1. McGraw-Hill/Irwin ©2009 The McGraw-Hill Companies, All Rights Reserved Chapter 3: Evaluating a Company’s External Environment Screen graphics created by: Jana F. Kuzmicki, Ph.D. Troy University

2. “Analysis is the critical starting point of strategic thinking.” Kenichi Ohmae Consultant and Author

3. “Things are always different – the art is figuring out which differences matter.” Laszlo Birinyi Investments Manager

4. 1-4 Chapter Learning Objectives 1. To gain command of the basic concepts and analytical tools widely used to diagnose a company’s industry and competitive conditions. 2. To become adept in recognizing the factors that cause competition in an industry to be fierce, more or less normal, or relatively weak. 3. To learn how to determine whether an industry’s outlook presents a company with sufficiently attractive opportunities for growth and profitability. 4. To understand why in-depth evaluation of specific industry and competitive conditions is a prerequisite to crafting a strategy well matched to a company’s situation.

5. 1-5 Chapter Roadmap The Strategically Relevant Components of a Company’s External Environment Thinking Strategically About a Company’s Industry and Competitive Environment  Question 1: What Are the Industry’s Dominant Economic Features?  Question 2: How Strong Are Competitive Forces?  Question 3: What Forces Are Driving Industry Change and What Impacts Will They Have?  Question 4: What Market Positions Do Rivals Occupy— Who Is Strongly Positioned and Who Is Not?  Question 5: What Strategic Moves Are Rivals Likely to Make Next?  Question 6: What Are the Key Factors for Future Competitive Success?  Question 7: Does the Outlook for the Industry Offer the Company a Good Opportunity to Earn Attractive Profits?

6. 1-6 Diagnosing a company’s situation has two facets  Assessing the company’s external or macro- environment  Industry and competitive conditions  Forces acting to reshape this environment  Assessing the company’s internal or micro-environment  Market position and competitiveness  Competencies, capabilities, resource strengths and weaknesses, and competitiveness Understanding the Factors that Determine a Company’s Situation

7. Figure 3.1: From Thinking Strategically About the Company’s Situation to Choosing a Strategy

8. Figure 3.2: The Components of a Company’s Macro-environment

9. 1-9 Thinking Strategically About a Company’s Macro-environment A company’s macro-environment includes all relevant factors and influences outside its boundaries Diagnosing a company’s external situation involves assessing strategically important factors that have a bearing on the decisions a company’s makes about its  Direction  Objectives  Strategy  Business model Requires that company managers scan the external environment to  Identify potentially important external developments  Assess their impact and influence  Adapt a company’s direction and strategy as needed

10. Key Questions Regarding the Industry and Competitive Environment What are the industry’s dominant economic traits? How strong are competitive forces? What forces are driving change in the industry? What market positions do rivals occupy? What moves will they make next? What are the key factors for competitive success? How attractive is the industry from a profit perspective?

11. 1-11 Market size and growth rate Number of rivals Scope of competitive rivalry Buyer needs and requirements Degree of product differentiation Product innovation Supply/demand conditions Pace of technological change Vertical integration Economies of scale Learning and experience curve effects Question 1: What are the Industry’s Dominant Economic Traits?

12. Table 3.1: What to Consider in Identifying an Industry’s Dominant Economic Features

13. 1-13 Learning/Experience Effects Learning/experience effects exist when a company’s unit costs decline as its cumulative production volume increases because of  Accumulating production know-how  Growing mastery of the technology The bigger the learning or experience curve effect, the bigger the cost advantage of the firm with the largest cumulative production volume

14. 1-14 Question 2: How Strong Are Competitive Forces? Objectives are to identify  Main sources of competitive forces  Strength of these forces Key analytical tool  Five Forces Model of Competition

15. Figure 3.3: The Five Forces Model of Competition

16. 1-16 Analyzing the Five Competitive Forces: How to Do It Step 1: Identify the specific competitive pressures associated with each of the five forces Step 2: Evaluate the strength of each competitive force – fierce, strong, moderate to normal, or weak? Step 3: Determine whether the collective strength of the five competitive forces is conducive to earning attractive profits

17. 1-17 Usually the strongest of the five forces Key factor in determining strength of rivalry  How aggressively are rivals using various weapons of competition to improve their market positions and performance? Competitive rivalry is a combative contest involving  Offensive actions  Defensive countermoves Competitive Pressures Among Rival Sellers

