1. Analyzing the External Environment of the Firm
Chapter Two
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Learning Objectives
After reading this chapter, you should have a good understanding of:
LO1 The importance of developing forecasts of the business environment.
LO2 Why environmental scanning, environmental monitoring, and collecting competitive intelligence are critical inputs to forecasting.
LO3 Why scenario planning is a useful technique for firms competing in industries characterized by unpredictability and change.
LO4 The impact of the general environment on a firm’s strategies and performance.
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3. Learning Objectives (cont.)
LO5 How forces in the competitive environment can affect profitability and how a firm can improve its competitive position by increasing its power vis-à-vis these forces.
LO6 How the Internet and digitally based compatibilities are affecting the five competitive forces and industry profitability.
LO7 The concept of strategic groups and their strategy and performance implications.
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4. Creating the Environmentally Aware Organization
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5. Environmental Scanning & Monitoring
External Scanning
Surveillance of a firm’s external environment:
Predict environmental changes to come
Detect changes already under way
Proactive mode
Alerts the firm to critical trends before changes have developed a discernible pattern and before competitors recognize them
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6. Environmental Scanning & Monitoring
External Monitoring
Track evolution of environmental trends, sequence of events or streams of activities
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7. How to Spot Hot Trends Listen Pay attention Follow trends online
Go old school
Ask your customers questions about your products and services
Read trade publications related to your industry
Add websites like trendhunter.com to your regular surfing
Ask your customers what they think
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8. Virgin Mobile and Crowdsourcing
Virgin Mobile USA relies on 2,000 carefully selected online customers, referred to as “Insiders” to keep it aware of trends and promising opportunities.
The Insider community—a very hip focus group—provides input on everything from designing phones to coming up with names for service plans.
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9. Competitive Intelligence
Define and understand a firm’s industry
Identify rivals’ strengths and weaknesses
Intelligence gathering (data)
Interpretation of intelligence data
Helps a firm avoid surprises
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10. Environmental Forecasting
Plausible projections about direction, scope, speed and intensity of environmental change
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11. Environmental Forecasting
Scenario analysis
involves experts’ detailed assessments of societal trends, economics, politics, technology, or other dimensions of the external environment
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12. QUESTION Which of the following is a danger of forecasting?
Managers assume that the world is not open to precise predictions.
Managers may view uncertainty as black and white and ignore grey areas.
Managers assume that the world is uncertain.
Managers view the world as completely unpredictable.
Answer: B
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13. SWOT Analysis Firm’s strategy must: Build on its strengths
Remedy the weaknesses or work around them
Take advantage of the opportunities presented by the environment
Protect the firm from threats
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14. SWOT Analysis Strengths and weaknesses Internal conditions of the firm
Opportunities and threats environmental conditions external to the firm
Strengths – where your firm excels
Weaknesses – where the firm is lacking relative to competitors
Opportunities and threats – general or competitive environment
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15. Example: Harley-Davidson
Strengths
Strong & adaptable brand image
Weaknesses
Limited ability to develop new non-traditional products
Opportunities
Growing leisure interest in motorcycles worldwide
Threats
Differing foreign policies governing motorcycles
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16. The General Environment
Factors external to an industry, usually beyond a firm’s control
Demographic
Sociocultural
Legal/Political
Technological
Economic
Global
General environmental trends and events:
Little ability to predict them
Even less ability to control them
Can vary across industries
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17. Demographic Segment Aging population Rising or declining affluence
Changes in ethnic composition
Geographic distribution of population
Greater disparities in income levels
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18. Sociocultural Segment
More women in the workforce
Dual-income families
Increase in temporary workers
Greater concern for healthy diets and physical fitness
Greater interest in the environment
Postponement of having children
Sociocultural forces influence the values, beliefs, and lifestyles of a society
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19. Political/Legal Segment
Tort reform
Americans with Disabilities Act (ADA)
Repeal of Glass-Steagall Act in 1999
Deregulation of utility and other industries
Increases in federally mandated minimum wages
Taxation at local, state, federal levels
Legislation on corporate governance reforms (Sarbanes-Oxley Act)
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20. Technological Segment
Genetic engineering
Emergence of Internet technology
Computer-aided design/computer-aided manufacturing systems (CAD/CAM)
Wireless communication
Nanotechnology
Genetic engineering
Emergence of Internet technology
Computer-aided design/computer-aided manufacturing systems (CAD/CAM)
Research in synthetic and exotic materials
Pollution/global warming
Miniaturization of computing technologies
Wireless communication
Nanotechnology
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21. Economic Segment Interest rates Unemployment Consumer Price index
Trends in GDP
Changes in stock market valuations
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22. Global Segment Increasing global trade Currency exchange rates
Emergence of the Indian and Chinese economies
Trade agreements (NAFTA, EU, ASEAN)
Creation of WTO (decreasing tariffs/free trade in services)
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23. The Competitive Environment
Competitive environment factors that pertain to an industry and affect a firm’s strategies
Competitors, customers, and suppliers
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24. Porter’s Five Forces Model of Industry Competition
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25. The Threat of New Entrants
Profits of established firms in the industry may be eroded by new competitors
Sources of entry barriers
Economies of scale
Product differentiation
Capital requirements
Switching costs
Access to distribution channels
Cost disadvantages independent of scale
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26. QUESTION
If you are considering opening a new pizza restaurant in your community, what would be the threat of new entrants? How would you evaluate Porter’s other forces for this industry? Explain.
