McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

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

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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

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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?