18. Figure 3.4: Weapons for Competing and Factors Affecting Strength of Rivalry

19. What Are the Typical Weapons for Competing? Lower prices More or different performance features Better product performance Higher quality Stronger brand image and appeal Wider selection of models and styles Bigger/better dealer network Low interest rate financing Better or more ads Stronger product innovation capabilities Better customer service Stronger capabilities to provide buyers with custom-made products

20. 1-20 Competitors are active in making fresh moves to improve market standing and business performance Slow market growth Number of rivals increases and rivals are ofequal size and competitive capability Buyer costs to switch brands are low Industry conditions tempt rivals to use price cuts or other competitive weapons to boost volume A successful strategic move carries a big payoff Diversity of rivals increases in terms of visions, objectives, strategies, resources, and countries of origin Outsiders acquire weak firms in the industry and use their resources to transform new firms into major market contenders What Causes Rivalry to be Stronger?

21. 1-21 Industry rivals move only infrequently or in a non-aggressive manner to draw sales from rivals Rapid market growth Products of rivals are strongly differentiated and customer loyalty is high Buyer costs to switch brands are high There are fewer than 5 rivals or there are numerous rivals so any one firm’s actions has minimal impact on rivals’ business What Causes Rivalry to be Weaker?

22. 1-22 Test Your Knowledge The rivalry among competing sellers in an industry intensifies A. when buyer demand for the product is growing rapidly. B. when customers are brand loyal and their costs to switch to competing brands or substitute products are relatively high. C. when buyer demand is strong and sellers have little or no excess capacity and only minimal inventories. D. as the number of rivals increases and as they become more equal in size and competitive capability. E. when the products of rival sellers are highly differentiated products and the industry consists of so many rivals that any one company’s actions have little direct impact on rivals’ business.

23. 1-23 Seriousness of threat depends on  Size of pool of entry candidates and available resources  Barriers to entry  Reaction of existing firms Evaluating threat of entry involves assessing  How formidable entry barriers are for each type of potential entrant and  Attractiveness of growth and profit prospects Competitive Pressures Associated With Potential Entry

24. Figure 3.5: Factors Affecting Threat of Entry

25. 1-25 Sizable economies of scale Cost and resource disadvantages independent of size Brand preferences and customer loyalty Capital requirements and/or other specialized resource requirements Access to distribution channels Regulatory policies Tariffs and international trade restrictions Ability of industry incumbents to launch vigorous initiatives to block a newcomer’s entry Common Barriers to Entry

26. 1-26 There’s a sizable pool of entry candidates Entry barriers are low Industry growth is rapid and profit potential is high Incumbents are unwilling or unable to contest a newcomer’s entry efforts When existing industry members have a strong incentive to expand into new geographic areas or new product segments where they currently do not have a market presence When Is the Threat of Entry Stronger?

27. 1-27 There’s only a small pool of entry candidates Entry barriers are high Existing competitors are struggling to earn good profits Industry’s outlook is risky Industry growth is slow or stagnant Industry members will strongly contest efforts of new entrants to gain a market foothold When Is the Threat of Entry Weaker?

28. 1-28 Competitive Pressures from Substitute Products Substitutes matter when customers are attracted to the products of firms in other industries  Sugar vs. artificial sweeteners  Eyeglasses and contact lens vs. laser surgery  Newspapers vs. TV vs. Internet Concept Examples

29. 1-29 How to Tell Whether Substitute Products Are a Strong Force Whether substitutes are readily available and attractively priced Whether buyers view substitutes as being comparable or better How much it costs end users to switch to substitutes

30. Figure 3.6: Factors Affecting Competition From Substitute Products

31. 1-31 There are many good substitutes readily available Substitutes are attractively priced The higher the quality and performance of substitutes The lower the end user’s switching costs End users grow more comfortable with using substitutes When Is the Competition From Substitutes Stronger?

32. 1-32 Good substitutes are not readily available or do not exist Substitutes are higher priced relative to performance they deliver End users incur high costs in switching to substitutes When Is the Competition From Substitutes Weaker?

