Capstone Project
EXTERNAL ANALYSIS Reading and Template
In this stage of our analysis, our objective is to understand the major trends and forces that characterize the industry, also referred to as the product-market, in which our focal firms competes. This stage is all about the external environment – the context – and has NOTHING to do with our firm or any specific firm. Don’t let your thinking/focus fall back to the firm here…stay at the INDUSTRY level.
Why do we need to understand the demands and trends external to the firm? Because we must make an assessment of how well a firm’s strategy and internal characteristics align, or fit, with he demands of the market in which they compete. We must know how the character of their industry defines certain key success factors – things producers must have or do. We must also pay attention to how those characteristics may change over time, and more importantly what underlying broad trends will cause such change. By understanding these factors and forces, and by working to ensure our firm’s strategic choices and activities are in line with those variables, we can better achieve strategic alignment and competitive advantage. We can spot opportunities and threats, poor or old choices that need updating, as well as signals of major changes ahead that suggest we need to completely rethink our business.
Up until now, we’ve mostly talked about the firm itself. That is all ‘internal’. But the firm operates in a dynamic environment. It is useful to break this environment into two parts – the task environment and the macro environment. You must step above thinking about your firm or the firm you are analyzing in external analysis. Focus on staying away from thinking at all about any individual firms.
The task environment is what we often call ‘our industry’. This is where the firm interacts with suppliers, customers, competitors, substitutes, etc. Everything here is interdependent, that is, a change in one segment affects the whole task environment system. This can also be thought of as the competitive environment for as you will soon see, all the players in this zone are seeking a share of the ‘value’ available from this market. Navigating the task environment is the core of competitive strategy and the related choices.
The macro environment is a level beyond just the focal industry. Here, there are conditions and forces of change that affect many industries and are virtually one-way influences, that is, firms can usually do little or nothing to change the nature and direction of such forces. These forces cause changes to the task environment over time. Thus navigating the macro environment is all about knowing when and how to adapt to keep up with such changes. Changes here can make once successful strategies and firms obsolete, can open doors for disruptive entrepreneurs to wipe out old dominant firms, and can make it a race among existing firms to see who can adapt most rapidly, efficiently, and effectively to stay in, or move to, the industry leader positions.
THE TASK ENVIRONMENT
FIRST we must get clear on what industry we are analyzing. Defining the industry is critical. Consider the primary products or services your focal firm and its main competitors offer. That often gets you to a good industry definition. (Refer to the sidebar in Porter’s article about how to define the boundaries of an industry). If needed, you can also look up the firm’s NAICS classification and see how they, and their known main rivals, are classified.
Once you are clear on the industry, get clear on the basic characteristics of Producers, Buyers, and Suppliers.
Producers (The rivals/competitors) – the firms that offer the primary industry good/service.
· The firm we are analyzing, “Our Firm”, is one of these. Therefore, the PRODUCER PERSPECTIVE is how we approach all external analysis.
· Don’t name all the rivals but just get clear on what KIND of firms we are talking about here. For example: Are they mostly large, international firms or are there thousands of little mom-and-pop producers? Are producers mostly multi-channel retailers operating with e-commerce and a chain of stores…or are they mostly designers/manufactures who sell to retailers (i.e. wholesale)? Are they mostly franchisors or are there other constants in the business models used in the industry? You just want to have an accurate understanding of what ‘producers’ refers to, generally, in this industry. If it is a mix and there is no ‘general’ character, well, you’ll need to understand that greater complexity. Why – because you will be analyzing ‘producers’ as a whole.
Buyers – the direct buyers or the buyers that truly affect the nature of demand.
· Of course you are not naming them, but in broad terms you should characterize the people or entities that purchase the producers’ goods/services. For example, the retail clothing industry can be segmented better to define product-markets selling to women, men, children, or entire families. The steel industry sells to manufacturers who use steel to make other products. The auto industry sells to franchise retailers, but really focuses on end consumers. (Think back to ‘target customers’ in describing competitive strategy…now just do it at the industry level). Note, like the auto industry, that it can be very useful to understand any ‘two-step’ channels and the degree either or both of those customers (one is direct one is indirect) are really what should be the focus for producer strategy. (example: auto makers focus on the end buyers; the franchise retailers who actually buy the cars are really more of just the conduit through which cars are sold, delivered, and serviced.).
