Chapter 3 Evaluating a Company’s External Environment
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Evaluating a Company’s
External Environment
Chapter Summary
Chapter 3 presents the concepts and analytical tools for assessing a company’s external environment. Attention
centers on the competitive arena in which a company operates, together with the technological, societal,
regulatory,ordemographicinuencesinthemacro-environmentthatareactingtoreshapethecompany’sfuture
market arena.
Lecture Outline
I. Introduction
1. Chapter2identifiedthatthestrategy-formulationstrategy-executionprocessbeginswithanappraisal
of the company’s present situation. The company’s situation includes two facets: (1) the competitive
conditions in the industry in which the company operates—its external environment; and (2) its resources
and organizational capabilities—its internal environment.
2. This chapter presents the concepts and analytical tools for zeroing in on a single-business company’s
external environment.
3. Figure 3.1, From Thinking Strategically about the Company’s Situation to Choosing a Strategy,
depicts the sequence recommended for managers to pursue.
II. The Strategically Relevant Components of a Company’s Macro-Environment
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1. Every company operates in a broad “macro-environment” that comprises six principal components:
a. Politicalfactors,economicconditionsinthefirm’sgeneralenvironment(local,country,regional,
CORE CONCEPT
The macro-environment encompasses the broad environmental context in which a
company’s industry is situated.
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CORE CONCEPT
PESTEL analysis focuses on the six principal components of strategic significance in
the macro-environment: Political, Economic, Social, Technological, Environmental, and
Legal forces.
2. Figure 3.2, The Components of a Company’s Macro-environment,identifiesthearenaswithinan
organization’s macro-environment, while table 3.1 provides descriptions of each of the six components
of the macro-environment.
3. Acompany’smacro-environmentincludesthemostrelevantfactorsandinuencesoutsideacompany’s
boundaries.
4. Forthemostpart,inuencescomingfromtheouterringofthemacro-environmenthavealowimpact
on a company’s business situation and shape only the edges of the company’s direction and stra tegy.
5. Thefactorsandforcesinacompany’smacro-environmenthavingthebiggeststrategy-shapingimpact
almost always pertain to the company’s immediate competitive environment.
1. Thinking strategically about a company’s competitive environment requires the manager to use some
well validated concepts and analytical tools.
a. Five forces framework
b. The value net
2. Proper use of these analytic tools can provide managers with the understanding needed to craft a strategy
thatfitsthecompany’ssituationwithintheirindustryenvironment.
IV. The Five Forces Framework
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1. The most powerful and widely used tool for systematically diagnosing the principal competitive
2. Figure 3.3, The Five-Forces Model of Competition: A Key Analytical Tool, depicts this tool.
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3. Usingthefiveforcesmodeltodeterminethenatureandstrengthofcompetitivepressuresinagiven
industry involves three steps:
a. Step 1: Foreachofthefiveforces,identifythedierentpartiesinvolved,alongwiththespecific
factors that bring about competitive pressures.
A. Competitive Pressures Created by the Rivalry among Competing Sellers
1. Thestrongestofthefivecompetitiveforcesisoftentherivalryforbuyerpatronageamongcompeting
sellers of a product or service.
2. Theintensityofrivalryamongcompetingsellerswithinanindustrydependsonanumberofidentifiable
factors. These factors are summarized in Figure 3.4 Factors Aecting the Strength of Rivalry. In
general:
a. Rivalry increases when buyer demand is growing slowly or declining.
b. Rivalry increases as it becomes less costly for buyers to switch brands.
directions, objectives, strategies, and countries of origin.
g. Rivalryisstrongerwhenhighexitbarrierskeepunprofitablefirmsfromleavingtheindustry.
3. Evaluating the strength of rivalry in an industry is a matter of determining whether the factors stated
here, taken as a whole, indicate that the rivalry is relatively strong, moderate, or weak.
B. Competitive Pressures Associated with the Threat of New Entrants
1. Severalfactorsaectthestrengthofthecompetitivethreatsofpotentialentryinaparticularindustry.
2. Figure 3.5, Factors Aecting the Strength of Threat of Entry,summarizesthefactorsthataecthow
strong the competitive threat of potential entry is in a particular industry.
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4. Industryincumbentscanmakeithardforanewentranttogainasucientmarketfootholdtosurvive
andeventuallybecomeprofitable.Costadvantagesofindustryincumbentscanstemfrom:
a. There are sizable economies of scale in production, distribution, advertising, or other activities.
b. Incumbents have other hard to replicate cost advantages over new entrants.
i. There are restrictive trade policies.
5. Itisalsoimportanttorecognizethatthebarrierstoenteringanindustrycanbecomestrongerorweaker
over time.
