FM-AA-CIA-15 Rev.

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Study Guide in (CBMEC 102 Strategic Management)

Module No. 01

STUDY GUIDE FOR MODULE NO. 02

Analyzing the External Environment of the Firm

MODULE OVERVIEW

Overview
The purpose of this module is to familiarize students with techniques for evaluating a
firm’s external environment. It focuses on the value managers add when they have a sense
of events outside the company. By focusing on external events, managers are able to stay a
step ahead of competitors by accurately anticipating and promptly responding to actions that
can impact the organization. The chapter is organized into three sections.
1. The environmentally aware organization. Emphasize that managers use
scanning, monitoring, and competitive intelligence to develop forecasts. Also, the
role of scenario planning is discussed.
2. The influence of the six broad segments (demographic, sociocultural,
political/legal, technological, economic, global) of the general environment of the
firm.
3. The role of the competitive (also called the task or industry) environment and its
analysis through the application of Porter’s five forces model. We address how
industry and competitive practices are being affected by the internet and digital
technologies. We also address the concept of strategic groups. Managers use
strategic groups to identify who its main competitors are and how a company fits
in with the overall industry in which it competes.
MODULE LEARNING OBJECTIVES

After reading this module, the students are able to:

1. Value the importance of developing forecast of the business environment
2. Learn how to perform environmental scanning, environmental monitoring, and
collecting competitive intelligence that are critical inputs in forecasting.
3. Acquire knowledge on how forces in the competitive environment can affect
profitability and how a firm can improve its competitive advantage.

LEARNING CONTENTS (Strategic Management: Creating Competitive Advantage)

I. Creating the Environmentally Aware Organization

We address three important processes—scanning, monitoring, and gathering
competitive intelligence—which managers use to develop environmental forecasts. We
address scenario analysis and its role in anticipating future major changes in the external
environment as well as the role of SWOT analysis.

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A. The Role of Scanning, Monitoring, Competitive Intelligence, and Forecasting

1. Environmental Scanning

Environmental scanning involves surveillance of the firm’s external environment to

predict environmental changes to come and detect changes that are already
underway. It alerts the firm to critical trends before changes have develop a discernible
pattern and before competitors recognize them.
2. Environmental Monitoring
Environmental monitoring tracks the evolution of trends, events, or streams of
activities in the external environment. It is a firm’s analysis of the external environment
that tracks the evolution of trends, sequences of events.
How to Spot Hot Trends
➢ Listen
➢ Pay attention
➢ Follow trends online
➢ Go to old school
How Zara Apparel and Fragrances Spot Opportunities
➢ Zara’s designers, marketing managers and buyers work side by side in an open
office plan that fosters frequent discussions and promotes the sharing of real-
time data as well as field observations and anecdotes.
➢ This allows them to break out their silos and develop a holistic feel for the market,
see how their work fits, and sense new opportunities as they arise.
3. Competitive Intelligence
Competitive intelligence helps firms define and understand their industry and
identify rivals’ strengths and weaknesses. If it is done properly, competitive intelligence
helps a company to avoid surprises by effectively anticipating and responding to
competitors’ moves.
Competitive intelligence also refers to the firm’s activities of collecting and
interpreting data on competitors, defining and understanding the industry, and
identifying competitors’ strength and weaknesses.
4. Environmental Forecasting

Environmental scanning, monitoring, and competitive intelligence are important

inputs for analyzing the external environment. However, they are of little use unless
they provide raw material that is accurate enough to help managers make accurate
forecasts.
Environmental scanning refers to the development of plausible projections
about the direction, scope, speed and intensity of environmental change.

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5. Scenario Analysis
Scenario analysis provides a set of tools that enable managers to imagine
threats and opportunities the future may bring. As a general rule, scenarios should
be used by businesses whose external environments are prone to fundamental or
sudden change and whose anticipation of such change is of vital strategic
importance.
It is an in-depth approach to environmental forecasting that involves experts’
detailed assessments of social trends, economics, politics, technology, or other
dimensions of the external environment.
It is also important to note that scenario analysis draws on a wide range of
disciplines and interests, among them economics, psychology, sociology, and
demographics.

