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Hitt, Ireland, Hoskisson, Strategic Management: Competitiveness & Globalization: Concepts & Cases, 13e. © 2020 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or part.

CHAPTER

2 The External Environment:

Opportunities, Threats, Industry Competition, and Competitor Analysis

LEARNING OBJECTIVES Studying this chapter should provide you with the strategic management knowledge needed to: 2-1 Explain the importance of analyzing and understanding the firm’s external

environment. 2-2 Define and describe the general environment and the industry

environment. 2-3 Discuss the four parts of the external environmental analysis process. 2-4 Name and describe the general environment’s seven segments. 2-5 Identify the five competitive forces and explain how they determine an

industry’s profitability potential. 2-6 Define strategic groups and describe their influence on firms. 2-7 Describe what firms need to know about their competitors and different

methods (including ethical standards) used to collect intelligence about them.

Figure 2.1 The External Environment

2-1 The General, Industry, and Competitor Environments (slide 1 of 3)

• The general environment is composed of dimensions in the broader society that influence an industry and the firms within it. • The dimensions are grouped into seven environmental

segments: 1. Demographic 2. Economic 3. Political/legal 4. Sociocultural 5. Technological 6. Global 7. Sustainable physical environment

Table 2.1 The General Environment: Segments and Elements (slide 1 of 2)

Demographic segment

• Population size • Age structure • Geographic distribution

• Ethnic mix • Income distribution

Economic segment

• Inflation rates • Interest rates • Trade deficits or surpluses • Budget deficits 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

Table 2.1 The General Environment: Segments and Elements (slide 2 of 2)

Technological segment

• Product innovations • Applications of knowledge

• Focus of private and government-supported research and development (R&D) expenditures

• New communication technologies

Global segment

• Important political events • Critical global markets

• Newly industrialized countries

• Different cultural and institutional attributes

Sustainable physical environment segment

• Energy consumption • Practices used to develop

energy sources • Renewable energy efforts • Minimizing a firm’s

environmental footprint

• Availability of water as a resource

• Producing environmentally friendly products

• Reacting to natural or man- made disasters

2-1 The General, Industry, and Competitor Environments (slide 2 of 3)

• The industry environment is a set of factors that directly influences a firm and its competitive actions and responses: • The threat of new entrants • The power of suppliers • The power of buyers • The threat of product substitutes • The intensity of rivalry among competing firms

• 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.

2-1 The General, Industry, and Competitor Environments (slide 3 of 3)

• An analysis of the general environment focuses on environmental trends and their implications.

• An analysis of the industry environment focuses on the factors and conditions influencing an industry’s profitability potential.

• 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 • Choice of strategies • Competitive actions and responses it will take to implement those

strategies

2-2 External Environmental Analysis (slide 1 of 2)

• To cope with often ambiguous and incomplete environmental data and to increase understanding of the general environment, firms complete an external environmental analysis. • The four parts of an external environmental analysis

are: 1. Scanning 2. Monitoring 3. Forecasting 4. Assessing

Table 2.2 Parts of the External Environmental Analysis

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 firms’ strategies and their management

2-2 External Environmental Analysis (slide 2 of 2)

• 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 reach strategic competitiveness.

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

• Effective scanning, monitoring, forecasting, and assessing are vital to the firm’s efforts to recognize and evaluate opportunities and threats.

2-2a 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 • Detect changes that are already under way

• Scanning activities must be aligned with the organizational context.

• The Internet provides a wealth of opportunities for scanning.

2-2b Monitoring

• When monitoring, analysts observe environmental changes to see if an important trend is emerging from among those spotted through scanning.

• Effective monitoring requires the firm to identify important stakeholders and understand its reputation among these stakeholders as the foundation for serving their unique needs.

2-2c Forecasting

• When forecasting, analysts develop feasible projections of what might happen, and how quickly, as a result of the events and trends detected through scanning and monitoring.

• Forecasting events and outcomes accurately is challenging.

• Forecasting demand for new technological products is difficult because technology trends are continually shortening product life cycles.

2-2d Assessing

• When assessing, the objective is to determine the timing and significance of the effects of environmental changes and trends that have been identified.

• The intent of assessment is to specify the implications of understanding the general environment.

• Although gathering and organizing information is important, appropriately interpreting that information to determine if an identified trend in the general environment is an opportunity or threat is critical.

2-3 Segments of the General Environment

• The general environment is composed of the following segments that are external to the firm: • Demographic • Economic • Political/legal • Sociocultural • Technological • Global • Sustainable physical environment

• These environmental segments affect all industries and the firms competing in them. • For each segment, firms have to determine the strategic relevance of

environmental changes and trends.

2-3a The Demographic Segment (slide 1 of 3)

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

Population Size • It is projected that population growth will continue in the twenty-first

century, but at a slower pace. • Firms may want to recognize the market potential that may exist for

them in the following five nations, which are expected to be the most populous nations in the world by 2050: 1. India 2. China 3. United States 4. Indonesia 5. Pakistan

2-3a The Demographic Segment (slide 2 of 3)

Age Structure • The world’s population is rapidly aging. • The aging of the population:

• Has significant implications for availability of qualified labor, health care, retirement policies, and business opportunities among others.

