection laws

• Waste disposal

• Energy consumption

Legal

• Competition law

• Employment law

• Health and safety

• Product safety

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Key Aspects of PESTEL Analysis

• Not just a list of influences

• Need to understand key drivers of change

• Focus is on future impact of environmental factors

• Combined effect of some of the factors likely to be most important

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Related and supporting industries

Demand conditions

Factor conditions

Firm strategy structure and

rivalry

Chance

GovernmentGovernment

Porter’s Diamond

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Determinants in the Diamond

I. Factor Conditions

The nation’s position in factors of production

These factors can be grouped as follows:

Human Resource; Physical Resource; Knowledge Resource; Capital Resource; Infrastructure

Competitive advantage from factors depends on how efficiently and effectively they are deployed

II. Demand Conditions

The quality of home demand determines competitive advantage

Nature of domestic Buyers + Size and Pattern of Growth +

Transmission to Foreign Market Competitive Advantage

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Determinants in the Diamond (Contd.)

III. Related and Supporting Industries

The presence or absence of supplier industries and related industries that are internationally competitive

IV. Firm Strategy, Structure and Rivalry

The conditions in the nation governing how companies are created, organised and managed and the nature of domestic rivalry

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Inter-relationship in the Diamond

New EntrantsEarly product

penetration feeds industry

Attracts New Entrants though factor abundance or specialisation

Firm Stgy. Structure and

Rivalry

Encourages formation of more

specialists

Stimulated growth of supplier industries

Factor pools are transferable to related

industries

Related & Supported Industries

Rivalry boosts home demand and

its specification

Pull foreign demand for the industry product

Attract Foreign firms/individuals for the nation’s products

Demand conditions

Stimulates faster creation though

rivalry/ challenges

Create or stimulate creation

of transferable factors

Influence priorities for faster creation

of investments

Factor conditions

Firm Stgy. Structure and

Rivalry

Related & Supported Industries

Demand conditions

Factor conditionsDeterminants

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Competitive Diamond Indian Apparel Cluster

Weak/MediumWeak/Medium

WeakWeak

Weak-With Potential

Weak-With Potential

Basic=StrongAdvanced=Weak

Basic=StrongAdvanced=Weak

Demand Condition

s

Strategy Structure Rivalry

Factors

Cluster

-Dependency on intermediaries-Lack of first-hand exposure to demanding

or trend-setting consumers-Low knowledge of high-income segments

-Dependency on foreign brands-Poorly Exposed to stringent buyer

requirements+Entrepreneurs read and travel widely

+Indirect exposure via clients

-Over-dependence on privileged market access-Mainly supplying labor

-Mainly commodity/price competition+Some moving to full package/design

+Many industry participantsBasic:+Proximity to Stgic. Mkts.

+Good IT Support+Good managerial/supervisory base

+Favorable tax incentives+Good park infrastructure and policy

+Relatively low labor costsAdvanced:

-Weak Telecom support- Weak port and airport

-Weak in higher skills training--Weak financial sector

+/-Transport logistics and costs+Some emerging CAD capability -Lack of local base of critical related industries

-Dependency on foreign providers of technology

-Inadequate schools and training providers-Lack Govt. vision for cluster development

-Bureaucracy & Red-tapisim

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Competitive Environment

The essence of strategy formulation is coping with competition.

The corporate strategists’ goal is to find a position in the industry where his or her company can best defend itself against these forces or can influence them in its favor.

Managers must understand the conditions of competition within their industry

Porter Five-Forces Model of Competition (determining the attractiveness of an industry)

Key Success Factors

Competitive Changes During industry Evolution

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Defining an Industry

Industry

A group of companies offering products or services that are close substitutes for each other

Competitors

Rival companies that serve the same basic customer needs

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Defining an Industry (cont’d)

SectorA group of closely related industries

Market segmentsDistinct groups of customers within a market that can be differentiated from each other based on their distinct attributes and demands

Changing industry boundaries

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The Computer Sector: Industries and Segments

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Five Forces Driving Industry Competition

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Threat of New Entrants

Fundamental question: how easy is it for another company to enter the industry?

