Assignment 1

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Studying this chapter should provide you with the strategic management knowledge needed to:

1. Explain the importance of analyzing and understanding the fi rm’s external environment.

2. Defi ne and describe the general environment and the industry environment.

3. Discuss the four activities of the external environmental analysis process.

4. Name and describe the general environment’s seven segments.

5. Identify the fi ve competitive forces and explain how they determine an industry’s profi t potential.

6. Defi ne strategic groups and describe their infl uence on the fi rm.

7. Describe what fi rms need to know about their competitors and different methods (including ethical standards) used to collect intelligence about them.

CHAPTER 2

The External Environment: Opportunities, Threats, Industry Competition, and Competitor Analysis

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The explosion that led to the subsequent sinking of the oil and gas drilling platform on April 20, 2010, sent ripples not only across the Gulf of Mexico but also had a huge infl uence on BP and its two subcontractors, Transocean and Halliburton. The Deepwater Horizon spill was the largest accidental offshore spill in history, at 206 million gallons. In comparison, the 1989 Exxon Valdez tanker wreck spilled 11.3 million gallons of oil. However, this was not BP’s only

large well-publicized disaster. In 2006 there was an environmental spill in Alaska, and in 2005 there was the largest refi nery explosion in Texas City, Texas, which killed 15 people. These events, especially the Deepwater Horizon disaster, have put BP in the crosshairs not only of regulators and government offi cials but also environmentalists. Furthermore, these events have enabled doubts about its legitimacy with critical stakeholders on Wall Street, and also infl uenced other industry participants (especially in the south- eastern and southwestern states associated with offshore drilling in the Gulf of Mexico) and its customers. One immedi- ate outcome of the disas- ter was the replacement of Tony Hayward, CEO at the time of the disaster, with Robert Dudley, on July 10, 2010. Addition- ally, BP announced a $32 billion charge realized on its 2010 balance sheet relative to past and cur- rent expenses associated with the disaster.

The strategic actions (see Figure 1.1) that BP will take relative to this disaster and to position for future success will be infl uenced by continuing pressures from its external environment. One of the main challenges for the fi rm’s strategic leader (Robert Dudley) is to understand what the external environment’s effects are on the fi rm and to predict how its future strategic actions might lead to success.

In the future, BP and all the other oil and gas fi rms focused on extracting such fuels should expect regulatory change in the political/legal segment of the general environment (the general environment and all of its segments are discussed in this chapter). In August 2010, President Obama appointed a federal commission to investigate the Deepwater Ho- rizon oil spill. Their report, issued in January 2011, concluded that government oversight of the industry needed to be fundamentally reformed and that oil company practices needed to improve dramatically. One co-chairman of that commission, William Reilly, former head of the Environmental Protection Agency, suggested that even with all techniques learned after the Exxon Valdez disaster, and increased technology, the oil capture was rather pathetic; “they collected 5 or 6% of what was spilled.” Because of this oversight commission, along with congressional hearings on the report, it is virtually assured that more regulatory and safety inspections of offshore drilling platforms and operations will be undertaken, both from a company standpoint and the government agency responsible for such inspections, the Bureau of Ocean Energy Management, Regulation and Enforcement (BOEMRE). Cer- tainly one of the effects is that regulation of drilling permits has become more intense, and in fact, very few have been approved since the Deepwater Horizon disaster.

The economic segment of the general environment will continue to produce demand for energy, especially with the rise of emerging markets such as China and India, thus exploration for hydrocarbon products will continue. Although demand for energy will

BRITISH PETROLEUM (BP) AND ITS

ENVIRONMENT: HOW THE DEEPWATER

HORIZON OFFSHORE DRILLING PLATFORM

DISASTER IS SHAPING ITS STRATEGY

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As described in the Opening Case and suggested by research, the external environment affects a firm’s strategic actions.1 For example, British Petroleum (BP) seeks to expand its oil reserves after the Deepwater Horizon oil and gas drilling platform disaster in the Gulf of Mexico by forming joint ventures in Russia with Rosneft Corporation, and in India with Reliance Industries.2 In addition, it is clear that BP’s strategic actions are affected by conditions in other segments of its general environment, such as the political/legal, social/cultural, and physical environment segments. As we explain in this chapter, a firm’s external environment creates both opportunities (e.g., the opportunity for BP to enter other global markets) and threats (e.g., the possibility that additional regulations in its markets will reduce opportunities to extract oil and gas). Collectively, opportunities and threats affect a firm’s strategic actions.3

persist, the pressure to use alternative sources of energy will be driven by the sociocul- tural segment of the environment because of the carbon emissions produced by such hydrocarbons. However, the demand for energy and the slowdown in the economy seems to have swamped the possible passage of any CO

2 emission legislation, which is needed for

our long-term future and health. Technology increases have also affected many companies in this industry. Gas drilling

and fracturing have dramatically increased gas reserves and may provide a substitute for other CO

2 emission-producing products such as coal. Coal is said to produce about 25 per-

cent of the CO 2 emissions in the United States.

The dramatic earthquake in Sendai, Japan at 9.0 on the Richter scale, and the subsequent tsunami has also created questions relative to a critical substitute energy source, nuclear power. Infl uence from the physical environment produced the problems seen in Japan. This infl uence created a disaster despite the fact that the Japanese have been very careful in regard to con- structing “safe” plants. The physical environment has an infl uence in the Gulf of Mexico, where drillers have suggested that natural pressure in the Gulf has realized more accidents compared to offshore reserves in the North Sea and Brazil, where deep water reserve pressures are lower.

BP has tried to rectify problems in the Gulf of Mexico by forming additional joint ventures in the global arena. A recent venture with Rosneft Corporation, which is similar to an existing Russian venture with other partners, has recently been proposed. If the deal goes through, BP would help Rosneft explore opportunities in the arctic region. “Rosneft insisted on a share swap, giving the Kremlin-controlled company a 5 percent stake in BP in exchange for 9.4 percent of Rosneft.” Similarly, BP has formed a $7.2 billion investment with an Indian partner, Reliance Industries, giving it a 30 percent stake in oil and gas fi elds off the east coast and possibly as large as those found in the North Sea. These deals signal the importance of the global segment of the external environment with which BP and other integrated oil fi rms have to deal with when contending with scarce reserves. The Russian reserves are 10 years away from producing. Not only do large integrated energy fi rms such as BP have to source energy globally, they also need to transport, refi ne, and distribute it through global partner- ships, both internal and external, to the company.

As the BP example shows, assessing the infl uence of various segments of the external environment is critical in assuring future success for any fi rm. This is especially true for energy fi rms, which are part of a global integrated process of extracting energy, refi n- ing various products, and distributing them around the world. The rise of China and India coupled with the rise of Brazil as an energy power and Russia’s historic energy reserves portends to their signifi cant infl uence in world markets. Understanding how these complex processes work and how to deal with these segments of the external environment are criti- cal in formulating strategies to be successful in such global environmental forces.

Sources: 2011, Business: Dancing with bears, BP in Russia, The Economist, February 5, 73; J. Ball, 2011, Environment (special report)—lessons from the gulf—William Reilly on why the oil spill happened, and where the industry goes from here, Wall Street Journal, March 7, R5; P. Elkind, D. Whitford, and D. Burke, 2011, An accident waiting to happen, Fortune, February 7, 105–132; P. Hunter and P. Russell, 2011, Capitol hill views divided on oil- spill report, Engineering News-Record, February 7, 7; A. Peaple, 2011, Reshaped BP fi nds east is no Eden, Wall Street Journal, February 23, C14; R. Gold, 2010, Halliburton faulted over cement job, Wall Street Journal, www .wsj.com, September 9; J. Weisman, 2010, BP softens political hit, Wall Street Journal, www.wsj.com, June 21.

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Regardless of the industry in which they compete, the external environment influ- ences firms as they seek strategic competitiveness and above-average returns. This chap- ter focuses on how firms analyze their external environment. The understanding of conditions in its external environment that the firm gains by analyzing that environment is matched with knowledge about its internal organization (discussed in the next chapter) as the foundation for forming the firm’s vision, developing its mission, and identifying and implementing strategic actions (see Figure 1.1).

As noted in Chapter 1, the environmental conditions in the current global economy differ from historical conditions. For example, technological changes and the continuing growth of information gathering and processing capabilities increase the need for firms to develop effective competitive actions on a timely basis.4 (In slightly different words, firms have little time to correct errors when implementing their competitive actions.) The rapid sociological changes occurring in many countries affect labor practices and the nature of products demanded by increasingly diverse consumers. Governmental policies and laws also affect where and how firms choose to compete.5 In addition, changes to nations’ financial regulatory systems that were enacted in 2010 and beyond are expected to increase the complexity of organizations’ financial transactions.6

Viewed in their totality, the conditions that affect firms today indicate that for most organizations, their external environment is filled with uncertainty. To successfully deal with this uncertainty and to achieve strategic competitiveness and thrive, firms must be aware of and fully understand the different segments of the external environment.7

Firms understand the external environment by acquiring information about competi- tors, customers, and other stakeholders to build their own base of knowledge and capa- bilities.8 On the basis of the new information, firms take actions, such as building new capabilities and core competencies, in hopes of buffering themselves from any negative environmental effects and to pursue opportunities as the basis for better serving their stake- holders’ needs.9 A firm’s strategic actions are influenced by the conditions in the three parts (the general, industry, and competitor) of its external environment (see Figure 2.1).

Figure 2.1 The External Environment

General Environment

Economic

Technological

Sociocultural

Physical

Political/Legal

Demographic

Industry Environment

Threat of New Entrants Power of Suppliers

Power of Buyers Product Substitutes Intensity of Rivalry

Competitor Environment

Global

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The General, Industry, and Competitor Environments The general environment is composed of dimensions in the broader society that influ- ence an industry and the firms within it.10 We group these dimensions into seven envi- ronmental segments: demographic, economic, political/legal, sociocultural, technological, global, and physical. Examples of elements analyzed in each of these segments are shown in Table 2.1.

Firms cannot directly control the general environment’s segments. The recent bank- ruptcy filings by General Motors and Chrysler Corporation highlight this fact. These firms could not directly control various parts of their external environment, including the economic and political/legal segments; however, these segments are influencing the actions the firms are taking, including Chrysler’s alliance with Fiat.11 Because firms can- not directly control the segments of their external environment, successful ones learn how to gather the information needed to understand all segments and their implications for selecting and implementing the firm’s strategies.

The industry environment is the set of factors that directly influences a firm and its competitive actions and responses:12 the threat of new entrants, the power of suppliers, the power of buyers, the threat of product substitutes, and the intensity of rivalry among competitors. In total, the interactions among these five factors determine an industry’s profit potential; in turn, the industry’s profit potential influences the choices each firm makes about its strategic actions. The challenge for a firm is to locate a position within an industry where it can favorably influence the five factors or where it can successfully defend against their influence. The greater a firm’s capacity to favorably influence its industry environment, the greater the likelihood that the firm will earn above-average returns.

