Chapter 2
The External Environment: Opportunities, Threats, Industry
Competition, and Competitor Analysis
CHAPTER OVERVIEW
LEARNING OBJECTIVES
LECTURE NOTES
2-1 THE GENERAL, INDUSTRY, AND COMPETITOR ENVIRONMENTS
2-3 SEGMENTS OF THE GENERAL ENVIRONMENT
2-3a The Demographic Segment
2-3b The Economic Segment
2-4 INDUSTRY ENVIRONMENT ANALYSIS
2-4a Threat of New Entrants
2-5 INTERPRETING INDUSTRY ANALYSES
2-6 STRATEGIC GROUPS
Chapter 2: The External Environment
MINI-CASE: Watch Out All Retailers, Here Comes Amazon; Watch Out Amazon,
Here Comes Other Competitors
ADDITIONAL QUESTIONS AND EXERCISES
INSTRUCTOR’S NOTES FOR MINDTAP
What Would You Do?
CHAPTER OVERVIEW
A firm’s external environment, which is both challenging and complex, has a tremendous
effect on a firm’s performance. To succeed, firms must develop the ability to identify
opportunities and threats in their external environment.
Next, students are introduced to the four parts of the external environmental analysis
process, which helps firms identify opportunities and threats. The four parts are scanning,
monitoring, forecasting, and assessing.
Chapter 2: The External Environment
Chapter 2: The External Environment
The chapter concludes with a discussion of competitor analysis. Firms need to collect
competitor intelligence in order to analyze the future objectives, current strategies,
assumptions, and capabilities of rivals. Different techniques can be used, but firms should
only use legal and ethical practices.
LEARNING OBJECTIVES
1. Explain the importance of analyzing and understanding the firm’s external environment.
2. Define and describe the general environment and the industry environment.
Lecture Notes
Chapter Introduction: This chapter can be introduced with a general statement regarding
the importance of understanding what is happening outside of the firm itself and how what
OPENING CASE
Cracks in the Golden Arches and McDonald’s New Glue
The opening case illustrates how McDonald’s can use information from the general
environment to develop plans for the future and how sociocultural factors affect their
Chapter 2: The External Environment
Teaching Note
The opening case lays out how McDonald’s uses information from the general
environment to make strategic decisions. The case provides a vehicle for discussing
1
Explain the importance of analyzing and understanding the firm’s
external environment.
Teaching Note
Given that the external environment will continue to change—and that change may be
unpredictable in terms of timing and strength—a firm’s management is challenged to be
External environmental factors—like war and political unrest, variations in the strength of
national economies, and new technologies—affect firm growth and profitability in the
United States and beyond.
Environmental conditions in the current global economy differ from those previously
faced by firms:
• Technological advances require more timely and effective competitive actions and
responses.
Chapter 2: The External Environment
Teaching Note
This section introduces definitions, Figure 2.1 (which deals with the external
FIGURE 2.1
The External Environment
Figure 2.1 illustrates the three components of a firm’s external environment and the
elements or factors that are part of each component. They are:
1. The general environment
2. The industry environment
3. The competitor environment
(Note: These components of the external environment and their elements or factors
and how they are related to each and to firm performance will be discussed in detail in
later sections of the chapter.
Chapter 2: The External Environment
2-1 THE GENERAL, INDUSTRY, AND COMPETITOR
ENVIRONMENTS
TABLE 2.1
The General Environment: Segments and Elements
Table 2.1 lists elements that characterize each of the seven segments of the general
environment: demographic, economic, political/legal, sociocultural, technological, global,
Competitor analysis represents the firm’s understanding of its current competitors. This
understanding will complement information and insights derived from investigating the
general and industry environments.
The following are important distinctions to make regarding different external analyses:
• Analysis of the general environment focuses on the future.
Teaching Note
It should be noted that, although firms cannot directly control the elements of the
external environment, they may be able to influence, and will be influenced by, these
Chapter 2: The External Environment
Teaching Note
Global implications should be—and are—integrated into the discussion of the general
3
Discuss the four activities of the external environmental analysis
process.
2-2 EXTERNAL ENVIRONMENTAL ANALYSIS
In addition to increasing a firm’s awareness and understanding of an increasingly
turbulent, complex, and global general environment, external environmental analysis also
is necessary to enable the firm’s managers to interpret information to identify
opportunities and threats.
Opportunities represent conditions in the general environment that may help a company
achieve strategic competitiveness by presenting it with possibilities, whereas threats are
Teaching Note
According to a recent comment by an industry analyst from a national firm, the Internet
is becoming an increasingly valuable source of data and information for analyzing the
Chapter 2: The External Environment
TABLE 2.2
Parts of the External Environment Analysis
Table 2.2 identifies the four parts of the external environmental analysis: scanning,
monitoring, forecasting, and assessing.
