Evaluating a Firm’s External Environment

1. Evaluating a Firm’s External Environment

2. Why External Analysis? External analysis allows firms to: • discover threats and opportunities • see if above normal profits are likely in an industry • better understand the nature of competition in an industry • make more informed strategic choices

3. The Environment – Outline • Macroenvironment • PESTEL • Sources of competition • 5-forces • Strategic gaps • Opportunities • Threats

4. Layers of the business environment

5. Macroenvironment – PESTEL (1)

6. Macroenvironment – PESTEL (2) • Political • Government stability • Taxation policy • Foreign trade regulations • Social welfare policies • Economic • Business cycles • GNP trends • Interest rates • Money supply • Inflation • Unemployment • Disposable income

7. Macroenvironment – PESTEL (3) • Sociocultural • Population demographics • Income distribution • Social mobility • Lifestyle changes • Attitudes to work and leisure • Consumerism • Levels of education • Technological • Government spending on research • Government and industry focus on technological effort • New discoveries /developments • Speed of technology transfer • Rates of obsolescence

8. Macroenvironment – PESTEL (4) • Environmental • Environmental protection laws • Waste disposal • Energy consumption • Legal • Competition law • Employment law • Health and safety • Product safety

9. Industry Analysis The Structure – Conduct – Performance Model • originally developed to spot anti-competitive conditions for anti-trust purposes • came to be used to assess the possibilities for above normal profits for firms within an industry • Porter’s Five Forces Model was developed from this economic tradition

10. The Structure-Conduct-Performance Model

11. Focal Firm Industry Analysis Porter’s Five Forces Model Entry Industry Rivalry Buyers Threat Substitutes Suppliers Lower Average Profits Higher Threat

12. Porter’s Five Forces Model Threat of Entry • if firms can easily enter the industry, any above normal profits will be bid away quickly • barriers to entry lower the threat of entry • barriers to entry make an industry more attractive • this is true whether the focal firm is already in the industry or thinking about entering

13. Porter’s Five Forces Model Threat of Entry Barriers to Entry: • economies of scale—firm that can’t produce the minimum efficient scale will be at a disadvantage • product differentiation—entrants are forced to overcome customer loyalties to existing products • cost advantages independent of scale—incumbents may have learning advantages, etc. • government policies—governments may impose trade restrictions and/or grant monopolies

14. Economies of Scale and the Cost of Production

15. Porter’s Five Forces Model Threat of Rivalry • high rivalry means firms compete vigorously—and compete away above average profits Industry conditions that facilitate rivalry: • large numbers of competitors • slow or declining growth • high fixed costs and/or high storage costs • low product differentiation • industry capacity added in large increments

16. Porter’s Five Forces Model Threat of Substitutes • substitutes fill the same need but in a different way - Coke and Pepsi are rivals, milk is a substitute for both • substitutes create a price ceiling because consumers switch to the substitute if prices rise • substitutes will likely come from outside the industry—be sure to look

17. Porter’s Five Forces Model Threat of Powerful Suppliers • powerful suppliers can ‘squeeze’ (lower profits) the focal firm Industry conditions that facilitate supplier power: • small number of firms in supplier’s industry • highly differentiated product • lack of close substitutes for suppliers’ products • supplier could integrate forward • focal firm is an insignificant customer of supplier

18. Porter’s Five Forces Model Threat of Powerful Buyers • powerful buyers can ‘squeeze’ (lower profits) the focal firm by demanding lower prices and/or higher levels of quality and service Industry conditions that facilitate buyer power: • small number of buyers for focal firm’s output • lack of a differentiated product • the product is significant to the buyer

19. Porter’s Five Forces Model Threat of Powerful Buyers Industry conditions that facilitate buyer power: • buyers operate in a competitive market—they are not earning above normal profits • buyers can vertically integrate backwards • many small buyers can be united around an issue to act as a block Example: Michelin, Monsanto

20. Focal Firm Porter’s Five Forces Model Entry Industry Rivalry Buyers Threat Substitutes Suppliers expect normal profits If all threats are high expect above normal profits If all threats are low Most industries are somewhere between the extremes

21. Complementors As Another Force Complementors Increase the Value of the Focal Firms Product • customers perceive more value in the focal firm’s product when it is combined with the complementor’s product • complementors may be found outside the focal firm’s industry Example: Nokia and Microsoft

22. Responding to Environmental Threats Neutralizing Threats • most firms cannot unilaterally change the threats in an industry • by altering relationships in an industry, firms may reduce threats and/or create opportunities, thereby increasing profits Examples: Reducing dependence on suppliers or buyers: Scania

23. Exploiting Industry Structure Opportunities Generic Industry Structures • at any point in time, the structure of most industries fits into one of four generic categories • each industry structure presents opportunities that may be exploited • firms can choose to exploit an industry structure, continue business as usual, or exit the industry

24. Exploiting Industry Structure Opportunities Fragmented Industry Structure Opportunity Industry Characteristics Consolidation • large number of small firms • buy competitors • no dominant firms • build market power • no dominant technology • exploit economies of scale • commodity type products • low barriers to entry • few, if any, economies of scale

25. Exploiting Industry Structure Opportunities Emerging Industry Structure Opportunity Industry Characteristics • new industry based on break through technology or product • first mover advantages • technology • no product standard has been reached • locking-up assets • creating switching costs • no dominant firm has emerged • new customers come from non- consumption not from competitors

26. Exploiting Industry Structure Opportunities Mature Industry Structure Opportunities Industry Characteristics • refine current products • slowing growth in demand • technology standard exists • improve service • increasing international competition • process innovation • industry-wide profits declining • industry exit is beginning

27. Exploiting Industry Structure Opportunities Declining Industry Structure Opportunities Industry Characteristics • industry sales have sustained pattern of decline • market leadership • niche • some well-established firms have exited • harvest • firms have stopped investing in maintenance • divest

28. Focal Firm General External Environment Technological Change Specific International Events Demographic Trends Entry Complementors Rivalry Industry Buyers Substitutes Legal/Political Conditions Cultural Trends Suppliers Economic Climate

29. Summary External Analysis: • takes time and effort • should include consideration of international markets • helps firms recognize threats and opportunities • provides assessment of likely levels of industry profitability (normal, above, below) • can be applied at the individual level to professional and personal environments