Chapter 3External Analysis Industry Structure, Competitive Fo

Chapter 3
External Analysis: Industry Structure, Competitive Forces, and
Strategic Groups
©McGraw-Hill Education.
1
The AFI Strategy Framework
Access the text alternative for slide image.
2
The Firm within Its External Environment, Industry, and
Strategic Group, Subject to PESTEL Factors
3
The PESTEL Framework

Framework to scan, monitor, and evaluate important external
factors/trends (opportunities and threats) impacting a firm in its
quest for competitive advantage.
Analyzing the General Environment
Consider the relevance of each of the six factors in the context
of the particular business
Identify and categorize the information that applies to the
relevant factors (identify opportunities and threats)
Analyze the data and draw conclusions – which O/T need to be
acted on and when (short term vs. long term)?
MACRO
MICRO
3-‹#›
6
EXTERNAL ANALYSIS

INDUSTRY ANALYSIS
Five Forces Model
COMPETITOR ANALYSIS
Strategic Group Mapping
PESTEL Framework
Definitions
Industry
A group of (**incumbent**) firms that face the same set of
suppliers and buyers
Industry Analysis
Identifies the industry's profit potential
Derive implications for a firm’s strategic position within an
industry
Strategic Position

A firm’s ability to create value (V) for customers while
containing costs (C)
Competitive Advantage = a large value gap (V - C)
Instructors:
The digital companion to this book McGraw-Hill Connect has
an brief case exercise on this section of the textbook. It builds
student confidence on the PESTEL tool (LO 3-1).
7
Michael Porter’s 5 Forces Model
A framework for identifying the five forces that determine
industry profit potential and help shape firm competitive
strategy
This model intersects:
Theory: industrial organization economics with
Practice: hundreds of case studies
Managers can predict industry profit potential and position their
firms for sustainable competitive advantage.
For example, hotel chains and resort owners have challenged
Airbnb in courts and lobbied local governments, some of which
passed regulations to limit or prohibit short-term rentals. Local
residents in New York, San Francisco, Berlin, Paris, and many
other cities are also pressuring local governments to enact more
aggressive rules banning short-term rentals because they argue
that companies such as Airbnb contribute to a shortage of
affordable housing by turning entire apartment complexes into
hotels or transforming quiet family neighborhoods into all -

night, every-night party hot spots.
8
Strategy Video
Michael Porter on Five Forces
Interview with Michael Porter, Professor at Harvard University
http://www.youtube.com/watch?v=mYF2_FBCvXw
13:12 Minutes
Topics: Five Forces Model; Competitive Strategy
Occasionally, boom periods can overheat and lead to
speculative asset bubbles. In the early 2000s, the United States
experienced an asset bubble in real estate.4 Easy credit, made
possible by the availability of subprime mortgages and other
financial innovations, fueled an unprecedented demand in
housing. Real estate, rather than stocks, became the investment
vehicle of choice for many Americans, propelled by the
common belief that house prices could only go up. When the
housing bubble burst, the deep economic recession of 2008–
2009 began, impacting in some way nearly all businesses in the
United States and worldwide.
9
Porter’s Five Forces Model
Exhibit 3.3
Source: Porter, M. E. (2008, Jan.). “The five competitive forces
that shape strategy,” Harvard Business Review.

Porter derived two key insights that form the basis of his
seminal five forces model:
1. Rather than defining competition narrowly as the firm’s
closest competitors to explain and predict a firm’s performance,
competition must be viewed more broadly, to also encompass
the other forces in an industry: buyers, suppliers, potential new
entry of other firms, and the threat of substitutes.
2. The profit potential of an industry is neither random nor
entirely determined by industry-specific factors. Rather, it is a
function of the five forces that shape competition: threat of
entry, power of suppliers, power of buyers, threat of substitutes,
and rivalry among existing firms.
As a rule of thumb, the stronger the five forces, the lower the
industry’s profit potential—making the industry less attractive
for competitors. The reverse is also true: the weaker the five
forces, the greater the industry’s profit potential—making the
industry more attractive.
10
INDUSTRY FORCES IMPACT FIRM PROFITABILITY
3-‹#›
Instructors:
End of Chapter Discussion Question 2 covers this point.
How do the five competitive forces in Porter’s five forces

model affect the profitability of the industry?
For example, in what way might strong forces increase industry
profits, and in what way do strong forces reduce industry
profits?
Identify an industry in which many of the competitors seem to
be having financial performance problems. Which of the five
forces seem to be strongest?
Weaker five forces equal greater industry profit potential,
emphasizing attractiveness. However, the greater the five forces
are, the lesser the industry profit potential, reducing the
attractiveness to competitors.
11
ATTRACTIVE INDUSTRY
Sustainable Competitive Advantage Easier
UNATTRACTIVE INDUSTRY
Sustainable Competitive Advantage Harder
High profit potential (higher than economy will provide)
The weaker the five forces
The stronger the five forces