2-2a Scanning
Scanning entails the study of all segments in the general environment. Firms use the
scanning process to detect either early warning signals regarding potential changes or
Teaching Note
Scanning may signal a future change in the needs and lifestyles of baby boomers as
they approach retirement age. This may not only provide opportunities for financial
institutions as they prepare for an increase in the number of retirees, but also may
provide opportunities for packagers and marketers of retirement communities and other
products specifically targeted to this segment.
The Internet provides significant opportunities to obtain information. For example,
2-2b Monitoring
Monitoring represents a process whereby analysts observe environmental changes over
time to see if, in fact, an important trend begins to emerge. The critical issue in monitoring
Chapter 2: The External Environment
Effective monitoring requires the firm to identify important stakeholders. Because the
importance of different stakeholders can vary over a firm’s life cycle, careful attention
2-2c Forecasting
The next step is for analysts to take the information and data gathered during the scanning
2-2d Assessing
Assessing represents the step in the external analysis process where all of the other steps
come together. The objective of assessing is to determine the timing and significance of
the effects of changes and trends in the environment on the strategic management of a
firm. Getting the strategy right will depend on the accuracy of the assessment.
Teaching Note
It is good to alert students to the fact that a major challenge for managers and firms
engaging in the process of external analysis is to recognize biases and assumptions that
4
Name and describe the general environment’s seven segments.
2-3 SEGMENTS OF THE GENERAL ENVIRONMENT
As outlined in Table 2.1, the general environment consists of seven segments: demographic,
economic, political/legal, sociocultural, global, technological, and the physical environment.
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11
External analysis efforts should focus on segments most important to the firm’s strategic
2-3a The Demographic Segment
The demographic segment is concerned with a population’s size, age structure,
geographic distribution, ethnic mix, and distribution of income.
Teaching Note
Though each of the elements of this segment are discussed below, you might note that
Population Size
Though population size itself may be important to firms that require a “critical mass” of
Age Structure
Changes in a nation’s birth rate or life expectancy can have important implications for
Geographic Distribution
Population shifts—as have occurred in the United States—from one region of a nation to
another or from metropolitan to non-metropolitan areas may have an impact on a firm’s
strategic competitiveness. Issues that should be considered include:
• The attractiveness of a firm’s location may be influenced by governmental support, and a
shrinking population may imply a shrinking tax base and a lesser availability of official
Chapter 2: The External Environment
Ethnic Mix
This reflects the changes in the ethnic make-up of a population and has implications both
for a firm’s potential customers and for the workforce. Issues that should be addressed
include:
• Will new products and services be demanded or can existing ones be modified?
• How can the firm position itself to take advantage of increased workforce heterogeneity?
Income Distribution
Changes in income distribution are important because changes in the levels of individual
2-3b The Economic Segment
The economic environment refers to the nature and direction of the economy in which a
firm competes or may compete. Analysts must scan, monitor, forecast, and assess a
number of key economic indicators or elements for both domestic and key international
markets, including levels and trends of:
• Inflation rates and interest rates
• Trade deficits and surpluses
Chapter 2: The External Environment
In addition, the implications of changes and trends in the economic segment may affect
2-3c The Political/Legal Segment
The political/legal segment is the arena in which organizations and interest groups
compete for attention, resources, and a voice in overseeing the body of laws and
regulations guiding the interactions among nations as well as between firms and various
Because of the influence that this segment can have on the nature of competition as well
as on the overall profitability of industries and individual firms, analysts must assess
changes and trends in administration philosophies regarding:
• Anti-trust regulations and enforcement
Teaching Note
It would be good to comment (using examples from the text or examples that may be
even more current) on strategies followed by firms as they attempt to manage or
influence the political/legal segment.
• How can firms in the electric utility industry manage the costs of deregulation, including
Chapter 2: The External Environment
• What is likely to be the competitive impact of loosening governmental controls in the
2-3d The Sociocultural Segment
The sociocultural segment is concerned with different societies’ social attitudes and
cultural values. This segment is important because the attitudes and values of society
influence and thus are reflected in changes in a society’s economic, demographic,
political/legal, and technological segments.
