STRATEGIC MANAGEMENT
UNIT 2: External Analysis
CONTENT
External Analysis:
1. From environmental analysis to industry analysis
2. The competitive forces
• Barriers to entry
• Substitute products
• The intensity of rivalry within the sector
• Bargaining power of suppliers
• Bargaining power of buyers
3. Intra-industry analysis. Strategic groups
The U.S. Automotive Industry
• The big three – GM, Ford and Chrysler dominated the market throughout most of the 20th
century.
• Globalization: Foreign carmakers (e.g., Volkswagen, Daimler, BMW, Honda, Toyota, and
Nissan) entered the U.S. market, at first mainly by importing vehicles from overseas plants.
• These foreign entrants intensified competition, threatened the Big Three’s market share, and
led to political pressure to impose import restrictions in the 1980s.
• The new players responded by building U.S. plants. Later, Korean carmakers Hyundai and Kia
also joined in and began making and selling cars in the United States.
Analyzing the business environment
• The business environment of a firm consists of the external influences that affect its
decisions and performance.
• How can managers monitor the vast array of possible influences?
- Need to distinguish the “vital” from the “merely” important
- Classification schemes like PESTEL can help
The Firm Embedded in Its External Environment: PESTEL
The PESTEL Framework
● Political, Economic, Sociocultural, Technological, Ecological, and Legal forces.
● Straightforward way to scan, monitor, and evaluate the important external factors and
trends that might affect a firm.
● These forces can create both opportunities and threats.
Political / Legal factors
● The political environment describes the processes and actions of government bodies
that can influence the decisions and behavior of firms.
● The legal environment captures the official outcomes of political processes as
manifested in laws, mandates, regulations, and court decisions.
Examples:
– Some governments may induce consumers to buy zero-emission vehicles by offering tax
credit with the purchase of an electric vehicle.
– Governments may have different laws that would affect copyright. It affects companies like
Netflix.
Economic Factors
• Macroeconomic factors
– Growth Rates
– Interest Rates
– Levels Of Employment
– Price Stability(inflation and deflation)
– Currency exchange rates
1. Growth Rates
• It indicates what stage of the business cycle the economy is in—that is, whether business
activity is expanding (boom) or contracting (recession).
• During these economic boom cycles, businesses expand operations to satisfy demand and are
more likely to be profitable.
– Internet Boom from 1995 to 2000.
– Housing in the early 2000s.
• Certain companies that focus on low-cost solutions may benefit from economic contractions
because demand for their products or services rises in such times.
2. Interest Rates
• When credit is cheap (because interest rates are low), consumers buy homes, automobiles,
computers, and even vacations on credit; in turn, all of this demand fuels economic growth.
• During periods of low interest rates, firms can easily borrow money to finance future growth.
Borrowing at lower rates lowers the cost of capital and enhances a firm’s competitiveness.
3. Level of Employment
• In boom times, unemployment is low, and skilled human capital becomes a scarce and more
expensive resource.
• In economic downturns, unemployment rises. As more people search for employment, skilled
human capital is abundant and wages usually fall.
• Some companies use downturns to train their workers on the latest techniques. The goal is to
position the company well when the economy picks up again.
• Periods of higher unemployment often spur an uptick in entrepreneurship as the opportunity
cost of starting a new venture falls.
– Examples: Microsoft, FedEx, GE, Revlon Cosmetics, and Hyatt Hotels.
4. Price Stability
• Inflation is a sustained increase in the general price level of goods and services in an economy
over a period of time.
• Deflation describes a decrease in the overall price level. A sudden and pronounced drop in
demand generally causes deflation, which in turn forces sellers to lower prices to motivate
buyers. Deflation may be a serious threat to economic growth because it distorts expectations
about the future. For example, once price levels start falling, companies will not invest in new
production capacity or innovation because they expect a further decline in prices.
5. Currency Exchange Rates
• The currency exchange rate determines how many dollars/euros one must pay for a unit of
foreign currency.
• It is a critical variable for any company that either buys or sells products and services across
national borders.
• If the U.S. dollar depreciates (declines in value), for example, it takes more dollars to buy one
euro:
– European imports such as BMW automobiles become more expensive for U.S. buyers.
– U.S. exports such as Boeing aircraft become relatively cheaper when exported to Europe.
Sociocultural Factors
● Society’s cultures, norms, and values.
– For example,agrowingnumberofU.S.consumershavebecomemore
health-conscious about what they eat.
● Demographic trends capture population characteristics related to age, gender, family
size, ethnicity, sexual orientation, religion, and socioeconomic class.
– Target market:Locals?Foreign?Cultural differences?
Technological Factors
Technological factors capture the application of knowledge to create new processes and
products.
Artificial intelligence
Social media and online search engines.
Ecological Factors
• Ecological factors concern broad environmental issues such as the natural environment,
global warming, and sustainable economic growth.
• Managers can no longer separate the natural and the business worlds; they are inextricably
linked.
• Business organizations have contributed to the pollution of air, water, and land, as well as
depletion of the world’s natural resources.
FROM ENVIRONMENTAL ANALYSIS TO INDUSTRY ANALYSIS
Industry Analysis
To identify an industry’s profit potential (the level of profitability that can be expected for the
average firm).
To derive implications for one firm’s strategic position within an industry.
Top 10 most profitable industries according to Insider Monkey: (2021)
1. Software (System and Application) 2. Computer Peripherals
3. Drugs and Pharmaceuticals
4. Oil and Gas Industry
5. Household Products
6. Software (Entertainment)
7. Computer Services
8. Healthcare Support and Services 9. Life insurance
10. Semiconductor Industry
Industry Analysis
• Five forces model:
– Theprofitpotentialofanindustryisneitherrandomnorentirely determined by industry- specific
factors. Rather, it is a function of the five forces that shape competition: threat of entry, power
of suppliers, power of buyers, threat of substitutes, and rivalry among existing firms.
