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Chapter 2
Analyzing the External Environment of the Firm: Creating
Competitive Advantages............................................................. 36 (2-2)
Creating the Environmentally Aware Organization............................... 38 (2-3)
The Role of Scanning, Monitoring, Competitive Intelligence,
and Forecasting................................................................................................... 39 (2-4)
SWOT Analysis................................................................................................................. 42 (2-9)
The General Environment......................................................................... 43 (2-9)
The Demographic Segment.............................................................................................. 45 (2-10)
The Sociocultural Segment.............................................................................................. 45 (2-11)
The Political/Legal Segment............................................................................................ 47 (2-12)
The Technological Segment............................................................................................. 48 (2-12)
The Economic Segment.................................................................................................... 49 (2-13)
The Global Segment......................................................................................................... 49 (2-14)
Relationships among Elements of the General Environment........................................... 49 (2-14)
The Competitive Environment.................................................................. 52 (2-16)
Porter’s Five Forces Model of Industry Competition...................................................... 52 (2-16)
How the Internet and Digital Technologies
Are Affecting the Five Competitive Forces.......................................................... 58 (2-19)
Using Industry Analysis: A Few Caveats......................................................................... 61 (2-23)
Strategic Groups within Industries.................................................................................. 64 (2-24)
Issue for Debate 67 (2-26)
Reflecting on Career Implications 68 (2-27)
Summary 68 (2-28)
Chapter 2
Analyzing the External Environment of the Firm:
Creating Competitive Advantages
Summary/Objectives
The purpose of this chapter is to familiarize students with techniques for evaluating a
firm’s external environment. This chapter focuses on the value managers add when they have a
sense of events outside the company. By focusing on external events, managers are able to stay a
step ahead of competitors by accurately anticipating and promptly responding to actions that can
impact the organization. The chapter is organized into three sections.
1. The environmentally aware organization. Emphasize that managers use scanning,
monitoring, and competitive intelligence to develop forecasts. Also, the role of
scenario planning is discussed.
2. The influence of the six broad segments (demographic, sociocultural, political/legal,
technological, economic, global) of the general environment of the firm.
3. The role of the competitive (also called the task or industry) environment and its
analysis through the application of Porter’s five-forces model. We address how
industry and competitive practices are being affected by the Internet and digital
technologies. We also address the concept of strategic groups. Managers use strategic
groups to identify who its main competitors are and how a company fits in with the
overall industry in which it competes.
Lecture/Discussion Outline
We lead off the chapter with the opening case of Cell Zone in LEARNING FROM
MISTAKES. Here’s a firm that clearly did a poor job of recognizing and understanding the
opportunity and threats in the external environment. Ask:
Discussion Question 1: What is the biggest stumbling block for Cell Zone?
Response guidelines: Students should understand that there are a few links in the chain of events
that prevent Cell Zone’s success. Most obviously, there is the issue of low demand for the
product. Few restaurants and libraries are willing to pay Cell Zone, or otherwise devote space,
Discussion Question 2: Are there other market segments where Cell Zone might work?
Response guidelines: Students may come up with a few intriguing suggestions. After they do,
instructors may want to develop characteristics of the market segments. Some characteristics
may be:
Situations where calls contain confidential information that should not be overheard, such
Places where the atmosphere requires quiet, such as libraries, lecture halls, or concert
These two characteristics suggest segments such as law firms, prisons, government offices,
I. Creating the Environmentally Aware Organization
We address three important processes—scanning, monitoring, and gathering competitive
intelligence—which managers use to develop environmental forecasts. EXHIBIT 2.1 depicts
We lead off the section with a discussion of Ram Charan’s concept of “perceptual
acuity”—the ability to sense what is coming before the fog clears. We give three examples of
Teaching Tip: Most students in your class will not likely be CEOs or top executives. So,
one way to help them apply this idea is to ask them how they could apply it in their present
position—or in a job to which they immediately aspire. Hopefully, they will come up with ideas
A. The Role of Scanning, Monitoring, Competitive Intelligence, and Forecasting
1. Environmental Scanning
Environmental scanning involves surveillance of the firm’s external environment to
predict environmental changes to come and detect changes that are already underway. We discuss
Discussion Question 3: Would these “tips” be equally appropriate for all industries?
Why? Why not?
Discussion Question 4: Could such an approach be used in other industries? What
investments would be required?
Environmental scanning can also involve obtaining information from your customer base.
