Analyzing a company's external environment

The strategically relevant components of a company's external

environment
• A company' macro environment includes all relevant factors
and influence outside the company's boundaries that have a
bearing on the decisions the company makes about its
strategy, objectives and business.
• These macro environment factors are
In the outer ring:
– societal values and lifestyles e.g McDonalds not using beef in India
– population demographics e.g. Insurance companies designing
products for young population in India
– legislation and regulations e.g. No FDI in sectors like retail
– general economic conditions e.g. cost cutting by companies
– Technology e.g. companies using video-conferencing
 The immediate industry and competitive environment factors like:
– rival firms e.g. Bajaj planning low-rpriced car
– new entrants e.g. ITC entering FMCG sector
– Buyers e.g. reduction in sales of Pepsi and Coke after pesticide controversy
– substitute products e.g. bikes replacing scooters
– Suppliers e.g. arm twisting by Microsoft to include Internet Explorer

• The shaping impact of outer ring influences is normally low but they
provide strategically relevant trends and developments to justify a
watchful eye. (exceptions are cigarette producers effected by
antismoking ordinances and growing cultural stigma attached to
smoking, health care companies effected by changing
demographics of aging population and longer life expectancy,
companies effected by internet technology applications)
Thinking strategically about a company's industry
and competitive environment
• Industries differ widely in their economic features,
competitive character and profit outlook. (e.g.
economic factors and competitive character is
different for trucking industry, retail, fast food,
softaware development)
• An industry's economic traits and competitive
conditions and how they are expected to change
determine whether its future profit prospects will
be poor, average or excellent.
The following are the seven critical questions that help in understanding a
company's competitive environment.
1. What are the dominant economic features of the industry in which the
company operates? E.g. high investment in realty
2. What kinds of competitive forces are industry members facing, and how
strong is each force? E.g. FMCG
3. What forces are driving changes in the industry, and what impact will
these changes have on competitive intensity and industry profitability?
E.g. airline industry
4. What market position do industry rivals occupy - who is strongly
positioned and who is not? E.g. FMCG, passenger cars
5. What strategic moves are rivals likely to make next? E.g. cars
6. What are the key factors for future competitive success? E.g. software
7. Does the outlook for the industry present the company with sufficiently
attractive prospects for profitability? E.g. cellphones
What are the industry's dominant economic features?
• Analyzing a company's industry and competitive
environment begins with identifying the industry's
dominant economic features.
• An industry's dominant economic features are
defined by the following factors
– Overall size and market growth rate
– Geographic boundaries of the market (local to worldwide)
– Number and size of competitors
– What buyers are looking for and the attributes that cause them
to choose one seller over another
– Pace of technology change and/or product innovations
– Whether sellers' products are virtually identical or highly
differentiated
– Extent to which costs are effected by scale economics
– Learning curve effects
• Analyzing the industry's distinguishing economic
features helps in understanding the kinds of
strategic moves that industry members are likely
to employ.
e.g. in a highly product innovative industry like
video games, computers and pharmaceuticals the
focus in on R&D, an industry with recent rapid
growth looks for cost reduction and improved
customer service, semiconductor industry gains
by learning/experience and is driven to pursue
increased sales volumes and capture the
resulting cost saving economics,
What kind of competitive forces are industry members facing?
• The character, mix and subtleties of competitive forces differ from
industry to industry. E.g. FMCG and microprocessors
• The most widely used tool for systematically diagnosing the
principal competitive pressure in a market place and assessing the
strength and importance of each is the five-forces model of
competition (also known as Porter's five force model).

