Chapter 4Exploring the External Environment: Macro and Industry Dynamics

2

OBJECTIVES

Explain the importance of the external context for strategy and firm performance

1

Use PESTEL to identify the macro characteristics of the external context

2

Identify the major features of an industry and the forces that affect industry profitability

3

Understand the dynamic characteristics of the external context

4

Show how industry dynamics may redefine industries5

Use scenario planning to predict the future structure of the external context

6

3

THE COLA WARS

“Coca-Cola sells a billion servings – in cans, bottles, and glasses – every day. You can grab a Coke in almost 200 countries. Its archrival, Pepsi, isn’t too far behind. Like ford versus Chevy, theirs is a battle not just for customer dollars, but for their hearts and minds as well.

– The History Channel, “Empires of industry. Cola Wars”

4

THE COLA WARS (TIMELINE)

Coca-Cola

Coca-Cola invented

“Kick Pepsi's can” Diet CokeNew Coke

Repair Coke and restore Stock price Diversify product line

1886

1950

1960

1970

1980

1990

2000

Pepsi

“Beat Coke”

“Pepsi Generation”

“Pepsi Challenge”

Foster entrepreneurial spirit of Pepsi’s people

Jettison slow-growing businesses

Diversify beyond soft-drinks

5

EXTERNAL CONTEXT OF STRATEGY

• An internal analysis is just half of what is needed to build strategy

• The SWOT and more complicated frameworks help us understand the full picture

Internal

• Strengths

• Weaknesses

• Capabilities

• Relationships

• Etc.

6

COMPARATIVE INDUSTRY – WIDE LEVEL OF PROFITABILITY, 1995 – 2004

Source: Data from Standard and Poor’s CompuStat

Weighted average return on invested capitalPercent

-5

0

5

10

15

20

25

Bever-ages

Ciga-rettes

Pharma-ceuticals

Eatingesta-blish-ments

Steel Rail-roads

Truck-ing

Bott-lers

Comp-uters

Agri-cul-turalproducts

Pre-packagedsoftware

Air-lines

Wire-lesspro-viders

7

THE EXTERNAL ENVIRONMENT OF THE ORGANIZATION

Macro Environment Political, Economic, Sociocultural,

Technological, Environmental, Legal

Industry Environment

Strategic Group

The Organization

8

KEY QUESTION TO ASK

What macro environmental conditions will have a material effect on our ability to implement our strategy successfully?

How stable are these characteristics?

What is our firm’s industry?

What are the characteristics of the industry?

9

UNDERSTANDING THE MACRO ENVIRONMENT USING A PESTEL ANALYSIS

• How stable is the political environment?• Tax policies• Etc.

• Projected interest rates?• Inflation?• Etc.

• Lifestyle trends?• Demographic changes?• Etc.

• Level of government research funding?• How mature is technology?• Etc.

Political

Economic

Socio-cultural

Technological

• Is intellectual property protected?• Relevant consumer laws? • Etc.

Legal

10

PRESSURES FAVORING INDUSTRY GLOBALIZATION

• Interdependent countries

• Homogeneous customer needs

• Favorable trade policies

• Large scale and scope economies

• Global competitors

• Global customer needs

• Common technological standards

• Learning and experience

• Global channels • Common manufacturing and marketing regulations

• Sourcing efficiencies

CompetitionMarkets GovernmentsCosts

• Favorable logistics

• Arbitrage opportunities

• High R&D costs

• Transferable marketing approaches

Source: Adapted from M.E. Porter, Competition in Global industries (Boston: Harvard Business School Press, 1986); G. Yip, “Global Strategy in a World of Nations, “ Sloan Management review 31:1 (1989), 29-40

11

COMPETITION DRIVES PROFITS TO A “NORMAL” LEVEL

CompetitionProfits (abovenormal)

CostsRevenue

Profits (abovenormal)

CostsRevenue

Co

mp

etit

ion

12

KEY SUCCESS FACTORS AS BARRIERS TO ENTRY

Key asset or requisite skill that all firms in an industry must possess in order to be a viable competitor

Key success factor (KSF)

