Chapter 3: External Analysis
Mobility Barriers
- Restrict movement between strategic groups. - Industry specific factors that separate one strategic group from another - these are actions that are costly and not easily reversed
economic → growth rates
- change in goods produced by a country - business expansion vs. contracting Economic Expansion = demand ↑ & competition ↓ firms expand during this time and become more profitable Economic Contracting = benefits low-cost focusing firms
attractive industry for Co-Operation
- high entry barriers - low exit barriers - low buyer/supplier power - low threat of substitutes - availability of complements ex) Samsung & Google cooperate as complementors to compete against Apple's strong position in the mobile device industry, while at the same time Samsung & Google are becoming competitive with one another
Industry
a group of incumbent companies that face more or less the same buyers / suppliers
2 Factors that determine Firm Performance
Firm Performance = Firm Effects + Industry Effects 1. Firm Effects = firm performance attributed to manager actions (55% of profitability) 2. Industry Effects = firm performance attributed to the structure of industry which firm competes- external circumstances (20% of profitability)
Porter's Five Forces: Rivalry Among Existing Competitors - define - impact on industry - 4 factors that determine intensity of competition
Rivalry = the intensity with which companies within the same industry compete for market share & profitability - competition by lower prices or more value products STRONGER forces → expect STRONGER competitive intensity → LIMITS ($) industry's profit potential Factors that determine Intensity of Competition: 1. Competitive Industry Structure 2. Industry Growth 3. Strategic Commitments 4. Exit Barriers
Factor #3: How "Strategic Commitments" Shapes Rivalry Among Competitors (definition & impact)
Strategic Commitment = firm actions to compete in an industry that are costly, long-term oriented, and difficult to reverse (large fixed cost requirement) firms make a strategic commitment→ rivalry is MORE intense ex) Airline has high fixed costs to start, high fixed cost before selling tickets creates HUGE pressure to fill empty seats - price cutting occurs driving industry profits down - also, bc they had a strategic commitment they are unlikely to exit an industry
Strategic Group - define - 2 general types
Strategic Group = a set of companies that pursue a similar strategy within a specific industry in a quest for competitive advantage - firms in same strategic group = direct competitors - firm performance → industry & strategic group membership - mobility barriers prevent movement between strategic groups Purpose: to analyze performance differences within the SAME industry Generally 2 Strategic Groups in an industry (2 business strategies) 1. Low-Cost Strategy 2. Differentiation Strategy
Strategic Group Model - definition of model & 3 steps - define cluster - define strategic dimension
Strategic Group Model = shows PERFORMANCE differences between clusters of firms in the same industry Cluster = group different firms based on a few key strategic dimensions - to understand competitive behavior and performance WITHIN an industry Strategic Dimensions: expenditures on R&D, technology, product differentiation, product/service offering, cost structure, mkt segments, distribution channels, customer service **strategic dimensions are "strategic commitments" based on manager actions that are costly & difficult to reverse** Steps: 1) identify the most important strategic dimensions 2) choose 2 key dimensions for horizontal and vertical axis: exposing important differences among competitors 3) graph firms in the strategic group, indicating each firm's market share by the size of the bubble
Factor #1: how "Competitive Industry Structure" Shapes Rivalry Among Competitors - 4 characteristics of an industry - 4 types of competitive structures - 2 types of industrys
Structure Characteristics: #/size, barriers, product, pricing power 1) number & size of companies in industry 2) level of entry & exit barriers 3) type of product/service industry offers (commodity or differentiated) 4) firms degree of pricing power Competitive Structures: 1. Perfectly Competitive Industry (low) - many small firms, commodity product, low entry barriers, no pricing power for individual firms 2. Monopolistic Industry (medium) - many firms, differentiated product, medium entry barriers, some pricing power 3. Oligopolistic Industry (high) - few large firms, differentiated products, high entry barriers, some degree of pricing power - competition firms are interdependent- actions of one influences the other 4. Monopoly (dominates) - one large firm supplies market, unique product, high entry barrier, all pricing power Types of Industry: - Fragmented Industry = many small firms, generating low profitability - Consolidated Industry = few firms, generating high potential profitability
Porter's Five Forces: Threat of Substitutes - define - impact - when is threat of substitutes high
Substitute = a product that meets the same basic customer needs as the industry's product but in a different way (energy drink vs. coffee) Substitutes HURT Profit Potential because: it limits the price the industry's competitors can charge for product/service Threat of Substitute is High when: 1) substitute offers an attractive price-performance trade-off OR more attractive by offering a higher value proposition 2) buyer has low switching costs to the substitute
5 Choices Required for Market Entry
the more profitable an industry, the more attractive it becomes to competitors who must consider: 1) WHO are the players? (stakeholders + comp) - identify all stakeholders & competitors 2) WHEN to enter? (industry life cylce) - entry timing, stage in industry life cycle 3) HOW to enter? (overcome barriers) - overcoming entry barriers, leveraging existing assets 4) WHAT type of entry? Decide Type of: - product market - value chain - geography - business model - scale 5) WHERE to enter? (like what part of the market) - product positioning - pricing strategy - potential partners
