Discussion Question 37: What are some other ways that end users can increase their
buying power by using the Internet?
STRATEGY SPOTLIGHT 2.5 addresses the role of the Internet in shaking up the legal
Discussion Question 38: What are some examples of other companies that have used the
Internet to enhance their buying power?
3. The Bargaining Power of Suppliers
The Internet has streamlined and quickened the process of acquiring supplies. But the
Suppliers provide products or services to other businesses. The term “B2B” is used to
refer to businesses that supply or sell to other businesses. On the one hand, the Internet makes it
possible for suppliers to access more customers at a relatively lower cost per customer. On the
Discussion Question 39: What can supply chain intermediaries do to strengthen their
position, that is, make it worthwhile for their customers in the supply chain to continue
using their services?
Discussion Question 40: What are some examples of companies that have abandoned
their traditional method of reaching customers and are using the Internet to reach
customers directly?
One of the greatest threats to supplier power is that the Internet inhibits a supplier’s
ability to offer highly differentiated products or unique services. Other factors may, in contrast,
contribute to stronger supplier power:
1. The growth of Web-based business in general may create more downstream
2. Suppliers may be able to create Web-based purchasing arrangements that make
3. The use of proprietary software that links buyers to a supplier’s website may
4. Suppliers will have greater power to the extent that they can reach end users
A process known as disintermediation is removing organizations or business process
layers responsible for intermediary steps in the value chain in many industries. The Internet is
Discussion Question 41: What are some examples of new companies that have emerged
to offer new types of electronic intermediary functions?
Discussion Question 42: If you were Home Depot, what would you do if one of your
major suppliers responded that they intended to sell directly to consumers online
anyway?
4. The Threat of Substitutes
In general, the threat of substitutes is heightened because the Internet introduces new
ways to accomplish the same tasks.
The primary factor that leads to substitution is economic—consumers will use a product or
economies created by Internet technologies have led to the development of numerous
substitutes for traditional ways of doing business. An example is provided:
1. Online electronic storage by companies such as Dropbox and Amazon Web
Discussion Question 43: What are some other examples of Internet companies that are
offering products or services that are viable substitutes for existing products or services?
5. The Intensity of Competitive Rivalry
Because the Internet provides more tools and means for competing, rivalry among
Discussion Question 44: What do you think the impact of diminishing brand loyalty will
be on the intensity of competitive rivalry? Explain.
Discussion Question 45: What are some examples of companies that still rely heavily on
brand loyalty to maintain their market power and sales?
Rivalry is more intense when switching costs are low and product or service
differentiation is minimized. The Internet has “commoditized” products that might previously
The problem is made worse for marketers because of shopping infomediaries that search
the Web for the best prices. Such infomediary services may be good for consumers, but they
Discussion Question 46: What steps can companies take to make their online business
more distinctive or unique?
Discussion Question 47: What are some examples of companies that have maintained
the distinctiveness of their online business? What features make them distinct? Are these
features sustainable?
C. Using Industry Analyses: A Few Caveats
This section was written as a “caveat” to address some limitations of Porter’s five-forces
Teaching Tip: Even when industry analysis shows that an industry is unattractive, there
are a few firms that seem to be able to earn high returns. For example, Southwest
Airlines has been consistently profitable in an otherwise unattractive industry over the
Second is the idea that business is not always a zero-sum game— which is an assumption
The SUPPLEMENT below provides a rather counterintuitive perspective on rivalry in an
Extra Example: Firms Can Benefit from a Rival’s New Product
Conventional wisdom that a rival’s launch can hurt a firm’s profits is often correct. But not always. Research has
shown that companies sometimes see profits increase after a rival’s rollout—even when they don’t aggressively seek
ways to undermine the new product’s sales.
The underlying mechanism is rather straightforward: When a firm extends a product line, it often raises the prices of
its existing products. These hikes may be designed to make the new product look cheaper and thus more attractive
by comparison or to capture the value customers place on a broader line of offerings. As the company adjusts its
pricing, its competitors can follow suit without risking customer defections over price.
For example, consider what happened with Yoplait became the first major producer to market low-fat yogurt in the
United States. Although Dannon took a 5 percent hit in units sold during the new product’s initial year, the vast
majority of its customers did not defect to Yoplait. Instead, they preferred Dannon’s style of yogurt. And, since
Yoplait had raised prices across its product line, Dannon raised its prices as well, by more than 10 percent. Thus,
despite the 5 percent decrease in volume, Dannon’s revenue increased by 5 percent.
