Chapter 2: The External Environment: Opportunities, Threats, Industry Competition, and Competitor Analysis

External Environment

affects the competitive actions and responses firms take to outperform competitors and earn above-average returns

Today’s External Environment:

• Technological changes and the continuing growth of information gathering and processing capabilities

• Rapid sociological changes occurring in many countries affect labor practices and the products consumers demand

• Governmental policies and laws as well as financial regulatory systems affect where and how firms choose to compete and increase the complexity of financial transactions

General Environment

Composed of dimensions in the broader society that influence an industry and the firms within it.

Dimensions of General Environments

1. Demographic

2. Economic

3. Political/Legal

4. Sociocultural

5. Technological

6. Global

7. Sustainable physical environment

Demographic Segment

• Population size

• Age structure

• Geographic distribution

• Ethnic mix

• Income distribution

Economic Segment

• Inflation rates

• Interest rates

• Trade deficits or surpluses

• Budget deficits or surpluses

• Personal savings rate\

• Business savings rates

• Gross domestic product

Political/Legal Segment

the arena in which organizations and interest groups compete for attention, resources, and a voice in overseeing the body of laws and regulations guiding interactions among nations as well as between firms and various governmental agencies

• Antitrust laws

• Taxation laws

• Deregulation philosophies

• Labor training laws

• Educational philosophies and policies

Sociocultural Segment

concerned with a society’s attitudes and cultural values.

• Women in the workforce

• Workforce diversity

• Attitudes about the quality of work life

• Shifts in work and career preferences

• Shifts in preferences regarding product and service characteristics

Technological Segment

includes the institutions and activities involved in creating new knowledge and translating that knowledge into new outputs, products, processes, and materials.

• Product innovations

• Applications of knowledge

• Focus of private and government-supported research and development (R & D) expenditures

• New communication technologies

Global Segment

includes relevant new global markets and their critical cultural and institutional characteristics, existing markets that are changing, and important international political events

• Important political events

• Critical global markets

• Newly industrialized countries

• Different cultural and institutional attributes

Sustainable Physical Environment Segment

refers to potential and actual changes in the physical environment and business practices that are intended to positively respond to those changes in order to create a sustainable environment

• Energy consumption

• Practices used to develop energy sources

• Renewable energy efforts

• Minimizing a firm’s environmental footprint

• Availability of water as a resource

• Producing environmentally friendly products

• Reacting to natural or man-made disasters

Industry Environment

a set of factors that directly influences a firm and its competitive actions and responses:

• The threat of new entrants

• The power of suppliers

• The power of buyers

• The threat of product substitutes

• The intensity of rivalry among competing firms

Competitor Analysis

How companies gather and interpret information about their competitors

• Understanding the firm’s competitor environment complements the insights provided by studying the general and industry environments.

Analysis of the General Environment

Focuses on environmental trends and their implications

Analysis of the Industry Environment

Focuses on the factors and conditions influencing an industry’s profitability potential

Analysis of Competitors

Focused on predicting competitors’ actions, responses, and intentions

In combination, the results of the general environment, industry environment, and competitors analyses influence the firm’s:

• Vision

• Mission

• Values

• Choice of strategies

• Competitive actions and responses it will take to implement those strategies

The four parts of an external environmental analysis are:

1. Scanning

2. Monitoring

3. Forecasting

4. Assessing

Scanning

• Identifying early signals of environmental changes and trends

• Detect changes that are already under way.

• Must be aligned with the organizational context

Monitoring

• Detecting meaning through ongoing observations of environmental changes and trends

• Observe environmental changes to see if an important trend is emerging from among those spotted through scanning

• Requires the firm to identify important stakeholders and understand its reputation among these stakeholders as the foundation for serving their unique needs

Forecasting

Developing projections of anticipated outcomes based on monitored changes and trends

Assessing

• Determining the timing and importance of environmental changes and trends for firms’ strategies and their management

• Appropriately interpreting that information to determine if an identified trend in the general environment is an opportunity or threat is critical

Opportunity

a condition in the general environment that, if exploited effectively, helps a company reach strategic competitiveness

Threat

a condition in the general environment that may hinder a company’s efforts to achieve strategic competitiveness

Population Size

Firms seeking to find growing markets in which to sell their goods and services need to consider the market potential that may exist for them in these five nations:

1. India

2. China

3. United States

4. Indonesia

5. Pakistan

Age Structure

The aging of the population:

• Have significant implications for availability of qualified labor, health care, retirement policies, and business opportunities, among others.

• Threatens the ability of firms to hire and retain a workforce that meets their needs.

