Evaluating a Firm

1
Evaluating a Firms External Environment

• Chapter 2

2
Objectives

• Understand the import role that the competitive
  environment plays on firms
• Gain an understanding of Porters Five Forces and
  how the tool is applied as part of an industry
  analysis.
• Have fun learning!

3
Questions

1. Name some of the participants in a external
   environment.
2. Name the external forces that managers must be
   aware of.
3. What are the names Porters Forces (Hint There
   are 5)?

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Why External Analysis?

• External analysis allows firms to
• Discover threats and opportunities.
• See if above normal profits are likely in an
  industry.
• Better understand the nature of competition in an
  industry.
• Make more informed strategic choices.

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The Competitive Environment

• The competitive environment is also called the
  task or industry environment.
• The CE consists of competitors (existing or
  potential), customers, and suppliers.

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General External Environment
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General External Environment
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Porters Five Forces

• Competition tends to be more intense among firms
  within a strategic group than between strategic
  groups.
• The competitive forces determine
• The state of competition in an industry and
• The degree to which the firms in an industry are
  constrained in raising prices.

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The Five Forces Model

• Helps to analyze the firms competitive
  environment for a specific industry.
• Should the firm remain in or exit an industry?
• Provides rational for increasing/decreasing
  resource commitments.
• Helps to assess how to improve the firms
  competitive position.

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Porters Five Forces

• The stronger the competitive force, the greater
  the threat.
• A weak force is an opportunity for the firms in
  the industry.
• The collective strength of these forces
  determines the ultimate profit potential of an
  industry.
• Strong competitive forces limit the profitability
  of the overall industry.

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Porters Five Forces Model
expect normal profits
If all threats are high
expect above normal profits
If all threats are low
Most industries are somewhere between the extremes
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Threat of Entrants

• New competitors may enter the industry and erode
  profits for established firms.
• Existing barriers to entry and firms reactions
  determine the extent of the threat. Therefore
• If barriers are low the threat from existing
  competitors is low than the threat of new
  entrants is high.

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Sources of Entry Barriers

• Economies of Scale High production costs spread
  over a large number of units.
• Product Differentiation Strong brand
  identification and customer loyalty.
• Capital Requirements Need to make a large
  investment to compete.

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Sources of Entry Barriers

• Switching Costs One-time costs that the buyer
  faces when switching to a new manufacturer.
• Distribution Channels Difficulty in securing
  distribution for product.
• Cost Disadvantages Independent of Scale
  Advantages derived from having a proprietary
  product, favorable access to raw materials,
  govt subsidies/policies.

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Buyers Bargaining Power

• Concentrated or Large Sales from Single Purchaser
  As a buyers purchases a greater percent of a
  suppliers output the buyers power increases.
• Products are Standard / Undifferentiated There
  are few differences in the product.
• Buyer Faces Few Switching Costs No or little
  cost to switch from one supplier to another.

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Buyers Bargaining Power

• Product Earns Low Profits Low profits create
  incentives to lower purchasing costs.
• Buyer Can Produce Product Buy has the
  capability to backward integrate its product.
• Quality is Unimportant to Buyers Product
  Quality of the product does not greatly affect
  the buyers product.

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Suppliers Bargaining Power

• There are Few Suppliers
• There are Few Substitute Products
• The Industry is Not an Important Customer
• The Suppliers Product is Important
• The Suppliers Product Has Switching Costs
• The Supplier Group Poses a Threat of Forward
  Integration

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Threat of Substitute Products

• Substitutes limit the potential returns of an
  Industry by placing a ceiling on prices.
• Identifying substitutes involves searching for
  other products/services that can perform the same
  function as the industrys offering.
• May have to look outside the industry for a
  substitute.

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Industry Rivalry

• Numerous or Equally Balanced Competitors
• Slow Industry Growth
• High Fixed or Storage Costs
• Lack of Differentiation/Switching Costs
• Capacity Augmented in Large Increments
• High Exit Barriers

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High Rivalry

• What does high rivalry look like?
• Firms are jockeying for position via price and/or
  non-price competition through
• Frequent Price Cutting
• Frequent Product Introductions
• Intense Advertising
• Rapid Competitive Actions Reactions

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Five Forces Weaknesses

• It assumes a zero sum game, i.e. one firm wins at
  the others expense. This analysis therefore down
  plays the potential for win-win relationships
  through partnering with customers/suppliers. An
  example of this is JIT inventory systems.
• It is static in that it looks at a dynamic
  environment at a single moment. Relationships
  can quickly change.

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Exploiting Industry Structure Opportunities

• Generic Industry Structures
• Most industries fits into one of four generic
  categories.
• Each industry structure presents opportunities
  that may be exploited.
• Firms can choose to exploit an industry
  structure, continue business as usual, or exit
  the industry.

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Exploiting Industry Structure Opportunities
Fragmented Industry Structure

• Industry Characteristics
• Large number of small firms.
• No dominant firms.
• No dominant technology.
• Commodity type products.
• Low barriers to entry.
• Few, if any, economies of scale.

• Opportunity Consolidation
• buy competitors
• build market power
• exploit economies of scale

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Exploiting Industry Structure Opportunities
Emerging Industry Structure

• Opportunity
• First mover advantages
• Technology
• Locking-up assets
• Creating switching costs

• Industry Characteristics
• New industry based on break through technology or
  product.
• No product standard has been reached.
• No dominant firm has emerged.
• New customers come from non-consumption not from
  competitors.

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Exploiting Industry Structure Opportunities
Mature Industry Structure

• Industry Characteristics
• Slowing growth in demand.
• Technology standard exists.
• Increasing international competition.
• Industry-wide profits declining.
• Industry exit is beginning.

• Opportunities
• Refine current products
• Improve service
• Process innovation

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Exploiting Industry Structure Opportunities
Declining Industry Structure

• Industry Characteristics
• Industry sales have sustained pattern of decline.
• Some well-established firms have exited.
• Firms have stopped investing in maintenance.

• Opportunities
• Market leadership
• Niche
• Harvest
• Divest

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Responding to Environmental Threats

• Neutralizing Threats
• Most firms cannot unilaterally change the threats
  in an industry.
• By altering relationships in an industry, firms
  may reduce threats and/or create opportunities,
  thereby increasing profits.

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Strategic Groups

• Factors that might be relevant in identifying
  strategic groups
• Leaders (innovators) and Followers
• Market Segments Served
• Pricing
• Quality
• Distribution Channels
• No two firms are totally different.
• No two firms are exactly the same.