CHAPTER 3

Evaluating a
Company’s
External
Environment

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 Learning Objectives
1. Identify factors in a company’s broad macro-
environment that may have strategic significance.
2. Recognize the factors that cause competition in an
industry to be fierce, normal, or relatively weak.
3. Map market positions of key groups of industry
rivals.
4. Determine whether an industry’s outlook presents
a company with sufficiently attractive
opportunities for growth and profitability.

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 The First Test of a Winning Strategy: “How well
does the current strategy fit the company’s
situation?”
Two facets of the company’s situation
• Its external environment— industry and competitive
environments in which it operates
• Its internal environment—the company’s resources and
organizational capabilities

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 Assessing the Company’s Industry and
Competitive Environment
Do macro-environmental factors and industry characteristics offer sellers
opportunities for growth and attractive profits?
What kinds and strengths of competitive forces are present in the industry?
How will forces driving change in the industry impact its competitive intensity
and profitability?
Which rivals are strongly positioned in the market and which are not?
What strategic moves are rivals likely to make next?
What are the key factors of competitive success?
Does the industry outlook offer good prospects for profitability?

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 Question 1: What Are the Strategically Relevant
Components of a Company’s Macro-Environment?

Relevant Factors
• Play a significant role in shaping management’s decisions
regarding the company’s long-term direction, objectives,
strategy, and business model
• Are on the immediate inner ring industry and competitive
environment of the company—competitive pressures, the
actions of rivals firms, buyer behavior, supplier-related
considerations, and so on

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FIGURE 3.1 The Components of a Company’s External Environment

Jump to Appendix 1 for long description.

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 Core Concepts: Macro-Environment and PESTEL
Analysis
The macro-environment encompasses the broad
environmental context in which a firm is situated and is
comprised of six principal components: political factors,
economic conditions, sociocultural forces, technological factors,
environmental factors, and legal/regulatory conditions.

PESTEL analysis can be used to assess the strategic relevance of

the six principal components of the macro-environment:
political, economic, social, technological, environmental, and
legal forces.

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 The Six Components of the Macro-Environment
Included in a PESTEL Analysis
1. Political factors
2. Economic conditions
3. Technological factors
4. Sociocultural factors
5. Environmental forces
6. Legal and regulatory
factors

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 Question 2: How Strong Are the Industry’s
Competitive Forces?
State of Competition: Where are we now?
The dynamics of competition are not the same from one
industry to another.
The Five-forces Model of Competition
It is the most powerful and widely used tool for assessing the
strength of the competitive forces that affect an industry’s
attractiveness.

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 The Five Competitive Forces Affecting
Industry Attractiveness
Competitive pressures:
• Bargaining power of buyers
• Substitute products of firms in other industries
• Bargaining power of suppliers
• The threat of new entrants into the market
• Rivalry among competing sellers

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 FIGURE 3.2 The Five-Forces Model of Competition

Jump to Appendix 2 for long description.

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 The Competitive Force of Buyer Bargaining
Power
Whether seller-buyer relationships represent a minor
or significant competitive force in limiting industry
profitability depends on:
• Some or many buyers having sufficient bargaining leverage
to obtain price concessions and other favorable terms
• The extent to which buyers are price sensitive

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 When Is the Bargaining Power of
Buyers Stronger?
Buyers gain bargaining leverage when:
Their costs of switching to competing brands or substitutes
are relatively low.
Their large size allows them to demand concessions.
They are few in number, control market access or, if a buyer-
customer is particularly important to a seller.
Weak buyer demand creates a “buyers’ market.”
Buyers are well informed about products, prices, and costs.
Buyers can integrate backward into the business of sellers.

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 FIGURE 3.3 Factors Affecting the Strength of Buyer Bargaining
Power

Jump to Appendix 3 for long description.

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 The Competitive Force of Substitute Products
The strength of competitive pressures from the sellers
of substitute products depends on whether:
Substitutes are readily available and attractively priced.
Buyers view the substitutes as comparable or better in terms
of quality, performance, and other relevant attributes.
The costs that buyers incur in switching to the substitutes are
high or low.

