chapter 3Evaluating a Company’s External Environment

chapter 3
Evaluating
a Company’s
External
Environment
Arthur A. Thompson
The University of Alabama
Copyright © 2020 by Arthur A. Thompson and Glo-Bus
Software, Inc
All rights reserved. Not for distribution to non-registrants
without permission.
An e-book published and distributed
by McGraw Hill Education
Sixth Edition of Strategy: Core Concepts and Analytical
Approaches (2020-2021). Arthur A. Thompson, The University
of Alabama. Published and distributed by McGraw Hill
Education. Image of globe comprised of puzzle pieces with
several pieces dislodged and scattered below the globe. Title of
Chapter 3 Evaluating a Company’s External Environment
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“Analysis is the critical starting point of strategic thinking.”
Kenichi Ohmae,

consultant and author
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“Things are always different—the art is figuring out which
differences matter.”
Laszlo Birinyi,
investments manager
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“In essence, the job of a strategist is to understand and cope
with competition.”
Michael E. Porter,
Professor, Harvard Business School
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“No matter what it takes, the goal of strategy is to beat the
competition.”
Kenichi Ohmae,
consultant and author
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Learning Objectives
To gain command of the basic concepts and analytical tools
widely used to diagnose a company’s industry and competitive
conditions.
To become adept in recognizing the factors that cause
competition in an industry to be fierce, more or less normal, or
relatively weak.
To learn how to determine whether an industry’s outlook
presents a firm with sufficiently attractive opportunities for
growth and profitability.
To understand why in-depth evaluation of specific industry and
competitive conditions is a prerequisite to crafting a strategy
well matched to a firm’s situation.
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Chapter 3 Roadmap
Assessing the Strategically Relevant Industry and Competitive
Factors in a Firm’s External Environment
Question 1: What competitive forces do industry members face,
and how strong are they?
Question 2: What forces are driving changes in the industry

and what impacts will they have on competitive intensity
and industry profitability?
Question 3: What market positions do rivals occupy—which
is strongly positioned and who is not?
Question 4: What strategic moves are rivals likely to make
next?
Question 5: What are key factors for future competitive
success?
Question 6: Is the industry outlook conducive to good
profitability?
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Actions to steer a firm in a different direction or alter its
strategy must be predicated on deep understanding of two facets
of its situation:
The industry and competitive environment in which the firm
operates and the forces acting to reshape this environment
The firm’s own market position and competitiveness
Its resources and capabilities
Its strengths and weaknesses vis-à-vis rivals
Its windows of opportunity
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Understanding a Company’s Situation
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Figure 3.1From Thinking Strategically about the Company’s
Situation
to Choosing a Strategy
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External factors and influences in the “macro-environment” that
influence a firm’s decisions about its direction, objectives,
strategy, and business model include:
General economic conditions
Political, regulatory, and legal influences
Technological influences
Sociocultural forces (values, lifestyles, and shifting population
demographics)
Considerations relating to the natural environment
The Strategically Relevant Factors Influencing a Firm’s
External Environment
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Figure 3.2The Components of a Company’s Macroenvironment
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There are six questions that must be asked and answered:
What competitive forces do industry members face, and how
strong are they?
What forces are driving changes in the industry, and what
impact will these changes have on competitive intensity and
industry profitability?
What market positions do industry rivals occupy—who is
strongly positioned and who is not?
What strategic moves are rivals likely to make next?
What are the key factors for future competitive success?
Is the industry outlook conducive to good profitability?
Assessing a Company’s Industry
and Competitive Environment
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The state of competition in an industry is a composite of five
competitive forces:
The market maneuvering and jockeying for buyer patronage
among industry rivals.
The threat of new entrants into the market.

The attempts of firms in other industries to win buyers over to
their own substitute products.
The exercise of supplier bargaining power.
The exercise of buyer (or customer) bargaining power.
Question 1: What Competitive Forces Do Industry Members
Face and How Strong Are They?
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Figure 3.3The Five-Forces Model of Competition: A Key
Analytical Tool
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How to Analyze
the Five Competitive Forces
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Step 1
Identify the specific competitive pressures associated with each
of the five forces.

Step 2
Evaluate how strong the pressures comprising each of the five
forces are (fierce, strong, moderate to normal, or weak).
Step 3
Determine whether the collective strength of the five
competitive forces is conducive to earning attractive profits.
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Core Concept
Competitive maneuvering among industry rivals is ever-
changing, as competing sellers initiate round after round of
offensive and defensive moves, emphasizing first one mix of
competitive weapons and then another in efforts to improve
their market positions and profitability.
These ongoing maneuvers and jockeying for position create a
continually evolving competitive landscape where the market
battle ebbs and flows, sometimes takes unpredictable twists and
turns, and produces winners and losers.
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Competitive Pressures Created by
the Rivalry among Competing Sellers
A market is a competitive battlefield where the contest among
industry rivals is ongoing and dynamic.
Each rival is motivated to use whatever “weapons” in its
business arsenal will attract and retain buyers, strengthen its
market position, and yield good profits.

The challenge is to craft a competitive strategy that at the very
least allows a firm to hold its own against rivals and, more
ideally, strengthens its ability to compete successfully enough
to produce a competitive edge over rivals.
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When one competitor deploys a strategy or makes a new
strategic move that produces good results, its rivals must
respond with offensive or defensive countermoves calculated to
preserve their market standing and avoid lower profitability.
This pattern of move and countermove, attack and defend,
adjust and readjust makes the competitive battle among rivals
dynamic and fluid, with firms gaining or losing ground in the
marketplace according to whether their strategic maneuvers
succeed or fail.
The winners—current market leaders—have no guarantees of
continued leadership; their market success is only as durable as
the power of their strategies to fend off the strategies of
ambitious challengers.
All this constant maneuvering and jockeying quite often results
in the competitive battle among industry rivals being the
strongest of the five competitive forces.
Why Rivalry Is Usually the Strongest
of the Five Competitive Forces
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Figure 3.4The “Weapons” Used to Battle Rivals and the Factors
Affecting the Strength of Rivalry
3–19
Software, Inc.Reducing prices; granting special discounts to win
the business of particular buyers
Introducing more or different features
Innovating to improve product performance or quality
Running ads to inform buyers of new or special features and/or
to strengthen brand awareness or brand image
Having periodic sales promotions, holding clearance sales,
advertising items on sale
Improving selection of models and stylesBuilding a
bigger/better dealer network
Offering low interest rate financing
Offering coupons
Improving customer service
Allowing buyers to customize what they buy
Improving warranties
Providing quicker or cheaper delivery
Developing competitively valuable capabilities rivals don’t
have
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Figure 3.4The Factors Affecting the Strength of Rivalry
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What Causes Rivalry to Become Stronger?
Rivalry is more intense when:
Competing sellers are active in making fresh moves to improve
their market standing and business performance.
Buyer demand is growing slowly.
Buyers incur low costs in switching to rival brands.
The products of rival sellers are essentially identical or else
weakly differentiated, resulting in little or no buyer brand
loyalty.
Sellers have idle capacity and/or excess inventory.
The industry’s product is costly to hold in inventory,
perishable, or seasonal.
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Rivalry is more intense when:
The number of rivals increases and/or rivals are of roughly
equal size and competitive capability.
One or more rivals are dissatisfied with their business
performance and are making aggressive moves to attract more
customers.
Outsiders have recently acquired weak competitors and are

spending heavily to turn them into major contenders.
Rivals have diverse industry outlooks, objectives, or strategies
and/or have production facilities in countries where production
costs are materially different.
What Causes Rivalry to Become Stronger? (continued)
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What Causes Rivalry to Become Weaker?
Rivalry tends to be less intense when:
Industry members infrequently launch aggressive actions to take
sales and market share away from rivals
Buyer demand is growing rapidly
The products of rival sellers are strongly differentiated and the
loyalty of buyers to their preferred brand is high
Buyer costs to switch to rival brands are high
Industry rivals are so numerous that any one firm’s attempt to
grow its business has little direct impact on rival businesses and
thus provokes little need for retaliation
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Rivalry tends to be less intense when:
Sellers have small inventories and/or little idle capacity
Rivals have low fixed costs and low inventory storage costs

