chapter 3

Evaluating a
Company’s
External
Environment

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 Learning Objectives

After reading this chapter, you should be able to:

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

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 FIGURE 3.1 From Analyzing the Company’s Situation
to Choosing a Strategy

Chapter 3 discussed the External Environment, and Chapter 4 discusses the Internal Environment.

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 Analyzing the Company's Macro-Environment

PESTEL Analysis.
• Focuses on principal components of strategic significance
in the macro-environment:
• Political factors.
• Economic conditions (local to worldwide).
• Sociocultural forces.
• Technological factors.
• Environmental factors (the natural environment).
• Legal and regulatory conditions.

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 Assessing the Company’s Industry and
Competitive Environment
Thinking strategically about the competitive
environment requires managers to use some well
validated concepts and analytical tools.
• Five forces framework.
• The value net.
• Driving forces.
• Strategic groups.
• Competitor analysis.
• Key success factors.

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 FIGURE 3.2 The Components of a Company’s Macro-Environment

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 The Five Forces Framework

The five competitive forces:

• Competition from rival sellers.
• Competition from potential new entrants.
• Competition from producers of substitute products.
• Supplier bargaining power.
• Customer bargaining power.

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 FIGURE 3.3 The Five Forces Model of Competition:
A Key Analytical Tool

Sources: Adapted from M.E. Porter, “How Competitive Forces Shape

Strategy,” Harvard Business Review 57, no. 2 (1979), pp.137-145;
M.E. Porter, “The Five Competitive Forces That Shape Strategy,”
Harvard Business Review 86, no 1 (2008), pp. 80-86.

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 Using the Five-forces Model of Competition

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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 Competitive Pressures Created by the Rivalry
among Competing Sellers
Buyer demand is growing slowly or declining.

It is becoming less costly for buyers to switch brands.

Industry products are becoming less strongly differentiated.

There is excess inventory, idle production capacity, or products

have high fixed costs or high storage costs.

The number of competitors is increasing, and are becoming

more equal in size and competitive capability.

The strategic and geographic diversity of competitors is

increasing.

High exit barriers keep weak firms from exiting the industry.
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 FIGURE 3.4 Factors Affecting the Strength of Rivalry

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 Competitive Pressures Associated with
the Threat of New Entrants

Entry threat considerations:

• Strength of barriers to entry.
• Expected defensive reactions of incumbent firms.
• Attractiveness of a particular market’s growth
in demand and profit potential.
• Capabilities and resources of potential entrants.
• Entry of existing competitors into market segments
in which they have no current presence.

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 Market Entry Barriers Facing New Entrants
There are sizable economies of scale in production, distribution,
advertising, or other activities.
Incumbents have hard-to-replicate learning curve and industry
relationship cost advantages over new entrants.
Customers have strong brand preferences and high degrees of loyalty
to seller.
Patents and other intellectual property protections are in place.
There are strong “network effects” in customer demand.
Capital investment requirements are high.
There are difficulties in building a network of distributors/dealers or in
securing adequate space on retailers’ shelves.
There are restrictive regulatory and trade policies.

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 FIGURE 3.5 Factors Affecting the Threat of Entry

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 Competitive Pressures from the
Sellers of Substitute Products
Substitute products Indicators of substitutes’
considerations: competitive strength:
• Readily available and • Increasing rate of growth
attractively priced? in sales of substitutes.
• Comparable or better in • Substitute producers
terms of quality, adding new output
performance, and other capacity.
relevant attributes? • Increasing profitability of
• Offer lower switching costs substitute producers.
to buyers?

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 FIGURE 3.6 Factors Affecting Competition from Substitute
Products

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 Competitive Pressures Stemming from
Supplier Bargaining Power
Supplier bargaining power depends on:
• Strength of demand for and availability of suppliers’ products.
• Whether suppliers provide a differentiated input that enhances the
performance of the industry’s product.
• Industry members’ costs for switching among suppliers.
• Size and number of suppliers relative to industry members.
• Possibility of backward integration into suppliers’ industry.
• Fraction of the cost of the supplier’s product relative to the total cost of
the industry’s product.
• Availability of good substitutes for suppliers’ products.
• Whether industry members are major customers of suppliers.

