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Chapter 3

External Analysis: Industry Structure, Competitive Forces, and Strategic Groups

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Learning Objectives

Generate a PESTEL analysis to evaluate the impact of external factors on the firm.

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

Examine how competitive industry structure shapes rivalry among competitors.

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

Explain the five choices required for market entry.

Generate a strategic group model to reveal performance differences between clusters of firms in the same industry.

AFI Framework review

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Broad to granular

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 and the structure of the industry.

EXTERNAL ANALYSIS

INDUSTRY ANALYSIS

Five Forces Model

COMPETITOR ANALYSIS

Strategic Group Mapping

PESTEL Framework

The Firm within Its External Environment, (PESTEL Framework)

PESTEL ======>

Why is it important for an organization to study and understand its external environment? It is important because it can affect the industry and firm’s performance.

The PESTEL framework, for instance, is helpful because it acts as a guide, allowing managers to mitigate threats and leverage opportunities accordingly.

The Firm within Its External Environment, Industry, and Strategic Group.

Key Concepts of PESTEL

Managers mitigate threats and exploit opportunities by analyzing the external environmental forces.

Factors are interdependent.

Framework to scan, monitor, and evaluate important external factors/trends impacting a firm in its quest for competitive advantage.

Results are used in SWOT analysis

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.

For example, hotel chains and resort owners have challenged Airbnb in courts and lobbied local governments, some of which passed regulations to limit or prohibit short-term rentals. Local residents in New York, San Francisco, Berlin, Paris, and many other cities are also pressuring local governments to enact more aggressive rules banning short-term rentals because they argue that companies such as Airbnb contribute to a shortage of affordable housing by turning entire apartment complexes into hotels or transforming quiet family neighborhoods into all-night, every-night party hot spots.

How will the current Administration impact this industry?

Relative to the chapter opener on Tesla the text notes the benefits of the U.S. government offering $7,500 in federal tax credits to consumers purchasing a new all electric vehicle. Some states also have such incentives. Other countries including China and several in the EU also offer such incentives.

Economic Factors

Largely macroeconomic.

Affect economy-wide phenomena.

Examples include:

Growth rates.

Levels of employment.

Interest rates.

Price stability.

Currency exchange rates.

Occasionally, boom periods can overheat and lead to speculative asset bubbles. In the early 2000s, the United States experienced an asset bubble in real estate. Easy credit, made possible by the availability of subprime mortgages and other financial innovations, fueled an unprecedented demand in housing. Real estate, rather than stocks, became the investment vehicle of choice for many Americans, propelled by the common belief that house prices could only go up. When the housing bubble burst, the deep economic recession of 2008–2009 began, impacting in some way nearly all businesses in the United States and worldwide.

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.

In recent years, for example, a growing number of U.S. consumers have become more health-conscious about what they eat. This trend led to a boom for businesses such as Chipotle, Subway, and Whole Foods. At the same time, traditional fast-food companies McDonald’s and Burger King, along with grocery chains such as Albertsons and Kroger, have all had to scramble to provide healthier choices in their product offerings.

The most recent U.S. census revealed that 55 million Americans (16.4 percent of the total population) are Hispanic. It is now the largest ethnic group in the United States and growing fast. On average, Hispanics are also younger and their incomes are climbing quickly. This trend is not lost on companies trying to benefit from this opportunity. For example, MundoFox and ESPN Deportes (specializing in soccer) have joined Univision and NBC’s Telemundo in the Spanish-language television market. In the United States, Univision is now the fifth most popular network overall, just behind the four major English-language networks (ABC, NBC, CBS, and Fox). Likewise, advertisers are pouring dollars into the Spanish-language networks to promote their products and services.

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, all-electric cars.

Advances in artificial intelligence and machine learning.

As discussed in the Chapter Case, Airbnb launched a radical process innovation of offering and renting rooms based on a business model leveraging the sharing economy. If one thing seems certain, technological progress is relentless and seems to be picking up speed.

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.

Unfortunately many business organizations have contributed to the pollution of air, water, and land, as well as depletion of the world’s natural resources. BP’s infamous oil spill in the Gulf of Mexico destroyed fauna and flora along the U.S. shoreline from Texas to Florida. This disaster led to a decrease in fish and wildlife populations, triggered a decline in the fishery and tourism industries, and threatened the livelihood of thousands of people.

Legal Factors

Official outcomes of political processes:

Laws.

Mandates.

Regulations.

Court decisions.

Many industries have been deregulated.

Airlines, telecom, energy, and trucking.

Legal factors often coexist with or result from political will.

