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Chapter 3

External Analysis: Industry

Structure, Competitive

Forces, and Strategic

Groups

No reproduction or further distribution permitted without the prior written consent of McGraw Hill.

Learning Objectives

1. Generate a PESTEL analysis to evaluate the impact of external

factors on the firm.

2. Differentiate the roles of firm effects and industry effects in

determining firm performance.

3. Apply Porter’s five competitive forces to explain the profit potential of

different industries.

4. Examine how competitive industry structure shapes rivalry among

competitors.

5. Describe the strategic role of complements in creating positive-sum

co-opetition.

6. Explain the five choices required for market entry.

7. Appraise the role of industry dynamics and industry convergence in

shaping the firm’s external environment.

8. Generate a strategic group model to reveal performance differences

between clusters of firms in the same industry.

How External Factors Impact a Firm

General environment:

• Managers have little control.

• Macroeconomic factors are included.

• Examples: interest, exchange rates, etc.

Task environment:

• Managers can influence.

• Includes the composition of strategic groups.

• Includes the structure of the industry.

The PESTEL Model

Groups environmental factors into six segments:

1. Political.

2. Economic.

3. Sociocultural.

4. Technological.

5. Ecological.

6. Legal.

A straightforward way to

scan, monitor, and evaluate

external factors.

The Firm within Its External Environment, Industry, and Strategic Group, Subject to PESTEL Factors Exhibit 3.1

Political Factors

Processes and actions of government bodies that

influence the firm can be shaped through:

• Lobbying.

• Public Relations.

• Contributions.

• Litigation.

Political and legal forces are closely related.

• Political pressure often results in changes in legislation.

Economic Factors

Largely macroeconomic.

Affect economy-wide

phenomena.

Examples include:

• Growth rates.

• Levels of employment.

• Interest rates.

• Price stability.

• Currency exchange rates.

Sociocultural Factors

Society’s cultures, norms, and values:

• Are constantly in flux.

• Differ across groups.

• Trends should be monitored.

Demographic trends:

• Population characteristics.

• Age, gender, family size, ethnicity, sexual orientation,

religion, and socioeconomic class.

Technological Factors

Application of knowledge:

• New processes and products.

Innovations in process technology:

• Lean manufacturing, Six Sigma quality and biotechnology.

Innovations in product technology:

• Smartphones, wearable devices, high-performing electric

cars.

Advances in artificial intelligence and machine

learning.

Ecological Factors

Broad environmental

issues:

• Natural environment.

• Global warming.

• Sustainable economic

growth.

The relationship

between organizations

and the environment

can be:

• Adversarial.

• Can provide business

opportunities.

Legal Factors

Official outcomes of political

processes:

• Laws.

• Mandates.

• Regulations.

• Court decisions.

Many industries have been

deregulated.

• Airlines, telecom, energy, and

Legal factors

often coexist

with or result

from political will.

Industry vs. Firm Effects

Industry Effects:

• Describe the economic

structure of the industry.

• Elements in common to

all.

• Entry and exit barriers,

number and size of

companies, and types of

products and services

offered.

Firm Effects:

• Attribute firm performance

to the manager’s actions.

• More important than

industry effects.

Industry, Firm, and Other Effects Explaining Firm Performance

Exhibit 3.2

Source: Data from O.

Bandiera, A. Prat, and R.

Sadun (2012),

“Management capital at

the top: Evidence from

the time use of CEOs,”

London School of

Economics and Harvard

Business School Working

Paper.

Industry and Industry Analysis

Industry:

• Group of incumbent

companies.

• Relatively similar suppliers

and buyers.

• Similar products and

services.

Industry analysis, a

method to:

• Identify an industry’s profit

potential.

• Derive implications for a

firm’s strategic position.

Strategic Positioning

A firm’s ability to:

• Create value for

customers (V).

• While containing costs

(C).

Goal.

To generate a large gap

between:

• The value the firm’s

product or service creates.

• The cost required to

produce it.

• V minus C.

The Five Forces Model

The Five Forces Model helps strategic leaders

understand:

• The profit potential of different industries.

• How they can position their firms to gain and sustain

competitive advantage.

Two key insights about this model:

• Competition is viewed more broadly in the five forces

model.

• Profit potential is a function of the five competitive forces.

Porter’s Five Forces Model

Exhibit 3.3

Source: Porter, M. E. (2008, Jan.). “The five

competitive forces that shape strategy,” Harvard

Business Review.

Threat of Entry

The risk that potential

competitors will enter an

industry:

• Lowers industry profit

potential.