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Demographic segment • Population size • Age structure • Geographic distribution

• Ethnic mix • Income distribution

Economic segment • Infl ation rates • Interest rates • Trade defi cits or surpluses • Budget defi cits or surpluses

• Personal savings rate • Business savings rates • Gross domestic product

Political/Legal segment • Antitrust laws • Taxation laws • Deregulation philosophies

• Labor training laws • Educational philosophies and policies

Sociocultural segment • Women in the workforce • Workforce • Diversity • Attitudes about the quality of work life

• Shifts in work and career preferences • Shifts in preferences regarding product and

service characteristics

Technological segment • Product innovations • Applications of knowledge

• Focus of private and government-supported R&D expenditures

• New communication technologies

Global segment • Important political events • Critical global markets

• Newly industrialized countries • Different cultural and institutional attributes

Physical environment segment

• Energy consumption • Practices used to develop energy sources • Renewable energy efforts • Minimizing a fi rm’s environmental footprint

• Availability of water as a resource • Producing environmentally friendly products • Reacting to natural or man-made disasters

Table 2.1 The General Environment: Segments and Elements

The general environment is composed of dimensions in the broader society that infl uence an industry and the fi rms within it.

The industry environment is the set of factors that directly infl uences a fi rm and its competitive actions and competitive responses: the threat of new entrants, the power of suppliers, the power of buyers, the threat of product substitutes, and the intensity of rivalry among competitors.

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How companies gather and interpret information about their competitors is called competitor analysis. Understanding the firm’s competitor environment complements the insights provided by studying the general and industry environments.13 This means, for example, that BP wants to learn as much as it can about its major competitors—such as Exxon-Mobil and Royal Dutch Shell plc—while also learning about its general and industry environments.

Analysis of the general environment is focused on environmental trends while an analysis of the industry environment is focused on the factors and conditions influenc- ing an industry’s profitability potential and an analysis of competitors is focused on predicting competitors’ actions, responses, and intentions. In combination, the results of these three analyses influence the firm’s vision, mission, and strategic actions. Although we discuss each analysis separately, performance improves when the firm integrates the insights provided by analyses of the general environment, the industry environment, and the competitor environment.

External Environmental Analysis Most firms face external environments that are highly turbulent, complex, and global— conditions that make interpreting those environments difficult.14 To cope with often ambiguous and incomplete environmental data and to increase understanding of the general environment, firms engage in external environmental analysis. This analysis has four parts: scanning, monitoring, forecasting, and assessing (see Table 2.2). Analyzing the external environment is a difficult, yet significant, activity.15

Identifying opportunities and threats is an important objective of studying the general environment. An opportunity is a condition in the general environment that, if exploited effectively, helps a company achieve strategic competitiveness. For example, recent market research results suggested to Procter & Gamble (P&G) after its acquisition of Gillette, a shaving products company, that an increasing number of men across the globe are interested in fragrances and skin care products. To take advantage of this opportunity, P&G is reorienting toward beauty products to better serve both men and women. The change constitutes an organization change focused on combining product categories rather than its typical organization around a specific branded product.16

A threat is a condition in the general environment that may hinder a company’s efforts to achieve strategic competitiveness.17 Microsoft is currently experiencing a severe external threat as smartphones are expected to surpass personal computer (PC) sales in the near future. Although Microsoft has a smartphone operating system, Apple, Google, and Research in Motion (BlackBerry phones) have operating platforms that are much more popular than those using Microsoft’s platform. Although PC growth will continue to expand, it is not growing at the rate that smartphones are, and possible substitution may happen between PCs, smartphones, and additional devices, such as Apple’s iPad and

Scanning • Identifying early signals of environmental changes and trends

Monitoring • Detecting meaning through ongoing observations of environmental changes and trends

Forecasting • Developing projections of anticipated outcomes based on monitored changes and trends

Assessing • Determining the timing and importance of environmental changes and trends for fi rms’ strategies and their management

Table 2.2 Components of the External Environmental Analysis

An opportunity is a condition in the general environment that if exploited effectively, helps a company achieve strategic competitiveness.

A threat is a condition in the general environment that may hinder a company’s efforts to achieve strategic competitiveness.

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ts similar devices. The main software platform is needed to assure other software producers will develop applications for the platform. Apple has large numbers of applications being developed, and Google’s Android system software applications are rapidly increasing as well. As such, Microsoft is in a severe catch-up position relative to its competition. It recently formed a joint venture with Nokia Corporation to establish a firmer platform for its existing software using Nokia’s large potential smartphone base. However, this threat remains until this opportunity is realized.18

Firms use several sources to analyze the general environment, including a wide variety of printed materials (such as trade publications, newspapers, business publications, and the results of academic research and public polls), trade shows and suppliers, customers, and employees of public-sector organizations. People in boundary-spanning positions can obtain a great deal of this type of information. Salespersons, purchasing managers, public relations directors, and customer service representatives, each of whom interacts with external constituents, are examples of boundary-spanning positions.

Scanning Scanning entails the study of all segments in the general environment. Through scanning, firms identify early signals of potential changes in the general environment and detect changes that are already under way.19 Scanning often reveals ambiguous, incomplete, or unconnected data and information. Thus, environmental scanning is challenging but critically important for firms, especially those competing in highly volatile environ- ments.20 In addition, scanning activities must be aligned with the organizational context; a scanning system designed for a volatile environment is inappropriate for a firm in a stable environment.21

Many firms use special software to help them identify events that are taking place in the environment and that are announced in public sources. For example, news event detection uses information-based systems to categorize text and reduce the trade-off between an important missed event and false alarm rates.22 The Internet provides significant opportunities for scanning. Amazon.com, for example, records significant information about individuals visiting its Web site, particularly if a pur- chase is made. Amazon then welcomes these customers by name when they visit the Web site again. The firm sends messages to customers about specials and new prod- ucts similar to those they purchased in previous visits. A number of other companies such as Netflix also collect demographic data about their customers in an attempt to identify their unique preferences (demographics is one of the segments in the general environment).

Philip Morris International continuously scans segments of its external environ- ment to detect current conditions and to anticipate changes that might take place in different segments. For example, PMI always studies various nations’ tax policies on cigarettes (these policies are part of the political/legal segment). The reason for this is that raising cigarette taxes might reduce sales while lowering these taxes might increase sales.

Monitoring When monitoring, analysts observe environmental changes to see if an important trend is emerging from among those spotted through scanning.23 Critical to successful moni- toring is the firm’s ability to detect meaning in environmental events and trends. For example, Tesco, the United Kingdom’s largest retailer, plans to add Turkish, Sri Lankan, Latin, Filipino, African, and South African cuisine to its food offerings. One analyst noted, “Britain has become one of the most ethnically diverse nations on earth, and there is a very strong, growing demand by those who have settled here to buy food from their homelands.”24 Tesco already sells Asian, Oriental, Afro-Caribbean, Kosher, Polish, and Halal foods. Continual monitoring of these trends is necessary for a large retailer such as Tesco to maintain the right balance among its products.

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Effective monitoring requires the firm to identify important stakeholders and under- stand its reputation among these stakeholders as the foundation for serving their unique needs.25 (Stakeholders’ unique needs are described in Chapter 1.) Scanning and monitoring are particularly important when a firm competes in an industry with high technological uncertainty.26 Scanning and monitoring can provide the firm with information; they also serve as a means of importing knowledge about markets and about how to successfully commercialize new technologies the firm has developed.27

Forecasting Scanning and monitoring are concerned with events and trends in the general environ- ment at a point in time. When forecasting, analysts develop feasible projections of what might happen, and how quickly, as a result of the changes and trends detected through scanning and monitoring.28 For example, analysts might forecast the time that will be required for a new technology to reach the marketplace, the length of time before differ- ent corporate training procedures are required to deal with anticipated changes in the composition of the workforce, or how much time will elapse before changes in govern- mental taxation policies affect consumers’ purchasing patterns.

Forecasting events and outcomes accurately is challenging. Forecasting demand for new technological products is difficult because technology trends are continually driving product life cycles shorter. This is particularly difficult for a firm like Intel, whose prod- ucts go into many customers’ technological products, which are consistently updated. Increasing the difficulty, each new wafer fabrication or silicone chip technology produc- tion plant that Intel invests in becomes significantly more expensive for each generation of chip products. Having tools that allow better forecasting of electronic product demand is increasingly important.29

During an economic downturn, forecasting becomes more difficult and more impor- tant. For example, Procter & Gamble (P&G), Unilever, and Colgate-Palmolive, which primarily sell branded products, have been pushed by retailers to lower their prices, while at the same time these retailers are selling lower-priced, private-label goods. Thus, these consumer product companies are forecasting the effects of the two trends noted as they seek to project demand. Fortunately, these consumer product companies are seeing demand increase for branded products as the economy improves.30

Assessing The objective of assessing is to determine the timing and significance of the effects of envi- ronmental changes and trends that have been identified.31 Through scanning, monitoring, and forecasting, analysts are able to understand the general environment. Going a step fur- ther, the intent of assessment is to specify the implications of that understanding. Without assessment, the firm is left with data that may be interesting but of unknown competitive relevance. Even if formal assessment is inadequate, the appropriate interpretation of that information is important.

How accurate senior executives are concerning their competitive environments may be less important for strategy and corresponding organizational changes than correctly interpreting environmental trends. Thus, although gathering and organizing information is important, appropriately interpreting that intelligence to determine if an identified trend in the external environment is an opportunity or threat is paramount.32

Segments of the General Environment The general environment is composed of segments that are external to the firm (see Table 2.1). Although the degree of impact varies, these environmental segments affect all industries and the firms competing in them. The challenge to each firm is to scan, monitor, forecast, and assess the elements in each segment to determine their effects on

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ts the firm. Effective scanning, monitoring, forecast- ing, and assessing are vital to the firm’s efforts to recognize and evaluate opportunities and threats.

The Demographic Segment The demographic segment is concerned with a population’s size, age structure, geographic dis- tribution, ethnic mix, and income distribution.33 Demographic segments are commonly analyzed on a global basis because of their potential effects across countries’ borders and because many firms compete in global markets.

Population Size The world’s population doubled (from 3 billion to 6 billion) between 1959 and 1999. Current projec- tions suggest that population growth will continue in the twenty-first century, but at a slower pace.

The U.S. Census Bureau projects that the world’s population will be 9 billion by 2040.34 By 2050, India is expected to be the most populous nation in the world (with over 1.8 billion people). China, the United States, Indonesia, and Pakistan are predicted to be the next four most populous nations in 2050. Firms seeking to find growing markets in which to sell their goods and services want to recognize the market potential that may exist for them in these five nations.

