External Environment

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External Environment

• 2nd Lecture
• MSc Agricultural Economics and Management

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Introduction

• All companies face competition.
• For resources, customers, sales revenues, and
  profits.
• All companies face uncertain industry
  environments.
• Managers must position the organizations
  strategically in order to compete successfully.
• This is what we call business definition.
• Requires that managers understand the dynamics of
  their firms markets before formulating
  strategies.

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Introduction (cont.)

• Rapidly growing markets (emerging industries)
  tend to be less competitive and often attract new
  entrants.
• Usually provide sufficient room in competitive
  space for making some mistakes.
• Mature, concentrated markets provide firms with
  very little breathing room.
• Mistakes by one firm can significantly impact
  entire industry.
• One firms price reductions can set off
  industry-wide price war.

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Purpose of External Analysis

• To understand the external environment as it
  affects the enterprise
• 3 levels of analysis
• General changes in business environment
• Changes within the industry
• Activities of competitors and other specifics

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Analysis Vs. Assessment

• Assessment is more than analysis
• Assessment focuses on testing decisions for
  validity in practice
• Analysis gives undue weight to what can be
  measured
• Assessment takes almost equal notice of
  quantitative and qualitative data
• Good assessment should give a balanced
  understanding of the context

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Selecting analytical tools

• Vast range of tools available
• Usually use several tools but choice is important
• Choice depends on
• Data available
• Nature of issues to be resolved
• Time and skills available

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External Environmental Analysis

• A continuous process which includes

• Scanning Identifying early signals of
  environmental changes and trends
• Monitoring Detecting meaning through ongoing
  observations of environmental changes and trends
• Forecasting Developing projections of
  anticipated outcomes based on monitored changes
  and trends
• Assessing Determining the timing and importance
  of environmental changes and trends for firms
  strategies and their management

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Steps in Environmental Analysis
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External Environmental Analysis
Analysis of general environment
Analysis of industry environment
Analysis of competitor environment
The External Environment
Strategic Intent Strategic Mission
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External Environment
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General Environment

• Dimensions in the broader society that influence
  and industry and the firms within it
• Economic
• Sociocultural
• Global
• Technological
• Political/legal
• Demographic

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General Environment (contd)

• The Economic Segment
• Inflation rates
• Interest rates
• Trade deficits or surpluses
• Budget deficits or surpluses
• Personal savings rate
• Business savings rates
• Gross domestic product

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General Environment (contd)

• The Sociocultural Segment
• Women in the workplace
• Workforce diversity
• Attitudes about quality of worklife
• Concerns about environment
• Shifts in work and career preferences
• Shifts in product and service preferences

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General Environment (contd)

• The Global Segment
• New global markets
• Changing existing markets
• Important international events
• Critical cultural and institutional
  characteristics of global markets

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General Environment (contd)

• The Technological Segment
• Product innovations
• Applications of knowledge
• Focus of private and government-supported RD
  expenditures
• New communication technologies

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General Environment (contd)

• The Political/Legal Segment
• Antitrust laws
• Taxation laws
• Deregulation philosophies
• Labor training laws
• Educational philosophies and policies

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General Environment

• The Demographic Segment
• Population size
• Age structure
• Geographic distribution
• Ethnic mix
• Income distribution

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Industry Environment

• Set of factors directly influencing a firm and
  its competitive actions and competitive responses
• Threat of new entrants
• Power of suppliers
• Power of buyers
• Threat of product substitutes
• Intensity of rivalry among competitors

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Porters Five Forces Model of Competition
Threat of New Entrants
Threat of New Entrants
Bargaining Power of Buyers
Bargaining Power of Suppliers
Rivalry Among Competing Firms in Industry
Threat of Substitute Products
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Five Forces Model of Competition

• Identify current and potential competitors and
  determine which firms serve them
• Conduct competitive analysis
• Recognize that suppliers and buyers can become
  competitors
• Recognize that producers of potential substitutes
  may become competitors

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Threat of New Entrants

• Barriers to entry

• Economies of scale
• Product differentiation
• Capital requirements
• Switching costs
• Access to distribution channels
• Cost disadvantages independent of scale
• Government policy
• Expected retaliation

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Bargaining Power of Suppliers

• A supplier group is powerful when

• it is dominated by a few large companies
• satisfactory substitute products are not
  available to industry firms
• industry firms are not a significant customer for
  the supplier group
• suppliers goods are critical to buyers
  marketplace success
• effectiveness of suppliers products has created
  high switching costs
• suppliers are a credible threat to integrate
  forward into the buyers industry

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Bargaining Power of Buyers

• Buyers (customers) are powerful when

• they purchase a large portion of an industrys
  total output
• the sales of the product being purchased account
  for a significant portion of the sellers annual
  revenues
• they could easily switch to another product
• the industrys products are undifferentiated or
  standardized, and buyers pose a credible threat
  if they were to integrate backward into the
  sellers industry

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Threat of Substitute Products

• Product substitutes are strong threat when

• customers face few switching costs
• substitute products price is lower
• substitute products quality and performance
  capabilities are equal to or greater than those
  of the competing product

