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Chapter 2 –The External Environment

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Knowledge ObjectivesStudying this chapter should provide you with the strategic management knowledge needed to:

1. Explain the importance of analyzing and understanding the firm’s external environment.

2. Define and describe the general environment and the industry environment.

3. Name and describe the general environment’s six segments.

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Knowledge Objectives – cont’dStudying this chapter should provide you with the strategic management knowledge needed to:

4. Identify the five competitive forces and explain how they determine an industry’s profit potential.

5. Describe what firms need to know about their competitors and different methods used to collect intelligence about them.

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The Strategic Management Process

Chapter 10Corporate

Governance

Chapter 11OrganizationalStructure and

Controls

Chapter 13Strategic

Entrepreneurship

Strategy Implementation

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Detroit’s Bet on the Future

Sources: “Chrysler falters as unsold gas guzzlers fill lots”, The Wall Street Journal, September 20, 2006: A14.

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What’s next…?“Most of us never recognize an opportunity until it goes to work in our competitor’s business.”

P. L. Andarr

“Only the paranoid survive.”

Andy Grove,former CEO of Intel

“[T]hat’s not true. The paranoid die because the paranoid take all threats as serious and get very distracted.”

Reed Hastings, CEO of Netflix

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Famous Misinterpretations“Heavier-than-air flying machines are impossible”

Lord Kelvin, British mathematician, physicist, and president of the British Royal Society, 1895

“Any customer can have a car painted any color that he wants so long as it is black.”

Attributed to Henry Ford

“I think there is a world market for about five computers”Thomas J. Watson, chairman of IBM, 1943

“We don’t like their sound. Groups of guitars are on the way out.”Decca Recording Co. executive, turning down the Beatles, 1962

“640K of memory should be enough for anybody.”Bill Gates, co-founder of Microsoft, 1982

“They couldn’t hit an elephant at this dist…”General John B. Sedgwick, last words, Battle of Spotsylvania, 1864

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Agenda1. Analysis of the external environment

2. “Five Forces” of competition model

3. Competitor analysis

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I/O Model: 4 AssumptionsExternal environment imposes pressures and constraints that determine strategies leading to above-average returns

1

2Most firms competing in an industry control similar strategically relevant resources and pursue similar strategies

Resources used to implement strategies are highly mobile across firms3

4Organizational decision makers are assumed to be rational and committed to acting in the firm’s best interests (profit-maximizing)

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The External Environment

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External Environment Analysis General environment

Focused on opportunities and threats

Industry environment

Focused on factors and conditions influencing a firm’s profitability within an industry

Competitor environment

Focused on predicting the dynamics of competitors’ actions, responses, and intentions

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General EnvironmentDimensions in the broader society that influence and industry and the firms within it

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General EnvironmentThe Economic SegmentThe Economic Segment

Nature and direction of economy a firm competes in

Inflation rates

Interest rates

Trade deficits or surpluses

Budget deficits or surpluses

Savings rate

GDP

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General Environment – cont’dThe Sociocultural SegmentThe Sociocultural Segment

Society’s attitudes and cultural values

Women in the workplace

Workforce diversity Attitudes about quality

of worklife Environmental concerns Shifts in work and

career preferences Shifts in product and

service preferences

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General Environment – cont’d

Source: Business Week, March, 2007: 4.

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General Environment – cont’dThe Global SegmentThe Global Segment

Institutional characteristics of global markets

Important political events

Critical global markets Newly industrialized

countries Different cultural and

institutional attributes WTO, NAFTA, EU,

ASEAN

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General Environment – cont’dThe Technological SegmentThe Technological Segment

Creating new knowledge and products/processes

Product innovations Applications of

knowledge Focus of private and

government-supported R&D expenditures

New communication technologies

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Examples for disruptive technologies:

Internet telephony

Digital photography

Hand-held computers

Discount brokers

E-commerce

Health maintenance

Nanotechnology

General Environment – cont’d

Link: “Future vision” of Vodafone

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General Environment – cont’dThe Political/Legal SegmentThe Political/Legal Segment

Regulatory environment Antitrust laws Taxation laws Deregulation

philosophies Labor training laws Educational

philosophies and policies

Legislation on corporate governance reforms (Sarbanes-Oxley Act)

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General Environment – cont’dThe Demographic SegmentThe Demographic Segment

Population characteristics

Population size

Age structure

Geographic distribution

Ethnic mix

Income distribution

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General Environment – cont’d

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Agenda1. Analysis of the external environment

2. “Five Forces” of competition model

3. Competitor analysis

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Industry EnvironmentIndustry defined

A group of firms producing products that are close substitutes

• Firms that influence one another

• Includes a rich mix of competitive strategies that companies use in pursuing strategic competitiveness and above-average returns

Sometimes, drawing the industry boundary is problematic(e.g., Whole Foods & Wild Oats)

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Five Forces of Competition

……explain explain industryindustry profitability!profitability!

