CONFIDENTIAL

Chapter 4
Exploring the External Environment:
Macro and Industry Dynamics

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OBJECTIVES
Unit of measure

1 Explain the importance of the external context for

strategy and firm performance

2 Use PESTEL to identify the macro characteristics of

the external context

3 Identify the major features of an industry and the

forces that affect industry profitability

4 Understand the dynamic characteristics of the

external context

5 Show how industry dynamics may redefine industries

6 Use scenario planning to predict the future structure

of the external context

* Footnote
2
Source: Source
THE COLA WARS
Unit of measure

“Coca-Cola sells a billion servings – in cans, bottles, and glasses –

every day. You can grab a Coke in almost 200 countries. Its archrival,
Pepsi, isn’t too far behind. Like ford versus Chevy, theirs is a battle
not just for customer dollars, but for their hearts and minds as well.

– The History Channel, “Empires of industry. Cola Wars”

* Footnote
3
Source: Source
THE COLA WARS (TIMELINE)
Unit of measure
Coca-Cola Pepsi

Coca-Cola invented 1886

1950 “Beat Coke”

1960 “Pepsi Generation”

1970 “Pepsi Challenge”

“Kick Pepsi's can” 1980 Foster entrepreneurial

Diet Coke spirit of Pepsi’s people
New Coke
1990 Jettison slow-growing
businesses

Repair Coke and restore 2000 Diversify beyond

Stock price soft-drinks
Diversify product line
* Footnote
4
Source: Source
EXTERNAL CONTEXT OF STRATEGY
Unit of measure

• An internal analysis is
just half of what is
Internal
needed to build
• Strengths strategy
• Weaknesses • The SWOT and more
complicated
• Capabilities
frameworks help us
• Relationships understand the full
• Etc. picture

* Footnote
5
Source: Source
COMPARATIVE INDUSTRY – WIDE LEVEL OF PROFITABILITY, 1995 – 2004
Unit of measure
Weighted average return on invested capital
Percent

25

20

15

10

-5

Bever- Ciga- Pharma- Eating Steel Rail- Truck- Bott- Comp- Agri- Pre- Air- Wire-
ages rettes ceuticals esta- roads ing lers uters cul- pack lines less
blish- tural aged pro-
ments pro soft viders
ducts ware

* Footnote
Source: Data from Standard and Poor’s CompuStat 6
Source: Source
THE EXTERNAL ENVIRONMENT OF THE ORGANIZATION
Unit of measure

Macro Environment
Political, Economic, Sociocultural,
Technological, Environmental, Legal

Industry Environment

Strategic Group

The Organization

* Footnote
7
Source: Source
KEY QUESTION TO ASK
Unit of measure

What macro environmental

conditions will have a material What is our
effect on our ability to implement firm’s industry?
our strategy successfully?

What are the

characteristics of the
How stable are these
industry?
characteristics?

* Footnote
8
Source: Source
UNDERSTANDING THE MACRO ENVIRONMENT USING A PESTEL ANALYSIS
Unit of measure
• How stable is the political environment?
Political • Tax policies
• Etc.
• Projected interest rates?
Economic • Inflation?
• Etc.
• Lifestyle trends?
Socio-cultural • Demographic changes?
• Etc.
• Level of government research funding?
Technological • How mature is technology?
• Etc.
• Is intellectual property protected?
Legal • Relevant consumer laws?
• Etc.
* Footnote
9
Source: Source
PRESSURES FAVORING INDUSTRY GLOBALIZATION
Unit of measure
Markets Costs Governments Competition

• Homogeneous • Large scale and • Favorable trade • Interdependent

customer needs scope economies policies countries
• Global customer • Learning and • Common • Global
needs experience technological competitors
standards
• Global channels • Sourcing • Common
efficiencies manufacturing
and marketing
regulations
• Transferable • Favorable
marketing logistics
approaches • Arbitrage
opportunities
• High R&D costs

Source: * Adapted
Footnotefrom M.E. Porter, Competition in Global industries (Boston: Harvard Business School Press,
1986); G. Yip, “Global Strategy in a World of Nations, “ Sloan Management review 31:1 (1989), 29-40 10
Source: Source
COMPETITION DRIVES PROFITS TO A “NORMAL” LEVEL
Unit of measure

Profits
Competition (above
Profits normal)
(above
normal)

Revenue Costs Revenue Costs

Competition

* Footnote
11
Source: Source
KEY SUCCESS FACTORS AS BARRIERS TO ENTRY
Unit of measure
Key success factor (KSF)
Key asset or requisite skill
that all firms in an industry
must possess in order to be
a viable competitor
* Footnote
Source: Source
SOFT DRINK EXAMPLE
KSFs:
 Ability to meet competitive pricing
 Extensive distribution
 Ability to raise consumer awareness
 Broad product mix
 Global presence
 Well positioned bottlers and bottling
capacity
12
INDUSTRY FRAGMENTATION AND CONCENTRATION
Unit of measure