A few large sellers have the majority of sales and dominant
market shares
Rivals have similar costs and similar industry outlooks—there
are no industry mavericks to disrupt the status quo
What Causes Rivalry to Become Weaker? (continued)
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Characterizing Industry Rivalry
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Cutthroat
or Brutal
When competitors engage in protracted price wars or habitually
undertake other aggressive strategic moves
that prove mutually destructive to profitability, causing
many/most industry members to lose money
Fierce to Strong
When the battle for market share is so vigorous that the profit
margins of most industry members are squeezed to sub-par or
even bare-bones levels
Weak
When most industry firms are relatively well satisfied with their
sales growth and market shares, rarely undertake offensives to
steal customers away from one another, and—because of weak
competitive forces—earn consistently good profits and returns
on investment
Moderate
or Normal
When the maneuvering among industry members, while lively
and healthy, still allows most industry members to earn

acceptable profits
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Competitive Pressures Associated with the Threat of Potential
Entry
The increase in competitive pressures faced by industry
members due to the threat of market entry of new firms depends
on:
Whether the barriers to successfully entering the industry are
high or low
The size of the pool of entry candidates and the resources at
their command to hurdle the entry barriers
The expected reaction of existing industry members to the entry
of newcomers
How attractive the industry’s growth and profit prospects
are to potential entrants
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Cost advantages held by industry incumbents
Strong brand preferences and high degrees of customer loyalty
to the brands they are currently purchasing
High capital requirements
The difficulties of building a network of distributors or retailers
and securing space on retailers’ shelves
Restrictive or costly regulatory policies that limit/bar new

entrants
Tariffs and international trade restrictions
The likelihood that industry incumbents will strongly resist
entrants’ efforts to secure a profitable volume of sales
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Common Barriers to Entry
Current industry members may have cost advantages that a new
entrant cannot easily overcome; these include:
Scale economies in production, distribution, or other activities
Learning-based costs savings that accrue from in-industry
experience in performing certain activities such as
manufacturing or new product development or inventory
management
Cost-savings accruing from patents or proprietary technology
Partnerships with the best and cheapest suppliers of raw
materials and components
Favorable locations
Low fixed costs (because incumbents have older facilities that
have been mostly depreciated)
The Cost Advantages of Incumbents:
An Important Entry Barrier
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Figure 3.5Factors Affecting the Threat of Entry
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Entry threats are stronger when:
The pool of entry candidates is large and some have resources
that make them strong market contenders
Entry barriers are low or easily hurdled by new entrants
Industry members can expand their presence into other product
segments or geographic areas
Newcomers can expect to earn attractive profits
Buyer demand is growing rapidly
Industry members are unable (or unwilling) to strongly contest
the entry of new firms
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Competitive Pressures Associated
with the Threat of New Entrants
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Core Concept
The threat of entry is stronger
when entry barriers are low,

when incumbent firms are unable or unwilling to vigorously
contest a newcomer’s entry,
when there’s a sizable pool of entry candidates, and
when the industry’s outlook is highly attractive to outsiders.
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Entry threats are weaker when:
The pool of entry candidates is small
Entry barriers are high
Existing competitors are struggling to earn good profits
The industry’s outlook is risky or uncertain
Buyer demand is growing slowly or is stagnant
Industry members will strongly contest the efforts of new
entrants to gain a market foothold
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When Is the Threat of Entry Weaker?
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Are the industry’s growth and profit prospects strongly
attractive to potential entry candidates?
A “Yes” answer = Threat of potential entry is a strong
competitive force
A “No” answer = Threat of potential entry is a
weak competitive force
The Best Test of Whether the Entry
of New Competitors Is Likely
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Rapidly growing market demand and high potential profits act
as magnets, growing the pool of entry candidates and motivating
potential entrants (most usually including resource-rich firms
capable of becoming formidable competitors!!!) to commit the
resources needed to hurdle entry barriers—in which case the
high probability of new entry qualifies as a strong competitive
force.
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When the Threat of Entry Is Certain
to Be High
Competitive Pressures from the Sellers
of Substitute Products
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Firms in one industry come under competitive pressure from
firms in a closely adjoining industry whenever buyers view the
products of the two industries as good substitutes
Examples of substitutes:
Attending movies at theaters versus subscribing to various
streaming services
Cell phone cameras versus traditional digital cameras
Beer versus wine versus hard liquors
Contact lens versus prescription glasses versus corrective laser

surgery
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Figure 3.6Factors Affecting Competition from Substitute
Products
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When Are Substitute Products
a Strong Competitive Force?
The strength of competitive pressures from substitute products
depends on:
Whether substitutes are readily available and attractively priced
Whether buyers view substitutes as being comparable or better
in term of attributes
How much it costs buyers to switch to substitutes
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Rule
The lower the price of substitutes, the higher their quality and
performance, and the lower the user’s switching costs, the more
intense the competitive pressures posed by substitute products.

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Competitive pressures from substitutes are stronger when:
Substitutes are readily available and attractively priced
Substitutes are of comparable or better quality and have
desirable performance features
Buyers incur low costs in switching to substitutes
Buyers are growing more comfortable with using substitutes
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When Is Competition from
Substitutes Stronger?
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Competitive pressures from substitutes are weaker when:
Good substitutes are not readily available or don’t exist
Substitutes are higher priced relative to the value they deliver to
buyers
Substitutes lack comparable or better performance features
Buyers have high costs in switching to substitutes
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When Is Competition from
Substitutes Weaker?

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Sales of substitutes are growing faster than overall sales of the
industry in question
An indication that the sellers of substitutes are
stealing the industry’s customers away
The producers of substitute products are investing in added
production capacity and expanding their market coverage
Profits of the producers of substitutes are rising
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Three Signs that Substitute Products
Are a Strong Competitive Force
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Competitive Pressures Stemming from the Bargaining Power of
Suppliers
Whether the suppliers of industry members represent a strong,
moderate, or weak competitive force depends on how much
bargaining power suppliers have to influence the terms and
conditions of supply in their favor.
Powerful or influential suppliers can be a source of strong
competitive pressure when they have the ability to
charge industry members higher prices and/or make it difficult
or more costly for industry members to switch to other
suppliers.
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Figure 3.7Factors Affecting the Bargaining Power of Suppliers
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Whether the item that industry members are purchasing from
suppliers is in short supply or whether ample quantities are
readily available from any of several suppliers
Whether certain suppliers provide a differentiated input that
enhances the performance or quality of the industry’s product
Whether certain suppliers provide equipment or services that
deliver valuable cost-saving efficiencies to industry members in
operating their production processes
Whether the item being supplied a standardized commodity
readily available from many suppliers at the going market price
Whether industry members easily switch their purchases from
one supplier to another or switch to substitute inputs
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Factors Affecting Whether the Bargaining Power of Suppliers Is
Strong or Weak

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Whether suppliers provide an item that accounts for a sizable
fraction of the costs of the industry’s product
Whether industry members are major customers of suppliers
Whether a few large suppliers are regarded as the best and most
reliable sources of a particular item
Whether it makes economic sense for industry members to
integrate backward to self-manufacture items bought from
suppliers
Whether suppliers have the resources and profit incentive to
integrate forward into the businesses of customers they are
supplying
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Factors Affecting Whether the Bargaining Power of Suppliers Is
Strong or Weak (cont’d)
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Supplier bargaining power is stronger when:
A needed input is in short supply
Certain suppliers either have a differentiated input that
enhances the quality or performance of sellers’ products or
provide equipment/services that deliver valuable cost-saving
efficiencies
Industry members incur high costs in switching to alternative
suppliers
There are no good substitutes for certain products/services
being supplied
When Is Supplier Bargaining Power

Stronger?
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Suppliers are not dependent on industry members for a large
portion of their revenues
Suppliers provide an item that accounts for a small fraction of
the costs of the industry’s product
There are only a few “preferred” suppliers of a particular input
Some suppliers are a threat to integrate forward into the
business of industry members and perhaps become a powerful
rival
When Is Supplier Bargaining Power
Stronger? (continued)
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Supplier bargaining power is weaker when:
There are ample supplies of a needed input
The item being supplied is a “commodity” obtainable from
many different suppliers at the going market price
Industry members incur low costs in switching to alternative
suppliers
Good substitutes exist for the products/services of suppliers
When Is Supplier Bargaining Power Weaker?

