Analyzing a Company's External Environment

Chapter
Three
Evaluating a
Company’s
External
Environment

Copyright © Houghton Mifflin Company. All rights reserved. 2 | 2
External Analysis requires an assessment of:
 Industry environment in which a company operates
• Porter’s Five Forces Model
• Analysis of Strategic Groups within the Industry
• Analysis of Industry Life Cycle
 Macroenvironment that may affect the company
and its industry
• Social
• Government
• Legal
• International
• Technological
• Economic
• Political
External Environmental Analysis
The purpose of external environmental analysis is to
identify the strategic opportunities and threats in the
organization’s operating environment that
will affect how it pursues its mission.

External Analysis:
Opportunities and Threats
Analyzing the dynamics of the industry in which
an organization competes in order to identify:
Opportunities
Conditions in the
environment that a
company can take
advantage of to
become more
profitable
Threats
Conditions in the
environment that
endanger the
performance and
profitability of an
organization

Industry Analysis:
Defining an Industry
 Industry
• A group of companies offering products or services that
are close substitutes for each other and that satisfy the
same basic customer needs
• Industry boundaries may change as customer needs
evolve and technology changes
 Sector
• A group of closely related industries
 Market Segments
• Distinct groups of customers within an industry
• Can be differentiated from each other with distinct
attributes and specific demands

The Computer Sector:
Industries and Market Segments
Figure 2.1

Porter’s Five Forces Model
Source: 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

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
Competitors
1. Economies of Scale
Sources of economies of scale include:
 Cost reductions gained from the increase in the level of production;
 Discounts on bulk purchases of raw material inputs and component
parts;
 The advantages gained by spreading fixed production costs over a
large production volume; and
 The cost savings associated with distributing, marketing, and
advertising costs over a large volume of output.

Competitors
2. Brand Loyalty
Exists when consumers have a preference for the products of
the established companies.
Achieved by advertising, branding, high product quality, and
good after-sales service.
Difficult for new entrants to take market share from
established brands.

Competitors
3. Patents and Other Forms of Intellectual Properly
4. High Customer Switching Costs
 Switching costs arise when a customer invests time,
energy, and money switching from the products
offered by one established company to the products
offered by a new entrant.
5. Government Regulation
 May be a strong entry barrier to certain
industries

Competitors
6. Absolute Cost Advantages
Absolute cost advantages arise from three main sources:
 Superior production operations and processes due to
state-of-the-art technology, accumulated experience,
learning, patents, or trade secrets;
 Control of particular inputs required for production,
such as labor, materials, equipment, or management
skills, that are limited in their supply; and
 Access to cheaper funds because existing companies
represent lower risks than new entrants.

1. Industry Competitive Structure
 Number and size distribution of companies
 Consolidated versus fragmented industries
2. Industry Demand Conditions
 Growing demand – tends to moderate competition and reduce
rivalry. Companies will be able to increase sales volume without
taking market share from others.
Declining demand –The firms in the industry may have
excess production capacity. Declining demand stage can
result in intense rivalry and lower profits.
 Rivalry Among Established
Companies
Competitive 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:

3. Cost Conditions
High fixed costs – If fixed cost is high and sales
volume is low, a company cannot cover the fixed cost
and will not be profitable.
profitability depends on sales volume. For example, air
express service, furniture business (Hatil, Partex, etc.).
4. The rivals have emotional stake in the business or
face high exit barriers – prevents companies from
leaving industry
 Rivalry Among Established
Companies

Industry Buyers may be the consumers (end-users) or
intermediaries that distribute or retail the products. These
buyers are most powerful when:
 Bargaining Power of Buyers
1. Buyers are dominant.
 Buyers are large in size and few in number.
 The industry supplying the product is composed of many small
companies.
2. Buyers purchase in large quantities.
 Buyers have purchasing power as leverage for price reductions.
3. The industry is dependent on the buyers.
 Buyers purchase a large percentage of a company’s total orders.

 Bargaining Power of Buyers
4. Switching costs for buyers are low.
 Buyers can play off the supplying companies against
each other.
5. Buyers can purchase from several supplying
companies at once.
6. Buyers can threaten to enter the industry themselves.
 Buyers produce themselves and supply their own
products.
 Buyers can use a threat of entry as a tactic to drive
prices down.

Suppliers are organizations that provide inputs such as
materials and labor into the industry. These suppliers are
most powerful when:
 Bargaining Power of Suppliers
1. The supplying industry is dominated by a few large firms.
2. The product supplied is vital to the industry and has few/no
substitutes.
3. The industry is not an important customer to suppliers.
 Suppliers are not significantly affected by the industry.

 Bargaining Power of Suppliers
4. Companies in the industry cannot threaten to enter suppliers’
industry.
5. Suppliers’ products and/services are in short supply.
6. Suppliers’ products and/services are differentiated or unique.

Substitute Products are the products from
different businesses or industries that can satisfy
similar customer needs.
 Substitute Products
1. The existence of close substitutes is
a strong competitive threat.
 Substitutes limit the price that companies can
charge for their product.
2. If there is no close substitute or
substitutes are a weak competitive
force, then….
 Companies in the industry have the
opportunity to raise prices and earn additional
profits.

