Chapter 2 External Environment

Learning Outcomes
Identify the external key factors influencing firm returns
General Environment Industry Environment (Porters 5 forces)

Determine industry attractiveness Understand the role of and ethics associated with competitive intelligence

Video
Monitor Your Environment and Anticipate Change. Paul Skinner Rio Tinto

Industries Vary in Profitability: Profitability of US Industries

(selected industries only)
Median return on equity (%), 1999-2005

Household & Personal Products Pharmaceuticals Tobacco Food Consumer Products Securities Diversified financials Beverages Mining & crude oil Petroleum Refining Medical Products & Equipment Commercial Banks Scientific & Photographic Equip. Apparel Computer Software Publishing, Printing Health Care Electronics, Electrical Equipment Specialty Retailers Computers, Office Equipment

22.7 22.3 21.6 19.6 18.9 18.3 18.8 17.8 17.3 17.2 15.5 15.0 14.4 13.9 13.5 13.1 13.0 13.0 11.7

Gas & Electric Utilities 10.4 Food and Drug Stores 10.0 Motor Vehicles & Parts 9.8 Hotels, Casinos, Resorts 9.7 Railroads 9.0 Insurance: Life and Health 8.6 Packaging & Containers 8.6 Insurance: Property & Casualty 8.3 Building Materials, Glass 8.3 Metals 8.0 Food Production 7.2 Forest and Paper Products 6.6 Semiconductors & Electronic Components 5.9 Telecommunications 4.6 Communications Equipment 1.2 Entertainment 0.2 Airlines (22.0)

General Environment

External Environment
Industry Environment

The General Environment impacts the firm through its effect on the Industry Environment. BUT, you must be aware of the general environment that could change the industry environment

General Environment
The Economic Segment (health of national economies)
Inflation rates Interest rates Trade deficits or surpluses Budget deficits or surpluses Personal savings rate Business savings rates Gross domestic product
e.g. Interest rates influence borrowing influence purchases of big ticket items

General Environment
The Sociocultural Segment (societal values & attitudes)
Women in the workplace Workforce diversity Attitudes about quality of worklife Concerns about environment (animals, clean air/water, sustainability) Shifts in work and career preferences Shifts in product and service preferences
Europeans take multi-week/month long holidays each summer influences sales Workforce diversity in US is increasing firms need to manage diversity

General Environment
The Global Segment
New markets Existing markets Global events Intl political events Intl institutions

e.g. Outsourcing to other countries such as US to India is changing competition e.g. wars and unrest

General Environment
The Technological Segment (influence of technology on competition)
Product innovations Applications of knowledge Focus of private and government-supported R&D expenditures New communication technologies
e.g. Internet technology is playing a key role in global commerce e.g. wireless technology on mobility of communication and exchange

General Environment
The Political/Legal Segment (laws and policies)
Antitrust laws Taxation laws Deregulation Labor training laws Educational philosophies and policies

e.g. Sarbenes-Oxley Act addresses corporate resp. in financial controls e.g. FDA rules in drug approval process for pharmaceutical firms

General Environment
The Demographic Segment (describes population)
Population size Age structure Geographic distribution Ethnic mix Income distribution
e.g. China and India combined account for 1/3 of world population e.g. US baby boomers are aging

Industry Environment: Porters 5 Forces of Competition

Threat of New Entrants

Entrants threat to industry profitability depends upon the height of barriers to entry. High barriers improve profitability. The principal sources of barriers to entry are: Capital requirements
Boeing & Airbus vs. service industry

Economies of scale
Need for efficiency or break even (Airbus $1.5 bill/ 300 airplanes; pharmaceuticals)

Absolute cost advantage

Lower raw materials or speed of learning

Product differentiation
Consumers less cost conscious (toothpaste, cigarettes)

Access to channels of distribution

Shelf space in retail stores is competitive

Legal and regulatory barriers

Patent protection, taxi licenses

Retaliation by incumbents
Airlines historically retaliate against low cost entrants (SW)

Barriers to Entry Complacency of Incumbents

Industries with high barriers to entry are more profitable. However, firms with sufficient resources can overcome these barriers so incumbents should not become complacent. Virgin, a leading branded venture capital organization, is one of the world's most recognized and respected brands. Conceived in 1970 by Sir Richard Branson, the Virgin Group has gone on to grow very successful businesses in sectors ranging from mobile telephony, to transportation, travel, financial services, leisure, music, holidays, publishing, and retailing. Virgin has created more than 200 branded companies worldwide, employing approximately 50,000 people, in 29 countries. Revenues around the world in 2006 exceeded 10 billion (approx. US$20 billion). (Source: www.virgin.com)

Bargaining Power of Suppliers

Supplier power increases when: Suppliers are large and few in number Suitable substitute products are not available Individual buyers are not large customers of suppliers Suppliers goods are critical to buyers marketplace success

Suppliers products create high switching costs.