While observing the population of different nations and regions of the world, firms also want to study changes occurring within different populations to assess their strategic implications. For example, in 2011, 23 percent of Japan’s citizens were 65 or older, while the United States and China will not reach this level until 2036.35 Aging populations are a significant problem for countries because of the need for workers and the burden of funding retirement programs. In Japan and other countries, employees are urged to work longer to overcome these problems. Interestingly, the United States has a higher birthrate and significant immigration, placing it in a better position than Japan and other European nations.

Age Structure As noted earlier, in Japan and other countries, the world’s population is rapidly aging. In North America and Europe, millions of baby boomers are approaching retirement. However, even in developing countries with large numbers of people under the age of 35, birth rates have been declining sharply. In China, for example, by 2040 there will be more than 400 million people over the age of 60. The more than 90 million baby boom- ers in North America may postpone retirement given the recent financial crisis. In fact, data now suggest that baby boomers (those born between 1946 and 1965) are struggling to meet their retirement goals and are uncertain if they will actually be able to retire as originally expected. This is partly because of declines in the value of their homes as well as declines in their other retirement investments—a number of baby boomers “are being forced to postpone retirement, find cheaper housing, and cut living expenses” due to a decline in their retirement assets between 2007 and 2009.36 The possibility of future declines is creating uncertainty for baby boomers about how to invest and when they might be able to retire.37 On the other hand, delayed retirements by baby boomers with value-creating skills may facilitate firms’ efforts to successfully implement their strate- gies. Moreover, delayed retirements may allow companies to think of creative ways for skilled, long-time employees to impart their accumulated knowledge to younger employ- ees as they work a bit longer than originally anticipated.

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The demographic segment is concerned with a population’s size, age structure, geographic distribution, ethnic mix, and income distribution.

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Geographic Distribution For decades, the U.S. population has been shifting from the north and east to the west and south. Firms should consider the effects of this shift in demographics as well.38 For example, Florida is the U.S. state with the largest percentage of its population (17.6 per- cent) 65 years or older. Thus, companies providing goods and services that are targeted to senior citizens might pay close attention to this group’s geographic preference for states in the south (such as Florida) and the southwest (such as Texas). Similarly, the trend of relocating from metropolitan to nonmetropolitan areas continues in the United States. These trends are changing local and state governments’ tax bases. In turn, business firms’ decisions regarding location are influenced by the degree of support that different taxing agencies offer as well as the rates at which these agencies tax businesses.

Geographic distribution patterns are not identical throughout the world. For exam- ple, in China, 60 percent of the population lives in rural areas; however, the growth is in urban communities such as Shanghai (with a current population in excess of 18 million) and Beijing (over 15 million). These data suggest that firms seeking to sell their products in China should recognize the growth in metropolitan areas rather than in rural areas. Larger cities are expected to generate more growth in GDP per person than smaller cities and also attract more human capital—people with talent to produce economic growth.39

Ethnic Mix The ethnic mix of countries’ populations continues to change. For example, Hispanics are now the largest ethnic minority (16 percent) in the United States, representing more than 50 million of the total U.S. population of 308 million.40 In fact, the U.S. Hispanic market is the third largest “Latin American” economy behind Brazil and Mexico. Spanish is now the dominant language in parts of U.S. states such as Texas, California, Florida, and New Mexico. Given these facts, some firms might want to assess the degree to which their goods or services could be adapted to serve the unique needs of Hispanic consum- ers. This is particularly appropriate for companies competing in consumer sectors such as grocery stores, movie studios, financial services, and clothing stores.

Changes in the ethnic mix also affect a workforce’s composition. In the United States, for example, the population and labor force will continue to diversify, as immigration accounts for a sizable part of growth. Projections are that the combined Latino and Asian population shares will increase to more than 20 percent of the total U.S. population by 2014. Interestingly, much of this immigrant workforce is bypassing high-cost coastal cities and settling in smaller rural towns. Many of these workers are in low-wage, labor- intensive industries such as construction, food service, lodging, and landscaping. For this reason, if border security is tightened, these industries will likely face labor shortages. In addition, well-trained medical and technical personnel have difficulties migrating to the United States even when their skills are in demand. U.S. migration policies have not maintained the same fluidity as global trade agreements; U.S. trade policies have been liberalized while U.S. immigration policies have been tightened.41

Income Distribution Understanding how income is distributed within and across populations informs firms of different groups’ purchasing power and discretionary income. Studies of income distributions suggest that although living standards have improved over time, varia- tions exist within and between nations.42 Of interest to firms are the average incomes of households and individuals. For instance, the increase in dual-career couples has had a notable effect on average incomes. Although real income has been declining in general in some nations, the household income of dual-career couples has increased, especially in the United States. These figures yield strategically relevant information for firms. For instance, research indicates that whether an employee is part of a dual-career couple can strongly influence the willingness of the employee to accept an international assignment. However, because of the worldwide economic downturn, many companies were still

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ts pursuing international assignments but changing them to avoid some of the additional costs of funding expatriates abroad.43

The growth of the economy in China has drawn many firms, not only for the low-cost production, but also because of the large potential demand for products, given its large population base. However, the amount of China’s gross domestic product that makes up consumption is the lowest of any major economy at less than one-third. In com- parison, India’s domestic consumption of consumer goods accounts for two-thirds of its economy, or twice China’s level. As such, many western multinationals are considering entering India as a consumption market as its middle class grows extensively. Although India as a nation has poor infrastructure, its consumers are in a far better position to spend. Furthermore, the urban-rural income difference has been declining in India more rapidly than in China. Because of situations like this, paying attention to the differences between markets based on income distribution can be very important.44 Of course, the recent global financial crisis may affect the size of the world’s “middle class.”

The Economic Segment The economic environment refers to the nature and direction of the economy in which a firm competes or may compete.45 In general, firms seek to compete in relatively stable economies with strong growth potential. Because nations are interconnected as a result of the global economy, firms must scan, monitor, forecast, and assess the health of their host nation and the health of the economies outside their host nation.

As firms compete during the second decade of the twenty-first century, the world’s economic environment is quite uncertain. Some businesspeople are even beginning to question the ability of economists to provide valid and reliable predictions about trends to anticipate in the world’s economic environment.46 The lack of confidence in predic- tions from those specializing in providing such predictions complicates firms’ efforts to understand the conditions they might face during future competitive battles.

In terms of specific economic environments, companies competing in Japan or desir- ing to do so might carefully evaluate the economic impact of the earthquake, subsequent tsunami, and radiation leaks at the nuclear power generation plants in Sendai.47 Although the crisis in Japan is country specific, its ripple effects have been felt around the globe. For example, many industries that source inputs from Japan, such as electronic gear and auto parts, have had to close plants for short periods due to lack of critical inputs.

Because of its acknowledged economic growth, a number of companies are evaluat- ing the possibility of entering Russia to compete or, for those already competing in that nation, to expand the scope of their operations. However, “there is no denying that doing business in Russia is not for the faint at heart.” 48 This unique, challenging, and sometimes difficult-to-understand business environment presents significant risks in doing business in Russia. This challenging environment can also be an advantage because it serves as an entry barrier to limit the number of companies willing to enter and learn how to operate effectively to reap the returns. Another country with growth opportunities is Vietnam, as firms across the globe take note of how their government reforms and economic decen- tralization are creating opportunities for investment for sourcing, as well as their develop- ing consumer market.49

The Political/Legal Segment The political/legal segment is the arena in which organizations and interest groups compete for attention, resources, and a voice in overseeing the body of laws and regu- lations guiding interactions among nations as well as between firms and various local governmental agencies.50 Essentially, this segment represents how organizations try to influence governments and how they try to understand the influences (current and pro- jected) of those governments on their strategic actions.

When regulations are formed in response to new laws that are legislated (e.g., the  Sarbanes-Oxley Act dealing with corporate governance—see Chapter 10 for more

The economic environment refers to the nature and direction of the economy in which a fi rm competes or may compete.

The political/legal segment is the arena in which organizations and interest groups compete for attention, resources, and a voice in overseeing the body of laws and regulations guiding interactions among nations as well as between fi rms and various local governmental agencies.

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information), they often influence a firm’s strategic actions. For example, less-restrictive regulations on firms’ actions are a product of the recent global trend toward privatization of government-owned or government-regulated firms. Much privatization in recent years has been driven by government budget concerns and the need to raise funds by selling government owned firms to reduce deficits.51 Some believe that the transformation from state-owned to private firms occurring in multiple nations has substantial implications for the competitive landscapes in a number of countries and across multiple industries.52

Firms must carefully analyze a new political administration’s business-related poli- cies and philosophies. Antitrust laws, taxation laws, industries chosen for deregulation, labor training laws, and the degree of commitment to educational institutions are areas in which an administration’s policies can affect the operations and profitability of indus- tries and individual firms across the globe. For example, President Obama’s administra- tion has sought to pursue policies with the intention of reducing the amount of work U.S. companies outsource to firms. This policy could affect information technology out- sourcing firms based in countries such as India. When President Obama visited India in 2010, he bypassed visiting Bangalore, which is an outsourcing and technology center and economic hotspot in India.53 The introduction of legislation in the U.S. Congress during the early tenure of the Obama administration suggested at least some support for these stated intentions. However, the legislation has not been enacted and has less likelihood of passing since the 2010 midterm elections.54

To deal with issues such as those we are describing, firms develop a political strategy to influence governmental policies that might affect them. Some argue that develop- ing an effective political strategy is essential to the restructured General Motors’ efforts to achieve strategic competitiveness since it received government funding during the economic downturn. In addition, the effects of global governmental policies (e.g., those related to firms in India that are engaging in IT outsourcing work) on a firm’s competi- tive position increase the need for firms to form an effective political strategy.55

Firms competing in the global economy encounter an interesting array of political/ legal questions and issues. For example, the European sovereign-debt crisis has destabi- lized the European Union. Starting with Greece and moving on to Ireland, Portugal, and Spain, economies weakened by large public debt burdens have caused fiscal policies to be much more restrictive, and still government debt is at sky-high levels which increases bond rates.56 The debt crisis has put many banks at risk and discourages investment because con- sumer consumption is likely to be limited. Another crisis in the Middle East and through- out the Arab world is the political revolutions in country after country demanding political reform. Starting with Tunisia and proceeding to Egypt, Libya, Bahrain, Syria, and other states in the region, there is significant turmoil, which has cre- ated significantly increased world oil prices.57 These are political events which create uncertainty in the world’s business affairs and make decision making more difficult.

The Sociocultural Segment The sociocultural segment is concerned with a society’s atti- tudes and cultural values. Because attitudes and values form the cornerstone of a society, they often drive demographic, economic, political/legal, and technological conditions and changes.

Societies’ attitudes and cultural values appear to be undergoing possible changes at the start of the second decade of the twenty-first century. In the United States, attitudes and values about health care are an area in which sociocultural changes might occur. Specifically, while the United States has the highest overall health care expen- diture as well as the highest expenditure per capita of any country in the world, millions of the nation’s citizens lack health insurance. Although health care reform legislation was passed in the early part

The sociocultural segment is concerned with a society’s attitudes and cultural values.