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 FIGURE 3.7 Factors Affecting the Bargaining Power of Suppliers

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 Competitive Pressures Stemming from Buyer
Bargaining Power and Price Sensitivity
Buyer bargaining power considerations:
• Strength of buyers’ demand for sellers’ products.
• Degree to which industry goods are differentiated.
• Buyers’ costs for switching to competing sellers or substitutes.
• Number and size of buyers relative to number of sellers.
• Threat of buyers’ integration into sellers’ industry.
• Buyers’ knowledge of products, costs and pricing.
• Buyers’ discretion in delaying purchases.
• Buyers’ price sensitivity due to low profits, relative size of purchase,
and consequences of purchase.
• Product quality not at issue price is primary concern.

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 FIGURE 3.8 Factors Affecting the Bargaining Power of Buyers

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 Is the Collective Strength of the
Five Competitive Forces
Conducive to Good Profitability?

Answers to three questions are needed:

1. Is the state of industry competition stronger than normal?
2. Can industry firms expect to earn decent profits given
prevailing competitive forces?
3. Are some of the competitive forces sufficiently powerful to
undermine industry profitability?

Even one powerful competitive force may

be enough to make the industry unattractive
in terms of its profit potential.

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 Matching Company Strategy to
Competitive Conditions

Effectively matching a firm’s business strategy to

prevailing competitive conditions has two aspects:
• Pursuing avenues that shield the firm from as many
competitive pressures as possible.

• Initiating actions calculated to shift competitive forces in

the firm’s favor by altering underlying factors driving the
five forces.

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 Complementors and the Value Net

How the value net differs from the five forces:

• Focuses on the interactions of industry participants with a
particular (focal) company.
• Defines the category of competitors to include the focal
firm’s direct competitors, industry rivals, the sellers of
substitute products, and potential entrants.
• Introduces a new category of industry participant—
complementors—producers of products that enhance the
value of the focal firm’s products when they are used
together.

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 FIGURE 3.9 The Value Net

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 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
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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 Identifying the Forces Driving Industry Change
Changes in an industry’s long-term growth rate.
Increasing globalization.
Emerging new Internet capabilities and applications.
Shifts in who buys industry products and how the products are used.
Technological change and manufacturing process innovation.
Product and marketing innovation.
Entry or exit of major firms.
Diffusion of technical know-how across firms and countries.
Changes in costs and efficiencies.
Reductions in uncertainty and business risk.
Regulatory influences and government policy changes.
Changing societal concerns, attitudes, and lifestyles

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 Assessing the Impact of the Factors Driving
Industry Change

Are the driving forces, on balance, acting to cause

demand for the industry’s product to increase or
decrease?
Is the collective impact of the driving forces making
competition more or less intense?
Will the combined impacts of the driving forces lead
to higher or lower industry profitability?

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 Adjusting Strategy to Prepare for
the Impacts of Driving Forces

What strategy adjustments will be needed

to deal with the impacts of the driving forces?
What immediate adjustments must be made?
What actions currently being taken should be halted
or abandoned?
What can we do now to prepare for adjustments we
anticipate making in the future?

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 Strategic Group Analysis

Strategic group.
• Consists of those industry members with similar
competitive approaches and positions in the market.
• Having comparable product-line breadth.
• Employing the same distribution channels.
• Depending on identical technological approaches.
• Competing in the same geographic areas
• Offering the same product attributes to buyers.
• Offering similar services and technical assistance.

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 Using Strategic Group Maps to Assess the
Market Positions of Key Competitors

Constructing a strategic group map:

• Identify the competitive characteristics that delineate
strategic approaches used in the industry.
• Plot the firms on a two-variable map using pairs of
competitive characteristics.
• Assign firms occupying about the same map location to
the same strategic group.
• Draw circles around each strategic group, making the
circles proportional to the size of the group’s share of total
industry sales revenues.

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 Typical Variables Used in Creating
Group Maps
Price and quality range (high, medium, low).
Geographic coverage (local, regional, national, global).
Product-line breadth (wide, narrow).
Degree of service offered (no frills, limited, full).
Distribution channels (retail, wholesale, Internet, multiple).
Degree of vertical integration (none, partial, full).
Degree of diversification into other industries (none, some,
considerable).

