Analyzing the External

Environment of the Firm

Chapter Two

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Learning Objectives

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

LO2.1 The importance of developing forecasts of the business environment.

LO2.2 Why environmental scanning, environmental monitoring, and collecting competitive intelligence are critical inputs to forecasting.

LO2.3 Why scenario planning is a useful technique for firms competing in industries characterized by unpredictability and change.

LO2.4 The impact of the general environment on a firm’s strategies and performance.

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Learning Objectives (cont.)

LO2.5 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.

LO2.6 How the Internet and digitally based compatibilities are affecting the five competitive forces and industry profitability.

LO2.7 The concept of strategic groups and their strategy and performance implications.

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Inputs to Forecasting

2-4Exhibit 2.1

Environmental Scanning & Monitoring

External Scanning surveillance of a firm’s external environment to

predict environmental changes and detect changes already under way.

Alerts the firm to critical trends before changes have developed a discernible pattern and before competitors recognize them

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Environmental Scanning & Monitoring

External Monitoring A firm’s analysis of the external environment that

tracks evolution of environmental trends, sequences of events, or streams of activities

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How to Spot Hot Trends

ListenPay attentionFollow trends

onlineGo old school

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How Zara Spots Opportunities

Zara’s designers, marketing managers, and buyers work side by side in an open office plan that fosters frequent discussions and promotes the sharing of real-time data as well as field observations and anecdotes

This allows them to break out of their silos and develop a holistic feel for the market, see how their work fits, and sense new opportunities as they arise.

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Competitive Intelligence

Competitive intelligence A firm’s activities of collecting and interpreting

data on competitors, defining and understanding the industry, and identifying competitors’ strengths and weaknesses.

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Environmental Forecasting

Environmental forecasting The development of

plausible projections about direction, scope, speed and intensity of environmental change

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Environmental Forecasting

Scenario analysis An in-depth approach to environmental

forecasting that involves experts’ detailed assessments of societal trends, economics, politics, technology, or other dimensions of the external environment

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QUESTION

Which of the following is a danger of forecasting?A.Managers assume that the world is not open to precise predictions.B.Managers may view uncertainty as black and white and ignore grey areas.C.Managers assume that the world is uncertain.D.Managers view the world as completely unpredictable.

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SWOT Analysis

Firm’s strategy must:Build on its strengthsRemedy the weaknesses or work around themTake advantage of the opportunities presented

by the environmentProtect the firm from threats

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SWOT Analysis

SWOT analysis A framework for

analyzing a company’s internal and external environment and that stands for strengths, weaknesses, opportunities, and threats.

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Example: Harley-Davidson

Strengths Strong & adaptable brand image

Weaknesses Limited ability to develop new non-traditional

products Opportunities

Growing leisure interest in motorcycles worldwide Threats

Differing foreign policies governing motorcycles

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The General Environment

DemographicSocioculturalLegal/Political

TechnologicalEconomicGlobal

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Factors external to an industry, usually beyond a firm’s control

Demographic Segment

Aging populationRising or declining affluenceChanges in ethnic compositionGeographic distribution of populationGreater disparities in income levels

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Sociocultural Segment

More women in the workforceDual-income familiesIncrease in temporary workersGreater concern for healthy diets and

physical fitnessGreater interest in the environmentPostponement of having children

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Political/Legal Segment

Tort reformAmericans with Disabilities Act (ADA)Repeal of Glass-Steagall Act in 1999Deregulation of utility and other industriesIncreases in federally mandated minimum wagesTaxation at local, state, federal levelsLegislation on corporate governance reforms

(Sarbanes-Oxley Act)

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Technological Segment

Genetic engineeringEmergence of Internet technologyComputer-aided design/computer-aided

manufacturing systems (CAD/CAM)Wireless communicationNanotechnology

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Economic Segment

Interest ratesUnemploymentConsumer Price indexTrends in GDPChanges in stock market valuations

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Global Segment

Increasing global tradeCurrency exchange ratesEmergence of the Indian and Chinese

economiesTrade agreements (NAFTA, EU, ASEAN)Creation of WTO (decreasing tariffs/free

trade in services)

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The Competitive Environment

Competitive environment factors that pertain to an industry and affect a

firm’s strategiesCompetitors, customers, and suppliers

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Porter’s Five Forces Model of Industry Competition

2-24Exhibit 2.7

The Threat of New Entrants

Profits of established firms in the industry may be eroded by new competitors

Sources of entry barriers 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 threaten an industry by: Forcing down prices Bargaining for higher quality or more services Playing competitors against each other

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The Bargaining Power of Buyers

A buyer group is powerful when It is concentrated or purchases large volumes relative to

seller sales The products it purchases from the industry are standard

or undifferentiated The buyer faces few switching costs It earns low profits The buyers pose a credible threat of backward integration The industry’s product is unimportant to the quality of the

buyer’s products or services

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The Bargaining Power of Suppliers

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

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The Bargaining Power of Suppliers

A supplier group will be powerful when The supplier group is dominated by a few companies

and is more concentrated than the industry it sells to The supplier group is not obliged to contend with

substitute products for sale to the industry The industry is not an important customer of the

supplier group

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The Bargaining Power of Suppliers (cont.)

A supplier group will be powerful when The supplier’s product is an important input to

the buyer’s business The supplier group’s products are differentiated

or it has built up switching costs for the buyer The supplier group poses a credible threat of

forward integration

The Threat of Substitute Products and Services

The Threat of Substitute Products and Services the threat of limiting the potential returns of an

industry by placing a ceiling on the prices that firms in that industry can profitably charge without losing too many customers to substitute products.

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The Intensity of Rivalry among Competitors in an Industry

Price competitionAdvertising battlesProduct introductionsIncreased customer service or warranties

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The Intensity of Rivalry among Competitors in an Industry

Numerous or equally balanced competitors

Slow industry growthHigh fixed or

shortage costs

Lack of differentiation or switching costs

Capacity augmented in large increments

High exit barriers

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Interacting factors lead to intense rivalry

How the Internet and Digital Technologies Influences Industry

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Exhibit 2.9

Using Industry Analysis: A Few Caveats

Managers must not always avoid low profit industries Can still yield high returns for players with sound

strategiesImplicitly assumes a zero-sum game,

determining how a firm can enhance its position relative to the forces

Five Forces analysis is essentially a static analysis

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Using Industry Analysis: A Few Caveats (cont.)

Good industry analysis looks rigorously at the structural underpinnings of profitability. A first step is to understand the time horizon

The point of industry analysis is not to declare the industry attractive or unattractive but to understand the underpinnings of competition and the root causes of profitability.

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The Value Net

2-38Exhibit 2.10

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 Cluster of firms that share similar strategies

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Strategic Groups within Industries

Value of strategic groups as an analytical tool Identify barriers to mobility that protect a group

from attacks by other groups Identify groups whose competitive position may

be marginal or tenuous Chart the future direction of firms’ strategies Thinking through the implications of each

industry trend for the strategic group as a whole

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