Chapter 3: Evaluating a Company’s External Environment

1. Chapter 3: Evaluating a Company’s External Environment Screen graphics created by: Jana F. Kuzmicki, Ph.D. Troy University

2. “Analysis is the critical starting point ofstrategic thinking.” Kenichi Ohmae Consultant and Author

3. “Things are always different – the art is figuring out which differences matter.” Laszlo Birinyi Investments Manager

4. Chapter Learning Objectives • To gain command of the basic concepts and analytical tools widely used to diagnose a company’s industry and competitive conditions. • To become adept in recognizing the factors that cause competition in an industry to be fierce, more or less normal, or relatively weak. • To learn how to determine whether an industry’s outlook presents a company with sufficiently attractive opportunities for growth and profitability. • 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.

5. 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?

6. Understanding the Factors that Determine a Company’s Situation • Diagnosing a company’s situation has two facets • Assessing 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

7. Figure 3.1: From Thinking Strategically About theCompany’s Situation to Choosing a Strategy 3-7

8. Figure 3.2: The Components of a Company’s Macro-environment 3-8

9. 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 factorsthat have a bearingon 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

10. 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? How attractive is the industry from a profit perspective? What are the key factors for competitive success? What market positions do rivals occupy? What moves will they make next? 3-10

11. Question 1: What are the Industry’sDominant Economic Traits? • 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

12. Table 3.1: What to Consider in Identifyingan Industry’s Dominant Economic Features 3-12

13. Learning/Experience Effects • Learning/experience effectsexist when a company’s unit costs decline as its cumulativeproduction 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 cumulativeproduction volume

14. 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

15. Figure 3.3: The Five Forces Model of Competition 3-15

16. Analyzing the Five Competitive Forces: How to Do It Step 1:Identify the specific competitivepressures associated with each ofthe five forces Step 2:Evaluatethe strength of eachcompetitive force – fierce, strong,moderate to normal, or weak? Step 3:Determinewhether the collectivestrength of the five competitive forcesis conducive to earning attractive profits

17. Competitive PressuresAmong Rival Sellers • Usually the strongestof 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

18. Figure 3.4: Weapons for Competing and Factors Affecting Strength of Rivalry 3-18

19. 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 3-19

20. What Causes Rivalry to be Stronger? • 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 termsof 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

21. What Causes Rivalry to be Weaker? • 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

22. 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.

23. Competitive PressuresAssociated With Potential Entry • Seriousness of threat depends on • Sizeof 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

24. Figure 3.5: Factors Affecting Threat of Entry 3-24

25. Common Barriers to Entry • 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

26. When Is the Threat of Entry Stronger? • 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

27. When Is the Threat of Entry Weaker? • 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

28. Competitive Pressures from Substitute Products Substitutes matter when customersare attracted to the products offirms in other industries Concept Examples • Sugar vs. artificial sweeteners • Eyeglasses and contact lensvs. laser surgery • Newspapers vs. TV vs. Internet

29. 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

30. Figure 3.6: Factors Affecting Competition From Substitute Products 3-30

31. When Is the CompetitionFrom Substitutes Stronger? • 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

32. When Is the CompetitionFrom Substitutes Weaker? • 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

33. Competitive Pressures From Suppliersand Supplier-Seller Collaboration • 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

34. Figure 3.7: Factors Affecting Bargaining Power of Suppliers 3-34

35. When Is the BargainingPower of Suppliers Stronger? • Industry members incur highcosts in switching their purchasesto alternative suppliers • Needed inputs are in short supply • Supplier provides a differentiated inputthat 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

36. When Is the Bargaining Power of Suppliers Weaker? • Item being supplied is a commodity • Seller switching costs to alternative suppliers are low • Good substitutes exist or new ones emerge • Surge in availability of supplies occurs • Industry members account for a bigfraction of suppliers’ total sales • Industry members threatento integrate backward • Seller collaboration with selected suppliers provides attractive win-win opportunities

