External

Analysis
The I/O View of Strategy
“To assure victory, always
carefully survey the field
before battle.”
- Sun Tzu
 External Analysis
The purpose of external 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
–  Competitive structure of industry
–  Competitive position of the company
–  Competitiveness and position of major rivals
•  The country or national environments in
which company competes
•  The wider socioeconomic or macroenvironment that
may affect the company and its industry
–  Social •  Legal •  Technological
–  Government •  International
 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
 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
The Computer Sector: Industries
and Market Segments
 Porter’s Five Forces Model

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.
 How the Five Forces Shape
Competition within an Industry
The stronger that each of these five forces is, the more
limited is the ability of established companies to raise
prices and earn greater profits within their industry.

–  A weak competitive force
•  may be viewed as an opportunity
•  as it allows company to earn greater profits
„ ‚ ƒ
–  A strong competitive force
•  may be viewed as a threat
•  as it depresses industry profits
…
–  Strength of forces may change
•  As industry conditions change

Through its choice of strategies,

a company may alter the strength of one
or more of the five forces to its advantage.
  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.  Economies of Scale – as firms expand output unit costs fall via:
v  Cost reductions – through mass production
v  Discounts on bulk purchases – of raw material and standard parts
v  Cost advantages – of spreading fixed and marketing costs over large volume
2.  Brand Loyalty
v  Achieved by creating well-established customer preferences
v  Difficult for new entrants to take market share from established brands
3.  Absolute Cost Advantages – relative to new entrants
v  Accumulated experience – in production and key business processes
v  Control of particular inputs required for production
v  Lower financial risks – access to cheaper funds
4.  Customer Switching Costs for Buyers – where significant
5.  Government Regulation
v  May be a barrier to enter certain industries
 ‚ 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
v  Number and size distribution of companies
v  Consolidated versus fragmented industries
2.  Demand Conditions
v  Growing demand – tends to moderate competition and reduce rivalry
v  Declining demand – encourages rivalry for market share and revenue
3.  Cost Conditions
v  High fixed costs – profitability leveraged by sales volume
v  Slow demand and growth – can result in intense rivalry and lower profits
4.  Height of Exit Barriers – prevents companies from leaving industry
v  Write-off of investment in assets v High fixed costs of exit
v  Economic dependence on industry v Emotional attachment to industry
v  Maintain assets - to participate v Bankruptcy regulations – allowing
effectively in an industry unprofitable assets to remain
 Industry Concentration & Competitive
Concentration Ratios Intensity

- Total market share of top four firms in an industry


- Total market share of top eight firms in an industry


e.g. = 100 %, implies a monopoly




 Market Power:
Herfindahl-Hirschman Index
n A B C D E
1 1.00 0.80 0.50 0.20 0.05
2 0.02 0.50 0.30 0.07
Where s = the market share (expressed
as a fraction) of a firm in the market 3 0.02 0.40 0.12
and n = number of firms 4 0.02 0.10 0.15
5 0.02 0.14
A HHI < 0.01 indicates a highly competitive index.
6 0.02 0.03
A HHI < 0.15 indicates an unconcentrated index. 7 0.02 0.02
8 0.02 0.05
A HHI between 0.15 to 0.25 indicates moderate
concentration. 9 0.02 0.07
10 0.02 0.08
A HHI > 0.25 indicates high concentration HHI 1.00 0.64 0.50 0.30 0.08
 ƒ 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.
v  Buyers are large and few in number.
v  The industry supplying the product is composed of many small companies.
2.  Buyers purchase in large quantities.
v  Buyers have purchasing power as leverage for price reductions.
3.  The industry is dependant on the buyers.
v  Buyers purchase a large percentage of a company’s total orders.
4.  Switching costs for buyers are low.
v  Buyers can play off the supplying companies against each other.
5.  Buyers can purchase from several supplying companies at once.
6.  Buyers can threaten to enter the industry themselves.
v  Buyers produce themselves and supply their own product.
v  Buyers can use threat of entry as a tactic to drive prices down.
 „ Bargaining Power of Suppliers
Suppliers are organizations that provide inputs such as
material and labor into the industry. These suppliers are
most powerful when:

1.  The product supplied is vital to the industry and has few
substitutes.
2.  The industry is not an important customer to suppliers.
v  Suppliers are not significantly affected by the industry.
3.  Switching costs for companies in the industry are significant.
v  Companies in the industry cannot play suppliers against each other.
4.  Suppliers can threaten to enter their customers’ industry.
v  Suppliers can use their inputs to produce and compete with
companies already in the industry.
5.  Companies in the industry cannot threaten to enter suppliers’
industry.
 … 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.
v Substitutes limit the price that companies
can charge for their product.

