This document outlines key concepts from Chapter 2 of a strategic management textbook. It discusses the importance of analyzing a firm's external environment, including the general environment and industry environment. The general environment comprises 6 segments: demographic, economic, political/legal, sociocultural, technological, and physical. The industry environment is analyzed using Porter's 5 forces model. Competitor analysis and identifying a firm's key success factors are also important parts of external analysis. The document provides examples and definitions to explain these strategic management concepts.

1. PowerPoint slides by:
R. Dennis Middlemist
Colorado State University
Copyright © 2004 South-Western
All rights reserved.
Chapter 2
The External
Environment

2. Knowledge Objectives
• Studying this chapter should provide you with the strategic
management knowledge needed to:
 Explain the importance of analyzing and understanding the firm’s
external environment.
 Define and describe the general environment and the industry
environment.
 Discuss the four activities of the external environmental analysis
process.
 Name and describe the general environment’s six segments.
 Identify the five competitive forces and explain how they determine
an industry’s profit potential.
 Define strategic groups and describe their influence on the firm.
 Describe what firms need to know about their competitors and
different methods used to collect intelligence about them.

3. Copyright © 2004 South-Western. All rights reserved. 2–3
Figure 1.1
The Strategic
Management
Process

4. Opening case of ITC Limited
• Political segment of ITS’s general environment affect how the
company conducts its business.
• Selling of tobacco products is highly restrictive in India
• Cigarettes – source of exercise duty by the government.
• Non priority sector
• It was difficult to expand its operations
• Consideration of public health, socio cultural segment was
affected and it effects strategic actions of the company.
• A. N. Haksar, made announcement in 1975, “I believe that
every company has two balance sheets. The one is accounts
and the other is related to obligations in the national interest
and thus to the public good.”

5. Case of ITC Limited
• The opportunity for ITC to enter other business and
threats; the possibility that additional regulations in its
market will reduce consumption of ITC’s tobacco
products.
• Collectively, opportunities and threats affect a firm’s
strategic actions.
• Regardless of the industry in which they compete,
the external environment influences firms as they
seek strategic competitiveness and the earning of
above average returns.

6. FIGURE 2.1 The External Environment
2–6

7. General Environment
• Dimensions in the broader society that
influence and industry and the firms within it
Economic
Sociocultural
Global
Technological
Political/legal
Demographic
Physical

8. General Environment
• Firms cannot directly control the general
environment’ segments. The bankruptcy filings by
General Motors and Chryster Corporation in the
United states during the 2008-2009 automotive crisis
highlight this fact.

9. Industry Environment
• Set of factors directly influencing a firm and
its competitive actions and competitive
responses
Threat of new entrants
Power of suppliers
Power of buyers
Threat of product
substitutes
Intensity of rivalry
among competitors

10. Industry Environment
• The challenge for a firm is to locate a position
within an industry where it can favorably
influence the five factors or where it can
successfully defend against their influence.
• The greater a firm’s capacity to favorably
influence its industry environment, the greater
the likelihood that the firm will earn above
average returns.
Copyright © 2004 South-Western. All rights reserved. 2–10

11. Competitor Environment
• All of the companies that the firm competes against.
• How companies gather and interpret information
about their competitors is called competitors
analysis.
• It complements the insights provided by studying the
general and industry environments.
• JSW steel needs to learn as much as it can about its
major two competitors – SAIL and Tata Steel - while
also learning about general and
Industry environment.

12. Analysis of the External Environments
• General environment
Focused on the future
Environmental trends
• Industry environment
Focused on factors and conditions influencing a firm’s
profitability potential within an industry
• Competitor environment
Focused on predicting the dynamics of competitors’ actions,
responses and intentions

13. External environment analysis
• Opportunity
A condition in the general environment that if
exploited, helps a company achieve strategic
competitiveness
• Threat
A condition in the general environment that may
hinder a company’s efforts to achieve strategic
competitiveness

14. External Environmental Analysis
• A continuous process which includes
Scanning for early signals of potential
changes and trends in the general environment
Internet provides significant opportunities for scanning
Amazon.com, records individuals visiting its web site,
welcomes these customers by their names when they visit
again
Indian banks continuously scan external to detect interest
rates, Cash Reserve Ratio regulations, need to be
monitored for opening new branches and custommer
service norms. The reason is small changes of the policy
affects the business substantially

15. External Environmental Analysis
• A continuous process which includes
Monitoring changes to see if an important trend is
emerging among those spotted by scanning
Critical is to detect meaning in different
environmental events and trends
effective monitoring requires the firm to identify
important stakeholders as the foundation for serving
their unique needs

16. External Environmental Analysis
• A continuous process which includes
Forecasting projections of what might happen, and how
quickly as a result of the changes and trends detected
through scanning and monitoring.
Analysts might forecast the time that will be required for a
new technology to reach the marketplace, the period of time
before different corporate training procedures are required to
deal with anticipated changes in the composition of the
workforce, or how much time will escape before changes in
government taxation policies affect consumer’s purchasing
patterns.