33. 1-33 Whether supplier-seller relationships represent a weak or strong competitive force depends on  Whether suppliers can exercise sufficient bargaining leverage to influence terms of supply in their favor  Nature and extent of supplier-seller collaboration in the industry Competitive Pressures From Suppliers and Supplier-Seller Collaboration

34. Figure 3.7: Factors Affecting Bargaining Power of Suppliers

35. 1-35 Industry members incur high costs in switching their purchases to alternative suppliers Needed inputs are in short supply Supplier provides a differentiated input that enhances the quality of performance of sellers’ products or is a valuable part of sellers’ production process There are only a few suppliers of a specific input Some suppliers threaten to integrate forward When Is the Bargaining Power of Suppliers Stronger?

36. 1-36 Item being supplied is a commodity Seller switching costs to alternative suppliers are low Good substitutes exist or new ones emerge Surge in availability of supplies occurs Industry members account for a big fraction of suppliers’ total sales Industry members threaten to integrate backward Seller collaboration with selected suppliers provides attractive win-win opportunities When Is the Bargaining Power of Suppliers Weaker?

37. 1-37 Industry members often forge strategic partnerships with select suppliers to  Reduce inventory and logistics costs  Speed availability of next-generation components  Enhance quality of parts being supplied  Squeeze out cost savings for both parties Competitive advantage potential may accrue to those industry members (sellers) doing the best job of managing supply-chain relationships Competitive Pressures: Collaboration Between Sellers and Suppliers

38. 1-38 Whether the relationships between industry members and buyers represent a weak or strong competitive force depends on  Whether buyers have sufficient bargaining leverage to influence terms of sale in their favor  Extent and competitive importance of strategic partnerships between certain industry members and the buyers Competitive Pressures From Buyers and Seller-Buyer Collaboration

39. Figure 3.8: Factors Affecting Bargaining Power of Buyers

40. 1-40 Buyer switching costs to competing brands or substitutes are low Buyers are large and can demand concessions Large-volume purchases by buyers are important to sellers Buyer demand is weak or declining Only a few buyers exists Identity of buyer adds prestige to seller’s list of customers Quantity and quality of information available to buyers improves Buyers have ability to postpone purchases until later Buyers threaten to integrate backward When Is the Bargaining Power of Buyers Stronger?

41. 1-41 Buyers purchase item infrequently or in small quantities Buyer switching costs to competing brands are high Surge in buyer demand creates a “sellers’ market” Seller’s brand reputation is important to buyer A specific seller’s product delivers quality or performance that is very important to buyer Buyer collaboration with selected sellers provides attractive win-win opportunities When Is the Bargaining Power of Buyers Weaker?

42. 1-42 Partnerships between industry members and some/many of their customers can impact competitive pressures Collaboration may result in mutual benefits regarding  Just-in-time deliveries  Order processing  Electronic invoice payments  Data sharing Competitive advantage may accrue to those industry members doing the best job of partnering with their customers Competitive Pressures: Collaboration Between Sellers and Buyers

43. 1-43 For Discussion: Your Opinion Explain why low switching costs and weakly differentiated products tend to give buyers a high degree of bargaining power.

44. 1-44 Competitive environment is unattractive from the standpoint of earning good profits when  Rivalry is vigorous  Entry barriers are low and entry is likely  Competition from substitutes is strong  Suppliers and customers have considerable bargaining power Strategic Implications of the Five Competitive Forces

45. 1-45 Competitive environment is ideal from a profit-making standpoint when  Rivalry is moderate  Entry barriers are high and no firm is likely to enter  Good substitutes do not exist  Suppliers and customers are in a weak bargaining position Strategic Implications of the Five Competitive Forces

46. 1-46 Objective is to craft a strategy to  Insulate firm from competitive pressures  Initiate actions to produce sustainable competitive advantage  Allow firm to be the industry’s “mover and shaker” with the “most powerful” strategy that defines the business model for the industry Coping With the Five Competitive Forces

47. 1-47 Question 3: What Forces Are Driving Industry Change and What Impacts Will They Have? Industries change because forces are driving industry participants to alter their actions Driving forces are the major underlying causes of changing industry and competitive conditions Where do driving forces originate?  Outer ring of macroenvironment  Inner ring of macroenvironment