PESTEL Framework: Legal Factors
the official outcomes of political processes as manifested in: - laws - mandates - regulations - court decisions → all have DIRECT bearing on a firm's profit potential & performance
economic → price stability
Inflation = rising prices → slower economic growth Deflation = falling prices→ serious economic threat
economic → levels of employment
- impacted by growth rates Economic Boom = - low unemployment rates - human capital is costly / scarce - as price of labor rises, firms have incentive to invest in good capital such as cutting edge technology Economic Downturn = - high unemployment - low wages - abundant human capital
2 Purposes of Industry Analysis
1) Identify an Industry's Profit Potential - explained by porter's 5 competitive forces 2) Derive Implications for a Firm's Strategic Position within an industry
Factor #2: How "Industry Growth" Shapes Rivalry Among Competitors
1) high growth = less rivalry (price competition ↓) - consumer demand rises - price competition decreases → competitors just want part of a larger pie, so they avoid price competition and focus on differentiation 2) slow/negative growth = INTENSE rivalry high rivalry because competitors can only gain at the expense of others, so focus on taking business away from others - price discounts - frequent new products released - intense promotion - fast retaliation
7 Entry Barriers: when each any is present, the threat of entry is reduced
1. Economies of Scale - cost advantage of firms w/large output - cost advantage over new entrants (when high, threat low) 2. Network Effects - positive externality: value of product/service increases with the number of users (ex. Facebook) - when present, reduces threat 3. Customer Switching Costs - occur when moving from one supplier to another - sunk cost; if high reduces threat 4. Capital Requirements - "price of the entry ticket" into a new industry - threat of entry is high when cap req. is low in comparison to the expected returns 5. Advantages Independent of Size Current firms have advantage of: - brand loyalty - proprietary technology - preferential access to materials/distribution - favorable geographical location - cumulative learning & experience 6. Government Policy - gov restricts/prevents new entrants - threat of entry is HIGH when theres deregulation / no restrictive policies 7. Credible Threat of Retaliation - threat of entry is high when potential new entrants won't / cannot retaliate (firms retaliate through price & quality/value)
Porter's 5 Forces that Shape Competition
5 Forces Explain Profit Potential of an Industry - to analyze environment & formulate strategy 1) Threat of Entry 2) Power of Suppliers 3) Power of Buyers 4) Threat of Substitutes 5) Rivalry Among Existing Firms
Porter's 5 Forces: 2 key insights
5 Forces: determines profit potential of an industry & shape firm's competitive strategy 1) view competition broadly to predict performance competition = competitors + (buyers, suppliers, potential new entry, threat of substitutes) - all of those other factors can take a share of economic value 2) profit potential of industry is not random nor all determined by industry specific factors. Profit Potential = a function of the 5 forces that shape competition
PESTEL Factor: Economic
5 Macroeconomic Factors that affect firm strategy: 1. Growth Rates = change in amount of goods produced by nations economy (business activity expanding/contracting) A) Economic expansion: consumer demand ↑ & competition ↓ - businesses expand and become more profitable B) Economic contracting: opportunity for low-cost focusing companies - hurts luxury products 2. Levels of Employment = Directly impacted by growth rates - economic boom → low unemployment → skilled human capital is scarce/expensive, as labor rises firms have interest to invest in cutting edge tech 3. Interest Rates = the amount creditors are paid for use of their money & amount debtors pay for that use - low-interest rates → fuels economic growth → cheap credit, so firms can easily borrow money at a low rate reducing cost of capital & enhancing firms competitiveness 4. Price Stability (Inflation & Deflation) - inflation = rising prices → lower economic growth - deflation = decreasing prices → serious economic threat bc companies wont invest in innovation expecting further price decline 5. Currency Exchange Rates - determines how many dollars one must pay for one unit for foreign currency - important if firm buys/sells abroad
Industry Dynamics & Industry Convergence role in shaping the firm's external environment
A) Industry Dynamics = industry structures change over time - Different conditions in different industries directly affect → firms competition in these industries & their profitability EX) consolidated industry = more profitable than fragmented industry → firms change industry structure making it more consolidated through horizontal M&A - w/fewer but larger competitors, firms can mitigate the threat of supplier/buyer power B) Industry Convergence = a process where formerly unrelated industries begin to satisfy the same customer need (usually brought on by tech advances) ex) media convergence has united computing, communications,and content → upheveal of newspapers, magaize, radio etc. industries
PESTEL Framework: Ecological
Broad Environment Issues: - natural environment - global warming - sustainable economic growth Threats: organizations contribute to pollution Opportunities: Tesla addresses environmental concerns w/ carbon emission
PESTEL Framework: Sociocultural
