External and Industry Environment Analysis

Dr. K. Rangarajan
28 May 2010

Two Determinants of Profitability

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Advantage Competitive Position

Disadvantage Low High

Environmental Attractiveness

Business Environment
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External & internal conditions effecting the firm Firm trades & competes within an economy, & an industry Constant changes require systematic monitoring Environmental changes destroy & create business opportunities

External Environment
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Outside forces which impact on the firm Economy Technology Society Government Competitors Customers Suppliers

Internal Environment
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Conditions & forces within the firm Owners Managers Employees Firm culture Physical resources

Environmental Uncertainty
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Level of uncertainty depends on 2 dimensions: Degree of change within the industry Stable to dynamic Degree of Homogeneity within industry Simple to complex

Environmental Turbulence
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Amount of simultaneous expansion, contraction, entry & exit within an industry Small firms exhibit higher level of turbulence than big business Less able to control environment through market dominance & political lobbying
Strategy Making Department

Competition
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Grounded in underlying industry economics + other external forces: government, suppliers etc Porters model for analyzing industry attractiveness useful tool Knowledge of competitive pressure within an industry provides basis for strategy formulation

Questions to Ask in Societal Environmental Analysis

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What are the current and emerging trends in each segment? What are the indicators of these trends? What is the historic evolution of these trends? What is the degree of change within these trends? How will competitors deal with these trends? How will these trends impact my organization?

Strategic Issues and Strategic Factors

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Strategic Issues Trends likely to affect future environment Strategic Factors Those strategic issues with high probability of occurrence and high probable impact on corporation

Issues Priority Matrix

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Probable Impact on Corporation High Medium Low

Probability of Occurrence

Medium

High

High Priority

High Priority

Medium Priority

High Priority

Medium Priority

Low Priority

Medium Priority

Some Important Variables in the Societal Environment

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Economic GDP trends Interest rates Money supply Inflation rates Unemployment levels Wage/price controls Devaluation/ revaluation Energy availability and cost Disposable and discretionary income

Low

Low Priority

Low Priority

Source: Adapted from L. L. Lederman, Foresight Activities in the U.S.A.: Time for a Reassessment? Long Range Planning (June 1984), p. 46. Copyright 1984 by Pergamon Press, Ltd. Reprinted with permission.

Technological Total government spending for R&D Total industry spending for R&D Focus of technological efforts Patent protection New products New developments in technology transfer from lab to marketplace Productivity Improvements through automation

Political-Legal Antitrust regulations Environmental protection laws Tax laws Special incentives Foreign trade regulations Attitudes toward foreign companies Laws on hiring and promotion Stability of government

Socio-cultural Lifestyle changes Career expectations Consumer activism Rate of family formation Growth rate of population Age distribution of population Regional shifts in population Life expectancies Birth rates

Porters Diamond
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Chance Firm strategy structure and rivalry

Factor conditions

Demand conditions

Related and supporting industries

Government

Determinants in the Diamond

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I. Factor Conditions The nations position in factors of production These factors can be grouped as follows: Human Resource; Physical Resource; Knowledge Resource; Capital Resource; Infrastructure Competitive advantage from factors depends on how efficiently and effectively they are deployed II. Demand Conditions The quality of home demand determines competitive advantage Nature of domestic Buyers + Size and Pattern of Growth + Competitive Advantage Transmission to Foreign Market

Determinants in the Diamond (Contd.)

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III. Related and Supporting Industries The presence or absence of supplier industries and related industries that are internationally competitive IV. Firm Strategy, Structure and Rivalry The conditions in the nation governing how companies are created, organised and managed and the nature of domestic rivalry

Inter-relationship in the Diamond

SESSION : 2 Related & Supported Industries Create or stimulate creation of transferable factors Firm Stgy. Structure and Rivalry

Determinants

Factor conditions

Demand conditions

Factor conditions

Influence priorities for faster creation of investments

Stimulates faster creation though rivalry/ challenges

Demand conditions

Attract Foreign firms/individuals for the nations products

Pull foreign demand for the industry product

Rivalry boosts home demand and its specification

Related & Supported Industries

Factor pools are transferable to related industries Attracts New Entrants though factor abundance or specialisation