Geographic Distribution

How a population is distributed within countries and regions is subject to change over time

Ethnic Mix

Important because of:

• Consumer needs

• The labor force composition

Income Distribution

• informs firms of different groups’ purchasing power and discretionary income.

• Of interest are the average incomes of households and individuals.

Economic Environment

Refers to the nature and direction of the economy in which a firm competes or may compete

Firms seek to compete in:

relatively stable economies with strong growth potential

Laws and Regulations

Regulations provide structure to guide strategic and competitive actions

The Political/Legal Segment is concerned with:

• How organizations try to influence governments

• How they try to understand the influences (current and projected) of those governments on their competitive actions and responses

Attitudes and Values:

• Form the cornerstone of a society

• Often drive demographic, economic, political/legal, and technological conditions and changes

Firms should continuously scan the general environment to identify:

• Potential substitutes for technologies that are in current use

• Newly emerging technologies from which their firm could derive competitive advantage

Globalization of business markets

may create opportunities to enter new markets, as well as threats that competitors from other economies may enter their market

Globalfocusing

• Is a more cautious approach to globalization in which firms focus on global niche markets

• Allows firms to build onto and use their competencies while limiting risks

informal economy

aspect of the global segment requiring analysis

An increasing number of companies are investing in sustainable development, though some participate in:

greenwashing

Industry

a group of firms producing products that are close substitutes

Compared with the general environment, the _______ _________ has a more direct effect on firms’ competitive actions and responses.

industry environment

To study an industry, the firm examines five forces that affect the ability of all firms to operate profitably within a given industry:

• The threats posed by new entrants

• The power of suppliers

• The power of buyers

• Product substitutes

• The intensity of rivalry among competitors

The likelihood that firms will enter an industry is a function of two factors:

1. Barriers to entry

2. The retaliation expected from current industry participants

Barriers to Entry

• Determine the degree to which their competitive position reduces the likelihood of new competitors being able to enter the industry to compete against them

• Determine the likelihood of being able to identify an attractive competitive position within the industry

There are several significant entry barriers:

• Economies of scale

• Product differentiation

• Capital requirements

• Switching costs

• Access to distribution channels

• Cost disadvantages independent of scale

• Government policy

• Expected retaliation

Economies of Scale

• The cost of producing each unit declines as the quantity of a product produced during a given period increases.

• A new entrant is unlikely to quickly generate the level of demand for its product that would allow it to develop economies of scale.

Product Differentiation

• Over time, customers may come to believe that a firm’s product is unique and consistently purchase that firm’s product.

• To combat the perception of uniqueness, new entrants frequently offer products at lower prices.

Capital Requirements

• Competing in a new industry requires a firm to have capital for physical facilities, inventories, marketing activities, and other critical business functions.

• Even when a new industry is attractive, the capital required for successful market entry may not be available to pursue the market opportunity.

Switching Costs

The one-time costs customers incur when they buy from a different supplier

If switching costs are high, a new entrant must attract buyers by offering either:

• A substantially lower price, or

• A much better product

Access to Distribution Channels

• Over time, industry participants commonly learn how to effectively distribute their products.

• New entrants must persuade distributors to carry their products, either in addition to or in place of those currently distributed.

• Price breaks and cooperative advertising allowances may be used for this purpose.

  • However, those practices reduce the new entrants’ profit potential.

Cost Disadvantages Independent of Scale

Successful competition requires new entrants to reduce the strategic relevance of cost advantages held by established competitors that cannot be duplicated

Government Policy

Governmental decisions and policies that can control entry into an industry include:

• The granting of licenses and permits

• Regulation or deregulation

• Antitrust issues

Expected Retaliation

• An expectation of swift and vigorous competitive responses reduces the likelihood of entry

• Can be expected when the existing firm has a major stake in the industry, when it has substantial resources, and when industry growth is slow or constrained

Bargaining Power of Suppliers

Suppliers can exert power over firms competing within an industry by increasing prices and reducing the quality of their products

A supplier group is powerful when:

• It is dominated by a few large companies and is more concentrated than the industry to which it sells.

• Satisfactory substitute products are not available to industry firms.

• Industry firms are not a significant customer for the supplier group.

• Suppliers’ goods are critical to buyers’ marketplace success.

• The effectiveness of suppliers’ products has created high switching costs for industry firms.

• It poses a credible threat to integrate forward into the buyers’ industry.

To reduce their costs, buyers bargain for:

• Higher quality

• Greater levels of service

• Lower prices

Customers (buyer groups) are powerful when:

• They purchase a large portion of an industry’s total output.