Extra Example: Ask your Customers for Ideas
Coastal Contacts, one of the largest online contact-lens retailers in North America, came out of its two-day planning
session with few ideas about how to spur growth. Thus, over the next six months CEO Roger Hardy and his senior
team called customers each week to see whether they had any ideas. To the company’s surprise, one recurring theme
emerged—customers wanted to get their lenses the next day. “We started overnighting everything,” he reports. Sales
in the U.S., where he recently made the change, were up 41 percent for the year, bringing company sales to $155
million.
Source: Harnish, V. 2011. Five ways to get your strategy right. Fortune. April 11: 42.
Discussion Question 5: What are some other examples of firms that got excellent ideas
by simply asking their customers for input?
2. Environmental Monitoring
Environmental monitoring tracks the evolution of trends, events, or streams of activities
in the external environment. In this section, we present some of the factors monitored by three
The SUPPLEMENT below represents the factors that the Director of Planning of Vought
Aircraft considered critical. You may initially ask the students:
Discussion Question 6: What indicators do you believe a firm should monitor that
produces both (1) weapon systems for the military, and, (2) key components for the
commercial aircraft industry?
Extra Example: Factors to Monitor—Vought Aircraft
Commercial Aircraft:
1. Oil prices
2. Age of fleet of airlines
3. Profitability of airlines
Defense Department:
1. Where weapons are in the life cycle
2. Mission requirements of the military
Source: Authors’ interviews.
The SUPPLEMENT below discusses how Cisco, the $47 billion (2014 revenues)
networking giant, learned from its mistakes during the Internet bust in 2001—and now carefully
Extra Example: How Cisco Learned from Its Mistakes
In April, 2001, Cisco made one of the more painful confessions of the Internet bust: It had so much networking gear
piled up that it had to take a $2.5 billion write-off for equipment that it figured nobody would ever buy. It has been
working hard ever since to make sure that such a thing never happens again.
Supply chain chief Angel Mendez is grilled at monthly reviews by CEO John Chambers and other top executives.
Now, Cisco has half the inventory it did in 2001—even though its revenues are twice as large. Says Mendez: “It
didn’t take John eight years to start asking questions (about inventory levels). He asks about every eight minutes.”
Source: Burrows, P. 2009. Tech: Lean and Ready to Spring. BusinessWeek.
April 27: 14-16.
Discussion Question 7: Are you aware of other firms that have failed to effectively
monitor key aspects of their internal environment (e.g., excessive numbers of employees
The SUPPLEMENT below discusses why Caterpillar may serve as a macroeconomic
early-warning system.
Extra Example: Caterpillar—A Macroeconomic Early-Warning System?
Although it is hard to confuse a 40-ton excavator with a crystal ball, forecasters could do worse than tracking retail
sales of the huge, yellow machines sold by Caterpillar Inc. Being the largest seller of equipment used to build stuff
or extract the stuff from the ground used to build that stuff, Caterpillar’s customers’ appetite is sort of a
macroeconomic early-warning system.
Two big worries—the slowdown in China’s property market and a related slump in demand for commodities from
crude oil to iron ore—show up quickly in its monthly sales reports, helpfully broken down by region and type of
machinery.
2014 has, not surprisingly, been a tough year for the firm’s shareholders. Its stock price trailed the S&P 500 by 31
percent.
Source: Jakab, S. 2015. Caterpillar is stuck in its cocoon. Wall Street Journal. April 23: C1.
3. Competitive Intelligence
Competitive intelligence helps firms define and understand their industry and identify
We briefly address the importance of competitive intelligence to firms in the banking,
Discussion Question 8: What are other industries where competitive intelligence is
extremely important? How might such information be collected?
We address how the Internet has accelerated the speed at which firms can find
STRATEGY SPOTLIGHT 2.1 discusses some of the ethical guidelines that United
Discussion Question 9: Are you aware of ethical guidelines that other companies have
developed? Were they effective? Why? Why not?
Teaching Tip: The discussion of Competitor Intelligence provides the instructor with an
opportunity to introduce the subject of ethics into the classroom. We suggest presenting
scenarios that are not “black and white.” For example, a firm advertises a position in
4. Environmental Forecasting
Environmental scanning, monitoring, and competitive intelligence are important inputs
We address the twin problems of either assuming that the world is certain and open to
precise predictions, or the assumption that it is uncertain and totally unpredictable. And, we
Discussion Question 10: What are some other errors in forecasting with which you are
familiar?
The SUPPLEMENT below provides another error (most likely!) in forecasting—the
value of Apple’s stock.
Extra Example: Forecasting Apple’s Stock Price
With every $100 level increment n Apple’s (AAPL) stock price, we hear a chorus of worrywarts on business TV
saying it just can’t continue. It’s unprecedented they say. . . . Yet no company this big before has ever had the
opportunities and relatively low market share that Apple now has.