17. External Environmental Analysis
• A continuous process which includes
Assessing: is to determine timing and significance of the
effects of environmental changes and trends that have been
identified.
After understanding general environment, further step is to
specify the implication of that understanding

18. Components of the External Environmental Analysis
Table 2.2

19. TABLE 2.1 The General Environment: Segments and Elements
Physical Environment - Energy consumption, renewable energy efforts, minimizing firms
environmental foot print, anti pollution laws, producing environment
friendly products
.2–19

20. Segments of the General Environment
• The Demographic
Segment
Population size
Age structure
Geographic
distribution
Ethnic mix
Income distribution

21. Segments of the General Environment (cont’d)
• The Economic Segment
Inflation rates
Interest rates
Trade deficits or
surpluses
Budget deficits or
surpluses
Personal savings rate
Business savings rates
Gross domestic
product

22. Segments of the General Environment(cont’d)
• The Political/Legal
Segment
Antitrust laws
Taxation laws
Deregulation
philosophies
Labor training laws
Educational
philosophies and
policies

23. Segments of the General Environment(cont’d)
• The Sociocultural Segment
Women in the workplace
Workforce diversity
Attitudes about quality
of worklife
Concerns about
environment
Shifts in work and
career preferences
Shifts in product and
service preferences

24. Segments of the General Environment(cont’d)
• The Technological
Segment
Product innovations
Applications of
knowledge
Focus of private and
government-supported
R&D expenditures
New communication
technologies

25. Segments of the General Environment(cont’d)
• The Global Segment
 Product innovations
 Applications of knowledge
 Focus of private and
government-supported R&D
expenditures
 New communication
technologies
 Important Political events
 Critical global markets
 Newly industrialized countries
 Different cultural and institutional
attributes

26. Segments of the General Environment(cont’d)
• Physical Environment Segment
Energy consumption
Practices used to develop energy sources
Renewable energy efforts
Minimizing a firm’s environmental footprint
Anti pollution laws
Environmental clearance
Availability of water as a resource
Producing environmentally friendly products

27. Industry Environment
• Industry Defined
A group of firms producing products that are
close substitutes
Firms that influence one another
Includes of competitive strategies that companies
use in pursuing strategic competitiveness and
above-average returns

28. The Five Forces of
Competition Model
Figure 2.2

29. Threat of New Entrants: Barriers to Entry
• Economies of scale
• Product differentiation
• Capital requirements
• Switching costs
• Access to distribution channels
• Cost disadvantages independent of scale
• Government policy
• Expected retaliation

30. Barriers to Entry
• Economies of Scale
Marginal improvements in efficiency that a firm experiences
as it incrementally increases its size
Advantages and disadvantages of large-scale and small-
scale entry
• Product differentiation
Unique products
Customer loyalty
Products at competitive
prices
• Capital Requirements
Physical facilities
Inventories
Marketing activities
Availability of capital

31. Barriers to Entry (cont’d)
• Switching Costs
One-time costs customers incur when they buy from a
different supplier
New equipment
Retraining employees
Psychic costs of ending a relationship
• Access to Distribution Channels
Stocking or shelf space
Price breaks
Cooperative advertising allowances

32. Barriers to Entry (cont’d)
• Cost disadvantages independent of scale
Patented product technology
Favorable access to raw materials
Desirable locations
• Government policy
Licensing and permit requirements
Deregulation of industries
• Expected retaliation
Responses by existing competitors may depend on a firm’s
present stake in the industry (available business options)

33. Bargaining Power of Suppliers
• Supplier power increases when:
Suppliers are large and few in
number
Suitable substitute products are
not available
Individual buyers are not large
customers of suppliers and there are many of
them
Suppliers’ goods are critical to buyers’
marketplace success
Suppliers’ products create high switching costs.
Suppliers pose a threat to integrate forward into
buyers’ industry

