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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, more or less 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

1. Do macro-environmental factors and industry characteristics

offer sellers opportunities for growth and attractive profits?
2. What kinds and strengths of competitive forces are present in
the industry?
3. How will forces driving change in the industry impact its
competitive intensity and profitability?
4. Which rivals are strongly positioned in the market and which
are not?
5. What strategic moves are rivals likely to make next?
6. What are the key factors of competitive success?
7. 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

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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

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Sources: Based on Michael E. Porter, “How Competitive Forces Shape Strategy,” Harvard Business Review 57, no. 2 (March–April 1979), pp. 137–145; and
Michael E. Porter, “The Five Competitive Forces That Shape Strategy,” Harvard Business Review 86, no. 1 (January 2008), pp. 80–86.

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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

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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

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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

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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?

• Sizable economies of scale in • Difficulties in building a

production or other areas of network of distributors–
operation. retailers and securing space
• Cost and resource on retailers’ shelves.
disadvantages not related to • Tariffs and international trade
scale of operation. restrictions.
• Strong brand preferences and • Industry incumbents that can
customer loyalty. launch initiatives to block a
• High capital requirements. successful entry.

• Restrictive regulatory policies.

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 Figure 3.6 Factors Affecting the Threat of Entry

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 When Is the Competitive Force of Rivalry Most Intense
Among Competing Sellers?

Competitors are becoming more equal in size and capability.

Market growth slows or declines and lower demand results in
no growth opportunities, excess capacity, and inventory.
Industry conditions tempt competitors to use price cuts or
other competitive weapons to boost unit volume.
It has become less costly for buyers to switch brands as
products of rival sellers have become more standardized.
High exit barriers block failing competitors from leaving the
industry.
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

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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 three to four
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

• Changes in the long-term industry • Diffusion of technical know-how

growth rate. across more companies and more
• Increasing globalization. countries.

• Emerging new Internet capabilities • Changes in cost and efficiency.

and applications. • Growing buyer preferences for
• Changes in who buys the product differentiated products instead of a
and how they use it. standardized commodity product (or
for standardized products instead of
• Product innovation. strongly differentiated products).
• Technological change and • Regulatory influences and
manufacturing process innovation. government policy changes.
• Marketing innovation. • Changing societal concerns,
• Entry or exit of major firms. attitudes, and lifestyles.

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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 on 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 sales of the members of each
strategic group to show their relative sizes in 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 Comparative Market Positions of
Selected Pizza Chains: A Strategic Group Map Example

(International to National to Regional)

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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 do not compete directly.
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 or develop to be competitively successful?
Which shortcomings are certain to put a company at a significant
competitive disadvantage over its rivals?

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Table 3.3 Common Types of Industry Key Success Factors (1 of 3)

Type Description
Technology- • Expertise in a particular technology or in scientific research (important in
related key pharmaceuticals, Internet applications, mobile communications, and most high-
success factors 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 effects
related key (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 with 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)

Type Description
Distribution- • A strong network of wholesale distributors/dealers
related key • Strong direct sales capabilities via the Internet and/or having
success factors company-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)

Type Description
Skills- and • A talented workforce (superior talent is important in professional services such as
capability- accounting and investment banking)
related key • National or global distribution capabilities
success • Product innovation capabilities (important where rivals are racing to be first to
factors market with new product attributes or performance features)
• Design expertise (important in fashion and apparel industries)
• Short delivery time and 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 of • Overall low costs (not only in manufacturing) to be able to meet low-price
key success 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

• 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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