Monopoly Duopoly Fragmented

* Footnote
13
Source: Source
CONCENTRATION IN SELECT U.S. INDUSTRIES
Unit of measure Others
Percent of market Top four competitors

Entire Animal Break- Dairy Entire Men’s Women’s

food fast pro- apparel and and girls’
industry food cereal ducts industry boys’ apparel
apparel

Source: U.S. Census Bureau, “Economic Census: Concentration Rations”, Economic Census 2002 (accessed July
* Footnote
15,2005),www.census.gov/epcd/www/concentration.html 14
Source: Source
ANALYZING INDUSTRY STRUCTURE USING FIVE – FORCES
Unit of measure
C Threat of New Entrants (and Entry Barriers)
om
• ple • Absolute cost advantages
Nu men • Proprietary learning curve
• mb
e
tor
s
• Relativ r of co • Access to inputs
Bar ev m
• r a pl • Government policy
Dif iers to lue a emen
• ficu
l co dde ts • Economies of scale
• Buyer ty of en mplem d • Capital requirements
Co p
mp erce gagin ent e Industry value chain –
lem p gc ntry • Brand identity
ent tion o o from raw materials and
exc f com mplem • Switching costs
lus other inputs, to channel
ivit plem ents • Access to distribution
y ent to end consumer
s • Expected retaliation
• Proprietary products

Supplier Power Degree of Rivalry
• Supplier concentration • Exit barriers
• Importance of volume to supplier • Industry concentration
• Differentiation of inputs • Fixed costs/value added
• Impact of inputs on cost or differentiation • Industry growth
• Switching costs of firms in the industry • Intermittent overcapacity
• Presence of substitute inputs • Product differences
• Threat of forward integration • Switching costs
• Cost relative to total purchases in industry • Brand identity
• Diversity of rivals
• Corporate stakes
Buyer Power (Channel and End consumer)
• Bargaining leverage
• Buyer volume
• Buyer information
• Brand identity
• Price sensitivity
• Threat of backward integration
• Product differentiation
• Buyer concentration vs. industry
• Substitutes available
• Buyer’s incentives

Threat of Substitutes
• Switching costs
• Buyer inclination to substitute
• Price-performance tradeoff of
substitutes
• Varity of substitutes
Source: * Adapted from M.E. Porter, Competitive Strategy:
Footnote • Techniques
Necessity offorproduct
Analyzing Industries and Competitors (New York: Free Press,
or service
1980) 15
Source: Source
CAUSES OF RIVARLY
Unit of measure
Barriers to Entry Barriers to Exit
In addition to entry
and exit barriers,
many factors drive
rivalry
• History of price wars

• Level of fixed costs

• Industry
concentration

• Market growth
• Strong brands • Few other opportunities
• Proprietary technology • Sunk investments • Etc.
• Start-up costs • Etc.,
• Etc.,

* Footnote
16
Source: Source
SUPPLIER POWER
Unit of measure

Diamond supply Diamond

Percent Retailers

Others 50

When firms in the supply

industry can dictate
terms, they can extract
greater profits

DeBeers 50

* Footnote
17
Source: Source
BUYER POWER ILLUSTRATIVE

Unit of measure
Industry A Industry B
Suppliers Buyers Suppliers Buyers

In industries
characterized with
many suppliers
and few buyers,
buyers often
capture a greater
Profits Profits share of profits

* Footnote
18
Source: Source
THREAT OF SUBSTITUTES
Unit of measure
Soft drinks Movie rentals

Block buster

Coke Pepsi

Bottled water Hollywood video

Cable TV
* Footnote
19
Source: Source
IMPACT OF COMPLEMENTOR
Unit of measure
Complementor: Three Examples

Any factor that makes it more attractive Hot dogs

for suppliers to supply an industry on
favorable terms or that makes it more + More sales
attractive for buyers to purchase
Buns
products or services from an industry
at prices higher than it would pay Music
absent the complementor
+ More attractive offering

MPS player

Delta plane

orders
+
Lower costs from Boeing
American
Airlines
plane orders
* Footnote
20
Source: Source
MAPPING STRATEGY GROUPS: U.S. BICYCLE INDUSTRY
Unit of measure

High
Cannondale, Gary
Fisher, Klein
Price/quality/image

Huffy,
Murray,
Brunswick

Trek Schwinn/GT
Specialized Mongoose
Low
Independent Independent Mass
dealers dealers and mass merchandisers
merchandisers only

Principal distribution channels

* Footnote
21
Source: Source
HOW WOULD YOU DO THAT? – U.S. AIRLINE INDUSTRY
Unit of measure

New
entrants?

