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:
1 Explain the importance of analyzing and understanding the firm’s external
environment.
2 Define and describe the general environment and the industry
environment.
3 Discuss the four parts of the external environmental analysis
process.
4 Name and describe the general environment’s seven segments.
5 Identify the five competitive forces and explain how they determine an
industry’s profitability potential.
6 Define strategic groups and describe their influence on firms.
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 • Population size • Ethnic mix

segment • Age structure • Income distribution
• Geographic distribution
Economic • Inflation rates • Personal savings rate
segment • Interest rates • Business savings rates
• Trade deficits or surpluses • Gross domestic product
• Budget deficits or surpluses
Political/Legal • Antitrust laws • Labor training laws
segment • Taxation laws • Educational philosophies
• Deregulation philosophies and policies
Sociocultural • Women in the workforce • Shifts in work and career
segment • Workforce diversity preferences
• Attitudes about the quality • Shifts in preferences
of work life regarding product and
service characteristics
 Table 2.1
The General Environment: Segments and Elements (slide 2 of 2)

Technological • Product innovations • Focus of private and

segment • Applications of knowledge government-supported
research and development
(R&D) expenditures
• New communication
technologies
Global • Important political events • Newly industrialized
segment • Critical global markets countries
• Different cultural and
institutional attributes
Sustainable • Energy consumption • Availability of water as a
physical • Practices used to develop resource
environment energy sources • Producing
segment • Renewable energy efforts environmentally
• Minimizing a firm’s friendly products
environmental footprint • 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
 2-4eIntensity 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
Thank you