Chapter 4 Exploring the External Environment: Macro and Industry Dynamics

1. Chapter 4Exploring the External Environment: Macro and Industry Dynamics

2. OBJECTIVES 1 • Explain the importance of the external context for strategy and firm performance 2 • Use PESTEL to identify the macro characteristics of the external context 3 • Identify the major features of an industry and the forces that affect industry profitability 4 • Understand the dynamic characteristics of the external context 5 • Show how industry dynamics may redefine industries 6 • Use scenario planning to predict the future structure of the external context

3. THE COLA WARS • “Coca-Cola sells a billion servings – in cans, bottles, and glasses – every day. You can grab a Coke in almost 200 countries. Its archrival, Pepsi, isn’t too far behind. Like Ford versus Chevy, theirs is a battle not just for customer dollars, but for their hearts and minds as well. • – The History Channel, “Empires of industry. Cola Wars”

4. Coca-Cola • Pepsi • Coca-Cola invented • 1886 • 1950 • “Beat Coke” • 1960 • “Pepsi Generation” • 1970 • “Pepsi Challenge” • “Kick Pepsi's can” Diet CokeNew Coke • 1980 • Foster entrepreneurial spirit of Pepsi’s people • 1990 • Jettison slow-growing businesses • Repair Coke and restore Stock price Diversify product line • 2000 • Diversify beyond soft-drinks THE COLA WARS (TIMELINE)

5. Internal • Strengths • Weaknesses • Capabilities • Relationships • Etc. EXTERNAL CONTEXT OF STRATEGY External environment • An internal analysis is just half of what is needed to build strategy • The SWOT and more complicated frameworks help us understand the full picture

6. COMPARATIVE INDUSTRY – WIDE LEVEL OF PROFITABILITY, 1995 – 2004 Weighted average return on invested capital Percent • Bever-ages • Ciga-rettes • Pharma-ceuticals • Eatingesta-blish-ments • Steel • Rail-roads • Truck-ing • Bott-lers • Comp-uters • Agri-cul-turalproducts • Pre-packagedsoftware • Air-lines • Wire-lesspro-viders Source: Data from Standard and Poor’s CompuStat

7. THE EXTERNAL ENVIRONMENT OF THE ORGANIZATION • Macro Environment Political, Economic, Sociocultural, Technological, Environmental, Legal • Industry Environment • Strategic Group • The Organization

8. What is our firm’s industry? • What are the characteristics of the industry? • How stable are these characteristics? KEY QUESTION TO ASK • What macro environmental conditions will have a material effect on our ability to implement our strategy successfully?

9. UNDERSTANDING THE MACRO ENVIRONMENT USING A PESTEL ANALYSIS • How stable is the political environment? • Tax policies • Etc. • Political • Projected interest rates? • Inflation? • Etc. • Economic • Lifestyle trends? • Demographic changes? • Etc. • Socio-cultural • Level of government research funding? • How mature is technology? • Etc. • Technological • Is intellectual property protected? • Relevant consumer laws? • Etc. • Legal

10. Global customer needs • Learning and experience • Common technological standards • Global competitors • Global channels • Sourcing efficiencies • Common manufacturing and marketing regulations • Transferable marketing approaches • Favorable logistics • Arbitrage opportunities • High R&D costs PRESSURES FAVORING INDUSTRY GLOBALIZATION • Markets • Costs • Governments • Competition • Homogeneous customer needs • Large scale and scope economies • Favorable trade policies • Interdependent countries Source: Adapted from M.E. Porter, Competition in Global industries (Boston: Harvard Business School Press, 1986); G. Yip, “Global Strategy in a World of Nations, “ Sloan Management review 31:1 (1989), 29-40

11. Profits (abovenormal) • Competition • Profits (abovenormal) • Revenue • Costs • Revenue • Costs • Competition COMPETITION DRIVES PROFITS TO A “NORMAL” LEVEL

12. KEY SUCCESS FACTORS AS BARRIERS TO ENTRY • SOFT DRINK EXAMPLE • Key success factor (KSF) • KSFs: • Key asset or requisite skill that all firms in an industry must possess in order to be a viable competitor • Ability to meet competitive pricing • Extensive distribution • Ability to raise consumer awareness • Broad product mix • Global presence • Well positioned bottlers and bottling capacity