We’re at $600 now (March 21, 2012), but I think Apple has much further to go from here. If things play out as I
expect, Apple with hit $1,650 by the end of 2015.
(Note: Apple was at $430 in early-April, 2013.)
Source: Jackson, E. 2012. Why Apple will hit $1,650 by the end of 2015. forbes.com. March 21. np.
Discussion Question 11: Do you agree with this forecast? (Although one can’t predict
where Apple’s stock price will be at the end of 2015, what do you think Mr. Jackson’s
5. Scenario Analysis
Scenario analysis provides a set of tools that enable managers to imagine threats and
opportunities the future may bring. As a general rule, scenarios should be used by businesses
It is important to note that scenario analysis draws on a wide range of disciplines and
Discussion Question 12: Why must scenario analysis and scenario planning draw on a
variety of disciplines and interests?
STRATEGY SPOTLIGHT 2.2 includes the example of how PPG Industries has benefited
We address the value of a firm in creating an environmentally aware organization—which
includes environmental scanning and monitoring, as well as competitive intelligence,
forecasting, and scenario planning. In contrast, the late Steve Jobs (Apple’s former Chairman)
Extra Example: Steve Jobs’ invaluable intuition
Steve Jobs was convinced that market research and focus groups only limited one’s ability to innovate. When asked
how much research was done to guide Apple when he introduced the iPad, Jobs famously quipped: “None. It isn’t
the consumers’ job to know what they want. It’s hard for (consumers) to tell you what they want when they’ve never
seen anything remotely like it.”
Jobs relied on his own intuition—his radar-like feel for emerging technologies and how they could be brought
together to create, in his words “insanely great” products, ultimately made the difference. For Jobs, who died in
2011 at the age of 56, intuition was no mere gut call. It was, as he put it in his often-quoted commencement speech
at Stanford, about “connecting the dots, glimpsing the relationships among wildly disparate life experiences and
changes in technologies.”
Source: Byrne, J. 2012. Great ideas are hard to come by. Fortune, April 7: 69+.
Discussion Question 13: Would such a mindset work for other organizations? Why? Why
not? (Firms in commodity industries—which experience much less uncertainty than
technology industries have less need for such “intuition” since these industries face
B. SWOT Analysis
We briefly address SWOT Analysis at this point. SWOT stands for strengths, weaknesses,
It is important to note that SWOT analysis provides the “raw material,” that is, a basic
Discussion Question 14: What do you consider to be some of the major advantages and
disadvantages of SWOT analysis? (This issue is addressed in more detail in Chapter 3,
but you should point out that a key disadvantage is that strengths may not necessarily
convert to sources of competitive advantage that are sustainable in the marketplace.)
II. The General Environment
The general environment consists of factors that can have a dramatic effect on a firm’s
We divide the general environment into six segments: demographic, sociocultural,
EXHIBIT 2.2 provides examples of key trends and events in each of the six segments of
the general environment
Discussion Question 15: How will the factors in Exhibit 2.3 affect specific industries?
Discussion Question 16: Which factors are more difficult to predict than others? (e.g.,
macroeconomic changes are typically more difficult to predict than demographic
changes)
Discussion Question 17: How are these factors interrelated?
Discussion Question 18: What factors that are not listed in this exhibit do you feel are
important?
A. The Demographic Segment
Demographics are the most easily understood and quantifiable elements of the general
environment. Demographics include elements such as the aging population, rising or declining
Discussion Question 19: What are the implications of ethnic diversity for the work
place?
Discussion Question 20: What implications does the migration to the South and West in
the United States have for individual businesses?
Discussion Question 21: How does the “graying of America” affect U. S. companies?
Among the trends we discuss are the aging of the population and how it may
Ask:
Discussion Question 22: It might be interesting to ask what the implications (of the
aging of the population) are for today’s organization (e.g., how can firms attract and
retain older workers, changes in financial and non-financial incentives, etc.) as well as
for public policy (e.g., changes in tax policies, increasing the number of immigrants,
etc.).
We also provide (pages 46–7) INSIGHTS FROM RESEARCH: New Tricks: Research
Debunks Myths about Older Workers. Here, results from a meta-analysis points out some
Discussion Question 23: What are the practical implications of these findings? (Hint: as
noted in the IFR: provide more opportunities for younger and older workers to work together;
promote positive attributes of older workers; and, engage employees in open discussions about
stereotypes. The broader learning point would be to encourage students to always question their
assumption bases—they might be wrong, at times!)
Strong backgrounds in science, technology, engineering, and math (STEM), as well as
social networks that provide a venue for the sharing of resources and ideas.