Competitive Forces and Firm Strategy
• The Five Forces Model
– The classic industry analysis model
• Threat of Entry/Barriers to Entry
– Note: High barriers to entry means threat of entry is low
• Power of Suppliers
• Power of Buyers
• Threat of Substitutes
• Rivalry Among Existing Competitors
Porter’s Five Forces Model
The Threat of Entry
• With the threat of newcomers coming into an industry, incumbent firms may lower prices to
make entry appear less attractive to the potential new competitors. Ex: Washing machine.
• The threat of entry by additional competitors may force incumbent firms to spend more to
satisfy their existing customers.
• Entry barriers are obstacles that determine how easily a firm can enter an industry.
Entry barriers
• Economies of scale
• Network effects
• Customer switching costs
• Capital requirements
• Advantages independent of size
• Government policy
• Credible threat of retaliation
1. Economies of Scale
• Economies of scale are cost advantages that accrue for firms with larger output because they
can spread fixed costs over more units, can employ technology more efficiently, can benefit
from a more specialized division of labor, and can demand better terms from their suppliers.
These factors in turn drive down the cost per unit, allowing large incumbent firms to enjoy a
cost advantage over new entrants who cannot reach such scale.
• Example:
– High barriers: Automotive industry.
– Tesla is joining it by using technology.
2. Network Effects
• Network effects describe the positive effect that one user of a product or service has on the
value of that product or service for other users.
• Examples: Facebook, eBay, Wallapop.
3. Customer switching costs
• Switching costs are incurred by moving from one supplier to another.
• Example: Windows, Apple iOS, Linux...
Capital requirements
• How Much Capital Is Required To Compete In This industry, and which companies are willing
and able to make such investments?
• Example:BoeingandAirbus(France,Germany,Spain, and the UK).
4. Advantages independent of size
• Brand loyalty, proprietary technology, preferential access to raw materials and/or
distribution channels, favorable geographic locations, and cumulative learning and experience
effects.
• Examples:
– Brand: Apple.
– Patents: Pharmaceutical.
– Access to raw material: De Beers – Location: Silicon Valley
– Learning: GE
5. Government policy
• Frequently Government Policies Restrictor Prevent new entrants.
• Example:ToysRUs Japan.
6. Credible threat of retaliation
• Price war
• Increased product or service innovation
• Increased advertising
• Increased sales promotions.
• If industry growth is slow or stagnant, incumbents are more likely to retaliate against new
entrants in order to protect their market share.
The Power of Suppliers
It is high when:
• Dominated by a few companies
• No substitutes for supplier products
• Suppliers' products are differentiated
• Incumbents face high switching costs
• Product is an important input to buyer
• Forward Integration is a credible threat
The Power of Buyers
It is high when:
• A few large buyers
• Products are standardized and undifferentiated
• Buyers face few switching costs
• Buyers can credibly threaten to backwardly
integrate into the industry.
The Threat of Substitutes
It is high when:
• Buyers switching costs to substitute is low.
• Products with similar functions limit the prices firms can charge.
Rivalry Among Existing Competitors
• Many competitors in the industry
– (industry concentration is low)
• Firms are of equal size
• Industry growth is slow or shrinking
– (over-capacity is high)
• Exit barriers are high
• Products and services are direct substitutes (product differentiation is low)
The Sixth Force
• Complementary Products Orcomplementsarethe products and services used together.
• They Can Affect The Demand For An Industry's Product (would you buy an app if you had no
phone?)
• Complements Affect The Industry Profitability through their impact on the 5 forces.
Some Criticisms of the framework
• it omits important variables.
• It Requires Significant Modification To Consider The dynamics and complex realities of many
industries.
The Uses of Industry Analysis
• Static Analysis
– How do we explain current rivalry and profitability?
• Dynamic Analysis
– How was the industry in the past?
– How will expect the industry to be in the future?
Applying industry analysis
• Industry Analysis Can Be Used To:
– Explain differences in profitability between industries and
changes in the profitability of a given industry over time
– Assist managers in positioning the firm advantageously
– Predict possible changes in competition and profitability in the near future
– Identify opportunities for changing industry structures and alleviating competitive pressures.
Explaining Performance Differences Within the Same Industry: Strategic Groups
• Strategic groups are groups of firms within the same industry.
• Implications
– Closest competitors in the same strategic group are viewed as substitutes for each other
– Each strategic group may face different set of opportunities/threats
• Mobility Barriers
– Inhibit movement between strategic groups
Example:
The Five Forces in the Airline Industry
• Rivalry is high, as consumers decide based on price.
• Low switching costs and nearly perfect information combine to strengthen buyer power.
• Entry barriers are relatively low, resulting in a number of new airlines popping up. To enter
the industry (on a small scale, serving a few select cities), a prospective new entrant needs only
a couple of airplanes which can be rented, a few pilots and crew members, some routes
connecting city pairs, and gate access in airports.
• In the airline industry, the supplier power is also strong. The providers of airframes (e.g.,
Boeing or Airbus), makers of aircraft engines (e.g., GE or Rolls-Royce), aircraft maintenance
companies (e.g., Goodrich), caterers (e.g., Marriott), labor unions, and airports controlling gate
access all bargain away the profitability of airlines.
• To make matters worse, substitutes are also readily available: If prices are seen as too high,
customers can drive their cars or use the train or bus.