Analysts are especially cautioned to pay attention to sociocultural changes and effects that
they may have on:
• Workforce composition, and the implications for managing, resulting from an increase in
2-3e The Technological Segment
As noted in many of the other segments of the general environment, and as discussed in
Chapter 1 as a key driver of the new competitive landscape, technological changes can
have broad effects on society. The technological segment includes institutions and
Chapter 2: The External Environment
2-3f The Global Segment
Factors in the global segment that should be assessed are:
• The potential impact of significant international events such as peace in the Middle East or
the recent entry of China into the WTO
• The identification of both important emerging global markets and global markets that are
changing
• The opportunities to learn from doing business in other countries
• Expanding access to the resources firms need for success (e.g., capital)
Teaching Note
Globalfocusing is a cautious approach to globalization in which firms with a moderate
2-3g The Sustainable Physical Environment Segment
The sustainable physical environment segment refers to potential and actual changes in
the physical environment and business practices that are intended to positively respond to
Chapter 2: The External Environment
STRATEGIC FOCUS
Target (Tar-zhey) Is Trying to Navigate in a New and Rapidly Changing Competitive
Landscape
Target became known by consumers as Tar-zhey, the retailer of cheaper but “chic”
products. The firm offered a step up in quality goods at a slightly higher price than
Teaching Note
The Strategic Focus introduces students to the concept of the general environment and
5
Identify the five competitive forces and explain how they
determine an industry’s profit potential.
2-4 INDUSTRY ENVIRONMENT ANALYSIS
An industry is a group of firms producing products that are close substitutes for each
other. As they compete for market share, the strategies implemented by these companies
influence each other and include a broad mix of competitive strategies as each company
pursues strategic competitiveness and above-average returns.
Chapter 2: The External Environment
FIGURE 2.2
The Five Forces of Competition Model
The five forces of competition model indicates that these forces interact to determine the
intensity or strength of competition, which ultimately determines the profitability of the
industry.
• Threat of New Entrants
• Threat of Substitute Products
Viewed differently, competition should be seen as groupings of alternative ways that
customers can obtain desired results. Thus, any analysis of an industry must expand
beyond the traditional practice of concentrating on direct competitors to include potential
competitors. For example:
• Suppliers can become competitors by integrating forward.
2-4a Threat of New Entrants
New entrants to an industry are important because with new competitors, the intensity of
competitive rivalry in an industry generally increases. This is because new competitors
may bring substantial resources into the industry and may be interested in capturing a
significant market share. If a new competitor brings additional capacity to the industry
Chapter 2: The External Environment
• The transformation of the steel industry when mini-mills (such as Nucor and
Birmingham Steel) entered the industry in competition with integrated domestic
producers such as US Steel and Bethlehem Steel
Barriers to Entry
Barriers to entering an industry are present when entry is difficult or when it is too costly and
places potential entrants at a competitive disadvantage (relative to firms already competing in
the industry). Seven factors represent potentially significant entry barriers that can emerge as
an industry evolves or might be explicitly “erected” by current participants in the industry to
protect profitability by deterring new competitors from entry.
Product Differentiation: Customers may perceive that products offered by existing firms
in the industry are unique as a result of service offered, effective advertising campaigns, or
being first to offer a product of service to the market. If customers perceive a product or
service as unique, they generally are loyal to that brand. Thus, new entrants may be
required to spend a great deal of money over a long period of time to overcome customer
loyalty to existing products.
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19
Though new entrants may be able to overcome perceived uniqueness and brand loyalty,
the cost of such strategies generally will be high: offering lower prices, adding additional
features, or allocating significant funds to a major advertising and promotion campaign. In
the short run, new entrants that try to overcome uniqueness and brand loyalty may suffer
lower profits or may be forced to operate at a loss.
Access to Distribution Channels: As existing firms in an industry generally have
developed effective channels for distributing products, these same channels may not be
available to new firms entering an industry. Thus, access (or lack thereof) may serve as an
effective barrier to entry.
This may be particularly true for consumer nondurable goods (because of the limited
amount of shelf space available in retail stores) and in international markets. In the case of
Cost Disadvantages Independent of Scale: Existing firms in an industry often are able to
achieve cost advantages that cannot be duplicated by new entrants (i.e., other than those
related to economies of scale and access to distribution channels). These can include
proprietary process (or product) technology, more favorable access to or control of raw
materials, the best locations, or favorable government subsidies.
Chapter 2: The External Environment
Potential entrants must find ways to overcome these disadvantages to be able to
effectively compete in the industry. This may mean successfully adapting technologies
from other industries and/or non-competing products for use in the target industry,
Teaching Note
Students should be reminded of the monopolistic nature (on a market-by-market
basis) of the public utility industry, including local telephone service, water,
electric power, and cable television. The “regulated monopolies” will provide
helpful illustrations to make sense of this section.
Expected Retaliation
Even if a firm concludes that it can successfully overcome all of the entry barriers, it still
must take into account or anticipate reactions that might be expected from existing firms.
Strong retaliation is likely when existing firms have a heavy investment in fixed assets
(especially when there are few alternative uses for those assets) or when industry growth
2-4b Bargaining Power of Suppliers
The bargaining power of suppliers depends on suppliers’ economic bargaining power