Chapter 2: The External Environment
Suppliers are powerful relative to firms competing in the industry when:
• The supplier segment of the industry is dominated by a few large companies and is more
concentrated than the industry to which it sells.
• Satisfactory substitute products are not available to industry firms.
2-4c Bargaining Power of Buyers
While firms seek to maximize their return on invested capital, buyers are interested in
purchasing products at the lowest possible price (the price at which sellers will earn the
lowest acceptable return). To reduce cost or maximize value, customers bargain for higher
quality or greater levels of service at the lowest possible price by encouraging competition
among firms in the industry.
Buyer groups are powerful relative to firms competing in the industry when:
• Buyers are important to sellers because they purchase a large portion of the supply
industry’s total sales.
2-4d Threat of Substitute Products
All firms must recognize that they compete against firms producing substitute products,
those products that are capable of satisfying similar customer needs but come from outside
the industry and thus have different characteristics. In effect, prices charged for substitute
products represent the upper limit on the prices that suppliers can charge for their
products.
The threat of substitute products is greatest when:
• Buyers or customers face few, if any switching costs.
Examples of Traditional and Substitute Products and Their Usage
Traditional product Substitute product Usage
Overnight delivery Fax machines/e-mail Document delivery
2-4e Intensity of Rivalry among Competitors
The intensity of rivalry in an industry depends on the extent to which firms in an industry
compete with one another to achieve strategic competitiveness and earn above-average
returns because success is measured relative to other firms in the industry. Competition
can be based on price, quality, or innovation.
Chapter 2: The External Environment
Numerous or Equally Balanced Competitors
Intense rivalries exist in industries with a high number of firms because the firms feel that
they can make competitive moves that will go unnoticed by others in the industry.
However, other firms will generally notice these moves and offer countermoves of their
own in response. Patterns of frequent actions and reactions often result in intense rivalry,
such as in local restaurant, retailing, or dry-cleaning industries.
Slow Industry Growth
When a market is growing at a level where there seem to be “enough customers for
everyone,” competition generally centers around effective use of resources so that a firm
can effectively serve a larger, growing customer base. Because of sufficient growth in the
market, firms do not concentrate on taking customers away from other firms.
High Fixed Costs or High Storage Costs
When an industry is characterized by high fixed costs relative to total costs, firms produce
in quantities that are sufficient to use a large percentage if not all of their production
capacity so that fixed costs can be spread over the maximum volume of output. Though
this may lower per unit costs, it also can result in excess supply if market growth is not
sufficient to absorb the excess inventory. The intensity of competitive rivalry increases as
firms use price reductions, rebates, and other discounts or special terms to reduce
inventory as observed in the automobile industry from the 1980s to the present.
Chapter 2: The External Environment
Lack of Differentiation or Low Switching Costs
Products that are not characterized by brand loyalty or perceived uniqueness are generally
viewed by buyers as commodities. For such products, industry rivalry is more intense and
High Strategic Stakes
The intensity of competitive rivalry increases when success in an industry is important to a
large number of firms (such as the domestic airline industry following deregulation). For
example, the success of a diversified firm may be important to its effectiveness in other
High Exit Barriers
Exit barriers, created by economic, strategic, and emotional factors that cause companies
to remain in an industry even though the profitability of doing so is in question, also can
increase the intensity of competition in an industry. The higher the barriers to exit, the
greater the probability that competitive actions and reactions will include price cuts and
extensive promotions.
Some sources of exit barriers include:
• Investments in specialized assets, or assets whose value is linked to use in a particular
Chapter 2: The External Environment
• Strategic relationships, interdependencies within the organization (e.g., shared facilities,
Teaching Note
One way to get students to recognize the industry forces Porter presents is to allow
them to learn about a given industry and report on these forces as they see them and
assess their strength. For example, one adopter of the text shows students the first
2-5 INTERPRETING INDUSTRY ANALYSES
Effective industry analyses are products of careful study and interpretation of data from
multiple sources. Because of globalization, international markets and rivalry must be
included in the firm’s analyses; in fact, research shows international variables may have
more impact on strategic competitiveness than domestic ones, in some cases.
Chapter 2: The External Environment
Characteristics of attractive and unattractive industries are summarized below.
