Chapter 3

External Analysis:
Industry Structure, Competitive Forces, and Strategic Groups

Copyright 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
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 Chapter Outline
3.1 The PESTEL Framework
3.2 Industry Structure and Firm Strategy: The Five Forces
Model
3.3 Changes over Time: Industry Dynamics
3.4 Explaining Performance Differences within the Same
Industry: Strategic Groups
3.5 Implications for the Strategist

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 Strategy Smart Videos
Michael Porter on Five Forces
Interview with Michael Porter, Professor at Harvard University

http://www.youtube.com/watch?v=mYF2_FBCvXw

13:12 Minutes
Topics: Five Forces Model; Competitive Strategy

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 ChapterCase 3
Courtesy of Tesla Motors

Tesla Motors and the U.S. Automotive Industry

With high entry barriers, the BIG THREE GM, Ford,

and Chrysler dominated the U.S. car market until the
1980s.
There have been no new recent entrants due to the
HIGH industry entry barriers.
Tesla Motors Model S received outstanding market
reception, and was awarded the 2013 MotorTrend Car
of the Year.

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 Strategy Smart Videos
Elon Musk Profiled: Bloomberg Risk Takers
Documentary on the life of Elon Musk (by Bloomberg, August
2011)

http://www.youtube.com/watch?v=CTJt547--
AM&list=FLJE5sYtPVhwCuLhzplhxitQ&index=3
Published on Jan 3, 2013

52:06 Minutes
A bit long, but well worth it. Perhaps best watched before class or
in specific segments.
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 EXTERNAL ANALYSIS
MACRO
PESTEL Framework

INDUSTRY ANALYSIS

Five Forces Model

MICRO COMPETITOR ANALYSIS

Strategic Group Mapping

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 3.1 The PESTEL Framework
KEY CONCEPTS
Managers mitigate threats and exploit opportunities
by analyzing the external environmental forces.

Factors are interdependent.

Framework to scan, monitor, and evaluate important

external factors/trends impacting a firm in its quest
for competitive advantage.

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Exhibit 3.1 The Firm Embedded in
Its External Environment

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 Political/Legal Factors
Political environment
Processes/actions of government that can influence the
decisions and behavior of firms

Legal environment
Laws, mandates, regulations, and court decisions all of
which can have a direct bearing on a firms profit potential

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 Economic Factors
Economy-wide phenomena, consisting of the following
five macroeconomic factors affecting firm strategy:
Growth rates
Interest rates
Levels of employment
Price stability (inflation and deflation)
Currency exchange rates

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 Strategy Highlight 3.1
How the Eurozone Crisis Is Hurting Companies
The EU (European Union) began its formation in the
early 1950s.
Today The euro is the common currency used by 17
of the 27 EU member states.
2009 Several European countries took on too much
debt and were unable to repay their credit obligations.
Strict austerity programs were enacted.
Banks tightened credit hampering firms worldwide.

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 Sociocultural Factors

Sociocultural factors
Capture cultures, norms, and values for society; are
dynamic and differ across groups.
Implications for firm strategy must be considered.

Demographic trends
Capture population characteristics related to age, gender,
family size, ethnicity, sexual orientation, religion, and
socioeconomic class.

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 Technological Factors
Technological factors
Capture the application of knowledge to create new
processes and products.
Innovations in process technology
Lean manufacturing, Six Sigma quality, and biotechnology.
Nanotechnology revolution
(Initial stages) Major upheaval for several industries
medical devices to new-age materials for earthquake-
resistant buildings.

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 Ecological Factors
Broad environmental issues, e.g., the natural
environment, global warming, and sustainable
economic growth

Business and natural worlds are interdependent and

inextricably linked.

Managing these relationships in a sustainable manner

directly influences the continued existence of human
societies and the organizations we create.

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 EXTERNAL ANALYSIS
MACRO
PESTEL Framework

INDUSTRY ANALYSIS

Five Forces Model

MICRO COMPETITOR ANALYSIS

Strategic Group Mapping

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3.2 Industry Structure and Firm
Strategy: The Five Forces Model
Industry
A group of (incumbent) firms that face the same set of
suppliers and buyers
Industry Analysis
Identifies the industry's profit potential
Derive implications for a firms strategic position within an
industry
Strategic Position
A firms ability to create value (V) for customers while
containing costs (C)
Competitive Advantage = a large value gap (V - C)

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 FIVE FORCES MODEL
MICHAEL PORTER
A framework for identifying the five forces that
determine industry profit potential and help shape
firm competitive strategy
This model intersects:
Theory: industrial organization economics with
Practice: hundreds of case studies
Managers can predict industry profit potential and
position their firms for sustainable competitive
advantage.

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 Strategy Highlight 3.2
The Five Forces in the Airline Industry

Low Entry Barriers

Powerful Suppliers
Powerful Buyers
Strong Substitute Threat
Intense Rivalry
RESULTS Low overall industry profit potential, thus
an unattractive industry for investment.

