Chapter 4 Exploring the External Environment: Macro and Industry Dynamics

LEARNING OBJECTIVES 1. Explain the importance of the external environment for strategy and company performance. 2. Use PESTEL to identify the macro characteristics of the external environment. 3. Identify the major features of an industry and the forces that affect industry profitability. 4. Understand the dynamic characteristics of the external environment. 5. Show how industry dynamics may redefine industries.

Trading Punches Coca-Cola Coca-Cola invented “Kick Pepsi's can” Diet Coke New Coke Repair Coke and restore stock price Diversify product line Pepsi “Beat Coke” “Pepsi Generation” “Pepsi Challenge” Foster entrepreneurial spirit of Pepsi’s people Jettison slow-growing businesses Diversify beyond soft-drinks 1886 1950 1960 1970 1980 1990 2000

The External Environment of Strategy Internal Strengths Weaknesses Capabilities Relationships Etc. An internal analysis is just half of what is needed to build strategy The SWOT and more complicated frameworks help us understand the full picture

The External Environment of Strategy Macro Environment Political, Economic, Sociocultural, Technological, Environmental, Legal Industry Environment Strategic Group The Organization

The External Environment of Strategy - KEY QUESTIONS TO ASK What is our firm’s industry? What macro environmental conditions will have a material effect on our ability to implement our strategy successfully? What are the characteristics of the industry? How stable are these characteristics?

and legal context(s) in which a company operates. Macro Environment PESTEL analysis is used widely to structure analysis of a company’s external environment. PESTEL is an acronym for the political, economic, sociocultural, technological, environmental, and legal context(s) in which a company operates.

Macro Environment – PESTEL analysis Political • How stable is the political environment? • What are local taxation policies and how do these affect your business? • Is the government involved in trading agreements such as EU, NAFTA, ASEAN, or others? • What are the foreign-trade regulations? • What are the social-welfare policies?

Macro Environment – PESTEL analysis Economic • What are current and projected interest rates? • What is the level of inflation, what is it projected to be, and how does this projection reflect the growth of your market? • What are local employment levels per capita and how are they changing? • What are the long-term prospects for gross domestic product (GDP) per capita and so on? • What are exchange rates between critical markets and how will they affect production and distribution of your goods?

Macro Environment – PESTEL analysis Sociocultural • What are local lifestyle trends? • What are the current demographics and how are they changing? • What is the level and distribution of education and income? • What are the dominant local religions and what influence do they have on consumer attitudes and opinions? • What is the level of consumerism and what are popular attitudes toward it? • What pending legislation affects corporate social policies (e.g., domestic-partner benefits or maternity/paternity leave)? • What are the attitudes toward work and leisure?

Macro Environment – PESTEL analysis Technological • What is the level of research funding in government and industry and are those levels changing? • What is the government and industry’s level of interest and focus on technology? • How mature is the technology? • What is the status of intellectual-property issues in the local environment? • Are potentially disruptive technologies in adjacent industries creeping in at the edges of the focal industry?

Macro Environment – PESTEL analysis Environmental • What are local environmental issues? • Are there any pending ecological or environmental issues relevant to your industry? • How do the activities of international pressure groups (e.g., Greenpeace, Earth First, PETA) affect your business? • Are there environmental-protection laws? • What are the regulations regarding waste disposal and energy consumption?

Macro Environment – PESTEL analysis Legal • What are the regulations regarding monopolies and private property? • Does intellectual property have legal protections? • Are there relevant consumer laws? • What is the status of employment, health and safety, and product-safety laws?