B. SWOT Analysis
We briefly address SWOT Analysis at this point. SWOT stands for strengths,
weaknesses, opportunities, and threats. SWOT analysis provides a framework for
analyzing these four elements of a company’s internal and external environment.
It is important to note that SWOT analysis provides the “raw material”, that is,
a basic listing of conditions and factors inside and outside of a company.
SWOT Analysis
➢ Build on its strength
➢ Remedy the weaknesses or work around them
➢ Take advantage of the opportunities presented by the environment
➢ Protected the firm from threats

II. The General Environment

The general environment consists of factors that can have a dramatic effect on a
firm’s strategy. Typically, a firm has little ability to predict trends and events in the general
environment, and even less ability to control them.
We divide the general environment into six segments: demographic, sociocultural,
political/legal, technological, economic, and global.

A. The Demographic Segment

Demographics are the most easily understood and quantifiable elements of the
general environment. Demographics include elements such as the aging population,
rising or declining affluence, changes in ethnic composition, geographic distribution of the
population, and income level disparities.

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B. The Sociocultural Segment

Sociocultural forces influence the values, beliefs, and lifestyles of a society. Examples
include a higher percentage of women in the workforce, dual-income families, increases
in the number of temporary workers, greater concern for healthy diets and physical
fitness, greater interest in the environment, and families postponing having children.
C. The Political/Legal Segment
Political processes and legislation influence the regulations with which industries
must comply. Some important elements of the political/legal arena include tort reform,
the Persons with Disabilities (PWD) Act, the Deregulation of utilities and other
industries, and increases in the Labor Law for mandated minimum wage.
D. The Technological Segment
Developments in technology lead to new products and services and improve how
they’re produced and delivered to the end user. Innovations can create entirely new
industries and alter existing industries.
Students speculate on the impact of the following technologies on current Philippine
industry setting as well as the world industry set up: (1) the Internet, (2) manufacturing
innovations (e.g., robotics), (3) genetic engineering/designer genes.
Key implications of the Internet, information technology, and nanotechnology has
had on industry — in particular has its impact on productivity gains.
Fascinating issue: some of the promising future applications of nanotechnology and
how it will impact some industries.
Addressing some of the “downsides” of technology. In addition, Ethical issues on
environmental damage, such as the emission of greenhouse gases.
E. The Economic Segment
The economy has an impact on all industries, from suppliers of raw materials to
manufacturers of finished goods and services, as well as all organizations in the service,
wholesale, retail, government, and nonprofit sectors of economies. Key indicators include
interest rates, unemployment rates, and the consumer price index.
F. The Global Segment
Globalization provides both opportunities to access larger potential markets and a
broad base of factors of production such as raw materials, labor, skilled managers, and
technical professionals. However, such endeavors carry many political, social, and
economic risks. Examples of important elements in the global segment include currency
exchange rates, increasing global trade, the economic emergence of India, China’s
admittance to the World Trade Organization, trade agreements among regional blocs
(e.g., EC), and the GATT Agreement (lowering of tariffs).

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III. The Competitive Environment

