CHAPTER 3

EVALUATING A COMPANY’S
EXTERNAL ENVIRONMENT

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THIS CHAPTER WILL HELP YOU UNDERSTAND:
LO 1 How to recognize the factors in a company’s broad
macro-environment that may have strategic significance.
LO 2 How to use analytic tools to diagnose the competitive
conditions in a company’s industry.
LO 3 How to map the market positions of key groups of industry
rivals.
LO 4 How to use multiple frameworks to determine whether an
industry’s outlook presents a company with sufficiently
attractive opportunities for growth and profitability.

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FIGURE 3.1 From Thinking Strategically about the Company’s Situation
to Choosing a Strategy

Chapter 3

Chapter 4
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CORE CONCEPT

♦ The macro-environment encompasses the

broad environmental context in which a
company’s industry is situated that includes
strategically relevant components over which
the firm has no direct control.

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CORE CONCEPT

♦ PESTEL analysis focuses on the six principal

components of strategic significance in the
macro-environment:
● Political
● Economic
● Social
● Technological
● Environmental
● Legal

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THE STRATEGICALLY RELEVANT FACTORS IN
THE COMPANY'S 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

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FIGURE 3.2 The Components of a Company’s Macro-Environment

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ASSESSING A COMPANY’S INDUSTRY AND COMPETITIVE
ENVIRONMENT

1. How strong are the industry’s competitive forces?

2. What are the driving forces in the industry, and what
impact will they have on competitive intensity and
industry profitability?
3. What market positions do industry rivals
occupy—who is strongly positioned and who is
not?
4. What strategic moves are rivals likely to make next?
5. What are the industry’s key success factors?
6. Is the industry outlook conducive to good
profitability?
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THE FIVE FORCES FRAMEWORK

◆ The Five Competitive Forces:

● Competition from rival sellers
● Competition from potential new entrants
● Competition from producers of substitute products
● Supplier bargaining power
● Customer bargaining power

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FIGURE 3.3
The Five-Forces Model
of Competition: A Key
Analytical Tool

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USING THE FIVE-FORCES MODEL
OF COMPETITION

For each of the five forces, identify the different

Step 1 parties involved, along with the specific factors
that bring about competitive pressures.

Evaluate how strong the pressures stemming

Step 2 from each of the five forces are (strong,
moderate, or weak).

Determine whether the five forces, overall, are

Step 3
supportive of high industry profitability.

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COMPETITIVE PRESSURES THAT INCREASE
RIVALRY AMONG COMPETING SELLERS

◆ Buyer demand is growing slowly or declining.

◆ It is becoming less costly for buyers to switch brands.
◆ Industry products are becoming less differentiated.
◆ There is unused production capacity, and\or products
have high fixed costs or high storage costs.
◆ The number of competitors is increasing and\or they are
becoming more equal in size and competitive strength.
◆ The diversity of competitors is increasing.
◆ High exit barriers keep firms from exiting the industry.

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FIGURE 3.4
Factors Affecting the
Strength of Rivalry

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COMPETITIVE PRESSURES ASSOCIATED WITH
THE THREAT OF NEW ENTRANTS

◆ Entry Threat Considerations:

● Expected defensive reactions of incumbent firms
● Strength of barriers to entry
● Attractiveness of a particular market’s growth
in demand and profit potential
● Capabilities and resources of potential entrants
● Entry of existing competitors into market segments
in which they have no current presence

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MARKET ENTRY BARRIERS
FACING NEW ENTRANTS

◆ Incumbent cost advantages related to learning and

experience, proprietary patents and technology,
favorable locations, and lower fixed costs
◆ Strong brand preferences and customer loyalty
◆ Strong “network effects” in customer demand
◆ High capital requirements
◆ Building a network of distributors or dealers and
securing adequate space on retailers’ shelves
◆ Restrictive regulatory and trade policies

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STRATEGIC MANAGEMENT PRINCIPLE

♦ Whether an industry’s entry barriers ought to

be considered high or low depends on the
resources and capabilities possessed by the
pool of potential entrants.
♦ High entry barriers and weak entry threats
today do not always translate into high entry
barriers and weak entry threats tomorrow.

