Chapter 4 Exploring the External Environment: Macro and Industry Dynamics

1 OBJECTIVES Explain the importance of the external context for strategy and firm performance 1 Use PESTEL to identify the macro characteristics of the external context 2 Identify the major features of an industry and the forces that affect industry profitability 3 Understand the dynamic characteristics of the external context 4 Show how industry dynamics may redefine industries 5 Use scenario planning to predict the future structure of the external context 6

2 THE COLA WARS “Coca-Cola sells a billion servings – in cans, bottles, and glasses – every day. You can grab a Coke in almost 200 countries. Its archrival, Pepsi, isn’t too far behind. Like ford versus Chevy, theirs is a battle not just for customer dollars, but for their hearts and minds as well. – The History Channel, “Empires of industry. Cola Wars”

3 THE COLA WARS (TIMELINE) 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

4 EXTERNAL CONTEXT OF STRATEGY 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 Internal Strengths Weaknesses Capabilities Relationships Etc.

5 COMPARATIVE INDUSTRY – WIDE LEVEL OF PROFITABILITY, 1995 – 2004 Source:Data from Standard and Poor’s CompuStat Weighted average return on invested capital Percent Bever- ages Ciga- rettes Pharma- ceuticals Eating esta- blish- ments SteelRail- roads Truck- ing Bott- lers Comp- uters Agri- cul- tural pro ducts Pre- pack aged soft ware Air- lines Wire- less pro- viders

6 THE EXTERNAL ENVIRONMENT OF THE ORGANIZATION Macro Environment Political, Economic, Sociocultural, Technological, Environmental, Legal Industry Environment Strategic Group The Organization

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

8 UNDERSTANDING THE MACRO ENVIRONMENT USING A PESTEL ANALYSIS How stable is the political environment? Tax policies Etc. Projected interest rates? Inflation? Etc. Lifestyle trends? Demographic changes? Etc. Level of government research funding? How mature is technology? Etc. Political Economic Socio-cultural Technological Is intellectual property protected? Relevant consumer laws? Etc. Legal

9 PRESSURES FAVORING INDUSTRY GLOBALIZATION Interdependent countries Homogeneous customer needs Favorable trade policies Large scale and scope economies Global competitors Global customer needs Common technological standards Learning and experience Global channels Common manufacturing and marketing regulations Sourcing efficiencies CompetitionMarketsGovernmentsCosts Favorable 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

10 COMPETITION DRIVES PROFITS TO A “NORMAL” LEVEL Competition Profits (above normal) CostsRevenue Profits (above normal) CostsRevenue Competition

11 KEY SUCCESS FACTORS AS BARRIERS TO ENTRY Key asset or requisite skill that all firms in an industry must possess in order to be a viable competitor Key success factor (KSF) Ability to meet competitive pricing Extensive distribution Ability to raise consumer awareness Broad product mix Global presence Well positioned bottlers and bottling capacity KSFs: SOFT DRINK EXAMPLE

12 INDUSTRY FRAGMENTATION AND CONCENTRATION MonopolyDuopolyFragmented

13 CONCENTRATION IN SELECT U.S. INDUSTRIES Source:U.S. Census Bureau, “Economic Census: Concentration Rations”, Economic Census 2002 (accessed July 15,2005), Percent of market Entire food industry Animal food Break- fast cereal Dairy pro- ducts Entire apparel industry Men’s and boys’ apparel Women’s and girls’ apparel Others Top four competitors

14 ANALYZING INDUSTRY STRUCTURE USING FIVE – FORCES Complementors Number of complements Relative value added Barriers to complement entry Difficulty of engaging complements Buyer perception of complements Complement exclusivity Buyer Power (Channel and End consumer) Bargaining leverage Buyer volume Buyer information Brand identity Price sensitivity Threat of backward integration Product differentiation Buyer concentration vs. industry Substitutes available Buyer’s incentives 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 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 Threat of Substitutes Switching costs Buyer inclination to substitute Price-performance tradeoff of substitutes Varity of substitutes Necessity of product or service 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 Source:Adapted from M.E. Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors (New York: Free Press, 1980) Industry value chain – from raw materials and other inputs, to channel to end consumer

15 CAUSES OF RIVARLY Barriers to Entry Strong brands Proprietary technology Start-up costs Etc., 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.