According to Porter’s model the state of competition in an industry is a

composite of competitive pressures operating in five areas of the
over all market.
1. Competitive pressures associated with the market maneuvering
and jockeying for buyer patronage that goes on among rival sellers
in the industry. E.g. FMCG
2. Competitive pressures associated with the threat
of new entrants into the market.(e. g. effect of big
retailers on kirana shops)
3. Competitive pressures coming from the attempts
of companies in other industries to win buyers
over to their own substitute products. (e. g. nano
car winning two wheeler customers)
4. Competitive pressures stemming from supplier
bargaining power and supplier-seller
collaboration. E.g. Intel, Microsoft
5. Competitive pressures stemming from buyer
bargaining power and seller-buyer collaboration.
E.g. Wal-Mart, big retailers
The five forces model can be used by the following
three steps
Step 1: Identify the specific competitive pressures
associated with each of the five forces.
Step 2: Evaluate how strong the pressures
comprising each of the five forces are (fierce,
strong, , moderate to normal, or weak)
Step 3: Determine whether the collective strength
of the five competitive forces is conductive
to earning attractive profits.
The rivalry among competing sellers
• It is the strongest of all the competitive forces.
• A market is a battlefield where it is expected that rival
sellers will employ whatever resources they have to
improve their market positions and performance.
• The challenge for managers is to make a strategy that
allows their company to at least maintain their position or
ideally strengthen their company's standing with buyers,
delivers good profitability and produces a competitive
edge over rivals.
• When one firm makes a strategic move that produces
good results, its rivals often respond with offensive or
defensive countermoves, shifting their strategic emphasis
from one combination of product attributes, marketing
tactics and competitive capabilities to another.
• This pattern of action and reaction, move and
countermove, adjust and readjust is what makes
competitive rivalry a combative, ever changing
contest.
• The market battle for buyer patronage in an
industry takes on a life its own, with one or
another rivals gaining or losing market
momentum according to whether their latest
strategic adjustment succeed or fail.
Some of the factors that influence the rivalry among
industry competitors are:
1. Rivalry among competing sellers intensifies the more
frequently and more aggressively that industry
members undertake fresh actions to boost their
market standing and performance against the
rivals.eg. FMCG

The indicators of intensity of rivalry among industry

members are:
– Lively price competition pressures rival companies to
aggressively pursue ways to drive costs out of the business;
high-cost companies are hard-pressed to survive.
– Whether industry members are racing to offer better
performance features, higher quality, improved customer
service or a wider product election.
– How frequently rivals resort to such marketing tactics as
sales promotion, new advertising campaign, rebates, or low-
interest-rate financing to drum up additional sales.
– How actively industry members are pursuing efforts to build
stronger dealer networks or established positions in foreign
markets or otherwise expand their distribution capabilities
and market presence.
– The frequency with which rivals introduce new and improved
products.
– How hard companies are striving to gain a market edge by
developing valuable expertise and capabilities that rivals
cannot match.

