Chapter 4 Exploring the External Environment: Macro and Industry Dynamics

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Chapter 4Exploring the External Environment
Macro and Industry Dynamics
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OBJECTIVES
Explain the importance of the external context
for strategy and firm performance

1
Use PESTEL to identify the macro characteristics
of the external context
2
Identify the major features of an industry and
the forces that affect industry profitability
3
Understand the dynamic characteristics of the
external context
4
Show how industry dynamics may redefine industries
5
Use scenario planning to predict the future
structure of the external context
6
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THE COLA WARS
Coca-Cola sells a billion servings in cans,
bottles, and glasses every day. You can grab a
Coke in almost 200 countries. Its archrival,
Pepsi, isnt too far behind. Like Ford versus
Chevy, theirs is a battle not just for customer
dollars, but for their hearts and minds as well.
The History Channel, Empires of industry. Cola
Wars
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THE COLA WARS (TIMELINE)
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EXTERNAL CONTEXT OF STRATEGY
External environment

• 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

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COMPARATIVE INDUSTRY WIDE LEVEL OF
PROFITABILITY, 1995 2004
Weighted average return on invested
capital Percent
Bever-ages
Ciga-rettes
Pharma-ceuticals
Eatingesta-blish-ments
Steel
Rail-roads
Truck-ing
Bott-lers
Comp-uters
Agri-cul-turalproducts
Pre-packagedsoftware
Air-lines
Wire-lesspro-viders
Source Data from Standard and Poors CompuStat
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THE EXTERNAL ENVIRONMENT OF THE ORGANIZATION
Macro Environment Political, Economic,
Sociocultural, Technological, Environmental,
Legal
Industry Environment
Strategic Group
The Organization
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KEY QUESTION TO ASK
What macro environmental conditions will have a
material effect on our ability to implement our
strategy successfully?
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UNDERSTANDING THE MACRO ENVIRONMENT USING A
PESTEL ANALYSIS

• How stable is the political environment?
• Tax policies
• Etc.

Political

• Projected interest rates?
• Inflation?
• Etc.

Economic

• Lifestyle trends?
• Demographic changes?
• Etc.

Socio-cultural

• Level of government research funding?
• How mature is technology?
• Etc.

Technological

• Is intellectual property protected?
• Relevant consumer laws?
• Etc.

Legal
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PRESSURES FAVORING INDUSTRY GLOBALIZATION
Competition
Markets
Governments
Costs

• Interdependent countries

• Homogeneous customer needs

• Favorable trade policies

• Large scale and scope economies

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
311 (1989), 29-40
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COMPETITION DRIVES PROFITS TO A NORMAL LEVEL
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KEY SUCCESS FACTORS AS BARRIERS TO ENTRY
SOFT DRINK EXAMPLE
Key success factor (KSF)
KSFs
Key asset or requisite skill that all firms in an
industry must possess in order to be a viable
competitor

• Ability to meet competitive pricing
• Extensive distribution
• Ability to raise consumer awareness
• Broad product mix
• Global presence
• Well positioned bottlers and bottling capacity

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INDUSTRY FRAGMENTATION AND CONCENTRATION
Monopoly
Duopoly
Fragmented
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CONCENTRATION IN SELECT U.S. INDUSTRIES
Others
Percent of market
Top four competitors
Entirefoodindustry
Animal food
Break-fastcereal
Dairy pro-ducts
Entireapparel industry
Mens and boys apparel
Womens and girls apparel
Source U.S. Census Bureau, Economic Census
Concentration Rations, Economic Census 2002
(accessed July 15,2005),www.census.gov/epcd/www/co
ncentration.html
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ANALYZING INDUSTRY STRUCTURE USING FIVE FORCES

• 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

• Buyer Power (Channel and End consumer)
• Bargaining leverage
• Buyer volume
• Buyer information
• Brand identity
• Price sensitivity
• Threat of backward integration
• Product differentiation
• Buyer concentration vs. industry
• Substitutes available
• Buyers incentives

