Session 2- External Analysis

PESTEL Framework

breaks down the macro-environment into 6 areas

• Political

• Economic

• Socio-cultural

• Technological

• Environmental

• Legal

By evaluating these areas, businesses can spot opportunities and threats

Porter’s Five Forces

looks at the industry’s competitive environment to understand the dynamics affecting profitability

Strategic Group Mapping

helps businesses figure out where they stand in comparison to competitors and who they are really competing against

Structure-Conduct-Performance (SCP) Model

Examines the industry from a broader economic standpoint to understand how market structures affect business performance

External Section of AFI Framework

Before using PESTEL…

• define the industry you’re examining

• take a macro-economic view

• strategic mngt is all abt recognizing external factors and using them to your advantage or minimize their potential negative impact

PESTEL Analysis

• executive can rely on it to organize factors within the general environment and to identify how these factors influence industries and the firms within them

• Six segments of the general environment:(1) political, (2) economic, (3) sociocultural, (4) technological, (5) environmental, and (6) legal

• executives examine each of these and identify opportunities and threats and adjust their firms strategy

PESTEL Analysis: Political

tax policies, changes in trade restrictions and tariffs, the stability of governments, and proposed legislative changes that have not yet been enacted into law.

• emphasizes the influence of govt actions on business operations

  U.S. government creating new regulations for the organic and GMO food products.

  Proposals to provide support to businesses are often featured within political campaigns.

  The word tariff derived from an Arabic word meaning "fees to be paid." By levying tariffs and implementing other trade restrictions, governments can -- to some extent -- protect domestic firms from international competition.

  The stability of the US government provides a source of confidence for foreign firms who want to do business in the United States. Countries that face frequent regime change and political turmoil have a harder time attracting foreign investments.

  One of the most important duties of elected officials in the United States is to debate and set new tax policies.

PESTEL Analysis: Economic

interest rates, inflation rates, gross domestic product, unemployment rates, levels of disposable income, and the general growth or decline of the economy. Think broad economic conditions!

• focuses on the financial conditions that influence organizational operations

  Interest Rates: an affect borrowing costs and investment.

  Gross domestic product (GDP) refers to the market value of goods and services within a country produced in a given time period and serves as a rough indicator of a country's standard of living. The United States has a much larger GDP than China, but China has enjoyed a much higher rate of GDP growth in recent years.

  Inflation Rates: Influence purchasing power and pricing strategies.

  Unemployment Rates: Impact consumer confidence and spending habits.

  Disposable Income Levels: Determine how much consumers can spend on goods and services.

  Discretionary income refers to the amount of money individuals have to spend after all necessary bills are paid. As discretionary income increases, firms such as boutique clothing retailers that sell nonessential goods and services are more likely to prosper.

PESTEL Analysis: Sociocultural

trends in demographics such as population size, age, and ethnic mix, as well as cultural trends and shifts such as attitudes toward obesity and consumer activism.

• examines how societal and cultural shifts impact businesses

  Demographic Trends: Changes in population size, age distribution, and ethnic composition.

  Cultural Trends and Consumer Preferences: Evolving attitudes and behaviors, like views on health and consumer rights.

  One in three Americans is obese, due in part to the increasing prevalence of fast-food restaurants and the popularity of sedentary activities such as playing video games.

  Hemline theory contends that women's skirt lengths predict stock market increases and declines. The idea was born in the 1920s when economist George Taylor noticed that many women raised their skirts to reveal their silk stockings when times were good, but lowered their skirts to hide the fact that they weren't wearing stockings when times were tough.

  The tendency to collect material items while being reluctant to throw them away has led to a rise in self-storage outlets as well as awareness of a hoarding epidemic.

PESTEL Analysis: Technological

changes in the rate of new product development, increases in automation, and advancements in service industry delivery.

• focusing on scientific advancements that enhance products and services

  Unsuccessful technological innovations such a Smell-O-Vision (a system that would release different odors that matched the events shown on screen) highlight the risk associated with the technology sector. Image watching a show on horse stables!

  The adoption rate of Artificial Intelligence which will certainly transform nearly every industry and how work is automated.

  The dramatic changes in the video game industry over the past 25 years highlight the need to constantly adapt to technological factors to maintain market leadership. Once-mighty Atari has given way to current leaders Sony, Nintendo, and Microsoft.

  Moore's law suggests that the performance of microcircuit technology roughly doubles every two years.

  Service Industry Delivery: Improvements in how services are offered to consumers.

PESTEL Analysis: Environmental/Ecological

natural disasters, weather patterns, and/or EPA regulations.

• physical and ecological aspects that businesses must navigate

  Pollution/Carbon Footprint Levels: May lead to regulations affecting business practices.

  Global Warming: Influences the development of new, eco-friendly products and services.

  Individuals embracing the three Rs of green living--reduce, reuse, recycle--has fueled new business concepts such as Recycle Match, a firm that brings together waste products with businesses that need those materials.