2 | 18
Suggested by Andrew Grove, the former
CEO of Intel.
A Sixth Force: Complementors
 Complementors are the firms that sell products that
add value to (complement) the products of the
industry.
 Complementors of personal computer industry are the
producers of software applications to run on the
personal computers.

2 | 19
Strategic Groups
Within Industries
A Strategic Group is a group of companies that
follow a similar business model – but are different
from that of other companies in other strategic
groups.
 Implications of Strategic Groups –
1. The closest competitors are within the same Strategic Group
and may be viewed by customers as substitutes for each other.
2. 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 groups
• Include barriers to enter another group or exit existing group

2 | 20
Strategic Groups in the
Pharmaceutical Industry
Figure 2.3

2 | 21
Industry Life Cycle Model analyzes the effects of
industry evolution on competitive forces over time
and is characterized by five distinct life cycle stages:
Industry Life Cycle Analysis
1. Embryonic – industry just beginning to develop
 Rivalry based on perfecting products, educating
customers, and opening up distribution channels.
2. Growth – first-time demand takes-off with new customers
 Low rivalry as focus is on keeping up with high
industry growth.

2 | 22
Industry Life Cycle Analysis
3. Shakeout – demand approaches saturation,
replacements
 Rivalry intensifies with the emergence of excess
productive capacity.
4. Mature – market totally saturated with low to no growth
 Competition intensifies for market share, driving
down prices, and often producing a price war.
 Consolidation can reduce competition.
5. Decline – industry growth becomes negative
 Rivalry further intensifies based on the rate of
decline and exit barriers.

2 | 23
Stages in the Industry Life Cycle
    
Strength and nature of five forces change as industry evolves Figure 2.4

2 | 24
Growth in Demand and Capacity
Industry Shakeout:
Rivalry Intensifies
with growth in
excess capacity
Anticipate how forces will change and formulate appropriate strategy Figure 2.5

2 | 25
The Role of the
Macroenvironment
Changes in the
forces in the macro-
environment can
directly impact:
• The Five Forces
•Industry
Attractiveness
Figure 2.7

CORE CONCEPT
♦ The macro-environment encompasses the
broad environmental context in which a
company’s industry is situated that includes
strategically relevant components over which
the firm has no direct control.
3–26

THE STRATEGICALLY RELEVANT FACTORS IN
THE COMPANY'S MACRO-ENVIRONMENT
 PESTEL Analysis
● Focuses on analyzing SIX principal components of
the macro-environment:
 Political factors
 Economic conditions (local to worldwide)
 Sociocultural forces
 Technological factors
 Environmental factors (the natural environment)
 Legal/regulatory conditions
3–27

FIGURE 3.2 The Components of a Company’s Macro-Environment
3–28

TABLE 3.1 The Six Components of the Macro-Environment
Component Description
Political
factors
These factors include political policies, including the extent to which a government
intervenes in the economy. They include such matters as tax policy, fiscal policy,
tariffs, the political climate, and the strength of institutions such as the federal
banking system. Some political policies affect certain types of industries more than
others. An example is energy policy, which affects energy producers and heavy
users of energy more than other types of businesses.
Economic
conditions
Economic conditions include the general economic climate and specific factors
such as interest rates, exchange rates, the inflation rate, the unemployment rate,
the rate of economic growth, trade deficits or surpluses, savings rates, and per-
capita domestic product. Economic factors also include conditions in the markets
for stocks and bonds, which can affect consumer confidence and discretionary
income. Some industries, such as construction, are particularly vulnerable to
economic downturns but are positively affected by factors such as low interest
rates. Others, such as discount retailing, may benefit when general economic
conditions weaken, as consumers become more price-conscious.
Sociocultural
forces
Sociocultural forces include the societal values, attitudes, cultural influences, and
lifestyles that impact demand for particular goods and services, as well as
demographic factors such as the population size, growth rate, and age distribution.
Sociocultural forces vary by locale and change over time. An example is the trend
toward healthier lifestyles, which can shift spending toward exercise equipment and
health clubs and away from alcohol and snack foods. Population demographics can
have large implications for industries such as health care, where costs and service
needs vary with demographic factors such as age and income distribution.
3–29

TABLE 3.1 The Six Components of the Macro-Environment (cont’d)
Component Description
Technological
factors
Technological factors include the pace of technological change and technical
developments that have the potential for wide-ranging effects on society, such as
genetic engineering and nanotechnology. They include institutions involved in
creating new knowledge and controlling the use of technology, such as R&D
consortia, university-sponsored technology incubators, patent and copyright laws,
and government control over the Internet. Technological change can encourage the
birth of new industries, such as the delivery drone industry, and disrupt others, such
as the recording industry.
Environmental
forces
These include ecological and environmental forces such as weather, climate,
climate change, and associated factors like water shortages. These factors can
directly impact industries such as insurance, farming, energy production, and
tourism. They may have an indirect but substantial effect on other industries such
as transportation and utilities.
Legal
and regulatory
factors
These factors include the regulations and laws with which companies must comply,
such as consumer laws, labor laws, antitrust laws, and occupational health and
safety regulation. Some factors, such as banking deregulation, are industry-specific.
Others, such as minimum wage legislation, affect certain types of industries (low-
wage, labor-intensive industries) more than others.
3–30

Analyzing a Company's External Environment

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