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External Environment of Business
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BOS 200: Sept. 10, 2013 Evaluating a Company’s External Environment
Sara Jane McCaffrey
Values What is our mission? What is our scope? What do we value?
Capabilities
What are our strengths? Where might we have a competitive advantage?
Opportunities What does the market demand? Who, if anyone else, offers this value proposition?
Valuable competitive
position
How do we create and
sustain value?
Source: Harris and Lenox, 2013.
This week
Fundamental Principal of Competitive Strategy
--or-- } In a perfectly competitive market, no firm realizes
economic profits (rents).
The Fundamental Principal } If everyone can do it, it’s difficult to create and capture
value from it – or
In a perfectly competitive market, no firm realizes economic profits (rents) (straight from Econ 100).
} The existence of economic profits suggests some type of
market inefficiency.
} The strategist’s tasks is to identify ways in which firms may capitalize on these market imperfections.
} Multiple frames: who does this benefit?
5.9% 5.9%
10.4% 10.5%
11.7% 12.6%
13.4% 13.4% 13.7% 13.8% 13.9%
15.0% 15.4% 15.6% 16.0% 16.5% 17.0% 17.6%
19.0% 19.2% 19.5% 19.5%
21.0% 21.3%
26.4% 27.3%
28.6% 31.7%
37.6% 37.6%
40.9%
0.0% 10.0% 20.0% 30.0% 40.0%
Catalog, Mail-Order Houses Airlines Hotels
Knitting Mills Soft Drink Bottling
Oil and Gas Machinery Book Publishing
Laboratory Equipment Engines and Turbines
Bakery Products Wine and Brandy
Mobile Homes Cookies and Crackers
Iron and Steel Foundries Grocery Stores
Drug Stores Household Furniture
Child Day Care Services Malt Beverages
Household Appliances Men’s and Boys’ Clothing
Tires Medical Instruments
Semiconductors Distilled Spirits
Advertising Agencies Perfume, Cosmetics, Toiletries
Pharmaceuticals Soft Drinks
Prepackaged Software Security Brokers and Dealers
Source: Porter (2008)
Average Return on Invested
Capital (ROIC), Selected US Industries, 1992-2006
5.9% 5.9%
10.4% 10.5%
11.7% 12.6% 13.4% 13.4% 13.7% 13.8% 13.9%
15.0% 15.4% 15.6% 16.0% 16.5% 17.0% 17.6%
19.0% 19.2% 19.5% 19.5%
21.0% 21.3%
26.4% 27.3%
28.6% 31.7%
37.6% 37.6%
40.9%
0.0% 10.0% 20.0% 30.0% 40.0%
Catalog, Mail-Order Houses Airlines Hotels
Knitting Mills Soft Drink Bottling
Oil and Gas Machinery Book Publishing
Laboratory Equipment Engines and Turbines
Bakery Products Wine and Brandy
Mobile Homes Cookies and Crackers
Iron and Steel Foundries Grocery Stores
Drug Stores Household Furniture
Child Day Care Services Malt Beverages
Household Appliances Men’s and Boys’ Clothing
Tires Medical Instruments
Semiconductors Distilled Spirits
Advertising Agencies Perfume, Cosmetics, Toiletries
Pharmaceuticals Soft Drinks
Prepackaged Software Security Brokers and Dealers
Source: Porter (2008)
Average Return on Invested Capital (ROIC), Selected US Industries, 1992-2006
Porter’s Five Forces framework
Threat of substitute
products or services
Threat of new entrants
Rivalry among existing
competitors
Bargaining power of suppliers
Bargaining power of buyers
Five Forces framework
Threat of substitute
products or services
Threat of new entrants
Rivalry among existing
competitors
Bargaining power of suppliers
Bargaining power of buyers
Rivalry is intense when
1. Many competitors, roughly equal in size and power
2. Slow industry growth
3. High barriers to exit
4. Rivals are highly committed
5. Difficulty reading competitors’ signals
6. Lack of product differentiation/ low switching costs
Five Forces framework
Threat of substitute
products or services
Threat of new entrants
Rivalry among existing
competitors
Bargaining power of suppliers
Bargaining power of buyers
Threat of entry: less likely when 1. Economies of scale
2. Brand identity/ proprietary product differences
3. Network effects/ customer switching costs are high
4. Large capital requirements (especially for sunk costs)
5. Unequal access distribution channels
and/or product inputs
6. Restrictive government policy
7. Expected retaliation
Five Forces framework
Threat of substitute
products or services
Threat of new entrants
Rivalry among existing
competitors
Bargaining power of suppliers
Bargaining power of buyers
Threat of Substitutes: higher when
1. Demand is elastic http://www.youtube.com/watch?v=COf2bQEQ7Zw
2. Attractive price-performance trade-off for industry’s products
3. Switching costs are low
Five Forces framework
Threat of substitute
products or services
Threat of new entrants
Rivalry among existing
competitors
Bargaining power of suppliers
Bargaining power of buyers
Bargaining power of buyers
HIGHER when
Buyer groups are weaker/ more price sensitive
1. Buyers are concentrated (monopsony)
2. Industry’s products standardized and prices are transparent
3. Buyers have low switching costs
4. Buyer can credibly threaten to backward integrate
1. Industry’s product affects buyers’ quality
2. Product has little effect on buyers’ other costs
Five Forces framework
Threat of substitute
products or services
Threat of new entrants
Rivalry among existing
competitors
Bargaining power of suppliers
Bargaining power of buyers
Supplier threat is higher when . . . 1. Sellers (suppliers) are
concentrated (monopoly) } Suppliers do not depend heavily
on one industry for revenues 2. Changing suppliers à high
switching costs
3. Suppliers offer differentiated (not commodity) products
4. No (few) substitutes available
5. Supplier can forward integrate
Monopoly Power Competitive
Mutual Dependence
Monopsony Power
many
many
few
few
BUYER
SUPPLIER
More forces?
Threat of substitute
products or services
Threat of new entrants
Rivalry among existing
competitors
Bargaining power of suppliers
Bargaining power of buyers
Role of Complements
Role of Institutions
Role of Complements
Role of Institutions
Critiques of Porter’s Five Forces Framework
} Zero sum; no collaboration } But, strategic alliances happen and buyers and suppliers often
work together } Toyota way
} Too static/ stable – markets change!
} Doesn’t consider non-market environment, social responsibility, and ethics
But, still a useful tool for understanding a firm’s external environment!
What if an industry is unattractive?
} Raise switching costs
} Differentiate
} Coordinate – tacitly of course!
} Consolidation, vertical integration
} Innovate
} Certify / Lobby
} frequent flyer programs
} Swatch watches
} best-price clauses
} Telecoms; media
} Dupont: CFCs to HCFCs
} lawyers, doctors
(Time Permitting): Five Forces Analysis
Industry forces that limit economic rents
} Entry is less likely when incumbent firms have a
competitive advantage and can credibly retaliate against new entrants.
} Substitution is less likely when switching costs are high and cross-price elasticity is low.
} Buyer and supplier power depend on relative concentration, the viability of alternatives, and information availability.
} Rivalry is more intense when incentives to fight are large and tacit coordination is difficult.
Housekeeping } Memos: ready to hand back
} Good news: they are only 1/7 of your final grade
} Bad news: they are only 1/7 of your final grade
} For next time } Use the rubric in the syllabus } Deeply engage the readings