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Exhibit 3.2 Porters Five Forces Model

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INDUSTRY FORCES IMPACT FIRM PROFITABILITY
ATTRACTIVE INDUSTRY
Sustainable Competitive Advantage Easier

High profit potential

The weaker the five forces
UNATTRACTIVE INDUSTRY
Sustainable Competitive Advantage Harder
Low profit potential
The stronger the five forces

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 The Threat of Entry

Entry barriers
The risk that potential competitors will enter an industry

With new entrants, profit potential is depressed for

incumbent firms:
Lower prices
Spend more to satisfy existing customers

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 The Threat of Entry

Incumbent firms can benefit from several important

sources of entry barriers:
Economies of scale
Network effects
Customer switching costs
Capital requirements
Advantages independent of size
Government policy
Credible threat of retaliation

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 The Power of Suppliers
POWERFUL SUPPLIERS
Can demand higher prices for their inputs.
Capture part (sometimes a large part) of the economic
value created.
Signs of Strong Suppliers
- Suppliers industry is concentrated.
- They dont depend heavily on the incumbents industry.
- Incumbent firms face high switching costs.
- Suppliers products are differentiated.
- Limited substitutes.
- Suppliers have credible forward integration threats.

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 The Power of Buyers
The bargaining power of buyers impacts industry profit potential.

POWERFUL BUYERS
Can demand a lower price or higher product quality
Reduce industry profit potential:
Through price discounts (limited revenue)
Through increased quality / better service (higher costs)
As they capture part of the economic value created

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 THE POWER OF BUYERS EXAMPLES
Google
Faces strong buyer power from Samsung who has 40% of
Android-operated smartphones
Walmart
As the worlds largest retailer, it leverages huge buyer
power from its suppliers.
CEMEX
Strong buyer power in the U.S. leaves it very small profits
Weaker buyer power in Mexico yields much higher profits.

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 The Threat of Substitutes
This threat derives from products/services fulfilling the
needs of current customers from outside the industry.

POWERFUL SUBSTITUTES: THE POWER OF

SUBSTITUTES is HIGH when:
Price-performance: Has an attractive trade-off.
The buyers switching cost is low.

Substitutes limit the price that industry competitors can

charge for their products/services.

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Rivalry among Existing Competitors

The intensity of rivalry among existing competitors is

determined largely by the following factors:
COMPETITIVE INDUSTRY STRUCTURE

INDUSTRY GROWTH

STRATEGIC COMMITMENTS

EXIT BARRIERS

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 COMPETITIVE INDUSTRY STRUCTURE

The structure of an industry is captured by:

Number and size of industry competitors
Pricing power possessed by firms
Products/services offered by firms
(Commodity vs. differentiated product)
Height of entry barriers

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Exhibit 3.3 Industry Competitive Structures along
the Continuum from Fragmented to Consolidated

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 Adding a Sixth Force:
The Strategic Role of Complements

COMPLEMENT
A product, service, or competency that adds value when
used in tandem with the original product offering

Complementor A firm that provides a good/service

that leads customers to value your firms offering
more when the two are combined
Co-opetition Cooperation by competitors to
achieve a strategic objective

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 3.3 Changes over Time:
Industry Dynamics
The static five forces model cannot determine the
speed of change for an industry.

As consolidated industries tend to be more profitable

than fragmented ones, firms tend to change their
industry structures toward being more consolidated
through (horizontal) mergers and acquisitions.

Industry Profitability Consolidation

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 INDUSTRY CONVERGENCE
A process whereby formerly unrelated industries begin to
satisfy the same customer need

Driver: Technological advances

Example: Convergence of media industries due to
technological progress in IT, telecommunications, and
digital media

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 EXTERNAL ANALYSIS
MACRO
PESTEL Framework

INDUSTRY ANALYSIS

Five Forces Model

MICRO COMPETITOR ANALYSIS

Strategic Group Mapping

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 STRATEGIC
GROUP MODEL
STRATEGIC
GROUP Framework that
explains performance
Set of firms differences within the
pursuing a similar FIRM same industry by
strategy within a PERFORMANCE clustering different
specific industry Determined not only firms into groups
by the industry to based on key strategic
which the firm dimensions
belongs, but also by its
strategic group
membership

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3.4 Explaining Performance Differences
Within the Same Industry: Strategic Groups

Firms in the same strategic group follow a similar

strategy.
Strategic group differences identify business-level
strategies.
Direct competitors same strategic group firms
Intra-group rivalry exceeds inter-group rivalry:
Rivalry among firms within a strategic group is more intense
than the rivalry between strategic groups.

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 MAPPING STRATEGIC GROUPS

1. Identify important strategic dimensions.

2. For the horizontal and vertical axes select two key
dimensions which expose pivotal differences among
the competitors.
These dimensions should not be highly correlated.
3. Graph the firms in their strategic groups, indicating each
firms market share by the size of the bubble with which
it is represented.

