CHAPTER 3

EVALUATING A COMPANY’S

EXTERNAL ENVIRONMENT

McGraw-Hill/Irwin Copyright ®2012 The McGraw-Hill Companies, Inc.

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1. Gain command of the basic concepts and analytical tools

widely used to diagnose the competitive conditions in a

company’s industry.

2. Learn how to diagnose the factors shaping industry dynamics

and to forecast their effects on future industry profitability.

3. Become adept at mapping the market positions of key groups

of industry rivals.

4. Understand why in-depth evaluation of a business’s strengths

and weaknesses in relation to the specific industry conditions

it confronts is an essential prerequisite to crafting a strategy

that is well-matched to its external situation.

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3.1 From Thinking Strategically about the Company’s Situation

to Choosing a Strategy

Thinking

strategically

about a firm’s

external

environment

Thinking

strategically

about a firm’s

internal

environment

Forming a

strategic

vision of

where the

firm needs

to head

Identifying

promising

strategic

options

for the firm

Selecting the

best strategy

and business

model for

the firm

Chapter 3

Chapter 4

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The External Environment

♦ The Macro-Environment

● Is the broad environmental context in

which a firm’s industry is situated.

● Includes strategically relevant components

over which the firm has no direct control.

General economic conditions

Immediate industry and competitive

environment

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3.2 The Components of a Company’s Macro-Environment

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3.1 The Seven Components of the Macro-Environment

Component Description

Demographics The size, growth rate, and age distribution of different sectors of the population. It

includes the geographic distribution of the population, the distribution of income

across the population, and trends in these factors.

Social forces Societal values, attitudes, cultural factors, and lifestyles that impact businesses.

Social forces vary by local and change over time.

Political, legal,

and regulatory

factors

Political policies and processes, as well as the regulations and laws with which

companies must comply—labor laws, antitrust laws, tax policy, regulatory policies,

the political climate, and the strength of institutions such as the court system.

Natural

environment

Ecological and environmental forces such as weather, climate, climate change, and

associated factors like water shortages.

Technological

factors

The pace of technological change and technical developments that have the

potential for wide-ranging effects on society, such as genetic engineering, the rise of

the Internet, changes in communication technologies, and knowledge and

controlling the use of technology,

Global forces Conditions and changes in global markets, including political events and policies

toward international trade, sociocultural practices and the institutional environment

in which global markets operate.

General

economic

conditions

Rates of economic growth, unemployment, inflation, interest, trade deficits or

surpluses, savings, per capita domestic product, and conditions in the markets for

stocks and bonds affecting consumer confidence and discretionary income.

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THINKING STRATEGICALLY ABOUT A COMPANY’S INDUSTRY AND COMPETITIVE ENVIRONMENT

1. Does the industry offer attractive opportunities for growth?

2. What kinds of competitive forces are industry members facing,

and how strong is each force?

3. What factors are driving changes in the industry, and what

impact will these changes have on competitive intensity and

industry profitability?

4. What market positions do industry rivals occupy—who is

strongly positioned and who is not?

5. What strategic moves are rivals likely to make next?

6. What are the key factors for competitive success in the

industry?

7. Does the industry offer good prospects for attractive profits?

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QUESTION 1: DOES THE INDUSTRY OFFER ATTRACTIVE OPPORTUNITIES FOR GROWTH?

♦ Defining Growth:

● What is the current market size in units or sales?

● What is the past, current and expected rate of

growth for the market\industry?

♦ Considerations:

● Different sectors\regions of a market grow at

different rates.

● Growth varies with the industry’s life cycle stage—

emergence, rapid growth, maturity, and decline.

● Growth does not guarantee profitability.

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QUESTION 2: WHAT KINDS OF COMPETITIVE FORCES ARE INDUSTRY MEMBERS FACING, AND HOW STRONG ARE THEY?

