Chapter

Three

Evaluating a
Company’s
External
Environment
 External Environmental Analysis
The purpose of external environmental analysis is to
identify the strategic opportunities and threats in the
organization’s operating environment that
will affect how it pursues its mission.
External Analysis requires an assessment of:
❖ Industry environment in which company operates
• Porter’s Five Forces Model
• Strategic Groups within the Industry
• Industry Life Cycle Analysis

❖ The wider socioeconomic or macroenvironment

that may affect the company and its industry
• Social • Legal • Technological
• Government • International

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 External Analysis:
Opportunities and Threats
Analyzing the dynamics of the industry in which
an organization competes to help identify:
Opportunities Threats
Conditions in the Conditions in the
environment that a environment that
company can take endanger the integrity
advantage of to and profitability of
become more the company’s
profitable business

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 Industry Analysis:
Defining an Industry
❖ Industry
• A group of companies offering products or services that are
close substitutes for each other and that satisfy the same
basic customer needs
• Industry boundaries may change as customer needs evolve
and technology changes
❖ Sector
• A group of closely related industries
❖ Market Segments
• Distinct groups of customers within an industry
• Can be differentiated from each other with distinct attributes
and specific demands

Industry analysis begins by focusing on

the overall industry –
before considering market segment or sector-level issues
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 The Computer Sector:
Industries and Market Segments
Figure 2.1

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 Porter’s Five Forces Model
Figure 2.2

Source: Adapted and reprinted by permission of Harvard Business Review. From “How Competitive Forces Shape Strategy,” by
Michael E. Porter, Harvard Business Review, March/April 1979 © by the President and Fellows of Harvard College. All rights reserved.

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 ① Risk of Entry by Potential
Competitors
Potential Competitors are companies that are not
currently competing in an industry but have the capability
to do so if they choose. Barriers to new entrants include:

1. The incumbents have large cost advantage due to

❖Economies of Scale – fixed production cost can be spread over larger production
volume

❖ Discounts on bulk purchases – of raw material and standard parts

❖ Other Cost advantages –

✔ spreading marketing and advertising costs over large volume
✔ experience based cost advantage
✔ learning effects
✔ access to cheaper funds
✔ control of particular inputs required for production

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 ① Risk of Entry by Potential
Competitors
3. Brand Loyalty
❖Exists when consumers have a preference for the products of the established
companies.

❖Achieved by advertising, branding, high product quality, and good after-sales

service.

❖Difficult for new entrants to take market share from established brands.

4. Patents and other form of intellectual properly protection are in

place.

5. Customer Switching Costs for Buyers – where significant

6. Government Regulation
❖ May be a barrier to enter certain industries

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 ② Rivalry Among Established
Companies
Competitive Rivalry refers to the competitive struggle
between companies in the same industry to gain market
share from each other. Intensity of rivalry is a function of:

1. Industry Competitive Structure

❖ Number and size distribution of companies
❖ Consolidated versus fragmented industries

2. Industry Demand Conditions

❖ Growing demand – tends to moderate competition and reduce rivalry
❖ Declining demand – encourages rivalry for market share and revenue

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 ② Rivalry Among Established
Companies
3. Cost Conditions
❖ High fixed costs – profitability depends on sales volume

4. Slow demand growth and a large number of companies – can

result in intense rivalry and lower profits

5. The firms in the industry have excess production capacity

6. The rivals have emotional stake in the business or face high exit
barriers – prevents companies from leaving industry

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 ③ Bargaining Power of Buyers
Industry Buyers may be the consumers or end-users who
ultimately use the product or intermediaries that distribute or
retail the products. These buyers are most powerful when:
1. Buyers are dominant.
❖ Buyers are large and few in number.
❖ The industry supplying the product is composed of many small companies.

2. Buyers purchase in large quantities.

❖ Buyers have purchasing power as leverage for price reductions.

3. The industry is dependent on the buyers.

❖ Buyers purchase a large percentage of a company’s total orders.

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 ③ Bargaining Power of Buyers
1. Switching costs for buyers are low.
❖ Buyers can play off the supplying companies against each other.

2. Buyers can purchase from several supplying companies at once.

3. Buyers can threaten to enter the industry themselves.

❖ Buyers produce themselves and supply their own product.
❖ Buyers can use a threat of entry as a tactic to drive prices down.

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 ④ Bargaining Power of Suppliers
Suppliers are organizations that provide inputs such as
materials and labor into the industry. These suppliers are
most powerful when:

1. The supplying industry is dominated by a few large firms.

2. The product supplied is vital to the industry and has few/no

substitutes.

3. The industry is not an important customer to suppliers.

❖ Suppliers are not significantly affected by the industry.

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 ④ Bargaining Power of Suppliers

4. Companies in the industry cannot threaten to enter suppliers’

industry.

5. Suppliers’ products and/services are in short supply.

6. Suppliers’ products and/services are differentiated or unique.

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 ⑤ Substitute Products
Substitute Products are the products from
different businesses or industries that can satisfy
similar customer needs.

1. The existence of close substitutes is

a strong competitive threat.
❖ Substitutes limit the price that companies
can charge for their product.

2. If there is no close substitute or

substitutes are a weak competitive
force, then….
❖ Companies in the industry have the
opportunity to raise prices and earn
additional profits.

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 A Sixth Force: Complementors
Suggested by Andrew Grove, the former
CEO of Intel.

❑ Complementors are the firms that sell products that

add value to (complement) the products of the
industry.