Caption to come, caption to come, caption to come, Caption to come, caption to come, caption to come

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ts of the Obama administration, it continues to be a bone of contention—especially since the 2010 midterm elections—with attempts made to repeal it and many states filing lawsuits.58 Continuing changes to the nature of health care policies can have a significant effect on busi- ness firms,59 so they must carefully examine trends regarding health care in order to anticipate the effects on their operations.

As the U.S. labor force has increased, it has become more diverse, as significantly more women and minorities from a variety of cultures enter the workplace. In 1993, the total U.S. workforce was slightly less than 130 million; in 2005, it was slightly greater than 148 million. It is predicted to grow to more than 192 million by 2050. In the same year, 2050, the U.S. workforce is forecast to be composed of 48 percent female workers, 11 percent Asian American workers, 14 percent African American workers and 24 percent Hispanic workers.60 The growing gender, ethnic, and cultural diversity in the workforce creates challenges and opportunities, including combining the best of both men’s and women’s traditional leadership styles. Although diversity in the workforce has the poten- tial to improve performance, research indicates that management of diversity initiatives is required in order to reap these organizational benefits. Human resource practitioners are trained to successfully manage diversity issues to enhance positive outcomes.61

Another manifestation of changing attitudes toward work is the continuing growth of contingency workers (part-time, temporary, and contract employees) throughout the global economy. This trend is significant in several parts of the world, including Canada, Japan, Latin America, Western Europe, and the United States. In the United States, the fastest growing group of contingency workers is those with 15 to 20 years of work experi- ence. The layoffs resulting from the recent global crisis and the loss of retirement income of numerous “baby boomers”—many of whom feel they must work longer to recover losses to their retirement portfolios—are a key reason for this. Companies interested in hiring on a temporary basis may benefit by gaining access to the long-term work experiences of these newly available workers. Also, temporary workers are the first to be employed as the economy revives after a downturn.62

Although the lifestyle and workforce changes referenced previously reflect the values of the U.S. population, each country and culture has unique values and trends. National cultural values affect behavior in organizations and thus also influence organizational outcomes such as differences in CEO compensation.63 Likewise, the national culture influences to a large extent the internationalization strategy that firms pursue relative to one’s home country.64 Knowledge sharing is important for dispersing new knowledge in organizations and increasing the speed in implementing innovations. Personal relation- ships are especially important in China as guanxi (personal connections) has become a way of doing business within the country and for individuals to advance their careers in what is becoming a more open market society. Understanding the importance of guanxi is critical for foreign firms doing business in China.65

The Technological Segment Pervasive and diversified in scope, technological changes affect many parts of societ- ies. These effects occur primarily through new products, processes, and materials. The technological segment includes the institutions and activities involved in creating new knowledge and translating that knowledge into new outputs, products, processes, and materials. Given the rapid pace of technological change and risk of disruption, it is vital for firms to thoroughly study the technological segment.66 The importance of these efforts is suggested by the finding that early adopters of new technology often achieve higher market shares and earn higher returns. Thus, both large and small firms should continu- ously scan the external environment to identify potential substitutes for technologies that are in current use, as well as to identify newly emerging technologies from which their firm could derive competitive advantage.67

As a significant technological development, the Internet has become a remarkable capability to provide information easily, quickly, and effectively to an ever-increasing

The technological segment includes the institutions and activities involved with creating new knowledge and translating that knowledge into new outputs, products, processes, and materials.

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percentage of the world’s population. Companies continue to study the Internet’s capa- bilities to anticipate how it may allow them to create more value for customers in the future and to anticipate future trends.

In spite of the Internet’s far-reaching effects, wireless communication technology is becoming the next significant technological opportunity for companies to apply when pursuing strategic competitiveness. Handheld devices and other wireless communi- cations equipment are used to access a variety of network-based services. The use of handheld computers with wireless network connectivity, Web-enabled mobile phone handsets, and other emerging platforms (e.g., consumer Internet-access devices such as the iPhone and iPad) has increased substantially and should soon become the dominant form of communication and commerce.68

For example, eBay’s iPhone application has become “by far the largest m[mobile]- commerce application in the world,” going from $600 million in volume in 2009 to between $1.5 billion and $2 billion in 2010.69 Amazon’s Kindle is not only a reader but also provides access to the Internet. With each new version of mobile devices such as the iPhone, iPad, and Kindle, amazing additional functionalities and software applications are added.

The Global Segment The global segment includes relevant new global markets, existing markets that are changing, important international political events, and critical cultural and institutional characteristics of global markets.70 There is little doubt that markets are becoming more global and that consumers as well as companies throughout the world accept this fact. Consider the automobile industry. The global auto industry is one in which an increasing number of people believe that because “we live in a global community,” consumers in multiple nations are willing to buy cars and trucks “from whatever area of the world.”71

When studying the global segment, firms (including automobile manufacturers) should recognize that globalization of business markets may create opportunities to enter new markets as well as threats that new competitors from other economies may also enter their market. This is both an opportunity and a threat for the world’s automobile manu- facturers—worldwide production capacity is now a potential threat to all global companies where entering another market to sell a company’s products appears to be an opportunity. In China, for example, even though car sales surged 37 percent in 2010, it is expected that by 2015 they will reach production overcapacity and have a glut of extra cars. Because of the global economic slowdown, in order to increase sales many car companies want to enter foreign markets. This has led to overcapacity worldwide. To add to the problem in China, labor unions have organized strikes to demand higher wages. For example at Toyota Motor Corporation and Honda Motor Corporation, as young workers coming from rural areas into urban areas are settling down to permanent work, they expect higher wages. This signals that China is no longer a “bargain-basement market for placid workers.” This is especially problematic for foreign automakers because by 2017 J. D. Power projects Chinese brands will count for 45 percent of the country’s passenger-vehicle market.72

The markets from which firms generate sales and income are one indication of the degree to which they are participating in the global economy. For example, H. J. Heinz Company, a large global food producer, is acquiring a stake in Coniexpress S. A. Industrias Alimenticias, a leading Brazilian manufacturer of tomato-based products, ketchup, condiments, and veg- etables. The full fiscal year 2011, which ends April 27, is expected to have a sales growth of 2 to 3 percent, while sales in emerging economies such as its Asia-Pacific area grew 16.8 percent and the rest of the world outside its main North-American group grew 14.5 percent. Thus, much of Heinz’s sales growth and its profit margins are coming from emerging mar- kets.73 Likewise, much of SABMiller’s growth in beer is coming from emerging economies. For example, at the 2010 World Cup, its purchase of Castle Lager allowed it to sell an extra 30 million bottles. Similar acquisitions of India’s Narang and Columbia’s Bavaria brands are part of its $17 billion string of acquisitions since 1999, leading to its increased sales growth in emerging markets.74 Citigroup’s CEO, Vikram S. Pandit, has steered his large financial

The global segment includes relevant new global markets, existing markets that are changing, important international political events, and critical cultural and institutional characteristics of global markets.

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ts service company through the financial crisis with the help of a $45 billion taxpayer-funded loan. However, Pandit sees much opportunity in developing markets, and as such, half of Citigroup’s profit comes from developing countries. For instance, in Latin America and Asia the bank increased its assets by $470 billion in 2010, an increase of 16 percent, by adding customers in countries such as Brazil, Mexico, and India.75 Thus, for these companies and so many others, understanding the conditions of today’s global segment and being able to predict future conditions are critical to their success.

The global segment presents firms with both opportunities and threats or risks. Because of the threats and risks, some firms choose to take a more cautious approach to competing in international markets. These firms participate in what some refer to as globalfocusing. Globalfocusing often is used by firms with moderate levels of international operations who increase their internationalization by focusing on global niche markets.76 In this way, they build on and use their special competencies and resources while limiting their risks within the niche market. Another way in which firms limit their risks in international markets is to focus their operations and sales in one region of the world.77 In this way, they can build stronger relationships in and knowledge of their markets. As they build these strengths, rivals find it more difficult to enter their markets and compete successfully.

In all instances, firms competing in global markets should recognize their sociocultural and institutional attributes. Furthermore, Korean ideology emphasizes communitarianism, a characteristic of many Asian countries. Korea’s approach differs from those of Japan and China, however, in that it focuses on inhwa, or harmony. Inhwa is based on a respect of hierarchical relationships and obedience to authority. Alternatively, the approach in China stresses guanxi—personal relationships or good connections—while in Japan, the focus is on wa, or group harmony and social cohesion. 78 The institutional context of China suggests a major emphasis on centralized planning by the government. The Chinese government pro- vides incentives to firms to develop alliances with foreign firms having sophisticated tech- nology in hopes of building knowledge and introducing new technologies to the Chinese markets over time.79 As such, it is important to analyze the strategic intent of foreign firms when pursuing alliances and joint ventures abroad, especially where the local partners are receiving technology which may in the long run reduce the foreign firms’ advantages.80

The Physical Environment Segment The physical environment segment refers to potential and actual changes in the physical environment and business practices that are intended to positively respond to and deal with those changes.81 Concerned with trends oriented to sustaining the world’s physical environment, firms recognize that ecological, social, and economic systems interactively influence what happens in this particular segment.82

There are many parts or attributes of the physical environment that firms should con- sider as they try to identify trends in this segment.83 Some argue that global warming is a trend firms and nations should carefully examine in efforts to predict any potential effects on the global society as well as on their business operations. Investors are seeking to take advantage of this trend, calling it “green alpha,” by looking to profit by increasing environ- mental sustainability.84 Energy consumption is another part of the physical environment that concerns both organizations and nations. In Canada, for example, a representative of the Energy Council of Canada said: “The electricity sector right now is 75 percent clean, and the idea is that over a well-defined period of time we’ll be a 90 percent clean electricity sec- tor.”85 Most of this clean power generation comes from hydroelectric produced electricity.

Because of increasing concern about sustaining the quality of the physical environ- ment, a number of companies are developing environmentally friendly policies. Indra K. Nooyi, CEO of PepsiCo, is pursuing a strategy called “capital performance with pur- pose.” This strategy links green efforts in all businesses to the bottom line. Through this approach, PepsiCo hopes to create technologies that can be replicated across its mul- tiple facilities, thereby creating large savings. For example, Frito-Lay, a PepsiCo business unit, operates the world’s seventh-largest private delivery fleet. In large urban areas it is

The physical environment segment refers to potential and actual changes in the physical environment and business practices that are intended to positively respond to and deal with those changes.

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The number of companies throughout the world that recognize that they compete within the confines of the physical environment and that they are expected to reduce the nega- tive effect of their operations on the physical

environment while competing continues to increase. Also, consumers concerned about the physical environment value this trend.