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

17 BUYER POWER SuppliersBuyers Profits ILLUSTRATIVE In industries characterized with many suppliers and few buyers, buyers often capture a greater share of profits Industry A SuppliersBuyers Industry B Profits

18 THREAT OF SUBSTITUTES Soft drinks CokePepsi Movie rentals Block buster Hollywood video Bottled waterCable TV

19 IMPACT OF COMPLEMENTOR Any factor that makes it more attractive for suppliers to supply an industry on favorable 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 Complementor: Hot dogs + Buns More sales Three Examples Music + MPS player More attractive offering Delta plane orders + American Airlines plane orders Lower costs from Boeing

20 MAPPING STRATEGY GROUPS: U.S. BICYCLE INDUSTRY Cannondale, Gary Fisher, Klein Huffy, Murray, Brunswick Schwinn/GT Mongoose Trek Specialized Independent dealers Independent dealers and mass merchandisers Mass merchandisers only Principal distribution channels Price/quality/image Low High

21 HOW WOULD YOU DO THAT? – U.S. AIRLINE INDUSTRY Rivalry? New entrants? Buyer power? Substitutes? Supplier power? Complementors? How would you define the industry?

22 IMPORTANCE OF DYNAMIC STRATEGIC ANALYSIS Pineapple industry pre-1980s Fresh Del-Monte introduces the “Extra Sweet Gold” brighter color, sweeter, resistant to nothing Fresh Del-Monte (70%) Pineapple industry post introduction

23 INDUSTRY LIFE CYCLE Source:Adapted from K. Rangan and G. Bowman, “Beating the Commodity Magnet,” Industrial Marketing Management 21 (1992), ; P. Kotler, “Managing Products through their Product Life Cycle,” in Marketing Management: Planning, Implementation, and Control, 7 th ed (Upper Saddle River, NJ: Prentice Hall, 1991) Market Size Time Embryonic Technological uncertainty Niche market – selected products for selected markets Participants emphasize problem solving – product as “solution” Growing Customers become better informed Market expands beyond niche More competitors enter Mature Aggressive customers Proliferation of products and markets served Market volatility and beginnings of industry consolidation In Decline Product/market contraction Further consolidation and industry regeneration

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

25 Modems WHEN INDUSTRIES DIVIDE OR COLLIDE Industries Divide Invents new interface Radio Cable TV Production TV networks Media conglomerate Time Warner Viacom Disney Etc. Launches palm pilot/ creates first PDA Industries Collide 3-Com Modems

26 SCENARIO PLANNING Assess the strategic implications of each scenario 6 Specify indicators that can signal which scenario is unfolding 5 Flesh out the picture 4 Develop the framework by defining two specific axes 3 Brainstorm key drivers, decision factors, and possible scenario departure or divergence points 2 Define target issue, time frame, and scope for scenarios 1 An understanding of the big picture and a plan to manage uncertainty

27 HOW WOULD YOU DO THAT? – CREDIT – UNION INDUSTRY Changes in the playing field MinorMajor Source:Adapted from Credit Union Society, 2005: Scenarios for Credit Unions, an Executive Report (Madison, WI: Credit Union Executives Society, 1999) Technological Change Radical Gradual Technocracy 2005: The wide-scale adoption of the internet by U.S. consumers has led to massive technological innovation for financial-services companies, increasing their range of distribution channels, as well as their products, services, and geographic scope. Regulations and other changes in the playing field, however, have been slow to follow Chameleon 2005: Radical changes occurring in the playing field and in technology make this a highly tumultuous scenario for all credit unions. The nature of competition has evolved so much that banks and credit unions compete directly – under the same rules of the game. This situation has caused a wide-scale convergence of cultures among various financial-services providers, testing the boundaries of the traditional credit-union mission Credit-Union Power 2005: Both technology and the playing field have changed at a moderate pace, making this the most stable scenario. Even with moderate change in these areas, however, the changing basis of competition, new business models, human resource challenges, and industry dynamics are different enough to pose significant challenges for many financial-services companies Wallet Wars 2005: Prompted by free-market economics, the playing field is changing radically, enabling credit unions and other financial-services institutions to compete more intensely. At the same time, technical innovations have not developed as quickly as many observers and analysts had predicted

28 SUMMARY Explain the importance of the external context for strategy and firm performance 1 Use PESTEL to identify the macro characteristics of the external context 2 Identify the major features of an industry and the forces that affect industry profitability 3 Understand the dynamic characteristics of the external context 4 Show how industry dynamics may redefine industries 5 Use scenario planning to predict the future structure of the external context 6