CHAPTER 3

EVALUATING A COMPANY’S
EXTERNAL ENVIRONMENT

STUDENT VERSION

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 Learning Objectives

 Describe concepts and analytical tools widely used to diagnose the

competitive conditions in a company’s industry
 Diagnose the factors shaping industry dynamics and to forecast
their effects on future industry profitability.
 Describe the concept of strategic groups and develop strategic
group maps in a given industry
 Describe why in-depth evaluation of a business’s strengths and
weaknesses in relation to the specific industry conditions it
confronts is an essential prerequisite to crafting a strategy that is
well-matched to its external situation

3–2
 THE STRATEGICALLY RELEVANT
COMPONENTS OF A COMPANY’S
MACRO-ENVIRONMENT
 Macro-environment
● encompasses the broad environmental context in which a
company’s industry is situated.
● includes seven principal components:
 population demographics;
 societal values and lifestyles;
 political, legal, and regulatory factors;
 the natural environment and ecological factors;
 technological factors;
 general economic conditions; and global forces.
● Each of these components has the potential to affect the firm’s
more immediate industry and competitive environment, although
some are likely to have a more important effect than others
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STRATEGICALLY RELEVANT FACTORS
IN THE 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

3–4
The Components of a Company’s Macro-environment

3-5
Key Questions Regarding the Industry and Competitive Environment

What are the

industry’s
dominant traits?

How strong are What forces are

competitive driving change in
forces? the industry?

What market What are the key How attractive is

positions do rivals factors for the industry
occupy? What competitive from a profit
moves will they
success? perspective?
make next?
 What to Consider in Identifying an Industry’s Dominant Features

 Market size and growth rate

 Scope of competitive rivalry
 Number of Rivals
 Buyer needs and requirements
 Production Capacity
 Pace of Technological Change
 Degree of Product Differentiation
 Product Innovation
 Vertical Integration
 Economies of Scale
 Learning and experience curve effects
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 Learning/Experience Effects
 Learning/experience effects exist when a
company’s unit costs decline as its cumulative
production volume increases because of
● Accumulating production know-how
● Growing mastery of the technology

 The bigger the learning or experience curve

effect, the bigger the cost advantage of the firm
with the largest cumulative production volume

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 Question 2: What Kinds of Competitive
Forces Are Industry Members Facing?

• Objectives are to identify

– Main sources of competitive forces

– Strength of these forces

• Key analytical tool

– Five Forces Model
of Competition
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The Five Forces Model of Competition

3-10
 Competitive Pressures
Associated With Potential Entry

• Seriousness of threat depends on

– Size of pool of entry candidates
and available resources
– Barriers to entry
– Reaction of existing firms
• Evaluating threat of entry involves assessing
– How formidable entry barriers are for each type of
potential entrant and
– Attractiveness of growth and profit prospects

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 Threat of New Entrants/ Entry Barriers
Factors HUF MUF Neutral MFA HFA comment
A A
Economies small large
of scale
Capital Low High
require red
Access to Ample Restri
distribution cted
channels
Expected
Low High
retaliation
Low High
Differentiati
on
Brand Low High
Loyalty
Experience Insignifi Signifi
Curve cant cant
Govt. Action Low high

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 Exit Barriers

Factors HUA MUA Neutr MA HA Comments

al
Specialized Hi LOW
Assets
Fixed Cost of Hi Low
Exit
Strategic Low
Hi
interrelations
hip
Government Low
Barriers Hi

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 Barriers and profitability

low Low, stable Low, risky

returns returns

Entry Barriers

High, stable High, risky

high returns returns

low high
Exit Barriers

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 Competitive Pressures
Among Rival Sellers

• Usually the strongest of the five forces

• Key factor in determining strength of rivalry
– How aggressively are rivals using various weapons
of competition to improve their market positions and
performance?
• Competitive rivalry is a combative
contest involving
– Offensive actions
– Defensive countermoves

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 Competitive Rivalry
Factors HU MU Neut MFA HF Comment
FA FA ral A
Composition of Equal Unequa
Competitors Size l Size
Mkt. Growth rate Slow High
Scope of Global Domest
competition ic
Fixed storage High Low
Cost
Capacity Increase Large Small

Degree of Comm High

differentiation odity

Strategic Stake High Low

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 Competitive Pressures from Substitute Products

Concept
Substitutes matter when customers
are attracted to the products of
firms in other industries

