Strategic Management Chapter 2

Chapter TwoExternal Analysis: The Identification of Opportunities and Threats

Copyright Houghton Mifflin Company. All rights reserved.2 | *External Analysis requires an assessment of:Industry environment in which company operatesCompetitive structure of industryCompetitive position of the companyCompetitiveness and position of major rivalsThe country or national environments in which company competesThe wider socioeconomic or macroenvironment that may affect the company and its industrySocialGovernment Legal International Technological

External AnalysisThe purpose of external analysis is to identify the strategic opportunities and threats in the organizations operating environment that will affect how it pursues its mission.

Copyright Houghton Mifflin Company. All rights reserved.2 | *External Analysis: Opportunities and ThreatsAnalyzing the dynamics of the industry in which an organization competes to help identify:Opportunities

Conditions in the environment that a company can take advantage of to become more profitableThreats

Conditions in the environment that endanger the integrity and profitability of the companys business

Copyright Houghton Mifflin Company. All rights reserved.2 | *Industry Analysis: Defining an Industry IndustryA group of companies offering products or services that are close substitutes for each other and that satisfy the same basic customer needsIndustry boundaries may change as customer needs evolve and technology changes SectorA group of closely related industries Market SegmentsDistinct groups of customers within an industryCan be differentiated from each other with distinct attributes and specific demandsIndustry analysis begins by focusing on the overall industry before considering market segment or sector-level issues

Copyright Houghton Mifflin Company. All rights reserved.2 | *Porters Five Forces ModelSource: Adapted and reprinted by permission of Harvard Business Review. From How Competitive Forces Shape Strategy, by Michael E. Porter, Harvard Business Review, March/April 1979 by the President and Fellows of Harvard College. All rights reserved.Figure 2.2

Copyright Houghton Mifflin Company. All rights reserved.2 | *Potential Competitors are companies that are not currently competing in an industry but have the capability to do so if they choose. Barriers to new entrants include: Risk of Entry by Potential CompetitorsEconomies of Scale as firms expand output unit costs fall via:Cost reductions through mass productionDiscounts on bulk purchases of raw material and standard partsCost advantages of spreading fixed and marketing costs over large volumeBrand LoyaltyAchieved by creating well-established customer preferencesDifficult for new entrants to take market share from established brandsAbsolute Cost Advantages relative to new entrantsAccumulated experience in production and key business processesControl of particular inputs required for productionLower financial risks access to cheaper fundsCustomer Switching Costs for Buyers where significantGovernment Regulation May be a barrier to enter certain industries

Copyright Houghton Mifflin Company. All rights reserved.2 | *Industry Competitive StructureNumber and size distribution of companiesConsolidated versus fragmented industriesDemand ConditionsGrowing demand tends to moderate competition and reduce rivalryDeclining demand encourages rivalry for market share and revenueCost ConditionsHigh fixed costs profitability leveraged by sales volumeSlow demand and growth can result in intense rivalry and lower profitsHeight of Exit Barriers prevents companies from leaving industryWrite-off of investment in assetsEconomic dependence on industryMaintain assets - to participate effectively in an industry Rivalry Among Established CompaniesCompetitive Rivalry refers to the competitive struggle between companies in the same industry to gain market share from each other. Intensity of rivalry is a function of: High fixed costs of exit Emotional attachment to industry Bankruptcy regulations allowing unprofitable assets to remain

Copyright Houghton Mifflin Company. All rights reserved.2 | *Industry Buyers may be the consumers or end-users who ultimately use the product or intermediaries that distribute or retail the products. These buyers are most powerful when: Bargaining Power of BuyersBuyers are dominant. Buyers are large and few in number.The industry supplying the product is composed of many small companies.Buyers purchase in large quantities.Buyers have purchasing power as leverage for price reductions.The industry is dependant on the buyers. Buyers purchase a large percentage of a companys total orders.Switching costs for buyers are low.Buyers can play off the supplying companies against each other.Buyers can purchase from several supplying companies at once. Buyers can threaten to enter the industry themselves.Buyers produce themselves and supply their own product.Buyers can use threat of entry as a tactic to drive prices down.

Copyright Houghton Mifflin Company. All rights reserved.2 | *Suppliers are organizations that provide inputs such as material and labor into the industry. These suppliers are most powerful when: Bargaining Power of SuppliersThe product supplied is vital to the industry and has few substitutes.The industry is not an important customer to suppliers.Suppliers are not significantly affected by the industry.Switching costs for companies in the industry are significant.Companies in the industry cannot play suppliers against each other.Suppliers can threaten to enter their customers industry.Suppliers can use their inputs to produce and compete with companies already in the industry.Companies in the industry cannot threaten to enter suppliers industry.

Copyright Houghton Mifflin Company. All rights reserved.2 | *Substitute Products are the products from different businesses or industries that can satisfy similar customer needs. Substitute ProductsThe existence of close substitutes is a strong competitive threat.Substitutes limit the price that companies can charge for their product.

Substitutes are a weak competitive force if an industrys products have few close substitutes.Other things being equal, companies in the industry have the opportunity to raise prices and earn additional profits.

Copyright Houghton Mifflin Company. All rights reserved.2 | *Strategic Groups Within IndustriesStrategic Groups are groups of companies that follow a business model similar to other companies within their strategic group but are different from that of other companies in other strategic groups.Implications of Strategic Groups The closest competitors are within the same Strategic Group and may be viewed by customers as substitutes for each other.Each Strategic Group can have different competitive forces and may face a different set of opportunities and threats.Mobility Barriers factors within an industry that inhibit the movement of companies between strategic groupsInclude barriers to enter another group or exit existing groupThe basic differences between business models in different strategic groups can be captured by a relatively small number of strategic factors.

Copyright Houghton Mifflin Company. All rights reserved.2 | *Industry Life Cycle Model analyzes the affects of industry evolution on competitive forces over time and is characterized by five distinct life cycle stages:Industry Life Cycle AnalysisEmbryonic industry just beginning to developRivalry based on perfecting products, educating customers, and opening up distribution channels.Growth first-time demand takes-off with new customersLow rivalry as focus is on keeping up with high industry growth.Shakeout demand approaches saturation, replacementsRivalry intensifies with emergence of excess productive capacity.Mature market totally saturated with low to no growthIndustry consolidation based on market share, driving down price.Decline industry growth becomes negativeRivalry further intensifies based on rate of decline and exit barriers.

Copyright Houghton Mifflin Company. All rights reserved.2 | *Growth in Demand and CapacityIndustry Shakeout: Rivalry Intensifies with growth in excess capacityAnticipate how forces will change and formulate appropriate strategyFigure 2.5

Copyright Houghton Mifflin Company. All rights reserved.2 | *Limitations of Models for Industry Analysis Life Cycle IssuesIndustry cycles do not always follow the life cycle generalization.In rapid growth situations embryonic stage is sometimes skipped. Industry growth revitalized through innovation or social change.The time span of the stages can vary from industry to industry. Innovation and ChangePunctuated Equilibrium occurs when an industrys long term stable structure is punctuated with periods of rapid change by innovation.Hypercompetitive industries are characterized by permanent and ongoing innovation and competitive change. Company DifferencesThere can be significant variances in the profit rates of individual companies within an industry.In addition to industry attractiveness, company resources and capabilities are also important determinants of its profitability.Models provide useful ways of thinking about competition within an industry but be aware of their limitations.

Copyright Houghton Mifflin Company. All rights reserved.2 | *The Role of the MacroenvironmentChanges in the forces in the macro-environment can directly impact: The Five Forces Relative Strengths Industry AttractivenessFigure 2.7

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Strategic Management Chapter 2