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Evaluating a Firm’s External Environment. Learning Objectives

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evaluating a firm s external environment

Evaluating a Firm’sExternal Environment

Learning Objectives

Understand the importance of environmental analysis, dimensions of the external environment, what determines profitability in an industry, the Structure – Conduct – Performance model, and opportunities based on type of industry structure

the structure conduct performance model
The Structure – Conduct – Performance Model
  • Origin: 1930s, to spot anti-competitive conditions
  • Can be used to assess potential for above-normal profits in an industry
  • Porter’s Five-Forces model developed from this tradition
the structure conduct performance model1
The Structure – Conduct – Performance Model

Number of competing firms, homogeneity of products, cost of entry and exit

Industry Structure

Price taking, cost cutting, product differentiation, tacit collusion, exploit market power

FirmConduct

Firm: above, normal, belowSociety: social welfare implications

Performance

type of industry perfect competition
Type of Industry = Perfect Competition

Large number of firms, homogeneous products,low cost of entry and exit

Industry Structure

Price taking

FirmConduct

Firm: normalSocial welfare: maximized

Performance

Industry Examples ?

type of industry monopolistic competition
Type of Industry = Monopolistic Competition

Large number of firms,heterogeneous products,low cost of entry and exit

Industry Structure

Cost leadership,Product differentiation

FirmConduct

Firm: above normalSocial welfare: less than perfect competition

Performance

Industry Examples ?

type of industry oligopoly
Type of Industry = Oligopoly

Small number of firms,costly entry and exit

Industry Structure

FirmConduct

Many options, including collusion

Firm: above normalSocial welfare: less than monopolistic competition

Performance

Industry Examples ?

type of industry monopoly
Type of Industry = Monopoly

Only one competing firm,costly entry

Industry Structure

FirmConduct

Uses market power to set prices

Firm: above normalSocial welfare: less than oligopoly

Performance

Industry Examples ?

five forces model of environmental threats
Five Forces Model of Environmental Threats

What’s the profit potential of the industry ?

five forces model threat of entry
Five Forces ModelThreat of Entry
  • Economies of scale
  • Product differentiation
  • Cost advantages independent of size

(Technology, know-how, access to raw materials, geographic locations, learning curve)

  • Government policy
  • Access to distribution channels *
  • Capital requirements *
  • Switching costs *

* Some disagreement among scholars

five forces model threat of rivalry
Five Forces Model Threat of Rivalry
  • Many competitors
  • Similar in size
  • Slow rate of industry growth
  • Product lacks differentiation
  • Capacity added in large increments
  • High level of fixed costs
  • Exit barriers are high
  • Reputation or past history
five forces model threat of substitute products
Five Forces Model Threat of Substitute Products
  • Products that appear to be different but satisfy the same need
  • Customer switching costs are low
  • Substitutes often come from outside the industry
    • good examples butter vs. margarine

calculators vs. slide rules

tape b/u vs. CD burner

    • bad examples Coke vs. Pepsi

Honda vs. Toyota

porter s five forces model threat of suppliers
Porter’s Five Forces Model Threat of Suppliers
  • Supplier has few competitors
  • Supplier offers a unique product
  • Substitutes not readily available
  • Supplier can integrate forward
  • Firm or industry purchases represent small share of supplier’s total sales
five forces model threat of buyers
Five Forces Model Threat of Buyers
  • Small number of buyers
  • Purchase products that are standard or undifferentiated
  • Industry products represent a large share of buyer’s total cost
  • Unimportant to final quality of product
  • Product does not save the buyer money
  • Buyer may integrate backward
types of industry structure
Fragmented

Emerging

Mature

Declining

International

Network

Hypercompetitive

Empty-core

Identified by M. Porter

Added by J. Barney

Types of Industry Structure

What is the structure of your firm’s industry ?

industry structure and environmental opportunities
Industry structure

Fragmented

Emerging

Mature

Declining

Opportunities

Consolidation

First-mover

Product refinement, service, process innovation

Leadership, niche, harvest, disinvestment

Industry Structure andEnvironmental Opportunities

Examples of industry structure ?

opportunities in fragmented industries
Opportunities in Fragmented Industries

Definition: …many small or medium-sized firms with no dominant technology or market share…

Industry examples: retailing, service, restaurant

Strategic opportunities: new economies of scale or governance mechanisms through consolidation

Practical examples: SCI funeral homes, KOA campgrounds,La Quinta motels

What causes industries to be fragmented ?

opportunities in emerging industries
Opportunities in Emerging Industries

Definition: …industry formed by changes in technology, demand, customer needs …

Industry examples: microprocessor, PC, medical imaging, biotechnology

Strategic opportunities: first-mover advantages from technological leadership, preemption of strategically valuable assets, customer-switching costs

Practical examples: Xerox, Wal-Mart, Microsoft

When can a firm expect first-mover advantages ?

opportunities in mature industries
Opportunities in Mature Industries

Definition: …slowing growth rate, experienced customers, limited growth in production capacity and new products, increase in international competition…

Industry examples: auto manufacturing, fast food, gaming (US)

Strategic opportunities: refining current products, emphasis on service, process innovation

Practical examples: Ford, GM, McDonalds, Starbucks

Strategies of firms in mature industries that fit these strategic opportunities ?

opportunities in declining industries
Opportunities in Declining Industries

Definition: …absolute decline in unit sales…

Industry examples: AM/FM broadcast radio, electronic vacuum tubes, hand-held calculators

Strategic opportunities: market leadership, niche strategy, harvest, divestment

Practical examples: GTE Sylvania, GE

How can market leader foster opportunities in a declining industry ?

opportunities in international industries
Opportunities in International Industries

Definition: …sales volume and growth comes from two or more independent countries…

Industry examples: many; most businesses assume international competition will be the norm in the 21st century

Strategic opportunities:

Multinational – independent operations

Global – seek to optimize (centralize) business functions

Transnational – hybrid of multinational and global

What are the pros and cons of these strategic opportunities ?

How are your firms addressing international opportunities ?

opportunities in network industries
Opportunities in Network Industries

Definition: …industry where value of product or service depends on number of total items sold…”increasing returns industry”…

Industry examples: telephone, fax, VCRs

Strategic opportunities: first-mover, winner take all

Practical examples: VHS vs. Beta, HDDVD vs. Blue Ray

Does the “best” technology win ?

Other examples of network industries ?

opportunities in hypercompetitive industries
Opportunities in Hypercompetitive Industries

Definition: …industry competition is unstable, unpredictable and/or constantly evolving…

Industry examples: biotechnology, music download, Internet TV

Strategic opportunities: flexibility, proactive disruption

Attributes of successful proactive disruption: satisfy current stakeholders, anticipate customer needs, act quickly with surprise, change the bases of competition, invest in multiple efforts or a sequence of activities

Examples of firms following proactive disruption ?

opportunities in empty core industries
Opportunities in Empty-core Industries

Definition: …bases of competition may be stable, but industry conditions make it difficult to earn profit…buyers are shopping and sellers are selling, but transactions may not take place…

Industry examples: industries with high fixed costs, low variable costs – airlines: “fixed costs with wings”

Strategic opportunities: collusion, government regulation, product differentiation, better demand prediction.

How have airlines addressed these industry forces ?

What can we expect from deregulation of the electric utility industry?