Lecture 3:

Evaluating a Company's External Environment

Anuar Peruash, MBA

Objectives

 Recognize the factors in a company’s broad macro-

environment that may have strategic significance.
 Use analytic tools to diagnose the competitive conditions in
a company’s industry.
 Map the market positions of key groups of industry rivals.
 Determine whether an industry’s outlook presents a
company with sufficiently attractive opportunities for
growth and profitability.

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Content

1. The strategically relevant factors in the company’s macro-environment

2. Assessing the company’s industry and competitive environment
3. The five forces framework
4. Complementors and the value net framework
5. Industry dynamics and the forces driving change
6. Strategic Group Analysis
7. Competitor Analysis
8. Key Success factors
9. The industry outlook for profitability

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1. The strategically relevant factors in the company’s macro-
environment
In the previous lecture, we learned that the strategy formulation,
strategy execution process begins with an appraisal of the company’s
present situation.

Two facets of a company’s situation are especially pertinent:

(1) its external environment — most notably, the competitive
conditions of the industry in which the company operates

(2) its internal environment — particularly the company’s resources

and organizational capabilities

This lecture presents the concepts and analytic tools for focusing on
those aspects of a company’s external environment that should be
considered in making strategic choices.

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From analyzing the company’s situation to choosing a strategy

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1. The strategically relevant factors in the company’s macro-
environment

A company’s external environment includes the immediate industry and

competitive environment and a broader “macro-environment”.

The macro-environment encompasses the broad environmental context

in which a company’s industry is situated.

PESTEL analysis can be used to assess the strategic relevance of the six
principal components of the macro-environment: Political, Economic,
Social, Technological, Environmental, and Legal/ Regulatory forces.

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The Components of a Company’s Macro-Environment

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1. The strategically relevant factors in the company’s macro-
environment

PESTEL analysis:

 political factors;
 economic conditions in the firm’s general environment (local,
country, regional, worldwide);
 sociocultural forces;
 technological factors;
 environmental factors (concerning the natural environment);
 legal/regulatory conditions.

Each of these components has the potential to affect the firm’s more
immediate industry and competitive environment, although some are
likely to have a more important effect than others.

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1. The strategically relevant factors in the company’s macro-
environment
Component Description

Pertinent political factors include matters such as

 tax policy
 fiscal policy
 tariffs
 the political climate
Political factors
 the strength of institutions such as the state banking system

Some political policies affect certain types of industries more

than others. An example is energy policy, which clearly affects
energy producers and heavy users of energy more than other
types of businesses.

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1. The strategically relevant factors in the company’s macro-
environment
Component Description

Economic conditions include the general economic climate and

specific factors such as
 interest rates
 exchange rates
 the inflation rate
 the unemployment rate
 the rate of economic growth
Economic
 trade deficits or surpluses
conditions
 savings rates
 per-capita domestic product

Some industries, such as construction, are particularly vulnerable

to economic downturns but are positively affected by factors
such as low interest rates. Others, such as discount retailing,
benefit when general economic conditions weaken, as
consumers become more price-conscious.

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1. The strategically relevant factors in the company’s macro-
environment
Component Description

Sociocultural forces include

 the societal values,
 attitudes,
 cultural influences,
 lifestyles that impact demand for particular goods and
services, demographic factors such as the population size,
growth rate, and age distribution.
Sociocultural
forces Sociocultural forces vary by locale and change over time.
An example is the trend toward healthier lifestyles, which can
shift spending toward exercise equipment and health clubs and
away from alcohol and snack foods.

The demographic effect of people living longer is having a huge

impact on the health care, nursing homes, travel, hospitality, and
entertainment industries.

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1. The strategically relevant factors in the company’s macro-
environment
Component Description

Technological factors include the pace of technological change

and technical developments that have the potential for wide-
ranging effects on society, such as
 genetic engineering
 nanotechnology
Technological
 solar energy technology
factors
Technological change can encourage the birth of new industries,
such as drones, virtual reality technology, and connected
wearable devices. They can disrupt others, as cloud computing,
3-D printing, and big data solution have done, and they can
render other industries obsolete (film cameras, music CDs).

