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Education.

Analyzing the External Environment of the Firm:

Creating Competitive Advantages

chapter 2

Learning Objectives2-2

After reading this chapter, you should have a good understanding of:

LO1.1 The importance of developing forecasts of the business environment.

LO1.2 Why environmental scanning, environmental monitoring, and collecting competitive intelligence are critical inputs to forecasting.

LO1.3 Why scenario planning is a useful technique for firms competing in industries characterized by unpredictability and change.

Learning Objectives

After reading this chapter, you should have a good understanding of:

LO1.4 How forces in the competitive environment can affect profitability, and how a firm can improve its competitive position by increasing its power vis-à-vis these forces.

LO1.5 How the Internet and digitally based capabilities are affecting the five competitive forces and industry profitability.

LO1.6 The concept of strategic groups and their strategy and performance implications.

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The Importance of External Environment

Consider…

If a company does not keep pace with changes in the external environment, it becomes difficult to sustain competitive advantages and deliver strong financial results.

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Creating the Environmentally Aware Organization

Exhibit 2.1 Inputs to Forecasting

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Environmental Scanning & Monitoring

Environmental scanning involves surveillance of a firm’s external environment Predicts environmental changes to come Detects changes already under way Allows firm to be proactive

Environmental monitoring tracks evolution of environmental trends Hard trends – measurable facts/events Soft trends – estimated, probable events

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Competitive Intelligence

Competitive intelligence Helps firms define & understand their industry Identify rivals’ strengths & weaknesses

Collect data on competitors Interpret intelligence data

Helps firms avoid surprises Anticipate competitors’ moves Decrease response time

Beware of the potential for unethical behavior while gathering intelligence

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Example: Using Competitive intelligence

Startups have a disadvantage – it takes a lot of time to be ready for the market - someone else can get there first.

How to find out if your competitor will beat you to launch? Do competitive intelligence:

Monitor the competitor’s blog posts, e-mail blasts, the CEO's Twitter messages, changes to the LinkedIn profile

Track the dates of each dispatch on a spreadsheet and look for patterns

When the company’s chatter becomes more frequent, broadcasting more and more positive messages about its new product, "It led me to believe they were entering launch mode” so “we put together a limited version of our software and released it to get the Qworky name out first.”

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Environmental Forecasting

Environmental forecasting predicts change Plausible projections about

Direction of environmental change? Scope of environmental change? Speed of environmental change? Intensity of environmental change?

Scenario analysis involves detailed assessments of the ways trends may affect an issue & development of alternative futures based on these assessments

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Question?

A danger of forecasting discussed in the text is thatA. in most cases, the expense of collecting the

necessary data exceeds the benefit.B. forecasting’s retrospective nature provides

little information about the future.C. managers may view uncertainty as “black and

white” while ignoring important “gray areas”.D. it can create legal problems for the firm if

regulators discover the company is making forecasts.

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SWOT Analysis

SWOT analysis is a basic technique for analyzing firm and industry conditions Firm or internal conditions = Strengths &

Weaknesses Where the firm excels or where it may be lacking

Environmental or external conditions = Opportunities & Threats Developments that exist in the general

environment Activities among firms competing for the same

customers

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SWOT Analysis

SWOT analysis Forces managers to consider both internal

& external factors simultaneously Makes firms act proactively Raises awareness about role of strategy

A firm’s strategy must build on its strengths, Remedy the weaknesses or work around them, Take advantage of the opportunities presented

by the environment, and Protect the firm from the threats.

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Example: SWOT Analysis

Southwest Airlines SWOT Strengths

Strong culture, employee relationships Weaknesses

Lack of cultural fit with new AirTran employees Opportunities

Consolidation in the airline industry means more routes or acquisition targets might be available

Threats Economic conditions/jet fuel prices might affect

profitability in the future

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The General Environment

Demographic Sociocultural Political/Legal

Technological Economic Global

The general environment is composed of factors that are both hard to predict and difficult to control:

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The Demographic Segment

Demographics are easily understandable & quantifiable: Aging population Rising affluence Changes in ethnic composition Geographic distribution of population Greater disparities in income levels

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The Sociocultural Segment

Sociocultural forces influence the values, beliefs, and lifestyles of a society: More women in the workforce Dual-income families Increase in temporary workers Greater concern for healthy diets & physical

fitness (increasing levels of obesity) Greater concern for the environment Postponement of marriage & family

formation, having children

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The Political/Legal Segment

Political/Legal processes & legislation influence environmental regulations with which industries must comply: Tort reform Americans with Disabilities Act (ADA) Deregulation of utilities & other industries Increases in minimum wages Taxation at local, state, federal levels Legislation on corporate governance reforms Affordable Health Care Act

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The Technological Segment

Technological developments lead to new products & services; can create new industries & alter existing ones: Genetic engineering Computer-aided design/computer-aided

manufacturing systems (CAD/CAM) Research in synthetic & exotic materials Pollution/global warming Wireless communications Nanotechnology