Low profit potential
Why these 5 Forces?
Price X Units Sold
>
Costs
Power of Buyers –
Power of Suppliers –
Threat of New Entrants –
Threat of Substitutes –
Rivalry –
As discussed in the Chapter Case, Airbnb launched a radical
process innovation of offering and renting rooms based on a
business model leveraging the sharing economy. If one thing
seems certain, technological progress is relentless and seems to
be picking up speed.
Strategy Highlight 3.1 details how BlackBerry fell victim by not
paying sufficient attention to the PESTEL factors.
12
Threat of Entry
The risk that potential competitors will enter an industry:
Lowers industry profit potential.

Increases spending among incumbent firms.
Entry barriers:
Economies of scale.
Network effects.
Customer switching costs.
Capital requirements.
Advantages independent of size.
Government policy.
Credible threat of retaliation.
The threat of entry is high when:
✓The minimum efficient scale to compete in an industry is low.
✓Network effects are not present.
✓Customer switching costs are low.
✓Capital requirements are low.
✓Incumbents do not possess:
Brand loyalty.
Proprietary technology.
Preferential access to raw materials.
Preferential access to distribution channels.
Favorable geographic locations.
Cumulative learning and experience effects.
✓Restrictive government regulations do not exist.
✓New entrants expect that incumbents will not or cannot
retaliate.
13
The Power of Suppliers
POWERFUL SUPPLIERS
Can demand higher prices for their inputs.

Capture part (sometimes a large part) of the economic value
created.
Signs of Strong Suppliers
Suppliers industry is concentrated.
They don’t depend heavily on the incumbent’s industry.
Incumbent firms face high switching costs.
Suppliers’ products are differentiated.
Limited substitutes.
Suppliers have credible forward integration threats.
3-‹#›
Instructors:
A physically engaging exercise suggestion from the IM:
To illustrate the supplier and buyer impacts on industry
attractiveness you can use a tug of war exercise.
One rope connects the suppliers to the industry rivals. Another
rope connects the buyers to the industry rivals. A knot in the
center of the buyer rope illustrates the industry sales price and a
knot is the supplier rope illustrates the industry COGS paid to
suppliers. The supplier rope will be manned by supplier sales
reps on one side and industry rival purchasing agents on the
other. Similarly, the buyer rope will be manned by the buyer
purchasing agents and the industry sales reps. Have the industry
sales reps and purchasing agents stand on opposite sides of the
room and the suppliers and buyers in the center. Draw a line
with masking tape in the center to represent a zero margin for
the industry. Draw a line on the industry purchasing agent side
to represent the suppliers COGS (zero margin for suppliers) and
a line on the sales rep side to represent the buyers value for the

product (zero benefit for the buyers).
Start with the knots centered between their respective lines. The
closer the two knots get to the center the smaller the industry
margin becomes. Choose the stronger students to represent
supplier, buyer, and industry power associated and switch the
power to show the difference between soft drinks and airlines.
14
Power of Buyers (Customers)
Lowers industry profit potential if:
Buyers obtain price discounts, which reduces revenue.
Buyers demand higher quality / service, which raises production
costs.
Situations when buyers are price sensitive:
The buyer’s purchase represents a significant portion of its
procurement budget.
Buyers earn low profits or are strapped for cash.
The quality (cost) of the buyers’ products and services is not
affected much by the quality (cost) of their inputs.
Buyers are the customers of an industry.
The power of buyers is high when:
✓There are a few buyers and each buyer purchases large
quantities relative to the size of a single seller.
✓The industry’s products are standardized or undifferentiated
commodities.
✓Buyers face low or no switching costs.
✓Buyers can credibly threaten to backwardly integrate into the
industry.
The retail giant Walmart provides perhaps the most potent

