Defining Strategic Management

2

Analyzing the External
Environment of the Firm

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Learning Objectives

After reading this chapter, you should have a good understanding of:

• The importance of developing forecasts of the business environment.
• Why environmental scanning, environmental monitoring, and collecting competitive intelligence are critical inputs to forecasting.
• Why scenario planning is a useful technique for firms competing in industries characterized by unpredictability and change.
• The impact of the general environment on a firm’s strategies and performance.

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Learning Objectives

After reading this chapter, you should have a good understanding of:

• How forces in the competitive environment can affect profitability and how a firm can improve its competitive position by increasing its power vis-à-vis these forces.
• How trends and events in the general environment and forces in the competitive environment are interrelated and affect performance.
• How the internet and digitally based compatibilities are affecting the five competitive forces and industry profitability.
• The concept of strategic groups and their strategy and performance implications.

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Creating the Environmentally
Aware Organization

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Environmental Scanning & Monitoring

• External Scanning
• Surveillance of a firm’s external environment:
• Predict environmental changes to come
• Detect changes already under way
• Proactive mode
• External Monitoring
• Track evolution of:
• Environmental trends
• Sequence of events
• Streams of activities

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Competitive Intelligence

• Define and understand a firm’s industry
• Identify rivals’ strengths and weaknesses
• Intelligence gathering (data)
• Interpretation of intelligence data
• Helps a firm avoid surprises

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What Competitive Intelligence
Is and Is Not

Competitive Intelligence Is …

• Information that has been analyzed to the point where you can make a decision.
• A tool to alert management to early recognition of both threats and opportunities.
• A means to deliver reasonable assessments.
• A way of life, a process.

Competitive Intelligence Is Not …

• Spying. Spying implies illegal or unethical activities. It is a rare activity.
• A crystal ball. Competitive Intelligence is good approximation of reality; it does not predict the future.
• Database search. Data by itself is not good intelligence.
• A job for one smart person.

Adapted from Exhibit 2.2 What Competitive Intelligence Is and Is Not!

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Environmental Forecasting

• Plausible projections about
• Direction of environmental change
• Scope of environmental change
• Speed of environmental change
• Intensity of environmental change
• Scenario analysis

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Question

Which of the following is a danger of forecasting?

Managers assume that the world is not open to precise predictions.

Managers may view uncertainty as black and white and ignore grey areas.

Managers assume that the world is uncertain.

Managers view the world as completely unpredictable.

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SWOT Analysis

• Managers need to analyze
• The general environment
• The firm’s industry and competitive advantage
• SWOT analysis
• Strengths
• Weaknesses
• Opportunities
• Threats
• Basic technique for analyzing firm and industry condition

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Example

• Harley Davidson SWOT
• Strengths
• Strong & adaptable brand image
• Weaknesses
• Limited ability to develop new non-traditional products
• Opportunities
• Growing leisure interest in motorcycles worldwide
• Threats
• Differing foreign policies governing motorcycles

Source: Developed from www.harley-davidson.com

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The General Environment

• Segments of the general environment include:
• Demographic
• Sociocultural
• Legal/Political
• Technological
• Economic
• Global
• General environmental trends and events:
• Little ability to predict them
• Even less ability to control them
• Can vary across industries

General Environment

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Demographic Segment

• Aging population
• Rising affluence
• Changes in ethnic composition
• Geographic distribution of population
• Greater disparities in income levels

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Sociocultural Segment

• More women in the workforce
• Increase in temporary workers
• Greater concern for fitness
• Greater concern for environment
• Postponement of family formation

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Political/Legal Segment

• Tort reform
• Americans with Disabilities Act (ADA)
• Repeal of Glass-Steagall Act in 1999
• Deregulation of utility and other industries
• Increases in federally mandated minimum wages
• Taxation at local, state, federal levels
• Legislation on corporate governance reforms (Sarbanes-Oxley Act)

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Technological Segment

• Genetic engineering
• Emergence of Internet technology
• Computer-aided design/computer-aided manufacturing systems (CAD/CAM)
• Research in synthetic and exotic materials
• Pollution/global warming
• Miniaturization of computing technologies
• Wireless communication
• Nanotechnology