2.  Substitutes are a weak competitive

force if an industry’s products have few
close substitutes.
v Other things being equal, companies in the
industry have the opportunity to raise
prices and earn additional profits.
 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.
The basic differences between business models in
different strategic groups can be captured by a
relatively small number of strategic factors.
v  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.
v  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
Strategic Groups in the
Pharmaceutical Industry
 Strategic Groups in the
Pharmaceutical Industry

High Risk – High Return

•  Focus on developing new
proprietary drugs
•  Heavy R&D spending

Low Risk – Low Return

v  Focus on low-cost copies of
drugs with expired patents
v  Production efficiency
 Strategic Barriers in the
Pharmaceutical Industry

Strategic Barrier
Lack of R&D Skills
to develop new
proprietary drugs
 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
 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
Example: Strategic Group Map of Selected Retail Chains
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
 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
 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
Ä  Rivalry based on perfecting products, educating customers, and opening
up distribution channels.
2.  Growth – first-time demand takes-off with new customers
Ä  Low rivalry as focus is on keeping up with high industry growth.
3.  Shakeout – demand approaches saturation, replacements
Ä  Rivalry intensifies with emergence of excess productive capacity.
4.  Mature – market totally saturated with low to no growth
Ä  Industry consolidation based on market share, driving down price.
5.  Decline – industry growth becomes negative
Ä  Rivalry further intensifies based on rate of decline and exit barriers.
Stages in the Industry Life Cycle
Strength and nature of five forces change as industry evolves

Œ  Ž  
 Growth in Demand and Capacity
Anticipate how forces will change and formulate appropriate strategy

Industry Shakeout:
Rivalry Intensifies
with growth in
excess capacity
 Limitations of Models for Industry
Analysis
•  Life Cycle Issues
–  Industry cycles do not always follow the life cycle generalization.
–  In rapid growth situations embryonic stage is sometimes skipped.
–  Industry growth revitalized through innovation or social change.
–  The time span of the stages can vary from industry to industry.
•  Innovation and Change
–  Punctuated Equilibrium occurs when an industry’s long term stable structure is
punctuated with periods of rapid change by innovation.
–  Hypercompetitive industries are characterized by permanent and ongoing
innovation and competitive change.
•  Company Differences
–  There can be significant variances in the profit rates of individual companies
within an industry.
–  In addition to industry attractiveness, company resources and capabilities are
also important determinants of its profitability.

Models provide useful ways of thinking about competition

within an industry – but be aware of their limitations.
 Punctuated Equilibrium
and Competitive Structure

Industry
Structure
revolutionized
by innovation

Periods of long
term stability
Periods of long
term stability
The Role of the Macroenvironment

Changes in the
forces in the macro-
environment can
directly impact:
•  The Five Forces
•  Relative Strengths
•  Industry
Attractiveness
 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
 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?
 Things to Consider in
Predicting Moves of Rivals
•  Which rivals need to increase their unit sales and market
share? What strategies are rivals most likely to pursue?
•  Which rivals have a strong incentive, along with
resources, to make major strategic changes?
•  Which rivals are good candidates to be acquired? Which
rivals have the resources to acquire others?
•  Which rivals are likely to enter new geographic markets?
•  Which rivals are likely to expand their product offerings
and enter new product segments?
 For Discussion: Your Opinion
Why does a company need to bother with
studying competitors and trying to predict what
moves rivals will make next? Why can’t it just
choose whatever strategy it wants or make
whatever moves in the marketplace it wishes
without first worrying about what rivals are
going to do?
 What Are the Key
Factors for Competitive Success?
•  KSFs are those competitive factors most affecting every
industry member’s ability to prosper
•  KSFs concern
–  Specific strategy elements
–  Product attributes
–  Resources
–  Competencies
–  Competitive capabilities
that a company needs to be competitively successful
•  KSFs are attributes that spell the difference between
–  Profit and loss
–  Competitive success or failure
 Identifying Industry Key Success Factors

•  Pinpointing KSFs involves determining

–  On what basis do customers choose
between competing brands of sellers?
–  What resources and competitive capabilities does a
seller need to have to be competitively successful?
–  What does it take for sellers to achieve a sustainable
competitive advantage?
•  KSFs consist of the major determinants for success
–  Rarely are there more than 5 - 6 factors that are truly
key to the future financial and competitive success of
industry members
 Example: KSFs for Beer Industry
•  Full utilization of brewing capacity –
to keep manufacturing costs low

•  Strong network of wholesale distributors –

to gain access to retail outlets

•  Clever advertising –
to induce beer drinkers to
buy a particular brand
Example: KSFs for Apparel
Manufacturing Industry
•  Appealing designs and
color combinations –
to create buyer appeal

•  Low-cost manufacturing
efficiency – to keep selling
prices competitive
 Example: KSFs for Tin and
Aluminum Can Industry
•  Locating plants close to end-use customers –
to keep costs of shipping empty cans low

•  Ability to market plant output within

economical shipping distances
 Does the Outlook for the Industry Present an
Attractive Opportunity?

•  Involves assessing whether the industry

and competitive environment is attractive
or unattractive for earning good profits
•  Under certain circumstances, a firm uniquely
well-situated in an otherwise unattractive
industry can still earn unusually good profits
–  Attractiveness is relative, not absolute
–  Conclusions about attractiveness have
to be drawn from the perspective of a
particular company
 Factors to Consider in
Assessing Industry Attractiveness
•  Industry’s market size and growth potential
•  Whether competitive forces are conducive to rising/falling
industry profitability
•  Whether industry profitability will be favorably or unfavorably
impacted by driving forces
•  Degree of risk and uncertainty in industry’s future
•  Severity of problems facing industry
•  Firm’s competitive position in industry vis-à-vis rivals
•  Firm’s potential to capitalize on
vulnerabilities of weaker rivals
•  Whether firm has sufficient resources to
defend against unattractive industry factors
Thank you