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1. The strategically relevant factors in the company’s macro-
environment
Component Description

These include ecological and environmental forces such as

 weather
 climate
 climate change
 associated factors like flooding, fire, and water shortages

These factors can directly impact industries such as insurance,

Environmental farming, energy production, and tourism. They may have an
forces indirect but substantial effect on other industries such as
transportation and utilities.

Growing numbers of companies worldwide, in response to

stricter environmental regulations and also to mounting public
concerns about the environment, are implementing actions to
operate in a more environmentally and ecologically responsible
manner.

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1. The strategically relevant factors in the company’s macro-
environment
Component Description

These factors include the regulations and laws with which

companies must comply, such as
 consumer laws
 labor laws
 occupational health and safety regulation
Legal and
Some factors, such as financial services regulation, are industry-
regulatory
specific. Others affect certain types of industries more than
factors
others.

For example, companies in coal-mining, meat-packing, and steel-

making, where many jobs are hazardous or carry high risk of
injury, are much more impacted by occupational safety
regulations than are companies in industries such as retailing or
software programming.

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2. Assessing the company`s industry and competitive
environment – 7 key questions
1. Do macro-environmental factors and industry characteristics offer sellers
opportunities for growth and attractive profits?
2. What kinds of competitive forces are industry members facing, and how
strong iseach force?
3. What forces are driving industry change, and what impact will these changes
haveon competitive intensity and industry profitability?
4. What market positions do industry rivals occupy—who is strongly positioned
andwho is not?
5. What strategic moves are rivals likely to make next?
6. What are the key factors of competitive success?
7. Does the industry outlook offer good prospects for profitability?

Analysis-based answers to these questions are prerequisites for a

strategy offering good fit with the external situation.

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2. Assessing the company`s industry and competitive
environment
After gaining an understanding of the industry’s general economic
characteristics, attention should be focused on the competitive
dynamics of the industry, which entails the use of some well-validated
concepts and analytic tools:

 The five forces framework

 The value net

 Driving forces

 Strategic groups

 Competitor analysis

 Key success factors

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3. The five forces framework – Model of Competition: A Key
Analytic Tool
The most powerful and widely used tool for diagnosing the principal
competitive pressures in a market, created by Michael Porter.

This framework holds that competitive pressures on companies within

an industry come from five sources. These include:
(1) competition from rival sellers
(2) competition from potential new entrants to the industry
(3) competition from producers of substitute products
(4) supplier bargaining power
(5) customer bargaining power

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3. The five forces framework – Model of Competition: A Key
Analytic Tool

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Force 1 - Factors Affecting the Strength of Rivalry

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Common “Weapons” for Competing with Rivals

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Lecture 1 fragment - The Business Model and
the Value-Price-Cost Framework
The customer value proposition can be expressed
as V − P, which is essentially the customers’
perception of how much value they are getting for
the money.

The profit formula, on a per-unit basis, can be

expressed as P − C. Plainly, from a customer
perspective, the greater the value delivered (V ) and
the lower the price (P), the more attractive is the
company’s value proposition. On the other hand,
the lower the costs (C), given the customer value
proposition (V − P), the greater the ability of the
busi- ness model to be a moneymaker.

The profit formula reveals how efficiently a

company can meet customer needs and deliver on
the value proposition.

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Force 2 - Factors Affecting the Threat of Entry

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Force 3 - Factors Affecting Competition from Substitute Products

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Force 4 - Factors Affecting the Bargaining Power of Suppliers

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Force 5 - Factors Affecting the Bargaining Power of Buyers

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3. The five forces framework – Model of Competition: A Key
Analytic Tool
Using the five forces model to determine the nature and strength of
competitive pressures in a given industry involves three steps:

• Step 1: For each of the five forces, identify the different parties
involved, along with the specific factors that bring about competitive
pressures

• Step 2: Evaluate how strong the pressures stemming from each of

the five forces are (strong, moderate, or weak)

• Step 3: Determine whether the five forces, overall, are supportive of

high industry profitability

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3. The five forces framework – Model of Competition: A Key
Analytic Tool - Conclusions
The most extreme case of a “competitively unattractive” industry occurs
when all five forces are producing strong competitive pressures:
• rivalry among sellers is vigorous
• low entry barriers allow new rivals to gain a market foothold
• competition from substitutes is intense
• both suppliers and buyers are able to exercise considerable leverage

Intense competitive pressures from one or more than one of the five
forces may suffice to destroy the conditions for good profitability and
prompt some companies to exit the business.