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 Guidelines for Creating Group Maps

Variables selected as map axes should not be highly

correlated.
Variables should reflect important (sizable) differences
among rival approaches.
Variables may be quantitative, continuous, discrete, or
defined in terms of distinct classes and combinations.
Drawing group circles proportional to the combined sales of
firms in each group will reflect the relative sizes of each
strategic group.
Drawing maps using different pairs of variables will show the
different competitive positioning relationships present in the
industry’s structure.

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 Illustration Capsule 3.2 Comparative Market Positions of Selected
Companies in the Pizza Chain Industry:
A Strategic Group Map Example

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 Examining the Comparative Market Positions of
Strategic Groups in the Pizza Chain Industry

Which strategic group is located in the least

favorable market position? Which group is in the
most favorable position?
Which strategic group is likely to experience
increased intragroup competition?
Which groups are most threatened by the likely
strategic moves of members of nearby strategic
groups?

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 The Value of Strategic Group Maps

Maps are useful in identifying groups of close and

distant rivals in an industry.
Not all map positions are equally attractive.
• Prevailing competitive pressures from the industry’s five
forces may cause the profit potential of different strategic
groups to vary.
• Industry driving forces may favor some strategic groups
and hurt others.

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 Competitor Analysis

Competitive intelligence.
• Information about rivals that is useful in anticipating their
next strategic moves.
Signals of the likelihood of strategic moves:
• Rivals under pressure to improve financial performance.
• Rivals seeking to increase market standing.
• Public statements of rivals’ intentions.
• Profiles developed by competitive intelligence units.

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 FIGURE 3.10 The SOAR Framework for Competitor Analysis

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 SOAR Framework for Competitor Analysis

Indicators of a rival firm’s likely strategic moves and

countermoves:
• The rival firm’s current strategy.
• The rival firm’s objectives.
• The rival firm’s resources and capabilities.
• The rival firm’s assumptions about itself and its industry.

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 Key Success Factors

Key success factors (KSFs):

• Are the strategy elements, product and service attributes,
operational approaches, resources, and competitive
capabilities that are necessary for competitive success by
any and all firms in an industry.
• These vary from industry to industry, and over time within
the same industry, and in their importance as drivers of
change and competitive conditions change.

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 Identification of Key Success Factors

On what basis do buyers of the industry’s product

choose between the competing brands of sellers—
that is, what product attributes and service
characteristics are crucial?
Given the nature of competitive rivalry prevailing in
the marketplace, what resources and competitive
capabilities must a firm have to be competitively
successful?
What shortcomings are almost certain to put a firm
at a significant competitive disadvantage?

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 The Industry Outlook for Profitability

An industry environment is fundamentally attractive

if it presents a firm with a good opportunity for
above-average profitability.
An industry environment is fundamentally
unattractive if a firm’s profit prospects in the industry
are unappealingly low.

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 Factors to Consider in Assessing
Industry Attractiveness
How the firm is impacted by the state of the macro-environment.
Whether strong competitive forces are squeezing industry profitability to
subpar levels.
Whether the presence of complementors and the possibility of
cooperative actions improve the firm’s prospects.
Whether industry profitability will be favorably or unfavorably affected by
the prevailing driving forces.
Whether the firm occupies a stronger market position than rivals.
Whether this is likely to change in the course of competitive interactions.
How well the firm’s strategy delivers on industry key success factors.

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 Industry Attractiveness Is Not
the Same for All Participants

Industry outsiders may conclude that they have the

resources to easily hurdle the barriers to entering an
attractive industry while other outsiders may find the same
industry unattractive because they do not want to challenge
market leaders and have better opportunities elsewhere.

A particular industry’s attractiveness depends in large part on

whether a company has the resources and capabilities to be
competitively successful and profitable in that environment.

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 What Should a Current Competitor Decide
About Its Industry?

When a competitor decides an industry is attractive, it should

invest aggressively to capture the opportunities it sees and to
improve its long-term competitive position in the business.

When a strong competitor concludes its industry is relatively

unattractive and lacking in opportunity, it may elect to protect
its present position, investing cautiously–if at all–and looking
for opportunities in other industries.

A competitively weak company in an unattractive industry

may see its best option as finding a buyer, perhaps a rival, to
acquire its business.

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