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portion of their revenues
Suppliers provide an item that accounts for a small fracti on of
the costs of the industry’s product
There are only a few “preferred” suppliers of a particular input
rival
When Is Supplier Bargaining Power Weaker? (continued)
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Competitive Pressures Stemming
from the Bargaining Power of Buyers
Buyers exert strong competitive pressures on industry members
when:
Buyers have bargaining leverage to obtain price concessions and
favorable terms and conditions of sale
Many buyers are price sensitive and can act in unison to limit
prices that industry members can charge

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Important
Point
Not all buyers of an industry’s product have equal degrees of
bargaining power with sellers, and some are more or less
sensitive than others to price, quality, or service differences.
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Strategic Insight
Buyers’ bargaining power is stronger when they are few in
number and purchase in large volumes. The larger buyers’
purchases, the more important their business is to sellers and
the more likely that sellers will grant them concessions or
special treatment to secure or retain their business.
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Figure 3.8Factors Affecting the Bargaining Power of Buyers
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The quantity that a buyer is purchasing
Whether buyer switching costs are high or low
Whether there are many or few buyers
Whether a buyer is particularly important to a seller
The strength or weakness of buyer demand in relation to the
available supplies
How well buyers are informed about sellers’ products, prices,
and costs
Whether buyers pose a credible threat of integrating backward
into the business of sellers
Whether buyers have discretion to delay their purchases or not
make a purchase at all
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Factors That Determine the Strength
of Buyer Bargaining Power
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Buyer bargaining power is stronger when:
Large-volume purchases by buyers enable them to gain special
treatment
A buyer’s identity adds prestige to the seller’s list of customers
Supplies of the product are greater than buyer demand
There are only a few buyers, so each one’s business is important
to sellers
Buyers have low costs in switching to competing brands or
substitute products
When Is the Bargaining Power
of Buyers Stronger?
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The products of industry members are “commodities” or el se
weakly differentiated.
Buyers are well informed about the product offerings of
industry members.
Buyers can postpone purchases if they do not like the deals
sellers are offering.
Some buyers are a threat to integrate backward into the business
of sellers and become an important competitor.
Buyers are highly price sensitive.
of Buyers Stronger? (cont’d)
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Buyer bargaining power is weaker when:
Buyer purchases are infrequent or in small quantities
Buyers have insufficient “prestige” to command special
treatment
Strong buyer demand creates tight supply conditions or
shortages
There are many buyers such that one buyer’s purchases account

for a tiny fraction of total industry sales
Buyers have high costs in switching to competing brands or
substitute products
of Buyers Weaker?
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The products of industry members are strongly differentiated
Buyers have limited information about the product offerings of
industry members
Buyers cannot easily postpone purchases
There is no credible threat of buyers integrating backward into
the business of industry members
Buyer price sensitivity is relatively low
of Buyers Weaker? (cont’d)
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Is the Collective Strength of the Five Competitive Forces
Unfavorable to Profitability?
The stronger the collective impact of the five competitive

forces, the lower the combined profitability of industry
participants.
Worst case scenario (Perfect Storm of Competitive Forces) —an
industry is very “competitively unattractive” and less profitable
when:
Rivalry among industry members is vigorous
Entry barriers are low, making new entry likely
Competition from substitute products is strong
Both suppliers and customers have considerable bargaining
power
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Is the Collective Strength of the Five Competitive Forces
Conducive to Good Profitability?
An industry is “competitively attractive” when industry
members can reasonably expect to earn good profits and a good
return on investment
Best case scenario—An industry is “competitively attractive”
and more profitable when:
Internal rivalry in the industry is weak to moderate
High barriers block new entrants from the market
Good substitutes do not exist
Both suppliers and customers are in weak bargaining positions
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Strategic Insights
The stronger the forces of competition, the harder it becomes
for industry members to earn attractive profits.
A firm’s strategy is increasingly effective the more insulation it
provides from competitive pressures and the more it shifts the
competitive battle in the firm’s favor.
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Working through the five-forces model step-by-step:
Aids strategy makers in assessing whether the intensity of
competition allows good profitability
Promotes sound strategic thinking about how to better match the
firm’s strategy to the competitive character of the marketplace
Effectively matching a firm’s strategy to competitive conditions
requires:
Pursuing strategic avenues that shield the firm from as many
different competitive pressures as possible
Initiating actions calculated to produce sustainable competitive
advantage, thereby shifting competition in the company’s favor,
putting added competitive pressure on rivals, and perhaps even
defining the business model for the industry
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Matching Company Strategy to Competitive Conditions

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Which one of the five competitive forces is strongest in your
company’s industry?
Are the competitive pressures your company experiences likely
to grow stronger, grow weaker, or remain about the same in the
upcoming decision rounds? Why?
If competitive pressures change in the manner you anticipate,
then what are the implications for the levels of competitive
effort your company will need to employ in upcoming years in
order to maintain (or better yet, improve) its competitive
standing vis-à-vis rivals?
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Questions for Simulation Company
Co-Managers
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Industry conditions are often fluid because certain forces are
enticing or pressuring industry rivals, their customers, or their
suppliers to alter their actions in important ways.
These important change agents are called driving forces because
they have the biggest influences in reshaping the industry
landscape and altering competitive conditions.
Where do driving forces originate?
Outer ring of macroenvironment (Figure 3.2)
Inner ring of macroenvironment (Figure 3.2)
Question 2: What Forces Are Driving Industry Change and What
Impact Will They Have?
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Core Concept
Industry conditions change because important forces are driving
industry participants (competitors, customers, or suppliers) to
alter their actions.
The driving forces in an industry are the major underlying
causes of changing industry and competitive conditions—they
have the biggest influence on how the industry landscape will
be altered.
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Analyzing an Industry’s Driving Forces
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Driving-forces analysis has three steps:
Identifying what the driving forces are
Assessing whether the drivers of change are acting to make the
industry more or less attractive
Determining what strategy changes are needed to prepare for the
impacts of the driving forces

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Identifying an Industry’s Driving Forces
Developments that can affect an industry enough to drive
industry and competitive change include:
Changes in an industry’s long-term growth rate
Increasing globalization
Emerging new Internet capabilities and applications
Changes in who buys the product and how they use it
Product innovation
Technological change and manufacturing process innovation
Marketing innovation
Entry or exit of major firms
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Identifying an Industry’s Driving Forces (continued)
Additional forces that can affect an industry powerfully enough
to drive industry and competitive change include:
Diffusion of technical know-how across more firms and more
countries
Changes in cost and efficiency
Growing buyer preferences for differentiated products instead
of a commodity product (or for a more standardized product
instead of strongly differentiated products)
Reductions in uncertainty and business risk
Regulatory influences and government policy changes
Changing societal concerns, attitudes, and lifestyles
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Strategic Insight
The most important part of driving-forces analysis is to
determine whether the collective impact of the driving forces
will be to increase or decrease market demand, make
competition more or less intense, and lead to higher or lower
industry profitability.
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Assessing the Impact of the Driving Forces
Answers to three questions are needed:
Are the driving forces collectively acting to cause demand for
the industry’s product to increase or decrease?
Is the collective impact of the driving forces making
competition more or less intense?
Will the combined impacts of the driving forces lead to higher
or lower industry profitability?
The answers to these three questions determine whether the
drivers of change are acting to make the industry more or less
attractive.
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Strategic Insight

The most important part of driving-forces analysis is to
determine whether the collective impact of the driving forces
will act to
Increase or decrease market demand
Make competition more or less intense
Lead to higher or lower industry profitability
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Adjusting Strategy to Prepare for
the Impacts of Driving Forces
The third step of driving-forces analysis—the payoff for
strategy-making—is for managers to decide on the strategy
adjustments required to deal with the impacts of the driving
forces.
If management’s diagnosis of the impact of the industry’s
driving forces is muddled or flawed, the chance of making
proper strategy adjustments is slim.
Insightful driving forces analysis leads to better managerial
judgments about where the industry is headed and how to
prepare for the changes ahead.
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Industry rivals can occupy stronger (or distinguishably

different) market positions than other rivals because they have
opted to
Incorporate product features appealing to different types of
buyers
Charge widely differing prices for products of widely differing
quality or performance
Emphasize different distribution channels
Compete in different geographic areas
Or otherwise stake out a different market position from rivals
The best technique for revealing the market positions of
industry competitors is strategic group mapping
Question 3: What Market Positions Do Rivals Occupy—Who Is
Strongly Positioned, Who Is Not?
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Core Concepts
A strategic group is a cluster of industry rivals that employ
similar competitive approaches, have product offerings that
appeal to similar types of buyers, and thus occupy similar
market positions.
Strategic group mapping is a technique for displaying the
different market positions that rival firms occupy in the
industry.
3–72
Software, Inc.

72
Defining a Strategic Group
Firms in the same strategic group can resemble one another in
any of several ways:
Comparable product-line breadth
Sell in the same price/quality range
Emphasize same distribution channels
Use much the same product attributes to appeal
to similar types of buyers
Use identical technological approaches
Offer buyers similar services and technical assistance
Compete in much the same geographic areas
3–73
Software, Inc.
How to Construct a Strategic Group Map
3–74
Software, Inc.
Step 1
Step 3
Step 2
Identify competitive characteristics that differentiate firms in an
industry from one another.
Plot firms on a two-variable map using pairs of these
differentiating characteristics.
Assign firms that fall in about the same strategy space to same
strategic group.
Step 4
Draw circles around each group, making circles proportional to
size of each group’s respective share of total industry sales.