example of tremendous buyer power. Walmart is not only the
largest retailer worldwide (with over 12,000 stores and 2
million employees), but it is also one of the largest companies
in the world (with $530 billion in revenues in 2019). Walmart is
one of the few large big-box global retail chains and frequently
purchases large quantities from its suppliers. Walmart leverages
its buyer power by exerting tremendous pressure on its suppliers
to lower prices and to increase quality or risk losing access to
shelf space at the largest retailer in the world. Walmart’s buyer
power is so strong that many suppliers co-locate offices directly
next to Walmart’s headquarters in Bentonville, Arkansas,
because such proximity enables Walmart’s managers to test the
supplier’s latest products and negotiate prices.
15
Threat of Substitutes
Meet the same basic customer need:
In a different way.
Available from outside the given industry.
Examples:
Software vs. professional services.
Energy drinks vs. coffee.
Videoconferencing vs. business travel.
Wireless phone services vs. internet-based services (Skype).
The threat of substitutes is high when:
✓The substitute offers an attractive price-performance trade-
off.
✓The buyer’s cost of switching to the substitute is low.

Examples: many software products are substitutes to
professional services, at least at the lower end. Tax preparation
software such as Intuit’s TurboTax is a substitute for
professional services offered by H&R Block and others.
LegalZoom, an online legal documentation service, is a threat to
professional law firms. Other examples of substitutes are energy
drinks versus coffee, videoconferencing versus business travel,
e-mail versus express mail, gasoline versus biofuel, and
wireless telephone services versus Voice over Internet Protocol
(VoIP), offered by Skype or Vonage.
16
Rivalry Among Competitors
The intensity with which companies in the same industry jockey
for market share and profitability.
Can range from genteel to cut-throat.
The other forces in the model pressure this rivalry.
The stronger the forces, the stronger the competitive intensity.
The rivalry among existing competitors is high when:
✓There are many competitors in the industry.
✓The competitors are roughly of equal size.
✓Industry growth is slow, zero, or even negative.
✓Exit barriers are high.
✓Incumbent firms are highly committed to the business.
✓Incumbent firms cannot read or understand each other’s
strategies well.
✓Products and services are direct substitutes.
✓Fixed costs are high and marginal costs are low.
✓Excess capacity exists in the industry.
✓The product or service is perishable.

17
Industry Competitive Structures along the Continuum from
Fragmented to Consolidated
Exhibit 3.4
Access the text alternative for slide image.
Perfect competition: Many Internet entrepreneurs learned the
hard way that it is difficult to beat the forces of perfect
competition. Fueled by eager venture capitalists, about 100
online pet supply stores such as pets.com, petopia.com, and pet-
store.com had sprung up by 1999, at the height of the Internet
bubble. Cut-throat competition ensued, with online retailers
selling products below cost. When there are many small firms
offering a commodity product in an industry that is easy to
enter, no one is able to increase prices and generate profits.
Besanko, D., E. Dranove, M. Hanley, and S. Schaefer (2010),
The Economics of Strategy, 5th ed. (Hoboken, NJ: John Wiley).
Examples of monopolistic competition: The computer hardware
industry provides one example of monopolistic competition.
Many firms compete in this industry, and even the largest of
them (Apple, ASUS, Dell, HP, or Lenovo) have less than 20
percent market share. Moreover, while products between
competitors tend to be similar, they are by no means identical.
Examples of oligopoly: The express-delivery industry is an
example of an oligopoly. The main competitors in this space are
FedEx and UPS. Any strategic decision made by FedEx (e.g., to
expand delivery services to ground delivery of larger-size
packages) directly affects UPS; likewise, any decision made by
UPS (e.g., to guarantee next-day delivery before 8:00 a.m.)
directly affects FedEx. Other examples of oligopolies include