• 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

• 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)
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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

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RIVALRY

• Exit barriers
• Industry concentration
• Fixed costs/value added
• Industry growth
• Intermittent overcapacity
• Product differences
• Switching costs
• Brand identity
• Diversity of rivals
• Corporate stakes

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SUBSTITUTES

• Switching costs
• Buyer inclination to substitute
• Price-performance tradeoff of substitutes
• Varity of substitutes
• Necessity of product or service

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BUYER POWER (Channel and End consumer)

• Bargaining leverage
• Buyer volume
• Buyer information
• Brand identity
• Price sensitivity
• Threat of backward integration
• Product differentiation
• Buyer concentration vs. industry
• Substitutes available
• Buyers incentives

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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

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IMPACT OF COMPLEMENTOR
Complementor
Any factor that makes it more attractive for
suppliers to supply an industry on favorable
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

• Number of complements
• Relative value added
• Barriers to complement entry
• Difficulty of engaging complements
• Buyer perception of complements
• Complement exclusivity

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MAPPING STRATEGY GROUPS U.S. BICYCLE INDUSTRY
High
Cannondale, GaryFisher, Klein
Huffy,Murray,Brunswick
Price/quality/image
Schwinn/GTMongoose
TrekSpecialized
Low
Independentdealers
Independentdealers and massmerchandisers
Massmerchandisersonly
Principal distribution channels
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HOW WOULD YOU DO THAT? U.S. AIRLINE INDUSTRY
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IMPORTANCE OF DYNAMIC STRATEGIC ANALYSIS
Pineapple industrypre-1980s
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INDUSTRY LIFE CYCLE
Market Size
Time
Embryonic
Growing
Mature
In Decline
Source Adapted from K. Rangan and G. Bowman,
Beating the Commodity Magnet, Industrial
Marketing Management 21 (1992), 215-224 P.
Kotler, Managing Products through their Product
Life Cycle, in Marketing Management Planning,
Implementation, and Control, 7th ed (Upper
Saddle River, NJ Prentice Hall, 1991)
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TECHNOLOGICAL DISCONTINUITIES
Example
In disk-drive industry, virtually every new
generation of technology led to demise of market
leader
Southwest airlines radically changed the airline
business model by adopting new processes (e.g., a
point-to-point model)
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WHEN INDUSTRIES DIVIDE OR COLLIDE
Industries Collide
Industries Divide
3-Com
Modems
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SCENARIO PLANNING
An understanding of the big picture and a plan to
manage uncertainty
Assess the strategic implications of each
scenario
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Specify indicators that can signal which scenario
is unfolding
5
Flesh out the picture
4
Develop the framework by defining two specific
axes
3
Brainstorm key drivers, decision factors, and
possible scenario departure or divergence points
2
1
Define target issue, time frame, and scope for
scenarios
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HOW WOULD YOU DO THAT? CREDIT UNION INDUSTRY
Changes in the playing field
Minor
Major
Gradual
Technological Change
Radical
Source Adapted from Credit Union Society, 2005
Scenarios for Credit Unions, an Executive Report
(Madison, WI Credit Union Executives Society,
1999)
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SUMMARY
Explain the importance of the external context
for strategy and firm performance

1
Use PESTEL to identify the macro characteristics
of the external context
2
Identify the major features of an industry and
the forces that affect industry profitability
3
Understand the dynamic characteristics of the
external context
4
Show how industry dynamics may redefine industries
5
Use scenario planning to predict the future
structure of the external context
6
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GROUP ACTIVITIES

• 1. Perform a five forces analysis for an industry
  with which you are familiar. Identify any
  strategic groups. Examine how the forces in the
  industry might evolve over time in response to
  strategies, events, and PESTEL trends.
• 2. Undertake a simple scenario analysis for your
  industry utilizing 2 or more possible futures.