External and Industry Environment Analysis

Dr. K. Rangarajan

April 20, 2023

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Two Determinants of Profitability

Environmental Attractiveness

CompetitivePosition

Advantage

Disadvantage

Low High

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Business Environment

External & internal conditions effecting the firm

Firm trades & competes within an economy, & an industryConstant changes require systematic monitoringEnvironmental changes destroy & create business opportunities

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External Environment

Outside forces which impact on the firmEconomyTechnologySocietyGovernmentCompetitorsCustomersSuppliers

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Internal Environment

Conditions & forces within the firmOwnersManagersEmployeesFirm culturePhysical resources

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Environmental Uncertainty

Level of uncertainty depends on 2 dimensions:

Degree of change within the industry Stable to dynamic

Degree of Homogeneity within industry Simple to complex

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Strategy Making Department

Environmental Turbulence

Amount of simultaneous expansion, contraction, entry & exit within an industrySmall firms exhibit higher level of turbulence than big businessLess able to control environment through market dominance & political lobbying

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Competition

Grounded in underlying industry economics + other external forces: government, suppliers etcPorter’s model for analyzing industry attractiveness useful toolKnowledge of competitive pressure within an industry provides basis for strategy formulation

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Questions to Ask in Societal Environmental Analysis

What are the current and emerging trends in each segment?

What are the indicators of these trends?

What is the historic evolution of these trends?

What is the degree of change within these trends?

How will competitors deal with these trends?

How will these trends impact my organization?

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Strategic Issues and Strategic Factors

Strategic Issues

Trends likely to affect future environment

Strategic Factors

Those strategic issues with high probability of occurrence and high

probable impact on corporation

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Issues Priority Matrix

High Priority

HighPriority

HighPriority

Medium Priority

Medium Priority

Medium Priority

Low Priority

LowPriority

Low Priority

LowMediumHigh

Med

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Hig

hLow

Probable Impact on CorporationProbable Impact on Corporation

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Source: Adapted from L. L. Lederman, “Foresight Activities in the U.S.A.: Time for a Reassessment?” Long Range Planning (June 1984), p. 46. Copyright © 1984 by Pergamon Press, Ltd. Reprinted with permission.

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Some Important Variables in the Societal Environment

Economic Technological Political-Legal Socio-cultural

GDP trendsInterest ratesMoney supplyInflation ratesUnemployment levelsWage/price controlsDevaluation/revaluationEnergy availabilityand costDisposable anddiscretionary income

Total governmentspending for R&DTotal industryspending for R&DFocus of technologicaleffortsPatent protectionNew productsNew developments intechnology transferfrom lab tomarketplaceProductivityImprovementsthrough automation

Antitrust regulationsEnvironmentalprotection lawsTax lawsSpecial incentivesForeign traderegulationsAttitudes towardforeign companiesLaws on hiring andpromotionStability ofgovernment

Lifestyle changesCareer expectationsConsumer activismRate of familyformationGrowth rate ofpopulation Age distribution of populationRegional shifts inpopulationLife expectanciesBirth rates

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Related and supporting industries

Related and supporting industries

Demand conditionsDemand

conditions

Factor conditions

Factor conditions

Firm strategy structure and

rivalry

Firm strategy structure and

rivalry

ChanceChance

GovernmentGovernment

Porter’s Diamond

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Determinants in the Diamond

I. Factor ConditionsThe nation’s position in factors of productionThese factors can be grouped as follows:

Human Resource; Physical Resource; Knowledge Resource; Capital Resource; Infrastructure

Competitive advantage from factors depends on how efficiently and effectively they are deployed

II. Demand ConditionsThe quality of home demand determines competitive advantage

Nature of domestic Buyers + Size and Pattern of Growth + Transmission to Foreign Market Competitive Advantage

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Determinants in the Diamond (Contd.)

III. Related and Supporting IndustriesThe presence or absence of supplier industries and related industries that are internationally competitive

IV. Firm Strategy, Structure and RivalryThe conditions in the nation governing how companies are created, organised and managed and the nature of domestic rivalry

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Inter-relationship in the Diamond

New EntrantsEarly product

penetration feeds industry

Attracts New Entrants though factor abundance or specialisation

Firm Stgy. Structure and

Rivalry

Encourages formation of more

specialists

Stimulated growth of supplier industries

Factor pools are transferable to related

industries

Related & Supported Industries

Rivalry boosts home demand and

its specification

Pull foreign demand for the industry product

Attract Foreign firms/individuals for

the nation’s products

Demand conditions

Stimulates faster creation though

rivalry/ challenges

Create or stimulate creation

of transferable factors

Influence priorities for faster creation

of investments

Factor conditions

Firm Stgy. Structure and

Rivalry

Related & Supported Industries

Demand conditions

Factor conditionsDeterminants

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Competitive Diamond Indian Apparel Cluster