Consider how several European countries and the European Union (EU) apply political and legal pressure on U.S. tech companies. European targets include Apple, Amazon, Facebook, Google, and Microsoft—the five largest U.S. tech companies—but also startups such as Uber, the taxi-hailing mobile app. Europe’s policy makers seek to retain control over important industries ranging from transportation to the internet to ensure that profits earned in Europe by Silicon Valley firms are taxed locally. The EU parliament even proposed legislation to break up “digital monopolies” such as Google. This proposal would require Google to offer search services independently as a standalone company from its other online services.

Exercise: US Automotive Industry & PESTEL

You will be divided into 6 groups. Each group will take on a factor for discussion.

How does PESTEL impact the US automakers as a whole?

Political

Economic

Sociocultural

Technological

Ecological

Legal

Use Word doc for answers. Pestel analysis auto industry

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EXTERNAL ANALYSIS

INDUSTRY ANALYSIS

Five Forces Model

COMPETITOR ANALYSIS

Strategic Group Mapping

PESTEL Framework

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.

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 Analysis and The Five Forces Model Michael Porter

A framework for identifying the five forces that determine industry profit potential and help shape firm competitive strategy

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.

4 Minute cartoon https://hbr.org/video/3590615226001/the-explainer-porters-five-forces

The five forces model is one of the most widely used tools in strategy. It is worth spending some time on it.

Michael Porter wrote his original work on the subject over 30 years ago. However, he updated this work in 2008 and you may want to

review his article in HBR for more details on the model. (Porter, M. E. (2008), “The five competitive forces that shape strategy.”)

Porter’s Five Forces Model

The stronger the five forces, the lower the industry’s profit potential—making the industry less attractive for competitors.

The reverse is also true: the weaker the five forces, the greater the industry’s profit potential—making the industry more attractive.

Porter derived two key insights that form the basis of his seminal five forces model:

1. Rather than defining competition narrowly as the firm’s closest competitors to explain and predict a firm’s performance, competition must be viewed more broadly, to also encompass the other forces in an industry: buyers, suppliers, potential new entry of other firms, and the threat of substitutes.

2. The profit potential of an industry is neither random nor entirely determined by industry-specific factors. Rather, it is a function of the five forces that shape competition: threat of entry, power of suppliers, power of buyers, threat of substitutes, and rivalry among existing firms.

As a rule of thumb, the stronger the five forces, the lower the industry’s profit potential—making the industry less attractive for competitors. The reverse is also true: the weaker the five forces, the greater the industry’s profit potential—making the industry more attractive.

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.

Incumbent advantages.

Customer switching costs.

Capital requirements.

Government policy.

Credible threat of retaliation by incumbents.

The threat of entry is high when:

✓The minimum efficient scale to compete in an industry is low.

✓Customer switching costs are low.

✓Capital requirements are low.

✓Incumbents do not possess:

Brand loyalty.

Proprietary technology.

Preferential access to raw materials.

Preferential access to distribution channels.

Favorable geographic locations.

Cumulative learning and experience effects.

✓Restrictive government regulations do not exist.

✓New entrants expect that incumbents will not or cannot retaliate.

Power of Suppliers

Pressures that industry suppliers can exert on an industry’s profit potential.

Suppliers demand higher prices for their inputs.

Suppliers capture part of the economic value created.

Supplier threats:

Supplier’s industry concentration.

Suppliers relation to industry vs. revenues.

Incumbent firms switching costs to change suppliers.

Suppliers offer products that are differentiated.

There are no readily available substitutes.

Suppliers can forward-integrate into the industry.

The power of suppliers is high when:

✓Supplier’s industry is more concentrated than the industry it sells to.

✓Suppliers do not depend heavily on the industry for their revenues.

✓Incumbent firms face significant switching costs when changing suppliers.

✓Suppliers offer products that are differentiated.

✓There are no readily available substitutes for the products or services that the suppliers offer.

✓Suppliers can credibly threaten to forward-integrate into the industry.

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.

Buyer threats:

There are a few buyers and each buyer purchases large quantities relative to the size of a single seller.

The industry’s products are standardized/undifferentiated commodities.

Buyers face low or no switching costs.

Buyers can backward integrate into the industry.

The power of buyers is high when:

✓There are a few buyers and each buyer purchases large quantities relative to the size of a single seller.

✓The industry’s products are standardized or undifferentiated commodities. (airfares)

✓Buyers face low or no switching costs. (Wireless providers)

✓Buyers can credibly threaten to backwardly integrate into the industry.

The retail giant Walmart provides perhaps the most potent example of tremendous buyer power. Walmart is not only the largest retailer worldwide (with over 12,000 stores and 2 million employees), but it is also one of the largest companies in the world (with $530 billion in revenues in 2019). Walmart is one of the few large big-box global retail chains and frequently purchases large quantities from its suppliers. Walmart leverages its buyer power by exerting tremendous pressure on its suppliers to lower prices and to increase quality or risk losing access to shelf space at the largest retailer in the world. Walmart’s buyer power is so strong that many suppliers co-locate offices directly next to Walmart’s headquarters in Bentonville, Arkansas, because such proximity enables Walmart’s managers to test the supplier’s latest products and negotiate prices.

