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

2. “To assure victory, always carefully survey the field before battle.”
- Sun Tzu
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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
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4. 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
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5. 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
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6. The Computer Sector: Industries and Market Segments
Figure 2.1
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7. 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.
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8. 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.
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9.  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
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10.  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
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11.  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.
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12.  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.
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 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.
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14. 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
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15. Strategic Groups in the Pharmaceutical Industry
Figure 2.3
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16. 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
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17. Strategic Barriers in the Pharmaceutical Industry
Lack of R&D Skills to develop new proprietary drugs
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18. 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.
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19. Stages in the Industry Life Cycle
Strength and nature of five forces change as industry evolves
Figure 2.4     
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20. 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
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21. 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.
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22. Punctuated Equilibrium and Competitive Structure
Figure 2.6
Industry Structure revolutionized by innovation
Periods of long term stability
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23. 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
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24. “Strategy is a choice on how to compete.”
- Michael Porter
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