37. Competitive Pressures: Collaboration Between Sellers and Suppliers • Industry members often forge strategic partnerships with select suppliers to • Reduce inventory and logistics costs • Speed availability ofnext-generation components • Enhance quality of parts being supplied • Squeeze out cost savings for both parties • Competitive advantage potential may accrue to those industry members (sellers) doing the best job of managing supply-chain relationships

38. Competitive Pressures From Buyersand Seller-Buyer Collaboration • Whether the relationships between industry members and buyers represent a weakor strong competitive force depends on • Whether buyers have sufficientbargaining leverage to influenceterms of sale in their favor • Extent and competitive importance ofstrategic partnerships between certain industry members and the buyers

39. Figure 3.8: Factors Affecting Bargaining Power of Buyers 3-39

40. When Is the BargainingPower of Buyers Stronger? • Buyer switching costs to competing brands or substitutes are low • Buyers are large and can demand concessions • Large-volume purchases by buyers are important to sellers • Buyer demand is weak or declining • Only a few buyers exists • Identity of buyer adds prestigeto seller’s list of customers • Quantity and quality of informationavailable to buyers improves • Buyers have ability to postpone purchases until later • Buyers threaten to integrate backward

41. When Is the BargainingPower of Buyers Weaker? • Buyers purchase item infrequently or in small quantities • Buyer switching costs tocompeting brands are high • Surge in buyer demandcreates a “sellers’ market” • Seller’s brand reputation is important to buyer • A specific seller’s product delivers qualityor performance that is very important to buyer • Buyer collaboration with selected sellers provides attractive win-win opportunities

42. Competitive Pressures: CollaborationBetween Sellers and Buyers • Partnerships between industry members and some/many of their customers can impact competitive pressures • Collaboration may result inmutual benefits regarding • Just-in-time deliveries • Order processing • Electronic invoice payments • Data sharing • Competitive advantage may accrue to those industry members doing the best job of partnering with their customers

43. For Discussion: Your Opinion Explain why low switching costs and weakly differentiated products tend to give buyers a high degree of bargaining power.

44. Strategic Implications ofthe Five Competitive Forces • Competitive environment isunattractive from the standpointof earning good profits when • Rivalry is vigorous • Entry barriers are lowand entry is likely • Competition from substitutes is strong • Suppliers and customers haveconsiderable bargaining power

45. Strategic Implications ofthe Five Competitive Forces • Competitive environmentis ideal froma profit-making standpoint when • Rivalry is moderate • Entry barriers are highand no firm is likely to enter • Good substitutesdo not exist • Suppliers and customers arein a weak bargaining position

46. Coping With theFive Competitive Forces • Objective is to craft a strategyto • Insulate firm fromcompetitive pressures • Initiate actions to producesustainable competitive advantage • Allow firm to be the industry’s “mover and shaker” with the “most powerful” strategy that defines the business model for the industry

47. Question 3: What Forces Are Driving Industry Change and What Impacts Will They Have? • Industries change because forcesare driving industry participantsto alter their actions • Driving forces are themajor underlying causesof changing industry andcompetitive conditions • Where do driving forces originate? • Outer ring of macroenvironment • Inner ring of macroenvironment

48. Analyzing Driving Forces: Three Key Steps STEP 1: Identify forces likely to exert greatest influence over next 1 - 3 years • Usually no more than 3 - 4 factorsqualify as real drivers of change STEP 2:Assess impact • Are driving forces acting to cause market demand for product to increase or decrease? • Are driving forces acting to make competitionmore or less intense? • Will driving forces lead to higher or lower industry profitability? STEP 3:Determine what strategy changes are needed to prepare for impacts of driving forces

49. Common Types of Driving Forces • Changes in long-term industry growth rate • Increasing globalization of industry • Emerging new Internet capabilitiesand applications • Changes in who buys theproduct and how they use it • Product innovation • Technological change/process innovation • Marketing innovation

50. Common Types of Driving Forces (con’t) • Entry or exit of major firms • Diffusion of technical knowledge • Changes in cost and efficiency • Consumer preferences shiftfrom standardized todifferentiated products (or vice versa) • Changes in degree of uncertainty and risk • Regulatory policies / government legislation • Changing societal concerns, attitudes, and lifestyles