Producing and selling additional “green” (i.e., environmentally friendly) products is one company response to this trend. Siemens AG, a large diversified engineering firm similar to General Electric in the United States, was traumatized by a global bribery scandal that led to a new outside CEO, Peter Loscher, being appointed. His leadership led to a significant restructuring effort. While Loscher divested telecommunication and information technology businesses, he increased the focus on selling sustainability oriented products to both con- sumers and industrial customers, including everything from light bulbs to high-speed trains to factory controls.

Siemens generates $38 billion in sales from wind power, solar energy, and energy- conserving electricity grids. It claims to be the lead offshore wind turbine producer, and about one quarter of its 400,000 employees are what Siemens calls “green-collar workers” that are focused sustainability products. This approach has allowed Siemens’ stock to surge 47 percent in 2009, almost twice the gain that GE’s stock achieved in the same period. Interestingly, GE has also made a significant emphasis on the green consciousness of its sales orientation.

In addition to products, companies across the globe are committing to or increasing their commitment to environmental sustainability. McDonald’s, for example, has pursued green restaurant design, sustainable packaging, and waste management, and seeks to improve energy efficiency to reduce its environmental footprint. More importantly, it has required its supply chain to strive to meet sustainability goals. For example, Cargill, Inc., a large basic food producer, has been recognized by McDonald’s as a “Global Best of Green” supplier.

McDonald’s is one of Cargill’s largest customers, and Cargill partners with them “in every area from menu devel- opment, to restaurant operations and risk management solutions.” McDonald’s supports an annual sustainability conference in which it challenges its suppliers to meet “best practices” to improve environmental sustainability. For instance, Cargill invested millions to install anaero- bic reactors at all of its largest beef and pork processing plants. Through this process, Cargill reclaims methane from wastewater lagoons and converts it to fuel the plants’ boilers. This process has reduced 30 percent of the natural gas demand at 11 meat plants. Cargill estimates that this process has reduced greenhouse gas emissions by more than 1.3 million metric tons over the last four years: “It reduces pollution, increases our renewable energy and cuts costs.”

Procter & Gamble (P&G) recently announced increased targets for its 2012 sustainability goals. Among the goals are those to (1) “develop and market at least $50 billion in cumulative sales of sustainable innovation products, (2) deliver a 20 percent reduction (per unit of production)

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ts in carbon dioxide emissions, energy consumption, water usage and disposed waste from P&G plants, and (3) enable 300 million children to Live, Learn and Thrive by delivering three billion liters of clean water through P&G’s Children’s Safe Drinking Water program.” Dutch consumer product giant Unilever also has an ongoing commitment to sustainabil- ity. The firm’s sustainability actions include reducing water usage in its plants, working with its suppliers to encourage sustainability practices on their parts, and improving the eco-efficiency of their manufacturing facilities. Again, an important aspect of these sustain- ability programs by large companies is that it extends to their supply chain. For example, Walmart’s sustainability has an immense impact on both major and minor supply chain partners.

Although many forces are pushing firms to become greener, not all the “green” claims of products on store shelves are valid. According to a recent study reported in the Wall Street Journal, 95 percent of consumer products examined committed at least one offense of “green washing,” a term used to describe unproven environmental claims. Both TerraChoice and Underwriters Laboratories offer green-certification programs, which could benefit many manufacturers who seek to have third-party verification of their green or environmentally friendly claims.

Although there are many firms whose claims are not verified, the examples noted above signify a growing commitment by firms around the globe in response to emerg- ing trends in the physical environment segment. In addition to positively responding to the observed trends in this segment of the general environment, there is some evi- dence that firms engaging in these types of behaviors outperform those failing to do so, as the Siemens example illustrates. This emerging evidence suggests that these behaviors benefit companies, their stakeholders, and the physical environment in which they operate.

Sources: 2011, Betting on green, Economist, March 12, 22; 2011, Thinking outside (and inside) the box, Refrigerated and Frozen Foods, March, 40–41; G. Colvin, 2011, Green forum, Fortune, April 11, 90–102; R. Pendrous, 2011, The green giant of sustainable thinking, Profitable Production, March, 37; D. Stanford, 2011, Sustainability meets the profit motive, Bloomberg Businessweek, April 4, 25–26; R. Weiss & B. Kammel, 2011, How Siemens got its Mojo back, Bloomberg Businessweek, http://www.businessweek.com, January 27; G. Bounds, 2010, Health and Wellness: Misleading claims on “green” labeling, Wall Street Journal, October 26, D4.

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putting in an all-electric fleet of delivery trucks that it estimates will save 500,000 gal- lons of diesel fuel a year, curbing greenhouse emissions by 75 percent over combustion engines. This conversion also expects to save $700,000 in maintenance costs.86

We discuss other firms’ efforts to “reduce their environmental footprint” and to be good stewards of the physical environment as a result of doing so in the following Strategic Focus. As we note, the number of “green” products companies are producing continues to increase.

As our discussion of the general environment shows, identifying anticipated changes and trends among external elements is a key objective of analyzing the firm’s general envi- ronment. With a focus on the future, the analysis of the general environment allows firms to identify opportunities and threats. It is necessary to have a top management team with the experience, knowledge, and sensitivity required to effectively analyze this segment of the environment.87 Also critical to a firm’s choices of strategic actions to take is an under- standing of its industry environment and its competitors; we consider these issues next.

Industry Environment Analysis An industry is a group of firms producing products that are close substitutes. In the course of competition, these firms influence one another. Typically, industries include a rich mix- ture of competitive strategies that companies use in pursuing above-average returns. In part, these strategies are chosen because of the influence of an industry’s characteristics.88

IInndduussttrryy EEnnvviirroonnmmeenntt AAnnaallyyssiiss

An industry is a group of fi rms producing products that are close substitutes.

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Compared with the general environment, the industry environment has a more direct effect on the firm’s strategic competitiveness and ability to earn above-average returns.89 An industry’s profit potential is a function of five forces of competition: the threats posed by new entrants, the power of suppliers, the power of buyers, product substitutes, and the intensity of rivalry among competitors (see Figure 2.2).

The five forces model of competition expands the arena for competitive analysis. Historically, when studying the competitive environment, firms concentrated on com- panies with which they competed directly. However, firms must search more broadly to recognize current and potential competitors by identifying potential customers as well as the firms serving them. For example, the communications industry is now broadly defined as encompassing media companies, telecoms, entertainment companies, and companies producing devices such as smartphones.90 In such an environment, firms must study many other industries to identify firms with capabilities (especially technology-based capabili- ties) that might be the foundation for producing a good or a service that can compete against what they are producing. Using this perspective finds firms focusing on customers and their needs rather than on specific industry boundaries to define markets.

When studying the industry environment, firms must also recognize that suppliers can become a firm’s competitors (by integrating forward) as can buyers (by integrating backward). For example, several firms have integrated forward in the pharmaceutical industry by acquiring distributors or wholesalers. In addition, firms choosing to enter a new market and those producing products that are adequate substitutes for existing products can become a company’s competitors. Next, we examine the five forces the firm analyzes to understand the profitability potential within the industry (or a segment of an industry) in which it competes or may choose to compete.

Threat of New Entrants Identifying new entrants is important because they can threaten the market share of exist- ing competitors.91 One reason new entrants pose such a threat is that they bring additional production capacity. Unless the demand for a good or service is increasing, additional capacity holds consumers’ costs down, resulting in less revenue and lower returns for

Threat of new entrants

Bargaining power of suppliers

Bargaining power of buyers

Threat of substitute products

Rivalry among competing firms

Figure 2.2 The Five Forces of Competition Model

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ts competing firms. Often, new entrants have a keen interest in gaining a large market share. As a result, new competitors may force existing firms to be more efficient and to learn how to compete on new dimensions (e.g., using an Internet-based distribution channel).

The likelihood that firms will enter an industry is a function of two factors: barriers to entry and the retaliation expected from current industry participants. Entry barriers make it difficult for new firms to enter an industry and often place them at a competitive dis- advantage even when they are able to enter. As such, high entry barriers tend to increase the returns for existing firms in the industry and may allow some firms to dominate the industry.92 Thus, firms competing successfully in an industry want to maintain high entry barriers in order to discourage potential competitors from deciding to enter the industry.

Barriers to Entry Firms competing in an industry (and especially those earning above-average returns) try to develop entry barriers to thwart potential competitors. For example, the server market is hypercompetitive and dominated by IBM, Hewlett-Packard, and Dell. Historically, the scale economies these firms have developed by operating efficiently and effectively have created significant entry barriers, causing potential competitors to think very carefully about entering the server market to compete against them. Oracle, primarily a software- oriented company, acquired Sun Microsystems, which is primarily a server hardware company, to overcome the barriers to entry that exist in this industry. Oracle intends to preload Oracle software into its new server line. “Hardware makers such as Dell and HP are getting into software, and software companies like Oracle are getting into hardware;” these “companies want to create the integrated hardware and software systems that can satisfy a corporate customer’s every IT need.”93 The degree of success Oracle will achieve as a result of its decision to enter the server market via an acquisition remains uncertain.

Several kinds of potentially significant entry barriers may discourage competitors from entering a market.

Economies of Scale Economies of scale are derived from incremental efficiency improvements through experience as a firm grows larger. Therefore, the cost of pro- ducing each unit declines as the quantity of a product produced during a given period increases. This is the case for IBM, Hewlett-Packard, and Dell in the server market, as previously described.

Economies of scale can be developed in most business functions, such as marketing, manufacturing, research and development, and purchasing.94 Increasing economies of scale enhances a firm’s flexibility. For example, a firm may choose to reduce its price and capture a greater share of the market. Alternatively, it may keep its price constant to increase profits. In so doing, it likely will increase its free cash flow, which is very helpful during financially challenging times.

New entrants face a dilemma when confronting current competitors’ scale economies. Small-scale entry places them at a cost disadvantage. Given the size of Sun Microsystems relative to the three major competitors in the server market, Oracle has found it difficult to compete against its scale advantaged competitors.95 Additionally, large-scale entry through such an acquisition, in which the new entrant manufactures large volumes of a product to gain economies of scale, risks strong competitive retaliation.

Some competitive conditions reduce the ability of economies of scale to create an entry barrier. Many companies now customize their products for large numbers of small customer groups. Customized products are not manufactured in the volumes necessary to achieve economies of scale. Customization is made possible by flexible manufacturing systems (this point is discussed further in Chapter 4). In fact, the new manufacturing technology facilitated by advanced information systems has allowed the development of mass customization in an increasing number of industries. Although it is not appropriate for all products and implementing it can be challenging, mass customization has become increasingly common in manufacturing products.96 Online ordering has enhanced the

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ability of customers to obtain customized products. Companies manufacturing custom- ized products learn how to respond quickly to customers’ needs in lieu of developing scale economies.

