CHAPTER 3

EVALUATING A COMPANYS
EXTERNAL ENVIRONMENT

1. Gain command of the basic concepts and analytical tools

widely used to diagnose the competitive conditions in a
companys industry.

2. Learn how to diagnose the factors shaping industry dynamics

and to forecast their effects on future industry profitability.
3. Become adept at mapping the market positions of key groups
of industry rivals.
4. Understand why in-depth evaluation of a businesss strengths
and weaknesses in relation to the specific industry conditions
it confronts is an essential prerequisite to crafting a strategy
that is well-matched to its external situation.

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32

3.1

From Thinking Strategically about the Companys Situation

to Choosing a Strategy

Chapter 3
Thinking
strategically
about a firms
external
environment

Thinking
strategically
about a firms
internal
environment

Forming a
strategic
vision of
where the
firm needs
to head

Identifying
promising
strategic
options
for the firm

Selecting the
best strategy
and business
model for
the firm

Chapter 4

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33

The External Environment

The Macro-Environment

Is the broad environmental context in

which a firms industry is situated.
Includes strategically relevant components
over which the firm has no direct control.
General economic conditions
Immediate industry and competitive
environment

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34

3.2

The Components of a Companys Macro-Environment

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35

3.1
Component

The Seven Components of the Macro-Environment

Description

Demographics The size, growth rate, and age distribution of different sectors of the population. It
includes the geographic distribution of the population, the distribution of income
across the population, and trends in these factors.

Social forces

Societal values, attitudes, cultural factors, and lifestyles that impact businesses.
Social forces vary by locale and change over time.

Political, legal, Political policies and processes, as well as the regulations and laws with which
and regulatory companies must complylabor laws, antitrust laws, tax policy, regulatory policies,
the political climate, and the strength of institutions such as the court system.
factors
Natural
environment

Ecological and environmental forces such as weather, climate, climate change, and
associated factors like water shortages.

Technological
factors

The pace of technological change and technical developments that have the
potential for wide-ranging effects on society, such as genetic engineering, the rise of
the Internet, changes in communication technologies, and knowledge and
controlling the use of technology,

Global forces

Conditions and changes in global markets, including political events and policies
toward international trade, sociocultural practices and the institutional environment
in which global markets operate.

General
economic
conditions

Rates of economic growth, unemployment, inflation, interest, trade deficits or

surpluses, savings, per capita domestic product, and conditions in the markets for
stocks and bonds affecting consumer confidence and discretionary income.

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36

THINKING STRATEGICALLY ABOUT A COMPANYS

INDUSTRY AND COMPETITIVE ENVIRONMENT

1. Does the industry offer attractive opportunities for growth?

2. What kinds of competitive forces are industry members facing,
and how strong is each force?
3. What factors are driving changes in the industry, and what
impact will these changes have on competitive intensity and
industry profitability?

4. What market positions do industry rivals occupywho is

strongly positioned and who is not?
5. What strategic moves are rivals likely to make next?
6. What are the key factors for competitive success in the
industry?
7. Does the industry offer good prospects for attractive profits?
Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

37

QUESTION 1: DOES THE INDUSTRY OFFER

ATTRACTIVE OPPORTUNITIES FOR GROWTH?

Defining Growth:

What is the current market size in units or sales?

What is the past, current and expected rate of
growth for the market\industry?

Considerations:

Different sectors\regions of a market grow at

different rates.
Growth varies with the industrys life cycle stage
emergence, rapid growth, maturity, and decline.
Growth does not guarantee profitability.

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38

QUESTION 2: WHAT KINDS OF COMPETITIVE

FORCES ARE INDUSTRY MEMBERS FACING,
AND HOW STRONG ARE THEY?

The Five Competitive Forces:

Competition from rival sellers

Competition from potential new entrants

Competition from substitute products

producers

Supplier bargaining power

Customer bargaining power

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39

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

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310

Using the Five-Forces Model of Competition

Step 1

For each of the five forces, identify the different

parties involved, and the specific factors that
bring about competitive pressures.

Step 2

Evaluate how strong the pressures stemming

from each of the five forces are (strong,
moderate to normal, or weak).

Step 3

Determine whether the strength of the five

competitive forces, overall, is conducive to
earning attractive profits in the industry.