74
Figure 3.9Comparative Market Positions of Selected Retail
Chains:
An Example of a Strategic Group Map
Note: Circles are drawn roughly proportional to the combined
total revenues of the retailers shown in each strategic group.
Access the alternative text for slide image.
3–75
Software, Inc.
75
Guidelines for Constructing
a Strategic Group Map
The variables used as axes must not be highly correlated
If they are, then all circles will fall along a diagonal and reveal
nothing more about the relative positions of rivals than would
be revealed by comparing the rivals on one of the variables
The chosen variables should reveal big differences in how rivals
compete
When rivals differ on both variables, locations of the rivals will
be scattered, showing how they are positioned differently
Drawing sizes of circles proportional to combined sales of firms
in each strategic group allows the map to reflect relative market
share sizes of each strategic group
If three or more good competitive variables can be used for the
two axes of the map, it is best to draw several maps

3–76
Software, Inc.
What Can Be Learned from
Strategic Group Maps?
Strategic group maps identify:
Which industry members are close rivals and which are distant
rivals. Firms in the same strategic group are the closest rivals;
the next closest rivals are in the immediately adjacent groups
Firms in strategic groups that are far apart on the map may
hardly compete with one another at all
Not all positions on the map are equally attractive:
Prevailing competitive pressures and driving forces often favor
some strategic groups and hurt others
Profit potential of different strategic groups often varies due to
strengths and weaknesses in each group’s market position
3–77
Software, Inc.
Have you studied the strategic group maps for each geographic
region shown in the Competitive Intelligence Report?
Based on these maps, which rival firms are your closest
competitors in each geographic region?
Which rival firms are distant competitors?
Which of the four regional strategic group maps indicate that
there are many rival firms grouped very close together,

signaling they are members of an “overcrowded” strategic
group?
Is the financial performance of firms in overcrowded strategic
groups suffering because of the tough competitive battle taking
place among similarly-positioned strategic group members?
Are there “open spaces” in the four regional group maps that
present good opportunities because competition is weaker in the
open spaces?
3–78
Software, Inc.
Questions for Simulation Company
Co-Managers
78
Core Concepts
Strategic group maps reveal which firms are close competitors
and which are distant competitors.
Some strategic groups are more favorably positioned than others
because they confront weaker competitive forces and/or because
they stand to be favorably impacted by the industry’s driving
forces.
3–79
Software, Inc.
Knowledge of rivals’ strategies, financial performance,
competitive strengths and weaknesses, actions and announced
plans, and the thinking and leadership styles of their executives
is valuable for:

Predicting or anticipating the likely strategic moves of
competitors.
Crafting a firm’s strategy with confidence about what market
maneuvers to expect from rivals
Being poised to capitalize on opportunities stemming from
competitors’ missteps or strategy flaws.
Question 4: What Strategic Moves Are Rivals Likely to Make
Next?
3–80
Software, Inc.
80
Strategic Insights
Closely monitoring the actions of competitors and preparing a
defense against their expected next moves reduces the risk of
being caught napping and suffering a damaging loss of sales and
profits.
Perhaps the most frequent reason why a firm gets outcompeted
by what it considers the “surprising” actions of rivals goes
directly to the failure of its management to do a competent job
of studying rivals well enough to recognize their need to
undertake certain actions to improve their sales and/or
profitability and to then be prepared with defensive actions and
countermoves
of their own.
3–81
Software, Inc.
Why Bother with Paying Attention to What Competitors Are

Doing?
Unless a firm studies competitors’ strategies and situations and
arrives at informed conclusions about moves they will be
making, it ends up flying blind into competitive battle.
A firm cannot expect to outcompete rivals when its managers
have little or no idea what rivals have been doing and are likely
to do next.
Smart rivals will take sales, market share, and profits away
from such a firm because its managers are clueless about what’s
going on!
Closely monitoring competitors and preparing a defense against
their expected next moves reduces the risk of being caught
napping and suffering a damaging loss of sales and profits.
3–82
Software, Inc.
82
Which competitors have strategies producing such good results
that they are likely to make only minor strategic adjustments?
Which rivals are performing so poorly that they must begin now
adjusting important strategy elements to move to a different
competitive position on the strategic group map?
Which competitors seem poised to gain market share, and whi ch
ones seem destined to lose ground?
Which competitors will likely to rank among the industry
leaders five years from now? Do any of them have strategies
and sufficient resource capabilities to overtake the current
industry leader?

Questions to Consider in Predicting
the Likely Actions of Rivals
3–83
Software, Inc.
Which rivals badly need to increase their unit sales and market
share?
What strategic options are rivals most likely to pursue:
Lowering prices, adding new models and styles, expanding
dealer networks, entering additional geographic markets,
boosting advertising to build brand-name awareness, acquiring a
weaker competitor, placing more emphasis on online sales, or
……?
the Likely Actions of Rivals (continued)
3–84
Software, Inc.
Which rivals will likely enter new geographic markets or make
major moves to increase their sales and market share in a
particular geographic region?
Which rivals are candidates to expand their product offerings
and enter new product segments where they currently have no
presence?
Which rivals are candidates to be acquired? Which rivals want
make an acquisition and are financially able to do so?

Scouting competitors to anticipate their next moves allows
managers to launch countermoves and to take rivals’ probable
moves into account in crafting a firm’s own best course of
action.
the Likely Actions of Rivals (continued)
3–85
Software, Inc.
Key Success Factors (KSFs)
Are competitive factors that most affect industry members’
ability to compete successfully and profitably
Are those particular strategy elements, product attributes,
resources, capabilities, and/or market achievements with the
greatest impact on a firm’s future competitive success
Why do industry KSFs matter?
Because how well a firm’s strategy elements, product attributes,
resources, and capabilities measure up against the industry’s
KSFs shape how financially and competitively successful it will
be
Question 5: What Are the Key Factors for
Future Competitive Success?
3–86
Software, Inc.
86

Core Concept
Key success factors (KSFs) are the strategy elements, product
attributes, resources, capabilities, and market achievements with
the greatest impact on future competitive success in the
marketplace.
KSFs are so important to competitive success that how well a
firm measures up on each industry KSF can spell the difference
between being a strong competitor and a weak competitor—and
sometimes between profit and loss.
3–87
Software, Inc.
87
Strategic Insight
To be a winner, a firm’s strategy must compare favorably with
rivals on all industry KSFs and be competitively superior on
one, maybe two, of the industry’s KSFs.
3–88
Software, Inc.
Example: KSFs for Bottled Water Industry
Access to distribution to get a firm’s brand stocked and
favorably displayed in retail outlets.
Image to induce consumers to buy a particular firm’s product
(brand name and attractiveness of packaging are key deciding
factors).
Low-cost production capabilities to keep selling prices
competitive.

Sufficient sales volume to achieve scale economies in marketing
expenditures.
3–89
Software, Inc.
89
Appealing designs and color combinations to create buyer
appeal
Low-cost manufacturing efficiency to keep selling prices
competitive
Strong network of retailers/firm-owned stores to ensure stores
keep best-selling items in stock
Clever image advertising to effectively induce consumers to
purchase a particular label
Example: KSFs for the Ready-to-Wear Apparel Industry
3–90
Software, Inc.
90
KSFs are specific to an industry, however they can vary over
time within the industry as driving forces and competitive
conditions change.
An industry rarely has more than five KSFs.
Questions that help identify industry’s KSFs:
On what basis do buyers choose between competing brands of
rival sellers? That is, what product or service attributes are
crucial?

Given an industry’s competitive rivalry and its prevailing
competitive forces, what resources and capabilities must a firm
have to be competitively successful?
What KSF shortcomings will put a firm at a significant
competitive disadvantage in its industry?
3–91
Software, Inc.
Identifying Industry Key Success Factors
Strategists seek to create a strategy that both allows the firm to
compete favorably with rivals on the industry’s future KSFs and
that aims at being distinctly better than rivals on one or more of
the KSFs.
Firms that excel on a KSF enjoy a stronger market position—
being distinctly better than rivals on one or two key success
factors often translates into competitive advantage.
3–92
Software, Inc.
Using KSFs in Crafting a Winning Strategy
Using the industry’s KSFs as cornerstones for the firm’s
strategy and trying to gain sustainable competitive advantage by
excelling at one particular KSF is a fruitful competitive strategy
approach.
92
Strategic Insight
To be a winner, a firm’s strategy must compare favorably with

rivals on all industry KSFs and be competitively superior on
one, maybe two, of the industry’s KSFs.
3–93
Software, Inc.
Factors that determine an industry’s profitability prospects
include:
Whether the industry and the firm are being favorably or
unfavorably impacted by macro-environmental factors
The industry’s potential for future growth
Whether strengthening competitive forces could squeeze
industry profitability to subpar levels or whether the firm can
earn good profits despite the expected strengthening of
competitive forces
Whether and to what degree industry profitability will be
favorably or unfavorably affected by the industry’s driving
forces
Whether the firm is strongly or weakly competitively positioned
on the industry’s strategic group map
How well the firm’s strategy, product offering, and capabilities
stack up against industry KSFs
The degrees of risk and uncertainty in the industry’s future
Question 6: Is the Industry Outlook Conducive to Good
Profitability?
3–94
Software, Inc.
94
Core Concept