Product Differentiation Over time, customers may come to believe that a firm’s product is unique. This belief can result from the firm’s service to the customer, effec- tive advertising campaigns, or being the first to market a good or service. The Coca-Cola Company and PepsiCo have established strong brands in the soft drink market. These brands compete with each other not only in the United States but around the world. Because each has used a great deal of resources building their brands, customer loyalty is strong. These companies battle each other for market leadership, which has changed back and forth over the years.97 Although Diet Coke is currently the lead brand in the soft drink market, PepsiCo is leading the way in regard to innovation in social media, such as advertising on Facebook and Twitter as well as other approaches through the Internet.98 When considering entry into the soft drink market, a company needs to pause to exam- ine how one can overcome the brand image and consumer loyalty to these two giants in this global industry. One needs significant resources to capture market share, although many firms are doing so that have the resources to produce private label products such as Walmart.

Companies such as Procter & Gamble (P&G) and Colgate-Palmolive spend a great deal of money on advertising and product development to convince potential custom- ers of their products’ distinctiveness and of the value buying their brands provides. Customers valuing a product’s uniqueness tend to become loyal to both the product and the company producing it. In turn, customer loyalty is an entry barrier for firms think- ing of entering an industry and competing against the likes of P&G and Colgate. To compete against firms offering differentiated products to individuals who have become loyal customers, new entrants often allocate many resources. To combat the perception of uniqueness, new entrants frequently offer products at lower prices. This decision, however, may result in lower profits or even losses.

Capital Requirements Competing in a new industry requires a firm to have resources to invest. In addition to physical facilities, capital is needed for inventories, marketing activities, and other critical business functions. Even when a new industry is attractive, the capital required for successful market entry may not be available to pursue the market opportunity.99 For example, defense industries are difficult to enter because of the substantial resource investments required to be competitive. In addition, because of the high knowledge requirements of the defense industry, a firm might acquire an existing company as a means of entering this industry, but it must have access to the capital necessary to do this. Obviously, Oracle had the capital required to acquire Sun Microsystems as a foundation for entering the server market.

Switching Costs Switching costs are the one-time costs customers incur when they buy from a different supplier. The costs of buying new ancillary equipment and of retraining employees, and even the psychic costs of ending a relationship, may be incurred in switching to a new supplier. In some cases, switching costs are low, such as when the consumer switches to a different brand of soft drink. Switching costs can vary as a function of time. For example, in terms of credit hours toward graduation, the cost to a student to transfer from one university to another as a freshman is much lower than it is when the student is entering the senior year.

Occasionally, a decision made by manufacturers to produce a new, innovative prod- uct creates high switching costs for the final consumer. Customer loyalty programs, such as airlines’ frequent flyer miles, are intended to increase the customer’s switching costs. If switching costs are high, a new entrant must offer either a substantially lower price or

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ts a much better product to attract buyers. Usually, the more established the relationships between parties, the greater the switching costs.

Access to Distribution Channels Over time, industry participants typically develop effective means of distributing products. Once a relationship with its distribu- tors has been built a firm will nurture it, thus creating switching costs for the distributors. Access to distribution channels can be a strong entry barrier for new entrants, particu- larly in consumer nondurable goods industries (e.g., in grocery stores where shelf space is limited) and in international markets. New entrants have to persuade distributors to carry their products, either in addition to or in place of those currently distributed. Price breaks and cooperative advertising allowances may be used for this purpose; however, those practices reduce the new entrant’s profit potential. Interestingly, access to distribu- tion is less of a barrier for products that can be sold on the Internet.

Cost Disadvantages Independent of Scale Sometimes, established competitors have cost advantages that new entrants cannot duplicate. Proprietary product technology, favorable access to raw materials, desirable locations, and government subsidies are exam- ples. Successful competition requires new entrants to reduce the strategic relevance of these factors. Delivering purchases directly to the buyer can counter the advantage of a desirable location; new food establishments in an undesirable location often follow this practice.

Government Policy Through licensing and permit requirements, governments can also control entry into an industry. Liquor retailing, radio and TV broadcasting, banking, and trucking are examples of industries in which government decisions and actions affect entry possibilities. Also, governments often restrict entry into some industries because of the need to provide quality service or the need to protect jobs. Alternatively, deregula- tion of industries, exemplified by the airline and utilities industries in the United States, allows more firms to enter.100 However, some of the most publicized government actions are those involving antitrust. Often the Antitrust Division of the Justice Department of the Federal Trade Commission will disallow a merger because it creates a firm that is too dominant in an industry and would thus create unfair competition.101 Such a negative ruling would obviously be an entry barrier for the acquiring firm.

Expected Retaliation Companies seeking to enter an industry also anticipate the reactions of firms in the industry. An expectation of swift and vigorous competitive responses reduces the likeli- hood of entry. Vigorous retaliation can be expected when the existing firm has a major stake in the industry (e.g., it has fixed assets with few, if any, alternative uses), when it has substantial resources, and when industry growth is slow or constrained. For example, any firm attempting to enter the airline industry at the current time can expect significant retaliation from existing competitors due to overcapacity.

Locating market niches not being served by incumbents allows the new entrant to avoid entry barriers. Small entrepreneurial firms are generally best suited for identifying and serving neglected market segments. When Honda first entered the U.S. motorcycle market, it concentrated on small-engine motorcycles, a market that firms such as Harley- Davidson ignored. By targeting this neglected niche, Honda avoided competition. After consolidating its position, Honda used its strength to attack rivals by introducing larger motorcycles and competing in the broader market. Competitive actions and competitive responses between firms such as Honda and Harley-Davidson are discussed more fully in Chapter 5.

Bargaining Power of Suppliers Increasing prices and reducing the quality of their products are potential means suppli- ers use to exert power over firms competing within an industry. If a firm is unable to

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recover cost increases by its suppliers through its own pricing structure, its profitability is reduced by its suppliers’ actions. A supplier group is powerful when

■ It is dominated by a few large companies and is more concentrated than the industry to which it sells.

■ Satisfactory substitute products are not available to industry firms. ■ Industry firms are not a significant customer for the supplier group. ■ Suppliers’ goods are critical to buyers’ marketplace success. ■ The effectiveness of suppliers’ products has created high switching costs for industry

firms. ■ It poses a credible threat to integrate forward into the buyers’ industry. Credibility is

enhanced when suppliers have substantial resources and provide a highly differenti- ated product.

The airline industry is one in which suppliers’ bargaining power is changing. Though the number of suppliers is low, the demand for major aircraft is also relatively low. Boeing and Airbus aggressively compete for orders of major aircraft, creating more power for buyers in the process. When a large airline signals that it might place a “significant” order for wide-body airliners which either Airbus or Boeing might produce, both companies are likely to battle for the business and include a financing arrangement, highlighting the buyer’s power in the potential transaction.

Bargaining Power of Buyers Firms seek to maximize the return on their invested capital. Alternatively, buyers (custom- ers of an industry or a firm) want to buy products at the lowest possible price—the point at which the industry earns the lowest acceptable rate of return on its invested capital. To reduce their costs, buyers bargain for higher quality, greater levels of service, and lower prices.102 These outcomes are achieved by encouraging competitive battles among the industry’s firms. Customers (buyer groups) are powerful when

■ They purchase a large portion of an industry’s total output. ■ The sales of the product being purchased account for a significant portion of the

seller’s annual revenues. ■ They could switch to another product at little, if any, cost. ■ The industry’s products are undifferentiated or standardized, and the buyers pose a

credible threat if they were to integrate backward into the sellers’ industry.

Consumers armed with greater amounts of information about the manufacturer’s costs and the power of the Internet as a shopping and distribution alternative have increased bargaining power in many industries. One reason for this shift is that individual buyers incur virtually zero switching costs when they decide to purchase from one manufacturer rather than another or from one dealer as opposed to any other.

Threat of Substitute Products Substitute products are goods or services from outside a given industry that perform similar or the same functions as a product that the industry produces. For example, as a sugar substitute, NutraSweet (and other sugar substitutes) places an upper limit on sugar manufacturers’ prices—NutraSweet and sugar perform the same function, though with different characteristics. Other product substitutes include e-mail and fax machines instead of overnight deliveries, plastic containers rather than glass jars, and tea instead of coffee. Newspaper firms have experienced significant circulation declines over the past decade or more. The declines are due to substitute outlets for news including Internet sources, cable television news channels, and e-mail and cell phone alerts. Likewise, sat- ellite TV and cable and telecommunication companies provide substitute services for basic media services such as television, Internet, and phone. However, as illustrated in the Strategic Focus, the possible switching is becoming more complicated as consumer

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In the Internet era, as media content has moved from a paper, tape, and film (or ana- log) world to a digital world based on Internet technology, new industry structures are emerg- ing as firms begin to utilize that technology and create commercial opportunities. This

process of new technology creation, utilization, and commercialization ultimately leads to changes in organizational patterns, and in particular, strategic alliances and mergers and acquisitions as firms restructure themselves around the utilization and commercial opportuni- ties being created.

At the base of this new digital world are firms that offer digital services. In particular focusing on television subscribers, there are about 64 million cable TV households and 32.5 million satellite consumers. However, although starting at a lower base, telecom TV homes are growing at an increased rate relative to satellite and cable providers. In 2011 telecom television providers are at 8.5 million but are projected to be at 16 million by 2014. Each of these providers is seeking to bundle their services to provide not only tele- vision but also broadband and telecommunication services. Many telecom providers are also reaching/pursuing mobile phone services, especially as the penetration rate of land-

lines is decreasing and mobile phones are increasing. Industry convergence is also being felt by device pro-

ducers such as Apple and other PC makers such as Dell and HP. Apple has produced a smartphone, the iPhone, which has sparked all other device makers to try to pro- duce similar products. Such products now are offered by all of the mobile phone producers, including Nokia, Samsung, and Motorola, among others. Not only do the smartphones provide telephone and texting capabilities but also increas- ingly numerous multimedia applications, including music and video as well as GPS services and general Internet searches. There are new applications almost every day. The opportunities here globally are even more significant than the purchases of personal computers because the price is lower.

The battle for a software platform among these smart- phones is also important. The iPhone platform produced by Apple is currently in the lead, but Google has been catching up through its Android platform. Although Microsoft is behind, Nokia has recently moved to adopt the Microsoft platform. Research in Motion’s (RIM) platform is also competing but is behind the Apple and Google platforms. The larger the base of users in these platforms the more draw there is for independent software pro- ducers to create new application uses for an increasing variety of smartphones, which draws more consumers to the platform and the company’s devices.

The platform is also important in the home, where there is a battle for control of the set-top box, which manages the media content available through televisions and other home devices such as the personal computer. Again, Apple TV, Google TV, and firms such as Netflix and Hulu are competing for this base, as are cable companies through video on demand (VOD) services.