• Threatens the ability of firms to hire and retain a workforce that meets their needs.

Geographic Distribution • How a population is distributed within countries and regions is

subject to change over time. • Examples: In the United States, the shift from states in the Northeast

and Great Lakes region to states in the West, South, and Southwest; in China, the shift from rural areas to urban communities

2-3a The Demographic Segment (slide 3 of 3)

Ethnic Mix • The ethnic mix of countries’ populations continues to change.

• Example: The increase in the Hispanic population in the United States • The ethnic diversity of the population is important because of:

• Consumer needs • The labor force composition

Income Distribution • Income distribution within and across populations informs firms of

different groups’ purchasing power and discretionary income. • Example: The rise in domestic consumption of consumer goods by

India’s middle class has positioned it as a market of interest. • Of particular interest to firms are the average incomes of households

and individuals.

2-3b The Economic Segment

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

• In general, firms seek to compete in relatively stable economies with strong growth potential.

• It is challenging for firms studying the economic environment to predict economic trends that may occur and their effects on them.

• When facing economic uncertainty, firms especially want to study closely the economic environment in multiple regions and countries throughout the world.

2-3c 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 regulations guiding interactions among nations as well as between firms and various local governmental agencies.

• Essentially, this segment is concerned with: • How organizations try to influence governments • How they try to understand the current and projected influences of those

governments on their competitive actions and responses • The relationship between national, regional, and local laws and

regulations creates a highly complex environment within which businesses must navigate.

2-3d The Sociocultural Segment

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

• Form the cornerstone of a society • Often drive demographic, economic, political/legal, and

technological conditions and changes • Are relatively stable, but can and often do change over time

• Firms must identify these changes in order to stay ahead of their competitors and stay relevant in the minds of their consumers.

2-3e The Technological Segment

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

• Firms should continuously scan the general environment to identify: • Potential substitutes for technologies that are in current use • Newly emerging technologies from which their firm could derive

competitive advantage • New technology and innovations are changing many industries.

• Examples: The Internet and wireless communication technology • Thus, firms in all industries must become more innovative in order to

survive.

2-3f The Global Segment (slide 1 of 2)

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

• When studying the global segment, firms should recognize that globalization of business markets may create opportunities to enter new markets, as well as threats that competitors from other economies may enter their market. • Globalfocusing:

• Is a more cautious approach to globalization in which firms focus on global niche markets

• Allows firms to build onto and use their competencies while limiting their risks within the niche market

2-3f The Global Segment (slide 2 of 2)

• Firms competing in global markets should recognize each market’s sociocultural and institutional attributes. • Examples: Korean ideology emphasizes

communitarism; Chinese ideology emphasizes guanxi—personal connections; Japanese ideology emphasizes wa—group harmony and social cohesion.

• The informal economy is another aspect of the global segment requiring analysis.

2-3g The Sustainable Physical Environment Segment

• The sustainable physical environment segment refers to potential and actual changes in the physical environment and business practices that are intended to positively respond to those changes in order to create a sustainable environment.

• 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 and that they are part of an interconnected global society.

• An increasing number of companies are investing in sustainable development.

2-4 Industry Environment Analysis

• An industry is a group of firms producing products that are close substitutes.

• Companies use a mix of different competitive strategies to pursue above-average returns when competing in a particular industry. • An industry’s structural characteristics influence a firm’s choice of strategies.

• Compared with the general environment, the industry environment has a more direct effect on firms’ competitive actions and responses.

• To study an industry, the firm examines five forces that affect the ability of all firms to operate profitably within a given industry: 1. The threats posed by new entrants 2. The power of suppliers 3. The power of buyers 4. Product substitutes 5. The intensity of rivalry among competitors

Figure 2.2 The Five Forces of Competition Model

2-4a Threat of New Entrants (slide 1 of 5)

• Identifying new entrants is important because they can threaten the market share of existing competitors.

• How likely firms will enter an industry is a function of two factors: 1. Barriers to entry 2. The retaliation expected from current industry participants

Barriers to Entry • Companies competing within a particular industry study entry

barriers to determine the degree to which their competitive position reduces the likelihood of new competitors being able to enter the industry to compete against them.

• Firms considering entering an industry study entry barriers to determine the likelihood of being able to identify an attractive competitive position within the industry.

2-4a Threat of New Entrants (slide 2 of 5)

• There are several significant entry barriers: • Economies of scale • Product differentiation • Capital requirements • Switching costs • Access to distribution channels • Cost disadvantages independent of scale • Government policy

Economies of Scale • With economies of scale, the cost of producing each unit declines as the

quantity of a product produced during a given period increases. • A new entrant is unlikely to quickly generate the level of demand for its

product that would allow it to develop economies of scale.