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Low entry barriers

Interpreting Industry Analyses

UnattractiveIndustry

Suppliers and buyers have strong positions

Strong threats from substitute products

Intense rivalry among competitors

Low profit potential!

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AttractiveIndustry

High entry barriers

Interpreting Industry Analyses

Suppliers and buyers have weak positions

Few threats from substitute products

Moderate rivalry among competitors

High profit potential!

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Barriers to Entry – cont’dEconomies of Scale

Marginal improvements in efficiency that a firm experiences as it incrementally increases its size

Advantages and disadvantages of large-scale and small-scale entry

Cost Disadvantages Independent of Scale

Proprietary product technology

Favorable access to raw materials

Desirable locations

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Barriers to Entry – cont’d

Access to Distribution Channels

Stocking or shelf space

Price breaks

Cooperative advertising allowances

Product Differentiation

Unique products

Customer loyalty

Products at competitive prices

Capital Requirements

Physical facilities

Inventories

Marketing activities

Availability of capital

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Barriers to Entry – cont’dSwitching Costs

One-time costs customers incur when they buy from a different supplier

New equipment

Retraining employees

Psychic costs of ending a relationship

Government policy

Licensing and permit requirements

Deregulation of industries

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Barriers to Entry – cont’dExpected retaliation

Responses by existing competitors may depend on a firm’s present stake in the industry (available business options)

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Suppliers’ Bargaining PowerSupplier power increases when:

Suppliers are large and few in number

Suitable substitute products arenot available

Individual buyers are not largecustomers of suppliers and thereare many of them

Suppliers’ goods are critical to buyers’ marketplace success

Suppliers’ products create high switching costs.

Suppliers pose threat to integrate forward into buyers’ industry

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Buyers’ Bargaining PowerBuyer power increase when:

Buyers are large and few in number

Buyers purchase large portion of industry’s total output

Buyers’ purchases are significant portion of supplier’s annual revenues

Buyers can switch to another product without incurring high switching costs

Buyers pose threat to integrate backward into sellers’ industry

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Threat of Substitute ProductsThe threat of substitute products increases when:

Buyers face few switching costs

The substitute product’s price is lower

Substitute product’s quality andperformance are equal to or greaterthan existing product

Differentiated industry products that are valued by customers reduce this threat

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Rivalry Among CompetitorsIndustry rivalry increases when:

There are numerous or equally balanced competitors

Industry growth slows or declines

There are high fixed costs or high storage costs

There is a lack of differentiationopportunities or low switching costs

Strategic stakes are high

High exit barriers prevent competitors from leaving the industry

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New Trends: The Internet Influence

Sources: Canzer, B. (2003). “E-business: Strategic thinking and practice”, Boston: Houghton Mifflin; Porter, M. E. (2001). “Strategy and the Internet”, Harvard Business Review, March: 63–78; Rangan, S. & Adner, R. (2001). “Profits and the Internet: Seven misconceptions”, MIT Sloan Management Review, Summer: 44–53.

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New Trends: Industry BoundariesThink about the nature of the following industries:

Telecommunications

Computers and peripheral equipment

Consumer electronics

In other words, ABC’s competitors may no longer only include CBS, NBC, CNN, and Fox, but also AT&T, SkyTV, Microsoft, Apple, Sony, and others!

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Agenda1. Analysis of the external environment

2. “Five Forces” of competition model

3. Competitor analysis

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Competitor AnalysisCompetitor Intelligence

The ethical gathering of needed information and data that provides insight into:

• A competitor’s capabilities and intentions (current strategy)

• A competitor’s beliefs about the industry (its assumptions)

• A competitor’s direction (future objectives)

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Competitor Analysis Components