34. Bargaining Power of Buyers
• Buyer power increase when:
Buyers are large and few in
number
Buyers purchase a large portion
of an industry’s total output
Buyers’ purchases are a significant
portion of a supplier’s annual revenues
Buyers can switch to another product without
incurring high switching costs
Buyers pose threat to integrate backward into the
sellers’ industry

35. Threat of Substitute Products
• The threat of substitute products
increases when:
Buyers face few switching costs
The substitute product’s price is
lower
Substitute product’s quality and performance are
equal to or greater than the existing product
• Differentiated industry products that are valued by
customers reduce this threat

36. Intensity of Rivalry Among Competitors
• Industry rivalry increases when:
There are numerous or equally
balanced competitors
Industry growth slows or
declines
There are high fixed costs or high storage costs
There is a lack of differentiation opportunities or
low switching costs
When the strategic stakes are high
When high exit barriers prevent competitors from
leaving the industry

37. Low entry barriers
Interpreting Industry Analyses
Unattractive
Industry
Suppliers and buyers
have strong positions
Strong threats from
substitute products
Intense rivalry
among competitors
Low profit potential

38. Attractive
Industry
High entry barriers
Interpreting Industry Analyses
Suppliers and buyers
have weak positions
Few threats from
substitute products
Moderate rivalry
among competitors
High profit potential

39. Strategic Groups
• Strategic Group Defined
A set of firms emphasizing similar strategic
dimensions and using similar strategies
Internal competition between strategic group firms is
greater than between firms outside that strategic group.
There is more heterogeneity in the performance of firms
within strategic groups.
–Similar market positions
–Similar products
–Similar strategic actions
2–39

40. Strategic Groups
• Strategic Dimensions which are treated
similarly.
Extent of technological leadership
Product quality
Pricing Policies
Distribution channels
Customer service
2–40

41. Competitor Analysis
• Competitor Intelligence
The ethical gathering of needed
information and data that provides insight
into:
A competitor’s direction (future objectives)
A competitor’s capabilities and intentions (current
strategy)
A competitor’s beliefs about the industry (its
assumptions)
A competitor’s capabilities
2–41

42. FIGURE 2.2
Competitor
Analysis
Components
2–42

43. Complementors
• Complementors
The network of companies that sell
complementary products or services or are
compatible with the focal firm’s own product or
service.
 If a complementor’s product or service adds value to the sale
of the focal firm’s product or service, it is likely to create
value for the focal firm.
 However, if a complementor’s product or service is in a
market into which the focal firm intends to expand, the
complementor can represent a formidable competitor.

44. Ethical Considerations
• Practices considered both legal and ethical:
Obtaining publicly available information
Attending trade fairs and shows to obtain
competitors’ brochures, view their exhibits, and listen
to discussions about their products
• Practices considered both unethical and illegal:
Blackmail
Trespassing
Eavesdropping
Stealing drawings, samples, or documents

45. What Are the Key Factors for Competitive
Success?
• KSFs are competitive elements that most
affect every industry member’s ability to
prosper in the marketplace
 Specific strategy elements
 Product attributes
 Resources
 Competencies
 Competitive capabilities
• KSFs spell difference between
 Profit and loss
 Competitive success or failure

46. Identifying Industry : Key Success Factors
• Answers to three questions pinpoint KSFs
 On what basis do customers choose between competing
brands of sellers?
 What must a seller do to be competitively successful --
what resources and competitive capabilities does it need?
 What does it take for sellers to achieve a sustainable
competitive advantage?
• KSFs consist of the 3 - 5 really major determinants
of financial and competitive success in an industry

47. KSFs for Apparel Manufacturing Industry
• Fashion design -- to
create buyer appeal
• Low-cost manufacturing
efficiency -- to keep selling
prices competitive

48. Example: KSFs for Tin and Aluminum Can
Industry
• Locating plants close to end-use
customers -- to keep costs of shipping
empty cans low
• Ability to market plant output within
economical shipping distances

49. KSFs for Beer Industry
• Utilization of brewing capacity -- to keep
manufacturing costs low
• Strong network of wholesale distributors
-- to gain access to retail outlets
• Clever advertising -- to induce beer
drinkers to buy a particular brand

50. Strategic Management Principle
A sound strategy incorporates
efforts to be competent on all
industry key success factors
and to excel on at least one
factor!