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Crafting & Executing Strategy 21e CHAPTER 3 Evaluating a Company’s External Environment Copyright © McGraw-Hill Education. Permission required for reproduction or display. LEARNING OBJECTIVES THIS CHAPTER WILL HELP YOU UNDERSTAND: How to recognize the factors in a company’s broad macro-environment that may have strategic significance How to use analytic tools to diagnose the competitive conditions in a company’s industry How to map the market positions of key groups of industry rivals How to use multiple frameworks to determine whether an industry’s outlook presents a company with sufficiently attractive opportunities for growth and profitability © McGraw-Hill Education. FIGURE 3.1 From Thinking Strategically about the Company’s Situation to Choosing a Strategy Chapter 3 Chapter 4 Jump to Appendix 1 long image description © McGraw-Hill Education. CORE CONCEPT (1 of 7) The macro-environment encompasses the broad environmental context in which a company’s industry is situated that includes strategically relevant components over which the firm has no direct control. © McGraw-Hill Education. 4 CORE CONCEPT (2 of 7) PESTEL analysis focuses on the six principal components of strategic significance in the macro-environment. Political Economic Social Technological Environmental Legal © McGraw-Hill Education. 5 THE STRATEGICALLY RELEVANT FACTORS IN THE COMPANY'S MACRO-ENVIRONMENT PESTEL Analysis Focuses on principal components of strategic significance in the macro-environment Political factors Economic conditions (local to worldwide) Sociocultural forces Technological factors Environmental factors (the natural environment) Legal and regulatory conditions © McGraw-Hill Education. FIGURE 3.2 The Components of a Company’s Macro-Environment Jump to Appendix 2 long image description © McGraw-Hill Education. ASSESSING A COMPANY’S INDUSTRY AND COMPETITIVE ENVIRONMENT How strong are the industry’s competitive forces? What are the driving forces in the industry, and what impact will they have on competitive intensity and industry profitability? What market positions do industry rivals occupy—who is strongly positioned and who is not? What strategic moves are rivals likely to make next? What are the industry’s key success factors? Is the industry outlook conducive to good profitability? © McGraw-Hill Education. THE FIVE FORCES FRAMEWORK The five competitive forces Competition from rival sellers Competition from potential new entrants Competition from producers of substitute products Supplier bargaining power Customer bargaining power © McGraw-Hill Education. FIGURE 3.3 The Five-Forces Model of Competition: A Key Analytical Tool Jump to Appendix 3 long image description © McGraw-Hill Education. USING THE FIVE-FORCES MODEL OF COMPETITION Step 1 For each of the five forces, identify the different parties involved, along with the specific factors that bring about competitive pressures. Step 2 Evaluate how strong the pressures stemming from each of the five forces are (strong, moderate, or weak). Step 3 Determine whether the five forces, overall, are supportive of high industry profitability. Jump to Appendix 4 long image description © McGraw-Hill Education. COMPETITIVE PRESSURES THAT INCREASE RIVALRY AMONG COMPETING SELLERS Buyer demand is growing slowly or declining. It is becoming less costly for buyers to switch brands. Industry products are becoming less differentiated. There is unused production capacity, or products have high fixed costs or high storage costs. The number of competitors is increasing or they are becoming more equal in size and competitive strength. The diversity of competitors is increasing. High exit barriers keep firms from exiting the industry. © McGraw-Hill Education. FIGURE 3.4 Factors Affecting the Strength of Rivalry Jump to Appendix 5 long image description © McGraw-Hill Education. COMPETITIVE PRESSURES ASSOCIATED WITH THE THREAT OF NEW ENTRANTS Entry threat considerations Expected defensive reactions of incumbent firms Strength of barriers to entry Attractiveness of a particular market’s growth in demand and profit potential Capabilities and resources of potential entrants Entry of existing competitors into market segments in which they have no current presence © McGraw-Hill Education. MARKET ENTRY BARRIERS FACING NEW ENTRANTS Incumbent cost advantages related to learning and experience, proprietary patents and