Factors making easy entry to industry

Low economies of scale

Low product differentiation

Low capital requirements

No switching costs

Easy access to distribution channels

Little government regulation

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Supplier Power

Fundamental question: how badly does a supplier need your business?

Factors giving power to supplier:

Supplier industry dominated by few firms

Buyer is not important to customer

Supplier’s product is important input to buyer’s product

Supplier’s products have high switching costs

Supplier can “integrate forward” and become competitor of buyer

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Threat of Substitutes

Fundamental question: what other products or services could perform the same function as your products or services?

Factors indicating high threat of substitutes:

Few switching costs for buyer

Price of substitute lower or quality higher than for your products

Firms offering substitutes have high profitability

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Buyer Power

Fundamental questions: How badly does a buyer need your products or services?

Factors contributing to high buyer power:

Few buyers compared to the number of sellers

Buyers purchases high relative to seller’s sales

Products are undifferentiated

Buyer has low switching costs

Buyer has low profits

Buyer can “integrate backward” and supply the product to itself

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Competitive Rivalry

Fundamental question: how intense is competition in the industry?

Factors leading to high competitive rivalry:

Numerous or equally balanced competitors

High fixed costs

Slow industry growth

Lack of differentiation or switching costs

High strategic stakes

High exit barriers

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A Sixth Force: Complementors

Not a supplier

Offers service or product that affects industry’s performance

When complementors are important and their number is increasing

Demand and profits in the industry are boosted

When complementors are weakIndustry growth can slow and profits can be limited

Example: Internet Service Providers “complementors” to eBusiness firms

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Strategic Implications of theFive Competitive Forces

• Competitive environment is unattractive from the standpoint of earning good profits when:

– Rivalry is strong

– Entry barriers are low and entry is likely

– Competition from substitutes is strong

– Suppliers and customers have considerable bargaining power

• Competitive environment is ideal from a profit-making standpoint when:

– Rivalry is moderate

– Entry barriers are high and no firm is likely to enter

– Good substitutes do not exist

– Suppliers and customers are in a weak bargaining position

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Key Success Factors

In many industries, there are certain actions or practices that a business must follow in order to compete in the industry.

May need effort to distinguish company from competitors

AN INDIVIDUAL COMPANY DOES NOT HAVE KEY SUCCESS FACTORS!!!!

KEY SUCCESS FACTORS ARE NOT THE SOURCE OF A COMPANY’S COMPETITIVE ADVANTAGE –THEY ARE REQUIREMENTS FOR COMPETING IN AN INDUSTRY AND DO NOT GIVE ANY FIRM A COMPETITIVE ADVANTAGE

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Examples of Key Success Factors in Selected Industries

Pharmaceuticals: research and personal selling

Beer: advertising and distribution

Restaurant: quality food, service, location

Retailer: location and priced-for-quality

Automobiles: Assembly line efficiency

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Changes in Competition During Industry’s Evolution

Over time as an industry evolves, the nature and basis of competition changes

Managers must anticipate how the forces will change as the industry evolves and formulate appropriate strategies

Five Stages ( similar to product-life cycle)

Embryonic—introduction of product

Growth

Shakeout

Mature

Declining

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Stages in the Industry Life Cycle

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Shakeout: Growth in Demand and Capacity

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Requirements in Each Stage of Industry’s Evolution

Embryonic: Know-how, educating customers, opening distribution channels

Growth: Know-how for continued innovation, financing, build demand

Shakeout: Dominant market position, low cost producer, high capacity

Maturity: low cost production, brand loyalty

Declining: lowest cost production, reduce capacity

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Limitations of Models for Industry Analysis

Life cycle issues

The embryonic stage can sometimes be skipped

Industry growth can be revitalized

The time span of the stages can vary

Innovation and change

Innovation can unfreeze and reshape industry structure

An industry may be hypercompetitive, with permanent and ongoing change

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Limitations of Models for Industry Analysis (cont’d)

Company differences

The importance of company differences within an industry or strategic group can be underemphasized

The individual resources and capabilities of a company may be more important in determining profitability than the industry or strategic group

THANK YOU