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Chapter 2 The External Environment
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Knowledge Objectives

• Studying this chapter should provide you with the
  strategic management knowledge needed to
• Explain the importance of analyzing and
  understanding the firms external environment.
• Define and describe the general environment and
  the industry environment.
• Name and describe the general environments six
  segments.

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Knowledge Objectives contd

• Studying this chapter should provide you with the
  strategic management knowledge needed to
• Identify the five competitive forces and explain
  how they determine an industrys profit
  potential.
• Describe what firms need to know about their
  competitors and different methods used to collect
  intelligence about them.

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The Strategic Management Process

Strategy Implementation
Chapter 10CorporateGovernance
Chapter 11OrganizationalStructure andControls
Chapter 13StrategicEntrepreneurship
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Detroits Bet on the Future
Sources Chrysler falters as unsold gas guzzlers
fill lots, The Wall Street Journal, September
20, 2006 A14.
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Whats next?
Most of us never recognize an opportunity until
it goes to work in our competitors
business. P. L. Andarr
Only the paranoid survive. Andy
Grove, former CEO of Intel
Thats not true. The paranoid die because the
paranoid take all threats as serious and get very
distracted. Reed Hastings, CEO of Netflix
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Famous Misinterpretations

• Heavier-than-air flying machines are impossible
• Lord Kelvin, British mathematician, physicist,
  and president of the British Royal Society,
  1895
• Any customer can have a car painted any color
  that he wants so long as it is black. Attributed
  to Henry Ford
• I think there is a world market for about five
  computers Thomas J. Watson, chairman of IBM,
  1943
• We dont like their sound. Groups of guitars are
  on the way out. Decca Recording Co. executive,
  turning down the Beatles, 1962
• 640K of memory should be enough for
  anybody. Bill Gates, co-founder of Microsoft,
  1982
• They couldnt hit an elephant at this
  dist General John B. Sedgwick, last words,
  Battle of Spotsylvania, 1864

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Agenda

1. Analysis of the external environment
2. Five Forces of competition model
3. Competitor analysis

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I/O Model 4 Assumptions

• External environment imposes pressures and
  constraints that determine strategies leading to
  above-average returns

Most firms competing in an industry control
similar strategically relevant resources and
pursue similar strategies
Resources used to implement strategies are highly
mobile across firms
Organizational decision makers are assumed to be
rational and committed to acting in the firms
best interests (profit-maximizing)
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The External Environment
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External Environment Analysis

• General environment
• Focused on opportunities and threats
• Industry environment
• Focused on factors and conditions influencing a
  firms profitability within an industry
• Competitor environment
• Focused on predicting the dynamics of
  competitors actions, responses, and intentions

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General Environment

• Dimensions in the broader society that influence
  and industry and the firms within it

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General Environment

• The Economic Segment
• Nature and direction of economy a firm competes
  in
• Inflation rates
• Interest rates
• Trade deficits or surpluses
• Budget deficits or surpluses
• Savings rate
• GDP

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General Environment contd

• The Sociocultural Segment
• Societys attitudes and cultural values
• Women in the workplace
• Workforce diversity
• Attitudes about quality of worklife
• Environmental concerns
• Shifts in work and career preferences
• Shifts in product and service preferences

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General Environment contd
Source Business Week, March, 2007 4.
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General Environment contd

• The Global Segment
• Institutional characteristics of global markets
• Important political events
• Critical global markets
• Newly industrialized countries
• Different cultural and institutional attributes
• WTO, NAFTA, EU, ASEAN

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General Environment contd

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

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General Environment contd

• Examples for disruptive technologies
• Internet telephony
• Digital photography
• Hand-held computers
• Discount brokers
• E-commerce
• Health maintenance
• Nanotechnology

Link Future vision of Vodafone
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General Environment contd

• The Political/Legal Segment
• Regulatory environment
• Antitrust laws
• Taxation laws
• Deregulation philosophies
• Labor training laws
• Educational philosophies and policies
• Legislation on corporate governance reforms
  (Sarbanes-Oxley Act)

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General Environment contd

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

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General Environment contd
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Agenda