C. Competitive Pressures from the Sellers of Substitute Products
1. Companies in one industry come under competitive pressure from the actions of companies in a closely
adjoining industry whenever buyers view the products of the two industries as good substitutes.
2. Figure 3.6, Factors Aecting Competition from Substitute Products, illustrates how strong the
competitive pressures are from sellers of substitute products. Competitive pressures are stronger when:
3. Company managers must identify the substitutes, which is less easy than it sounds since it involves:
a. Determining where the industry boundaries lie
D. Competitive Pressures Stemming from Supplier Bargaining Power
1. Whether the suppliers of industry members represent a weak or strong competitive force depends on
2. Supplier bargaining power is stronger when:
a. Demand for suppliers’ products is high and the products are in short supply
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d. The supplier industry is dominated by a few large companies and it is more concentrated than the
industry it sells to
h. Industry members are not major customers of suppliers
3. Figure 3.7, Factors Aecting the Bargaining Power of Suppliers, summarizes the conditions that
tend to make supplier bargaining power strong or weak
4. Thiscanbe acomplex tasksofirst stepisfor managersto identifythedierent typesof suppliers,
paying particular attention to those that provide the industry with important inputs. The next step is to
assess the bargaining power of each type of supplier separately
E. Competitive Pressures Stemming from Buyer Bargaining Power and Price Sensitivity
1. Whether buyers are able to exert strong competitive pressures on industry members depends on (1) the
degree to which buyers have bargaining power and (2) the extent to which buyers are price-sensitive.
2. Buyer bargaining power is stronger when:
a. Buyer demand is weak in relation to available supply
b. Industrygoodsarestandardizedorundierentiated
g. Buyers have discretion to delay their purchase or perhaps even not make a purchase at all
3. The following factors increase buyer price sensitivity and result in greater competitive pressures on the
industry as a result:
4. Thestartingpointfortheanalysisofbuyersasacompetitiveforceistoidentifythedierenttypesof
buyers along the value chain—then proceed to analyzing the bargaining power and price sensitivity of
5. Figure 3.8, Factors Aecting the Bargaining Power of Buyers, summarizes the circumstances that
make for strong or weak bargaining power on the part of buyers.
F. Is the Collective Strength of the Five Competitive Forces Conducive to Good Profitability?
1. Intensecompetitivepressuresfromjustoneofthefiveforcesmaysucetodestroytheconditionsfor
goodprofitabilityandpromptsomecompaniestoexitthebusiness.
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CORE CONCEPT
The strongest of the five forces determines the extent of the downward pressure on an
industry’s profitability.
G. Matching Company Strategy to Competitive Conditions
1. A company’s strategy is increasingly eective the more it provides some insulation from these
competitivepressures,shiftsthecompetitivebattleinthecompany’sfavor,andpositionsthefirmto
2. Eectively matching a company’s business strategy to prevailing competitive conditions has two
aspects:
V. Complementors and the Value Net
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1. Not all interactions among industry participants are necessarily competitive in nature. Some have the
potential to be cooperative.
2. The value net includes an analysis of buyers, suppliers, and substitutors. This is illustrated in Figure 3.9,
The Value Net.
valueofthefocalfirm’sproductswhentheyareusedtogether
CORE CONCEPT
Complementors are the producers of complementary products, which are products
that enhance the value of the focal firm’s products when they are used together.
VI. Industry Dynamics and the Forces Driving Change
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1. Industry and competitive conditions change because certain forces are enticing or pressuring industry
participants to alter their actions.
2. Driving Forces arethosethathavethebiggestinuenceonwhatkindsofchangeswilltakeplaceinthe
industry’s structure and competitive environment.
CORE CONCEPT
Driving forces are the major underlying causes of change in industry and competitive
conditions.
A. Identifying an Industry’s Drivers of Change
1. Manydevelopmentscanaectanindustrypowerfullyenoughtoqualifyasdrivingforces.Someare
uniqueandspecificto aparticularindustrysituation,butmostdrivers ofchangefallintooneofthe
following categories:
a. Changes in the long-term industry growth rate
b. Increasing globalization
l. Changing societal concerns, attitudes, and lifestyles
2. Table 3.3, The Most Common Driving Forces, summarizes these 12 most common forces.
B. Assessing the Impact of Factors Driving Industry Change
1. The second step in driving forces analysis is to determine whether the driving forces are acting to make
the industry environment more or less attractive.
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c. Changesinindustryprofitability
2. Getting a handle on the collective impact of the driving forces usually requires looking at the likely
eectsofeachforceseparately,sincethedrivingforcesmaynot allbepushing changeinthesame
direction.
C. Adjusting Strategy to Prepare for the Impacts of Driving Forces
1. Thethirdstepinthestrategicanalysisofindustrydynamics—wheretherealpayoforstrategymaking
comes—is for managers to draw some conclusions about what strategy adjustments will be needed to
deal with the impacts of the driving forces.
slim.
