1. Analyzing the External Environment of the Firm Chapter Two McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Learning Objectives After reading this chapter, you should have a good understanding of: LO2.1 The importance of developing forecasts of the business environment. LO2.2 Why environmental scanning, environmental monitoring, and collecting competitive intelligence are critical inputs to forecasting. LO2.3 Why scenario planning is a useful technique for firms competing in industries characterized by unpredictability and change. LO2.4 The impact of the general environment on a firm’s strategies and performance. 2-2

3. Learning Objectives (cont.) LO2.5 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. LO2.6 How the Internet and digitally based compatibilities are affecting the five competitive forces and industry profitability. LO2.7 The concept of strategic groups and their strategy and performance implications. 2-3

4. Inputs to Forecasting 2-4 Exhibit 2.1

5. Environmental Scanning & Monitoring  External Scanning  surveillance of a firm’s external environment to predict environmental changes and detect changes already under way.  Alerts the firm to critical trends before changes have developed a discernible pattern and before competitors recognize them 2-5

6. Environmental Scanning & Monitoring  External Monitoring  A firm’s analysis of the external environment that tracks evolution of environmental trends, sequences of events, or streams of activities 2-6

7. How to Spot Hot Trends  Listen  Pay attention  Follow trends online  Go old school 2-7

8. How Zara Spots Opportunities  Zara’s designers, marketing managers, and buyers work side by side in an open office plan that fosters frequent discussions and promotes the sharing of real-time data as well as field observations and anecdotes  This allows them to break out of their silos and develop a holistic feel for the market, see how their work fits, and sense new opportunities as they arise. 2-8

9. Competitive Intelligence  Competitive intelligence  A firm’s activities of collecting and interpreting data on competitors, defining and understanding the industry, and identifying competitors’ strengths and weaknesses. 2-9

10. Environmental Forecasting  Environmental forecasting  The development of plausible projections about direction, scope, speed and intensity of environmental change 2-10

11. Environmental Forecasting  Scenario analysis  An in-depth approach to environmental forecasting that involves experts’ detailed assessments of societal trends, economics, politics, technology, or other dimensions of the external environment 2-11

12. QUESTION Which of the following is a danger of forecasting? A. Managers assume that the world is not open to precise predictions. B. Managers may view uncertainty as black and white and ignore grey areas. C. Managers assume that the world is uncertain. D. Managers view the world as completely unpredictable. 2-12

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 2-13

14. SWOT Analysis  SWOT analysis  A framework for analyzing a company’s internal and external environment and that stands for strengths, weaknesses, opportunities, and threats. 2-14

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 2-15

16. The General Environment  Demographic  Sociocultural  Legal/Political  Technological  Economic  Global 2-16 Factors external to an industry, usually beyond a firm’s control

17. Demographic Segment  Aging population  Rising or declining affluence  Changes in ethnic composition  Geographic distribution of population  Greater disparities in income levels 2-17

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 2-18

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) 2-19

20. Technological Segment  Genetic engineering  Emergence of Internet technology  Computer-aided design/computer-aided manufacturing systems (CAD/CAM)  Wireless communication  Nanotechnology 2-20

21. Economic Segment  Interest rates  Unemployment  Consumer Price index  Trends in GDP  Changes in stock market valuations 2-21

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) 2-22

23. The Competitive Environment  Competitive environment  factors that pertain to an industry and affect a firm’s strategies  Competitors, customers, and suppliers 2-23

24. Porter’s Five Forces Model of Industry Competition 2-24 Exhibit 2.7

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 2-25

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. 2-26

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 2-27

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 2-28

29. The Bargaining Power of Suppliers  Suppliers can exert power by threatening to raise prices or reduce the quality of purchased goods and services 2-29

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 2-30

31. 2-31 The Bargaining Power of Suppliers (cont.)  A supplier group will be powerful when  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

32. The Threat of Substitute Products and Services  The Threat of Substitute Products and Services  the threat of limiting the potential returns of an industry by placing a ceiling on the prices that firms in that industry can profitably charge without losing too many customers to substitute products. 2-32

33. The Intensity of Rivalry among Competitors in an Industry  Price competition  Advertising battles  Product introductions  Increased customer service or warranties 2-33

34. The Intensity of Rivalry among Competitors in an Industry  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 2-34 Interacting factors lead to intense rivalry

35. How the Internet and Digital Technologies Influences Industry 2-35 Exhibit 2.9

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 2-36

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. 2-37

38. The Value Net 2-38 Exhibit 2.10

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 2-39

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 2-40