Ability to meet competitive pricing

Extensive distribution

Ability to raise consumer awareness

Broad product mix

Global presence

Well positioned bottlers and bottling capacity

KSFs:

SOFT DRINK EXAMPLE

13

INDUSTRY FRAGMENTATION AND CONCENTRATION

Monopoly Duopoly Fragmented

14

CONCENTRATION IN SELECT U.S. INDUSTRIES

Source: U.S. Census Bureau, “Economic Census: Concentration Rations”, Economic Census 2002 (accessed July 15,2005),www.census.gov/epcd/www/concentration.html

Percent of market

Entirefoodindustry

Animal

food

Break-fastcereal

Dairy pro-ducts

Entireapparel industry

Men’s and boys’ apparel

Women’s and girls’ apparel

Others

Top four competitors

15

ANALYZING INDUSTRY STRUCTURE USING FIVE – FORCES

Complementors

•Number of complements

•Relative value added

•Barriers to complement entry

•Difficulty of engaging complements

•Buyer perception of complements

•Complement exclusivity

Buyer Power (Channel and End consumer)• Bargaining leverage• Buyer volume• Buyer information• Brand identity• Price sensitivity• Threat of backward integration• Product differentiation• Buyer concentration vs. industry• Substitutes available• Buyer’s incentives

Supplier Power• Supplier concentration• Importance of volume to supplier• Differentiation of inputs • Impact of inputs on cost or differentiation• Switching costs of firms in the industry• Presence of substitute inputs• Threat of forward integration• Cost relative to total purchases in industry

Threat of New Entrants (and Entry Barriers)• Absolute cost advantages • Proprietary learning curve• Access to inputs• Government policy• Economies of scale• Capital requirements• Brand identity• Switching costs• Access to distribution• Expected retaliation• Proprietary products

Threat of Substitutes• Switching costs• Buyer inclination to substitute • Price-performance tradeoff of

substitutes• Varity of substitutes• Necessity of product or service

Degree of Rivalry• Exit barriers • Industry concentration• Fixed costs/value added• Industry growth• Intermittent overcapacity• Product differences • Switching costs• Brand identity• Diversity of rivals• Corporate stakes

Source: Adapted from M.E. Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors (New York: Free Press, 1980)

Industry value chain – from raw materials and other inputs, to channel to end consumer

16

CAUSES OF RIVARLY

Barriers to Entry

• Strong brands • Proprietary technology• Start-up costs • Etc.,

Barriers to Exit

• Few other opportunities • Sunk investments• Etc.,

In addition to entry and exit barriers,many factors drive rivalry

• History of price wars

• Level of fixed costs

• Industry concentration

• Market growth

• Etc.

17

SUPPLIER POWER

When firms in the supply industry can dictate terms, they can extract greater profits

Diamond supplyPercent

DeBeers

Others

50

Diamond Retailers

50

18

BUYER POWER

Suppliers Buyers

Profits

ILLUSTRATIVE

In industries characterized with many suppliers and few buyers, buyers often capture a greater share of profits

Industry A

Suppliers Buyers

Industry B

Profits

19

THREAT OF SUBSTITUTES

Soft drinks

Coke Pepsi

Movie rentals

Block buster

Hollywood videoB

ott

led

wat

er

Cab

le T

V

20

IMPACT OF COMPLEMENTOR

Any factor that makes it more attractive for suppliers to supply an industry on favorable terms or that makes it more attractive for buyers to purchase products or services from an industry at prices higher than it would pay absent the complementor

Complementor:

Hot dogs

+

Buns

More sales

Three Examples

Music

+

MPS player

More attractive offering

Delta plane

orders+

American Airlinesplane orders

Lower costs from Boeing

21

MAPPING STRATEGY GROUPS: U.S. BICYCLE INDUSTRY

Cannondale, GaryFisher, Klein

Huffy,Murray,Brunswick

Schwinn/GTMongoose

TrekSpecialized

Independentdealers

Independentdealers and massmerchandisers

Massmerchandisersonly

Principal distribution channels

Pri

ce/q

ual

ity/

imag

e

Low

High

22

HOW WOULD YOU DO THAT? – U.S. AIRLINE INDUSTRY

Rivalry?