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311

3.2

Common Weapons for Competing with Rivals

Competitive Weapons

Primary Effects

Price discounting, clearance sales,

blowout sales

Lowers price (P), acts to boost total sales volume and market share,
lowers profit margins per unit sold when price cuts are big and/or
increases in sales volume are relatively small

Couponing, advertising items on sale

Acts to increase unit sales volume and total revenues, lowers price (P),
increases unit costs (C), may lower profit margins per unit sold (P C)

Advertising product or service

characteristics, using ads to enhance
a companys image or reputation

Boosts buyer demand, increases product differentiation and perceived

value (V), acts to increase total sales volume and market share, may
increase unit costs (C) and/or lower profit margins per unit sold

Innovating to improve product

performance and quality

Acts to increase product differentiation and value (V), boosts buyer

demand, acts to boost total sales volume, likely to increase unit costs (C)

Introducing new or improved features,

increasing the number of styles or
models to provide greater product
selection

Acts to increase product differentiation and value (V), strengthens buyer

demand, acts to boost total sales volume and market share, likely to
increase unit costs (C)

Increasing customization of product or

service

Acts to increase product differentiation and value (V), increases

switching costs, acts to boost total sales volume, often increases unit
costs (C)

Building a bigger, better dealer network

Broadens access to buyers, acts to boost total sales volume and market
share, may increase unit costs (C)

Improving warranties, offering lowinterest financing

Acts to increase product differentiation and value (V), increases unit

costs (C), increases buyer costs to switch brands, acts to boost total
sales volume and market share

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312

Competitive Pressures That Act to Increase the

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 more alike.

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 stop firms from exiting the industry.

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

313

3.4
Factors Affecting the
Strength of Rivalry

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314

Competitive Pressures Associated

with the Threat of New Entrants

Entry Threat Considerations:

Strength of barriers to entry

Expected reaction of incumbent firms

Attractiveness of a particular markets 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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315

Market Entry Barriers Facing New Entrants

Economies of scale in production, distribution,
advertising, or other areas of operation
Experience and learning curve effects
Unique cost advantages of industry incumbents
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 government policies
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316

3.5
Factors Affecting
the Threat of Entry

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317

Competitive Pressures from the Sellers

of Substitute Products
Substitute Products Considerations:

Ready availability of substitutes

Pricing, quality, performance, and other relevant
attributes of substitutes
Switching costs that buyers incur

Indicators of Substitutes Competitive Strength:

Increasing rate of growth in sales of substitutes

Substitute producers adding output capacity
Increasing profitability of substitute producers

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318

3.6
Factors Affecting
Competition from
Substitute Products
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319

Competitive Pressures Stemming from

Supplier Bargaining Power
Supplier Bargaining Power Considerations:

Ready availability of supplier products

Criticality of supplier products as industry inputs
Number of suppliers of standard\commodity items
Buyers costs for switching among suppliers
Availability of substitutes for suppliers products
Fraction of supplier sales due to industry demand
Ratio of suppliers relative to industry buyers
Backward integration into suppliers industry

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320

3.7
Factors Affecting
the Bargaining
Power of Suppliers

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321

Competitive Pressures Stemming from Buyer

Bargaining Power and Price Sensitivity
Buyer Bargaining Power Considerations:

Buyer costs for switching to competing sellers

Degree to which industry products are commoditized

Number and size of buyers relative to sellers
Strength of buyer demand for sellers products
Buyer knowledge of products, costs and pricing
Backward integration of buyers into sellers industry
Buyer discretion in delaying purchases
Buyer price sensitivity due to low profits, size of
purchase, and consequences of purchase
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322

3.8
Factors Affecting
the Bargaining
Power of Buyers

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323

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?

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324

Matching Strategy to Competitive Conditions

1. Pursuing avenues that shield the firm from as
many competitive pressures as possible.
2. Initiating actions calculated to shift competitive
forces in the firms favor by altering underlying
factors driving the five forces.
3. Spotting attractive arenas for expansion, where
competitive pressures in the industry are
somewhat weaker.

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

325

QUESTION 3: WHAT FACTORS ARE DRIVING

INDUSTRY CHANGE, AND WHAT IMPACTS
WILL THEY HAVE?