48. 1-48 STEP 1: Identify forces likely to exert greatest influence over next 1 - 3 years  Usually no more than 3 - 4 factors qualify as real drivers of change STEP 2: Assess impact  Are driving forces acting to cause market demand for product to increase or decrease?  Are driving forces acting to make competition more or less intense?  Will driving forces lead to higher or lower industry profitability? STEP 3: Determine what strategy changes are needed to prepare for impacts of driving forces Analyzing Driving Forces: Three Key Steps

49. 1-49 Changes in long-term industry growth rate Increasing globalization of industry Emerging new Internet capabilities and applications Changes in who buys the product and how they use it Product innovation Technological change/process innovation Marketing innovation Common Types of Driving Forces

50. 1-50 Entry or exit of major firms Diffusion of technical knowledge Changes in cost and efficiency Consumer preferences shift from standardized to differentiated products (or vice versa) Changes in degree of uncertainty and risk Regulatory policies / government legislation Changing societal concerns, attitudes, and lifestyles Common Types of Driving Forces (con’t)

51. Table 3.2: The Most Common Driving Forces

52. 1-52 Question 4: What Market Positions Do Rivals Occupy? One technique to reveal different competitive positions of industry rivals is strategic group mapping A strategic group is a cluster of firms in an industry with similar competitive approaches and market positions

53. 1-53 Firms in same strategic group have two or more competitive characteristics in common  Have comparable product line breadth  Sell in same price/quality range  Emphasize same distribution channels  Use same product attributes to appeal to similar types of buyers  Use identical technological approaches  Offer buyers similar services  Cover same geographic areas Strategic Group Mapping

54. 1-54 STEP 1: Identify competitive characteristics that differentiate firms in an industry from one another STEP 2: Plot firms on a two-variable map using pairs of these differentiating characteristics STEP 3: Assign firms that fall in about the same strategy space to same strategic group STEP 4: Draw circles around each group, making circles proportional to size of group’s respective share of total industry sales Procedure for Constructing a Strategic Group Map

55. Example: Strategic Group Map of Selected Automobile Manufacturers

56. 1-56 Variables selected as axes should not be highly correlated Variables chosen as axes should expose big differences in how rivals compete Variables do not have to be either quantitative or continuous Drawing sizes of circles proportional to combined sales of firms in each strategic group allows map to reflect relative sizes of each strategic group If more than two good competitive variables can be used, several maps can be drawn Guidelines: Strategic Group Maps

57. 1-57 Interpreting Strategic Group Maps The closer strategic groups are on the map, the stronger the cross-group competitive rivalry tends to be Not all positions on the map are equally attractive  Driving forces and competitive pressures often favor some strategic groups and hurt others  Profit potential of different strategic groups varies due to strengths and weaknesses in each group’s market position

58. 1-58 Test Your Knowledge A strategic group map is a helpful analytical tool for A. assessing why competitive pressures and driving forces usually impact the biggest strategic groups more so than the smaller groups. B. determining which companies have how big a competitive advantage and how good their prospects are for increasing their market shares. C. determining which company is the most profitable in the industry and why it is doing so well. D. determining who competes most closely with whom; evaluating whether industry driving forces and competitive pressures favor some strategic groups and hurt others; and ascertaining whether the profit potential of different strategic groups varies due to the strengths and weaknesses in each group’s respective market positions. E. pinpointing which of the five competitive forces is the strongest and which is the weakest.

59. 1-59 A firm’s best strategic moves are affected by  Current strategies of competitors  Future actions of competitors Profiling key rivals involves gathering competitive intelligence about  Current strategies  Most recent actions and public announcements  Resource strengths and weaknesses  Efforts being made to improve their situation  Thinking and leadership styles of top executives Question 5: What Strategic Moves Are Rivals Likely to Make Next?

60. 1-60 Sizing up strategies and competitive strengths and weaknesses of rivals involves assessing  Which rival has the best strategy? Which rivals appear to have weak strategies?  Which firms are poised to gain market share, and which ones seen destined to lose ground?  Which rivals are likely to rank among the industry leaders five years from now? Do any up-and-coming rivals have strategies and the resources to overtake the current industry leader? Competitor Analysis

61. 1-61 Which rivals need to increase their unit sales and market share? What strategies are rivals most likely to pursue? Which rivals have a strong incentive, along with resources, to make major strategic changes? Which rivals are good candidates to be acquired? Which rivals have the resources to acquire others? Which rivals are likely to enter new geographic markets? Which rivals are likely to expand their product offerings and enter new product segments? Things to Consider in Predicting Moves of Rivals

62. 1-62 For Discussion: Your Opinion Why does a company need to bother with studying competitors and trying to predict what moves rivals will make next? Why can’t it just choose whatever strategy it wants or make whatever moves in the marketplace it wishes without first worrying about what rivals are going to do?

