CHAPTER 2

EXTERNAL ANALYSIS: THE IDENTIFICATION OF

OPPORTUNITIES AND THREATS

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LEARNING OBJECTIVES
Review the primary technique used to
analyze competition in an industry
environment: the Five Forces model
Explore the concept of strategic groups
and illustrate the implications for
industry analysis
Discuss how industries evolve over
time, with reference to the industry lifecycle model
Show how trends in the
macroenvironment can shape the
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OPPORTUNITIES AND THREATS

Opportunities
Elements in a companys environment
that allow it to formulate and
implement strategies to become more
profitable
Threats
Elements in the external environment
that could endanger a firms integrity
and profitability

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DEFINING AN INDUSTRY
Industry: Group of companies offering
products or services that are close
substitutes for each other
Sector: Group of closely related
industries
Market segments - Distinct groups of
customers within a market that can be
differentiated on the basis of their:
Individual attributes
Specific demands
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FIGURE 2.1 - THE COMPUTER

SECTOR: INDUSTRIES AND
SEGMENTS

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FIGURE 2.2 - COMPETITIVE

FORCES

Source: Based on How Competitive Forces Shape Strategy, by Michael E. Porter, Harvard Business Review, March/April 1979.
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RISK OF ENTRY BY POTENTIAL

COMPETITORS
Potential competitors
Companies that are currently not competing in the
industry but have the potential to do so
Economies of scale
Reductions in unit costs attributed to a larger output
Brand loyalty
Preference of consumers for the products of
established companies
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RISK OF ENTRY BY POTENTIAL

COMPETITORS
Absolute cost advantage
Enjoyed by incumbents in an industry and that new
entrants cannot expect to match
Switching costs
Costs that consumers must bear to switch from the
products offered by one established company to the
products offered by a new entrant
Government regulations
Falling entry barriers due to government regulation results
in significant new entry, increase in the intensity of industry
competition, and lower industry profit rates

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RIVALRY AMONG ESTABLISHED

COMPANIES
Competitive struggle between
companies within an industry to gain
market share from each other
Intense rivalry among established companies
constitutes a strong threat to profitability

Factors that impact the intensity of

rivalry among established companies
within an industry
Industry competitive structure - number and
size distribution of companies in it
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RIVALRY AMONG ESTABLISHED

COMPANIES
Demand conditions - Increasing demand
moderates competition by providing greater
scope for companies to compete for
customers
Cost conditions - When fixed costs are high,
profitability is highly leveraged to sales
volume
Exit barriers - Economic, strategic, and
emotional factors that prevent companies
from leaving an industry
High exit barriers - Companies become locked
into an unprofitable industry where overall
demand is static or declining

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10

BARGAINING POWER OF
BUYERS
Bargain down prices or raise costs by
demanding better product quality and
service
Choose sellers and purchase in large
quantities
Supplier industry is dependent on them for a
major portion of sales
With low switching costs and ability to
purchase an input from several companies
at once, buyers can pit companies against
each other
Threat of entering the industry and

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11

BARGAINING POWER OF
SUPPLIERS
Suppliers ability to raise input prices or
industry costs through various means
Product has no substitutes and is vital to the
buyer
Not dependent on one particular industry for
their sales
Companies would incur high switching costs
if they moved to a different supplier
Threat of entering customers industry
Knowledge that companies cannot enter the
suppliers industry
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12

SUBSTITUTE PRODUCTS AND

COMPLEMENTORS
Substitute products - Those of different
businesses that satisfy similar
customer needs
Limit the price that companies in an industry
can charge for their product

Complementors - Companies that sell

products that add value to the other
products
Strong complementors - Provide a increased
opportunity for creating value
Weak complementors - Slow industry growth
and limit profitability

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STRATEGIC GROUPS WITHIN

INDUSTRIES
Companies in an industry differ in the
way they strategically position products
in the market
Product positioning is determined by
the:
Product quality, distribution channels and
market segments served
Technological leadership and customer
service
Pricing and advertising policy
Promotions offered
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FIGURE 2.3 - STRATEGIC GROUPS

IN THE COMMERCIAL AEROSPACE
INDUSTRY

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15

IMPLICATIONS OF STRATEGIC
GROUPS
Since all companies in a strategic
group pursue a similar strategy:
Customers view them as direct substitutes
for each other
Immediate threat to a company are rivals
within its own strategic group

Different strategic groups have

different relationships to each of the
competitive forces

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16

MOBILITY BARRIERS
Within-industry factors that inhibit the
movement of companies between
strategic groups
Managers must:
Determine if it is cost-effective to overcome
mobility barriers
Realize that companies in other strategic
groups become their competitors if they
overcome mobility barriers

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FIGURE 2.4 - STAGES IN THE

INDUSTRY LIFE CYCLE

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18

EMBRYONIC INDUSTRY
Development stage
Growth is slow owing to:
Buyers unfamiliarity with the product and
poor distribution channels
High prices due to companies inability to
reap significant scale economies

Barriers to entry are based on access

to technological expertise

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19

GROWTH INDUSTRY
First-time demand expands rapidly due
to new customers in the market
Prices fall since:
Scale economies have been attained
Distribution channels have developed

Threat from potential competitors is

highest at this stage
Rivalry is low - Companies are able to
expand their revenues without taking market
share away from other companies
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20

INDUSTRY SHAKEOUT
Demand approaches saturation levels
There are fewer potential first-time buyers

Rivalry between companies intensifies

Price war results in bankruptcy of
inefficient companies and deters new
entry

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21

FIGURE 2.5 - GROWTH IN

DEMAND AND CAPACITY

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22

MATURE INDUSTRIES
Market is totally saturated, demand is
limited to replacement demand, and
growth is low or zero
Barriers to entry increase and threat of
entry from potential competitors
decreases
Industries consolidate and become
oligopolies
Companies try to avoid price wars
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23

DECLINING INDUSTRIES
Growth becomes negative due to:

Technological substitution
Social changes
Demographics
International competition

Rivalry among established companies

increases
Falling demand results in excess
capacity
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24

LIMITATIONS OF MODELS
FOR INDUSTRY ANALYSIS
Life-cycle issues
Industries do not always follow the pattern of
the industry life-cycle model
Time span of the stages vary from industry
to industry

Innovation
Punctuated equilibrium - Long periods of
equilibrium are punctuated by periods of
rapid change

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25

LIMITATIONS OF MODELS
FOR INDUSTRY ANALYSIS
Because competitive forces and strategic
group models are static, they cannot capture
periods of rapid change in the industry
environment when value is migrating

Company differences
Overemphasize importance of industry
structure as a determinant of company
performance
Underemphasize importance of variations
among companies within a strategic group

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FIGURE 2.6 - PUNCTUATED

EQUILIBRIUM AND COMPETITIVE
STRUCTURE

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FIGURE 2.7 - THE ROLE OF THE

MACROENVIRONMENT

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28

MACROECONOMIC FORCES

Growth rate of
the economy

Interest rates

Currency
exchange rates

Inflation or
deflation rates

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29

GLOBAL AND TECHNOLOGICAL

FORCES
Global forces - Falling barriers to
international trade have enabled:
Domestic markets enter to foreign markets
Foreign enterprises to enter the domestic
markets

Technological forces - Technological

change can:
Make products obsolete
Create a host of new product possibilities
Impact the height of the barrier to entry and
reshape industry structure
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DEMOGRAPHIC, SOCIAL, AND

POLITICAL FORCES
Demographic forces - Outcomes of
changes in the characteristics of a
population
Social forces - Way in which changing
social morals and values affect an
industry
Political and legal forces - Outcomes of
changes in laws and regulations

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