Suppliers – from what types of entities do the producers have to buy their important inputs?
· First think about the major inputs all producers need in this industry. Then describe the ‘types’ of firms that producers must deal with to get those inputs.
Example: For the Movie Theatre industry :
PRODUCERS: Movie Theatre firms (mostly large national chains, but some local specialty operators)
BUYERS: Individuals of all types
SUPPLIERS: * Film studios (major and independent) and their distributors; * Concession product distributors (soft drinks, candy, etc.)
It is really helpful to also get a clear perspective on the NEED BEING MET by the producers. Why does this industry even exist…what is the need that buyers have that the producers or services of producers is designed to meet? Understanding this is CRITICAL to being able to identify substitutes, i.e. alternative ways buyers might be able to get their needs met.
Example: For the Movie Theater industry :
· Why do people go to a movie theater? They want “entertainment”. Substitutes, as we will soon discuss, are all the alternative ways people might go to OTHER industries to buy their entertainment (examples- concerts, video games, streaming movies at home, plays).
Now we need to understand the competitive forces of this industry. The term ‘competitive’ here does NOT mean just the firm and its rivals/competitors. As Porter describes, there are many actors who are competing over the profits (or value) available in any industry.
Take and break here and READ – and STUDY – Porter’s article – The five competitive forces that shape strategy.
HOW TO USE THE FIVE FORCES FRAMEWORK
Recall that you need to approach external analysis from a producer perspective. This is because your firm, or the firm you are analyzing, is one of the PRODUCERS. The firm is already in this industry, so do not approach this as an ‘industry attractiveness’ analysis to see if this would be a good industry to enter. You are already there! Yes, five forces is a great tool for assessing the attractiveness of entry for an firm/entrepreneur, but that is not what we are doing in strategic management. Our objective, recall, is to understand what this industry demands and how it is likely to change so that we can make good strategic choices that lead to superior performance.
Porter details factors you can consider to evaluate if any one of the five forces is ‘strong’ or ‘weak’. That is, strong forces inhibit producers’ ability to make good profits. Strong is bad from the producer perspective. Each of the five forces is competing against our firm for profit. However, some forces are stronger than others. The combined strength of competitive forces dictates a producer’s level of profitability to a large degree.
So how do we use five forces for strategic management?
Think about any competitive context. Each involves some set of ‘key success factors’ that can be identified. These are the things that competitors need to have or do to be successful. Those that have or do more or have or do better than the others are very likely to be those that achieve the best performance. We are not talking about basics here, not ‘survival’ factors; we need to focus of factors that determine success – that lead to competitive advantage and superior performance.
Think now about strong forces in an industry. Strong forces are barriers to producer profits/performance. So, those producers that can best avoid or overcome that force in some way have an advantage. That force doesn’t affect their ability to make profit as negatively as it does lesser rivals. A-HA! Overcoming STRONG forces, therefore, is a key success factor. So, if we can identify the strongest competitive forces in our industry, and identify the underlying reasons those forces are strong, we can identify the barriers producers must minimize or overcome to achieve superior performance – that is “KEY SUCCESS FACTORS”.
Take a break and review the Five Forces Indicator Sheet.
With this worksheet, I’ve taken some of the points Porter raises that determine if a force is strong or weak and I’ve added others from other textbooks and research. There are many indicators related to each force, but this is simplified to cover them main ones and the ones usually easiest to identify. For each indicator, I’ve worded it as a question and the answer to that question helps you assess if that indicator suggests a strong or weak force. From the set of indicators you can then identify which, if any, help you understand why a force is strong and that leads, as you’ll see, to a likely Key Success Factor (KSF).
Work through each question on the worksheet. TAKE YOUR TIME. THINK…A LOT! If you do this poorly your entire external analysis can be significantly flawed!
Use your best judgement based on your knowledge of the industry. If you need, and time permits, you may need to do some research on a topic to get the necessary knowledge to make a good judgement. Often, though, just good logic, basic knowledge, and taking time to be thoughtful about an question can get you to a good judgement on an indicator. Answer yes or no…or get more detailed and think of it as a scale/continuum between absolutely Yes to absolutely No…with room in the middle for ‘don’t know’ or neither yes nor no (yes, this is an acceptable answer).