The degree to which an industry’s outlook is attractive or
unattractive is not the same for all industry participants and all
potential entrants. Some firms may be strongly positioned with
the strategies and competitive strengths to capture the
opportunities an industry presents; others may not.
3–95
Software, Inc.
95
Reasons why future industry conditions may be attractive to
some industry participants and potential entrants, but not to
others:.
Even if an industry’s outlook is unattractive, a favorably
situated and competitively capable firm may see ample
opportunity to outcompete weaker rivals and significantly grow
its revenues and profits
Weak competitors in an attractive industry decide competing
against stronger rivals holds no promise of future market
success or even average profitability
Some entrants may conclude they have the resources to readily
hurdle the entry barriers of an attractive industry while other
outsiders view the same industry as unattractive because they
face difficulties in challenging the current market leaders and
because they see better opportunities elsewhere
An industry’s attractiveness depends in large part on whether
a firm has sufficient competitively valuable resources and
capabilities to be competitively successful and profitable in that
environment.
3–96

Software, Inc.
Factors to Consider in Assessing
Industry Attractiveness
96
A strong competitor in an attractive industry should invest
aggressively to capture opportunities to improve its long-term
competitive position.
A strong competitor in an unattractive industry should try to
protect its position by investing cautiously, striving to take
sales and market share away from weaker rivals, while also
looking for opportunities to enter other industries.
Often, a competitively weak firm in an unattractive industry
will decide to find a buyer, (e.g., a rival), to acquire its business
rather than struggling futilely to boost its financial and strategic
performance.
What Should a Current Competitor Decide about Investing in Its
Industry?
3–97
Software, Inc.
97
Accessibility Content: Text Alternatives for Images
98
Figure 3.1 From Thinking Strategically about the Company’s

Situation to Choosing a Strategy, Text Alternate
Return to parent slide.
The process for analyzing both a company’s external and
internal environment begins with forming a strategic vision of
where the company needs to head. Then identify promising
strategic options for the company. Finally, select the best
strategy and business model for the company.
99
Figure 3.2 The Components of a Company’s
Macroenvironment, Text Alternate
A company’s immediate industry and competitive environment
includes:
The industry’s profit outlook.
Industry growth rate.
Market demand-supply conditions.
Competitive pressures.
Forces driving changes in the industry.
The market position and likely actions of rival firms.
Factors affecting future competitive success.
The macro environment includes:
general economic conditions.
political, legal, and regulatory influences.
technological influences.
Social cultural forces (values, lifestyles, shifting population
demographics).
and considerations relating to the natural environment.
100
Figure 3.3 The Five-Forces Model of Competition: A Key

Analytical Tool, Text Alternate
The graphic shows that competitive pressures on companies
within an industry come from five forces.
Competition from rival sellers. Competitive pressures created
by the maneuvers of rival sellers to win increased sales and
market share and build or strengthen competitive advantage.
Competition from potential new entrants to the industry. There
is competitive pressures coming from the threat of entry of new
rivals.
Competition from producers of substitute products. Firms in
other industries offering substitute products. Competitive
pressures coming from the market attempts of outsiders to win
buyers over to their products.
Supplier bargaining power. Suppliers of raw materials, parts,
components, or other resources input. Competitive pressures
stemming from supplier bargaining power.
Customer bargaining power. There is competitive pressures
stemming from buyer bargaining power.
101
Figure 3.4 The Factors Affecting the Strength of Rivalry,
Text Alternate
Rivalry among Competing Sellers.
How strong are the competitive pressures stemming from the
maneuvers of rivals to win higher sales and market shares and
build and or strengthen competitive advantage?
Rivalry is generally stronger when:
Competing sellers are active in making fresh moves to improve
their market standing and business performance.
Buyer demand is growing slowly.
Buyers incur low costs in switching to rival brands.
The products of rival sellers are essentially identical or else

weakly differentiated, resulting in little or no buyer brand
loyalty.
Sellers have idle capacity and or excess inventory.
The industry’s product is costly to hold in inventory,
perishable, or seasonal.
The number of rivals increases and or rivals are of roughly
equal size and competitive capability.
One or more rivals are dissatisfied with their business
performance and are making aggressive moves to attract more
customers.
Outsiders have recently acquired weak competitors and are
spending heavily to turn them into major contenders.
Rivals have diverse industry outlooks, objectives, or strategies
and or have production facilities in countries where production
costs are materially different.
Rivalry is generally weaker when:
Industry members infrequently launch aggressive actions to take
sales and market share away from rivals.
Buyer demand is growing rapidly.
Buyer costs to switch to rival brands are high.
The products of rival sellers are strongly differentiated and the
loyalty of buyers to their preferred brand is high.
There are so many rivals that any one company’s actions have
little direct impact on the businesses of rivals.
Sellers have small inventories and or little idle capacity.
Rivals have low fixed costs and low inventory storage costs.
A few large sellers have the majority of sales and dominant
market shares.
Rivals have similar costs and similar industry outlooks—there
are no industry mavericks to disrupt the status quo.
102

102
Figure 3.5 Factors Affecting the Threat of Entry, Text Alternate
How strong are the competitive pressures associated with the
entry threat from new rivals?
Entry threats are stronger when:
Entry barriers are low or can be readily hurdled by entry
candidates with adequate resources.
Potential entrants do not expect that industry members are
likely or able to strongly contest the entry of newcomers.
The pool of entry candidates is large and some have adequate
resources to overcome entry barriers and combat defensi ve
actions of existing industry members.
Existing industry members are looking for expand their market
reach by entering product segments or geographic areas where
they currently do not have a presence.
Buyer demand is growing rapidly.
Newcomers can expect to earn attractive profits.
Entry threats are weaker when:
Entry barriers are high.
Entry candidates expect that industry members will strongly
contest the efforts of newcomers to gain a market foothold.
The pool of entry candidates is small.
Buyer demand is growing slowly or is stagnant.
The industry’s outlook is risky or uncertain or offers limited
profit opportunities for newcomers.
Industry conditions often cause existing competitors to struggle
to earn a decent profit.
103
103

Figure 3.6 Factors Affecting Competition from Substitute
Products, Text Alternate
How strong are the competitive pressures coming from the
attempts of companies outside the industry to win buyers over
to their products?
Competitive pressures from substitutes are stronger when:
Good substitutes are readily available or new ones are
emerging.
Substitutes are attractively priced.
Substitutes have comparable or better performance features
Buyers have low costs in switching to substitutes.
Buyers are growing more comfortable with using substitutes.
Competitive pressures from substitutes are weaker when:
Good substitutes are not readily available or don’t exist.
Substitutes are higher priced relative to the value they deliver to
buyers.
Substitutes lack comparable or better performance features.
Buyers have high costs in switching to substitutes.
Signs that Competition from Substitutes Is Strong:
Sales of substitutes are growing faster than sales of the industry
being analyzed (an indication that the sellers of substitutes are
stealing the industry’s customers away).
Producers of substitutes are investing in new capacity and
expanding their market coverage.
Profits of the producers of substitutes are rising.
104
104
Figure 3.7 Factors Affecting the Bargaining Power of Suppliers,

Text Alternate
How strong are the competitive pressures stemming from
supplier bargaining power?
A needed input is in short supply.
Certain suppliers either have a differentiated input that
enhances the quality or performance of seller’s products or
provide equipment and or services that deliver valuable cost-
saving efficiency.
Industry members incur high cots in switching to alternative
suppliers
There are no good substitutes for certain products/services
being supplied.
portion of their revenues.
Suppliers provide an item that accounts for a small fraction of
the costs of the industry’s product.
There are only a few “preferred” suppliers of a particular input.
rival.
There are simple supplies of a needed input.
The item being supplied is a commodity obtainable from many
different suppliers at the going market price.
Industry members incur low costs in switching to alternative
suppliers.
Good substitutes exist for the products/services of suppliers.
Industry members are major customers and continuing to secure
their business is important to suppliers’ well-being.
Suppliers provide an item that accounts for a sizable fraction of
the costs of the industry’s product.
Industry members can purchase what they need from any of
many different “good to acceptable” suppliers.
Industry members are a threat to integrate backward into the

business of suppliers and to self-manufacture their own
requirements.
105
105
Figure 3.8 Factors Affecting the Bargaining Power of Buyers,
Text Alternate
How strong are the competitive pressures stemming from buyer
bargaining power?
Large-volume purchases by buyers enable them to gain special
treatment.
A buyer’s identity adds prestige to the seller’s list of customers.
Supplies of the product are greater than buyer demand.
There are only a few buyers, so each one’s business is important
to sellers.
Buyers have low costs in switching to competing brands or
substitute products.
The products of industry members are “commodities” or else
weakly differentiated.
Buyers are well informed about the product offerings of
industry members
Buyers can postponed purchases if the you not like the deals
sellers are offering.
Some buyers are a threat to integrate backward into the business
of sellers and become an important competitor.
Buyers are highly price sensitive.
Buyers purchase the time in small quantities.
Buyers have insufficient “prestige” to command special

treatment.
Strong buyer demand creates tight supply conditions or
shortages.
There are so many buyers that any one buyer’s purchases
account for a tiny fraction of total industry sales.
Buyers have high costs in switching to competing brands or
substitute products.
The products of industry members are strongly differentiated.
Buyers have limited information about the product offerings of
industry members.
There is no credible threat of buyers integrating backward into
the business of industry members.
Buyer price sensitivity is relatively low.
106
106
Figure 3.9 Comparative Market Positions of Selected Retail
Chains: An Example of a Strategic Group Map, Text Alternate
The graphic is broken into nine segments, with the x axis being
Geographic Coverage and the y axis being Price and or Quality.
Geographic Coverage goes from Few Localities to Many
Localities. Price and or Quantity axis goes from low to high.
In the low end of price and quality and few locations is T.J.
Maxx.
In the low end, but with some in the medium price and quality
range and with more locations are Kohl’s and Ross Stores.
Target borders low and medium price and medium locations and
many locations.
Kmart and Walmart have the largest amount of locations out of
the lower end of price and quality stores.