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Economic Segment

• Interest rates
• Unemployment
• Consumer Price index
• Trends in GDP
• Changes in stock market valuations

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Global Segment

• Increasing global trade
• Currency exchange rates
• Emergence of the Indian and Chinese economies
• Trade agreements among regional blocs (NAFTA, EU, ASEAN)
• Creation of WTO (decreasing tariffs/free trade in services)

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The Competitive Environment

• Segments of the competitive environment include:
• Competitors
• Customers
• Suppliers
• Sometimes called the task or industry environment
• Porter’s five forces model

Competitive Environment

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Porter’s Five Forces Model
of Industry Competition

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Example

• Porter’s Five Forces Model: BMW
• Threat of new entrants
• Very low
• Threat of substitutes
• Medium
• Power of suppliers
• Medium
• Power of buyers
• Medium
• Rivalry among existing firms
• Very High

Source: Developed from www.bmw.com

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The Threat of New Entrants

• Profits of established firms in the industry may be eroded by new competitors
• High entry barriers lead to low threat of new entries
• Economies of scale
• Product differentiation
• Capital requirements
• Switching costs
• Access to distribution channels
• Cost disadvantages independent of scale

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Question

If you are considering opening a new pizza restaurant in your community, what would be the threat of new entrants? How would you evaluate Porter’s other forces for this industry?

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The Bargaining Power of Buyers

Buyers threaten an industry

• Force down prices
• Bargain for higher quality or more services
• Play competitors against each other

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The Bargaining Power of Buyers

• A buyer group is powerful when
• It is concentrated or purchases large volumes relative to seller sales
• The products it purchases from the industry are standard or undifferentiated
• The buyer faces few switching costs
• It earns low profits
• The buyers pose a credible threat of backward integration
• The industry’s product is unimportant to the quality of the buyer’s products or services

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The Bargaining Power of Suppliers

Suppliers can exert power by threatening to raise prices or reduce the quality of purchased goods and services

A supplier group will be powerful when

• The supplier group is dominated by a few companies and is more concentrated than the industry it sells to
• The supplier group is not obliged to contend with substitute products for sale to the industry
• The industry is not an important customer of the supplier group

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A supplier group will be powerful when (cont.)

The supplier’s product is an important input to the buyer’s business

The supplier group’s products are differentiated or it has built up switching costs for the buyer

The supplier group poses a credible threat of forward integration

The Bargaining Power of Suppliers

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The Threat of Substitute
Products and Services

Substitutes limit the potential returns of an industry

Ceiling on the prices that firms in that industry can profitably charge

Price/performance ratio

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The Intensity of Rivalry among
Competitors in an Industry

Jockeying for position

Price competition

Advertising battles

Product introductions

Increased customer service or warranties

Interacting factors lead to intense rivalry

• Numerous or equally balanced competitors
• Slow industry growth
• High fixed or shortage costs
• Lack of differentiation or switching costs
• Capacity augmented in large increments
• High exit barriers

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How the Internet and Digital Technologies Influences Industry

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Using Industry Analyses: A Few Caveats

• Five Forces analysis implicitly assumes a zero-sum game
• Five Forces analysis is essentially a static analysis
• Value net
• Suppliers and customers (the vertical net)
• Substitutes and complements (the horizontal net)

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The Value Net

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Strategic Groups within Industries

• Two unassailable assumptions in industry analysis
• No two firms are totally different
• No two firms are exactly the same
• Strategic groups
• Cluster of firms that share similar strategies
• Breadth of product and geographic scope
• Price/quality
• Degree of vertical integration
• Type of distribution system

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Strategic Groups within Industries

• Value of strategic groups as an analytical tool
• Identify barriers to mobility that protect a group from attacks by other groups
• Identify groups whose competitive position may be marginal or tenuous
• Chart the future direction of firms’ strategies
• Thinking through the implications of each industry trend for the strategic group as a whole

2

Analyzing the External
Environment of the Firm