Ch. 3: 

Strategic Management

 The External Environment

Chapter 3 questions:

1. What is an industry?

2. What is the Porter Model, and what use does it serve?

3. What are the stages of an industry’s evolution?

4. WHAT specific factors should I study in learning about a firm’s environment?

5. What TOOLS may I use to analyze a firm’s environment?

What is an INDUSTRY?

A group of companies offering products or services that are close substitutes for each other.

     Close substitutes are products or services that satisfy the same basic need. 

What is the Porter Model, and what use does it serve?

ANSWER:

It is used to analyze a firm’s industry, and the firm’s position in it.  

Two Questions Porter's Model seeks to Answer:

1.  Why are some industries structured for profitability?

2.  What is my company's position within its industry?      

How is my company doing?

Force #1:
                                                
Entry Barriers =  Risk of Entry.

Refers to risk of competitors coming into your industry.

Impact of New Entry:     

           Expands supply,

           Depresses prices, profit

High risk of entry = Threat

Low risk of entry allows established companies to raise prices.

Liklihood that firms will enter industry a function of two factors:

–    Barriers to entry,

–    Retaliation from current industry participants

Characteristics of Industries with HIGH entry barriers:

    1.   Brand loyalty and high switching costs
2.      Absolute cost advantage over potential entrants.
3.   Cost economies of established Companies, and matching Capital Equipment

    4.  Access to distribution channels

Force #2:   Rivalry among established companies.

Strong rivalry is a threat to established companies.  Weak rivalry provides opportunity to raise prices to earn more.

Rivalry depends on:

    1.         Industry competitive structure (fragmented or consolidated)

2.        Demand conditions

Characteristics of Rivalrous Industry:

Many firms ... OR ... 

A few firms of equal size and power

Slow industry growth -- SOM fights

High fixed costs or storage costs

excess capacity and low prices to dump

Low switching costs

High exit barriers

These tend to create HIGH exit barriers:

Investments in specialized assets,

High fixed exit costs, e.g. severance ($)

Emotional attachments to an industry

Strategic relationships between business units

Dependence on an industry



Low entry barriers

Commodity-type products hard to differentiate

When entry barriers are Low...New entrants will flood to cash in on boom.

Excess Capacity will be created, companies will lower prices to be rid of excess capacity.  (AOL Example)

This cycle will continue until capacity is in line with demand (via bankruptcies), at which point prices will stabilize again.

                             Force #3:    
Bargaining Power of Buyers
Buyers can force down prices or demand higher quality, thus may be threats

          E.g. Prescription drug buyers'  demand for generic drugs.

Characteristics of powerful buyer groups:

Purchase large portion of industry’s output

Product being purchased from industry accounts for significant portion of buyers’ total costs

Buyer can switch to another product at any time

Industry’s products are NOT differentiated, buyer COULD vertically integrate backward.

Force #4
Bargaining Power of Suppliers

Characteristics of Powerful Suppliers:

Few suppliers in industry

Substitute products are NOT available to buying industry firms

Customers of supplying firms buy in small quantities, and are therefore NOT powerful.

Goods are CRITICAL to industry success

Suppliers may integrate FORWARD

Force #5      Substitute products

Substitute products limit price companies in industries can charge without losing customers to makers of substitutes.

Closer the substitute, greater the threat.

Studying company's competitive position in industry:

1. Analysis of Industries should be the start of any strategic process.

2. All industries differ with regard to which force is most significant

3.      Companies have to be on the constant lookout for change.

4.      Companies have the power to shape their industry.

Studying company's competitive position in industry:

5.      Companies have the power to DESTROY their industry -- make the five forces worse.

6.     Impact of government is best viewed by looking at how government action effects each of five forces.

STRATEGIC Groups:

A group of companies within an industry that are pursuing the same basic strategy.

Consumers tend to view all products in group as substitutes for one another.

Mobility barriers inhibit movement between groups...  Similar to entry barriers in industries.

U.S. Restaurant Chain Industry Groups:

Mobility Barriers

Prevent movement between strategic groups.

Analogous to entry barriers

Brand loyalty, cost advantages, economies of scale

Role of Innovation:

Alters industry conditions across 5 forces

Industry will be PUNCTUATED by dramatic, rapid change

          = Punctuated Equilibrium

Hypercompetition

Many industries are characterized by permanent and ongoing innovation

Constant change

How does this complicate our use of Porter’s model?

What are the stages of an industry’s evolution?

Embryonic Industry

Just beginning to develop

Slow growth

Poor distribution

High prices

Barriers to entry based on technological know-how

Growth Industry

First-time demand expands rapidly

Demand takes off

Little rivalry 

    Why?  Companies can expand revenues without taking away business from competitors

Industry Shakeout

Rate of industry growth slows down

Demand approaches saturation

Most of demand limited to replacement

    What is replacement demand?

Rivalry between companies is intense

Mature Industry

Market is totally saturated

Demand totally limited to replacement

Growth is low, or is zero

Growth that does exist is via population growth

Competition for share can lower prices

Most industries have consolidated, become oligopolies.

Companies recognize interdependence, avoid price wars.

Declining Industry

Growth is negative (shrinking business) due to:

       Technological substitution, social changes, demographics, international competition

Falling demand leads to excess capacity, leads to price wars

WHAT should I study in learning about a firm’s environment? 

Factor conditions = a bundle of internal,external factors

General environment factors

Industry environment

Internal factors (next chapter) =

          resources, capabilities,

          core competencies

What are factor conditions?

Cost and quality of factors of production.

Vary from country to country

BASIC factors: 

         Land, labor, capital, raw materials

ADVANCED FACTORS:

        Technological know-how, managerial sophistication, physical infrastructure

General Environmental Factors:

Demographics

Economics

political/legal issues

sociocultural issues

technological issues

global issues

What TOOLS may I use to analyze a firm’s environment?

Porter Framework

SWOPT

The Process Model of External analysis

Industry environment:

Analyze using Porter Framework:

Entry barriers

Threat of Substitutes

Bargaining power of suppliers

Bargaining power of buyers

Rivalry

Another tool for logging key environmental factors, and then prioritizing

them:

SWOPT analysis

SWOPT

Strengths

Weaknesses = internal to firm

Opportunities

Problems = involve externalities

Threats = may occur in future

The Process Model of External Analysis

FOUR STEPS:

Scanning =           What early warning signals do I see? 

          e.g., corrugated cardboard sales, housing sales.

Monitoring = Are any trends emerging?

Forecasting =

    From above 2 steps, what might happen in future, and how quickly?

Assessing =

    How will above affect our strategies?