2. Rivalry is usually stronger in slow-growing markets and

weaker in fast growing markets. E. g. FMCG for slow-growing
and software for fast growing
3. Rivalry intensifies as the number of competitors increases and as
competitors become more equal in size and capability. E. g.
Mobile telecom
4. Rivalry is usually weaker in industries comprised of so many rivals
that the impact of any one company's actions is spread thinly
across all industry members; likewise, it is often weak when there
are fewer than five competitors. E. g. software
5. Rivalry increases as the products of rival sellers become more
standardized. E. g. mineral water. Rivalry weakens as the products
become more differentiated. E. g. white goods
6. Rivalry increases as it becomes less costly for buyers to switch
brands. E. g. FMCG, low-cost air lines
7. Rivalry is more intense when industry conditions tempt
competitors to use price cuts or other competitive weapons to
boost unit volume. E.g. Intel and AMD
8. Rivalry increases when one or more competitors
become dissatisfied with their market position
and launch moves to bolster their standing at the
expense of rivals. E. g. Unilever's response to
Nirma
9. Rivalry increases in proportion to the size of the
payoff from a successful strategic move. E. g. any
move in any sunrise industry like mobile set
10. Rivalry becomes more volatile and
unpredictable as the diversity of competitors
increases in terms of visions, strategic intents,
objectives, resources and countries of origin. E. g.
move by ITC to enter FMCG market, Hutch being
acquired by Vodafone
11. Rivalry increases when strong companies
outside the industry acquire weak firms in the
industry and launch aggressive, well-funded
moves to transform their newly
acquired competitors into major market
contenders. E. g. many software companies
buying firms which are specialized in a particular
area like ERP
12. A powerful, successful competitive strategy
employed by one company greatly intensifies the
competitive pressures on its rivals to develop
effective strategic responses or be relegated to
also-ran status. E. g. ITC entry into food industry
Rivalry can be classified in the following ways:
Cut-throat or brutal - when competitors engage in protracted
price wars or habitually employ other aggressive tactics that
are mutually destructive to profitability. E. g. low cost airlines
Fierce or strong - when the battle for market share is so vigorous
that the profit margins of most industry members are
squeezed to minimum. E. g. FMCG
Moderate or normal - when the maneuvering among industry
members, while lively and healthy, still allows most industry
members to earn acceptable profits. E. g. software
Weak - when most companies in the industry are relatively well
satisfied with their sales growth and market shares, rarely
undertake offensives to steal customers away from one
another and have comparatively attractive earnings and
returns on investment. E. g. heavy trucks industry
The potential entry of new competitors
• One of the important factors the affect the strength of
the competitive threat of a potential entry in a particular
industry is the number of candidates who enter and
resources at their disposal.
• The strongest competitive pressures associated with
potential entry is often from the existing industry
members entering market segments or geographies
where currently they do not have a market share. They
possess the resources, competencies and competitive
capabilities to overcome the challenges of entering a
new market segment or geography.
E. g. Vodafone buying Hutch
• The second factor that affect the likely candidates is the
entry barriers.
Some of the entry barriers are:
1. The presence of sizable economics of scale in
production or other areas of operation. E. g. petroleum
production
2. Cost and resource disadvantages not related to size.
Like learning curve, patents, partnerships, cheap raw
materials, proprietary technology, low fixed cost. E. g.
Nano
3. Brand preference and customer loyalty. E. g. Microsoft
as a brand is preferred and has brand loyalty
- New entrant must spend money on advertising and
promotions to overcome brand loyalty.
- They must persuade customers that their brand is worth the
switching cost
- Discounted pricing or extra margin of quality or service may
be needed
4. Capital requirements. E. g. cement industry
5. Access to distribution channels. eg. FMCG
- reluctance of distributors to take new product
- retailers have to be convinced to provide display space
- distributors and retailers will have to be given better
margins
6. Regulatory policies. E. g. mobile telephone
industry
7. Tariffs and international trade restrictions. E.g.
dumping duties in steel industry
In evaluating the potential threat of entry, the
management has to consider:
1. How formidable the entry barriers are for each
type of potential entrant - start-up enterprises,
specific companies in other industries and
companies within the industry looking for market
expansion.
2. How attractive the growth and profit prospectus
are for the new entrants. Rapidly growing market
demand and high potential profits motivate
potential entrants to commit resources. eg.
mobile telecom industry
• Another important issue to be considered by the
new entrant is the reaction of the existing
players. If the existing players show strong signs
of defending their market with price cuts, new
feature additions, better service, aggressive
advertising and promotion, etc. then the new
entrant has to be careful with his decision to
enter the market.
• The threat of entry changes as the industry
prospects grow brighter or dimmer and as entry
barriers rise or fall. E.g. expiry of patent
on high selling drugs, lowing of tariffs by
countries to increase competition
Competitive pressures from the sellers of substitute
products
• There is competitive pressure when products from
other industries are looked upon as substitute
products by the customers. E.g. threat of nano to two
wheelers, threat of artificial sweeteners' and honey to
sugar producers, eyeglasses and contact lens
threatened by corrective laser surgery,
The competitive pressure from sellers of substitute
products depends on:
1. whether substitutes are readily available and
attractively priced.
2. whether buyers view the substitutes as being
comparable or better in terms of quality, performance
and other relevant attributes.
3. how much it costs end users to switch to substitutes.
• Readily available and attractively priced substitute
products put pressure on companies in the existing
industry to cut price.
• When substitutes are available, customers compare
performance, features, ease of use and other attributes as
well as price. E.g. customer of film based cameras
compare the camera feature with digital cameras
• Competition from well performing substitute products
push existing companies to incorporate new features and
increase efforts to convince their customers about the
superiority of their products.
• The switching costs include
– time and inconvenience that may be involved
– cost of additional equipment
– time and cost in testing the quality and reliability of the substitute
– psychological costs of severing old supplier relationships and establishing new
ones
– payments for technical help in making the changeover
– employee retraining cost
• When prices of the substitute products are low,
quality and performance is high and switching
cost is low then the competition from substitute
products is very intense.
• Competition pressures stemming from supplier
bargaining power and supplier-seller collaboration
• The strength of the suppler-seller competitive
force depends on
– Whether major suppliers can exercise sufficient
bargaining power to influence the the terms and
conditions of supply in their favor
– The nature and extent of supplier-seller collaboration in
the industry
How supplier bargaining power can create
competitive pressures
• When major suppliers determine terms and
conditions of supply in an industry then they
exert competitive pressure on rival sellers. E.g.
Microsoft and Intel have considerable power
because of the market dominance
• Small time retailers must content with pressure
from manufacturers of branded products. E.g.
earlier Unilever use to have positive working
capital, franchises face pressure from established
brands like pizza hut and burger king,
Following are the factors that determine whether
any of the suppliers to an industry are in a
position to exert substantial bargaining power:
1. Whether the item being supplied is a commodity that
is readily available from many suppliers at the going
market price. vegetables from farmers,
2. Whether a few large suppliers are the primary sources
of a particular item.
3. Whether it is difficult or costly for industry members to
switch their purchases from one supplier to another or
to switch to attractive substitute inputs. railways
depending on coal supplied by coal India Ltd.
4. Whether certain needed inputs are in short supply.
5. Whether certain suppliers provide a differentiated
input that enhances the performance or quality of the
industry's product. eg. tea leaves from Darjeeling
6. Whether certain suppliers provide equipment or services
that deliver valuable cost-saving efficiencies to industry
members in operating their production process. E.g. Indian
software industry serving foreign companies
7. Whether suppliers provide an item that accounts for a
sizable fraction of the costs of the industry's product. E.g.
rigs provided for oil drilling in deep oceans
8. Whether industry members are major customers of
suppliers. E.g. automobile component manufacturers
supplying to automobile companies
9. Whether it makes good economic sense for industry
members to integrate backward and self-manufacture items
they have been buying from suppliers. The economics of
scale in manufacturing decides if companies will opt for
backward integration. E.g. MNC companies setting up
captive BPOs in India
How seller-supplier partnerships can create
competitive pressures
• Sellers are forging strategic partnerships with
select suppliers for the following reasons:
1. reduce inventory and logistics cost. e.g. Toyota
with its just-in-time deliveries
2. speed the availability of next-generation
components. e.g. PC manufacturers with Intel
3. enhance the quality of the parts and components
being supplied and reduce defect rates.
4. squeeze out important cost savings for both
themselves and their suppliers.
• The benefits of effective seller-supplier
collaboration can be an competitive advantage if
it is well managed. e.g. Dell, Tata motors
• Competitive pressures stemming from buyer
bargaining power and seller-buyer collaboration

