External Analysis: The Identification of Opportunities and Threats Chapter Two External Analysis: The Identification of Opportunities and Threats

“To assure victory, always carefully survey the field before battle.” - Sun Tzu Copyright © Houghton Mifflin Company. All rights reserved. © RoyaltyFree/ Stockdisc/ Getty Images

Copyright © Houghton Mifflin Company. All rights reserved. External Analysis The purpose of external analysis is to identify the strategic opportunities and threats in the organization’s operating environment that will affect how it pursues its mission. External Analysis requires an assessment of: Industry environment in which company operates Competitive structure of industry Competitive position of the company Competitiveness and position of major rivals The country or national environments in which company competes The wider socioeconomic or macroenvironment that may affect the company and its industry Social Government Legal International Technological Copyright © Houghton Mifflin Company. All rights reserved.

External Analysis: Opportunities and Threats Analyzing the dynamics of the industry in which an organization competes to help identify: Opportunities Conditions in the environment that a company can take advantage of to become more profitable Threats Conditions in the environment that endanger the integrity and profitability of the company’s business Copyright © Houghton Mifflin Company. All rights reserved.

Industry Analysis: Defining an Industry A group of companies offering products or services that are close substitutes for each other and that satisfy the same basic customer needs Industry boundaries may change as customer needs evolve and technology changes Sector A group of closely related industries Market Segments Distinct groups of customers within an industry Can be differentiated from each other with distinct attributes and specific demands Industry analysis begins by focusing on the overall industry – before considering market segment or sector-level issues Copyright © Houghton Mifflin Company. All rights reserved.

The Computer Sector: Industries and Market Segments Figure 2.1 Copyright © Houghton Mifflin Company. All rights reserved.

Porter’s Five Forces Model Figure 2.2 Source: Adapted and reprinted by permission of Harvard Business Review. From “How Competitive Forces Shape Strategy,” by Michael E. Porter, Harvard Business Review, March/April 1979 © by the President and Fellows of Harvard College. All rights reserved. Copyright © Houghton Mifflin Company. All rights reserved.

How the Five Forces Shape Competition within an Industry The stronger that each of these five forces is, the more limited is the ability of established companies to raise prices and earn greater profits within their industry.      A weak competitive force may be viewed as an opportunity as it allows company to earn greater profits A strong competitive force may be viewed as a threat as it depresses industry profits Strength of forces may change As industry conditions change Through its choice of strategies, a company may alter the strength of one or more of the five forces to its advantage. Copyright © Houghton Mifflin Company. All rights reserved.

 Risk of Entry by Potential Competitors Potential Competitors are companies that are not currently competing in an industry but have the capability to do so if they choose. Barriers to new entrants include: Economies of Scale – as firms expand output unit costs fall via: Cost reductions – through mass production Discounts on bulk purchases – of raw material and standard parts Cost advantages – of spreading fixed and marketing costs over large volume Brand Loyalty Achieved by creating well-established customer preferences Difficult for new entrants to take market share from established brands Absolute Cost Advantages – relative to new entrants Accumulated experience – in production and key business processes Control of particular inputs required for production Lower financial risks – access to cheaper funds Customer Switching Costs for Buyers – where significant Government Regulation May be a barrier to enter certain industries Copyright © Houghton Mifflin Company. All rights reserved.

 Rivalry Among Established Companies Competitive Rivalry refers to the competitive struggle between companies in the same industry to gain market share from each other. Intensity of rivalry is a function of: Industry Competitive Structure Number and size distribution of companies Consolidated versus fragmented industries Demand Conditions Growing demand – tends to moderate competition and reduce rivalry Declining demand – encourages rivalry for market share and revenue Cost Conditions High fixed costs – profitability leveraged by sales volume Slow demand and growth – can result in intense rivalry and lower profits Height of Exit Barriers – prevents companies from leaving industry Write-off of investment in assets Economic dependence on industry Maintain assets - to participate effectively in an industry  High fixed costs of exit  Emotional attachment to industry  Bankruptcy regulations – allowing unprofitable assets to remain Copyright © Houghton Mifflin Company. All rights reserved.

 Bargaining Power of Buyers Industry Buyers may be the consumers or end-users who ultimately use the product or intermediaries that distribute or retail the products. These buyers are most powerful when: Buyers are dominant. Buyers are large and few in number. The industry supplying the product is composed of many small companies. Buyers purchase in large quantities. Buyers have purchasing power as leverage for price reductions. The industry is dependant on the buyers. Buyers purchase a large percentage of a company’s total orders. Switching costs for buyers are low. Buyers can play off the supplying companies against each other. Buyers can purchase from several supplying companies at once. Buyers can threaten to enter the industry themselves. Buyers produce themselves and supply their own product. Buyers can use threat of entry as a tactic to drive prices down. Copyright © Houghton Mifflin Company. All rights reserved.