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Exhibit 3.5 Strategic Groups and the Mobility
Barrier in the U.S. Domestic Airline Industry

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 Mobility Barriers

Mobility barriers
Restricts movement between groups; industry-specific
factors that separate one strategic group from another

Exhibit 3.5 Airline industry strategic groups:

Hub-and-spoke group with international routes
Point-to-point airline groups do not

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3.5 Implications for the Strategist

PESTEL analysis guiding consideration: How the

external factors identified affect the firms industry
environment.

Porters five forces model identifies industry profit

potential and firm positioning for gaining and
sustaining competitive advantage.

Strategic group map helps to find performance

differences within the focal industry.

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 ChapterCase 3
Courtesy of Tesla Motors

Consider This

Recent dynamics in the automotive industry have lowered the

profit potential, reducing its attractiveness.
Tesla Motors has demonstrated how new technology can be
used to circumvent entry barriers.

However, incumbent firms are also introducing hybrid or all-

electric cars, further increasing rivalry in the industry.

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 Take-Away Concepts
A firms macroenvironment consists of a wide range of factors
LO 3-1 that can affect industry and firm performance.
Political environment describes the influence government
Generate a bodies can have on firms.
PESTEL analysis Economic environment is mainly affected by five factors:
growth rates, interest rates, levels of employment, price stability
to evaluate the (inflation and deflation), and currency exchange rates.
impact of external Sociocultural factors capture a societys cultures, norms, and
values.
forces on the firm. Technological factors capture the application of knowledge to
create new processes and products.
Ecological factors concern a firms regard for environmental
issues such as the natural environment, global warming, and
sustainable economic growth.
Legal environment factors capture the official outcomes of the
political processes that manifest themselves in laws, mandates,
regulations, and court decisions.

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 Take-Away Concepts
LO 3-2 Competition must be viewed more broadly to not
only encompass direct rivals but also a set of other
Apply Porters five forces in an industry: buyers, suppliers, the
potential new entry of other firms, and the threat
competitive forces of substitutes.
to explain the The profit potential of an industry is a function of
profit potential of the five forces that shape competition: (1) threat of
entry, (2) power of suppliers, (3) power of buyers,
different industries. (4) threat of substitutes, and (5) rivalry among
existing competitors.
The stronger a competitive force, the greater the
threat it represents. The weaker the competitive
force, the greater the opportunity it presents.
A firm can shape an industrys structure in its
favor through its strategy.

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 Take-Away Concepts
The competitive structure of an industry is largely
LO 3-3 captured by the number and size of competitors in an
industry, whether the firms possess some degree of
Explain how pricing power, the type of product or service, and the
competitive height of entry barriers.
A perfectly competitive industry is characterized by
industry structure many small firms, a commodity product, low entry
shapes rivalry barriers, and no pricing power for individual firms.
among A monopolistic industry is characterized by many
firms, a differentiated product, medium entry barriers,
competitors. and some pricing power.
An oligopolistic industry is characterized by few (large)
firms, a differentiated product, high entry barriers, and
some degree of pricing power.
A monopoly exists when there is only one (large) firm
supplying the market. A few reasons that can cause this
are that the firm may offer a unique product, the barriers
to entry may be high, and the monopolist has
considerable pricing power.
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 Take-Away Concepts
LO 3-4 Co-opetition can create a positive-sum
game, resulting in a larger pie for
Describe the everyone involved.
strategic role of Complements increase demand for the
complements in primary product, enhancing the profit
creating positive- potential for the industry and the firm.
sum co-opetition. Attractive industries for co-optetion are
characterized by high entry barriers, low
exit barriers, low buyer and supplier
power, a low threat of substitutes, and the
availability of complements.

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 Take-Away Concepts
LO 3-5 Industries are dynamicthey change
Appraise the over time.
role of industry Different conditions prevail in different
dynamics and industries, directly affecting the firms
industry competing in these industries and their
convergence in profitability.
shaping the In industry convergence, formerly
firms external unrelated industries begin to satisfy the
environment. same customer need.
This is often brought on by technological
advances.

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 Take-Away Concepts
LO 3-6 A strategic group is a set of firms within a specific
industry that pursue a similar strategy in their quest for
Generate a competitive advantage.
strategic group Generally, there are two strategic groups in an industry
model to reveal based on two different business strategies: low-cost
and differentiation strategies.
performance Rivalry within the same strategic group is more intense
differences than the rivalry between strategic groups: intra-group
between rivalry exceeds inter-group rivalry.
clusters of firms Strategic groups are affected differently by the external
environment and the five competitive forces.
in the same
Some strategic groups are more profitable than others.
industry.
Movement between strategic groups is restricted by
mobility barriersindustry-specific factors that
separate one strategic group from another.

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