Industry Characteristic Attractive Unattractive
Threat of New Entry Low High
Teaching Note
It may be helpful to explain that the relationship between the strength of industry forces
6
Define strategic groups and describe their influence on firms.
2-6 STRATEGIC GROUPS
As implied by the previous discussion, not all firms in an industry may adopt the same
strategies in their quest for strategic competitiveness and above-average returns. However,
many firms in an industry may follow similar strategies. These firms are generally
classified as strategic groups, or groups of firms in an industry following the same or
similar strategies along the same strategic dimensions.
Membership in a particular strategic group is determined by the essential characteristics of
a firm’s strategy, which may include the
• Extent of technological leadership
Chapter 2: The External Environment
Teaching Note
Many strategy experts believe that the strategic group concept provides a useful tool for
analyzing an industry from firm-specific perspectives in order to learn how to compete
The strategic group concept can be useful in analyzing the competitive structure of an
industry and can serve as a framework for assessing competition, positioning alternatives,
and potential profitability of firms in an industry.
High mobility barriers, high rivalry, and low resources among the firms within an industry
Use of the strategic group concept requires that analysts be aware of several implications:
• A firm’s major or primary competitors are those in its strategic group, thus competitive
STRATEGIC FOCUS
Toys ‘R’ Us Exemplifies the Apocalypse in the Retail Industries
Among many high-profile bankruptcies in the retail sector in recent years, the end of Toys
‘R’ Us was one of the most notable. Due to complacent leadership, the toy giant failed to
analyze competitors, ultimately losing significant market share to Walmart and Target.
Compounding the problem, Toys ‘R’ Us entered into an online retailing agreement with
Amazon, rather than setting up its own online retail operation, and essentially paid
Amazon to become a competitor in the process. All stores closed in 2018.
Chapter 2: The External Environment
Teaching Note
The Strategic Focus provides a good discussion vehicle for competitor analysis with a
strategic group. How do traditional retailers compete with online competitors? What
can online retailers do to compete against new entrants?
2-7 COMPETITOR ANALYSIS
Competitor analysis represents a necessary adjunct to performing an industry analysis. An
industry analysis provides information regarding potential sources of competition
(including the possible strategic actions and reactions and effects on profitability for all
firms competing in an industry). However, a structured competitor analysis enables the
firm to focus its attention on those firms with which it will directly compete and is
especially important when a firm faces a few powerful competitors.
FIGURE 2.3
Competitor Analysis Components
Figure 2.3 shows how the components of competitor analysis help the firm prepare an
anticipated response profile for each competitor.
Chapter 2: The External Environment
Components
Future Objectives
Response
What will our competitors do in the future?
Where do we hold an advantage over our competitors?
How will this change our relationship with our competitors?
Teaching Note
To help students understand the usefulness of competitor analysis, have them develop a
Other significant components are the complementors of a firm’s products and strategy.
These are the networks of companies that sell goods and services compatible with the
firm’s own product or service.
2-8 ETHICAL CONSIDERATIONS
A major concern of many managers is the methods used to gather data on competitors, a
process generally referred to as competitor intelligence. The illustration of Microsoft’s
struggle to understand Google is especially helpful in explaining this concept. It is a great
managerial challenge to ensure that all data and information related to competitors are
Chapter 2: The External Environment
30
Teaching Note
It might be useful and insightful to require students to develop (and bring to class) their
ANSWERS TO REVIEW QUESTIONS
1. Why is it important for a firm to study and understand the external environment?
The external environment influences the firm’s strategic options as well as the decisions
made in light of them. The firm’s understanding of the external environment is especially
2. What are the differences between the general environment and the industry
environment? Why are these differences important?
The general environment represents those elements in the broader society that can
influence all (or most) industries and the firms that compete in those industries; it
Chapter 2: The External Environment
3. What is the external environmental analysis process (four parts)? What does the
firm want to learn when using this process?
The environmental analysis process represents an organized attempt by the firm to better
understand turbulent, complex, and global environments. This is achieved by scanning
4. What are the seven segments of the general environment? Explain the differences
among them.
The demographic segment is concerned with characteristics of the population or society
that makes up the general environment. Characteristics of interest are size, age, structure,