 Bargaining Power of Suppliers Suppliers are organizations that provide inputs such as material and labor into the industry. These suppliers are most powerful when: The product supplied is vital to the industry and has few substitutes. The industry is not an important customer to suppliers. Suppliers are not significantly affected by the industry. Switching costs for companies in the industry are significant. Companies in the industry cannot play suppliers against each other. Suppliers can threaten to enter their customers’ industry. Suppliers can use their inputs to produce and compete with companies already in the industry. Companies in the industry cannot threaten to enter suppliers’ industry. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved.  Substitute Products Substitute Products are the products from different businesses or industries that can satisfy similar customer needs. The existence of close substitutes is a strong competitive threat. Substitutes limit the price that companies can charge for their product. Substitutes are a weak competitive force if an industry’s products have few close substitutes. Other things being equal, companies in the industry have the opportunity to raise prices and earn additional profits. Copyright © Houghton Mifflin Company. All rights reserved.

Strategic Groups Within Industries Strategic Groups are groups of companies that follow a business model similar to other companies within their strategic group – but are different from that of other companies in other strategic groups. The basic differences between business models in different strategic groups can be captured by a relatively small number of strategic factors. Implications of Strategic Groups – The closest competitors are within the same Strategic Group and may be viewed by customers as substitutes for each other. Each Strategic Group can have different competitive forces and may face a different set of opportunities and threats. Mobility Barriers – factors within an industry that inhibit the movement of companies between strategic groups Include barriers to enter another group or exit existing group Copyright © Houghton Mifflin Company. All rights reserved.

Strategic Groups in the Pharmaceutical Industry Figure 2.3 Copyright © Houghton Mifflin Company. All rights reserved.

Strategic Groups in the Pharmaceutical Industry High Risk – High Return Focus on developing new proprietary drugs Heavy R&D spending Low Risk – Low Return Focus on low-cost copies of drugs with expired patents Production efficiency Copyright © Houghton Mifflin Company. All rights reserved.

Strategic Barriers in the Pharmaceutical Industry Lack of R&D Skills to develop new proprietary drugs Copyright © Houghton Mifflin Company. All rights reserved.

Industry Life Cycle Analysis Industry Life Cycle Model analyzes the affects of industry evolution on competitive forces over time and is characterized by five distinct life cycle stages: Embryonic – industry just beginning to develop Rivalry based on perfecting products, educating customers, and opening up distribution channels. Growth – first-time demand takes-off with new customers Low rivalry as focus is on keeping up with high industry growth. Shakeout – demand approaches saturation, replacements Rivalry intensifies with emergence of excess productive capacity. Mature – market totally saturated with low to no growth Industry consolidation based on market share, driving down price. Decline – industry growth becomes negative Rivalry further intensifies based on rate of decline and exit barriers. Copyright © Houghton Mifflin Company. All rights reserved.

Stages in the Industry Life Cycle Strength and nature of five forces change as industry evolves Figure 2.4      Copyright © Houghton Mifflin Company. All rights reserved.

Growth in Demand and Capacity Anticipate how forces will change and formulate appropriate strategy Figure 2.5 Industry Shakeout: Rivalry Intensifies with growth in excess capacity Copyright © Houghton Mifflin Company. All rights reserved.

Limitations of Models for Industry Analysis Life Cycle Issues Industry cycles do not always follow the life cycle generalization. In rapid growth situations embryonic stage is sometimes skipped. Industry growth revitalized through innovation or social change. The time span of the stages can vary from industry to industry. Innovation and Change Punctuated Equilibrium occurs when an industry’s long term stable structure is punctuated with periods of rapid change by innovation. Hypercompetitive industries are characterized by permanent and ongoing innovation and competitive change. Company Differences There can be significant variances in the profit rates of individual companies within an industry. In addition to industry attractiveness, company resources and capabilities are also important determinants of its profitability. Models provide useful ways of thinking about competition within an industry – but be aware of their limitations. Copyright © Houghton Mifflin Company. All rights reserved.

Punctuated Equilibrium and Competitive Structure Figure 2.6 Industry Structure revolutionized by innovation Periods of long term stability Copyright © Houghton Mifflin Company. All rights reserved.

The Role of the Macroenvironment Figure 2.7 Changes in the forces in the macro-environment can directly impact: The Five Forces Relative Strengths Industry Attractiveness Copyright © Houghton Mifflin Company. All rights reserved.

“Strategy is a choice on how to compete.” - Michael Porter Copyright © Houghton Mifflin Company. All rights reserved. © RoyaltyFree/ Stockdisc/ Getty Images