Chapter Four: The External Environment

• “It is not the strongest species that survive, nor the most
intelligent, but the one most responsive to change’’ Charles
Darwin
4.1) External Environmental Analysis
• External environmental analysis enables the firm’s managers to
interpret information & identify opportunities & threats
• An opportunity is a condition in the general environment that
may help a company to achieve strategic competitiveness
• A threat is a condition in the general environment that may
hinder a company’s efforts to achieve strategic competitiveness
Sources of information
• Several sources can be used to analyze the external environment :
• Trade publications, news papers, business publications, the
results of academic research
• Trade shows, suppliers, customers & employees
• External network contacts: salespersons, purchasing
managers, public relations officers, & customer service
representatives 1
Analytical Tools of Environmental Analysis
Includes: Scanning, monitoring, forecasting, and assessing
Scanning
• Identifying early signals of environmental changes and trends
• During scanning, the firm often deal with ambiguous, incomplete, or unconnected
data & information
• Scanning techniques that are used for volatile environment is inappropriate for a
firm in a stable environment
• For example, the early retirement trend & aging population will be a challenge to
those advanced countries - governments offer state-funded pensions to their
elderly populations
Monitoring
• Detecting meaning through ongoing observations of environmental changes &
trends among those spotted by scanning
• By monitoring trends, firms can be prepared to introduce goods & services at the
appropriate time to take advantage of the opportunities these trends provide
• Scanning & monitoring are important when a firm competes in an industry with
high technological uncertainty
• Scanning & monitoring can provide the firm with information & serve as a means
of importing new knowledge about markets & how to successfully commercialize
new technologies
• For example, the size of the middle class of African American continues to grow
in the United States 2
Forecasting
•Developing projections of anticipated outcomes based on monitored
changes & trends
•When forecasting, analysts develop:
• feasible projections of what might happen & how quickly, as a
result of the changes & trends detected through scanning &
monitoring
•Example, analysts might forecast how much time will elapse before
changes in government taxation policies affect consumers' purchasing
patterns
Assessing
• Determining the timing & importance of environmental changes &
trends for firms’ strategies & their management
• The intent of assessment is to specify implications for the
organization
• Without assessment, the firm is left with data that may be
interesting but are of unknown competitive relevance

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• For example,
– Previously, American cars dominate the US market
– In recent years, however, the appeal of foreign cars has
increased
– Foreign cars slowly infiltrated the market & consumers began
to perceive foreign products as superior in design & quality
– As a result, American car manufacturers’ share fell
significantly
– Accordingly, in 2001, the US firms' offered vehicles at 0%
interest on loans to increase sales levels – without this action,
high volume sales were unlikely to persist
• Thus, firms must assess the reasons for sales relative to
competitors to be able to accurately forecast future sales

The Process of Performing an External Analysis

• Gather relevant information
• Identify the most important opportunities and threats
• Rank them from the most important to the least important
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The external environmental analysis
consists of:
• The General Environment (General
Analysis)
• The Industry Environment (Industry
Analysis)
• The Competitor Environment (Competitor
Analysis)

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 4.2) The General Environmental Analysis
• Analysis of the general environment is focused on its
future impacts on firm’s performance
• In this respect, the awareness & understanding of an
increasingly turbulent, complex & global general
environment is critical
• Indeed, firms cannot directly control the segments of the
general environment
• However, successful companies gather the information
required to understand each segment & its implications
on the firm’s strategies
• This is because the general environment influences the
firm’s strategic options & the decisions made in light of
this
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 Key Economic Variables

• Availability of credit • Import/Export factors

• Level of disposable • Demand shifts
income • Price fluctuations
• Interest rates • Fiscal policies
• Inflation rates • Tax rates
• Federal Government • European Economic
budget deficits Community (EEC)
• Unemployment trends policies
• Consumption patterns • Organisation of
• Value of the dollar in Petroleum Exporting
world markets Countries (OPEC)
• Stock market trends policies

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 Key Social, Cultural, Demographic & Environmental
Variables

• Childbearing rates • Attitudes towards leisure

• Number of births/ deaths time
• Immigration and • Pollution control
immigration rates • Population changes
• Lifestyles • Regional changes in
• Attitudes towards tastes and preferences
business • Waste management
• Trust in Government • Recycling
• Average level of • Air pollution
Education

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 Some Political, Governmental & Legal Variables

• Tax laws • Import/Export

• Environmental regulations
protection laws • Fiscal and
• Level of government monetary policies
subsidies • Lobbying activities
• Antitrust legislation • Size of Government
• Terrorist activities budget
• Local, state and
national elections
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 Some Global Variables
• Relevant new global markets & relevant existing markets that are changing
• International political events
• Critical cultural & institutional characteristics of global markets
• Globalization of business markets creates both opportunities & challenges
• For example,
•
China presents both opportunities in reducing trade barriers
•
Toyota receives 50% of its total revenue from outside Japan
•
Over 60% of McDonald’s revenues are from outside the U.S.A
•
Almost 98% of Nokia’s revenues are from outside of its home
country
• Cultural differences of countries: Japan (group harmony & social
cohesion), Korea (respect hierarchical r/ships & obedience to
authority), China (personal r/ships or good connections) etc.
• Therefore, firms should identify, analyze & enter valuable new global
markets