Having done all indicator questions for a force, review the pattern of the entire set. Are the answers skewed toward Yes or No? As noted at the bottom of the sheet, YES answers suggest a STRONG force…something that limits producer profitability. So if your answers are skewed heavily to YES, then you probably have a STRONG force (mark that conclusion in the box at the right). Obviously, the opposite is true…skewed toward NO suggests a weak force…and a balanced set probably means “Moderate” (and you can again use a range….such as Strong; Moderately Strong; Moderate; Moderately Weak; Weak).
Review your assessment of each of the five forces. You want to prioritize the STRONGEST forces then go back to each and note/highlight which indicators are the most significant causes of that force being strong.
Now review the Five Forces indicator sheet with SUGGESTED KSFs.
Knowing that superior performance is achieved by producers who best overcome or avoid strong forces, we can identify suggested Key Success Factors for each cause of strong forces.
NOTE that Key Success Factors describe the ‘overcoming’ of a force but not the precise method for overcoming it. For example, if the lack of switching costs is a major factor why Buyer Power is strong, then a KSF may be ‘create switching costs’. But there are lots of ways to create switching costs. Our objective here is NOT to define the precise method, but just to identify the broader KSF.
Your conclusion from the five forces analysis will be a list of the suggested Key Success Factors. You should try to prioritize them based on your judgment of the value each has to contributing to competitive advantage. That is, if a producer can only chose one KSF, being the best on which one do you think would deliver the greatest results toward superior performance. And so on…
BUT WAIT… might things in the industry change over the next few years and raise new and different key success factors? YES -
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THE MACRO ENVIROMENT
The world is always changing and that, obviously, means the competitive environment of a firm is always changing. Sure, most of the day-to-day, observable change is all about the maneuvering of firms as they seek to pursue the KSFs and navigate the competitive forces as we just discussed. Beyond the task environment, however, are broader systemic forces that are always evolving. Macro forces are not industry-specific...they are forces that affect multiple industries. They may affect industries in different ways, but the implications for producers in a specific industry are generally the same. While some macro forces are subject to some degree of influence from firms, it is best to assume that macro forces have a one-way influence on industries and the firms within them. That is, these are ‘realities’ that must be faced by firms much like strong competitive forces.
Whereas with strong competitive forces the aim is to make choices that allow a firm to avoid or reduce the negative impact of that force, with macro forces the aim is to identify CHANGES that will affect producers. These changes may be good (opportunities) or bad (threats). Just as the producers who best overcome strong forces are better able to achieve superior profits, producers who more effectively respond to significant changes will also be able to sustain, or achieve, superior performance over the long term. And THAT is the real goal…sustained competitive advantage. Long-term success.
A common framework for understanding the macro environment, and for identifying those forces of change that must be accounted for over the next few years, is the PEST framework.
PEST is an acronym for the four broad dimensions of the macro environment:
Political; Economic: Social; Technological. Some add Environmental and Legal dimensions for a PESTEL view. The point is not to get the right dimensions, but to consider all relevant areas of the macro environment that might cause change for your industry.
This macro analysis is not about the firm or even the specific industry – you are looking for BROAD issues that are certainly relevant to this industry but that also are broad in the effects across multiple industry. A ‘shortage of trained pilots’ is specific to the airline industry so is WRONG. A correct example: ‘Advances in technology for extracting oil (e.g. fracking)’ affects multiple industries in which oil/fuel is a key issue…thus, it is important for airlines as it affects the cost of fuel (a major cost issue!)
Think through each category (Political, Economic, Socio-cultural, and Technological) and use your general knowledge and your research to identify (and list) all the factors and issues you can .
*Remember that is all about identifying things that ARE CHANGING or ARE LIKELY To CHANGE and that will affect CHANGE in the industry we are analyzing. Be specific…do not say a category/dimension is changing…you must specify the issue that is changing (or is likely to change).
Political
· These are factors related to government policy, regulations, and economic interventions. Examples: tax policy; international trade policy (tariffs, etc); employment regulations; international relations/conflicts; immigration etc.