Newentrants?

Buyerpower?

Substitutes?

Supplierpower?

Complementors?

How would youdefine the industry?

23

IMPORTANCE OF DYNAMIC STRATEGIC ANALYSIS

Pineapple industrypre-1980s

Fresh Del-Monte introduces the “Extra Sweet Gold” brighter

color, sweeter, resistant to nothing

FreshDel-Monte

(70%)

Pineapple industry post introduction

24

INDUSTRY LIFE CYCLE

Source: Adapted from K. Rangan and G. Bowman, “Beating the Commodity Magnet,” Industrial Marketing Management 21 (1992), 215-224; P. Kotler, “Managing Products through their Product Life Cycle,” in Marketing Management: Planning, Implementation, and Control, 7th ed (Upper Saddle River, NJ: Prentice Hall, 1991)

Mar

ket

Siz

e

Time

Embryonic

Technological uncertainty

Niche market – selected products for selected markets

Participants emphasize problem solving – product as “solution”

Growing

Customers become better informed

Market expands beyond niche

More competitors enter

Mature

Aggressive customers

Proliferation of products and markets served

Market volatility and beginnings of industry consolidation

In Decline

Product/market contraction

Further consolidation and industry regeneration

25

TECHNOLOGICAL DISCONTINUITIES

Discontinuities

Process-related

Product-related

Southwest airlines radically changed the airline business model by adopting new processes (e.g., a point-to-point model)

In disk-drive industry, virtually every new generation of technology led to demise of market leader

Example

26

Modems

WHEN INDUSTRIES DIVIDE OR COLLIDE

Industries Divide

Invents new interface

Radio

Cable

TV Production

TV networks

Media conglomerate

• Time Warner

• Viacom

• Disney

• Etc.

Launches palm pilot/ creates first PDA

Industries Collide

3-Com

Modems

27

SCENARIO PLANNING

Assess the strategic implications of each scenario

6

Specify indicators that can signal which scenario is unfolding

5

Flesh out the picture4

Develop the framework by defining two specific axes3

Brainstorm key drivers, decision factors, and possible scenario departure or divergence points

2

Define target issue, time frame, and scope for scenarios1

An understanding of the big picture and a plan to manage uncertainty

28

HOW WOULD YOU DO THAT? – CREDIT – UNION INDUSTRY

Changes in the playing field

Minor Major

Source: Adapted from Credit Union Society, 2005: Scenarios for Credit Unions, an Executive Report (Madison, WI: Credit Union Executives Society, 1999)

Tec

hn

olo

gic

al C

han

ge

Rad

ical

Gra

du

al

Technocracy 2005:

The wide-scale adoption of the internet by U.S. consumers has led to massive technological innovation for financial-services companies, increasing their range of distribution channels, as well as their products, services, and geographic scope. Regulations and other changes in the playing field, however, have been slow to follow

Chameleon 2005:

Radical changes occurring in the playing field and in technology make this a highly tumultuous scenario for all credit unions. The nature of competition has evolved so much that banks and credit unions compete directly – under the same rules of the game. This situation has caused a wide-scale convergence of cultures among various financial-services providers, testing the boundaries of the traditional credit-union mission

Credit-Union Power 2005:

Both technology and the playing field have changed at a moderate pace, making this the most stable scenario. Even with moderate change in these areas, however, the changing basis of competition, new business models, human resource challenges, and industry dynamics are different enough to pose significant challenges for many financial-services companies

Wallet Wars 2005:

Prompted by free-market economics, the playing field is changing radically, enabling credit unions and other financial-services institutions to compete more intensely. At the same time, technical innovations have not developed as quickly as many observers and analysts had predicted

29

SUMMARY

Explain the importance of the external context for strategy and firm performance

1

Use PESTEL to identify the macro characteristics of the external context

2

Identify the major features of an industry and the forces that affect industry profitability

3

Understand the dynamic characteristics of the external context

4

Show how industry dynamics may redefine industries5

Use scenario planning to predict the future structure of the external context

6