1. Chapter 4 Exploring the External
Environment: Macro
and Industry Dynamics

2. 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.

3. 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

4. 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

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

6. 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?

7. 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.

8. 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?

9. 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?

10. 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?

11. 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?

12. 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?

13. 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?

14. 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

15. 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.”

16. 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)

17. 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.

18. 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

19. 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

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

21. 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

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

23. 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

24. 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)