Threat of Substitutes

Meet the same basic customer need:

In a different way.

Available from outside the given industry.

Substitutes work if:

The substitute offers an attractive price-performance trade-off.

The buyer’s cost of switching to the substitute is low.

The threat of substitutes is high when:

✓The substitute offers an attractive price-performance trade-off.

✓The buyer’s cost of switching to the substitute is low.

Examples: many software products are substitutes to professional services, at least at the lower end. Tax preparation software such as Intuit’s TurboTax is a substitute for professional services offered by H&R Block and others. LegalZoom, an online legal documentation service, is a threat to professional law firms. Other examples of substitutes are energy drinks versus coffee, videoconferencing versus business travel, e-mail versus express mail, gasoline versus biofuel, and wireless telephone services versus Voice over Internet Protocol (VoIP), offered by Skype or Vonage.

Rivalry Among Competitors

The intensity of 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.

Buyer threats:

There are many competitors in the industry.

Competitors are roughly of equal size.

Industry growth is poor

Exit barriers are high.

Products and services are direct substitutes.

Excess capacity exists in the industry.

The product or service is perishable.

The rivalry among existing competitors is high when:

✓There are many competitors in the industry. (Soda)

✓The competitors are roughly of equal size.

✓Industry growth is slow, zero, or even negative. (Wireless carriers)

✓Exit barriers are high.

✓Incumbent firms are highly committed to the business.

✓Incumbent firms cannot read or understand each other’s strategies well.

✓Products and services are direct substitutes.

✓Fixed costs are high and marginal costs are low.

✓Excess capacity exists in the industry.

✓The product or service is perishable.

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.

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.

Competitive Industry Structures

Jump to Appendix 5 long image description

Perfect - When there are many small firms offering a commodity product in an industry that is easy to enter, no one is able to increase prices and generate profits.

Monopolistic competition: The computer hardware industry provides one example of monopolistic competition. Many firms compete in this industry, and even the largest of them (Apple, ASUS, Dell, HP, or Lenovo) have less than 20 percent market share. Moreover, while products between competitors tend to be similar, they are by no means identical.

Oligopoly: The express-delivery industry is an example of an oligopoly. The main competitors in this space are FedEx and UPS. Any strategic decision made by FedEx (e.g., to expand delivery services to ground delivery of larger-size packages) directly affects UPS; likewise, any decision made by UPS (e.g., to guarantee next-day delivery before 8:00 a.m.) directly affects FedEx. Other examples of oligopolies include the soft drink industry (Coca-Cola vs, Pepsi), airframe manufacturing business (Boeing vs. Airbus), home-improvement retailing (The Home Depot vs. Lowe’s), toys and games (Hasbro vs. Mattel), and detergents (P&G vs. Unilever). When there are only two main competitors, it’s called a duopoly and is a special case of oligopoly.

Monopoly: Utilities or Satellite radio…the only supplier..

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.

In Michigan, entire communities still depend on GM, Ford, and Chrysler. If any of those carmakers were to exit the industry, communities would suffer. Other social and economic factors include ripple effects through the supply chain. When one major player in an industry shuts down, its suppliers are adversely impacted as well.

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, (whereas substitutes decrease value)

Enhances the profit potential for the industry and the firm.

Think of something that you can use, but it a better experience with the complement.

Hotel, rental cars and airlines…A good example of what a complement is would be the Halo game franchise and the effect it has had on driving increased sales in the video game console industry, in this case helping Microsoft Xbox at the expense of its rivals, but still increasing the total industry sales.

You also need an example of what complements are NOT. Students often think that if products “go together” then they must be complements ... not so. Gasoline is not a complement to the car industry. When you purchase a gallon of gasoline it does not make you want to go out an buy an extra car to go with it. A gas station is a complement. Same with Ink and Printer, needed together, but cannot operate alone so not a complement.

Co-opetition: cooperation among competitors to achieve a strategic objective

Industry Dynamics

Provides insight about:

Changing speed of an industry

Rate of innovation

Analysis must repeat over time

Industry structures aren’t stable

They are dynamic

The U.S. domestic airline industry has witnessed several large, horizontal mergers between competitors, including Delta and Northwest, United and Continental, Southwest and AirTran, as well as American and U.S. Airways. These moves allow the remaining carriers to enjoy a more benign industry structure. It also allows them to retire some of the excess capacity in the industry as the merged airlines consolidate their networks of routes. The merger activity in the airline industry provides one example of how firms can proactively reshape industry structure in their favor. A more consolidated airline industry is likely to lead to higher ticket prices and fewer choices for customers, but also more profitable airlines.