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COMPETITIVE PRESSURES FROM THE SELLERS
OF SUBSTITUTE PRODUCTS

◆ Substitute Products Considerations:

1. Readily available and attractively priced?
2. Comparable or better in terms of quality,
performance, and other relevant attributes?
3. Offer lower switching costs to buyers?
◆ Indicators of Substitutes’ Competitive Strength:
● Increasing rate of growth in sales of substitutes
● Substitute producers adding new output capacity
● Increasing profitability of substitute producers
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FIGURE 3.6
Factors Affecting
Competition from
Substitute Products

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COMPETITIVE PRESSURES STEMMING FROM
SUPPLIER BARGAINING POWER

◆ Supplier Bargaining Power Depends On:

● Strength of demand for and availability of suppliers’ products.
● Whether suppliers provide a differentiated input that enhances
the performance of the industry’s product.
● Industry members’ costs for switching among suppliers
● Size and number of suppliers relative to industry members
● Possibility of backward integration into suppliers’ industry
● Fraction of the cost of the supplier’s product relative to the total
cost of the industry’s product
● Availability of good substitutes for suppliers’ products
● Whether industry members are major customers of suppliers.

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 FIGURE 3.7
Factors
Affecting the
Bargaining
Power of
Suppliers

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COMPETITIVE PRESSURES STEMMING
FROM BUYER BARGAINING POWER AND
PRICE SENSITIVITY

◆ Buyer Bargaining Power Considerations:

● Strength of buyers’ demand for sellers’ products
● Degree to which industry goods are differentiated
● Buyers’ costs for switching to competing sellers or substitutes
● Number and size of buyers relative to number of sellers
● Threat of buyers’ integration into sellers’ industry
● Buyers’ knowledge of products, costs and pricing
● Buyers’ discretion in delaying purchases
● Buyers’ price sensitivity due to low profits, size of purchase, and
consequences of purchase

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FIGURE 3.8
Factors Affecting
the Bargaining
Power of Buyers

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IS THE COLLECTIVE STRENGTH OF THE FIVE
COMPETITIVE FORCES CONDUCIVE TO GOOD
PROFITABILITY?

◆ Is the state of competition in the industry

stronger than “normal”?
◆ Can industry firms expect to earn decent profits
given prevailing competitive forces?
◆ Are some of the competitive forces sufficiently
powerful to undermine industry profitability?
● Even one powerful force may be enough to make the
industry unattractive in terms of its profit potential

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CORE CONCEPT

♦ The strongest of the five forces determines the

extent of the downward pressure on an
industry’s profitability.
♦ Having more than one strong force means that
an industry has multiple competitive challenges
with which to cope.

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COMPLEMENTORS AND THE VALUE NET

◆ How the Value Net differs from the Five Forces

● Focuses on the interactions of industry participants
with a particular (focal) company.
● Defines the category of “competitors” to include the
focal firm’s direct competitors, industry rivals, the
sellers of substitute products, and potential entrants.
● Introduces a new category of industry
participant—“complementors”—producers of products
that enhance the value of the focal firm’s products
when they are used together.

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CORE CONCEPT

♦ Complementors are the producers of

complementary products, which are products
that enhance the value of the focal firm’s
products when they are used together.

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MATCHING COMPANY STRATEGY
TO COMPETITIVE CONDITIONS

Effectively matching a firm’s business strategy

to prevailing competitive conditions has two
aspects:
1. Pursuing avenues that shield the firm from
as many competitive pressures as possible.
2. Initiating actions calculated to shift
competitive forces in the firm’s favor by
altering underlying factors driving the five
forces.

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STRATEGIC MANAGEMENT PRINCIPLE

♦ A company’s strategy is increasingly effective

the more it provides some insulation from
competitive pressures, shifts the competitive
battle in the company’s favor, and positions
firms to take advantage of attractive growth
opportunities.

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INDUSTRY DYNAMICS AND
THE FORCES DRIVING CHANGE

◆ Driving forces analysis has three steps:

1. Identifying what the driving forces are.
2. Assessing whether the drivers of change are,
on the whole, acting to make the industry more or
less attractive.
3. Determining what strategy changes are needed to
prepare for the impact of the driving forces.