A similar dynamic plays out in fast food. My research shows that McDonald’s franchisees who open additional
outlets (a type of horizontal product extension) often price the menu items in all their locations higher than before.
This allows competing Burger Kings to raise their prices as well. At independent Burger Kings in Silicon Valley, this
has led to increase margins more than 10 percent of the time.
Source: Thomadsen, R. 2013. You can benefit from a rival’s new product. Harvard Business Review. 91(4): 24.
The third issue we raise is that the five-forces analysis has often been criticized for being
The concept of complementors is often considered to be the single most important
contribution of value net analysis. Complements typically are products or services that have a
STRATEGY SPOTLIGHT 2.6 addresses the importance of complementors to the success
of the Apple iPod.
D. Strategic Groups within Industries
Most of your students are probably very interested in the automobile industry. EXHIBIT
2.7 provides a strategic grouping of the worldwide automobile industry. It is rather clear from the
Point out four benefits of strategic groups as an analytical tool:
1. Strategic groupings help a firm identify mobility barriers that protect a group from
2. It helps a firm to identify groups whose competitive position may be marginal or
3. It helps chart the future directions of firms’ strategies.
4. It helps in thinking through the implications of each industry trend for the
It may be interesting to ask the students what dynamics they envision in the automobile
Discussion Question 48: What are some of the strategic groups in other industries with
which you may be familiar? What are the implications? (e.g., retailing)
We close with an example with an industry closely related to the one addressed in this
Extra Example: The Two Key Strategic Groups in the Motorcycle Industry
In most industries, firms cluster around a relatively small number of strategic positions and within each cluster hold
similar ideas about how to compete. In the motorcycle industry, there are two major clusters of firms.
The Japanese producers—Honda, Yamaha, Suzuki, and Kawasaki—compete on technical innovation and lower
costs. The Harley-Davidsons and Ducatis, in contrast, view their business through a very different lens—as
entertainment. Here’s how Federic Minoli, the CEO and chairman of Ducati from 1996 to 2007 described his
decision to build a museum celebrating the firm before he repaired a damaged factory: “Ducati is not, or not only, a
motorcycle company. We sell something more: a dream, passion, a piece of history.”
Analyze most industries, and you will find a similar situation: two or three groups of firms jostling for position upon
the same two or three competitive mountaintops. Now consider the major U.S. airlines. They all struggled for many
years in cutthroat competition around the same position until Herb Kelleher of Southwest Airlines saw a different,
low-cost way to compete.
Source: Gavetti, G. 2011. The new psychology of strategic leadership. Harvard Business Review. 89 (7/8): 118-125.
IV. Issue for Debate
Here, we discuss Mondelez International, the snack food company recently spun off by
Kraft Foods. Consistent with several other firms, Mondelez has notified suppliers it will extend
Discussion Question 49: Should Mondelez and other companies follow the practice of
lengthening payment terms with their suppliers? Why? Why not?
This question should spark some interesting class discussion. Some students may argue
that if other firms are engaging in this activity, Mondelez may have to follow suit in order to
remain competitive. Others may claim that Mondelez may enjoy favorable “treatment” by
suppliers if they treat them in a “fairer” manner. One important factor to raise to the class is that
Discussion Question 50: Do you feel this practice can raise ethical issues?
It does raise some ethical issues if customers exploit their suppliers in a manner that
erodes trust and confidence among their partners. For example, suppliers (drawing on the point
Discussion Question 51: What actions can suppliers take to respond to the lengthening
of the payment terms?
The supplier could take actions to enhance its bargaining power vis-à-vis the customer.
For example, it could aggressively strive to attract other customers for its products—thus
V. Reflecting on Career Implications
Below, we provide some suggestions on how you can lead the discussion on the career
implications for the material in Chapter 2.