Finally, firms that actually produce the media—musicians, news organizations and news- papers, television and movie producers, and publishers—want to make sure that their content is available through all sources. Now, that means mobile as well as home devices, where they can gain access to advertising dollars, which have been the traditional ways of

caption to come

THE MULTI-INDUSTRY BATTLE FOR MOBILE

AND HOME DIGITAL COMPUTING AND ENTERTAINMENT

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demand for content changes through increasing use of mobile devices such as tablets and smartphones.103 Tablets such as the iPad are reducing the number of PCs sold and this is curtailing the growth of PC producers such as Taiwan’s Acer Computers, at least until they can come out with their own successful tablet product.104 These products are increasingly popular, especially among younger and technologically savvy people, and as product substitutes they have significant potential to continue to reduce traditional media sources such as newspaper circulation sales.

In general, product substitutes present a strong threat to a firm when customers face few, if any, switching costs and when the substitute product’s price is lower or its quality and performance capabilities are equal to or greater than those of the competing product. Differentiating a product along dimensions that customers value (such as quality, service after the sale, and location) reduces a substitute’s attractiveness.

Intensity of Rivalry among Competitors Because an industry’s firms are mutually dependent, actions taken by one company usu- ally invite competitive responses. In many industries, firms actively compete against one another. Competitive rivalry intensifies when a firm is challenged by a competitor’s actions or when a company recognizes an opportunity to improve its market position.

profiting from media. For example, people are going to movies in theaters less than they used to, even with increased use of technology such as three dimensions (3D). More and more people are watching media at home through big screen televisions and via VOD ser- vices, which are available not only in the home but on mobile devices, netbooks, laptops, and desktop PCs.

This convergence among players has led to acquisitions between buyers and suppli- ers and competitors as well as multiple relationships and strategic partnerships through strategic alliances, which have become the norm as firms compete to take advantage of the resources available. A recent trend has been to partner with social network firms such as Twitter and Facebook in order to better utilize social media and gain new advertising dollars. This convergence makes competitor analysis much more difficult than it used to be because it is difficult to say who is a competitor, who is a supplier, who is a buyer, and who is a new entrant into the industry, and what products, services, and processes will be substituted next as the industry structure evolves. One day a firm provides a complementary product such as software to hardware producers, and the next day the complementor (formally defined later in the chapter) makes an acquisition, as Oracle did of Sun Microcomputers, and becomes a competitor to other server producers such as Dell, HP, and IBM. Competitor analysis must take into consideration the technologi- cal changes which lead to the utilization and commercialization of technologies. It also must ultimately examine how such technological changes will lead to convergence of competitors or other firms and associated organizational changes through alliances and acquisitions and the possible re-creation of a new set of industry competitors, buyers and suppliers.

Sources: P. Burrows, 2011, Mobile wars! Apple vs. Google vs. those other guys, Bloomberg Businessweek, http://www .businessweek.com, February 16; J. Christensen, 2011, Industrial evolution through complementary convergence: The case of IT security, Industrial & Corporate Change, 20(1): 57–89; J. Davis, 2011, Lenovo’s tablet, smartphone focus: New business unit created, http://www.channelinsider.com, January 25; G. Rivlin, 2011, The problem with Microsoft, Fortune, April 11, 45–52; G. Winslow, 2011, Map to TV everywhere, Broadcast & Cable, February 14, 23; 2010, The competitive landscape, Multichannel News, http://www.multichannel.com, December 27; A. Pierce, 2010, The convergence of communication technologies, Tech Directions, 70(5): 12–13; D. Sullivan & J. Yuening, 2010, Media convergence and the impact of the internet on the M&A activity of large media companies, Journal of Media Business Studies, 7(4): 21–40.

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ts Firms within industries are rarely homogeneous; they differ in resources and capa- bilities and seek to differentiate themselves from competitors.105 Typically, firms seek to differentiate their products from competitors’ offerings in ways that customers value and in which the firms have a competitive advantage. Common dimensions on which rivalry is based include price, service after the sale, and innovation.

Next, we discuss the most prominent factors that experience shows to affect the intensity of firms’ rivalries.

Numerous or Equally Balanced Competitors Intense rivalries are common in industries with many companies. With multiple com- petitors, it is common for a few firms to believe they can act without eliciting a response. However, evidence suggests that other firms generally are aware of competitors’ actions, often choosing to respond to them. At the other extreme, industries with only a few firms of equivalent size and power also tend to have strong rivalries. The large and often similar-sized resource bases of these firms permit vigorous actions and responses. The competitive battles between Airbus and Boeing exemplify intense rivalry between rela- tively equal competitors, especially as airlines place bids for the new wide-body planes they are producing. Coca-Cola and PepsiCo have a strong rivalry in drink products as consumers demand not only great taste but real health benefits.106

Slow Industry Growth When a market is growing, firms try to effectively use resources to serve an expand- ing customer base. Growing markets reduce the pressure to take customers from com- petitors. However, rivalry in no-growth or slow-growth markets (slow change) becomes more intense as firms battle to increase their market shares by attracting competitors’

customers. For example, there is a growing trend for health care of baby boomers, who are now reaching age 65. Growth can be realized by managed-care firms like WellPoint Inc. and Aetna Inc. without strong rivalry.107 The same is true for home health care, but as regulation becomes more prominent in this indus- try, growth is likely to slow and rivalry increase.108

Typically, battles to protect market share are fierce. Certainly, this has been the case in the airline industry and in the fast-food industry as McDonald’s, Wendy’s, and Burger King try to win each other’s customers. The instability in the market that results from these competitive engagements may reduce the profitability for all firms engaging in such battles.

High Fixed Costs or High Storage Costs When fixed costs account for a large part of total costs, compa- nies try to maximize the use of their productive capacity. Doing so allows the firm to spread costs across a larger volume of out- put. However, when many firms attempt to maximize their pro- ductive capacity, excess capacity is created on an industry-wide basis. To then reduce inventories, individual companies typi- cally cut the price of their product and offer rebates and other special discounts to customers. However, these practices, com- mon in the automobile manufacturing industry in the recent past, often intensify competition. The pattern of excess capac- ity at the industry level followed by intense rivalry at the firm level is observed frequently in industries with high storage costs. Perishable products, for example, lose their value rapidly with the passage of time. As their inventories grow, producers of per- ishable goods often use pricing strategies to sell products quickly.

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Lack of Differentiation or Low Switching Costs When buyers find a differentiated product that satisfies their needs, they frequently purchase the product loyally over time. Industries with many companies that have suc- cessfully differentiated their products have less rivalry, resulting in lower competition for individual firms. Firms that develop and sustain a differentiated product that cannot be easily imitated by competitors often earn higher returns. However, when buyers view products as commodities (i.e., as products with few differentiated features or capabili- ties), rivalry intensifies. In these instances, buyers’ purchasing decisions are based pri- marily on price and, to a lesser degree, service. Personal computers are a commodity product. Thus, the rivalry between Dell, Hewlett-Packard, Lenovo, and other computer manufacturers is strong and these companies are always trying to find ways to differen- tiate their offerings (Hewlett-Packard now pursues product design as a means of differ- entiation). Apple has been able to maintain a differentiation strategy through ease of use of its software applications and it integration capabilities with other software platforms.

High Strategic Stakes Competitive rivalry is likely to be high when it is important for several of the competi- tors to perform well in the market. For example, although it is diversified and is a market leader in other businesses, Samsung has targeted market leadership in the consumer electronics market and is doing quite well. This market is quite important to Sony and other major competitors, such as Hitachi, Matsushita, NEC, and Mitsubishi, suggesting that rivalry among these competitors will remain strong.

High strategic stakes can also exist in terms of geographic locations. For example, Japanese automobile manufacturers are committed to a significant presence in the U.S. mar- ketplace because it is the world’s largest single market for automobiles and trucks. Due to the high stakes involved in the United States for both Japanese and U.S. manufacturers, rivalry among the global firms from these two countries is intense. With the excess capacity in this industry we mentioned earlier in this chapter, there is every reason to believe that the rivalry among global automobile manufacturers will remain intense in the foreseeable future.

High Exit Barriers Sometimes companies continue competing in an industry even though the returns on their invested capital are low or negative. Firms making this choice likely face high exit barriers, which include economic, strategic, and emotional factors causing them to remain in an industry when the profitability of doing so is questionable. Exit barriers are especially high in the airline industry. Although earning even average returns is difficult for these firms, they face substantial exit barriers, such as their ownership of specialized assets (e.g., large aircraft).109 Common exit barriers include the following:

■ Specialized assets (assets with values linked to a particular business or location) ■ Fixed costs of exit (such as labor agreements) ■ Strategic interrelationships (relationships of mutual dependence, such as those

between one business and other parts of a company’s operations, including shared facilities and access to financial markets)

■ Emotional barriers (aversion to economically justified business decisions because of fear for one’s own career, loyalty to employees, and so forth)

■ Government and social restrictions (often based on government concerns for job losses and regional economic effects; more common outside the United States).

Interpreting Industry Analyses Effective industry analyses are products of careful study and interpretation of data and infor- mation from multiple sources. A wealth of industry-specific data is available to be analyzed by individual country. Because of globalization, international markets and rivalries must be

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ts included in the firm’s analyses. In fact, research shows that in some industries, international variables are more important than domestic ones as determinants of strategic competitive- ness. Furthermore, because of the development of global markets, a country’s borders no longer restrict industry structures. In fact, movement into international markets enhances the chances of success for new ventures as well as more established firms.110

Analysis of the five forces in the industry allows the firm to determine the industry’s attractiveness in terms of the potential to earn adequate or superior returns. In general, the stronger competitive forces are, the lower the profit potential for an industry’s firms. An unattractive industry has low entry barriers, suppliers and buyers with strong bargain- ing positions, strong competitive threats from product substitutes, and intense rivalry among competitors. These industry characteristics make it difficult for firms to achieve strategic competitiveness and earn above-average returns. Alternatively, an attractive industry has high entry barriers, suppliers and buyers with little bargaining power, few competitive threats from product substitutes, and relatively moderate rivalry.111 Next, we explain strategic groups as an aspect of industry competition.

Strategic Groups A set of firms that emphasize similar strategic dimensions and use a similar strategy is called a strategic group.112 The competition between firms within a strategic group is greater than the competition between a member of a strategic group and companies outside that strategic group. Therefore, intrastrategic group competition is more intense than is interstrategic group competition. In fact, more heterogeneity is evident in the per- formance of firms within strategic groups than across the groups. The performance lead- ers within groups are able to follow strategies similar to those of other firms in the group and yet maintain strategic distinctiveness to gain and sustain a competitive advantage.113

The extent of technological leadership, product quality, pricing policies, distribution channels, and customer service are examples of strategic dimensions that firms in a stra- tegic group may treat similarly. Thus, membership in a particular strategic group defines the essential characteristics of the firm’s strategy.114

The notion of strategic groups can be useful for analyzing an industry’s competitive structure. Such analyses can be helpful in diagnosing competition, positioning, and the profitability of firms within an industry.115 High mobility barriers, high rivalry, and low resources among the firms within an industry limit the formation of strategic groups.116 However, research suggests that after strategic groups are formed, their membership remains relatively stable over time, although recent research does examine how change occurs.117 Using strategic groups to understand an industry’s competitive structure requires the firm to plot companies’ competitive actions and competitive responses along strategic dimensions such as pricing decisions, product quality, distribution channels, and so forth. This type of analysis shows the firm how certain companies are competing similarly in terms of how they use similar strategic dimensions.

