Analyzing the

External
Environment of
the Firm

Chapter Two
McGraw-Hill/Irwin

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Learning Objectives
After reading this chapter, you should have a good
understanding of:
LO2.1 The importance of developing forecasts of the
business environment.
LO2.2 Why environmental scanning, environmental
monitoring, and collecting competitive intelligence
are critical inputs to forecasting.
LO2.3 Why scenario planning is a useful technique for
firms competing in industries characterized by
unpredictability and change.
LO2.4 The impact of the general environment on a firms
strategies and performance.
2-2

Learning Objectives (cont.)

LO2.5 How forces in the competitive environment
can affect profitability and how a firm can
improve its competitive position by
increasing its power vis--vis these forces.
LO2.6 How the Internet and digitally based
compatibilities are affecting the five
competitive forces and industry profitability.
LO2.7 The concept of strategic groups and their
strategy and performance implications.

2-3

Inputs to Forecasting

Exhibit 2.1

2-4

Environmental Scanning & Monitoring

External Scanning
surveillance of a firms external environment to
predict environmental changes and detect
changes already under way.

Alerts the firm to critical trends before changes

have developed a discernible pattern and before
competitors recognize them

2-5

Environmental Scanning & Monitoring

External Monitoring
A firms analysis of the external environment that
tracks evolution of environmental trends,
sequences of events, or streams of activities

2-6

How to Spot Hot Trends

Listen
Pay attention
Follow trends online
Go old school

2-7

How Zara Spots Opportunities

Zaras 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 of their silos and
develop a holistic feel for the market, see how
their work fits, and sense new opportunities as
they arise.
2-8

Competitive Intelligence
Competitive intelligence
A firms activities of collecting and interpreting
data on competitors, defining and understanding
the industry, and identifying competitors
strengths and weaknesses.

2-9

Environmental Forecasting
Environmental
forecasting
The development of
plausible projections
about direction,
scope, speed and
intensity of
environmental
change

2-10

Environmental Forecasting
Scenario analysis
An in-depth approach to environmental
forecasting that involves experts detailed
assessments of societal trends, economics,
politics, technology, or other dimensions of the
external environment

2-11

QUESTION
Which of the following is a danger of
forecasting?

A.

B.
C.
D.

Managers assume that the world is not open to

precise predictions.
Managers may view uncertainty as black and white
and ignore grey areas.
Managers assume that the world is uncertain.
Managers view the world as completely
unpredictable.
2-12

SWOT Analysis
Firms strategy must:
Build on its strengths
Remedy the weaknesses or work around them
Take advantage of the opportunities presented
by the environment
Protect the firm from threats

2-13

SWOT Analysis
SWOT analysis
A framework for

analyzing a
companys internal
and external
environment and
that stands for
strengths,
weaknesses,
opportunities, and
threats.
2-14

Example: Harley-Davidson
Strengths
Strong & adaptable brand image

Weaknesses
Limited ability to develop new non-traditional
products

Opportunities
Growing leisure interest in motorcycles worldwide

Threats
Differing foreign policies governing motorcycles
2-15

The General Environment

Factors external to an industry, usually beyond a
firms control

Demographic
Sociocultural
Legal/Political

Technological
Economic
Global

2-16

Demographic Segment
Aging population
Rising or declining affluence
Changes in ethnic composition
Geographic distribution of population
Greater disparities in income levels

2-17

Sociocultural Segment
More women in the workforce
Dual-income families
Increase in temporary workers
Greater concern for healthy diets and physical
fitness
Greater interest in the environment
Postponement of having children
2-18

Political/Legal Segment
Tort reform
Americans with Disabilities Act (ADA)
Repeal of Glass-Steagall Act in 1999
Deregulation of utility and other industries
Increases in federally mandated minimum wages
Taxation at local, state, federal levels
Legislation on corporate governance reforms
(Sarbanes-Oxley Act)
2-19

Technological Segment
Genetic engineering
Emergence of Internet technology
Computer-aided design/computer-aided
manufacturing systems (CAD/CAM)
Wireless communication
Nanotechnology

