1. The Honda Question (via Rumelt)  In 1977 my MBA final exam on Honda motorcycle case asked “Should Honda enter the global automobile business”?  Giveaway question. Anyone who said yes flunked. - Markets saturated; efficient competition existed globally; Honda had little or no experience in autos; Honda had no distribution system  In 1985, my wife drove a Honda

2. Analyzing the external environment MGMT 619 Prof. Sanjay Jain

3. Learning Objectives  Understand: Strategizing under different levels of uncertainty The five forces framework and how to use them to analyze industry profitability. Applicability of the framework

4. Traditional approaches to managing uncertainty  By applying a set of powerful analytic tools, executives can predict future accurately enough to allow them to choose a clear strategic direction  Discounted cash flow analysis Underlying assumption: likely outcomes identifiable  Binary approach World is open to precise predictions about the future or is completely unpredictable

5. Types of Uncertainty  Uncertainty Clear enough future Alternate futures Range of futures True ambiguity  Identify right tools of strategic analysis for different levels of uncertainty

6. Strategy under uncertainty Stances - Shape - Adapt - Reserve right to play Portfolio of actions - Big bets - No-regret moves - Options

7. Defining the General Environment Environmental TechnologicalPolitical/Legal Economic Sociocultural Demographic Global

8. Industry Analysis  Key tool: Porter’s “Five Forces” model identifies the potential profitability of an industry (attractiveness) specifies the forces that represent threats to the profitability of firms in the industry

9. Industry Boundaries  What is an industry? collection of firms whose products (or services) are perfect or near perfect substitutes  similarity of products/services is key  Importance of industry boundaries helps managers understand arena of competition  enables identification of competitors  helps managers identify key success factors  provides basis to evaluate firm goals

10. Industry Analysis: The Five Forces Model Risk of entry by potential competitors Risk of entry by potential competitors Rivalry Among Established Firms Rivalry Among Established Firms Threat of substitute products Threat of substitute products Bargaining power of suppliers Bargaining power of suppliers Bargaining power of buyers Bargaining power of buyers

11. Threat of Entry  Entry barriers reduce threat of entry protect incumbents from competition  Barriers to entry Product/service differentiation (Brand identity) Capital requirements Absolute cost advantages Economies of scale Government regulation Switching costs

12. Buyer Power  Buyer concentration / Buyers purchase in large quantities  Buyer accounts for large percentage of sellers’ total orders  Buyers can switch suppliers at low cost  Buyers can vertically integrate

13. Supplier Power  Suppliers’ product has few substitutes and is important to buyer  The buyers’ industry is not an important customer to the supplier’s  Suppliers can vertically integrate and compete with buyer  Buyers can’t vertically integrate backward and supply their own needs  Supplier concentration

14. Threat of Substitute Products Products with similar function(s) limit the prices firms can charge  Switching costs  Buyer inclination to substitute  Variety/quality of substitutes

15. Intensity of Rivalry  Numerous competitors  Industry is growing slowly (or contracting)  High fixed costs  Little product differentiation  Minimal customer switching costs  Significant exit barriers

16. Process of Industry Analysis  Define industry boundaries  Identify the participants  Highlight each of the five forces  Identify the factors that drive each force  Assess the strength of each force  Conclude: Assess industry profitability potential

17. Strategic implications of Industry Analysis  Decide whether to participate  Guide entry strategy  Locate profitable positions  Improve competitive strategy  Exploit industry change  Shape/define industry

18. Limitations of Five Forces Analysis  Static snapshot of industry attractiveness  Exogenous forces vs. endogenous change  Individual firm actions that change industry structure are not considered Example: role of innovation de- emphasized

19. Limitations of five forces analysis  Certain actors (government, complementers, etc) underemphasized Porter’s response - These are factors, not forces: can be incorporated into framework

20. Limitations of Five Forces Analysis  Assumes buyers, suppliers, competitors and substitute providers interact at arm’s length ignores role of cooperation and complementors  Assumes low-moderate uncertainty often difficult to accurately identify relevant actors, industry boundaries, and predict competitor behavior  Firm differences underestimated

21. Key points  External analysis is fundamental starting point for strategy development Opportunities and threats  Five forces framework is a useful tool to understand the competitive environment With some limitations  Environments evolve, often as a result of firms’ actions endogenous vs. exogenous influence

22. For next time  Read the Cola Wars case Prepare answers to discussion questions  Be prepared to discuss and debate!