Macro Environment - PRESSURES FAVOURING INDUSTRY GLOBALIZATION Markets Costs Governments Competition Homogeneous customer needs Large scale and scope economies Favourable trade policies Interdependent countries Global competitors Global customer needs Common technological standards Learning and experience Global channels Common manufacturing and marketing regulations Sourcing efficiencies Favourable logistics Arbitrage opportunities High R&D costs Transferable marketing approaches Source: Adapted from M.E. Porter, Competition in Global industries (Boston: Harvard Business School Press, 1986); G. Yip, “Global Strategy in a World of Nations, “ Sloan Management Review 31:1 (1989), 29-40

Value System Analysis The company’s value chain is embedded in a larger system that Michael Porter calls the “value system.” The system is a chain of companies, each with its own value chain. That part of the system that creates and delivers the inputs used by the company is “upstream,” while that part of the system that takes the company’s output to the final consumer is “downstream.”

Industry Analysis – THE FIVES FORCES MODEL Threat of New Entrants (and Entry Barriers) Absolute cost advantages Proprietary learning curve Access to inputs Government policy Economies of scale Capital requirements Brand identity Switching costs Access to distribution Expected retaliation Proprietary products Complementors Number of complements Relative value added Barriers to complement entry Difficulty of engaging complements Buyer perception of complements Complement exclusivity Industry value chain – from raw materials and other inputs, to channel, to end consumer Supplier Power Supplier concentration Importance of volume to supplier Differentiation of inputs Impact of inputs on cost or differentiation Switching costs of firms in the industry Presence of substitute inputs Threat of forward integration Cost relative to total purchases in industry Degree of Rivalry Exit barriers Industry concentration Fixed costs/value added Industry growth Intermittent overcapacity Product differences Switching costs Brand identity Diversity of rivals Corporate stakes Buyer Power (Channel and End Consumer) Buyer concentration Importance of volume to customers Differentiation of inputs Impact of outputs on cost of differentiation Switching costs of customers Presence of substitute products Threat of backward integration Costs relative to total purchases in industry Threat of Substitutes Switching costs Buyer inclination to substitute Price-performance tradeoff of substitutes Varity of substitutes Necessity of product or service Source: Adapted from M.E. Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors (New York: Free Press, 1980)

Industry Analysis - CAUSES OF RIVARLY Barriers to Entry Barriers to Exit Few other opportunities Sunk investments Etc. In addition to entry and exit barriers, many factors drive rivalry History of price wars Level of fixed costs Industry concentration Market growth Etc. Strong brands Proprietary technology Start-up costs Etc.

Industry Analysis - SUPPLIER POWER Diamond supply Percent Diamond Retailers Others 50 When firms in the supply industry can dictate terms, they can extract greater profits DeBeers 50

Industry Analysis - BUYER POWER Suppliers Buyers Industry B Profits Suppliers Buyers In industries characterized with many suppliers and few buyers, buyers often capture a greater share of profits Profits

Industry Analysis - THREAT OF SUBSTITUTES Soft drinks Movie rentals Blockbuster Coke Pepsi Hollywood video Bottled water Cable TV

Industry Analysis - IMPACT OF COMPLEMENTOR Three Examples Any factor that makes it more attractive for suppliers to supply an industry on favourable terms or that makes it more attractive for buyers to purchase products or services from an industry at prices higher than it would pay absent the complementor Hot dogs + Buns More sales Music + MP3 player More attractive offering Westjet plane orders + Air Canada plane orders Lower costs from Boeing

Predicting Competitors’ Behaviours Competitor Analysis Mapping Competitors The Value Curve Predicting Competitors’ Behaviours

Dynamic Characteristics of the External Environment - INDUSTRY LIFE CYCLE Market Size Time Embryonic Growing Mature In Decline Technological uncertainty Niche market – selected products for selected markets Participants emphasize problem solving – product as “solution” Customers become better informed Market expands beyond niche More competitors enter Aggressive customers Proliferation of products and markets served Market volatility and beginnings of industry consolidation Product/market contraction Further consolidation and industry regeneration

Dynamic Characteristics of the External Environment - TECHNOLOGICAL DISCONTINUITIES Example Product-related In disk-drive industry, virtually every new generation of technology led to demise of market leader Discontinuities Process-related Southwest Airlines radically changed the airline business model by adopting new processes (e.g., a point-to-point model)