Industry Convergence

When unrelated industries satisfy the same need

Caused by technological advances

Disruption

Example: Media Industries with content going online vs. newspapers, magazines, TV, movies, radio, music)

Will print media become obsolete?

Internet companies such as Google, Facebook, Instagram (acquired by Facebook), LinkedIn (acquired by Microsoft), Snap, Pinterest, and Twitter are changing the industry structure by constantly morphing their capabilities and forcing old-line media companies such as News Corp., Time Warner, and Disney to adapt. A wide variety of mobile devices, including smartphones, tablets, and e-readers, provide a new form of content delivery that has the potential to make print media obsolete.

Five Forces in the Airline Industry

Low Entry Barriers

Powerful Suppliers

Powerful Buyers

Strong Substitute Threat

Intense Rivalry

Good or bad profit potential?

Low overall industry profit potential, thus an “unattractive” industry for investment.

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Strategic group map helps to find performance differences within the focal industry.

EXTERNAL ANALYSIS

INDUSTRY ANALYSIS

Five Forces Model

COMPETITOR ANALYSIS

Strategic Group Mapping

PESTEL Framework

Strategic Groups defined

A set of companies…

pursuing a similar strategy…

in the same industry

Strategic groups differ from one another along important dimensions such as expenditures on research and development, technology, product differentiation, product and service offerings, market segments, distribution channels, and customer service.

Strategic Group Model Framework

Clusters different firms into groups.

Is based on key strategic dimensions such as:

All about identifying your competitors…and what if any competitive advantages they hold over your firm.

How to Create a Strategic Group Model

1. Identify the important strategic dimensions.

Examples: expenditures on research and development, technology, product differentiation, product and service offerings, pricing, market segments, distribution channels, and customer service.

2. Choose two key dimensions for horizontal and vertical axis.

3. Graph the firms in the strategic group.

Each firm’s market share indicated by the size of the bubble.

All about identifying your competitors…and what if any competitive advantages they hold over your firm.

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

Exhibit 3.8

Jump to Appendix 3.6 long image description

The two strategic dimensions on the axes are prices and routes. As a result of this mapping, two strategic groups become apparent, as indicated by the dashed lines: Group A, low-cost, point-to-point airlines (Virgin Atlantic, Alaska Airlines, JetBlue, and Southwest Airlines) and Group B, differentiated airlines using a hub-and-spoke system (American, Delta, and United). The low-cost, point-to-point airlines are clustered in the lower-left corner because they tend to offer lower ticket prices but generally serve fewer routes due to their point-to-point operating system.

The differentiated airlines in Group B, offering full services using a hub-and-spoke route system, are clustered in the upper-right corner because their frequently higher ticket prices reflect frequently higher cost structures. They usually offer many more routes than the point-to-point low-cost carriers, made possible by use of the hub-and-spoke system, and thus offer many different destinations.

Insights from Strategic Group Mapping

Competitive rivalry is strongest between firms in the same strategic group. (duh!)

External environment affects strategic groups differently, (Fuel costs on hub/spoke vs. P2P carriers).

Five competitive forces affect strategic groups differently. (which carrier has advantage during economic downturns?)

Some strategic groups more profitable than others. (better profits with hub/spoke or point-to-point?)

Mobility Barriers

Restrict movement between strategic groups.

Industry-specific factors that separate one group from another.

Based on hard-to-reverse investments (strategic commitments).

What prevents Southwest Airlines from becoming a global carrier?

The two groups identified in Exhibit 3.8 are separated by the fact that offering international routes necessitates the hub-and-spoke model. Frequently, the international routes tend to be the remaining profitable routes left for the legacy carriers; albeit the up-and-coming Persian Gulf region carriers, in particular Emirates, Etihad Airways, and Qatar Airways, are beginning to threaten this profit sanctuary.

If carriers in the lower-left cluster, such as SWA or JetBlue, would like to compete globally, they would likely need to change their point-to-point operating model to a hub-and-spoke model. Or they could select a few profitable international routes and service them with long-range aircrafts such as Boeing 787s or Airbus A-380s. Adding international service to the low-cost model, however, would require managerial commitments resulting in significant capital investments and a likely departure from a well-functioning business model. Additional regulatory hurdles reinforce these mobility barriers, such as the difficulty of securing landing slots at international airports around the world.

Practice creating Strategic Maps

Beverages, (Soft drinks, Energy drinks, Water)

Alcoholic beverages, (Beer, Whiskey, Wine)

Watches

Automobiles

Athletic Shoes

Divide the students into Breakouts and assign them to an industry.

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Refresher on Strategic Positioning and Value Creation

A firm’s ability to create value for customers (V), while containing costs (C).

The goal is to generate a large gap between:

The value the firm’s product or service creates.

The cost required to produce it.

V minus C.