• Increases spending

among incumbent firms.

Entry barriers:

• Economies of scale.

• Network effects.

• Customer switching costs.

• Capital requirements.

• Advantages independent of size.

• Government policy.

• Credible threat of retaliation.

Power of Suppliers

Pressures that industry suppliers can exert on an

industry’s profit potential.

Lowers industry profit potential if:

• Suppliers demand higher prices for their inputs.

• Suppliers capture part of the economic value created.

Power of Buyers (Customers)

Lowers industry profit potential if:

• Buyers obtain price discounts, which reduces

revenue.

• Buyers demand higher quality / service, which

raises production costs.

Situations when buyers are price

sensitive:

• The buyer’s purchase represents a significant

portion of its procurement budget.

• Buyers earn low profits or are strapped for

cash.

Buyers are

the

customers

of an

industry.

Threat of Substitutes

Meet the same basic

customer need:

• In a different way.

• Available from outside the

given industry.

Examples:

• Software vs. professional

services.

• Energy drinks vs. coffee.

• Videoconferencing vs.

business travel.

• Wireless phone services

vs. internet-based

services (Skype).

Rivalry Among Competitors

The intensity with which companies in the same

industry jockey for market share and profitability.

• Can range from genteel to cut-throat.

• The other forces in the model pressure this rivalry.

• The stronger the forces, the stronger the competitive

intensity.

Competitive Industry Structure is Defined By

Number and size of competitors.

Firm’s degree of pricing power.

Type of product or service

(commodity or differentiated product).

Height of entry barriers.

Industry Competitive Structures along the Continuum from Fragmented to Consolidated

Exhibit 3.4

Access the text alternative for slide image.

Industry Growth

Affects intensity of rivalry among competitors.

During periods of high growth:

• Consumer demand rises.

• Price competition among firms decreases.

During periods of negative growth:

• Rivalry is fierce.

• Rivals can only gain at the expense of one another.

• Price discounts, promotional campaigns, and retaliation

abound.

Strategic Commitments

Firm actions that are:

• Costly, long-term oriented and difficult to reverse.

Can stem from:

• Large, fixed cost requirements.

• Non-economic considerations.

Affects intensity of rivalry among competitors.

Exit Barriers

Obstacles that determine how easily a firm can

leave that industry.

Mainly economic and social factors.

Include fixed costs that must be paid.

Examples: employee health care and retirement

benefits.

A Sixth Force: Complements

A product, service, or competency that adds value

when used with the original product.

• Complements increase demand for the primary product.

• Enhances the profit potential for the industry and the firm.

Co-opetition:

• cooperation among competitors to achieve a strategic

objective.

Entry Choices

Exhibit 3.6

Source: Based on and

adapted from Zachary,

M.A., P.T. Gianiodis, G.

Tyge Payne, and G.D.

Markman (2014),

“Entry timing: enduring

lessons and future

directions,” Journal of

Management 41: 1409;

and Bryce, D.J., and

J.H. Dyer (2007, May),

“Strategies to crack

well-guarded markets,”

Harvard Business

Review: 84–92.

Access the text alternative for slide image.

Industry Dynamics

A weakness of other models is that they are static

(point-in-time snapshot).

Industry dynamics provides insight about:

• Changing speed of an industry.

• Rate of innovation.

• Help capture structural changes in the industry.

Industry Convergence

When unrelated

industries begin to satisfy

the same customer need.

Caused by technological

advances.

Example:

• Media Industries:

• Content going online.

• Newspapers,

magazines, TV,

movies, radio, music.

• Will print media

become obsolete?

Strategic Groups

Strategic groups:

• A set of companies.

• Pursue a similar strategy.

• In the same industry.

The strategic group model (framework):

• Clusters different firms into groups.

• Is based on key strategic dimensions.

How to Create a Strategic Group Model

Identify the important strategic dimensions.

Choose two key dimensions:

• For horizontal and vertical axes.

• Ensure they’re not highly correlated.

Graph the firms in the strategic group.

• Each firm’s market share indicated by the size of the

bubble.

Strategic Groups and Mobility Barrier in U.S. Domestic Airline Industry

Exhibit 3.8

Jump to Appendix 3.6 long image

description

Insights from Strategic Group Mapping

Competitive rivalry is strongest between firms in the

same strategic group.

External environment affects strategic groups

differently. Five competitive forces affect strategic groups

differently. Some strategic groups more profitable than others.

Mobility Barriers

Restrict movement between strategic groups.

Industry-specific factors that separate one group

from another.

Based on hard-to-reverse investments (strategic

commitments).

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