CHAPTER 2

The External Environment:

Opportunities, Threats,
Competition, and
Competitor Analysis

IMPORTANT DEFINITIONS
A firms EXTERNAL ENVIRONMENT is
broken down into three parts:
General
Industry
Competitor
A firms strategic actions are influenced
by the conditions in all three parts.
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IMPORTANT
DEFINITIONS

General Environment

MACRO

Dimensions in the broader society that

influence an industry and the firms
within it

Industry Environment

MICRO

Set of factors that directly influences a

firm and its competitive actions and
response

Competitor Environment
Focuses on each company against
which a firm directly competes

THE EXTERNAL
ENVIRONMENT

THE EXTERNAL ENVIRONMENT

GENERAL
The General Environment is grouped into
seven environmental segments:
[1] Demographic
[2] Economic
[3] Political/Legal
[4] Sociocultural
[5] Technological
[6] Global
[7] Physical
To successfully deal with uncertainty in the
external environment and achieve strategic
competitiveness, firms must be aware of and
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understand these segments.

THE EXTERNAL ENVIRONMENT

GENERAL
Firms cannot directly CONTROL the
general environments segments.

However, these segments influence

the actions that firms take.
Successful firms learn how to gather
the information needed to understand
all segments and their implications for
selecting and implementing the firms
strategies.
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EXTERNAL ENVIRONMENTAL
ANALYSIS
Firms engage in external environmental
analysis to better understand and cope with
their environments.
This analysis has four parts:
scanning, monitoring, forecasting, and
assessing.
Scanning :
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 underway.
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EXTERNAL ENVIRONMENTAL
ANALYSIS
Monitoring :
(1) Analysts observe MEANINGFUL
environmental changes to see if an
important trend is emerging from among
those spotted through scanning
(2)Effective monitoring requires the
firm to identify important stakeholders
and understand its reputation among
these stakeholders as the foundation for
serving their unique needs.
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EXTERNAL ENVIRONMENTAL
ANALYSIS

Forecasting :

Feasibility projections developed for what

might happen, and how quickly, as a result
of the changes and trends detected through
scanning and monitoring, both of which
focus on events at a point in time
Assessing:
Determining the timing and significance of
the effects of environmental trends that
have been identified; specifying the
implications of the understanding gathered
in the previous stages
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EXTERNAL ENVIRONMENTAL
ANALYSIS

Identifying opportunities and threats

is an important objective of studying
the general environment.
OPPORTUNITY

Ex. Procter & Gamble (P&G) is reorienting beauty

products to better serve both men and women.

THREAT
Ex. Microsoft is experiencing a severe external
threat as smartphones are expected to surpass
personal computer (PC) sales in the near future.
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INDUSTRY ENVIRONMENT
ANALYSIS
An industry is a group of firms that produce
similar products or offer similar services that
are close substitutes.
Compared with the general environment,
the industry environment has a more direct
effect on the firms:

(1) Strategic competitiveness

(2) Ability to earn aboveaverage returns
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Porters Five Forces Competition

Framework
New
ThreatEntrants
of
new entrants

Bargaining
INDUSTRY
power of
COMPETITORS buyers

SUPPLIE
RS Bargaini
ng
power of
suppliers

BUYERS
Rivalry among
existing firms

Threat of
substitutes

SUBSTITU
TES

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Threat of New Entrants

Entrants threat to industry
profitability depends upon the
height of barriers to entry
The principle sources of barriers
to entry is:

Economies of scale
Product differentiation
Capital requirements
Switching costs
Access to distribution channels
Cost disadvantages independent of

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Threat of New Entrants

ECONOMIES OF SCALE
Marginal improvements in efficiency that
a firm experiences as it incrementally
increases its size
Economies of scale can be developed in
most business functions, such as
marketing, manufacturing, research and
development, and purchasing
14

Threat of New Entrants

ECONOMIES OF SCALE (cont.)
Factors
(advantages/disadvantages) related to
large- and small-scale entry
Flexibility in pricing and market share
Costs related to scale economies
Competitor retaliation
Flexible manufacturing systems
diminishes the effectiveness of
economies scale to act as a barrier.
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Threat of New Entrants

