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Evaluating a Evaluating a Firm’sFirm’sExternal External EnvironmentEnvironment
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Chapter 2Chapter 2
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Evaluating a Firm’s External EnvironmentEvaluating a Firm’s External Environment
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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
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Evaluating a Firm’s External EnvironmentEvaluating a Firm’s External Environment
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FocalFirm
Buyers
Suppliers
Entry
Rivalry
Substitutes
Complementors
DemographicTrends
TechnologicalChange
CulturalTrends
EconomicClimate
Legal/PoliticalConditions
SpecificInternational
Events
Industry
General External Environment
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Evaluating a Firm’s External EnvironmentEvaluating a Firm’s External Environment
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FocalFirm
DemographicTrends
TechnologicalChange
CulturalTrends
EconomicClimate
Legal/PoliticalConditions
SpecificInternational
Events
General External Environment
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
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Evaluating a Firm’s External EnvironmentEvaluating a Firm’s External Environment
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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
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Evaluating a Firm’s External EnvironmentEvaluating a Firm’s External Environment
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The Structure-Conduct-Performance Model
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Evaluating a Firm’s External EnvironmentEvaluating a Firm’s External Environment
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Industry Analysis
Porter’s Five Forces Model
FocalFirm
Buyers
Suppliers
Entry
Rivalry
Substitutes
Industry
Threat
Higher Threat Lower Average Profits
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Evaluating a Firm’s External EnvironmentEvaluating a Firm’s External Environment
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Porter’s Five Forces Model
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
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Evaluating a Firm’s External EnvironmentEvaluating a Firm’s External Environment
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Porter’s Five Forces Model
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
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Evaluating a Firm’s External EnvironmentEvaluating a Firm’s External Environment
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Economies of Scale and the Cost of Production
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Evaluating a Firm’s External EnvironmentEvaluating a Firm’s External Environment
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Porter’s Five Forces Model
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
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Evaluating a Firm’s External EnvironmentEvaluating a Firm’s External Environment
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Porter’s Five Forces Model
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
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Evaluating a Firm’s External EnvironmentEvaluating a Firm’s External Environment
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Porter’s Five Forces Model
Threat of Powerful 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
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Evaluating a Firm’s External EnvironmentEvaluating a Firm’s External Environment
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Porter’s Five Forces Model
Threat of Powerful 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
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Evaluating a Firm’s External EnvironmentEvaluating a Firm’s External Environment
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Porter’s Five Forces Model
Threat of Powerful 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
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Evaluating a Firm’s External EnvironmentEvaluating a Firm’s External Environment
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Porter’s Five Forces Model
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
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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
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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
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Evaluating a Firm’s External EnvironmentEvaluating a Firm’s External Environment
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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
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Evaluating a Firm’s External EnvironmentEvaluating a Firm’s External Environment
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Exploiting Industry Structure Opportunities
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
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Evaluating a Firm’s External EnvironmentEvaluating a Firm’s External Environment
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Exploiting Industry Structure Opportunities
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
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Exploiting Industry Structure Opportunities
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
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Exploiting Industry Structure Opportunities
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
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Evaluating a Firm’s External EnvironmentEvaluating a Firm’s External Environment
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FocalFirm
Buyers
Suppliers
Entry
Rivalry
Substitutes
Complementors
DemographicTrends
TechnologicalChange
CulturalTrends
EconomicClimate
Legal/PoliticalConditions
SpecificInternational
Events
Industry
General External Environment
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Evaluating a Firm’s External EnvironmentEvaluating a Firm’s External Environment
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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