The seller-buyer relationships as a competitive force

depends on
1. Whether some or many buyers have sufficient
bargaining leverage to obtain price concessions
and other favorable terms and cond itions of sale
2. The extent and competitive importance of seller-
buyer strategic partnerships in the industry
How buyer bargaining power can create competitive
pressures
• Large retailers have considerable negotiating leverage
in purchasing products from manufactures because of
manufacturer's need for broad retail exposure and the
most appealing shelf locations. e.g. Wal-Mart, Future
group
• Since retails keep only limited brands on the shelf
there is competition among manufacturers for shelf
space, vehicle manufacturers bargain with type
manufacturers

The buyers have a bargaining power in the following

circumstances:
1. If buyers' cost of switching to competing brands or
substitutes are relatively low. e.g. commonly available
at automobile components
2. If the number of buyers is small or if a customer is particularly
important to seller. e.g. seller of nuclear plant equipments
3. If buyer demand is weak and sellers are scrambling to secure
additional sales of their products.
4. If buyers are well informed about sellers' products, prices and
costs. e.g. recent rejection of certain brand when it was sold by
the manufacturer at a lower cost to other retailers
5. If buyers pose a credible threat of integrating backward into the
business of sellers. e.g. in-house brands by big retailers
6. If buyers have discretion in whether and when they purchase the
product. e.g. purchasing of defense equipment by countries
How seller-buyer partnerships can create competitive pressures
• Partnerships between sellers and buyers is an important element
in business-to-business relationships.
• Sellers to business customers find it to their mutual interest to
collaborate closely with buyers on matters like just-in-time
deliveries, order processing, electronic invoice payments and
data sharing. e.g. Wal-Mart sharing daily sales data with P&G

