AB3602

Strategic Management
Chapter 2:
External Environment Analyses

Caleb Tse
Strategy, IB and Entrepreneurship Division
Nanyang Business School
Nanyang Technological University
AY2023-24 S2
 AGENDA

• Group formation Reminder

• External Analysis
• General-environment
• Industry – Porter’s Five Forces
-- Break ---
• Strategic Groups
• Competitor Analysis
 So Far…

• We know about the concept of strategy…

• What is strategy?
• What are the elements of a good strategy?
• …and we know about the strategic management framework
• Analysis, formulation, and implementation
• How the vision and mission are situated in this framework
• Now, we are going to study the tools for strategic analysis
Strategic Management Framework:
Analyses
 Lesson Outcomes
❖ Distinguish and demonstrate how to apply
selected analytical frameworks
❖ General Environment Analysis
❖ Porter’s Five Forces Model
❖ Sustainability considerations in external
analysis
 Sources of Performance

Macro-environment

Industry
Services , Manufacturing,
Textile, Gasoline, Electronics, etc.
vs
Strategic
Group
 Tools for External Analysis

MACRO General Environment Analysis

7 Environment Segments

Industry Analysis

5 Forces Model

MICRO Group Analysis

Strategic Group Model

 General Environment Analysis

Why is it important for an organization to study and

understand its external environment?

• It is important because it can affect the industry and

firm’s performance
• The General environment analysis…
• is helpful because it acts as a guide, allowing managers to
mitigate threats and leverage opportunities accordingly
• allows managers to scan, monitor, forecast, and assess
changes and trends in the firm’s macro-environment
General Environment Analysis
❖ Demographics
❖ Population size, age, income distribution, etc.
❖ Sociocultural
❖ Societal values, attitudes, and lifestyles
❖ Political/Legal
❖ Laws and regulations
❖ Technological
❖ New products, processes, materials, etc.
❖ Economic
❖ Economic growth, inflation, interest rate, etc.
❖ Global
❖ New global markets, existing markets that are changing, important international
political events, etc.
❖ Sustainable Physical Environment
❖ Actual and potential changes in the physical environment and business practices
intended to respond to these changes
 The General Environment:
Segments and Elements
Demographic • Population size • Ethnic mix
segment • Age structure • Income distribution
• Geographic distribution
Economic segment • Inflation rates • Personal savings rate
• 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 and
• Deregulation philosophies policies

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 The General Environment:
Segments and Elements
Sociocultural • Women in the workforce • Shifts in work and career
segment • Workforce diversity preferences
• Attitudes about the quality of • Shifts in preferences regarding
work life product and service
characteristics

Technological • Product innovations • Focus of private and government-

segment • Applications of knowledge supported research and
development (R&D) expenditures
• New communication technologies

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 The General Environment:
Segments and Elements
Global segment • Important political events
• Critical global markets
Sustainable physical • Energy consumption
environment • Practices used to develop
segment energy sources
• Renewable energy efforts
• Minimizing a firm’s
environmental footprint
• Newly industrialized countries
• Different cultural and institutional
attributes
• Availability of water as a resource
• Producing environmentally
friendly products
• Reacting to natural or man-made
disasters
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 Parts of 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

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 Tools for External Analysis

MACRO General Environment Analysis

7 Environment Segments

Industry Analysis

5 Forces Model

MICRO Group Analysis

Strategic Group Model

Industry Environment Analysis:
The Five Competitive Forces
❖ 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.
❖ Compared with the general
environment, the industry
environment has a more direct
effect on firms’ competitive actions
and responses. VIDEO
 Industry Determinants of Performance

~25%
To what extent
the performance
of a firm depends
on the industry? ~55%

~20%

Firm Effects Industry Effects Other Effects

Rothaermel, 2017
 Industry Profitability

Profitability
varies across
industries

Porter (2008)
 Industry & Industry Analysis
• Defining an industry?
• Group of incumbent companies
• Relatively the same set of suppliers and buyers
• Tend to offer similar products and services
• Industry Analysis, a method to:
• Identify an industry’s profit potential for average firms
• Derive implications for a firm’s strategic position (Value – Cost)

Industry’s Strategic
profit potential Positioning

Unique value created

within the industry but
containing the cost
Profit Potential & Strategic Position:
Value Stick Discussion

Perceived
Value (V):
Willingness to
pay (WTP)
Value created = V - C
Price (P)

Profit = P - C

Cost (C)
 Industry Structure & Analysis

• Premise that underlies industry analysis

• The level of industry profitability is not random
• But it is not entirely the result of industry-specific factors
• It is determined by the systematic influence of the industry’s
structure
• And this is why we can use a framework for industry
analysis across different industries
 Industry Structure & Analysis

• An industry analysis can be used to:

• Identify opportunities to increase profits
• Observe threats to existing profits and design mechanisms
to counter them
• Decide whether or not to enter a market
• Decide whether or not to exit a market
• Position a firm to succeed in an industry
 Market/Industry Analysis:
❖ Porter’s Five Forces

供应商的
议价能力

行业企业竞
争激烈程度

Prof. Porter’s Explanation

https://www.youtube.com/watch?v=mYF2_FBCvX
w&feature=youtu.be&t=35
 Porter & 5 forces

• Why 5 forces? An accurate view of competition should include

suppliers, buyers, potential entrants and substitutes
• This is called “extended competition” – shaping the industry structure
• Managers usually focus on a narrow set of competitors (i.e. direct
competitors)
• May the forces be with you?
• “Strategy can be viewed as building defences against competitive forces
or as finding a position in an industry where the forces are weakest”
 Before we begin…

• It is a data reduction technique

• In other words, it’s a way to organize complex information which when
arranged in this framework helps you make informed decisions
• Avoid over reduction
• Don’t try and force fit things into this framework
• Our goal is to try and find a balance between the two
• Industry analysis gives you a platform for thoughtful judgement
• It is not an algorithm that gives you an answer
 Common Pitfalls

• What does 5 Forces tell us about the firm’s advantage?