the soft drink industry (Coca-Cola vs, Pepsi), airframe
manufacturing business (Boeing vs. Airbus), home-improvement
retailing (The Home Depot vs. Lowe’s), toys and games (Hasbro
vs. Mattel), and detergents (P&G vs. Unilever). When there are
only two main competitors, it’s called a duopoly and is a special
case of oligopoly.
Examples of monopoly: Examples: Georgia Power is the only
supplier of electricity for some 2.5 million customers in the
southeastern United States. Philadelphia Gas Works is the only
supplier of natural gas in the city of Philadelphia, Pennsylvania,
serving some 500,000 customers.
18
Important Things to Remember!
This is an industry level analysis
This analysis is always conducted from the perspective of
incumbents (those already in the industry)
There is not a direct relationship between buyers and suppliers
Consider how several European countries and the European
Union (EU) apply political and legal pressure on U.S. tech
companies. European targets include Apple, Amazon, Facebook,
Google, and Microsoft—the five largest U.S. tech companies—
but also startups such as Uber, the taxi-hailing mobile app.
Europe’s policy makers seek to retain control over important
industries ranging from transportation to the internet to ensure
that profits earned in Europe by Silicon Valley firms are taxed
locally. The EU parliament even proposed legislation to break
up “digital monopolies” such as Google. This proposal would
require Google to offer search services independently as a
standalone company from its other online services.
19

Suppliers, Buyers, and the Industry
Suppliers Industry Buyers
Power of Suppliers
Power of Buyers
Threat of New Entrants is Low When:

23Very HighHighMediumLowVery LowEconomies of scale are
XProduct differentiation isXCapital requirements
areXSwitching costs areXIncumbent's control of distribution
channels is XIncumbent's proprietary knowledge
isXIncumbent's access to raw materials is XIncumbents access
to government subsidies isX
23
Supplier Power is Low When:
24Very HighHighMediumLowVery LowConcentration relative
to buyer industry is XAvailability of substitute products is
XImportance of customer to the supplier isXDifferentiation of
the supplier's products areXSwitching costs of the buyer
areXThreat of forward integration by the supplier isX
24
Buyer Power is Low When:
25Very HighHighMediumLowVery LowConcentration of buyers
relative to suppliers isXSwitching costs areXProduct
differentiation of supplier is XThreat of backward integration
by buyers is XExtent of buyer's profits is XImportance of
suppliers input to final product isX
25

Threat of Substitutes is Low When:
26Very HighHighMediumLowVery LowThe quantity of
substitutes is XThe likelihood that a consumer will switch to a
substitute isX
26
Intensity of Rivalry is Low When:
27Very HighHighMediumLowVery LowNumber of competitors
isXIndustry growth rate isXFixed costs areXStorage costs
areXProduct differentiation is XSwitching costs areXExit
barriers areXStrategic stakes areX
27
Steps for Completing a 5 Forces Analysis:
28
Identify (define) the industry which you are analyzing.
Choose a factor/force and evaluate sub-factors. For example, if
choosing the threat of substitutes you will evaluate switching
costs, consumer loyalty, price/performance tradeoffs for
substitutes, number and variety of substitutes, and necessity of
product or service.
29
Rate the force. Example: The threat of substitution in the ice

cream industry is very high. Other possible ratings for forces
include high, moderate, medium to high, medium, medium to
low, low, and very low.
Repeat steps 2 and 3 until all 5 forces have been completed.
30
After considering all 5 forces, answer the question: Is this
industry attractive (for incumbents and/or those looking to enter
the industry)?
Adding a Sixth Force:
The Strategic Role of Complements
Complementor – A firm that provides a good/service that leads
customers to value your firm’s offering more when the two are
combined
Co-opetition – Cooperation by competitors to achieve a
strategic objective
3-‹#›
Instructors:
The IM has a good insight here on what a Complement is NOT.
See below.
A good example of what a complement is would be the Halo
game franchise and the effect it has had on driving increased

sales in the video game console industry, in this case helping
Microsoft Xbox at the expense of its rivals, but still increasing
the total industry sales.
You also need an example of what complements are NOT.
Students often think that if products “go together” then they
must be complements ... not so. Gasoline is not a complement to
the car industry. When you purchase a gallon of gasoline it does
not make you want to go out an buy an extra car to go with it.
31
A product, service, or competency that adds value when used in
tandem with the original product offering
COMPLEMENT
Changes over Time: Industry Dynamics
The static five forces model cannot determine the speed of
change for an industry.
As consolidated industries tend to be more profitable than
fragmented ones, firms tend to change their industry structures
toward being more consolidated through (horizontal) mergers
and acquisitions.
Industry Profitability Consolidation

MACRO
MICRO
3-‹#›
33
EXTERNAL ANALYSIS
INDUSTRY ANALYSIS
Five Forces Model
COMPETITOR ANALYSIS

Strategic Groups
PESTEL Framework
Explaining Differences within Industries: Strategic Groups
Firms in the same strategic group follow a similar strategy.
Strategic group differences identify business-level strategies.
Direct competitors – same strategic group firms
Hint - Think about the automobile industry
Strategic Groups in the Global Automobile Industry
Implications for the Strategist
PESTEL analysis guiding consideration: How the external
factors identified affect the firm’s industry environment/future
profits.
Porter’s five forces model identifies industry profit potential
and firm positioning for gaining and sustaining competitive
advantage.