PRODUCT DIFFERENTIATION
Unique products
Customer loyalty
New entrants frequently offer products at
lower prices

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Threat of New Entrants

CAPITAL REQUIREMENTS
Differ according to industry
Availability of capital
Physical facilities/Inventories/Marketing
activities
Knowledge requirements

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Threat of New Entrants

SWITCHING COSTS
One-time costs customers incur when they
buy from a different supplier
New equipment
Retraining employees
Psychological costs of ending a supplier
relationship

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Threat of New Entrants

ACCESS TO DISTRIBUTION CHANNELS
Stocking or shelf space
Price breaks/Cooperative advertising
allowances
Less of a barrier for products that can be
sold on the Internet

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Threat of New Entrants

COST DISADVANTAGES INDEPENDENT
OF SCALE
Proprietary product technology
Favorable access to raw materials
Desirable locations

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Threat of New Entrants

GOVERNMENT POLICY
Licensing and permit requirements
Regulation/Deregulation of industries
Antitrust violations resulting from
industry dominance

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Threat of New Entrants

EXPECTED RETALIATION
Vigorous retaliation can be expected when the
existing firm has a major stake in the industry.
It has fixed assets with few, if any, alternative uses
It has substantial resources
When industry growth is slow or constrained

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

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Threat of New Entrants

The impacts of barriers to entry
Can threaten market share of existing
competitors
May stimulate additional production capacity
New competitors may force existing firms to
be more efficient and to learn how to compete
on new dimensions.
High entry barriers tend to increase the
returns for existing firms in the industry and
may allow some firms to dominate the
industry
Industry incumbents want to maintain high
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BARGAINING POWER OF
SUPPLIERS
Supplier power increases when
Suppliers are large and few in number
Suitable substitute products are not available
Industry firms are not a significant customer
for the suppliers
Suppliers goods are critical to buyers
marketplace success
Suppliers products create high switching
costs
Suppliers have substantial resources and
provide a highly differentiated product
Suppliers pose a credible threat to integrate
forward into the buyers industry

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BARGAINING POWER OF
BUYERS
Buyer power increases when
Buyers purchase a large portion of an
industrys total output
Buyers purchases are a significant portion of
a sellers annual revenues
Switching costs are low (to other industry
product)
The industrys products are undifferentiated or
standardized
Buyers pose a credible threat to integrate
backward into the sellers industry
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THREAT OF SUBSTITUTE
PRODUCTS
Threat of substitute product
increases when
Buyers face few switching costs
The substitute products price is lower
Substitute products quality and performance
are equal to or greater than the existing
product
Differentiated industry products that are
valued by customers reduce this threat
Places a ceiling on prices firms can charge
Goods or services outside a given industry
perform the same or similar functions at a

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INTENSITY OF RIVALRY AMONG

COMPETITORS
Industry rivalry
Competitors are rarely homogeneous; they
differ in resources and capabilities and seek to
differentiate themselves from competitors
Firms seek to differentiate their products in
ways that customers value and in which the
firms have a competitive advantage

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INTENSITY OF RIVALRY AMONG

COMPETITORS
Industry rivalry increases when
Numerous or equally balanced competitors
Slow industry growth
High fixed costs or high storage costs
Lack of differentiation opportunities or low
switching costs
High strategic stakes
High exit barriers
(1) Specialized assets: assets with values
linked to a particular business
(2)Fixed costs of exit: such as labor
agreements

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INTENSITY OF RIVALRY AMONG

COMPETITORS
Industry rivalry increases when
High exit barriers
(3) Strategic interrelationships:
Relationships of mutual dependence,
such as those between one business and
other parts of a companys operations,
including shared facilities and access to
financial markets
(4)Emotional barriers:
Aversion to economically justified
business decisions because of fear for
ones own career, loyalty to employees,
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INTENSITY OF RIVALRY AMONG

COMPETITORS
Industry rivalry increases when
High exit barriers
(5) Government and social restrictions:
Often based on government concerns for
job losses and regional economic effects.