Stimulated growth of supplier industries

Encourages formation of more specialists

Firm Stgy. Structure and Rivalry

Early product penetration feeds industry

New Entrants

Competitive Diamond Indian Apparel Cluster

SESSION : 2 Weak/Medium

Basic=Strong Advanced=Weak

Strategy Structure Rivalry

-Over-dependence on privileged market access -Mainly supplying labor -Mainly commodity/price competition +Some moving to full package/design +Many industry participants

Weak

Factors

Basic: +Proximity to Stgic. Mkts. +Good IT Support +Good managerial/supervisory base +Favorable tax incentives +Good park infrastructure and policy Weak-With +Relatively low labor costs Potential Advanced: -Weak Telecom support - Weak port and airport -Weak in higher skills training --Weak financial sector +/-Transport logistics and costs +Some emerging CAD capability -Lack of local base of critical related industries -Dependency on foreign providers of technology -Inadequate schools and training providers -Lack Govt. vision for cluster development -Bureaucracy & Red-tapisim

Demand Conditions
-Dependency on intermediaries -Lack of first-hand exposure to demanding or trend-setting consumers -Low knowledge of high-income segments -Dependency on foreign brands -Poorly Exposed to stringent buyer requirements +Entrepreneurs read and travel widely +Indirect exposure via clients

Cluster

Industry Analysis
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An Industry is defined as: A group of organizations offering products or services which are close substitutes for each other Boundaries of the industry are determined from a users point of view

Forces in the Industry Analysis

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Threat of new entrants Bargaining power of suppliers Suppliers

New Entrants

Industry Competitors

Bargaining power of buyers Buyers

Intensity of rivalry

Threat of substitutes Substitutes

Intensity of Rivalry
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Determinants of rivalry Industry growth Share of fixed costs to total value added Depth of product differentiation Concentration and balance among competitors

Strong Rivalry Occurs When:

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Low industry growth High relative fixed costs Little product differentiation Fragmented industry with different competitive perspectives

Rivalry Among Established Companies

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Industry Competitive Structure

Fragmented Many firms. No dominant firm

Consolidated One firm or one dominant firm. (monopoly)

Few firms, Shared dominance (Oligopoly)

The Continuum of Industry Structures

Threat of New Entrants

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Likelihood of New Entrants is Determined by Height of Entry Barriers

Some Barriers to Entry:

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Economies of Scale Product Differentiation Capital Requirements Switching Costs Access to Distribution Channels Cost Disadvantages Independent of Size Government Policy

High Entry Barriers Means High Profitability

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High barriers restrict new entrants

Bargaining Power of Buyers

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Buyers as consumers of the industrys output Powerful buyers can demand lower prices, higher quality or better services Powerful buyers reduce industry profitability

Buyers become powerful when:

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Few important buyers Buyer switching costs are low Buyers can easily vertically integrate Substitutes for the industrys product are readily available

Bargaining Power of Suppliers

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Suppliers provide inputs to the industry Powerful Suppliers--raise prices or reduce quality of raw materials Powerful suppliers reduce industry profitability

Suppliers become powerful when:

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Few substitutes exist Differentiation or high switching costs Small number of suppliers Supplier threat of vertical integration is high

Threat of Substitutes
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Substitutes can replace the industrys products and services or present an alternative to fulfill demand Substitutes establish a price ceiling for the industrys product Substitutes establish a quality threshold for the industrys product

Substitutes become powerful when:

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Buyers perceive performance and value of the substitute to be similar to the industrys product Buyers switching cost is low Substitutes are readily available

Vs.

The Five Forces are Unique to Your Industry

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Five-Forces Analysis is a framework for analyzing a particular industry Yet, the five forces affect all the other businesses in that industry

Industry Scenarios
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1. Examine possible shifts in societal variable globally. 2. Identify uncertainties in each of the six forces of the task environment. 3. Make a range of plausible assumptions about future trends. 4. Combine assumptions into internally consistent scenarios. 5. Analyze the industry situation under each scenario. 6. Determine sources of competitive advantage under each scenario. 7. Predict competitors behavior under each scenario. 8. Select most likely scenario to use in strategy formulation.

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