Chapter

Two
External
Analysis:
The
Identification of
Opportunities
and Threats
 “To assure victory, always
carefully survey the field
before battle.”
- Sun Tzu

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Components of the General Environment
Economic

Demographic
Sociocultural

Industry
Environment
Competitive
Environment
Political/
Legal Global

Technological
 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 macro environment that
may affect the company and its industry
• Social • Legal • Technological
• Government • International
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 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

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Opportunities and Threats form a
basis for EXTERNAL analysis

 By examining opportunities, you can

discover untapped markets, and new
products or technologies, or identify
potential avenues for diversification.
 By examining threats, you can identify
unfavorable market shifts or changes in
technology, and create a defensive posture
aimed at preserving your competitive
position.
 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
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 The Computer Sector:
Industries and Market Segments
Figure 2.1

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 The purpose of
Five-Forces Analysis

The five forces are environmental

forces that impact on a company’s
ability to compete in a given market.
The purpose of five-forces analysis
is to diagnose the principal
competitive pressures in a market
and assess how strong and
important each one is.
 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.

2 | 10
 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
   • 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.
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Porter’s Five Forces
Model of Competition
Threat
Threat of
of
New
New
Entrants
 Threat of New Entrants
Economies of Scale
Barriers Product Differentiation
to Entry Capital Requirements
Switching Costs
Access to Distribution Channels
Cost Disadvantages
Independent of Scale
Government Policy
Expected Retaliation
  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:
 Cost reductions – through mass production
 Discounts on bulk purchases – of raw material and standard parts
 Cost advantages – of spreading fixed and marketing costs over large volume
1. Brand Loyalty
 Achieved by creating well-established customer preferences
 Difficult for new entrants to take market share from established brands
1. Absolute Cost Advantages – relative to new entrants
 Accumulated experience – in production and key business processes
 Control of particular inputs required for production
 Lower financial risks – access to cheaper funds
1. Customer Switching Costs for Buyers – where significant
2. Government Regulation
 May be a barrier to enter certain industries

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 Porter’s Five Forces
Model of Competition
Threa
Threat of
tNew
of
Entrants

Bargaining
Power of
Suppliers
 Bargaining Power of Suppliers
Suppliers are likely to be powerful if:

Suppliers exert power

in the industry by:
* Threatening to raise
prices or to reduce quality
Powerful suppliers
can squeeze industry
profitability if firms
are unable to recover
cost increases
Supplier industry is dominated by
a few firms
Suppliers’ products have few
substitutes
Buyer is not an important customer
to supplier
Suppliers’ product is an important
input to buyers’ product
Suppliers’ products are differentiated
Suppliers’ products have high
switching costs
Supplier poses credible threat of
forward integration
 Porter’s Five Forces
Model of Competition
Threa
Threat of
tNew
of
New
Entrants
E
Bargaining Bargaining
Power of Power of
Suppliers Buyers
 Bargaining Power of Buyers
Buyer groups are likely to be powerful if:
Buyers are concentrated or purchases
are large relative to seller’s sales Buyers compete
Purchase accounts for a significant with the supplying
fraction of supplier’s sales industry by:
Products are undifferentiated
* Bargaining down prices
Buyers face few switching costs
* Forcing higher quality
Buyers’ industry earns low profits
Buyer presents a credible threat of
backward integration
Buyer has full information
 Porter’s Five Forces
Model of Competition
Threa
Threat of
t New
of
Entrants
New

Bargaining Bargaining
Power of Power of
Suppliers Buyers

Threat of
Substitute
Products
 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.
 Substitutes limit the price that companies
can charge for their product.

1. Substitutes are a weak competitive

force if an industry’s products have few
close substitutes.
 Other things being equal, companies in
the industry have the opportunity to raise
prices and earn additional profits.

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 Porter’s Five Forces
Model of Competition
Threa
Threat of
t New
of
Entrants
New
ts
Bargaining Rivalry Among Bargaining
Power of Competing Firms Power of
Suppliers in Industry Buyers

Threat of
Substitute
Products
Rivalry Among Existing Competitors
Cutthroat competition is more likely to occur when:
Numerous or equally balanced competitors
Slow growth industry
High fixed costs
High storage costs
Lack of differentiation or switching costs
Capacity added in large increments
Diverse competitors
High strategic stakes
High exit barriers
 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.
 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.
 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

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Strategic Groups in the
Pharmaceutical Industry

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Strategic Groups in the
Pharmaceutical Industry

High Risk – High Return

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

Low Risk – Low Return

 Focus on low-cost copies of
drugs with expired patents
 Production efficiency

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 Strategic Barriers in the
Pharmaceutical Industry

Strategic Barrier
Lack of R&D Skills
to develop new
proprietary drugs

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 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
 Rivalry based on perfecting products, educating customers, and
opening up distribution channels.
1. Growth – first-time demand takes-off with new customers
 Low rivalry as focus is on keeping up with high industry growth.
1. Shakeout – demand approaches saturation, replacements
 Rivalry intensifies with emergence of excess productive capacity.
1. Mature – market totally saturated with low to no growth
 Industry consolidation based on market share, driving down price.
1. Decline – industry growth becomes negative
 Rivalry further intensifies based on rate of decline and exit barriers.

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 Stages in the Industry Life Cycle
Strength and nature of five forces change as industry evolves

    

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 Growth in Demand and Capacity
Anticipate how forces will change and formulate appropriate strategy

Industry Shakeout:
Rivalry Intensifies
with growth in
excess capacity

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 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.

 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.

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The Role of the Macroenvironment

Changes in the
forces in the macro-
environment can
directly impact:
• The Five Forces
• Relative Strengths
• Industry
Attractiveness

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“Strategy is a choice
on how to
compete.”
- Michael Porter