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The Structural Determinants of

Competition
SUPPLIER POWER
Relative bargaining
power

THREAT OF ENTRY
Capital requirements
Economies of scale
Absolute cost
advantage
Product differentiation
Access to distribution
channels
Legal/regulatory
barriers
retaliation

INDUSTRY RIVALRY
Concentration
Diversity of
competitors
Product differentiation
Excess capacity and
exit barriers
Cost conditions
BUYER POWER
Buyers price
sensitivity
Relative bargaining
power

SUBSTITUTE
COMPETITION
Buyers propensity
to substitute
Relative prices and
performances of
substitutes

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INDUSTRY ENVIRONMENT
ANALYSIS

THE FIVE FORCES OF

COMPETITION MODEL
Low entry
barriers
Suppliers and
buyers have
strong positions
Strong threats
from substitute
products
Intense rivalry
among competitors

Unattractive
Industry

LOW PROFIT
POTENTIAL
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INDUSTRY ENVIRONMENT
ANALYSIS

THE FIVE FORCES OF

COMPETITION MODEL
High entry
barriers
Suppliers and
buyers have weak
positions
Few threats from
substitute
products
Moderate rivalry
among competitors

Attractive
Industry

HIGH PROFIT
POTENTIAL 33

Applying Five-Forces Analysis

Forecasting Industry Profitability

If we can forecast changes in industry
structure we can predict likely impact on
competition and profitability

Strategic Planning
Once we know which structural features of the
industry support profitability and which depress
profitability, we can choose a favourable
positioning within the industry

Strategies to Improve Industry

Profitability
Which of the structural variables that are

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Extending the Five

Forces Framework

1. Five Forces or Six?

Introducing Complements
SUPPLIERS

SUPPLIERS

Threat of
new
entrants

Bargaining
power of
suppliers
INDUSTRY
COMPETITOR
S

The suppliers of
complements
create value for
the industry and
can exercise
bargaining power

COMPLEMEN
TS
Threat of
SUBSTITUTE
substitute
S
s

Rivalry
among
Bargaining
existing
power of
firms
buyers
BUYERS

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Complements
Complements: Products or services which have a
potential impact on the value of a firms own products
or services.
Ex. Microsoft Windows and PCs
Video game consoles and video game

Complementors: Those who produce complements

Bargaining power of complements:
Ex. 1 Windows became a proprietary standard, while PCs were
gradually reduced to commodity status.
2. Nitendo controls the console operating system to
enforce
restrictive developer licenses to software producers of
games.

2. STRATEGIC GROUPS
A strategic group is a group of firms in an
industry that follow the same or similar strategies
Firms within a strategic group are direct
competitors (offer similar products), thus rivalry
can be intense; the greater the rivalry the greater
the threat to each firms profitability.
The strengths of the five forces differ across
strategic groups.
The closer the strategic groups in terms of
strategy, the greater the likelihood of rivalry.
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Strategic Group
Within the World Automobile
Industry

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Strategic
Group
Within
the PC
Industry

Strategic Groups within

Industries
Value of strategic groups as an
analytical tool
Identify barriers to mobility that protect
a group from attacks by other groups
Identify groups whose competitive
position may be marginal or tenuous
Chart the future direction of firms
strategies
Thinking through the implications of
each industry trend for the strategic
2-41

3. Stable or Dynamic?
Porter framework assumes:
a) Industry structure drives competitive
behaviour
b) Industry structure is (fairly) stable
But, competition also changes industry structure
) Schumpeterian Competition A perennial
gale of creative destruction market leaders over
thrown by innovation
) Hypercompetition Intense and rapid
competition moves continuously creating new
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4. Competition or
Cooperation?
Main value of strategic analysis:
1. Framing strategic decisions as interactions
between competitors
2. Predicting outcomes of competitive situations
involving a few, evenly-matched players

. Competition and Cooperation Game theory

can show conditions where cooperation is more
advantageous than competition

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References
1. Ireland, RD., Hoskisson, R. & Titt, M. 2013.
The Management of Strategy
Concepts (10e) South-Western
2. Grant, R. 2013 Contemporary Strategy
Analysis (8e) Wiley

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