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4.3) Industry Environmental Analysis
• Analysis of the industry environment is focused on
the factors & conditions influencing the firm’s
profitability in the industry
• Definition
• An industry is a group of firms producing products
that are close substitutes
• Firms that influence one another
• Includes a rich mix of competitive strategies
that companies use in pursuing strategic
competitiveness & above-average returns
• Compared to the general environment, the industry
environment has a more direct effect on the firm’s
strategic competitiveness and above-average
returns
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The Five Forces Model of Competition

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 Threat of New Entrants

• Barriers to entry
•Economies of scale
•Product differentiation
•Capital requirements
•Switching costs
•Access to distribution channels
•Government policy
•Expected retaliation/make an attack in return for a similar attack.
Economies of scale
• Marginal improvements in efficiency that a firm experiences as it
incrementally increases in size
• Advantages and disadvantages of large-scale and small-scale
entry

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 Barriers to Entry
Product differentiation
• Unique products, customer loyalty, products at competitive prices
Capital requirements
• Physical facilities, inventories, marketing activities, availability of capital
Switching costs
• One-time costs customers incur when they buy from a different supplier
• New equipment
• Retraining employees
• Psychic costs of ending a relationship
Access to distribution channels
• Stocking or shelf space
• Price breaks
• Cooperative advertising allowances
Government policy
• Licensing and permit requirements
• Deregulation of industries
Expected retaliation
• Responses by existing competitors 15
 Bargaining Power of Suppliers
• Supplier power increases when:
• Suppliers are large and few in number
• Suitable substitute products are not available
• Individual buyers are not large customers of suppliers and there are
many buyers
• Suppliers’ goods are critical to buyers’ marketplace success
• Suppliers’ products create high switching costs
• Suppliers pose a threat to integrate forward into buyers’ industry
Bargaining Power of Buyers
• Buyer power increases when:
• Buyers are large and few in number
• Buyers purchase a large portion of an industry’s total output
• Buyers’ purchases are a significant portion of a supplier’s annual
revenues
• Buyers can switch to another product without incurring high switching
costs
• Buyers pose threat to integrate backward into the sellers’ industry 16
 Threat of Substitute Products
• The threat of substitute products increases when:
• Buyers face few switching costs
• The substitute product’s price is lower
• Substitute product’s quality and performance are equal to or greater
than the existing product
• Differentiated industry products that are valued by customers reduce
this threat
Intensity of Rivalry Among Competitors
• Industry rivalry increases when:
• There are numerous or equally balanced competitors
• Industry growth slows or declines
• There are high fixed costs or high storage costs
• There is a lack of differentiation opportunities or low switching costs
• When the strategic stakes/risks are high
• When high exit barriers prevent competitors from leaving the industry
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 Interpreting Industry Analyses

Low entry barriers

Suppliers & buyers

have strong positions
Unattractive
Strong threats from industry
substitute products

Intense rivalry among

competitors
Low profit
potential

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 Interpreting Industry Analyses

High entry barriers

Suppliers & buyers

have weak positions
Attractive
Few threats from industry
substitute products

Moderate rivalry among

competitors High profit
potential

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4.4) Strategic Groups and Competitor Analysis

• Strategic Groups
• Definition
• A group of firms in an industry following the same or a similar
strategy along the same strategic dimensions
• Internal competition between strategic group firms is greater
than between firms outside that strategic group
• There is more heterogeneity in the performance of firms within
strategic groups
• Strategic Dimensions
• Extent of technological leadership
• Product quality
• Pricing policies
• Distribution channels
• Customer service

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 Competitor Analysis
• Analysis of competitors is focused on predicting the dynamics of
competitors' actions, responses & intentions
• Competitor intelligence
• The ethical gathering of needed information and data that
provides insight into the competitor’s:
•Future objectives
–What drives the competitor?
•Current strategy
–What the competitor is doing and can do
•Assumptions
–What the competitor believes about its own firm and
the industry
•Capabilities
–Competitor firm’s capabilities, strengths and
weaknesses

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Competitor analysis components

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 Summary
1. The external environment consists of three main parts:
• The general (remote, mega, macro) environment – elements in
the broader society that affected industries & their firms
• The industry (immediate, micro) environment – factors that
influence a firm, its competitive actions & responses, as well as
the industry's profit potential
• The competitor environment – refers to the analysis that the firm
undertakes concerning each major competitor’s future
objectives, current strategies, assumptions, and capabilities
2. The external environmental analysis process has four steps:
scanning, monitoring, forecasting, & assessing
3. The general environment has six segments: demographic,
economic, political/legal, social-cultural, technological & global
4. The main objective of analyzing the industry environment is to
increase firm’s ability to earn above-average returns

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