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 FIGURE 3.4 Factors Affecting Competition from Substitute Products

Jump to Appendix 4 for long description.

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 The Competitive Force of Supplier Bargaining
Power (1 of 2)
Industry suppliers can exert substantial bargaining
power or leverage if:
The supplied item is not a commodity readily available from
many suppliers.
Industry members cannot switch their purchases to another
supplier or switch to attractive substitutes.
Certain required inputs are in short supply.
Certain suppliers provide a differentiated item that enhances
the desired performance, quality, or image of the industry’s
product.

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 The Competitive Force of Supplier Bargaining
Power (2 of 2)
Industry suppliers can exert substantial bargaining
power or leverage when:
They provide specialized equipment or services that yield
cost savings to industry members in conducting their
operations.
A large fraction of the costs of the buyer industry’s product is
accounted by the cost of a particular input.
Industry members are not major or large customers of
suppliers.
It does not make good economic sense for industry members
to vertically integrate backward.

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 FIGURE 3.5 Factors Affecting the Strength of Suppliers

Jump to Appendix 5 for long description.

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 The Competitive Force of Potential New
Entrants
The threat of entrants into the marketplace presents
significant competitive pressure when:
There is a sizable pool of likely entry candidates.
Potential entrants have ample entry resources at their
command.
Current industry participants are looking beyond their
current markets for growth opportunities.
When the industry is growing, offers attractive profit
opportunities, and its barriers to entry are low.

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 What Are the Barriers to Entry?
Barriers to Entry • Difficulties in building a
• Sizable economies of scale network of distributors-
retailers and securing space
in production or other
on retailers’ shelves
areas of operation
• Tariffs and international
• Cost and resource
trade restrictions
disadvantages not related
to scale of operation • Industry incumbents that
• Strong brand preferences can launch initiatives to
block a successful entry
and customer loyalty
• High capital requirements
• Restrictive regulatory
policies

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 FIGURE 3.6 Factors Affecting the Threat of Entry

Jump to Appendix 6 for long description.

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 When Is the Competitive Force of Rivalry Most
Intense among Competing Sellers?
Rivals can boost market standing and business performance.
Competitors are equal in size and capability.
Market growth slows or declines and lower demand results in no
growth opportunities, excess capacity and inventory.
It has become less costly for buyers to switch brands.
Products of rival sellers have become more standardized.
Industry conditions tempt competitors to use price cuts or other
competitive weapons to boost unit volume.
Competitors are dissatisfied with their market position.
Strong outside firms acquire weak firms in the industry and
launch aggressive, well-funded moves to build market share.

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 When Is the Competitive Force of Rivalry
Among Competing Sellers Weak?
The rivalry among industry competitors is usually
weaker in industries where:
The products of industry rivals become more differentiated.
Markets or market segments are expanding and fast-growing.
Markets are comprised of vast numbers of small rivals;
likewise, it is often weak when there are fewer than five
competitors.

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 FIGURE 3.7 Factors Affecting the Strength of Competitive Rivalry

Jump to Appendix 7 for long description.

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 Industry Rivalry
Cutthroat (Brutal)
Competitors engage in protracted price wars or employ other
aggressive tactics mutually destructive to profitability.
Fierce (Strong)
A vigorous market share battle reduces the profit margins of
most industry rivals to bare-bones levels.
Moderate (Normal)
Maneuvering among industry rivals, while lively and healthy,
still allows most rivals to earn acceptable profits.
Weak
Industry rivals satisfied with their sales growth and market
share rarely undertake offensives against their competitors.
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 The Collective Strengths of the Five Competitive
Forces and Industry Profitability
As a rule, the stronger the collective impact of the five
competitive forces, the lower the combined profitability
of industry participants.

The stronger the forces of competition, the harder it

becomes for industry members to earn attractive
profits.