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CORE CONCEPT

♦ Driving forces are the major underlying causes

of change in industry and competitive
conditions.

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STRATEGIC MANAGEMENT PRINCIPLE

♦ The most important part of driving forces

analysis is to determine whether the collective
impact of the driving forces will be to increase
or decrease market demand, make competition
more or less intense, and lead to higher or
lower industry profitability.

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ASSESSING THE IMPACT OF THE FACTORS
DRIVING INDUSTRY CHANGE

1. Are the driving forces as a whole causing

demand for the industry’s product to increase
or decrease?
2. Is the collective impact of the driving forces
making competition more or less intense?
3. Will the combined impacts of the driving forces
lead to higher or lower industry profitability?

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STRATEGIC GROUP ANALYSIS

◆ Strategic Group
● Consists of those industry members with similar
competitive approaches and positions in the market:
❖ Having comparable product-line breadth
❖ Emphasizing the same distribution channels
❖ Depending on identical technological approaches
❖ Offering the same product attributes to buyers
❖ Offering similar services and technical assistance

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CORE CONCEPTS

♦ A strategic group is a cluster of industry

rivals that have similar competitive approaches
and market positions.
♦ Strategic group mapping is a technique for
displaying the different market or competitive
positions that rival firms occupy in the industry.

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USING STRATEGIC GROUP MAPS TO ASSESS
THE MARKET POSITIONS OF KEY COMPETITORS

◆ Constructing a strategic group map:

● Identify the competitive characteristics that delineate
strategic approaches used in the industry.
● Plot the firms on a two-variable map using pairs of the
competitive characteristics.
● Assign firms occupying about the same map location
to the same strategic group.
● Draw circles around each strategic group, making the
circles proportional to the size of the group’s share of
total industry sales revenues.

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TYPICAL VARIABLES USED
IN CREATING GROUP MAPS

◆ Price/quality range (high, medium, low)

◆ Geographic coverage (local, regional, national, global)
◆ Product-line breadth (wide, narrow)
◆ Degree of service offered (no frills, limited, full)
◆ Distribution channels (retail, wholesale, Internet,
multiple)
◆ Degree of vertical integration (none, partial, full)
◆ Degree of diversification into other industries (none,
some, considerable)

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STRATEGIC MANAGEMENT PRINCIPLE

♦ Strategic group maps reveal which companies

are close competitors and which are distant
competitors.

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STRATEGIC MANAGEMENT PRINCIPLE

♦ Some strategic groups are more favorably

positioned than others because they confront
weaker competitive forces and/ or because
they are more favorably impacted by industry
driving forces.

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THE VALUE OF STRATEGIC GROUP MAPS

◆ Maps are useful in identifying which industry

members are close rivals and which are distant
rivals.
◆ Not all map positions are equally attractive:
1. Prevailing competitive pressures from the
industry’s five forces may cause the profit potential
of different strategic groups to vary.
2. Industry driving forces may favor some strategic
groups and hurt others.

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COMPETITOR ANALYSIS

◆ Competitive Intelligence
● Information about rivals that is useful in anticipating
their next strategic moves.
◆ Signals of the Likelihood of Strategic Moves:
● Rivals under pressure to improve financial
performance
● Rivals seeking to increase market standing
● Public statements of rivals’ intentions
● Profiles developed by competitive intelligence units

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STRATEGIC MANAGEMENT PRINCIPLE

♦ Studying competitors’ past behavior and

preferences provides a valuable assist in
anticipating what moves rivals are likely to
make next and outmaneuvering them in the
marketplace.

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A FRAMEWORK FOR COMPETITOR ANALYSIS

◆ Indicators of a rival firm’s likely strategic moves

and countermoves:
● The rival firm’s current strategy
● The rival firm’s objectives
● The rival firm’s capabilities
● The rival firm’s assumptions
about itself and its industry

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USEFUL QUESTIONS TO HELP PREDICT THE
LIKELY ACTIONS OF IMPORTANT RIVALS

◆ Which competitors’ strategies are achieving good results?