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3. The five forces framework – Model of Competition: A Key
Analytic Tool - Conclusions
As a rule, the strongest competitive forces determine the extent of the
competitive pressure on industry profitability.

The ideal competitive environment for earning superior profits is one in

which
• both suppliers and customers have limited power
• there are no good substitutes
• high barriers block further entry
• and rivalry among present sellers is muted

When the overall impact of the five competitive forces is moderate to

weak, even an average industry member can reasonably expect to earn
good profits and a return on investment.

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4. Complementors and the value net framework
Complementors are the producers of complementary products, which
are products that enhance the value of the focal firm’s products when
they are used together.

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4. Complementors and the value net framework

The inclusion of complementors draws particular attention to the fact

that success in the marketplace need not come at the expense of other
industry participants.

Interactions among industry participants may be cooperative in nature

rather than competitive.

The value net framework encourages managers to consider other forms

of cooperative interactions and realize that value is created jointly by all
industry participants.

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5. Industry dynamics and the forces driving change

While it is critical to understand the nature and intensity of competitive

and cooperative forces in an industry, it is equally critical to understand
that the intensity of these forces is fluid and subject to change.

The popular hypothesis that industries go through a life cycle of

• takeoff
• rapid growth
• maturity
• market saturation
• slowing growth, followed by stagnation or decline

is but one aspect of industry change—many other new developments and

emerging trends cause industry change

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5. Industry dynamics and the forces driving change

Driving forces are the major underlying causes of change in industry and
competitive conditions.

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5. Industry dynamics and the forces driving change

Driving-forces analysis has three steps:

(1) identifying what the driving forces are

(2) assessing whether the drivers of change are, on the whole, acting to

make the industry more or less attractive

(3) determining what strategy changes are needed to prepare for the

impact of the driving forces

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6. Strategic Group Analysis

Within an industry, companies commonly sell in

different price/quality ranges,
appeal to different types of buyers,
have different geographic coverage, and so on.

The best technique for revealing the market positions of industry

competitors is strategic group mapping, which is a technique for
displaying the different market or competitive positions that rival firms
occupy in the industry.

A strategic group is a cluster of industry rivals that have similar

competitive approaches and market positions.

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6. Strategic Group Analysis
Comparative Market Positions of Selected Companies in the Pizza Chain
Industry: A Strategic Group Map Example

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7. Competitor Analysis

Gathering competitive intelligence about the strategic direction and likely

moves of key competitors allows a company
• to prepare defensive countermoves,
• to craft its own strategic moves with some confidence about what
market maneuvers to expect from rivals in response
• to exploit any openings that arise from competitors’ missteps

Michael Porter’s SOAR Framework for Competitor Analysis points to four

indicators of a rival’s likely strategic moves and countermoves.

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7. Competitor Analysis

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8. Key Success factors
An industry’s key success factors (KSFs) are those competitive factors that
most affect industry members’ ability to survive and prosper in the
marketplace:
• the particular strategy elements,
• product attributes,
• operational approaches,
• resources,
• competitive capabilities
that spell the difference between being a strong competitor and a weak
competitor—and between profit and loss.

The key success factors of an industry point to those things that every
firm in the industry needs to attend to in order to retain customers and
weather the competition.

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9. The industry outlook for profitability

Each of the frameworks presented — PESTEL, five forces analysis, driving

forces, strategy groups, competitor analysis, and key success factors—
provides a useful perspective on an industry’s outlook for future
profitability. Putting them all together provides an even richer and more
nuanced picture.

Industry environment is fundamentally attractive if it presents a

company with good opportunity for above-average profitability.

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