2-4a Threat of New Entrants (slide 3 of 5)

Product Differentiation • Over time, customers may come to believe that a firm’s product

is unique and consistently purchase that firm’s product. • To combat the perception of uniqueness, new entrants

frequently offer products at lower prices. • However, this may result in lower profits or even losses.

Capital Requirements • Competing in a new industry requires a firm to have capital for

physical facilities, inventories, marketing activities, and other critical business functions.

• The capital required for successful market entry may not be available to pursue the market opportunity.

2-4a Threat of New Entrants (slide 4 of 5)

Switching Costs • Switching costs are the one-time costs customers incur when

they buy from a different supplier. • If switching costs are high, a new entrant must attract buyers by

offering either: • A substantially lower price • A much better product

Access to Distribution Channels • After building a relationship with its distributors, a firm will nurture

it, thus creating switching costs for the distributors. • New entrants may use price breaks and cooperative advertising

allowances to persuade distributors to carry their products. • However, those practices can reduce new entrants’ profit potential.

2-4a Threat of New Entrants (slide 5 of 5)

Cost Disadvantages Independent of Scale • Successful competition requires new entrants to reduce the

strategic relevance of cost advantages held by established competitors that cannot be duplicated.

• Examples: Proprietary product technology, favorable access to raw materials, desirable locations, and government subsidies

Government Policy • Governmental decisions and policies that can control entry into

an industry include: • The granting of licenses and permits • Deregulation • Antitrust issues

2-4b Bargaining Power of Suppliers

• Suppliers can exert power over firms competing within an industry by: • Increasing prices • Reducing the quality of their products

• 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.

2-4c Bargaining Power of Buyers

• To reduce their costs, buyers bargain for: • Higher quality • Greater levels of service • Lower prices

• 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.

2-4d 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.

• In general, product substitutes present a strong threat to a firm when: • Customers face few, if any, switching costs • The substitute product’s price is lower • The substitute product’s quality and performance capabilities are equal

to or greater than those of the competing product • To reduce a substitute’s attractiveness, a firm can differentiate a

product along dimensions that are valuable to customers, such as: • Quality • Service after the sale • Location

2-4e Intensity of Rivalry among Competitors

• Competitive rivalry intensifies when: • A firm is challenged by a competitor’s actions • A company recognizes an opportunity to improve its market position

• Common dimensions on which rivalry is based include: • Price • Service after the sale • Innovation

• Factors that increase the intensity of rivalries among firms include: • Numerous or equally balanced competitors • Slow industry growth • High fixed costs or high storage costs • Lack of differentiation or low switching costs • High strategic stakes • High exit barriers

2-5 Interpreting Industry Analyses

• Analysis of the five forces within a given industry allows the firm to determine the industry’s attractiveness in terms of the potential to earn average or above-average returns. • Stronger competitive forces usually mean a lower potential to earn profits.

• An unattractive industry has: • Low entry barriers • Suppliers and buyers with strong bargaining positions • Strong competitive threats from product substitutes • Intense rivalry among competitors

• An attractive industry has: • High entry barriers • Suppliers and buyers with little bargaining power • Few competitive threats from product substitutes • Relatively moderate rivalry

2-6 Strategic Groups (slide 1 of 3)

• A set of firms emphasizing similar strategic dimensions and using a similar strategy is called a strategic group.

• Competitive rivalry is greater within a strategic group than between strategic groups.

2-6 Strategic Groups (slide 2 of 3)

• Analyzing strategic groups can be helpful in diagnosing competition, positioning, and the profitability of firms competing within an industry. • Using strategic groups to understand an industry’s competitive

structure requires the firm to plot companies’ competitive actions and responses along strategic dimensions, such as:

• Pricing decisions • Product quality • Distribution channels

• This shows the firm how certain companies are competing similarly in terms of how they use similar strategic dimensions.

2-6 Strategic Groups (slide 3 of 3)

• Strategic groups have several implications: • 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 is the threat to each firm’s profitability.

• The strengths of the five forces differ across strategic groups.

• The closer the strategic groups are in terms of their strategies, the greater is the likelihood of rivalry between the groups.

2-7 Competitor Analysis (slide 1 of 2)

• Competitor analysis focuses on each company against which a firm competes directly.

• 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, 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 • Knowledge about these four dimensions helps the firm prepare an

anticipated response profile for each competitor.

Figure 2.3 Competitor Analysis Components

2-7 Competitor Analysis (slide 2 of 2)

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

• When gathering competitive intelligence, a firm must pay attention to the complementors of its products and strategy. • Complementors are companies or networks of companies that

sell complementary goods or services that are compatible with the focal firm’s good or service.

• Example: Intel and Microsoft

2-8 Ethical Considerations

• Firms must follow laws, regulations, and ethical guidelines when gathering competitor intelligence. • Practices considered both legal and ethical include:

• Obtaining publicly available information • Examples: Court records and annual reports

• Attending trade fairs and shows to obtain competitors’ brochures, view their exhibits, and listen to discussions about their products

• Practices widely viewed as unethical include: • Blackmail • Trespassing • Eavesdropping • Stealing drawings, samples, or documents