  Concern about the environmental effects of burning fossil fuels has contributed to the growing popularity of scooters.

  The increase in the number of food cooperatives reflects the growing interest in sustainable, natural foods that are produced with a high degree of social responsibility.

PESTEL Analysis: Legal

current laws involving issues such as employment, health and safety, discrimination, and antitrust.

• laws and regulations that frame business activities

  Electronic recycling laws are creating opportunities for "green collar jobs." A Missouri law, for example, requires computer electronic equipment manufacturers to develop and implement recycling plans.

  The Sherman Antitrust Act of 1890 limits cartels and monopolies in the United States. Senator John Sherman was the principal author of this legislation.

  In the United States, it is illegal to discriminate against anyone based on age, race, religion, gender or disability.

  The role of the Occupational Safety and Health Administration (OSHA) is to prevent work-related injuries, diseases, and fatalities by enforcing standards for workplace safety and health.

  Laws requiring that nutrition information must appear on the packaging of most food products are intended to protect consumers and help them make informed choices.

Porter’s Five Forces

• developed by Harvard Business Prof: Michael Porter (Godfather of strategy)

• tool used to measure industry attractiveness but also forces us to look at interactions among competitors in an industry, potential new entrants to the industry, substitutes for the industry’s offerings, suppliers to the industry, and the industry’s buyers

• if none of these works to undermine the profits in the industry, then the profit potential is very strong

• value may be drained away through the rivalry among existing competitors but it can also be bargained away through the power of suppliers or the power of buyers or be constrained by the threat of new entrants or the threat of substitutes

• Changes in the strength of the forces signal changes in the competitive landscape critical to ongoing strategy formulation.

• The Five Forces are not immune to industry-wide advancements of technology but instead can be greatly influenced by them

• since this is an INDUSTRY level tool, we NEVER run this analysis on a single firm

Porter’s Five Forces: Rivalry Among Existing Competitors

• price discounting, new product introductions, advertising campaigns, service improvements

• high rivalry limits the profitability of an industry

• the degree to which rivalry drives down an industry’s profit potential depends on the intensity with which companies compete and the basis on which they compete

• Competitive Rivalry is HIGH when:

  • There are many competitors in the industry. Often the greater the number of players, the more intense the rivalry

  • The competitors are roughly of equal size

  • The industry growth rate is slow, zero or even negative. In a stagnant or declining market, companies often fight intensely for a smaller and smaller market

  • Exit barriers are high

  • Products and/or services are direct substitutes

Porter’s Five Forces: Bargaining Power of Buyers

• powerful customers- the flip side of powerful suppliers- can capture more value by forcing down prices, demanding better quality or more service (drives up costs), and playing industry participants off against one another, all at the expense of industry profitability

• Buyers are powerful if they have negotiating leverage relative to industry participants, especially if they are price sensitive, using their clout primarily to pressure price reductions

• Bargaining Power of Buyers is HIGH when:

  • There are a few large buyers

  • Buyers purchase in large quantities relative to the size of a single seller

  • The industry’s products are standardized or undifferentiated commodities

  • Buyer’s face little to no switching costs

  • Buyers can credibly threaten to backward-integrate in their supply chain

Porter’s Five Forces: Threat of New Entrants

• New entrants to an industry bring new capacity and a desire to gain market share that puts pressure on prices, costs, and the rate of investment necessary to compete

• particularly when new entrants are diversifying from other markets, they can leverage existing capabilities and cash flows to shake up competition

• Threat of New Entrants are HIGH when:

  • Customer switching costs are low

  • Capital requirements are low

  • Incumbents do not possess:

    • proprietary technology

    • established brand equity

    • the ability for economies of scale

  • New entrants expect that incumbents will not or cannot retaliate

Porter’s Five Forces: Threat of Substitute Products/Services

• a substitute performs the same or a similar function as an industry’s product by a different means but exists outside the current industry

• videoconferencing is a sub for travel, plastic is a sub for aluminum, email is a sub for express mail

• Threat of Substitutes are HIGH when:

  • The substitute offers an attractive price-performance trade-off

  • The buyers cost of switching to the substitute is low

Porter’s Five Forces: 6th Force?

1. Government: should not be one bc there is no monotonic (direct linear) relationship btwn the strength and influence of govt and profitability of an industry

   • you cant say govt is low, industry profitability is high; it all depends on exactly what govt does

   • there are many diff parts of govt, each with its own distinct impacts and you can assess the consequences of what govt does if you look at the 5 forces

2. orgs whose products and services are complementary to the primary org’s products and services

   • there is no monotonic relationship btwn the extent of complements and profitability, sometimes with low profitability

   • it has to do w how complements affect the 5 forces; complements have much to do with the size of the pie, but their role in the division of the pie is independent of other factors

Structure-Conduct-Performance (SCP Framework)

• used as an analytical framework, to make relations among market structure, market conduct, and market performance

• developed in 1959 by Bain in his book Industrial Organization

• starting point when analyzing markets and industries (porter used it to base his five forces off of)

• if we can identify our clients industry as being fragmented or concentrated, then well better have an idea of how we should advise our clients positioning w/in their industry

Structure-Conduct-Performance (SCP Framework): High-Concentration Industries

• 80-100%

• Circuses (89%) Breakfast Cereal manufacturing (85%)

• ex. circus industry where just four big companies own almost 90% of the market. They don’t trash-talk each other and avoid direct competition. This friendly rivalry can lead to good profits, but it’s not the only factor that matters.