13. INDUSTRY FRAGMENTATION AND CONCENTRATION • Monopoly • Duopoly • Fragmented

14. CONCENTRATION IN SELECT U.S. INDUSTRIES • Others • Percent of market • Top four competitors • Entirefoodindustry • Animal food • Break-fastcereal • Dairy pro-ducts • Entireapparel industry • Men’s and boys’ apparel • Women’s and girls’ apparel Source: U.S. Census Bureau, “Economic Census: Concentration Rations”, Economic Census 2002 (accessed July 15,2005),www.census.gov/epcd/www/concentration.html

15. Degree of Rivalry • Exit barriers • Industry concentration • Fixed costs/value added • Industry growth • Intermittent overcapacity • Product differences • Switching costs • Brand identity • Diversity of rivals • Corporate stakes ANALYZING INDUSTRY STRUCTURE USING FIVE – FORCES Threat of New Entrants (and Entry Barriers) • Absolute cost advantages • Proprietary learning curve • Access to inputs • Government policy • Economies of scale • Capital requirements • Brand identity • Switching costs • Access to distribution • Expected retaliation • Proprietary products Complementors • Number of complements • Relative value added • Barriers to complement entry • Difficulty of engaging complements • Buyer perception of complements • Complement exclusivity Industry value chain – from raw materials and other inputs, to channel to end consumer Buyer Power (Channel and End consumer) • Bargaining leverage • Buyer volume • Buyer information • Brand identity • Price sensitivity • Threat of backward integration • Product differentiation • Buyer concentration vs. industry • Substitutes available • Buyer’s incentives Supplier Power • Supplier concentration • Importance of volume to supplier • Differentiation of inputs • Impact of inputs on cost or differentiation • Switching costs of firms in the industry • Presence of substitute inputs • Threat of forward integration • Cost relative to total purchases in industry • Threat of Substitutes • Switching costs • Buyer inclination to substitute • Price-performance tradeoff of substitutes • Varity of substitutes • Necessity of product or service Source: Adapted from M.E. Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors (New York: Free Press, 1980)

16. THREAT OF NEW ENTRANTS (and Entry Barriers) • Absolute cost advantages • Proprietary learning curve • Access to inputs • Government policy • Economies of scale • Capital requirements • Brand identity • Switching costs • Access to distribution • Expected retaliation • Proprietary products

17. RIVALRY • Exit barriers • Industry concentration • Fixed costs/value added • Industry growth • Intermittent overcapacity • Product differences • Switching costs • Brand identity • Diversity of rivals • Corporate stakes

18. SUBSTITUTES • Switching costs • Buyer inclination to substitute • Price-performance tradeoff of substitutes • Varity of substitutes • Necessity of product or service

19. BUYER POWER (Channel and End consumer) • Bargaining leverage • Buyer volume • Buyer information • Brand identity • Price sensitivity • Threat of backward integration • Product differentiation • Buyer concentration vs. industry • Substitutes available • Buyer’s incentives

20. SUPPLIER POWER • Supplier concentration • Importance of volume to supplier • Differentiation of inputs • Impact of inputs on cost or differentiation • Switching costs of firms in the industry • Presence of substitute inputs • Threat of forward integration • Cost relative to total purchases in industry

21. Three Examples Hot dogs + More sales Buns Music + More attractive offering MP3 player Delta plane orders + Lower costs from Boeing American Airlinesplane orders IMPACT OF COMPLEMENTOR Complementor: Any factor that makes it more attractive for suppliers to supply an industry on favorable terms or that makes it more attractive for buyers to purchase products or services from an industry at prices higher than it would pay absent the complementor • Number of complements • Relative value added • Barriers to complement entry • Difficulty of engaging complements • Buyer perception of complements • Complement exclusivity

22. MAPPING STRATEGY GROUPS: U.S. BICYCLE INDUSTRY • High • Cannondale, GaryFisher, Klein • Huffy,Murray,Brunswick • Price/quality/image • Schwinn/GTMongoose • TrekSpecialized • Low • Independentdealers • Independentdealers and massmerchandisers • Massmerchandisersonly • Principal distribution channels