In this topic, we draw upon a well-known analytic tool, Michael Porter’s five forces
model of industry competition. In this model it tackle examples of each force in address
the impact of the Internet on the five forces and the strategic groups concept and its
implications for studying rivalry and competition.
A. Porter’s Five Forces Model of Industry Competition
Illustrates Porter’s five forces model of industry competition. In introducing this
model, it is useful to show how the model provides insight into an industry’s dynamics and
expected profit levels.
It is useful to point out that there can also be very profitable opportunities to compete
in industries that have overall low profits, overall. For example, in the paint industry,
Davies or Boysen has typically been a very successful and highly-profitable firm because
they have found an attractive niche in the market and developed a differentiated product
(through product development and advertising).
1. Threat of New Entrants
➢ Indicates a scenario that profits of established firms in the industry may be
eroded by new companies.
Sources of entry barriers:
❖ Economies of scale
❖ Product differentiation
❖ Capital requirements
❖ Switching cost
❖ Access for distribution channels
❖ Cost disadvantages independent
2. Bargaining Power of Buyers
In this scenario, it indicates that buyers threaten an industry by:
❖ Forcing down prices
❖ Bargaining for higher quality or more services
❖ Playing competitors against each other
3. Bargaining Power of Suppliers
This refers to a condition under which a supplier group may become powerful. The
bargaining power of suppliers can be presented as the mirror opposite of the
bargaining power of suppliers. For example, the relative sizes and concentrations
largely determine the bargaining power of the two parties involved in the transaction.
The products it purchases from the industry are standard or undifferentiated. The
buyer faces new switching cost. It earns low profit, the buyer pose a credible threat of
backward integration and the industry’s product is unimportant to the quality of the
buyer’s product and services.
Suppliers can exert power by threatening to raise prices or reduce the quality of
goods and services. A supplier group will be powerful when the group is dominated by
a few companies like the power producers, telephone companies (Telco’s), water
service providers, petroleum, gasoline and oil producers/ distributors where their
products are very important inputs to buyer business. Their group are not obliged to
contend with substitute products for sale to the industry.

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4. The Threat of Substitute Products and Services
This refers viability of a substitute product depends largely on its relative price-
performance trade-off, i.e., more value for the same price or the same value for a lower
price. Examples are the branded medicines of pharmaceutical companies versus the
efficacy of generic brand medicines.
It may also refer to a threat of limiting the potential returns of an industry placing a
ceiling on the prices that firms in that industry can profitably charge without losing too
many customers to substitute products.
5. The Intensity among Competitors in an Industry
Intense rivalry in an industry, provide an example of an industry in which
competition has recently been intense. For example, most customer are familiar with
the recurring price wars in the airline industry by offering price cuts or promo sale on
air plane seat particular on off peak season.
B. How the Internet and Digital Technologies Are Affecting the Five Competitive
Forces
The changes caused by the Internet economy have made strategizing more
challenging. Strategic analysis, informed formulation, and successful implementation may
be even more difficult in the Internet era because of the uncertainty surrounding the new
technology. In this section we address the impact of the Internet and digital technologies
in terms of Porter’s five-force model of competition.
1. The Threat of New Entrants
In most industries, new entrants will be a bigger threat because the Internet lowers
barriers to entry. Thus, scale economies may be less important in an Internet context
and new entrants can go to market with lower capital costs.
Businesses launched on the Internet may enjoy savings on traditional expenses
such as office rent, salaries, and postage. Thus, a new entrant could use the savings to
charge lower prices and compete on price despite an incumbent competitor’s scale
advantages. Alternatively, a new entrant may be able to serve a market more effectively,
with more personalized services and greater attention to product details. Then they could
build a reputation in their niche and charge premium prices.
Another potential benefit for Internet-based businesses is access to distribution
channels. Manufacturers or distributors that can reach potential outlets for their products
via the Internet may be encouraged to enter markets that were previously closed to them.
Such access is not guaranteed, however.
2. The Bargaining Power of Buyers
The Internet may increase buyer power by providing consumers with more
information to make buying decisions and lowering switching costs. But, by giving buyers
new ways to access sellers, the Internet may also suppress the power of traditional buyer
channels that have concentrated buying power in the hands of a few. In this module, we
address two types of buyers: end users and buyer channel intermediaries.
End users are the final customers in a distribution channel. Internet sales activity
that is labeled “B2C” is concerned with end users. Because a large amount of consumer
information is available on the Internet, end users can easily shop for quality
merchandise and bargain for price concessions. Switching costs are also potentially
lower because the cost of switching may involve only a few clicks of the mouse to find
and view a competing product or service online.