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 When Do the Five Competitive Forces Result in
Attractive Industry Conditions?
The ideal competitive environment for earning superior
profits occurs when:
Suppliers and customers are in weak bargaining positions.
There are no good substitutes.
High entry barriers deter entry of new competitors.
Internal rivalry produces moderate competitive pressure.

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 When Do the Five Competitive Forces Result in
Unattractive Industry Conditions?
An industry is competitively unattractive when all five
forces are producing strong competitive pressures.
Internal rivalry among competitors is strong.
Low entry barriers result in entry of new competitors.
Competition from substitutes is intense.
Suppliers and customers are in strong bargaining positions.

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 Question 3: What Are the Industry’s Driving Forces
of Change and What Impact Will They Have?
Driving forces analysis has three steps:
1. Identifying the present driving forces, as only 3 to 4
factors qualify as real drivers of change
2. Assessing whether the drivers of change are, individually
or collectively, acting to make the industry more or less
attractive
3. Determining what strategy changes are needed to
prepare for the impact of the driving forces

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 CORE CONCEPT: Driving Forces
Driving forces are the major underlying causes of
change in industry and competitive conditions.

Some driving forces originate in the outer ring of the

company’s macro-environment but most originate in
the company’s more immediate industry and
competitive environment.

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 Common Driving Forces
Driving Forces • Diffusion of technical know-how
• Changes in the long-term industry across more companies and more
growth rate countries
• Increasing globalization • Changes in cost and efficiency
• Emerging new Internet • Growing buyer preferences for
capabilities and applications differentiated products instead of
a standardized commodity
• Changes in who buys the product product (or for standardized
and how they use it products instead of strongly
• Product innovation differentiated products)
• Technological change and • Regulatory influences and
manufacturing process government policy changes
innovation • Changing societal concerns,
• Marketing innovation attitudes, and lifestyles
• Entry or exit of major firms

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 Question 4: How Are Industry Rivals Positioned?
Strategic Group Mapping
It is a useful technique for graphically displaying
different market or competitive positions that
rival firms occupy in the industry.
A Strategic Group
It is a cluster of industry rivals that have similar
competitive approaches and market positions.

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 CORE CONCEPTS: Strategic Group Mapping and
Strategic Groups
Strategic group mapping is a technique for displaying
the different market or competitive positions that rival
firms occupy in the industry.

A strategic group is a cluster of industry rivals that

have similar competitive approaches and market
positions.

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 Constructing a Strategic Group Map
Identify the competitive characteristics of strategic approaches
used in the industry.
Typical variables: the price/quality range, geographic
coverage, degree of vertical integration, product-line
breadth, distribution channels, and degree of service offered.
Plot firms on a two-variable map based upon their strategic
approaches.
Assign firms occupying the same map location to a common
strategic group.
Draw circles around each strategic group proportional to the size
of the group’s share of total industry sales revenues.

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 Guidelines for Strategic Group Map
Construction
The variables used as map axes must not be highly correlated.
Variables must reflect large differences in how rivals are
positioned to offer customer value in their marketplace.
Variables can be either quantitative or continuous; can be
discrete variables or distinct classes and combinations.
Draw circle sizes proportional to combined sales of each strategic
group to show the relative sizes of each strategic group.
Use various competitive variables as map axes, multiple maps
can show different views of competitive positioning in the
industry.

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 Concepts and Connections 3.1

Jump to Appendix 8 for long description.

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 The Value of Strategic Group Maps
The closer groups are to each other on the map, the
stronger the cross-group rivalry.
Firms in groups that are far apart hardly compete.
Not all map positions are equally attractive.
Some groups are more favorably positioned because they
confront weaker competitive forces.
Industry driving forces favor some groups over others.
Competitive pressures cause profit potential differences.