♦ The Five Competitive Forces:

● Competition from rival sellers

● Competition from potential new entrants

● Competition from substitute products

producers

● Supplier bargaining power

● Customer bargaining power

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3.3

The Five-Forces Model

of Competition: A Key

Analytical Tool

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Using the Five-Forces Model of Competition

Step 1

For each of the five forces, identify the different

parties involved, and the specific factors that

bring about competitive pressures.

Step 2

Evaluate how strong the pressures stemming

from each of the five forces are (strong,

moderate to normal, or weak).

Step 3

Determine whether the strength of the five

competitive forces, overall, is conducive to

earning attractive profits in the industry.

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3.2 Common “Weapons” for Competing with Rivals

Competitive Weapons Primary Effects

Price discounting, clearance sales,

“blowout” sales

Lowers price (P), acts to boost total sales volume and market share,

lowers profit margins per unit sold when price cuts are big and/or

increases in sales volume are relatively small

Couponing, advertising items on sale Acts to increase unit sales volume and total revenues, lowers price (P),

increases unit costs (C), may lower profit margins per unit sold (P – C)

Advertising product or service

characteristics, using ads to enhance

a company’s image or reputation

Boosts buyer demand, increases product differentiation and perceived

value (V), acts to increase total sales volume and market share, may

increase unit costs (C) and/or lower profit margins per unit sold

Innovating to improve product

performance and quality

Acts to increase product differentiation and value (V), boosts buyer

demand, acts to boost total sales volume, likely to increase unit costs (C)

Introducing new or improved features,

increasing the number of styles or

models to provide greater product

selection

Acts to increase product differentiation and value (V), strengthens buyer

demand, acts to boost total sales volume and market share, likely to

increase unit costs (C)

Increasing customization of product or

service

Acts to increase product differentiation and value (V), increases

switching costs, acts to boost total sales volume, often increases unit

costs (C)

Building a bigger, better dealer network Broadens access to buyers, acts to boost total sales volume and market

share, may increase unit costs (C)

Improving warranties, offering low-

interest financing

Acts to increase product differentiation and value (V), increases unit

costs (C), increases buyer costs to switch brands, acts to boost total

sales volume and market share

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Competitive Pressures That Act to Increase the Rivalry among Competing Sellers

♦ Buyer demand is growing slowly or declining.

♦ It is becoming less costly for buyers to switch brands.

♦ Industry products are becoming more alike.

♦ There is unused production capacity, and\or products

have high fixed costs or high storage costs.

♦ The number of competitors is increasing and\or they are

becoming more equal in size and competitive strength.

♦ The diversity of competitors is increasing.

♦ High exit barriers stop firms from exiting the industry.

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3.4

Factors Affecting the

Strength of Rivalry

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Competitive Pressures Associated with the Threat of New Entrants

♦ Entry Threat Considerations:

● Strength of barriers to entry

● Expected reaction of incumbent firms

● Attractiveness of a particular market’s growth in

demand and profit potential

● Capabilities and resources of potential entrants

● Entry of existing competitors into market segments

in which they have no current presence

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Market Entry Barriers Facing New Entrants

♦ Economies of scale in production, distribution,

advertising, or other areas of operation

♦ Experience and learning curve effects

♦ Unique cost advantages of industry incumbents

♦ Strong brand preferences and customer loyalty

♦ Strong “network effects” in customer demand

♦ High capital requirements

♦ Building a network of distributors or dealers and

securing adequate space on retailers’ shelves

♦ Restrictive government policies

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3.5

Factors Affecting

the Threat of Entry

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Competitive Pressures from the Sellers of Substitute Products

♦ Substitute Products Considerations:

● Ready availability of substitutes

● Pricing, quality, performance, and other relevant

attributes of substitutes

● Switching costs that buyers incur

♦ Indicators of Substitutes’ Competitive Strength:

● Increasing rate of growth in sales of substitutes

● Substitute producers adding output capacity

● Increasing profitability of substitute producers

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3.6

Factors Affecting

Competition from

Substitute Products

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Competitive Pressures Stemming from Supplier Bargaining Power

♦ Supplier Bargaining Power Considerations:

● Ready availability of supplier products

● Criticality of supplier products as industry inputs

● Number of suppliers of standard\commodity items

● Buyers’ costs for switching among suppliers

● Availability of substitutes for suppliers’ products

● Fraction of supplier sales due to industry demand

● Ratio of suppliers relative to industry buyers

● Backward integration into suppliers’ industry

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3.7

Factors Affecting

the Bargaining

Power of Suppliers

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Competitive Pressures Stemming from Buyer Bargaining Power and Price Sensitivity

♦ Buyer Bargaining Power Considerations:

● Buyer costs for switching to competing sellers

● Degree to which industry products are commoditized

● Number and size of buyers relative to sellers

● Strength of buyer demand for sellers’ products

● Buyer knowledge of products, costs and pricing

● Backward integration of buyers into sellers’ industry

● Buyer discretion in delaying purchases

● Buyer price sensitivity due to low profits, size of

purchase, and consequences of purchase

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Factors Affecting

the Bargaining

Power of Buyers

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Is the Collective Strength of the Five Competitive Forces Conducive to Good Profitability?

♦ Is the state of competition in the industry

stronger than “normal”?

♦ Can industry firms expect to earn decent profits

given prevailing competitive forces?

♦ Are some of the competitive forces sufficiently

powerful to undermine industry profitability?

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Matching Strategy to Competitive Conditions

1. Pursuing avenues that shield the firm from as

many competitive pressures as possible.

2. Initiating actions calculated to shift competitive

forces in the firm’s favor by altering underlying

factors driving the five forces.

3. Spotting attractive arenas for expansion, where

competitive pressures in the industry are

somewhat weaker.

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QUESTION 3: WHAT FACTORS ARE DRIVING INDUSTRY CHANGE, AND WHAT IMPACTS WILL THEY HAVE?

♦ Strategic Analysis of Industry Dynamics:

1. Identifying the drivers of change.

2. Assessing whether the drivers of change

are, individually or collectively, acting to

make the industry more or less attractive.

3. Determining what strategy changes are

needed to prepare for the impacts of the

anticipated change.

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3.3 The Most Common Drivers of Industry Change

1. Changes in the long-term industry growth rate

2. Increasing globalization

3. Changes in who buys the product and how they use it

4. Technological change

5. Emerging new Internet capabilities and applications

6. Product and marketing innovation

7. Entry or exit of major firms

8. Diffusion of technical know-how across companies and

countries

9. Improvements in efficiency in adjacent markets

10. Reductions in uncertainty and business risk

11. Regulatory influences and government policy changes

12. Changing societal concerns, attitudes, and lifestyles

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Assessing the Impact of the Factors Driving Industry Change

1. Overall, are the factors driving change causing

demand for the industry’s product to increase

or decrease?

2. Is the collective impact of the drivers of change

making competition more or less intense?

3. Will the combined impacts of the change

drivers lead to higher or lower industry

profitability?

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Developing a Strategy That Takes the Changes in Industry Conditions into Account

♦ What strategy adjustments will be needed

to deal with the impacts of the changes in

industry conditions?

● What adjustments must be made immediately?

● What actions must we not take or should we cease

to do now?

● What can we do now to prepare for adjustments

we anticipate making in the future?

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QUESTION 4: HOW ARE INDUSTRY RIVALS POSITIONED—WHO IS STRONGLY POSITIONED AND WHO IS NOT?

♦ A Strategic Group

● Is a cluster of industry rivals that have similar

competitive approaches and market positions:

Have comparable product-line breadth

Sell in the same price/quality range

Emphasize the same distribution channels

Use the same product attributes to buyers

Depend on identical technological approaches

Offer similar services and technical assistance

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Using Strategic Group Maps to Assess the Market Positions of Key Competitors

♦ Constructing a strategic group map:

● Identify the competitive characteristics that

differentiate firms in the industry.

● Plot the firms on a two-variable map using pairs

of differentiating competitive characteristics.