Examples
 Sugar vs. artificial sweeteners
 Eyeglasses and contact lens vs. laser
surgery
 Newspapers vs. TV vs. Internet
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 Threat Of Substitute Product

Factors HUF MUFA N MFA HFA Comment

A
Threat of Hi Low
Obsolescence
of Industry’s
product
Aggressivenes
Hi Low
s of substitute
products in
promotion
Switching Cost Low High
Perceived
price/ value Hi Low

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 Competitive Pressures From Suppliers
and Supplier-Seller Collaboration

• Whether supplier-seller relationships represent

a weak or strong competitive force depends on

– Whether suppliers can exercise

sufficient bargaining leverage to
influence terms of supply in their favor

– Nature and extent of supplier-seller

collaboration in the industry

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 Power of Supplier
Factors HUF MUFA N MFA HFA commen
A t
# of important Few Many
Suppliers
Switching cost
High Low
Availability of
substitutes low high
Threat of forward High Low
integration
Importance of
Buyer industry to small large
supplier’s profit
Quantity purchased low High
by the industry of
supplier’s product
Suppliers product
an important input Highly Less
to the buyer’s Importa import
business nt ant

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 Competitive Pressures From Buyers
and Seller-Buyer Collaboration

• Whether the relationships between industry

members and buyers represent a weak or
strong competitive force depends on

– Whether buyers have sufficient

bargaining leverage to influence
terms of sale in their favor

– Extent and competitive importance of

strategic partnerships between certain industry
members and the buyers

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 Power Of Buyer
Factors HUFA MUFA N MFA HFA Comment
Number of Few Many
Important
buyers
Threat of High Low
Backward
integration
Commodit Specialty
Product
y
supplied
Switching
cost low high
% of High Low
buyer’s
cost Low High
Profit
earned by
buyer
Importance low
to final High
quality of
buyers Pr.

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 Overall Industry attractiveness

Factors Unfavora Neutral Favorable

ble
Entry Barriers
Exit Barriers
Rivalry among
existing firms
Power of buyers
Power of
Suppliers
Threat of
substitutes

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 Strategic Implications of
the Five Competitive Forces

• Competitive environment is ideal from

a profit-making standpoint when
– Rivalry is moderate

– Entry barriers are high

and no firm is likely to enter

– Good substitutes
do not exist

– Suppliers and customers are

in a weak bargaining position

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 Is the Collective Strength of the Five
Competitive Forces Conducive to Good
Profitability
♦ As a rule, the stronger collective impact of the five forces,
the lower the combined profitability of industry
participants
♦ Fierce to strong competitive pressures come from all five
forces driving industry profitability to unacceptably low
levels
♦ An industry can be competitively unattractive even when
not all five forces are strong
♦ Intense competitive pressure from just two or three
forces may suffice to destroy the conditions for good
profitability and prompt some companies to exit the
business

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 Question 3: What Forces Are Driving Industry
Change and What Impacts Will They Have?

• Industries change because forces

are driving industry participants
to alter their actions
• Driving forces are the
major underlying causes
of changing industry and
competitive conditions
• Where do driving forces originate?
– Outer ring of macroenvironment (general environment)
– Inner ring of macroenvironment ( specific
environment)

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Table 3.2: The Most Common Driving Forces

3-27
 Question 4: What Market
Positions Do Rivals Occupy?

 One technique to reveal different competitive

positions of industry rivals is
strategic group mapping

 A strategic group is a cluster of firms in an

industry with similar competitive
approaches and market positions

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 Strategic Group Mapping
• Firms in same strategic group
have two or more competitive characteristics in
common
– Have comparable product line breadth
– Sell in same price/quality range
– Emphasize same distribution channels
– Use same product attributes to appeal
to similar types of buyers
– Use identical technological approaches
– Offer buyers similar services
– Cover same geographic areas
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 Procedure for Constructing
a Strategic Group Map

STEP 1: Identify competitive characteristics that

differentiate firms in an industry from one
another
STEP 2: Plot firms on a two-variable map using
pairs of these differentiating characteristics
STEP 3: Assign firms that fall in about the same
strategy space to same strategic group
STEP 4: Draw circles around each group, making
circles proportional to size of group’s
respective share of total industry sales
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 Strategic Group Map of Selected Retail
Chains

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Example: Strategic Group Map of Selected Automobile Manufacturers

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 3.10 Mapping Strategic Groups in the U.S. Restaurant Chain Industry (Fig. 3.5)

Mapping Strategic Groups in the U.S.