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 Question 5: What Strategic Moves Are Rivals
Likely to Make Next?
Framework for Analysis of Rival Competitors
Current Strategy?
Rival’s market position, competitive advantage basis, and its
investments in infrastructure, technology, or other resources
Objectives?
Its performance on current financial and strategic objectives
Capabilities?
Its current set of capabilities and efforts to acquire new capabilities
related to future strategic moves
Assumptions?
Views and beliefs of rival’s top managers about their firm’s strategic
situation can strongly impact their future behaviors

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 Question 6: What Are the
Industry Key Success Factors?
Key Success Factors (KSFs) are competitive factors that
most affect the ability of all industry firms to prosper.
KSFs include:
Specific product attributes
Necessary resources, competencies, and capabilities
Specific intangible assets
Competitive capabilities

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 CORE CONCEPT: Key Success Factors
Key success factors are the strategy elements, product
attributes, competitive capabilities, or intangible
assets with the greatest impact on future success in
the marketplace.

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 Questions to Ask in Identifying Industry Key
Success Factors
Which crucial product attributes do industry buyers
consider when choosing between competing sellers?
Which resources and competitive capabilities must a
company have to be competitively successful?
Which shortcomings are certain to put a company at a
significant competitive disadvantage to its rivals?

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 TABLE 3.3 Common Types of Industry Key Success Factors (1 of 3)
Technology- • Expertise in a particular technology or in scientific research
related key (important in pharmaceuticals, Internet applications, mobile
success factors communications, and most high-tech industries)
• Proven ability to improve production processes (important in
industries where advancing technology opens the way for higher
manufacturing efficiency and lower production costs)
Manufacturing- • Ability to achieve scale economies and/or capture experience curve
related key effects (important to achieving low production costs)
success factors • Quality control know-how (important in industries where customers
insist on product reliability)
• High utilization of fixed assets (important in capital-intensive/high
fixed-cost industries)
• Access to attractive supplies of skilled labor
• High labor productivity (important for items with high labor content)
• Low-cost product design and engineering (reduces manufacturing
costs)
• Ability to manufacture or assemble products that are customized to
buyer specifications

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 TABLE 3.3 Common Types of Industry Key Success Factors (2 of 3)
Distribution- • A strong network of wholesale distributors/dealers
related key • Strong direct sales capabilities via the Internet and/or having company-
success factors owned retail outlets
• Ability to secure favorable display space on retailer shelves
Marketing- • Breadth of product line and product selection
related key • A well-known and well-respected brand name
success factors • Fast, accurate technical assistance
• Courteous, personalized customer service
• Accurate filling of buyer orders (few back orders or mistakes)
• Customer guarantees and warranties (important in mail-order and
online retailing, big-ticket purchases, and new-product introductions)
• Clever advertising

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 TABLE 3.3 Common Types of Industry Key Success Factors (3 of 3)
Skills- and • A talented workforce (superior talent is important in professional
capability- services such as accounting and investment banking)
related key • National or global distribution capabilities
success factors • Product innovation capabilities (important where rivals are racing to be
first to market with new product attributes or performance features)
• Design expertise (important in fashion and apparel industries)
• Short delivery time capability
• Supply chain management capabilities
• Strong e-commerce capabilities—a user-friendly website and/or skills in
using Internet applications to streamline internal operations
Other types • Overall low costs (not just in manufacturing) to be able to meet low-
of key success price expectations of customers
factors • Convenient locations (important in many retailing businesses)
• Ability to provide fast, convenient, after-the-sale repairs and service
• A strong balance sheet and access to financial capital (important in
newly emerging industries with high degrees of business risk and in
capital-intensive industries)
• Patent protection

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 Examples of Industry Key Success Factors
Examples:
• Expertise in a particular technology
• Scale economies
• Experience curve benefits
• High capacity utilization
• Strong network of wholesale distributors
• Brand-building skills
• Convenient retail locations

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 Question 7: Does the Industry Offer Good
Prospects for Attractive Profits?
Factors that determine a firm’s prospects for attractive
future profits in its industry include:
• Both the firm’s and its industry’s growth potential
• Effects of internal industry competition
• Effects of prevailing and future driving forces
• The firm’s competitive position in its industry vis-à-vis its
rivals
• The firm’s competence in performing the industry’s key
success factors

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