● Assign firms occupying about the same map

location to the same strategic group.

● Draw circles around each strategic group, making

the circles proportional to the size of the group’s

share of total industry sales revenues.

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Typical Variables for Differentiating the Market Positions of Key Competitors on Group Maps

♦ Price/quality range (high, medium, low)

♦ Geographic coverage (local, regional, national, global)

♦ Product-line breadth (wide, narrow)

♦ Degree of service offered (no frills, limited, full)

♦ Distribution channels (retail, wholesale, Internet, multiple)

♦ Degree of vertical integration (none, partial, full)

♦ Degree of diversification into other industries (none,

some, considerable).

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Choosing Variables for Group Maps

♦ Variables selected as map axes:

● Must not be highly correlated.

● Must reflect key approaches to customer

value and expose sizable differences in the

marketplace positions of rivals.

● May be quantitative, continuous, discrete

and\or defined in terms of distinct classes

and combinations.

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Guidelines for Constructing Group Maps

♦ Draw map circles proportional to the combined

sales of firms in each strategic group to reflect

the relative sizes of each group to the total size

of the industry.

♦ Use different variable sets to show different

views of relationships among competitive

positions in the industry’s structure—there is no

one best map for portraying how competing

firms are positioned.

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Follow-up

♦ Which strategic group is located in the least

favorable market position? Which group is in

the most favorable position?

♦ Which strategic group is likely to experience

increased intragroup competition?

♦ Which groups are most threatened by the

likely strategic moves of members of nearby

strategic groups?

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What Can Be Learned from Strategic Group Maps?

♦ Maps are useful in identifying which industry

members are close rivals and which are

distant rivals.

♦ Not all map positions are equally attractive.

1. Prevailing competitive pressures in the industry

and drivers of change favor some strategic

groups and hurt others.

2. Profit prospects vary from strategic group to

strategic group.

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QUESTION 5: WHAT STRATEGIC MOVES ARE RIVALS LIKELY TO MAKE NEXT?

♦ Competitive Intelligence

● Information about rivals that is useful in anticipating

their next strategic moves.

♦ Signals of the Likelihood of Strategic Moves:

● Rivals under pressure to improve financial

performance

● Rivals seeking to increase market standing

● Public statements of rivals’ intentions

● Profiles developed by competitive intelligence units

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Useful Questions to Help Predict the Likely Actions of Important Rivals

♦ Which competitors’ strategies are achieving good results?

♦ Which competitors are losing in the marketplace or badly

need to increase their unit sales and market share?

♦ Which rivals are likely make major moves to enter new

geographic markets or to increase sales and market share

in a particular geographic region?

♦ Which rivals can expand product offerings to enter new

product segments where they do not have a presence?

♦ Which rivals can be acquired? Which rivals are financially

able and looking to make an acquisition?

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QUESTION 6: WHAT ARE THE KEY FACTORS FOR FUTURE COMPETITIVE SUCCESS?

♦ Key Success Factors

● Are the strategy elements, product and

service attributes, operational approaches,

resources, and competitive capabilities that

are necessary for competitive success by

any and all firms in an industry.

● Vary from industry to industry, and over time

within the same industry, as drivers of

change and competitive conditions change.

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Identification of Key Success Factors

1. What product attributes and service features

buyers strongly affect buyers when choosing

between the competing brands of sellers?

2. What resources and competitive capabilities

are required for a firm to execute a successful

strategy in the marketplace?

3. What shortcomings will put a firm at a

significant competitive disadvantage?

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QUESTION 7: DOES THE INDUSTRY OFFER GOOD PROSPECTS FOR ATTRACTIVE PROFITS?

♦ Industry Profitability Considerations:

● The industry’s overall growth potential

● Effects of strong competitive forces

● Effects of prevailing drivers of change in the industry

● Competitive strength of the firm: its market position

relative to its rivals, its capability to withstand

competitive forces, and whether its position will

change in the course of competitive interactions

● The success of the firm’s strategy in delivering on

the industry’s key success factors