Creating the Environmentally Aware Organization: Advancing your career requires
constant scanning, monitoring, and intelligence gathering to find out not only about
Students will likely be very interested in the topic of learning about new job opportunities and
their associated skill requirements and compensation. Later in the course, there will be specific
advice related to finding jobs through networking. Here, the point is to raise in students a general
awareness of the types of career options available to them. On LinkedIn, job postings are
grouped in various ways. Employers list desired skills and experience. Students should browse a
SWOT Analysis: As an analytical method, SWOT analysis is applicable for individuals
as it is for firms. It is important for you to periodically evaluate your strengths and
The SWOT analysis directly pertains to individuals, and students will usually grasp how it
applies to them personally. A useful exercise is to have students complete a SWOT analysis on
themselves and then pair with another and share reviews. As a check, ask student volunteers to
General Environment: The general environment consists of several segments, such as
the demographic, sociocultural, political/legal, technological, economic, and global
environments. It would be useful to evaluate how each of these segments can affect your
When students choose a segment, they should identify a trend within that segment. Then they
should be able to identify an industry that would benefit from that trend. This industry is
therefore likely to be a growth industry that may provide good career opportunities. It also may
Five-Forces Analysis: Before you go for a job interview, consider the five forces
affecting the industry within which the firm competes. This will help you to appear
It is good advice to do due diligence of a firm and its industry prior to a job interview. It helps
job candidates to appear knowledgeable about their prospective employers, which may be a
differentiator. In class discussions, it is probably less important to make a general conclusion of
“favorableness” vs. “unfavorableness.” Better is to identify the specific forces that are the
VI. Summary
Managers must analyze the external environment to minimize or eliminate threats and
exploit opportunities. This involves a continuous process of environmental scanning and
We identified two types of environment: the general environment and the competitive
environment. The six segments of the general environment are demographic, sociocultural,
political/legal, technological, economic, and global. Trends and events occurring in these
The competitive environment consists of industry-related factors and has a more direct
impact than the general environment. Porter’s five-forces model of industry analysis includes the
threat of new entrants, buyer power, supplier power, threat of substitutes, and rivalry among
competitors. The intensity of these factors determines, in large part, the average expected level of
profitability in an industry. A sound awareness of such factors, both individually and in
The concept of strategic groups is also very important to the external environment of a
firm. No two organizations are completely different nor are they exactly the same. The question
Chapter 2: Analyzing the External Environment of the Firm
Explain the profitability of an industry (of your choice) by applying the tools that you
learned in this chapter (five-forces analysis). How can the five-forces zero-sum perspective be
a disadvantage?
Teaching Suggestions:
You can organize the discussion on this topic around the following sub-questions:
*What are the five forces that drive the profitability in an industry?
The five forces are:
-The threat of new entrants
-The bargaining power of buyers
*What are the barriers to entry into a particular industry? Are they high or low?
What are the implications?
Six major sources of entry barriers as outlined in the text are:
-Product differentiation
-Switching costs (one time costs that the buyer faces when switching from one
-Cost disadvantages independent of scale
(These derive from: proprietary product, favorable access to raw materials,
*Who are the buyers in this industry? Are they powerful? What makes the buyers powerful
(not powerful)? Are the buyers likely to engage in backward integration?
*What are the implications of buyers bargaining power?
*Who are the suppliers to your industry? Do you think the suppliers are powerful?
What makes the suppliers powerful (not powerful) in your industry?
Are there any ‘switching costs?’ What are the implications of high bargaining
power of the suppliers in the industry?
*If you are a firm in this industry, how would you define competition? Would
you consider all firms operating in the industry as your competitors? Why/why not?
*What are ‘strategic groups?’ How would you know the ‘strategic groups’ in
your industry? What kind of dimensions should you choose when mapping the
‘strategic groups?’ Why is it important to understand ‘strategic groups?’
(We provide the example of the worldwide automobile industry.)
The concept of ‘strategic groups’ is important because competition would be more
intense among firms within the same strategic group as compared to competition with
You should emphasize that for strategic group mapping to serve any meaningful purpose,
the dimensions should be chosen in a manner that they reflect the variety of strategic
*What are the substitutes to your products or services? How do substitutes impact the
profitability of your industry?
You might want to make a point here that identifying substitutes can be quite a difficult
task sometimes. Firms in seemingly unrelated industries may be providing products or
Some more interesting questions to ask would be the following:
*If two industries have the same profitability levels, can you employ a common strategy
in both the industries?
Even though two industries might have the same profitability levels, the underlying
industry structures can be entirely different. For example, in both the automobile industry
and in the Internet-based businesses, profit margins are quite low. However, while the
*Why is the five-force analysis important?
It is important to understand these five forces because they affect a firm’s ability to
compete in a given market. This analysis helps in deciding whether or not to remain in a
particular industry and also in choosing industries to enter. A sound understanding of the
*Is the five-force analysis “zero sum” in perspective? Is that a disadvantage?
It would often be the case that students, in the position of a company, think about
counteracting the effects of each force and blunting it. This is the essence of the zero-sum
*Do the competitive forces remain the same over a period of time? What impact will it have
on profitability?