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Buyer channel intermediaries are the wholesalers and distributors who serve as
“middlemen” between manufacturers and end users. In some industries buyer channels
are dominated by powerful players. The Internet, however, makes it easier and less
expensive for businesses to reach customers directly. Thus, the Internet may increase
the power of incumbent firms relative to these traditional buyer channels.
3. The Bargaining Power of Suppliers
The Internet has streamlined and quickened the process of acquiring supplies. But
the extent to which the Internet is a benefit or a detriment to suppliers may depend on
where the supplier is positioned along the supply chain.
Suppliers provide products or services to other businesses. The term “B2B” is used
to refer to businesses that supply or sell to other businesses. On the other hand, the
Internet makes it possible for suppliers to access more customers at a relatively lower
cost per customer, because buyers can comparatively shop more easily and negotiate
prices faster, suppliers may not be able to hold on to them. This is especially damaging
to supply chain intermediaries, such as product distributors, who may not be able to stop
suppliers from directly accessing other potential business customers.
One of the greatest threats to supplier power is that the Internet inhibits a supplier’s
ability to offer highly differentiated products or unique services. Other factors may, in
contrast, contribute to stronger supplier power:
1. The growth of Web-based business in general may create more downstream
outlets for suppliers to sell to.
2. Suppliers may be able to create Web-based purchasing arrangements that
make purchasing easier and discourages their customers from switching.
3. The use of proprietary software that links buyers to a supplier’s website may
create a rapid, low-cost ordering capability that discourages the buyer from
seeking other sources of supply.
4. Suppliers will have greater power to the extent that they can reach end users
directly without intermediaries.
A process known as disintermediation is removing organizations or business
process layers responsible for intermediary steps in the value chain in many industries.
The Internet is also creating an opening for new functions. These new activities are
entering the value chain by a process known as reintermediation, the introduction of
new types of intermediaries. Electronic delivery is an example.
4. The Threat of Substitutes
In general, the threat of substitutes is heightened because the Internet
introduces new ways to accomplish the same tasks.
The primary factor that leads to substitution is economic — consumers will use a product
or service until a substitute that meets the same need becomes available at a lower cost.
The economies created by Internet technologies have led to the development of
numerous substitutes for traditional ways of doing business. Examples are provided:
1. Online conferences by a company called Conferenza particularly this time of the
Covid19 Pandemic. Works, meetings and conferences are conducted at home.
2. Online electronic storage by a company called MyDocsOnline, Inc.

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5. The Intensity of Competitive Rivalry

Internet provides more tools and means for competing, rivalry among competitors
is likely to be more intense. The Internet increases rivalry by making it difficult for firms to
differentiate themselves and by shifting customers’ attention to issues of price.
Technology and a vast array of product choices has made brand loyalty a
diminishing factor in marketing.
Rivalry is more intense when switching costs are low and product or service
differentiation is minimized. The Internet has “commoditized” products that might
previously have been regarded as rare or unique. The Internet also eliminates the
importance of location making products that were previously distant readily available
online. This makes competitors more equally balanced, thus intensifying rivalry.
The problem is made worse for marketers because of shopping infomediaries
that search the Web for the best prices. Such infomediary services may be good for
consumers, but they increase business rivalry by consolidating the marketing messages
that consumers use to make purchases to a few key pieces of information that the selling
company has little control over. Internet and digital technologies are affecting industry
structure.
C. Using Industry Analyses: A Few Caveats
This section was written as a “caveat” to address some limitations of Porters five
forces model. First, managers should not always avoid low profit industries.
When industry analysis shows that an industry is unattractive, there are a few firms
that seem to be able to earn high returns. For example, Cebu Pacific Airlines has been
consistently profitable in an otherwise unattractive industry over the past several
years. Does this mean that industry analysis is misleading? You may point out that
industry analysis is useful to predict an industry’s average profitability, but not
necessarily, a single firm’s profitability. This is a good opportunity to introduce the role
of the strategist in outperforming industry norms.
Second is the idea that business is not always a “zero-sum game”— which is an
assumption that is implicit in Porter’s five forces model. We discuss how companies can
collaborate with each other for mutually beneficial outcomes.
The third issue we raise is that the five forces analysis has often been criticized for
being a static — rather than a dynamic analysis.
The concept of complementors is often considered to be the single most important
contribution of value net analysis. Complements typically are products or services that
have a potential impact on the value of the firms’ own product and services. Examples of
complements (software and microprocessors) in the personal computer industry and the
video game industry. (Professor Michael Porter would not add complements to the “five
forces” because they don’t have a direct linear relationship to industry profitability.
However, they clearly can have an impact on an industry’s profitability.)
D. Strategic Groups within Industries
In the automobile industry a strategic grouping of the worldwide automobile industry
are a very good example. There is an intense competition within strategic groups across
groups.