VII. Strategic Group Analysis
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1. Understanding which companies are strongly positioned and which are weakly positioned is an integral
part of analyzing an industry’s competitive structure.
2. The best technique for revealing the market positions of industry competitors is strategic group
mapping .
CORE CONCEPT
Strategic group mapping is a technique for displaying the different market or
competitive positions that rival firms occupy in the industry.
A. Using Strategic Group Maps to Assess the Market Positions of Key Competitors
1. A strategic group consists of those industry members with similar competitive approaches and positions
in the market.
CORE CONCEPT
A strategic group is a cluster of industry rivals that have similar competitive approaches
and market positions.
2. The procedure for constructing a strategic group map is straightforward:
a. Identifythecompetitivecharacteristicsthatdierentiatefirmsintheindustry
b. Plotthefirmsonatwo-variablemapusingpairsofthesedierentiatingcharacteristics
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3. Illustration Capsule 3.1, Comparative Market Positions of Selected Companies in the Casual Dining
Industry: A Strategic Group Map Example, represents a two-dimensional diagram for this industry.
ILLUSTRATION CAPSULE 3.1
Comparative Market Positions of Companies in the Casual Dining Industry:
A Strategic Group Map Example
Discussion Question 1: According to the diagram, which companies comprise the strategic group
of firms to which Olive Garden belongs? Why is the circle containing Olive Garden bigger than
the one containing Panera Bread?
Answer: The diagram reveals Olive Garden’s strategic group member to be Longhorn Steakhouse.
Discussion Question 2: According to the diagram, which are Applebee’s closest competitors?
Answer: The diagram reveals Chili’s, On the Border, and TGI Friday’s as Applebee’s closest
competitors based upon an international coverage. However, based upon Price, Service, and
B. The Value of Strategic Group Maps?
1. Generally speaking, the closer strategic groups are to each other on the map, the stronger the cross-
group competitive rivalry tends to be.
2. Notalllocationsinagroupmapareequallyattractiveduetoprofitprospects,prevailingcompetitive
pressures, and drivers of change. There are two primary reasons:
VIII. Competitor Analysis
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1. Unless a company pays attention to what competitors are doing and knows their strengths and
weaknesses,itendsupyingblindintocompetitivebattle.
2. Having good information about the strategic direction and likely moves of key competitors allows a
companytoprepare defensivecountermoves,tocraft itsownstrategicmoveswithsomeconfidence
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3. Michael Porter’s Framework for Competitor Analysis points to four indicators of a rival’s likely
strategic moves and countermoves. These include a rival’s current strategy, objectives, capabilities, and
assumptions about itself and the industry.
4. Figure 3.10, A Framework for Competitor Analysis,illustrateshowtodevelopastrategicprofileofa
rivalfirm.
a. Current Strategy—Questions to consider include: How is the competitor positioned in the market?
What is the basis for its competitive advantage (if any)? What kinds of investments is it making (as
an indicator of its growth trajectory)?
b. Objectives—Anappraisalofarival’sobjectivesshouldincludenotonlyitsfinancialperformance
5. Informationregardingthesefourcomponentscanoftenbefoundbyexaminingpublicdocumentssuch
aspressreleases,websites,andSECfilings.
IX. Key Success Factors
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1. An industry’s key success factors (KSF) are those competitive factors that most aect industry
members’ ability to prosper in the marketplace.
2. Howwellacompany’sproductoering,resources,andcapabilitiesmeasureupagainstandindustry’s
3. The answer to three questions help identify an industry’s key success factors:
a. On what basis do buyers of the industry’s product choose between the competing brands of sellers?
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ACTIVITY
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Success Factors in a particular industry. You can post instructions for the student within the assignment
and collect their attachments for grading.
4. Onlyrarelyaretheremorethanfivekeyfactorsforfuturecompetitivesuccess,andtwoorthreeoften
carry the most weight.
X. The Industry Outlook for Profitability
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1. Thefinalstepinevaluatingtheindustryandcompetitiveenvironmentistousetheresultsoftheanalyses
just performed to determine whether the industry presents the company with strong prospects for
competitivesuccessandattractiveprofits.
2. The important factors on which to base a conclusion include:
a. How the company is being impacted by the state of the macro-environment.
b. Whetherstrongcompetitiveforcesaresqueezingindustryprofitabilitytosubparlevels.
g. How well the company’s strategy delivers on the industry key success factors.
3. It is a mistake to think of a particular industry as being equally attractive or unattractive to all industry
participants and all potential entrants.
4. When a company decides an industry is fundamentally attractive and presents good opportunities, a
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