The key point is that in the five-force analysis, we are essentially taking a point in time
and trying to understand the industry situation at that point in time. This is a static
approach to understanding the competitive environment. However, these external forces
*What is “Value Net?” Who are on the vertical and horizontal dimensions? How are
those on the vertical dimension different from those on the horizontal dimension?
Who are “complementors?” How are complements different from substitutes?
(We provide the example of the video game industry.)
The value net represents all players in the game and analyzes how their interactions affect
Suppliers and customers form the vertical dimension of the value net and the firm
Substitutes and complements are on the horizontal dimension of the value net. These are
Substitute products or services serve the same purpose that the products and services
Complements are typically products or services that have a potential impact on the value
of a firm’s own products or services. The firms that produce complements are referred to
as “complementors.” For example, very sophisticated cameras may be useless if we do
End-of-Chapter Teaching Notes
Chapter 2: Analyzing the External Environment of the Firm
Summary Review Questions
1. Why must managers be aware of a firm’s external environment? (pages 37–38)
Response:
Being responsive to the external environment enables firms to avoid strategic mistakes. It is
possible for firms to become internally focused, efficient producers of obsolete goods and
2. What is gathering and analyzing competitive intelligence and why is it important for
firms to engage in it? (pages 39–40)
Response:
Competitive intelligence is a firm’s activities of collecting and interpreting data on competitors,
defining and understanding the industry, and identifying competitors’ strengths and weaknesses.
3. Discuss and describe the six elements of the external environment. (pages 43–49)
Response:
The six elements of the general environment are the demographic segment, the sociocultural
segment, the political/ legal segment, the technological segment, the economic segment, and the
global segment. The demographic segment refers to the statistics of a population, such as age,
The technological segment refers to new products and services derived from advances in
engineering, applied science, and/or pure science. These new products and services can change
manufacturing processes, create new industries, and alter the boundaries between industries. The
4. Select one of these elements and describe some changes relating to it in an industry that
interests you. (pages 43–49)
Response:
The answer will vary according to segment and industry chosen. Exhibit 2.5 may summarize
some of the possible findings. The purpose of this question is to get students to classify various
5. Describe how the five forces can be used to determine the average expected profitability
in an industry. (pages 52–61)
Response:
The five-forces model consists of the threat of new entrants, the bargaining power of buyers, the
bargaining power of suppliers, the threat of substitute products and services, and the intensity of
The threat of new entrants limits a firm’s ability to raise prices because then a new entrant may
decide to enter the industry and offer a lower price. The bargaining power of buyers directly
limits a firm’s ability to raise prices. The bargaining power of suppliers directly limits a firm’s
6. What are some of the limitations (or caveats) in using five-forces analysis? (pages 61–64)
Response:
Three limitations of the five-forces analysis are 1) the implication that low-profitability
industries should be avoided may not be optimal. Low-profitability industries may be profitable
opportunities for firms with innovative business models that change the competitive landscape.
2) The five-forces model assumes a zero-sum game, with a firm’s loss of profitability associated
7. Explain how the general environment and industry environment are highly related. How
can such interrelationships affect the profitability of a firm or industry? (pages 49–50)
Response:
The general environment can affect all of the five forces in various ways. A growing economy
can reduce the intensity of rivalry within the industry because firms will be scrambling to meet
8. Explain the concept of strategic groups. What are the performance implications? (pages
64–67)
Response:
Strategic groups are groups of firms, usually within an industry, that share similar strategies. The
performance implications are that firms can group themselves with close competitors and 1)
Experiential Exercise
Select one of the following industries: personal computers, airlines, or automobiles. For this
industry, evaluate the strength of each of Porter’s five forces as well as complementors.
Response:
This exercise is very useful for helping students understand the value of the five-forces model.
For undergraduate and even graduate classes, it might be useful to work with only one force at a
time. In general, students may identify a number of firms and organizations for each of the five
forces. To evaluate the strength of each force, it is important to refer to relevant characteristics.
The list below shows these:
Threat of new entrants—you can look at the barriers to entry for the industry, as indicated
by economies of scale, product differentiation, capital requirements, and switching costs,
Bargaining power of buyers—identify buyers who are large or in concentrated buyer
industries, standard or undifferentiated products, few buyer switching costs, buyer with
Bargaining power of suppliers—it is often a challenge to find suppliers, but to the extent
you can, look for suppliers that are large and concentrated (few in number), suppliers
Threat of substitute products and services—identify substitutes that are a) outside the
Intensity of rivalry—identify rivals within the industry and evaluate each rival’s product
Then have students put them all together and provide a summary evaluation of the overall ability
Application Questions and Exercises
1. Imagine yourself as the CEO of a large firm in an industry in which you are interested.
Please (1) identify major trends in the general environment, (2) analyze their impact on the
firm, and (3) identify major sources of information to monitor these trends. (Use Internet
and library resources.)