Structure-Conduct-Performance (SCP Framework): Medium-Concentration Industries

• 50-79%

• flight training (52%), sugar manufacturing (60%)

Structure-Conduct-Performance (SCP Framework): Low-Concentration/Fragmented Industries

• Below 50%

• Full-service restaurants (9%), Legal services (3%), Truck driving schools (27%), phone call centers (22%)

• Ex. restaurant world. It’s a free-for-all where many players, big and small, fight for a slice of the pie. Take Quiznos and Subway: Quiznos once launched ads attacking Subway to grab attention and customers. This kind of aggressive competition can lead to price wars, which might be great for us as customers but can squeeze the industry’s profits

The SCP framework is split up into the following four categories:

• Perfect Competition

• Monopolistic Competition

• Oligopoly

• Monopoly

Structure-Conduct-Performance (SCP Framework: 4 Categories
Perfect Competition

• Imagine a market where many sellers offer the same product, like fish at a local market. No single seller can sway the price; they all accept the market rate. It’s a level playing field where everyone’s in the same boat, or in this case, fish market.

• many small comps, none of which control prices; they accept the market price determined by supply and demand

Structure-Conduct-Performance (SCP Framework: 4 Categories
Monopolistic Competition

• Still have many sellers (as we had under perfect competition) but they don’t sell identical products.

• differentiated products—products that differ somewhat, or are perceived to differ, even though they serve a similar purpose

  • quality, style, convenience, location, and brand name

  • Although many people are fiercely loyal to their favorites, most products in most categories are quite similar and address the same consumer need.

  • But what if there was a substantial price difference among products? In that case, many buyers would likely be persuaded to switch brands, at least on a trial basis.

    • Product differentiation: Sometimes, it’s simply geographical. Or promoted by advertising designed to convince consumers that one product is different from another—and better than it.

    • Regardless of customer loyalty to a product, however, if its price goes too high, the seller will lose business to a competitor. Under monopolistic competition, therefore, companies have only limited control over price.

Structure-Conduct-Performance (SCP Framework: 4 Categories
Oligopoly

• Few sellers

• each seller supplies a large portion of all the products sold in the marketplace

• bc the cost of starting a business in an oligopolistic industries is usually high, the number of firms entering is low

• ex. large scale enterprises (automobile comps and airlines)

• large firms supplying a sizable portion of a market, these comps have some control over the prices they charge

• bc products are fairly similar, when one comp lowers prices, others are often forced to do the same to remain competitive

Structure-Conduct-Performance (SCP Framework: 4 Categories
Monopoly

• lies at the opposite end of the spectrum from perfect comp in terms of number of sellers and degree of comp

• One seller to rule them all

• the market could be a geographical area (city/regional area and doesn’t have to be an entire country)

• only a few in the U.S bc the govt limits them. Two categories: natural and legal

  • Natural monopolies: public utilities (electricity and gas suppliers) req huge investments and its inefficient to duplicate the products they provide. Inhibit competition, but they’re legal bc they are important to society. In exchange for the right to conduct business w/o competition, they are regulated. They cant charge whatever prices they want, but they must adhere to govt controlled prices. Req to serve all customers, even if its not cost efficient

  • Legal monopoly: when a comp receives a patent giving it exclusive use of an invented product or process. Patents are issued for a limited time, generally 20 yrs. Other comps can’t use the invented product or process w/o permission from the patent holder. Patents allow companies a certain period to recover the heavy costs of researching and developing products and tech

Strategic Group Mapping (SGM)

• the analysis of the strategic groups in an industry can offer important insights to executives

• strat groups are sets sets of firms that follow similar strategies to one another

  • consists of a set of industry competitors that have similar characteristics to one another but differ in important ways from the members of other groups

• Why is understanding the nature of strat groups w/in an industry important?

  1. emphasizing the members of a firm’s group is helpful because these firms are usually its closest rivals. When assessing their firm’s performance and considering strategic moves, the other members of a group are often the best references for executives to consider. 

  2. the strategies pursued by firms within other strategic groups highlight alternative paths to success. A firm may be able to borrow an idea from another strategic group and use this idea to improve its situation. 

  3. the analysis of strategic groups can reveal gaps in the industry that represent untapped opportunities