In the medium range of price and quality is Macy’s, Nordstrom,
Dillard’s, Bloomingdale’s, and Belk. They do not have many
locations.
In the medium range of price and quality, and with a few more
locations is Gap, Old Navy, Victoria’s Secret, and Sears.
Straddling the medium and high price and quality is Neiman
Marcus and Saks Fifth Avenue, as well as Polo-Ralph Lauren,
Barney’s New York, and Coach. They all have few localities.
On the high end of price and quality but with few locations are
Gucci, Chanel, Prada, Hermes, Burberry, and Louis Vitton.
The only space with out any presence is high price and quality
with many localities.
107
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chapter 4
Evaluating a Company’s Resources and Ability to Compete
Successfully
Arthur A. Thompson
The University of Alabama
Software, Inc
All rights reserved. Not for distribution to non-registrants
without permission.
An e-book published and distributed
by McGraw Hill Education
Sixth Edition of Strategy: Core Concepts and Analytical
Approaches (2020-2021). Arthur A. Thompson, The University
of Alabama. Published and distributed by McGraw Hill
Education. Image of globe comprised of puzzle pieces with
several pieces dislodged and scattered below the globe. Chapter
4 Evaluating a Company’s Resources and Ability to Compete
Successfully
1
“Before executives can chart a new strategy, they must reach a
common understanding of the company’s current position.”
4–2
Software, Inc.
W. Chan Kim and
Rene Mauborgne
2

“Organizations succeed in a competitive marketplace over the
long run because they can do certain things their customers
value better than can their competitors.”
4–3
Software, Inc.
Robert Hayes,
Gary Pisano, and
David Upton
3
“A new strategy nearly always involves acquiring new resources
and capabilities.”
4–4
Software, Inc.
Laurence Capron and Will Mitchell
4
Learning Objectives
Learn how to determine whether a firm’s strategy is working
well and to evaluate the competitive power of a firm’s resources
and capabilities.
Understand the meaning and significance of company and
industry value chains.
Gain proficiency in using four analytical tools to evaluate a
firm’s ability to compete successfully: SWOT analysis, value
chain analysis, benchmarking, and competitive strength
assessment.
Learn what to look for in identifying the strategic issues

company managers must address.
4–5
Software, Inc.
5
Chapter 4 Roadmap
Evaluating a Firm’s Resources and Ability to Compete
Successfully: The Six Questions to Answer
Question 1: How well is the firm’s present strategy working?
Question 2: What are the firm’s important resources and
capabilities and do they have the competitive power to enable
the company to build and/or sustain a competitive advantage
over rivals?
Question 3: Are the firm’s resources and capabilities
attractive and well-matched to its market opportunities and
external threats?
Question 4: Are the firm’s prices and costs competitive with
those of key rivals and does it have an attractive customer value
proposition?
Question 5: Is the firm competitively stronger or weaker
than key rivals?
Question 6: What strategic issues and problems merit front-
burner managerial attention?
4–6
Software, Inc.
6
4–7

Software, Inc.
Evaluating a Firm’s Ability to Compete Successfully: Six Key
Questions
The analytical spotlight in evaluating a firm’s resources and
ability to compete successfully is trained on six questions:
How well is the company’s present strategy working?
What are the company’s important resources and capabilities,
and do they have the competitive power to enable the company
to build and/or sustain a competitive advantage over rival
companies?
Does the company have attractively strong resource capabilities
and how well do they match its market opportunities and the
external threats to its future well-being?
Are the company’s prices and costs competitive with those of
key rivals, and does it have an appealing customer value
proposition?
Is the company competitively stronger or weaker than key
rivals?
What strategic issues and problems merit front-burner
managerial attention?
7
Begin by understanding what its strategy is:
Identify the firm’s competitive approach
Lower-costs relative to rivals?
A different or better product/service?
Superior ability to serve a particular
market niche or group of buyers?
Determine its competitive scope
Broad or narrow geographic market coverage?
Wide or narrow product line?

Examine recent strategic moves
Identify functional strategies
4–8
Software, Inc.
Question 1: How Well Is the Firm’s
Present Strategy Working?
8
Figure 4.1 Identifying the Components of a Single-Business
Company’s Strategy
Access alternative text for slide image.
4–9
Software, Inc.
9
4–10
Software, Inc.
Key Indicators of How Well
a Company’s Strategy Is Working
The three best indicators:
Whether the firm is meeting or beating its financial and
strategic performance targets
Whether the firm is an above-average industry performer
Whether the firm is gaining customers and outcompeting one or
more of its close rivals
Persistent shortfalls in meeting performance targets

and weak performance relative to rivals are warning signs that
the firm has a weak strategy or suffers
from poor strategy execution or both.
10
4–11
Software, Inc.
Other Good Indicators of How Well
a Company’s Strategy Is Working
Whether the firm’s sales are growing faster, slower, or at about
the same pace as the market as a whole, thus resulting in a
rising, eroding, or stable market share.
How well the firm stacks up against rivals on product
innovation, customer service, product quality, delivery time,
price, getting newly developed products to market quickly, and
other relevant factors affecting buyers’ choice of brands.
Whether the firm’s image and reputation with its customers is
growing stronger or weaker.
Whether the firm’s profit margins are increasing or decreasing.
Trends in the firm’s net profits and return on investment and
how these compare to the same trends for rival companies.
Whether the firm’s overall financial strength, credit rating, key
financial and operating ratios, and cash flows from operations
are improving, holding steady, or deteriorating.
Strategic Insight
Sluggish financial performance and second-rate market
accomplishments almost always signal weak strategy, weak
execution, or both.

4–12
Software, Inc.
4–13
Software, Inc.
Evaluating a Company’s Financial Performance
Accurate diagnosis of a company’s financial performance and
financial statements requires some number-crunching.
The financial ratios in Table 4.1 provide guidance and direction
in what numbers need to be calculated and how to interpret
them.
13
TABLE 4.1 Key Financial Ratios: How to Calculate Them and
What They Mean
4–14
Software, Inc.
14
What They Mean
4–15
Software, Inc.

15
What They Mean
4–16
Software, Inc.
16
What They Mean
4–17
Software, Inc.
17
A firm’s resources and capabilities are competitive assets and
determine whether its competitive power in the marketplace will
be impressively strong or disappointingly weak.
Firms with second-rate competitive assets nearly always are
relegated to a trailing position in the industry
Resource and capability analysis is a two-step process for
determining whether a firm’s competitive assets can provide the

foundation necessary for competitive success in the
marketplace.
Identify the firm’s competitively important resources and
capabilities.
Evaluate the competitive power of these resources and
capabilities—whether they are potent enough for the firm to be
competitively successful and perhaps achieve a sustainable
competitive advantage over rival firms
Question 2: What Are the Firm’s Resources and Capabilities
and Do They Have the Competitive Power to Enable the Firm to
Build and/or Sustain a Competitive Advantage Over Rivals?
4–18
Software, Inc.
Any asset or productive input that a firm owns or controls
qualifies as a resource.
Firms typically have many kinds and types of resources
More importantly, resources tend to vary widely in quality,
competitive relevance, and competitive value from company to
company in the same industry
Our interest here is not in cataloging every resource a company
has but rather in identifying those resources that have
competitive value and can underpin its strategy.
4–19
Software, Inc.
Identifying a Company’s Valuable Resources