The threat of new entrants in the food industry is very high, which is why a majority of new food restaurants fail within their first year. The minimum requirements to open a pizza shop are an oven and a small amount of capital. The potential number of competitors is unlimited due to these factors. Based on other forces also, this industry is not very attractive.
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27. The Bargaining Power of Buyers
Buyers threaten an industry by:
Forcing down prices
Bargaining for higher quality or more services
Playing competitors against each other
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28. The Bargaining Power of Buyers
A buyer group is powerful when
It is concentrated or purchases large volumes relative to seller sales
The products it purchases from the industry are standard or undifferentiated
The buyer faces few switching costs
It earns low profits
The buyers pose a credible threat of backward integration
The industry’s product is unimportant to the quality of the buyer’s products or services
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29. The Bargaining Power of Suppliers
Suppliers can exert power by threatening to raise prices or reduce the quality of purchased goods and services
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30. The Bargaining Power of Suppliers
A supplier group will be powerful when
The supplier group is dominated by a few companies and is more concentrated than the industry it sells to
The supplier group is not obliged to contend with substitute products for sale to the industry
The industry is not an important customer of the supplier group
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31. The Bargaining Power of Suppliers
A supplier group will be powerful when (cont.)
The supplier’s product is an important input to the buyer’s business
The supplier group’s products are differentiated or it has built up switching costs for the buyer
The supplier group poses a credible threat of forward integration
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32. The Threat of Substitute Products and Services
Substitutes limit the potential returns of an industry
Ceiling on the prices that firms in that industry can profitably charge
Price/performance ratio
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33. The Intensity of Rivalry among Competitors in an Industry
Price competition
Advertising battles
Product introductions
Increased customer service or warranties
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34. The Intensity of Rivalry among Competitors in an Industry
Interacting factors lead to intense rivalry
Numerous or equally balanced competitors
Slow industry growth
High fixed or shortage costs
Lack of differentiation or switching costs
Capacity augmented in large increments
High exit barriers
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35. How the Internet and Digital Technologies Influences Industry
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36. Using Industry Analysis: A Few Caveats
Managers must not always avoid low profit industries
Can still yield high returns for players with sound strategies
Implicitly assumes a zero-sum game, determining how a firm can enhance its position relative to the forces
Five Forces analysis is essentially a static analysis
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37. Using Industry Analysis: A Few Caveats (cont.)
Good industry analysis looks rigorously at the structural underpinnings of profitability.
A first step is to understand the time horizon
The point of industry analysis is not to declare the industry attractive or unattractive but to understand the underpinnings of competition and the root causes of profitability.
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38. The Value Net
Value net
Suppliers and customers (the vertical net)
Substitutes and complements (the horizontal net)
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39. Strategic Groups within Industries
Two unassailable assumptions in industry analysis
No two firms are totally different
No two firms are exactly the same
Strategic groups
Cluster of firms that share similar strategies
Breadth of product and geographic scope
Price/quality
Degree of vertical integration
Type of distribution system
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40. Strategic Groups within Industries
Value of strategic groups as an analytical tool
Identify barriers to mobility that protect a group from attacks by other groups
Identify groups whose competitive position may be marginal or tenuous
Chart the future direction of firms’ strategies
Thinking through the implications of each industry trend for the strategic group as a whole
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