1. Analysis of the external environment
2. Five Forces of competition model
3. Competitor analysis

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Industry Environment

• Industry defined
• A group of firms producing products that are
  close substitutes
• Firms that influence one another
• Includes a rich mix of competitive strategies
  that companies use in pursuing strategic
  competitiveness and above-average returns

Sometimes, drawing the industry boundary is
problematic (e.g., Whole Foods Wild Oats)
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Five Forces of Competition
explain industry profitability!
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Interpreting Industry Analyses
Low entry barriers
Suppliers and buyers have strong positions
Strong threats from substitute products
Low profit potential!
Intense rivalry among competitors
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Interpreting Industry Analyses
High entry barriers
Suppliers and buyers have weak positions
Few threats from substitute products
High profit potential!
Moderate rivalry among competitors
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Barriers to Entry contd

• Economies of Scale
• Marginal improvements in efficiency that a firm
  experiences as it incrementally increases its
  size
• Advantages and disadvantages of large-scale and
  small-scale entry
• Cost Disadvantages Independent of Scale
• Proprietary product technology
• Favorable access to raw materials
• Desirable locations

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Barriers to Entry contd

• Access to Distribution Channels
• Stocking or shelf space
• Price breaks
• Cooperative advertising allowances

• Product Differentiation
• Unique products
• Customer loyalty
• Products at competitive prices

• Capital Requirements
• Physical facilities
• Inventories
• Marketing activities
• Availability of capital

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Barriers to Entry contd

• Switching Costs
• One-time costs customers incur when they buy from
  a different supplier
• New equipment
• Retraining employees
• Psychic costs of ending a relationship
• Government policy
• Licensing and permit requirements
• Deregulation of industries

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Barriers to Entry contd

• Expected retaliation
• Responses by existing competitors may depend on a
  firms present stake in the industry (available
  business options)

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Suppliers Bargaining Power

• Supplier power increases when
• Suppliers are large and few in number
• Suitable substitute products arenot available
• Individual buyers are not largecustomers of
  suppliers and thereare many of them
• Suppliers goods are critical to buyers
  marketplace success
• Suppliers products create high switching costs.
• Suppliers pose threat to integrate forward into
  buyers industry

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Buyers Bargaining Power

• Buyer power increase when
• Buyers are large and few in number
• Buyers purchase large portion of industrys
  total output
• Buyers purchases are significant portion
  of suppliers annual revenues
• Buyers can switch to another product without
  incurring high switching costs
• Buyers pose threat to integrate backward into
  sellers industry

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Threat of Substitute Products

• The threat of substitute products increases when
• Buyers face few switching costs
• The substitute products price is lower
• Substitute products quality andperformance are
  equal to or greaterthan existing product
• Differentiated industry products that are valued
  by customers reduce this threat

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Rivalry Among Competitors

• Industry rivalry increases when
• There are numerous or equally balanced
  competitors
• Industry growth slows or declines
• There are high fixed costs or high storage
  costs
• There is a lack of differentiationopportunities
  or low switching costs
• Strategic stakes are high
• High exit barriers prevent competitors from
  leaving the industry

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New Trends The Internet Influence
Sources Canzer, B. (2003). E-business
Strategic thinking and practice, Boston
Houghton Mifflin Porter, M. E. (2001). Strategy
and the Internet, Harvard Business Review,
March 6378 Rangan, S. Adner, R. (2001).
Profits and the Internet Seven misconceptions,
MIT Sloan Management Review, Summer 4453.
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New Trends Industry Boundaries

• Think about the nature of the following
  industries
• Telecommunications
• Computers and peripheral equipment
• Consumer electronics
• In other words, ABCs competitors may no longer
  only include CBS, NBC, CNN, and Fox, but also
  ATT, SkyTV, Microsoft, Apple, Sony, and others!

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Agenda

1. Analysis of the external environment
2. Five Forces of competition model
3. Competitor analysis

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Competitor Analysis

• Competitor Intelligence
• The ethical gathering of needed information and
  data that provides insight into
• A competitors capabilities and intentions
  (current strategy)
• A competitors beliefs about the industry (its
  assumptions)
• A competitors direction (future objectives)

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Competitor Analysis Components