2-20

Economic Segment
Interest rates
Unemployment
Consumer Price index
Trends in GDP
Changes in stock market valuations

2-21

Global Segment
Increasing global trade
Currency exchange rates
Emergence of the Indian and Chinese
economies
Trade agreements (NAFTA, EU, ASEAN)
Creation of WTO (decreasing tariffs/free trade
in services)

2-22

The Competitive Environment

Competitive environment
factors that pertain to an industry and affect a
firms strategies

Competitors, customers, and suppliers

2-23

Porters Five Forces Model

of Industry Competition

Exhibit 2.7

2-24

The Threat of New Entrants

Profits of established firms in the industry
may be eroded by new competitors
Sources of entry barriers

Economies of scale
Product differentiation
Capital requirements
Switching costs
Access to distribution channels
Cost disadvantages independent of scale
2-25

QUESTION
If you are considering opening a new pizza
restaurant in your community, what would be
the threat of new entrants? How would you
evaluate Porters other forces for this industry?
Explain.

2-26

The Bargaining Power of Buyers

Buyers threaten an industry by:
Forcing down prices
Bargaining for higher quality or more services
Playing competitors against each other

2-27

The Bargaining Power of Buyers

A buyer group is powerful when
It is concentrated or purchases large volumes relative
to seller sales
The products it purchases from the industry are
standard or undifferentiated
The buyer faces few switching costs
It earns low profits
The buyers pose a credible threat of backward
integration
The industrys product is unimportant to the quality
of the buyers products or services
2-28

The Bargaining Power of Suppliers

Suppliers can exert
power by threatening
to raise prices or
reduce the quality of
purchased goods and
services

2-29

The Bargaining Power of Suppliers

A supplier group will be powerful when
The supplier group is dominated by a few companies
and is more concentrated than the industry it sells to
The supplier group is not obliged to contend with
substitute products for sale to the industry
The industry is not an important customer of the
supplier group

2-30

The Bargaining Power of Suppliers

(cont.)
A supplier group will be powerful when
The suppliers product is an important input to
the buyers business
The supplier groups products are differentiated
or it has built up switching costs for the buyer
The supplier group poses a credible threat of
forward integration

2-31

The Threat of Substitute

Products and Services
The Threat of Substitute Products and
Services
the threat of limiting the potential returns of an
industry by placing a ceiling on the prices that
firms in that industry can profitably charge
without losing too many customers to substitute
products.

2-32

The Intensity of Rivalry among

Competitors in an Industry
Price competition
Advertising battles
Product introductions
Increased customer service or warranties

2-33

The Intensity of Rivalry among

Competitors in an Industry
Interacting factors lead to intense rivalry

Numerous or equally
balanced competitors
Slow industry growth
High fixed or
shortage costs

Lack of differentiation
or switching costs
Capacity augmented
in large increments
High exit barriers

2-34

How the Internet and Digital

Technologies Influences Industry

Exhibit
2.9
2-35

Using Industry Analysis: A Few Caveats

Managers must not always avoid low profit
industries
Can still yield high returns for players with sound
strategies

Implicitly assumes a zero-sum game,

determining how a firm can enhance its
position relative to the forces
Five Forces analysis is essentially a static
analysis
2-36

Using Industry Analysis: A Few Caveats

(cont.)
Good industry analysis looks rigorously at the
structural underpinnings of profitability.
A first step is to understand the time horizon

The point of industry analysis is not to declare

the industry attractive or unattractive but to
understand the underpinnings of competition
and the root causes of profitability.

2-37

The Value Net

Exhibit 2.10
2-38

Strategic Groups within Industries

Two unassailable assumptions in industry
analysis
No two firms are totally different
No two firms are exactly the same

Strategic groups
Cluster of firms that share similar strategies

2-39

Strategic Groups within Industries

Value of strategic groups as an analytical tool
Identify barriers to mobility that protect a group
from attacks by other groups
Identify groups whose competitive position may
be marginal or tenuous
Chart the future direction of firms strategies
Thinking through the implications of each
industry trend for the strategic group as a whole

2-40