How
Supplier Buyer
would you Rivalry?
power? power?
define the
industry?

Co
m ple
me
nto
Substitutes? r s?

* Footnote
22
Source: Source
IMPORTANCE OF DYNAMIC STRATEGIC ANALYSIS
Unit of measure

Pineapple Pineapple
industry industry post
pre-1980s introduction

Fresh Del-Monte
introduces the “Extra
Sweet Gold” brighter
Fresh
color, sweeter,
Del-Monte
resistant to nothing
(70%)

* Footnote
23
Source: Source
INDUSTRY LIFE CYCLE
Unit of measure

Market Size

Time

Embryonic Growing Mature In Decline

Niche market – Market expands Proliferation of Product/market

selected products for beyond niche products and contraction
selected markets markets served
Participants More competitors Market volatility and Further consolidation
emphasize problem enter beginnings of and industry
solving – product as industry regeneration
“solution” consolidation
Technological Customers become Aggressive
uncertainty better informed customers

Source: Adapted from K. Rangan and G. Bowman, “Beating the Commodity Magnet,” Industrial Marketing Management 21 (1992), 215-224; P. Kotler,
“Managing
* Products through their Product Life Cycle,” in Marketing Management: Planning, Implementation, and Control, 7th ed (Upper Saddle River, NJ:
Footnote
Prentice Hall, 1991) 24
Source: Source
TECHNOLOGICAL DISCONTINUITIES
Unit of measure
Example
In disk-drive industry,
Product-related virtually every new
generation of technology
led to demise of market
leader

Discontinuities

Southwest airlines
Process-related radically changed the
airline business model
by adopting new
processes (e.g., a
point-to-point model)

* Footnote
25
Source: Source
WHEN INDUSTRIES DIVIDE OR COLLIDE
Unit of measure
Industries Divide Industries Collide

Launches
palm pilot/
creates Radio
3-Com first PDA

Cable
Invents
Modems Media
new Modems
conglomerate
interface
TV
Production
• Time Warner
• Viacom
TV • Disney
networks
• Etc.

* Footnote
26
Source: Source
SCENARIO PLANNING
Unit of measure
An understanding of the big picture
and a plan to manage uncertainty

6 Assess the strategic

implications of each scenario

5 Specify indicators that can signal which

scenario is unfolding

4 Flesh out the picture

3 Develop the framework by defining two specific axes

2 Brainstorm key drivers, decision factors, and possible scenario departure

or divergence points

1 Define target issue, time frame, and scope for scenarios

* Footnote
27
Source: Source
HOW WOULD YOU DO THAT? – CREDIT – UNION INDUSTRY
Unit of measure
Changes in the playing field
Minor
Credit-Union Power 2005:
Both technology and the playing field have
changed at a moderate pace, making this the
most stable scenario. Even with moderate
Gradual
change in these areas, however, the
changing basis of competition, new business
Technological Change
models, human resource challenges, and
industry dynamics are different enough to
pose significant challenges for many
financial-services companies
Technocracy 2005:
The wide-scale adoption of the internet by
U.S. consumers has led to massive
technological innovation for financial-services
Radical
companies, increasing their range of
distribution channels, as well as their
products, services, and geographic scope.
Regulations and other changes in the playing
field, however, have been slow to follow
Source: * Adapted
Footnotefrom Credit Union Society, 2005: Scenarios for Credit Unions, an Executive Report (Madison, WI: Credit Union
Executives Society, 1999)
Source: Source
Major
Wallet Wars 2005:
Prompted by free-market economics, the playing
field is changing radically, enabling credit unions
and other financial-services institutions to
compete more intensely. At the same time,
technical innovations have not developed as
quickly as many observers and analysts had
predicted
Chameleon 2005:
Radical changes occurring in the playing field
and in technology make this a highly tumultuous
scenario for all credit unions. The nature of
competition has evolved so much that banks and
credit unions compete directly – under the same
rules of the game. This situation has caused a
wide-scale convergence of cultures among
various financial-services providers, testing the
boundaries of the traditional credit-union mission
28
SUMMARY
Unit of measure

1 Explain the importance of the external context for

strategy and firm performance

2 Use PESTEL to identify the macro characteristics of

the external context

3 Identify the major features of an industry and the

forces that affect industry profitability

4 Understand the dynamic characteristics of the

external context

5 Show how industry dynamics may redefine industries

6 Use scenario planning to predict the future structure

of the external context

* Footnote
29
Source: Source