• The sales of the product being purchased account for a significant portion of the seller’s annual revenues.

• They could switch to another product at little, if any, cost.

• The industry’s products are undifferentiated or standardized, and the buyers pose a credible threat if they were to integrate backward into the sellers’ industry.

Substitute Products

Goods or services from outside a given industry that perform similar or the same functions as a product that the industry produces

In general, product substitutes present a strong threat to a firm when:

• Customers face few, if any, switching costs

• The substitute product’s price is lower

• The substitute product’s quality and performance capabilities are equal to or greater than those of the competing product

To reduce a substitute’s attractiveness, a firm can differentiate a product along dimensions that are valuable to customers, such as:

• Quality

• Service after the sale

• Location

Competitive rivalry intensifies when:

• A firm is challenged by a competitor’s actions

• A company recognizes an opportunity to improve its market position

Firms differentiate their products from competitors’ offerings in ways that:

customers value and in which they have a competitive advantage

Common dimensions on which rivalry is based include:

• Price

• Service after the sale

• Innovation

Factors that increase the intensity of rivalries among firms include:

• Numerous or Equally Balanced Competitors

• Slow Industry Growth

• High Fixed Costs or High Storage Costs

• Lack of Differentiation or Low Switching Costs

• High Strategic Stakes

• High Exit Barriers

Numerous or Equally Balanced Competitors

• Evidence suggests that firms generally are aware of competitors’ actions, often choose to respond to them.

• Industries with only a few firms of equivalent size and power tend to have strong rivalries.

Slow Industry Growth

Rivalry in no-growth or slow-growth markets becomes more intense as firms battle to increase their market shares by attracting competitors’ customers

High Fixed Costs or High Storage Costs

• When fixed costs account for a large part of total costs, companies try to maximize the use of their productive capacity.

• When many firms attempt to maximize their productive capacity, excess capacity is created on an industry-wide basis.

Lack of Differentiation or Low Switching Costs

• Industries with many companies that have successfully differentiated their products have less rivalry.

• When buyers view products as commodities, rivalry intensifies. In these instances, buyers’ purchasing decisions are based primarily on price and, to a lesser degree, service.

High Strategic Stakes

Competitive rivalry is likely to be high when it is important for several of the competitors to perform well in the market.

High Exit Barriers

Sometimes companies continue competing in an industry even though the returns on their invested capital are low or even negative—likely because of high exit barriers

Common exit barriers include:

• Specialized assets

• Fixed costs of exit

• Strategic interrelationships

• Emotional barriers

• Government and social restrictions

Unattractive Industry

industry has low entry barriers, suppliers and buyers with strong bargaining positions, strong competitive threats from product substitutes, and intense rivalry among competitors

Attractive Industry

has high entry barriers, suppliers and buyers with little bargaining power, few competitive threats from product substitutes, and relatively moderate rivalry.

Strategic Group

A set of firms emphasizing similar strategic dimensions and using a similar strategy

Intra-strategic group competition is _______ intense than is inter-strategic group competition.

more

Using strategic groups to understand an industry’s competitive structure requires the firm to plot companies’ competitive actions and responses along strategic dimensions, such as:

• Pricing decisions

• Product quality

• Distribution channels

High mobility barriers, high rivalry, and low resources among the firms within an industry limit the formation of:

strategic groups

Strategic groups have several implications:

• Because firms within a group offer similar products to the same customers, the competitive rivalry among them can be intense.

  • The more intense the rivalry, the greater is the threat to each firm’s profitability.

• The strengths of the five forces differ across strategic groups.

• The closer the strategic groups are in terms of their strategies, the greater is the likelihood of rivalry between the groups.

In a competitor analysis, the firm seeks to understand the following:

• What drives the competitor, as shown by its future objectives.

• What the competitor is doing, as revealed by its current strategy.

• What the competitor believes about the industry, as shown by its assumptions.

• What the competitor’s capabilities are, as shown by its strengths and weaknesses.

Competitor Intelligence

the set of data and information the firm gathers to better understand and anticipate competitors’ objectives, strategies, assumptions, and capabilities.

Complementors

are companies or networks of companies that sell complementary goods or services that are compatible with the focal firm’s goods or services

Business Ecosystem

a complex network of interconnected organizations whose competitive and cooperative efforts are associated with the satisfaction of a particular value proposition

Practices considered both legal and ethical include:

• Obtaining publicly available information

• Attending trade fairs and shows to obtain competitors’ brochures, view their exhibits, and listen to discussions about their products

Practices widely viewed as unethical include:

• Blackmail

• Trespassing

• Eavesdropping

• Stealing drawings, samples, or documents