Strategic group map helps to find performance differences
within the focal industry.
After the Break – Cola Wars Case
Which industry is more attractive?
Bottling industry
Concentrate production industry
Take-Away Concepts
Competition must be viewed more broadly to not only
encompass direct rivals but also a set of other forces in an
industry: buyers, suppliers, the potential new entry of other
firms, and the threat of substitutes.
The profit potential of an industry is a function of the five
forces that shape competition: (1) threat of entry, (2) power of
suppliers, (3) power of buyers, (4) threat of substitutes, and (5)
rivalry among existing competitors.
The stronger a competitive force, the greater the threat it
represents. The weaker the competitive force, the greater the
opportunity it presents.
A firm can shape an industry’s structure in its favor through its
strategy.
Apply Porter’s five competitive forces to explain the profit
potential of different industries.

Take-Away Concepts
Co-opetition can create a positive-sum game, resulting in a
larger pie for everyone involved.
Complements increase demand for the primary product,
enhancing the profit potential for the industry and the firm.
Attractive industries for co-optetion are characterized by high
entry barriers, low exit barriers, low buyer and supplier power,
a low threat of substitutes, and the availability of complements.
Describe the strategic role of complements in creating positive-
sum co-opetition.
Take-Away Concepts
Industries are dynamic…they change over time.
Different conditions prevail in different industries, directly
affecting the firms competing in these industries and their
profitability.
In industry convergence, formerly unrelated industries begin to
satisfy the same customer need.
This is often brought on by technological advances.
Appraise the role of industry dynamics and industry
convergence in shaping the firm’s external environment.
Take-Away Concepts

A strategic group is a set of firms within a specific industry that
pursue a similar strategy in their quest for competitive
advantage.
Generally, there are two strategic groups in an industry based
on two different business strategies: low-cost and
differentiation strategies.
Rivalry within the same strategic group is more intense than the
rivalry between strategic groups: intra-group rivalry exceeds
inter-group rivalry.
Strategic groups are affected differently by the external
environment and the five competitive forces.
Some strategic groups are more profitable than others.
Movement between strategic groups is restricted by mobility
barriers—industry-specific factors that separate one strategic
group from another.
Generate a strategic group model to reveal performance
differences between clusters of firms in the same industry.
Threat of New Entrants Is Low
When: High Low Justification
Economies of scale are X
Product differentiation is X
Capital Requirements are X

Switching costs are X
Incumbents control of
distribution channels is
X
Incumbents proprietary
knowledge is
X
Incumbents access to raw
materials is
X
Incumbents access to
government subsidies is
X
Power of Buyers Is Low When: High Low Justification
Concentration of buyers relative
to suppliers is
X
Product differention of suppliers
is
X

Threat of backward integration is X
Extent of buyers profits is X
Importance of the supplier's
input to the quality of the
buyer's final product is
X
Threat of Substitute Products Is
Low When: High Low Justification
Number of substitutes is X
The liklihood that consumers will
switch to a substitute
X
Analyzing the Five Forces
Power of Suppliers Is Low When: High Low Justification
Concentration relative to buyer
industry is
X
Availability of substitute supplies

is
X
Importance of the customer to
the supplier is
X
Differentiation of the supplier's
products and services is
X
Switching costs of the buyer are X
Threat of forward integration is X
Intensity of Competitive Rivalry
is low When: High Low Justification
Number of competitors is X
Industry growth rate is X
Fixed costs are X
Storage costs are X
Product differentiation is X
Exit barriers are
X

Chapter 3External Analysis Industry Structure, Competitive Fo

Recommended

Recommended

More Related Content

Similar to Chapter 3External Analysis Industry Structure, Competitive Fo

Similar to Chapter 3External Analysis Industry Structure, Competitive Fo (20)

More from EstelaJeffery653

More from EstelaJeffery653 (20)

Recently uploaded

Recently uploaded (20)

Chapter 3External Analysis Industry Structure, Competitive Fo