Economic
· These are factors about the general economic conditions. This is NOT about firm or industry economics! Examples: interest rates; inflation; unemployment; economic growth rate (i.e. recession, expansion, depression); consumer confidence; debt levels; etc.
Social
· Social, or sociocultural factors refer to societal variable such as demographics, values, norms, attitudes, and tastes. Examples: aging population; increasing ethnic diversity; increasing acceptance of and freedom for various sexual orientation; increasing concern for the environment; increasing concern for economic inequality; decreasing role of religious beliefs; etc.
Technological
· Factors here are specific technological developments. Examples: genetic engineering; space travel/industry; autonomous vehicles; artificial intelligence; renewable energy; cloud computing; etc.
Remember, the PEST categories are just there to break up the macro environment into manageable dimensions. Unlike the Five Forces framework, some PEST dimensions may be irrelevant / unimportant for a certain industry. For example, there probably isn’t a broad technological development that is affecting demand or producer operations in the dog grooming industry. The objective is NOT to identify forces in each category or the strongest forces in each category. Some dimensions may be irrelevant and the important forces may all be in one dimension. Don’t force to some balance across all four areas!
I suggest you start by creating four columns, one for each of the P E S T dimensions. Now think through what POLITICAL issues are changing or are likely to change in the next 3-5 years. Be sure you stay in the MACRO realm and do not drop into industry-specific issues. Do the same for each dimension. Review your list and see if anything else comes to mind. Try to build a good inventory of issues that are causing or potentially causing change in the near future (3-5 years). Don’t purely speculate and think about all the “what ifs”. Focus on factors where there is at least evidence that change may occur soon. You must be able to make a well-reasoned and justified argument that a change/trend you identify exists or is likely to develop.
Now rank these issues for the focal industry. Evaluate your listed items based on their implications (your judgment) for industry demand and/or producer operations. Ask yourself: To what degree will this change increase or decrease demand for the producers in this industry? To what degree will this change increase or decrease producers’ costs or otherwise affect their operations? Which issues are, or are most likely to, really shake things up….good or bad. We’re looking for threats and opportunities. Remember – this is not about how these might affect a specific firm….these should be issues that affect ALL producers in the industry.
When you have a prioritized list…where you can make your argument for the most important 3-5 broad drivers of change , you now must fully develop them. Clearly describe the issue. Don’t generalize! For example, it is not acceptable to say “ technological change” or even “technological advances will change the way people shop and buy”. You must identify and describe a specific issue AND its implications on demand and/or producer operations. Examples: “the pervasive use of social media is changing where and how people access and consume journalism content” or “the social trend toward delaying marriage and having babies will negatively affect demand for disposable diapers”.
Final - KEY SUCCESS FACTORS
Key success factors (KSFs) are the things that producers need to have or do in order to succeed in their external environment (i.e. to achieve superior performance). There are two major categories:
(1) Battling the strongest competitive forces. What competitive forces and underlying indicator factors must producers avoid, minimize, or overcome in order to achieve superior performance?
This is what you did to conclude the Five Forces analysis.
(2) Adapting to major change. If one or more of your Drivers of Change has significant and highly probable implications for success in the next few years, you might need to argue that adapting to this change will be a critical factors in which producers do well and which do not in the coming years.
This is what you did using PEST.
Now you need to review the combined list form 1 and 2 above and prioritize those KSFs you believe are the most critical issues producers in this industry must have, do, or address to have a superior level of performance in over the next 3-5 years. You do not need to try to equally balance KSFs that relate to strong forces and those that relate to adapting to change. It may be that none of the changes occurring are as critical as overcoming several very strong forces that will persist over time. Or, it may be that the competitive forces are quite weak, but there are significant changes ahead and to be successful producers will need to adapt quickly and significantly. You have to apply your knowledge and best judgment.
Remember that you must be able to justify and argue your conclusion, so be sure you have data and evidence (good reasoning) to back up your final list of prioritized Key Success Factors.
If done completely and effectively, you now have a solid understanding of what a producer firm, like yours or the one you are analyzing, faces and must do to achieve or sustain competitive advantage.