Weak/MediumWeak/Medium

WeakWeak

Weak-With Potential

Weak-With Potential

Basic=StrongAdvanced=Weak

Basic=StrongAdvanced=Weak

Demand Condition

s

Strategy Structure

Rivalry

Factors

Cluster

-Dependency on intermediaries-Lack of first-hand exposure to demanding or trend-setting consumers-Low knowledge of high-income segments-Dependency on foreign brands-Poorly Exposed to stringent buyer requirements+Entrepreneurs read and travel widely+Indirect exposure via clients

-Over-dependence on privileged market access-Mainly supplying labor-Mainly commodity/price competition+Some moving to full package/design+Many industry participantsBasic:

+Proximity to Stgic. Mkts.+Good IT Support+Good managerial/supervisory base+Favorable tax incentives+Good park infrastructure and policy+Relatively low labor costsAdvanced:-Weak Telecom support- Weak port and airport-Weak in higher skills training--Weak financial sector+/-Transport logistics and costs+Some emerging CAD capability -Lack of local base of critical related industries

-Dependency on foreign providers of technology-Inadequate schools and training providers-Lack Govt. vision for cluster development-Bureaucracy & Red-tapisim

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Industry Analysis

An Industry is defined as:A group of organizations offering products or services which are close substitutes for each otherBoundaries of the industry are determined from a user’s point of view

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SuppliersSuppliers

Bargainingpower ofsuppliers

Bargainingpower ofsuppliers

NewEntrants

NewEntrants

Threat ofnew entrants

Threat ofnew entrants

BuyersBuyers

Bargainingpower ofbuyers

Bargainingpower ofbuyers

SubstitutesSubstitutes

Threat ofsubstitutesThreat of

substitutes

IndustryCompetitors

Intensity of rivalry

Forces in the Industry Analysis

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Intensity of Rivalry

Determinants of rivalryIndustry growthShare of fixed costs to total value addedDepth of product differentiationConcentration and balance among competitors

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Strong Rivalry Occurs When:

Low industry growthHigh relative fixed costsLittle product differentiationFragmented industry with different competitive perspectives

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Rivalry Among Established Companies

Consolidated

One firm or onedominant firm.

(monopoly)

Fragmented

Many firms.No dominant

firmFew firms,

Shared dominance(Oligopoly)

The Continuum of Industry Structures

Industry Competitive Structure

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Threat of New Entrants

Likelihood of New Entrants is Determined by Height of Entry Barriers

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Some Barriers to Entry:

Economies of Scale

Product Differentiation

Capital Requirements

Switching Costs

Access to Distribution Channels

Cost Disadvantages Independent of Size

Government Policy

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High Entry Barriers Means High Profitability

High barriers restrict new entrants

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Bargaining Power of Buyers

Buyers as consumers of the industry’s outputPowerful buyers can demand lower prices, higher quality or better servicesPowerful buyers reduce industry profitability

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Buyers become powerful when:

Few important buyers

Buyer switching costs are low

Buyers can easily vertically integrate

Substitutes for the industry’s product are readily available

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Bargaining Power of Suppliers

Suppliers provide inputs to the industry

Powerful Suppliers--raise prices or reduce quality of raw materials

Powerful suppliers reduce industry profitability

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Suppliers become powerful when:

Few substitutes exist

Differentiation or high switching costs

Small number of suppliers

Supplier threat of vertical integration is high

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Threat of Substitutes

Substitutes can replace the industry’s products and services or

present an alternative to fulfill demand

Substitutes establish a price ceiling for the industry’s product

Substitutes establish a quality threshold for the industry’s product

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Substitutes become powerful when:

Buyers perceive performance and value of the substitute to be similar to the industry’s productBuyer’s switching cost is lowSubstitutes are readily available

Vs.

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The Five Forces are Unique to Your Industry

Five-Forces Analysis is a framework for analyzing a particular industry

Yet, the five forces affect all the other businesses in that industry

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Industry Scenarios

1. Examine possible shifts in societal variable globally.2. Identify uncertainties in each of the six forces of the task

environment.3. Make a range of plausible assumptions about future trends.4. Combine assumptions into internally consistent scenarios.5. Analyze the industry situation under each scenario.6. Determine sources of competitive advantage under each scenario.7. Predict competitors’ behavior under each scenario.8. Select most likely scenario to use in strategy formulation.

THANK YOU