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Intensity of Rivalry

• Intensity of rivalry is stronger when competitors

• are numerous or equally balanced
• experience slow industry growth
• have high fixed costs or high storage costs
• lack differentiation or low switching costs
• experience high strategic stakes
• have high exit barriers

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High Exit Barriers

• Common exit barriers include

• specialized assets (assets with values linked to
  a particular business or location)
• fixed costs of exit such as labor agreements
• strategic interrelationships (relationships of
  mutual dependence between one business and other
  parts of a companys operation, such as shared
  facilities and access to financial markets)
• emotional barriers (career concerns, loyalty to
  employees, etc.)
• government and social restrictions

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Effects of Entry Barriers and Exit Barriers on
Industry Profits
Exit Barriers
High
Low
Low
Entry Barriers
High
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Effects of Entry Barriers and Exit Barriers on
Industry Profits
Exit Barriers
High
Low
Low, Stable Returns
Low
Entry Barriers
High
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Effects of Entry Barriers and Exit Barriers on
Industry Profits
Exit Barriers
High
Low
Low, Stable Returns
Low
Entry Barriers
High, Stable Returns
High
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Effects of Entry Barriers and Exit Barriers on
Industry Profits
Exit Barriers
High
Low
Low, Risky Returns
Low, Stable Returns
Low
Entry Barriers
High, Stable Returns
High
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Effects of Entry Barriers and Exit Barriers on
Industry Profits
Exit Barriers
High
Low
Low, Stable Returns
Low, Risky Returns
Low
Entry Barriers
High, Risky Returns
High, Stable Returns
High
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Limitations of the Five Forces Model

• Attempt to minimize the impact of any of the
  forces that are acting to make the industry
  attractive.
• Make their industries more attractive by reducing
  the power of the five forces or
• Shield or protect their companies from the power
  of the forces.
• Certain action may lead to allegations of
  collusion or other unfair practices (Microsoft
  vs. Justice Department).

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Limitations of the Five Forces Model (cont.)

• Model provides snapshot of industry at that
  time, but fails to show how industry is changing.
• Most managers assume that conditions will remain
  relatively stable.

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The life cycle model
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Industry Analysis (EFE)

• External Factor Evaluation Matrix
• Summarize evaluate

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Industry Analysis (EFE)

• Five-Step process
• List key external factors (10-20)
• Opportunities threats
• Assign weight to each (0 to 1.0)
• Sum of all weights 1.0

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Industry Analysis (EFE)

• Assign 1-4 rating to each factor
• Firms current strategies response to the factor
• Multiply each factors weight by its rating
• Produces a weighted score
• Sum the weighted scores for each
• Determines the total weighted score for the
  organization.
• Highest possible weighted score for the
  organization is 4.0 the lowest, 1.0. Average
  2.5

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Industry Analysis (EFE)

• Total weighted score of 4.0
• Organization response is outstanding to threats
  weaknesses
• Total weighted score of 1.0
• Firms strategies not capitalizing on
  opportunities or avoiding threats

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Industry Analysis (EFE)

• The firm in the previous example, has a total
  weighted score of 2.10 indicating that the firm
  is below average in its effort to pursue
  strategies that capitalize on external
  opportunities and avoid threats.

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Industry Analysis (EFE)

• Important
• Understanding of the factors used in the EFE
  Matrix is more important than the actual weights
  and ratings assigned.

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Competitor Analysis
The follow-up to Industry Analysis is effective
analysis of a firms Competitors
Industry Environment
Competitive Environment
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Competitor Environment

• All of the companies that the firm competes
  against.

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Continuum of Types of Competition
PURE MONOPOLY
AVOIDED COMPETITION
HYPER- COMPETITION
PERFECT COMPETITION
Typically, one firm provides goods or services
that customer value
No, or very limited, direct competition
Low level of competition allows abnormally high
level of profits
Little competitive pressure to provide higher
levels of customer value
In free-market economies, government regulation
is usually developed to limit monopolistic
behaviour and encourage competition as a means
of improving value available to consumers
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Continuum of Types of Competition
PURE MONOPOLY
AVOIDED COMPETITION
HYPER- COMPETITION
PERFECT COMPETITION
Typically, a small number of players
Rivals work to segment market or otherwise
position around each other while avoiding
head-to-head competition
Where rivalssegments overlap, emphasis is placed
on tacit collusion to limit price wars or other
forms of severe competition
Barriers to entry are used to limit threat of new
entrants
Differentiation is used to limit threat of
substitutes and reduce customers power
Vertical integration is used to limit power of
suppliers and customers
To the extent competition is avoided,
above-normal level of profitability can be
sustained
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Continuum of Types of Competition
PURE MONOPOLY
AVOIDED COMPETITION
HYPER- COMPETITION
PERFECT COMPETITION
Typically, several players aggressively position
against each other
Emphasis is placed on either gaining an
advantage, negating a competitors advantage, or
both
Innovation is used to obsolete old goods and
services in search of the latest improved means
of providing customer value
Nature of competitive advantage is constantly
being redefined
Market leadership continually changes hands or
threatens to do so
Abnormally high profits are intermittent as
competitive advantages come and go
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Continuum of Types of Competition
PURE MONOPOLY
AVOIDED COMPETITION
HYPER- COMPETITION
PERFECT COMPETITION
Typically, many players, all more or less at
parity with one another in terms of quality,
cost, and/or speed
No one firm dominates the others
With parity on quality and speed, competition
often shifts to price and costs
Absence of competitive advantage limits
profitability
Customer has many comparable options to choose
between, but firms see limited profit potential
and seek to avoid this form of competition
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Summary of Factors Affecting the Approach Taken
to Rivalry
Tendency Toward Avoided Competition