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The Economic Segment

Economic forces affect all industries: Interest rates Unemployment Consumer Price Index Trends in GDP & net disposable income Changes in stock market valuations

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The Global Segment

Global forces offer both opportunities & risks: Increasing global trade Currency exchange rates Emergence of the Indian & Chinese

economies Trade agreements among regional blocs

(NAFTA, EU, ASEAN) Creation of WTO (leading to decreasing

tariffs/free trade in services) Increased risks associated with terrorism

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The Competitive Environment

The competitive environment consists of factors in the task or industry environment that are particularly relevant to a firm’s strategy: Competitors (existing or potential)

Including those considering entry into an entirely new industry

Customers (or buyers) Suppliers

Including those considering forward integration

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Porter’s Five-Forces Model of Industry Competition

Exhibit 2.4 Porter’s Five-Forces Model of Industry CompetitionSource: Adapted and reprinted with permission of The Free Press, a division of Simon & Schuster Adult Publishing Group, from Competitive Strategy: Techniques for Analyzing Industries and Competitors by Michael E. Porter. Copyright © 1980, 1998 by The Free Press. All rights reserved.

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The Threat of New Entrants

The threat of new entrants - possibility that the profits of established firms in the industry may be eroded by new competitors.

Depends on existing barriers to entry: Economies of scale Product differentiation Capital requirements Switching costs Access to distribution channels Cost disadvantages independent of scale

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Question?

If you are considering opening a new pizza restaurant in your community, what would be the threat of new entrants? How would you evaluate Porter’s other forces for this industry? Explain.

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The Bargaining Power of Buyers

Buyers have bargaining power: Buyers can force down prices, bargain for

higher quality or more services, play competitors against each other.

Buyer groups are powerful when: Purchasing standard products in large

volumes Profits are low & switching costs are few Backward integration is possible Quality is not affected by industry product

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The Bargaining Power of Suppliers

Suppliers can exert bargaining power by threatening to raise prices or reduce the quality of purchased goods and services.

Supplier groups are powerful when: Only a few firms dominate the industry No competition from substitute products Suppliers sell to several industries Buyer quality is affected by industry product Products are differentiated & have switching

costs Forward integration is possible

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The Threat of Substitute Products & Services

Substitute products & services limit the potential returns of an industry by placing a ceiling on the prices that firms can profitably charge.

Substitutes come from another industry Can perform the same function as the

industry’s offerings The more attractive the

price/performance ratio, the more the substitute erodes industry profits.

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The Intensity of Rivalry Among Competitors in an

Industry Rivalry tactics include price competition,

advertising battles, new product introductions, increased customer service or warranties

Interacting factors lead to intense rivalry: Numerous or equally balanced competitors Slow industry growth High fixed or shortage costs Lack of differentiation or switching costs Capacity augmented in large increments High exit barriers

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How the Internet and Digital Technologies Affect Competitive

Forces2-29

Using Industry Analysis: A Few Caveats

Managers must not always avoid low profit industries – these can still yield high returns for players who pursue sound strategies

Five forces analysis implicitly assumes a zero-sum game – yet mutually beneficial relationships can still be established with buyers & suppliers

Five forces analysis is essentially a static analysis – yet external forces can still change the structure of all industries See the value net

Vertical dimension = suppliers & customers Horizontal dimension = substitutes & complements

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The Value Net

Exhibit 2.6 The Value NetSource: reprinted by permission of Harvard Business Review. Exhibit from “The Right Game: Use Game Theory to Shape Strategy,” by A. Brandenburger and B.J. Nalebuff, July-August 1995. Copyright © 1995 by the Harvard Business School Publishing Corporation. All rights reserved.

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Doing a Good Industry Analysis

Good industry analysis looks rigorously at the structural underpinnings & root causes of profitability Must choose the appropriate time frame

Consider the industry business life cycle Average profitability over 3-5 years or longer

Must consider quantitative factors as well as qualitative Get numbers to quantify five forces factors

Percentages of cost or sales, actual switching costs

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Strategic Groups Within Industries

Two unassailable assumptions in industry analysis: No two firms are totally different No two firms are exactly the same

Strategic groups – clusters of firms that share similar strategies: Breadth of product & geographic scope Price/quality Degree of vertical integration Type of distribution

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Strategic Groups Within Industries

Exhibit 2.7 The World Automobile Industry: Strategic GroupsNote: Members of each strategic group are not exhaustive, only illustrative.

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Strategic Groups Within Industries

Strategic groups as an analytical tool Helps identify barriers to mobility that

protect a group from attacks by other groups

Helps identify groups whose competitive position may be marginal or tenuous

Helps chart the future direction of firms’ strategies

Helps to think through the implications of each industry trend for the strategic group as a whole

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