◆ Which competitors are losing in the marketplace or badly
need to increase unit sales and market share?
◆ Which rivals are likely make major moves to enter new
geographic markets or to increase sales and market share
in a particular geographic region?
◆ Which rivals can expand product offerings to enter new
product segments where they do not have a presence?
◆ Which rivals can be acquired? Which rivals are financially
able and looking to make an acquisition?

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CREATING A STRATEGIC PROFILE
OF A RIVAL COMPETITOR FIRM

◆ Current Strategy
● How is the competitor positioned in the market?
● What is the basis for its competitive advantage?
● What kinds of investments is it making (as an
indicator of its expected growth trajectory)?
◆ Objectives
● What are its financial performance objectives?
● What are its strategic objectives?
● How well is it performing in meeting its objectives?
● Is it under pressure to improve its performance?
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CREATING A STRATEGIC PROFILE
OF A RIVAL COMPETITOR FIRM (cont’d)

◆ Capabilities
● What are the competitor’s current capabilities?
● What weaknesses does it have?
● Which capabilities is it making efforts to obtain?
◆ Assumptions
● What do the competitor’s top managers believe about
their strategic situation?
● How will their beliefs affect the competitor’s behavior
in the market?

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KEY SUCCESS FACTORS

◆ Key Success Factors (KSFs)

● Are the strategy elements, product and service
attributes, operational approaches, resources, and
competitive capabilities that are necessary for
competitive success by any and all firms in an
industry.
● Vary from industry to industry, and over time within
the same industry, and in importance as drivers of
change and competitive conditions change.

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CORE CONCEPT

♦ Key success factors are the strategy

elements, product and service attributes,
operational approaches, resources, and
competitive capabilities that are essential to
surviving and thriving in the industry.

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IDENTIFICATION OF KEY SUCCESS FACTORS

1. On what basis do buyers of the industry’s product

choose between the competing brands of sellers? That
is, what product attributes and service characteristics
are crucial to competitive success?
2. Given the nature of competitive rivalry prevailing in the
marketplace, what resources and competitive
capabilities must a firm have to be competitively
successful?
3. What shortcomings are almost certain to put a firm
at a significant competitive disadvantage?

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THE INDUSTRY OUTLOOK FOR PROFITABILITY

◆ An industry environment is fundamentally

attractive if it presents a company with good
opportunity for above-average profitability.
◆ An industry environment is fundamentally
unattractive if a firm’s profit prospects in the
industry are unappealingly low.

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FACTORS TO CONSIDER IN ASSESSING
INDUSTRY ATTRACTIVENESS

◆ How the firm is being impacted by the state of the macro-environment.

◆ Whether strong competitive forces are squeezing industry profitability
to subpar levels.
◆ Whether the presence of complementors and the possibility of
cooperative actions improve the company’s prospects.
◆ Whether industry profitability will be favorably or unfavorably affected
by the prevailing driving forces.
◆ Whether the firm occupies a stronger market position than rivals.
◆ Whether this is likely to change in the course of competitive
interactions.
◆ How well the firm’s strategy delivers on industry key success factors.

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STRATEGIC MANAGEMENT PRINCIPLE

♦ The degree to which an industry is attractive or

unattractive is not the same for all industry
participants and all potential entrants.

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INDUSTRY ATTRACTIVENESS IS NOT THE SAME
FOR ALL PARTICIPANTS

● Industry outsiders may conclude that they have the

resources to easily hurdle the barriers to entering an
attractive industry while other outsiders may find the
same industry unattractive because they do not want
to challenge market leaders and have better
opportunities elsewhere.
A particular industry’s attractiveness depends in
large part on whether a company has the
resources and capabilities to be competitively
successful and profitable in that environment.

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in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
WHAT SHOULD A CURRENT COMPETITOR
DECIDE ABOUT ITS INDUSTRY?

◆ When a competitor decides an industry is attractive, it

should invest aggressively to capture the opportunities it
sees and to improve its long-term competitive position in
the business.
◆ When a strong competitor concludes its industry is
relatively unattractive and lacking in opportunity, it may
elect to protect its present position, investing cautiously
if at all and looking for opportunities in other industries.
◆ A competitively weak company in an unattractive
industry may see its best option as finding a buyer,
perhaps a rival, to acquire its business.

(c) 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution
3–56
in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.