Restaurant Chain Industry
High
Red Lobster
Olive Garden
ChiChi's

Perkins
International House
of Pancakes

Ponderosa
Price

Bonanza Shoney's
Denny's
Country Kitchen

Kentucky Fried Chicken

Pizza Hut
Long John Silver's

Arby's Wendy's
Domino's Dairy Queen
Hardee's Taco Bell
Burger King McDonald's

Low
Limited Menu Full Menu

Product-Line Breadth

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 Guidelines: Strategic Group Maps
• Variables selected as axes should not be highly
correlated
• Variables chosen as axes should expose big
differences in how rivals compete
• Variables do not have to be either quantitative or
continuous
• Drawing sizes of circles proportional to combined
sales of firms in each strategic group allows map
to reflect relative sizes of each strategic group
• If more than two good competitive variables can
be used, several maps can be drawn
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 Interpreting Strategic Group Maps
• The closer strategic groups are
on the map, the stronger the cross-group
competitive rivalry tends to be
• Not all positions on the map
are equally attractive
– Driving forces and competitive pressures often
favor some strategic groups and hurt others
– Profit potential of different strategic
groups varies due to strengths and
weaknesses in each group’s market
position
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 Implications of Strategic groups
• The strategic group a firm should consider entering
• The type and level of entry barriers the firm will
face
• The number and type of entry barriers the firm will
face
• The strategic dimensions that will make the firm
similar to its strategic group members and different
from members of different strategic groups
• The relative effect of five forces of competition on
its relative profitability

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 Question 5: What Strategic Moves
Are Rivals Likely to Make Next

• A firm’s best strategic moves

are affected by
– Current strategies of competitors
– Future actions of competitors
• Profiling key rivals involves gathering
competitive intelligence about
– Current strategies
– Most recent actions and public announcements
– Resource strengths and weaknesses
– Efforts being made to improve their situation
– Thinking and leadership styles of top executives
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 Competitor Analysis
• Sizing up strategies and competitive
strengths and weaknesses of rivals involves
assessing
– Which rival has the best strategy? Which
rivals appear to have weak strategies?
– Which firms are poised to gain
market share, and which ones
seen destined to lose ground?
– Which rivals are likely to rank among the industry
leaders five years from now? Do any up-and-coming
rivals have strategies and the resources to overtake
the current industry leader?
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 Question 6: What Are the Key
Factors for Competitive Success?
• Key Success Factors (KSFs) are competitive factors
and attributes that affect every industry member’s
ability to be competitively and financially successful
• KSFs are those particular attributes that are so
important that they spell the difference between
– Profit and loss
– Competitive success or failure
• KSFs can relate to
– Specific strategy elements
– Product attributes
– Resources
– Competencies
– Competitive capabilities
– Market achievements

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 Identifying Industry Key Success Factors

• The answers to 3 questions often help pinpoint an

industry’s KSFs
– On what basis do customers choose
between competing brands of sellers?
– What resources and competitive capabilities does a
company need to have to be competitively successful?
– What shortcomings are likely to place a company at a
significant competitive disadvantage?
• Rarely are there more than 5 - 6
factors that are truly key to the future financial and
competitive success of industry members

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 Common Types of Industry Key Success Factors (KSF)

Technology Expertise in particular technology or in scientific research

( important in pharmaceuticals, internet applications, mobile
Related communications, and many high tech. industry
Proven ability to improve
production processes ( important in industries where advancing
technology opens the way for higher manufacturing efficiency
Ability
Manufacturing and lowertoproduction
achieve scale economies and/or capture learning
costs)
curve effects (important to achieving low production costs)
Related KSF Quality control know-how
( important in those industries where customers insists on
product reliability)
High utilization of fixed assets (important in capital intensive/
high fixed cost industries)
Access to attractive supplies of skilled labor
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 specification
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Distribution A strong network of wholesale distributors/dealers
Strong direct sales capabilities via the internet and or having
related KSF company owned retail outlets
Ability to secure favorable display space on retailer shelves

Marketing Breadth of product line and product selection

Related KSF A well known and respected brand name
Courteous, personalized customer service
Customer guarantees and warranties
Clever advertising
A talented workforce
Distribution capabilities
Product innovation capabilities
Short delivery time capability
Supply chain management capabilities
Strong e-commerce capabilities
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 Industry Matrix/ Competitive Profile Matrix
( CPM)

Company A Company A Company B Company B

Strategic Factors Weight Rating Weighted Score Rating Weighted Score

1 2 3 4 5 6

Total 1.00

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