• Students often put a focal firm in the centre and consider rivals to be
substitutes
▪ Understand that the framework addresses the industry and not the firm

• What industry to choose for 5 forces?

• Students often choose an umbrella industry instead of the specific segment
they are considering entering (e.g., beer instead of micro brews in South Africa)
• The result, then, is almost useless for making decisions and the analysis is not
used to make recommendations
• Looking at the past
• Industry analysis needs to be a current/future oriented activity
 Common Pitfalls: Example

• Are these three sports in the same “industry?”

 5 Forces on Two Dimensions

Bargaining Vertical
Power of Competition
Suppliers
Horizontal
Competition

Rivalry
among Threat of Substitute
Threat of New Entrants
Existing Products or Services
Competitors

Bargaining
Power of
Buyers
 5 Forces: Value Stick Considerations

Perceived
Value (V): Each of the 5 Forces can
Willingness to have an impact on WTP,
price and/or cost (and
pay (WTP)
therefore: on profit
potential).
Price (P)

Profit

Cost (C)
 Fundamental Equation:
Unit Profit Margin = Price - Cost
The Force The Impact (on industry) Why?
IF Threat of entry Profitability Prices
IF Supplier power Profitability Costs
IF Buyer power Profitability Prices
IF Substitutes Profitability Prices
IF Rivalry Profitability Prices Costs
Threat of Buyer
Substitutes Entry Power
- - -
Price – Cost = Profit
- + +
Supplier
Rivalry Power
Threat of New Entrants

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Bargaining Power of Suppliers

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Bargaining Power of Buyers
Buyer switching
Is buyer group price-
costs to rival
sensitive?
NO HIGH products/svcs

•Differentiated products?
•Form a significant portion
of buyers’ costs? LOW
•Important to the quality of
Bargaining Power
buyers’ products/svcs?
of Buyers

Is buyer group
concentrated or
NO LOW Threat of buyer
purchase in large integrating backward
quantities?
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 Cement Industry in U.S. vs. Mexico

Cement Buyers: Cement Buyers:

Few large Thousands of
construction small individual
companies customers (‘ants’)

Where does CEMEX make more profit?

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Threat of Substitute Products

Substitute
for coffee?

Substitute
for business
travel?

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Intensity of Rivalry

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10-min Break

41
 Attractive Industry Structure
LOW
Threat of
Entry

WEAK LOW WEAK

Supplier’s Industry Buyer’s
Power Power
Rivalry

LOW
Substitutes

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 Unattractive Industry Structure
HIGH
Threat of
Entry

STRONG HIGH STRONG

Supplier’s Industry Buyer’s
Power Power
Rivalry

HIGH
Substitutes

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 Limitation of 5 Forces

• Static framework: disruptive innovation and blind spots

• Collaborations: 5-forces is a competition framework
• Complementarities? Particularly common in modern era
• Quantitative precision & tractability: Complexity and
multiple business lines
Industry Analysis: Porter’s Five Forces

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Example?
 A Sixth Force: Complements

• A product, service, or competency

• Adds value (WTP) when used with the original product
• Complementor:
• A company that provides a good or service that leads
customers to value your firm’s offering more when the two
are combined
• Example?
• App developers to Android and iOS
• Coffee shop and bookstore
• Cars and petrol
Example: Airline Industry
Group Discussion: Diamond Industry

Bargaining
Power of
Suppliers
?

Rivalry
Threat of New among Threat of Substitute
Entrants? Existing
Products or Services?
Competitors
?

Bargaining
Power of
Buyers?
 Summary & Purpose
• An industry analysis can be used to:
• Identify opportunities to increase profits
• Observe threats to existing profits and design mechanisms to
counter them
• Decide whether or not to enter a market
• Decide whether or not to exit a market
• Position a firm to succeed in an industry

• Can you find a position where forces are weakest?

• Can you build defences against certain forces?
• Can you reshape the structure in your favor?
 Tools for External Analysis

MACRO General Environment Analysis

7 Environment Segments

Industry Analysis

5 Forces Model

MICRO Group Analysis

Strategic Groups
Competitor Environment
❖ Strategic groups
❖ 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.
❖ 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.
Example of a Strategic Group:
The Airline Industry

Rothaermel, 2017
 Strategic Group: Issues

• Any other examples?

• What are some limitations? Are there
really strategic groups?
 Tools for External Analysis

MACRO General Environment Analysis

Environmental Factors

Industry Analysis

5 Forces Model

MICRO Group Analysis

Strategic Groups

Competitor Analysis
Competitor Environment
❖ Competitor analysis focuses on each company against which a
firm competes directly.
❖ In competitor analysis, the firm seeks to understand the
following questions:
❖ 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.
Competitor Analysis Components
 Sustainability Considerations in
External Analysis
Sustainability considerations include understanding
the impact of sustainability, such as environment (E)
and social (S) factors in the general environment, on
Porter’s Five Forces. Examples include:
❖ Incumbents in the oil and gas industry may experience
higher threat of substitute products from renewables.
❖ Consumer’s bargaining power may increase if there is
lower switching cost to “greener” substitute products.
❖ More examples may be found in Tylenda (2014) -
https://www.sasb.org/blog/five-forces/
See you next week

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