Capture a society's cultures, norms, and values → managers monitor trends and consider implications for firm strategy Demographic Trends = important sociocultural factors → trends capture population characteristics related to age, gender, family size, ethnicity, sex, religion, socioeconomic class ex) Rising US Hispanic group- opportunity so invest in Spanish networks for promotion
Sixth Force: The Strategic Role of Complements - complement - complementor - co-operation
Complement = a product/service that adds value to the original product when the two are used together - increases demand for primary product, enhances industry&firm profit potential Complementor = a company is a complementor to your company if customers value your product offering more when they can combine it with the company's other product/services Co-Operation = cooperation among competitors to achieve a strategic objective - creates a positive-sum game → larger pie for everyone involved
d) How "Exit Barriers" Shapes Rivalry Among Competitors
Exit Barrier = obstacles that determine how easily it is to leave an industry low exit barriers → less rivarly - reduces rivalry bc excess capacity is removed - more attractive bc it allows underperforming firms to exit easily
Firm's External Environment
External Environment = includes factors that can affect firm's potential to gain/sustain competitive advantage **analyze factors to mitigate threats & leverage opportunities** External Factors in: 1) Firm's General Environment = manager has little direct influence - Macroeconomic 2) Firm's Task Environment = manager has some influence over - Organization; composition of their strategic groups or structure of the industry
IMPACT of strong/weak competitive forces on: Industry Environment & Shaping Firm's Strategy
Industry Environment: 1) stronger competitive forces → greater threat - less chance of earning above-average profits - lower ability to gain & sustain competitive advantage 2) weaker competitive forces → greater opportunity Firm can shape an industry's structure to be in its favor through its strategy: 1) leverage weak forces into opportunities 2) mitigate strong forces that are potential threats to gaining an sustaining competitive advantage
economic → interest rates
Low-Interest Rates: - fuels economic growth - cheap credit - firms borrow money at low cost → reduces capital & enhances competitive edge
Strategic Position
Position in Industry = A firm's strategic profile → based on difference between firm's ability to create value for customers (V) while containing the cost to do so (C) "Economic Value" = firm creates by enlargening the gap between the value generated & the cost to produce product/service Goal = create AND capture significant share of economic value to create competitive advantage
Porter's Five Forces: Power of Buyers - define - when is bargaining power high
Pressures that buyers can put on the producers' margins in the industry by: - demanding a lower price (dec. revenue) - demanding higher product quality (inc. production costs) Buyer Bargaining Power is High when: 1) few buyers & each buyer purchases large amounts relative to the size of a single seller 2) industry has standard / commodity products 3) buyers have low/no switching costs 4)buyers can threaten to backwardly integrate into the industry: buyer moves into seller business
PESTEL Factor: Political
Processes & actions of government bodies that can influence the decisions / behaviors of firms Firms try to influence this by applying "non market strategies" in favor of the firm→ lobbying, public relations, contributions, litigation etc.
Porter's Five Forces: Power of Suppliers - define - impact - when is bargaining power high
bargaining power of suppliers captures pressures that industry suppliers can exert on an industry's profit potential How Suppliers reduce firm's ability to gain superior performance: - suppliers can raise cost of production by demanding higher prices for their inputs - suppliers can reduce quality of input/service Supplier Bargaining Power is High when: 1) few suppliers, many companies 2) supplier doesn't depend on 1 industry for large portion of revenue 3) firms face large switching costs when changing suppliers 4) suppliers offer differentiated products 5) no readily available substitutes for products/service suppliers offer 6) suppliers can threaten to forward-integrate into the industry
PESTEL Model
model: scan, monitor, evaluate → Evaluates the IMPACT of external factors on the firm: **factors create opportunities & threats** 1. Political - influence of government bodies on firms 2. Economic - growth rates, interest rates, levels of employment, price stability (inflation/deflation), currency exchange rates 3. Sociocultural - capture society's cultures, norms, values 4. Technological - capture application of knowledge to create processes and products 5. Ecological - firm's regard to environmental issues: natural environment, global warming, sustainable economic growth 6. Legal - official outcomes of political processes that manifest in: laws, mandates, regulations, court decisions
Strategic Model Picture
strategic group = group of firms in the same industry that pursue the same business strategy - "mobility barriers" restrict movement between strategic groups strategic position = position of firm inside of group depending on firm's ability to enlarge gap between value created (V) and cost (C) to do so
Porter's Five Forces: Threat of Entry - define - what does it do to industry profit potential - how to mitigate
the risk that potential competitors will enter an industry Potential new entry depresses industry profit potential in 2 ways: 1) firms lower prices to make entry appear less attractive to potential new competitors 2) firms spend more $ to satisfy existing customers Entry Barriers = obstacles that determine ease of entering an industry & predict industry profit potential - Economies of Scale - Network Effects - Customer Switching Costs - Capital Requirements - Advantages Independent of Size - Government Policy - Credible Threat of Retaliation