Response:
Students should respond with a variety of industries and approaches. It may be useful to have
students justify their classification of trends into segments of the general environment. It may
As for sources of information, there are many good sources from the government. Try the census
department, the Bureau of Economic Analysis, Department of Commerce, Department of Labor,
and the Central Intelligence Agency. Many of these sources are freely available directly from the
2. Analyze movements across the strategic groups in the U.S. retail industry. How do these
movements within this industry change the nature of competition?
Response:
We suggest following these five steps. First, develop a list of retailers. The list may include only
Second, choose two dimensions for mapping the firms. Depending on the type of stores chosen,
Third, for each store assign a value for each dimension and plot it on the strategic group space.
For example, Wal-Mart would have a broad product line, high vertical integration (it often buys
Fourth, after putting your firms on the strategic group space, look for clusters and spaces
between clusters. Evaluate each cluster. Ask students which clusters would be more profitable
and which less so. And most important, ask why. Students should be able to articulate the
Fifth, for the firm that has changed in the past year, chart that movement on the strategic group
space. No matter what dimensions you use, this firm will be moving away from some
3. What are the major trends in the general environment that have impacted the U.S.
pharmaceutical industry?
Response:
The U.S. pharmaceutical industry consists of firms that manufacture and market medicines for
people. All segments impact this industry. The demographic segment affects demand, as the
aging baby-boomers require age-specific medicines and marketing approaches. Also, older
The political/legal segment is extremely important due to the regulatory approval process for
new medicines, intellectual property right protection, government insurance programs, and price
controls. Regulatory approval of new medicines is extremely rigorous and costly. To recoup the
costs of obtaining approval, pharmaceutical firms exploit their monopoly power that stems from
The technological segment affects the new product development process. Biotechnology
involves the use of living organisms to develop new drugs and has created an explosion in
The economic segment affects the industry, as general economic growth affects market potential.
The recent recession has therefore hurt the industry. In addition, expected interest rates affect the
financial prospects of many biotech firms. These firms often take decades to develop new drugs
4. Go to the Internet and look up www.kroger.com. What are some of the five forces driving
industry competition that are affecting the profitability of this firm?
Response:
A couple of clicks first to the “about the Kroger company” at the bottom of the home page, then
The first step is to define Kroger’s industry. While Kroger does have jewelry stores and
For the threat of new entrants, this force is weak. Kroger notes that the industry is consolidating.
There are very large barriers to entry due to capital requirements and economies of scale. The
bargaining power of buyers is weak. The buyers are the general public, which is an aggregation
of very small customers. No customer is a very large part of the market, and customers will not
have an information advantage over Kroger. The primary source of buyer power is the ability of
Ethic Questions
1. What are some of the legal and ethical issues involved in collecting competitor
intelligence in the following situations?
a. Hotel A sends an employee posing as a potential client to Hotel B to find out who Hotel
B’s major corporate customers are.
Response:
The scheme risks exposure. Hotel B might find out who the employee is and find out that he or
she represents Hotel A. Hotel B’s list of major corporate customers is likely to be a trade secret,
It is likely that Hotel B will share this information with the press, trade publications, or other
media. It is also possible that Hotel B will use this information to tarnish Hotel A’s reputation.
b. A firm hires an MBA student to collect information directly from a competitor while
claiming the information is for a course project.
Response:
It is possible that this action would be a crime, although doubtful. The competitor is not likely to
However, the scheme is certainly fraudulent and therefore unethical. The firm is using the MBA
In addition, the competitor can use the scheme to discredit the firm and embarrass its
c. A firm advertises a nonexistent position and interviews a rival’s employees with the
intention of obtaining competitor information.
Response:
The scheme is fraudulent. Advertising a position without an intention of hiring is unethical. If the
The possibility of criminal violations occurs within the purview of many states’ trade secret laws.
But the unethical nature of this scheme is likely to be the largest problem. The rival can use the
2. What are some of the ethical implications that arise when a firm tries to exploit its power
over a supplier?
Response:
A monopsonist, or a firm that is the only buyer in a market, has great power over suppliers. It
might try to exploit this power by forcing the supplier to reduce prices or provide extra services.