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Point out four benefits of strategic groups as an analytical tool:

1. Strategic groupings help a firm identify mobility barriers that protect a group
from attacks by other groups.
2. It helps a firm to identify groups whose competitive position may be marginal
or tenuous.
3. It helps chart the future directions of firms’ strategies.
4. It helps in thinking through the implications of each industry trend for the
strategic group as a whole.
It may be interesting to ask the students what dynamics they envision in the
automobile industry, i.e., how membership in strategic groups may change and if new
strategic groups may emerge.

LEARNING ACTIVITY

Imagine yourself as the CEO of a large firm in an industry in which you are interested.
Please (1) identify major trends in the general environment, (2) analyze their impact on
the firm, and (3) identify major sources of information to monitor these trends. (Use
Internet and library resources.)

SUMMARY

Managers must analyze the external environment to minimize or eliminate threats

and exploit opportunities. This involves a continuous process of environmental scanning
and monitoring as well as obtaining competitive intelligence on present and potential
rivals. These activities provide valuable inputs for developing forecasts. In addition, many
firms use scenario planning to anticipate and respond to volatile and disruptive
environmental changes.
We identified two types of environment: the general environment and the competitive
environment. The six segments of the general environment are demographic,
sociocultural, political/legal, technological, economic, and global. Trends and events
occurring in these segments, such as the aging of the population, higher percentages of

women in the workplace, governmental legislation, and increasing (or decreasing) interest
rates, can have a dramatic effect on your firm. A given trend may have a positive impact
on some industries and a negative or neutral impact, or none at all on others.
The competitive environment consists of industry-related factors and has a more
direct impact than the general environment. Porter’s five forces model of industry analysis
includes the threat of new entrants, buyer power, supplier power, threat of substitutes,
and rivalry among competitors. The intensity of these factors determines, in large part,
the average expected level of profitability in an industry. A sound awareness of such
factors, both individually and in combination, is beneficial not only for deciding what

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industries to enter but also for assessing how a firm can improve its competitive position.
We also address how industry and competitive practices are being affected by Internet
technologies. We also addressed some of the limitations of Porter’s five forces model,
including its “zero-sum perspective” and its omission of the key role of complements.
Although we discussed the general environment and competitive environment in separate
sections, they are quite interdependent. A given environmental trend or event, such as
changes in the ethnic composition of a population or a technological innovation, typically
has a much greater impact on some industries than on others.
The concept of strategic groups is also very important to the external environment
of a firm. No two organizations are completely different nor are they exactly the same.
The question is how to group firms in an industry on the basis of similarities in their
resources and strategies. The strategic groups concept is valuable for determining
mobility barriers across groups, identifying groups with marginal competitive positions,
charting the future directions of firm strategies, and assessing the implications of industry
trends for the strategic group as a whole.

REFERENCES

Dess, Gregory G., Lumpkin G.T. Eisner, Alan B., eBook Online Access for Strategic
Management: Text and Cases 2019 Edition
Dess, Gregory G., eBook Online Access for Strategic Management: Creating
Competitive Advantage, 2019 Edition
Gamble, John, Thompson, Arthur, and Peteraf, Essentials of Strategic Management 4th
Edition
Clerc, Strategic Intelligence For The Future 1: A New Strategic and Operational
Approach
Yjone, Gareth. And Hill Charles W.L. Strategic Management Theory and Cases,
Cengage Asia Pte. 10th Edition
Ireland Duane R., Hoskisson Robert E., & Hitt, Michael E., The Management of Strategy
Concepts and Cases, Cengage Learning Asia Pte Ltd. 12th Edition
David, Fred R., Strategic Management An integrated Approach, Pearson Education
South Asia Pte Ltd. 2018 Edition

Prepared By:

NARCISO F. CASTRO, DBA

Associate Professor V

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