Determining whether the collective strength of the five competitive

forces promotes profitability
• Scrutinizing each of the five competitive forces provides a
powerful diagnosis of what the competition is like in the given
market.
• The collective strength of the five forces have to be evaluated to
determine whether the state of competition promotes
profitability.
• The stronger the collective impact of the five forces, the lower
the combined profitability of industry participants. Sometimes it
may even force some companies to close down. e.g. memory
chips manufacturing industry
• When the collective impact of the five forces is moderate the
industry members can expect good profits and return on their
investment.
• An ideal competitive environment is one in which both suppliers
and customers are in weak bargaining positions, there are no
good substitutes, high barriers block further entry and rivalry
among present sellers generates moderate competition. e.g.
heavy truck industry
• Weak competition ensures even also-ran companies make profit.
e.g. early software industry
Analyzing the five forces helps to better match the
company strategy to the specific competitive
character of the marketplace. This helps in:
1. Pursuing actions to shield the firm from the
prevailing competitive pressures.
2. Initiating actions calculated to produce
sustainable competitive advantage, thereby
shifting competition in the company's favor.
What factors are driving industry change and what impacts
will they have?
• All industries are characterized by trends and new
developments that produce change important enough to
require a strategic response from participating firms.
• The life cycle of an industry - take off, rapid growth,
early maturity, market saturation and stagnation or
decline - is sometimes disturbed by driving forces that
entice or pressurize the participants to alter their
actions.
• Driving forces are those that have the biggest influence
on what kind of changes will take place in the industry's
structure and competitive environment. They may be
from the macro environment or from the industry and
competitive environment.
Identifying an industry's driving forces
1. Growing use of the internet and emerging new internet
technology applications.
2. Increasing globalization
3. Changes in the long-term industry growth rate.
4. Changes in who buys the product and how they use it.
5. Product innovation.
6. Technological change and manufacturing process
innovation
7. Marketing innovation
8. Entry or exit of major firms
9. Diffusion of technical know-how across more
companies and more countries
10.Changes in cost and efficiency
11.Growing buyer preference for differentiated
products instead of a commodity product.
12.Reductions in uncertainty and business risk
13.Regulatory influence and government policy
changes
14.Changing societal concerns, attitudes and
lifestyles
Assessing the impact of the driving forces
The assessment of whether the sum effect of all the
forces is making the industry more or less
attractive can be done by asking the following
questions:
1. Are the driving forces causing demand for the
industry's product to increase or decrease?
2. Are the driving forces acting to make competition
more or less intense?
3. Will the driving forces lead to higher or lower
industry profitability?
• Each of the forces have toe be analyzed
separately. The powerful forces will be the most
influential.

Link between driving forces and strategy

• Sound analysis of the industry's driving forces is a
prerequisite to sound strategy making.
• Understanding the forces driving industry change
and the impacts these forces will have on the
character of the industry environment and on the
company's business over the next one to three
years will help in crafting a strategy that is
responsive to the driving forces.
What are the key factors for future competitive success?
• An industry's Key Success Factors (KSF) are those
competitive factors that most effect industry members'
ability to prosper in the market place.
• They are - the strategy, product attributes, resources,
competencies, competitive capabilities and market
achievements.
• How well a company's product offerings, resources and
capabilities measure up to an industry's KSFs determine
how successful that company is.
• Identifying KSFs is a top priority analytical and strategy-
making consideration.
• An industry's KSFs can be deduced from the analysis of
the industry and competitive environment.
Answer to the following questions help identify an
industry's Key Success Factors:
1. On what basis do buyers of the industry's product
choose between the competing brands of sellers?
What attributes of competitors' product offerings
are crucial?
2. Given the nature of competitive rivalry and the
competitive forces prevailing in the marketplace,
what resources and competitive capabilities does
a company need to have to be competitively
successful?
3. What shortcomings are almost certain to put a
company at a significant competitive
disadvantage?
• Usually two or three factors become the most
important on which the management has to
concentrate. These vary over time even within
the same industry.
• Correctly diagnosing an industry's KSFs raises a
company's chances of crafting a sound strategy.
• The goal of company strategists should be to
design a strategy aimed at taking care of all the
industry's future KSFs and trying to be
distinctively better than rivals on one or two of
the KSFs.
• Being distinctively better than rivals on one or
two key success factors tends to translate into
competitive advantage. This can be the
cornerstone for a fruitful competitive strategy.