Evaluating a Firm’s External Environment 2-1 Copyright © 2008 Pearson Prentice Hall. All rights reserved Chapter 2

Evaluating a Evaluating a Firm’sFirm’sExternal External EnvironmentEnvironment

2-2-11Copyright © 2008 Pearson Prentice Hall. All rights reservedCopyright © 2008 Pearson Prentice Hall. All rights reserved

Chapter 2Chapter 2

Evaluating a Firm’s External EnvironmentEvaluating a Firm’s External Environment

2-2-22Copyright © 2008 Pearson Prentice Hall. All rights reserved.Copyright © 2008 Pearson Prentice Hall. All rights reserved.

Why External Analysis?

External analysis allows firms to:

• discover threats and opportunities

• see if above normal profits are likely in an industry

• better understand the nature of competition inan industry

• make more informed strategic choices



FocalFirm

Buyers

Suppliers

Entry

Rivalry

Substitutes

Complementors

DemographicTrends

TechnologicalChange

CulturalTrends

EconomicClimate

Legal/PoliticalConditions

SpecificInternational

Events

Industry

General External Environment



FocalFirm

DemographicTrends

TechnologicalChange

CulturalTrends

EconomicClimate



Events


PDA’s &Cell Phones

Hispanic Population Growth

Changing Image of SUV’sRisingInterestRates

Changing Policy toward OilExploration on Public Lands

European Union Ban onHormone-Treated U.S. Beef



Industry Analysis

The Structure – Conduct – Performance Model

• originally developed to spot anti-competitive conditionsfor anti-trust purposes

• came to be used to assess the possibilities for above normal profits for firms within an industry

• Porter’s Five Forces Model was developed fromthis economic tradition



Industry Analysis

Porter’s Five Forces Model

FocalFirm

Buyers

Suppliers

Entry

Rivalry

Substitutes

Industry

Threat

Higher Threat Lower Average Profits




Threat of Entry

• if firms can easily enter the industry, any abovenormal profits will be bid away quickly

• barriers to entry lower the threat of entry

• barriers to entry make an industry more attractive

• this is true whether the focal firm isalready in the industry or thinking aboutentering




Threat of Entry

Barriers to Entry:

• economies of scale—firm that can’t producethe minimum efficient scale will be at a disadvantage

• product differentiation—entrants are forced toovercome customer loyalties to existing products

• cost advantages independent of scale—incumbentsmay have learning advantages, etc.

• government policies—governments may imposetrade restrictions and/or grant monopolies




Threat of Rivalry

• high rivalry means firms compete vigorously—andcompete away above average profits

Industry conditions that facilitate rivalry:

• large numbers of competitors

• slow or declining growth

• high fixed costs and/or high storage costs

• low product differentiation

• industry capacity added in large increments




Threat of Substitutes

• substitutes fill the same need but in a different way

- Coke and Pepsi are rivals, milk is asubstitute for both

• substitutes create a price ceiling because consumersswitch to the substitute if prices rise

• substitutes will likely come from outside theindustry—be sure to look




Threat of Suppliers

• powerful suppliers can ‘squeeze’ (lower profits)the focal firm

Industry conditions that facilitate supplier power:

• small number of firms in supplier’s industry

• highly differentiated product

• lack of close substitutes for suppliers’ products

• supplier could integrate forward

• focal firm is an insignificant customer of supplier




Threat of Buyers

• powerful buyers can ‘squeeze’ (lower profits)the focal firm by demanding lower prices and/orhigher levels of quality and service

Industry conditions that facilitate buyer power:

• small number of buyers for focal firm’s output

• lack of a differentiated product

• the product is significant to the buyer




Threat of Buyers

Industry conditions that facilitate buyer power:

• buyers operate in a competitive market—they arenot earning above normal profits

• buyers can vertically integrate backwards

• many small buyers can be united around an issueto act as a block

Example: Monsanto’s Life Sciences Strategy




FocalFirm

Buyers

Suppliers

Entry

Rivalry

Substitutes

Industry

Threat

If all threats are high expect normal profits

If all threats are low expect above normal profits

Most industries are somewhere between the extremes



Complementors As Another Force

Complementors Increase the Value of the Focal Firms Product

• customers perceive more value in the focal firm’sproduct when it is combined with the complementor’sproduct

• complementors may be found outside the focal firm’sindustry

Example: Goodyear Tires on Corvette



Responding to Environmental Threats

Neutralizing Threats

• most firms cannot unilaterally change thethreats in an industry

• by altering relationships in an industry, firmsmay reduce threats and/or create opportunities, thereby increasing profits

Examples: Regional Healthcare System, BuildingContractor, and the Bakery



Exploiting Industry Structure Opportunities

Generic Industry Structures

• at any point in time, the structure of mostindustries fits into one of four generic categories

• each industry structure presents opportunitiesthat may be exploited

• firms can choose to exploit an industry structure,continue business as usual, or exit the industry




Fragmented Industry Structure

Industry Characteristics Opportunity

• large number of small firms

• no dominant firms

• no dominant technology

• commodity type products

• low barriers to entry

• few, if any, economies of scale

Consolidation

• buy competitors

• build market power

• exploit economiesof scale




Emerging Industry Structure

Industry Characteristics Opportunity

• new industry based on breakthrough technology or product

• no product standard has been reached

• no dominant firm has emerged

• new customers come from non-consumption not from competitors

• first mover advantages

• technology

• locking-up assets

• creating switchingcosts




Mature Industry Structure

Industry Characteristics Opportunities

• slowing growth in demand

• technology standard exists

• increasing internationalcompetition

• industry-wide profits declining

• industry exit is beginning

• refine current products

• improve service

• process innovation




Declining Industry Structure

Industry Characteristics Opportunities

• industry sales have sustainedpattern of decline

• some well-establishedfirms have exited

• firms have stopped investingin maintenance

• market leadership

• niche

• harvest

• divest



International Opportunities

Approaches to International Markets

• international markets present opportunities thatvary depending on market characteristics

• firms can improve the probability of abovenormal profits by exploiting the opportunitiespresented by international market characteristics

• external analysis should include an assessmentof international market characteristics




Multinational Opportunity

Market Characteristics Structural Response

• no global product standard

• tastes and preferences vary

• transportation of finishedproduct is cost prohibitive

• governments imposelocal content rules

• replicate headquartersfunctions in multiplemarkets

• give local managersautonomy to respond

• modify product to localtastes & preferences




Global Opportunity


• global product standard

• governments allow importation

• significant economies of scale exist

• product development costsare significant

• minimal replication ofheadquarters functions

• centralized decisionmaking at headquarters

• centralized manufacturing

• little responsivenessto local tastes &preferences




Transnational Opportunity


• product standardization differsfrom region to region

• government policy variesfrom region to region

• local tastes and preferencesvary from region to region

• headquarters functionsare replicated in somebut not all regions

• high degree of coordi-nation between regionsand headquarters

• this is a combination of amultinational and globalapproach



FocalFirm

Buyers

Suppliers

Entry

Rivalry

Substitutes

Complementors

DemographicTrends

TechnologicalChange

CulturalTrends

EconomicClimate



Events

Industry




Summary

External Analysis:

• takes time and effort

• should include consideration of international markets

• helps firms recognize threats and opportunities

• provides assessment of likely levels ofindustry profitability (normal, above, below)

• can be applied at the individual level to professionaland personal environments

Documents

Evaluating a Firm’s External Environment 2-1 Copyright © 2008 Pearson Prentice Hall. All rights reserved Chapter 2