23. Newentrants? Buyerpower? How would youdefine the industry? Supplierpower? Rivalry? Complementors? Substitutes? HOW WOULD YOU DO THAT? – U.S. AIRLINE INDUSTRY

24. Pineapple industry post introduction Fresh Del-Monte introduces the “Extra Sweet Gold” brighter color, sweeter, resistant to nothing FreshDel-Monte (70%) IMPORTANCE OF DYNAMIC STRATEGIC ANALYSIS Pineapple industrypre-1980s

25. Niche market – selected products for selected markets Market expands beyond niche Proliferation of products and markets served Product/market contraction Participants emphasize problem solving – product as “solution” More competitors enter Market volatility and beginnings of industry consolidation Further consolidation and industry regeneration Technological uncertainty Customers become better informed Aggressive customers INDUSTRY LIFE CYCLE Market Size Time Embryonic Growing Mature In Decline Source: Adapted from K. Rangan and G. Bowman, “Beating the Commodity Magnet,” Industrial Marketing Management 21 (1992), 215-224; P. Kotler, “Managing Products through their Product Life Cycle,” in Marketing Management: Planning, Implementation, and Control, 7th ed (Upper Saddle River, NJ: Prentice Hall, 1991)

26. Product-related Discontinuities Process-related TECHNOLOGICAL DISCONTINUITIES Example In disk-drive industry, virtually every new generation of technology led to demise of market leader Southwest airlines radically changed the airline business model by adopting new processes (e.g., a point-to-point model)

27. Radio Launches palm pilot/ creates first PDA Cable Invents new interface Media conglomerate TV Production Modems • Time Warner • Viacom • Disney • Etc. TV networks WHEN INDUSTRIES DIVIDE OR COLLIDE Industries Collide Industries Divide 3-Com Modems

28. SCENARIO PLANNING • An understanding of the big picture and a plan to manage uncertainty 6 • Assess the strategic implications of each scenario 5 • Specify indicators that can signal which scenario is unfolding 4 • Flesh out the picture 3 • Develop the framework by defining two specific axes 2 • Brainstorm key drivers, decision factors, and possible scenario departure or divergence points 1 • Define target issue, time frame, and scope for scenarios

29. Credit-Union Power 2005: • Wallet Wars 2005: • Both technology and the playing field have changed at a moderate pace, making this the most stable scenario. Even with moderate change in these areas, however, the changing basis of competition, new business models, human resource challenges, and industry dynamics are different enough to pose significant challenges for many financial-services companies • Prompted by free-market economics, the playing field is changing radically, enabling credit unions and other financial-services institutions to compete more intensely. At the same time, technical innovations have not developed as quickly as many observers and analysts had predicted • Technocracy 2005: • Chameleon 2005: • The wide-scale adoption of the internet by U.S. consumers has led to massive technological innovation for financial-services companies, increasing their range of distribution channels, as well as their products, services, and geographic scope. Regulations and other changes in the playing field, however, have been slow to follow • Radical changes occurring in the playing field and in technology make this a highly tumultuous scenario for all credit unions. The nature of competition has evolved so much that banks and credit unions compete directly – under the same rules of the game. This situation has caused a wide-scale convergence of cultures among various financial-services providers, testing the boundaries of the traditional credit-union mission HOW WOULD YOU DO THAT? – CREDIT – UNION INDUSTRY • Changes in the playing field • Minor • Major • Gradual • Technological Change • Radical Source: Adapted from Credit Union Society, 2005: Scenarios for Credit Unions, an Executive Report (Madison, WI: Credit Union Executives Society, 1999)

30. SUMMARY 1 • Explain the importance of the external context for strategy and firm performance 2 • Use PESTEL to identify the macro characteristics of the external context 3 • Identify the major features of an industry and the forces that affect industry profitability 4 • Understand the dynamic characteristics of the external context 5 • Show how industry dynamics may redefine industries 6 • Use scenario planning to predict the future structure of the external context

31. GROUP ACTIVITIES • 1. Perform a five forces analysis for an industry with which you are familiar. Identify any strategic groups. Examine how the forces in the industry might evolve over time in response to strategies, events, and PESTEL trends. • 2. Undertake a simple scenario analysis for your industry utilizing 2 or more possible futures.