❑ Complementors of personal computer industry are the

producers of software applications to run on the
personal computers.

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 Strategic Groups Within
Industries
Strategic Groups are groups of companies that
follow a business model similar to other companies
within their strategic group – but are different from
that of other companies in other strategic groups.

❖ Implications of Strategic Groups –

1. The closest competitors are within the same Strategic Group
and may be viewed by customers as substitutes for each other.

2. Each Strategic Group can have different competitive forces

and may face a different set of opportunities and threats.

❖ Mobility Barriers – factors within an industry that inhibit the

movement of companies between strategic groups
• Include barriers to enter another group or exit existing group

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 Strategic Groups in the
Pharmaceutical Industry
Figure 2.3

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 Industry Life Cycle Analysis
Industry Life Cycle Model analyzes the affects of
industry evolution on competitive forces over time
and is characterized by five distinct life cycle stages:

1. Embryonic – industry just beginning to develop

Rivalry based on perfecting products, educating customers, and
opening up distribution channels.

2. Growth – first-time demand takes-off with new customers

Low rivalry as focus is on keeping up with high industry growth.

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 Industry Life Cycle Analysis

3. Shakeout – demand approaches saturation, replacements

Rivalry intensifies with emergence of excess productive capacity.

4. Mature – market totally saturated with low to no growth

Industry consolidation based on market share, driving down price.

5. Decline – industry growth becomes negative

Rivalry further intensifies based on rate of decline and exit barriers.

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 Stages in the Industry Life Cycle
Strength and nature of five forces change as industry evolves Figure 2.4

❶ ❷ ❸ ❹ ❺

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 Growth in Demand and Capacity
Anticipate how forces will change and formulate appropriate strategy Figure 2.5

Industry Shakeout:
Rivalry Intensifies
with growth in
excess capacity

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The Role of the Macroenvironment
Figure 2.7

Changes in the
forces in the
macro-environment
can directly impact:
• The Five Forces
•Industry
Attractiveness

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CORE CONCEPT

♦ The macro-environment encompasses the

broad environmental context in which a
company’s industry is situated that includes
strategically relevant components over which
the firm has no direct control.

(c) 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
CORE CONCEPT

♦ PESTEL analysis focuses on the six principal

components of strategic significance in the
macro-environment:
● Political
● Economic
● Social
● Technological
● Environmental
● Legal

(c) 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
THE STRATEGICALLY RELEVANT FACTORS IN
THE COMPANY'S MACRO-ENVIRONMENT

◆ PESTEL Analysis
● Focuses on principal components of strategic
significance in the macro-environment:
❖ Political factors
❖ Economic conditions (local to worldwide)
❖ Sociocultural forces
❖ Technological factors
❖ Environmental factors (the natural environment)
❖ Legal/regulatory conditions

(c) 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution
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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
FIGURE 3.2 The Components of a Company’s Macro-Environment

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TABLE 3.1 The Six Components of the Macro-Environment
Component Description
Political These factors include political policies, including the extent to which a government
factors intervenes in the economy. They include such matters as tax policy, fiscal policy,
tariffs, the political climate, and the strength of institutions such as the federal
banking system. Some political policies affect certain types of industries more than
others. An example is energy policy, which affects energy producers and heavy
users of energy more than other types of businesses.
Economic Economic conditions include the general economic climate and specific factors
conditions such as interest rates, exchange rates, the inflation rate, the unemployment rate,
the rate of economic growth, trade deficits or surpluses, savings rates, and
per-capita domestic product. Economic factors also include conditions in the
markets for stocks and bonds, which can affect consumer confidence and
discretionary income. Some industries, such as construction, are particularly
vulnerable to economic downturns but are positively affected by factors such as low
interest
rates. Others, such as discount retailing, may benefit when general economic
conditions weaken, as consumers become more price-conscious.
Sociocultural Sociocultural forces include the societal values, attitudes, cultural influences, and
forces lifestyles that impact demand for particular goods and services, as well as
demographic factors such as the population size, growth rate, and age distribution.
Sociocultural forces vary by locale and change over time. An example is the trend
toward healthier lifestyles, which can shift spending toward exercise equipment and
health clubs and away from alcohol and snack foods. Population demographics can
have large implications for industries such as health care, where costs and service
needs vary with demographic factors such as age and income distribution.
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TABLE 3.1 The Six Components of the Macro-Environment (cont’d)

Component Description
Technological Technological factors include the pace of technological change and technical
factors developments that have the potential for wide-ranging effects on society, such as
genetic engineering and nanotechnology. They include institutions involved in
creating new knowledge and controlling the use of technology, such as R&D
consortia, university-sponsored technology incubators, patent and copyright laws,
and government control over the Internet. Technological change can encourage the
birth of new industries, such as the delivery drone industry, and disrupt others, such
as the recording industry.
Environmental These include ecological and environmental forces such as weather, climate,
forces climate change, and associated factors like water shortages. These factors can
directly impact industries such as insurance, farming, energy production, and
tourism. They may have an indirect but substantial effect on other industries such
as transportation and utilities.
Legal These factors include the regulations and laws with which companies must comply,
and regulatory such as consumer laws, labor laws, antitrust laws, and occupational health and
safety regulation. Some factors, such as banking deregulation, are industry-specific.
factors
Others, such as minimum wage legislation, affect certain types of industries
(low-wage, labor-intensive industries) more than others.

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THANK YOU…………

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