Strategic Analysis of Industry Dynamics:

1. Identifying the drivers of change.
2. Assessing whether the drivers of change
are, individually or collectively, acting to
make the industry more or less attractive.
3. Determining what strategy changes are
needed to prepare for the impacts of the
anticipated change.
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326

3.3

The Most Common Drivers of Industry Change

1. Changes in the long-term industry growth rate

2. Increasing globalization
3. Changes in who buys the product and how they use it
4. Technological change
5. Emerging new Internet capabilities and applications
6. Product and marketing innovation
7. Entry or exit of major firms

8. Diffusion of technical know-how across companies and

countries
9. Improvements in efficiency in adjacent markets
10. Reductions in uncertainty and business risk

11. Regulatory influences and government policy changes

12. Changing societal concerns, attitudes, and lifestyles
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327

Assessing the Impact of the Factors

Driving Industry Change
1. Overall, are the factors driving change causing
demand for the industrys product to increase
or decrease?

2. Is the collective impact of the drivers of change

making competition more or less intense?
3. Will the combined impacts of the change
drivers lead to higher or lower industry
profitability?

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328

Developing a Strategy That Takes the Changes

in Industry Conditions into Account
What strategy adjustments will be needed
to deal with the impacts of the changes in
industry conditions?

What adjustments must be made immediately?

What actions must we not take or should we cease

to do now?

What can we do now to prepare for adjustments

we anticipate making in the future?

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

329

QUESTION 4: HOW ARE INDUSTRY RIVALS

POSITIONEDWHO IS STRONGLY POSITIONED
AND WHO IS NOT?

A Strategic Group

Is a cluster of industry rivals that have similar

competitive approaches and market positions:

Have comparable product-line breadth

Sell in the same price/quality range

Emphasize the same distribution channels
Use the same product attributes to buyers
Depend on identical technological approaches
Offer similar services and technical assistance

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330

Using Strategic Group Maps to Assess

the Market Positions of Key Competitors
Constructing a strategic group map:

Identify the competitive characteristics that

differentiate firms in the industry.

Plot the firms on a two-variable map using pairs

of differentiating 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 groups
share of total industry sales revenues.

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331

Typical Variables for Differentiating the Market

Positions of Key Competitors on 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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332

Choosing Variables for Group Maps

Variables selected as map axes:

Must not be highly correlated.

Must reflect key approaches to customer
value and expose sizable differences in the
marketplace positions of rivals.
May be quantitative, continuous, discrete
and\or defined in terms of distinct classes
and combinations.

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333

Guidelines for Constructing Group Maps

Draw map circles proportional to the combined
sales of firms in each strategic group to reflect
the relative sizes of each group to the total size
of the industry.

Use different variable sets to show different

views of relationships among competitive
positions in the industrys structurethere is no
one best map for portraying how competing
firms are positioned.

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334

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335

Follow-up

Which strategic group is located in the least

favorable market position? Which group is in
the most favorable position?
Which strategic group is likely to experience
increased intragroup competition?
Which groups are most threatened by the
likely strategic moves of members of nearby
strategic groups?

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336

What Can Be Learned from 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 in the industry
and drivers of change favor some strategic
groups and hurt others.
2. Profit prospects vary from strategic group to
strategic group.

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337

QUESTION 5: WHAT STRATEGIC MOVES

ARE RIVALS LIKELY TO MAKE NEXT?
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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338

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 their 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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339

QUESTION 6: WHAT ARE THE KEY FACTORS

FOR FUTURE COMPETITIVE SUCCESS?

Key Success Factors

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, as drivers of
change and competitive conditions change.

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340

Identification of Key Success Factors

1. What product attributes and service features
buyers strongly affect buyers when choosing
between the competing brands of sellers?

2. What resources and competitive capabilities

are required for a firm to execute a successful
strategy in the marketplace?
3. What shortcomings will put a firm at a
significant competitive disadvantage?

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341

QUESTION 7: DOES THE INDUSTRY OFFER

GOOD PROSPECTS FOR ATTRACTIVE
PROFITS?
Industry Profitability Considerations:

The industrys overall growth potential

Effects of strong competitive forces

Effects of prevailing drivers of change in the industry

Competitive strength of the firm: its market position

relative to its rivals, its capability to withstand
competitive forces, and whether its position will
change in the course of competitive interactions

The success of the firms strategy in delivering on

the industrys key success factors

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342

Thank You

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