Suppliers pose a threat to integrate forward into buyers industry

Supplier Power: The Impact of Unionization on Profitability

25 20
Profitability (%)

15 ROI (%) 10 5 0 0% 1%-35% 36%-60% 61%-75% over 75% ROS (%)

Percentage of employees unionized

Bargaining Power of Buyers

Buyer power increase when: Buyers are large and few in number Buyers purchase a large portion of a suppliers total output Buyers purchases are a significant portion of a suppliers annual revenues Buyers can switch to another product without incurring high switching costs Buyers pose threat to integrate backward into the sellers industry

Threat of Substitute Products

The threat of substitute products increases when: Buyers face few switching costs The substitute products price is lower

Substitute products quality and performance are equal to or greater than the existing product
Differentiated industry products that are valued by customers reduce this threat

Intensity of Rivalry Among Competitors

Industry rivalry increases when:

There are numerous or equally balanced competitors

Industry growth slows or declines

There are high fixed costs or high storage costs

There is a lack of differentiation opportunities or low switching costs When high exit barriers prevent competitors from leaving the industry

Industry Attractiveness
Low entry barriers Suppliers and buyers have strong positions Strong threats from substitute products

Unattractive Industry
Low profit potential

Intense rivalry among competitors

Industry Attractiveness
High entry barriers

Suppliers and buyers have weak positions

Few threats from substitute products Moderate/Low rivalry among competitors

Attractive Industry
High profit potential

Additions to Porters 5 Forces

Complementors firms that offer complementary products that can positively influence firm profits (ink cartridge / printers; video game system / games)

Class Discussion Federal Express

WSJ June 19, 2008. FedEx Swings To a Rare Loss on Fuel Costs, Retail Slump Using the General and Industry Environment frameworks, describe the influences that are affecting the profitability of FedEx

Competitor Environment: Strategic Groups

A set of firms emphasizing similar strategic dimensions and using similar strategies
Internal competition between strategic group firms is greater than between firms outside that strategic group

Strategic Dimensions
Extent of technological leadership Product quality Pricing Policies Distribution channels Customer service

Three Strategic Groups in the Global Automobile Industry

Class Discussion
Analyze the industry environment of the wine industry. What can you say about the attractiveness of the industry? What factors make the industry attractive or unattractive?

Competitors & Competitive Intelligence

Competitor Intelligence
The ethical gathering of needed information and data that provides insight into:
A competitors direction (future objectives)

A competitors intentions (current strategy)

A competitors beliefs about the industry (its assumptions)

A competitors capabilities

Class Discussion
WSJ June 11, 2008 Target of Spying Get Smart

Competitive Intelligence and Ethics

Scenarios
1) You meet someone in a hotel lounge (not official work business) and find out they work for a competitor of your firm. You develop a rapport (without disclosing your employer) and find out valuable information about their firm. Can you use the information gained for your firms advantage?

Competitive Intelligence and Ethics

2) You are sitting in an airplane and a document is on the floor. You pick it up and it is the strategic plan of a competitor of your firm. Should you continue to read it and use the information to your firms advantage?

Competitive Intelligence and Ethics

3) You are flying on a foreign owned airliner. The airliner has cameras inside the overhead light and can read the documents you read while flying. Information is transferred to your competitor within the foreign country. Is this right?

Competitive Intelligence and Ethics

4) You are given some interesting documents regarding a competitor and were told the documents were gained from the dumpster located outside of the competitors building. Should you use this information?

Competitive Intelligence and Ethics

There are many ways to collect competitive intelligence legally and ethically such as:
buy a competitor's product hire their employees visit their booth at trade shows and conferences talk to their vendors use publicly available data