63. 1-63 Key Success Factors (KSFs) are competitive factors and attributes that affect every industry member’s ability to be competitively and financially successful KSFs are those particular attributes that are so important that they spell the difference between  Profit and loss  Competitive success or failure KSFs can relate to  Specific strategy elements  Product attributes  Resources  Competencies  Competitive capabilities  Market achievements Question 6: What Are the Key Factors for Competitive Success?

64. 1-64 The answers to 3 questions often help pinpoint an industry’s KSFs  On what basis do customers choose between competing brands of sellers?  What resources and competitive capabilities does a company need to have to be competitively successful?  What shortcomings are likely to place a company at a significant competitive disadvantage? Rarely are there more than 5 - 6 factors that are truly key to the future financial and competitive success of industry members Identifying Industry Key Success Factors

65. Table 3.3: Common Types of Industry Key Success Factors

66. 1-66 Access to distribution – to get a company’s brand stocked and favorably displayed in retail outlets Image – to induce consumers to buy a particular company’s product (brand name and attractiveness of packaging are key deciding factors) Low-cost production capabilities – to keep selling prices competitive Sufficient sales volume – to achieve scale economies in marketing expenditures Example: KSFs for Bottled Water Industry

67. 1-67 Example: KSFs for Ready-to-Wear Apparel Industry Appealing designs and color combinations – to create buyer appeal Low-cost manufacturing efficiency – to keep selling prices competitive Strong network of retailers/company- owned stores – to allow stores to keep best-selling items in stock Clever advertising – to effectively convey a specific image to induce consumers to purchase a particular label

68. 1-68 Involves assessing whether the industry and competitive environment presents a company with an attractive or unattractive opportunity for earning good profits Factors to consider:  Industry growth potential  Whether competitive forces are growing stronger/weaker  Whether driving forces will favorable/unfavorably impact industry profitability  Degree of risk and uncertainty in industry’s future  Whether the industry confronts severe problems  Firm’s competitive position in industry vis-à-vis rivals  Firm’s potential to capitalize on industry opportunities or the vulnerabilities of weaker rivals  Whether a firm has sufficient competitive strength to defend against unattractive industry factors Question 7: Does the Outlook for the Industry Offer an Attractive Opportunity?

69. 1-69 Factors to Consider in Assessing Industry Attractiveness As a general proposition  If an industry’s overall profit prospects are above average, the industry environment is basically attractive  If an industry’s overall profit prospects are below average, the industry environment is basically unattractive However  Attractiveness is relative, not absolute  Conclusions about attractiveness have to be drawn from the perspective of a particular company

70. 1-70 An industry is unlikely to be equally attractive or unattractive to all industry members  Industry environments attractive to strong competitors may be unattractive to weak competitors  A favorably positioned company may survey an industry environment and see opportunities that weak competitors have little or no ability to capture  Industry environments attractive to insiders may be unattractive to potential entrants  Under certain circumstances, a firm uniquely well- situated in an otherwise unattractive industry can still earn good profits by taking sales and market share away from weaker competitors Factors to Consider in Assessing Industry Attractiveness

71. Core Concept: Assessing Industry Attractiveness The degree to which an industry is attractive or unattractive is not the same for all industry participants or potential entrants. The opportunities an industry presents depend partly on a company’s ability to capture them.

72. 1-72 Test Your Knowledge Which of the following is not an important factor for company managers to consider in drawing conclusions about whether the industry presents an attractive opportunity? A. Whether powerful competitive forces are squeezing industry profitability to subpar levels and whether competition appears destined to grow stronger or weaker B. The industry’s growth potential and the degree of uncertainty and risk in the industry’s future C. Whether industry profitability will be affected favorably or unfavorably by the prevailing driving forces D. How many of the industry’s key success factors do companies in the industry typically incorporate into their strategies E. The company’s ability to capitalize on the vulnerabilities of weakly positioned rivals and whether the company has sufficient competitive strength to defend against or counteract the factors that make the industry unattractive