• The Industrys Structure
• The Possibility for Implicit
• Collusion
• The Sustainability of
• Competitive Advantage
• The Stability of the
• Environment
• The Strategies Pursued

The Emphasis Observed in Any Particular Market
Tendency Toward Hypercompetition
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Strategic Groups

• Strategic group a group of firms in an industry
  following the same or similar strategy along the
  same strategic dimensions
• The strategy followed by a strategic group
  differs from strategies being implemented by
  other companies in the industry

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Strategic Group Analysis

• Strategic Group Analysis is useful to
• Identify firms with similar strategic
  characteristics
• Therefore identify the most direct competitors
• Identify mobility barriers
• Identify strategic opportunities (strategic
  spaces)
• Strategic threats and problems

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Strategic Groupsin the Personal Computer Industry
High
Compaq Hewlett-Packard IBM
Product Quality
Packard Bell AST Research Tandy
Fragmented Players
Exited from market, 1999
Low
Low
High
Customization and Speed of Delivery
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Trends in Strategic Groups

• Strategic groups can shift over time as market
  changes
• Entire strategic groups can emerge or disappear
  over time
• Industry consolidation alters strategic groups
• Distinctiveness enhances firms sustainable
  competitive advantage

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Competitor Environment

• Competitor intelligence is the ethical gathering
  of needed information and data about competitors
  objectives, strategies, assumptions, and
  capabilities

• What drives the competitor as shown by its future
  objectives
• What the competitor is doing and can do as
  revealed by its current strategy
• What the competitor believes about itself and the
  industry, as shown by its assumptions
• What the the competitor may be able to do, as
  shown by its capabilities

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Competitor Analysis

• Future Objectives

• How do our goals compare with our competitors
  goals?
• Where will the emphasis be placed in the future?
• What is the attitude toward risk?

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Competitor Analysis

• Current Strategy

• How are we currently competing?
• Does this strategy support changes in the
  competitive structure?

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Competitor Analysis

• Assumptions

• Do we assume the future will be volatile?
• Are we operating under a status quo?
• What assumptions do our competitors hold about
  the industry and themselves?

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Competitor Analysis

• Capabilities

• What are our strengths and weaknesses?
• How do we rate compared to our competitors?

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Competitor Analysis
Response

• What will our competitors do in the future?
• Where do we hold an advantage over our
  competitors?
• How will this change our relationship with our
  competitors?

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Industry Analysis (CPM)

• Competitive Profile Matrix
• Identifies firms major competitors and their
  strengths weaknesses in relation to a sample
  firms strategic position

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(CPM) Procter
Avon LOreal Gamble
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Summary of Managerial Practices to Adopt

• Make external analysis an important part of your
  strategy formulation process. Formulate your
  strategy in the light of a clear understanding of
  environmental forces most likely to impact your
  organization.
• In analyzing the general environment, consider
  each of its six major components demographic,
  socio-cultural, political/legal, technological,
  macroeconomic, and global
• Where appropriate, in analyzing the competitive
  environment, focus your analysis on a strategic
  group rather than an overall industry.

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Summary of Managerial Practices to Adopt

• Regardless of whether you are analyzing the
  entire industry or a more narrowly defined
  strategic group, do not fixate on a narrow
  definition of competition, but consider all five
  forces in the competitive environment new
  entrants, supplier and customer bargaining power,
  substitute products, and rivalry.
• Be aware of the different levels of rivalry and
  the factors that lead competitors to particular
  forms of rivalry and competition. In particular,
  be familiar with environmental forces associated
  with the most common forms of rivalry, avoided
  competition and hypercompetition.

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Summary of Managerial Practices to Adopt

• Instead of viewing your competitive environment
  in strictly competitive terms. use concepts from
  evolutionary economics to help identify
  opportunities to cooperate.
• In gathering the intelligence needed to analyze
  the environment, do not underestimate the power
  and usefulness of obvious sources of information.
• The implications of environmental developments
  will be most clear if information about the
  environment is organized into scenarios that
  paint a more meaningful picture of the
  environment than that obtained from studying the
  raw intelligence data alone.

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Summary of Managerial Practices to Adopt

• Appreciate the power of the environment and its
  ability to impact the success of any particular
  strategy. However, do not underestimate the
  ability of a well-developed strategy to shape a
  firm's environment.