Competitively relevant and potentially valuable resources can
relate to:
Physical resources—valuable land and real estate, state-of-the-
art manufacturing plants and/or equipment and/or distribution
facilities, the locations of retail stores, plants, and distribution
centers (including the overall pattern of their physical
locations), and ownership of or access rights to valuable natural
resource deposits.
Human assets and intellectual capital—an educated, well-
trained, and experienced workforce, the cumulative learning and
know-how of key personnel and work groups regarding
important business functions and/or technologies; proven
managerial and leadership skills, the creativity and
innovativeness of certain personnel, proven skills in operating
key parts of the business efficiently and effectively, the work
ethic and motivational drive of the company’s workforce
Organizational and technological resources—proprietary
technology and production capabilities, patents, proven R&D
capabilities, strong e-commerce capabilities, proven quality
control systems, state-of-the-art information and data
management systems (systems for monitoring various operating
activities in real-time, just-in-time inventory management
systems, and business analytics capabilities), and proven
software development capabilities
4–20
Software, Inc.
Types of Competitively Relevant and Valuable Company
Resources
Competitively relevant and potentially valuable resources can
relate to:
Financial resources: cash and marketable securities, a strong
balance sheet and credit rating (thus giving the company added

borrowing capacity and access to additional financial capital).
Intangible assets: brand names, trademarks, copyrights,
company image, reputational assets (for technological
leadership or excellent product quality or customer service or
honesty and fair dealing), buyer loyalty and goodwill, and the
trust established with various partners.
Relationships: alliances, joint ventures or partnerships that
provide access to valuable technologies, specialized know-how,
or attractive geographic markets; fruitful partnerships with
suppliers that reduce costs and/or enhance product quality and
performance; a strong network of distributors and/or retail
dealers
4–21
Software, Inc.
Types of Competitively Relevant and Valuable Company
Resources (cont.)
4–22
Software, Inc.
Identifying Valuable Company Capabilities
A capability concerns the proficiency with which a company
can perform an activity.
In general, the competitive value of a company’s capability to
perform an activity depends on two factors:
The proficiency a company has achieved in performing the
activity
The role of the activity in the company’s strategy and its
importance to the company’s competitive success and
performance
There are four competitively relevant levels of capability:
Minimal capability—achieved when a company has
demonstrated only minimal ability to perform an internal
activity

A competence—achieved when a company has learned to
perform an internal activity consistently well and at acceptable
cost
A core competence—a demonstrated competence in performing
a competitively relevant activity that is central to the company’s
strategy and competitiveness
A distinctive competence—the capability to perform a
competitively valuable activity better than any other company
in the industry
4–23
A Proven Competence
A firm’s proficiency in performing an activity rises from that of
minimal capability to the level of a proven competence when it
demonstrates enough proficiency to perform the activity
consistently well and at acceptable cost
Usually, competence in performing an activity begins with a
deliberate effort to develop the capability to do it the first time
and then a second time. Then, as experience builds consistent
proficiency in performing the activity at an acceptable cost, its
performance of the activity evolves into a true competence and
capability.
The competitive value of a competence is directly related to a
whether the competence has an important positive impact on the
firm’s competitive success or whether it has little, if any,
impact on the firm’s competitive success (like the competence
with which it performs routine maintenance or administers
employee benefit programs).
Software, Inc.
Core Concept
A firm has a competence in performing an activity when, over
time, it gains the experience, know-how, and proficiency to

perform that activity consistently well and at acceptable cost.
4–24
Software, Inc.
24
4–25
Software, Inc.
Examples of Company Competencies
Specific skills and expertise (like proficiencies in low -cost
manufacturing, picking locations for new stores, or designing an
unusually appealing and functional social media website)
Proficiency in a single discipline or function that is performed
in a single department or organizational unit
Inherently multidisciplinary and cross-functional activities that
are the result of effective collaboration among people with
different expertise working in different organizational units
A competence in continuous product innovation, for example,
comes from teaming the efforts of people and groups with
expertise in market research, new product R&D, design and
engineering, cost-effective manufacturing, and market testing
Virtually all organizational capabilities and proven
competencies are knowledge based, residing in people and in a
company’s intellectual capital.
4–26
Software, Inc.
A Core Competence—A Competitively Valuable Capability
A proven competence takes on a higher level of competitive

value and becomes a core competence when a company achieves
a high level of proficiency in performing an activity that is
central to its strategy and competitiveness.
A core competence is a more competitively valuable capability
than a competence because
It adds power to a company’s strategy by positively impacting
The company’s efforts to compete successfully against rivals
The company’s ability to achieve its financial and strategic
objectives
The company’s overall performance
Core Concept
A core competence is an activity that a firm performs not only
consistently well and at acceptable cost, but that is also central
to its strategy and that positively impacts its competitiveness
and performance.
A core competence is a more competitively valuable capability
than a competence because it adds power to a firm’s strategy
and enhances its competitive strength and profitability.
4–27
Software, Inc.
27
2–28
Software, Inc.
Examples of Core Competencies
A core competence can relate to any of several aspects of a
company’s business and strategy:
Expertise in product innovation
Expertise in developing new and more efficient production

technologies
Expertise in marketing
Skills in manufacturing a high-quality product at a low cost
Strong capability to fill customer orders accurately and swiftly
Often, the most valuable core competencies are grounded in
cross-department combinations of knowledge and expertise
rather than being the product of a single department or work
group
2–29
Software, Inc.
A Distinctive Competence—A Very Competitively Valuable
Capability
A core competence rises to an even higher level of competitive
importance and becomes a distinctive competence when a
company is able to achieve sufficiently high proficiency to
perform a competitively important activity better than its rivals
A distinctive competence thus represents a greater proficiency
(and a stronger capability) than a core competence
Because a distinctive competence represents a level of
proficiency that rivals do not have, it qualifies as a
competitively superior capability with the potential to produce
competitive advantage
Core Concept
A distinctive competence is a competitively important activity
that a company performs better than its rivals—it thus
represents a competitively superior capability.
Because a distinctive competence represents a competitively
valuable capability that rivals do not have, it can be a basis for
sustainable competitive advantage.
4–30

Software, Inc.
30
4–31
Software, Inc.
Why a Distinctive Competence Matters
A distinctive competence adds real power to a firm’s strategy
and provides a pathway to competitive advantage when:
It relates to an activity important to competitive success
Rival companies do not have offsetting competencies or
capabilities
It is costly and time-consuming for rivals to match the caliber
of the competence the firm has developed
31
Core Concept
A company’s resources and capabilities represent its
competitive assets and are big determinants of its
competitiveness and ability to succeed in the marketplace.
4–32
Software, Inc.
32
A particular resource or capability which may not seem to have

much competitive value by itself can prove to be much more
valuable when bundled with certain other company resources
and/or capabilities (that also, taken singly, appear to lack
“high” competitive value).
For example, Nike’s resource bundle of styling expertise,
professional endorsements, well-regarded brand name and
image, marketing and brand-building skills, network of
distributors/retailers, and managerial know-how has provided
sufficient competitive power for Nike to remain the dominant
global leader in athletic footwear and sports apparel for over 20
years.
2–33
Software, Inc.
Astute Bundling of a Company’s Resources and Capabilities
Can Result in Added
Competitive Power
Core Concept
A resource/capability bundle is a group of resources and
capabilities that, when linked and integrated into a functioning
whole, has greater competitive value than the summed value of
the individual resource/capability components—in other words,
combining individual resources and capabilities into an
integrated bundle can produce
a 1 +1 = 3 gain in competitive power versus
just a 1 + 1 = 2 gain when the same resources and capabilities
are unbundled.
4–34
Software, Inc.
The competitive power of a resource or capability i s measured
by how many of the following four tests it can pass:

Does the resource or capability have competitive value?
Do many or most rivals have much the same resource or
capability?
Is the resource or capability hard to copy?
Can the value of a resource or capability be trumped by
substitute resources and capabilities of rivals?
4–35
Software, Inc.
Ways to Test the Competitive Power
of a Resource or Capability
Core Concept
The degree of success a company enjoys in the marketplace is
governed by the combined competitive power of its resources
and capabilities.
4–36
Software, Inc.
Some things to consider in evaluating the attractiveness of a
company’s set of resources, competencies, and capabilities
Both core competencies and distinctive competencies are
valuable because they enhance a company’s competitiveness
However, some competencies merely enable market survival
because most rivals also possess them
Not having an important competence or competitive capability
that rivals have can result in competitive disadvantage
4–37
Software, Inc.