Strategic groups have several implications. First, because firms within a group offer similar products to the same customers, the competitive rivalry among them can be intense. The more intense the rivalry, the greater the threat to each firm’s profitability. Second, the strengths of the five industry forces differ across strategic groups. Third, the closer the strategic groups are in terms of their strategies, the greater is the likelihood of rivalry between the groups.

Competitor Analysis The competitor environment is the final part of the external environment requiring study. Competitor analysis focuses on each company against which a firm directly competes.

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A set of fi rms that emphasize similar strategic dimensions and use a similar strategy is called a strategic group.

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For example, Coca-Cola and PepsiCo, Home Depot and Lowe’s, and Boeing and Airbus are keenly interested in understanding each other’s objectives, strategies, assumptions, and capabilities. Indeed, intense rivalry creates a strong need to understand competi- tors.118 In a competitor analysis, the firm seeks to understand the following:

■ What drives the competitor, as shown by its future objectives ■ What the competitor is doing and can do, as revealed by its current strategy ■ What the competitor believes about the industry, as shown by its assumptions ■ What the competitor’s capabilities are, as shown by its strengths and weaknesses.119

Information about these four dimensions helps the firm prepare an anticipated response profile for each competitor (see Figure 2.3). The results of an effective competi- tor analysis help a firm understand, interpret, and predict its competitors’ actions and responses. Understanding the actions of competitors clearly contributes to the firm’s ability to compete successfully within the industry.120 Interestingly, research suggests that executives often fail to analyze competitors’ possible reactions to competitive actions their firm takes,121 placing their firm at a potential competitive disadvantage as a result.

Critical to an effective competitor analysis is gathering data and information that can help the firm understand its competitors’ intentions and the strategic implications result- ing from them.122 Useful data and information combine to form competitor intelligence, the set of data and information the firm gathers to better understand and anticipate com- petitors’ objectives, strategies, assumptions, and capabilities. In competitor analysis, the firm gathers intelligence not only about its competitors, but also regarding public poli- cies in countries around the world. Such intelligence facilitates an understanding of the

Competitor intelligence is the set of data and information the fi rm gathers to better understand and better anticipate competitors’ objectives, strategies, assumptions, and capabilities.

Figure 2.3 Competitor Analysis Components

Future Objectives • How do our goals compare with our competitors’ goals? • Where will emphasis be placed in the future? • What is the attitude toward risk?

Current Strategy • How are we currently competing? • Does their strategy support changes in the competitive structure?

Assumptions • Do we assume the future will be volatile? • Are we operating under a status quo? • What assumptions do our competitors hold about the industry and themselves?

Capabilities • What are our strengths and weaknesses? • How do we rate compared to our competitors?

Response • What will our competitors do in the future? • Where do we hold an advantage over our competitors? • How will this change our relationship with our competitors?

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ts strategic posture of foreign competitors. Through effective competitive and public policy intelligence, the firm gains the insights needed to make effective strategic decisions on how to compete against its rivals.

When asked to describe competitive intelligence, it seems that a number of people respond with phrases such as “competitive spying” and “corporate espionage.” These phrases denote the fact that competitive intelligence is an activity that appears to involve trade-offs.123 According to some, the reason for this is that “what is ethical in one country is different from what is ethical in other countries.” This position implies that the rules of engagement to follow when gathering competitive intelligence change in different con- texts.124 However, firms avoid the possibility of legal entanglements and ethical quanda- ries only when their competitive intelligence gathering methods are governed by a strict set of legal and ethical guidelines.125 This means that ethical behavior and actions as well as the mandates of relevant laws and regulations should be the foundation on which a firm’s competitive intelligence-gathering process is formed. We address this matter in greater detail in the next section.

When gathering competitive intelligence, firms must also pay attention to the com- plementors of its products and strategy.126 Complementors are companies or networks of companies that sell complementary goods or services that are compatible with the focal firm’s good or service. When a complementor’s good or service adds value to the sale of the focal firm’s good or service, it is likely to create value for the focal firm.

There are many examples of firms whose good or service complements other com- panies’ offerings. For example, firms manufacturing affordable home photo printers complement other companies’ efforts to sell digital cameras. Intel and Microsoft are perhaps the most widely recognized complementors. The Microsoft slogan “Intel Inside” demonstrates the relationship between two firms who do not directly buy from or sell to each other but whose products have a strong complementary relationship. Alliances among airline operations (e.g., the Star Alliance and the SkyTeam Alliance) find these companies sharing their route structures and customer loyalty programs as means of complementing each others’ operations. (Each alliance is a network of complementors.) Recently, Continental Airlines announced that it was leaving the SkyTeam Alliance to join the Star Alliance. The primary reason for this change was to provide greater global coverage to Continental’s customers by combining its routes with those of the other members of the Star Alliance. In essence, Continental’s conclusion was that the comple- mentors of the Star Alliance created more value for its customers than did its comple- mentors in the SkyTeam Alliance. Ultimately, Continental merged with United Airlines, a key Star Alliance member.

As our discussion shows, complementors expand the set of competitors firms must evaluate when completing a competitor analysis. For example, as illustrated in the Strategic Focus, sometimes complementors change, as in the purchase of Sun Microsystems by Oracle. After the acquisition Oracle was no longer a complementor of Dell and HP, but a competitor. Similarly, Intel and Microsoft analyze each other’s actions in that those actions might either help each firm gain a competitive advantage or damage each firm’s ability to exploit a competitive advantage.

Ethical Considerations Firms must follow relevant laws and regulations as well as carefully articulated ethi- cal guidelines when gathering competitor intelligence. Industry associations often develop lists of these practices that firms can adopt. Practices considered both legal and ethical include (1) obtaining publicly available information (e.g., court records, competitors’ help-wanted advertisements, annual reports, financial reports of publicly

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Complementors are companies or networks of companies that sell complementary goods or services that are compatible with the focal fi rm’s good or service.

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held corporations, and Uniform Commercial Code filings), and (2) attending trade fairs and shows to obtain competitors’ brochures, view their exhibits, and listen to discussions about their products. In contrast, certain practices (including blackmail, trespassing, eavesdropping, and stealing drawings, samples, or documents) are widely viewed as unethical and often are illegal.

Some competitor intelligence practices may be legal, but a firm must decide whether they are also ethical, given the image it desires as a corporate citizen. Especially with electronic transmissions, the line between legal and ethical practices can be difficult to determine. For example, a firm may develop Web site addresses that are similar to those of its competitors and thus occasionally receive e-mail transmissions that were intended for those competitors. The practice is an example of the challenges companies face in deciding how to gather intelligence about competitors while simultaneously determining how to prevent competitors from learning too much about them. To deal with these challenges, firms should establish principles and take actions that are consistent with them. Many firms follow the Strategy and Competitive Intelligence Professionals, a professional association, code of professional practice and ethics deal- ing with this issue.127

Open discussions of intelligence-gathering techniques can help a firm ensure that employees, customers, suppliers, and even potential competitors understand its convic- tions to follow ethical practices for gathering competitor intelligence. An appropriate guideline for competitor intelligence practices is to respect the principles of common morality and the right of competitors not to reveal certain information about their prod- ucts, operations, and strategic intentions.128

■ The firm’s external environment is challenging and complex. Because of the external environment’s effect on perfor- mance, the firm must develop the skills required to identify opportunities and threats existing in that environment.

■ The external environment has three major parts: (1) the general environment (elements in the broader society that affect industries and their firms), (2) the industry environ- ment (factors that influence a firm, its competitive actions and responses, and the industry’s profit potential), and (3) the competitor environment (in which the firm analyzes each major competitor’s future objectives, current strategies, assumptions, and capabilities).

■ The external environmental analysis process has four steps: scanning, monitoring, forecasting, and assessing. Through environmental analyses, the firm identifies opportunities and threats.

■ The general environment has seven segments: demographic, economic, political/legal, sociocultural, technological, global, and physical. For each segment, the firm has to determine the strategic relevance of environmental changes and trends.

■ Compared with the general environment, the industry environ- ment has a more direct effect on the firm’s strategic actions. The five forces model of competition includes the threat of entry, the power of suppliers, the power of buyers, product

substitutes, and the intensity of rivalry among competitors. By studying these forces, the firm finds a position in an industry where it can influence the forces in its favor or where it can buffer itself from the power of the forces in order to achieve strategic competitiveness and earn above-average returns.

■ Industries are populated with different strategic groups. A strategic group is a collection of firms following similar strat- egies along similar dimensions. Competitive rivalry is greater within a strategic group than between strategic groups.

■ Competitor analysis informs the firm about the future objec- tives, current strategies, assumptions, and capabilities of the companies with which it competes directly. A thorough analysis examines complementors that sustain a competitor’s strategy and major networks or alliances in which competi- tors participate. When analyzing competitors, the firm should also identify and carefully monitor major actions taken by firms with performance below the industry norm.

■ Different techniques are used to create competitor intel- ligence: the set of data, information, and knowledge that allows the firm to better understand its competitors and thereby predict their likely strategic and tactical actions. Firms should use only legal and ethical practices to gather intelligence. The Internet enhances firms’ capabilities to gather insights about competitors and their strategic intentions.

S U M M A R Y

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1. Why is it important for a firm to study and understand the external environment?

2. What are the differences between the general environment and the industry environment? Why are these differences important?

3. What is the external environmental analysis process (four steps)? What does the firm want to learn when using this process?

4. What are the seven segments of the general environment? Explain the differences among them.

5. How do the five forces of competition in an industry affect its profit potential? Explain.

6. What is a strategic group? Of what value is knowledge of the firm’s strategic group in formulating that firm’s strategy?

7. What is the importance of collecting and interpreting data and information about competitors? What practices should a firm use to gather competitor intelligence and why?

TO COME

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2. A. Peaple, 2011, Reshaped BP finds east is no Eden, Wall Street Journal, February 23, C14.

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4. M. Xu, V. Ong, Y. Duan, & B. Mathews, 2011, Intelligent agent systems for executive information scanning, filtering and interpretation: Perceptions and challenges, Information Processing & Management, 47(2): 186–201; C. Weigelt & M. B. Sarkar, 2009, Learning from supply-side agents: The impact of technology solution providers’ experiential diversity on clients’ innovation adoption, Academy of Management Journal, 52: 37–60.

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