Does a Company Have a Competitively Attractive Collection of
Resources and Capabilities?
37
Why is it important for a company to keep competencies
updated and on the cutting-edge?
It often takes freshly-honed and sometimes totally refurbished
or altogether new resources/capabilities
To effectively respond to ongoing changes in customer needs
and expectations
To protect a company’s long-term competitiveness against the
improving resources/capabilities and strategic maneuvering of
rivals to steal away customers
To help maintain or improve its performance over the long-term
4–38
Software, Inc.
A Company’s Important Resources and Capabilities Must Be
Dynamic and Freshly-Honed to Sustain Its Competitiveness
38
Core Concept
A company requires a dynamically evolving portfolio of
competitively valuable resources and capabilities to sustain its
competitiveness and help drive improvements in its
performance.
Absent deliberate managerial efforts to improve and sometime
recalibrate company competencies and capabilities, there’s

growing risk that the power of its competitive assets will grow
stale and cause company performance to erode.
4–39
Software, Inc.
Management’s challenge in developing dynamic capabilities has
two elements:
Attending to ongoing recalibration of existing competencies and
capabilities
Casting a watchful eye for opportunities to develop totally new
capabilities for delivering better customer value and/or
outcompeting rivals
Keeping company competencies freshly honed and on the
cutting edge is a strategically important top management task.
4–40
Software, Inc.
Dynamic Capabilities—What to Do?
Strategic Insight
Executive attention to making sure a company always has
competitively valuable resources and capabilities that
dynamically evolve and, at a minimum, help sustain, if not
actually improve, the company’s competitiveness is a
strategically important top management task.
4–41
Software, Inc.
SWOT analysis
Zeros in on a firm’s competitively important Strengths and
Weaknesses, its market Opportunities, and those external

Threats that can adversely impact the firm’s well-being.
Helps managers single out and focus on all the factors needed to
craft a winning strategy that fits the firm’s overall internal and
external situation.
4–42
Software, Inc.
Question 3: What Are the Firm’s Strengths and Weaknesses and
How Do They Relate to Its Market Opportunities and External
Threats?
Core Concept
SWOT analysis is a simple but powerful tool for sizing up a
company’s competitively relevant strengths and weaknesses, its
market opportunities, and the external threats to its future well-
being.
4–43
Software, Inc.
Figure 4.2 The Three Steps of SWOT Analysis: Identify, Draw
Conclusions, Translate into Strategic Action
4–44
Software, Inc.
Access alternative text for slide image.
44
4–45

Software, Inc.
Identifying a Company’s Competitively Important Strengths
Tying strategy to the company’s most competitively potent
resources and capabilities is a no-risk proposition. There’s
nothing to lose and much to gain.
If the firm’s resource strengths and capabilities turn out to be
competitively stronger than those of some or many rivals, its
business performance is certain to improve
And, in the best-case outcome, effectively deploying
competitively valuable resources and capabilities that are hard
for rivals to copy or trump usually puts achieving a sustainable
competitive advantage within reach
45
2–46
Software, Inc.
Identifying a Company’s Competitively Important Strengths
A competitively important strength can be
Something a company is good at doing (a capability or a core
competence that enhances its ability to compete effectively
against rivals)
A competitively valuable resource (like a well-known brand
name or state-of-the-art plants and/or distribution centers,
proprietary technology, valuable natural resources, or large
numbers of high-traffic store locations)
Certain kinds of competitively relevant achievements or
attributes that contribute to a company’s competitiveness in the
marketplace (like having low overall costs relative to
competitors, being a market share leader, having a wider
product line than rivals, and having wider geographic market
coverage than rivals).

Core Concept
A company’s competitively relevant strengths are competitive
assets that positively impact its competitiveness and ability to
succeed in the marketplace.
4–47
Software, Inc.
TABLE 4.2 What to Look for in Identifying a Firm’s Strengths
4–48
Software, Inc.
Core competencies in _______
A distinctive competence in _______
A product that is strongly differentiated from those of rivals
Resources and capabilities well matched to industry key success
factors
A strong financial condition; ample financial resources to grow
the business
Strong brand name/company reputation
Strong customer loyalty
Proven technological capabilities, proprietary
technology/important patents
Strong bargaining power over suppliers or buyers
Cost advantages over rivals
Skills in advertising and promotion
Product innovation capabilities
Proven capabilities in improving production processes
Good supply chain management capabilities
Strong customer service capabilities
Better product quality relative to rivals
Wide geographic coverage and/or strong global distribution

capability
Alliances/joint ventures with firms that provide access to
valuable technology, expertise and/or attractive geographic
markets
48
A firm’s strategy should be anchored on and seek to fully
exploit its most competitively powerful resources and
capabilities (and also competitively valuable bundles of
resources/capabilities)
WHY?
Because using its most potent resources and capabilities to
power strategic initiatives to deliver value to customers and win
business away from rivals gives a company its best chances for
competitive success and better performance.
4–49
Software, Inc.
A Firm’s Strategy Should Rely Upon Its Most Competitively
Powerful Resources and Capabilities
4–50
Software, Inc.
Identifying a Firm’s Important Weaknesses and Competitive
Deficiencies
A weakness, or competitive deficiency, is something a firm
lacks, does poorly, or that puts it at a disadvantage in the
marketplace
Resource/capability weaknesses relate to:

Inferior or unproven skills, capabilities, expertise, or
intellectual capital in important areas of the business
Deficiencies in competitively important physical,
organizational, or intangible assets
Missing or competitively weak capabilities in key areas
Core Concept
A firm’s competitively important weaknesses are internal
shortcomings or resource/capability deficiencies that constitute
competitive liabilities.
The degree to which a firm’s weaknesses make it competitively
vulnerable depends on how much they matter in the marketplace
and the extent to which they can be offset by the firm’s
competitively valuable resources and capabilities.
4–51
Software, Inc.
51
Table 4.2 What to Look for in Identifying a Firm’s Weaknesses
4–52
Software, Inc.
No well-developed or proven core competencies
Resources and capabilities that are not well matched to an
industry’s key success factors
Too much debt; a weak credit rating
Short on financial resources to grow the business and pursue

promising initiatives
Higher overall unit costs relative to key rivals
Weaker product innovation capabilities than key rivals
A product/service with attributes or features inferior to those of
rivals
Too narrow a product line relative to rivals
Weaker brand name/reputation than rivals
Weaker dealer network than key rivals
Weak global distribution capability
Weaker product quality, R&D, and/or technological know -how
than key rivals
In an overcrowded strategic group
Losing market share because _________
Competitive disadvantages in ________
Inferior intellectual capital relative to rivals
Subpar profitability because _________
Plagued with internal operating problems or obsolete facilities
Too much underutilized plant capacity
52
4–53
Software, Inc.
Identifying a Firm’s Market Opportunities
To tailor the firm’s strategy to its situation, managers must first
identify and appraise its market opportunities and the growth
and profit potential each one holds.
A firm’s market opportunities can be:
Plentiful or scarce, fleeting or lasting
Very attractive (an absolute “must” to pursue)
Marginally interesting (because of the high risks or large capital
requirements or unappealing revenue growth and profit
potentials)

Unsuitable (because its resource strengths and capabilities are
ill-suited to capturing particular opportunities)
53
4–54
Software, Inc.
Identifying a Firm’s Market Opportunities
The market opportunities most relevant to a firm are those that:
Match up well with the firm’s competitively valuable resources
and capabilities
Offer the best prospects for growth and profitability
Present the most potential for achieving competitive advantage
Sound Advice
A firm should pass on a particular market opportunity unless it
has or can acquire the resources and capabilities to capture it.
Table 4.2 What to Look for in Identifying Market Opportunities
4–55
Software, Inc.
Openings to win market share from rivals
Sharply rising buyer demand for the industry’s product
Serving additional customer groups or market segments
Expanding into new geographic markets
Expanding the company’s product line to meet a broader range
of customer needs
Utilizing existing company skills or technological knowhow to
enter new product lines or new businesses
Online sales via the Internet

Integrating forward or backward
Falling trade barriers in attractive foreign markets
Acquiring rival firms or companies with attractive capabilities
Entering into alliances or joint ventures to expand the firm’s
market coverage or boost its competitiveness
Openings to exploit emerging new technologies
55
4–56
Software, Inc.
Identifying External Threats to
a Firm’s Future Profitability
Factors in a firm’s external environment can pose threats to its
profitability and competitive well-being
External threats vary in importance
Some pose only a moderate degree of adversity (most all
companies confront some threatening outside elements in the
course of conducting their business)
Some may be formidable enough to make a firm’s situation and
outlook quite tenuous
On rare occasions, a market shock can give birth to a sudden-
death threat that throws a firm into an immediate crisis and
battle
to survive
56
Table 4.2 What to Look for in Identifying External Threats
4–57

Software, Inc.
More intense competitive pressures from industry rivals and/or
sellers of substitute products—may squeeze profit margins
The entry (or likely entry) of new competitors into the
company’s market stronghold (especially lower-cost foreign
competitors)
Growing bargaining power of buyers or suppliers
Slowing or declining market demand for the industry’s product
A shift in buyer needs and tastes away from the industry’s
product
Adverse demographic changes that threaten to curtail demand
for the industry’s product
Vulnerability to unfavorable industry driving forces
Unfavorable trade policies and tariffs; a threat of trade wars
Costly new regulatory requirements
Tight credit conditions
Rising prices for energy or other key inputs
57
2–58
Software, Inc.
What Do the Four SWOT Lists Reveal?
Two most important parts of SWOT analysis are
Drawing conclusions from the SWOT listings about the
company’s overall situation, and
Translating these conclusions into strategic actions and an
overall strategy that is well-matched to the company’s overall
situation—as indicated by its strengths and weaknesses, its
market opportunities, and its external threats.
4–59

chapter 3Evaluating a Company’s External Environment

chapter 3Evaluating a Company’s External Environment

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