technology, favorable locations, and lower fixed costs Strong brand preferences and customer loyalty Strong “network effects” in customer demand High capital requirements Building a network of distributors or dealers and securing adequate space on retailers’ shelves Restrictive regulatory and trade policies © McGraw-Hill Education. STRATEGIC MANAGEMENT PRINCIPLE (1 of 8) Whether an industry’s entry barriers ought to be considered high or low depends on the resources and capabilities possessed by the pool of potential entrants. High entry barriers and weak entry threats today do not always translate into high entry barriers and weak entry threats tomorrow. © McGraw-Hill Education. 16 FIGURE 3.5 Factors Affecting the Threat of Entry Jump to Appendix 6 long image description © McGraw-Hill Education. COMPETITIVE PRESSURES FROM THE SELLERS OF SUBSTITUTE PRODUCTS Substitute products considerations Readily available and attractively priced? Comparable or better in terms of quality, performance, and other relevant attributes? Offer lower switching costs to buyers? Indicators of substitutes’ competitive strength Increasing rate of growth in sales of substitutes Substitute producers adding new output capacity Increasing profitability of substitute producers © McGraw-Hill Education. FIGURE 3.6 Factors Affecting Competition from Substitute Products Jump to Appendix 7 long image description © McGraw-Hill Education. COMPETITIVE PRESSURES STEMMING FROM SUPPLIER BARGAINING POWER Supplier bargaining power depends on: Strength of demand for and availability of suppliers’ products Whether suppliers provide a differentiated input that enhances the performance of the industry’s product Industry members’ costs for switching among suppliers Size and number of suppliers relative to industry members Possibility of backward integration into suppliers’ industry Fraction of the cost of the supplier’s product relative to the total cost of the industry’s product Availability of good substitutes for suppliers’ products Whether industry members are major customers of suppliers © McGraw-Hill Education. FIGURE 3.7 Factors Affecting the Bargaining Power of Suppliers Jump to Appendix 8 long image description © McGraw-Hill Education. COMPETITIVE PRESSURES STEMMING FROM BUYER BARGAINING POWER AND PRICE SENSITIVITY Buyer bargaining power considerations Strength of buyers’ demand for sellers’ products Degree to which industry goods are differentiated Buyers’ costs for switching to competing sellers or substitutes Number and size of buyers relative to number of sellers Threat of buyers’ integration into sellers’ industry Buyers’ knowledge of products, costs and pricing Buyers’ discretion in delaying purchases Buyers’ price sensitivity due to low profits, size of purchase, and consequences of purchase © McGraw-Hill Education. FIGURE 3.8 Factors Affecting the Bargaining Power of Buyers Jump to Appendix 9 long image description © McGraw-Hill Education. IS THE COLLECTIVE STRENGTH OF THE FIVE COMPETITIVE FORCES CONDUCIVE TO GOOD PROFITABILITY? Is the state of competition in the industry stronger than normal? Can industry firms expect to earn decent profits given prevailing competitive forces? Are some of the competitive forces sufficiently powerful to undermine industry profitability? Even one powerful force may be enough to make the industry unattractive in terms of its profit potential © McGraw-Hill Education. CORE CONCEPT (3 of 7) The strongest of the five forces determines the extent of the downward pressure on an industry’s profitability. Having more than one strong force means that an industry has multiple competitive challenges with which to cope. © McGraw-Hill Education. 25 MATCHING COMPANY STRATEGY TO COMPETITIVE CONDITIONS Effectively matching a firm’s business strategy to prevailing competitive conditions has two aspects Pursuing avenues that shield the firm from as many competitive pressures as possible Initiating actions calculated to shift competitive forces in the firm’s favor by altering underlying factors driving the five forces © McGraw-Hill Education. STRATEGIC MANAGEMENT PRINCIPLE (2 of 8) A company’s strategy is increasingly effective the more it provides some insulation from competitive pressures, shifts the competitive battle in the company’s favor, and positions firms to take advantage of attractive growth opportunities. © McGraw-Hill Education. 27 COMPLEMENTORS AND THE VALUE NET How the value net differs from the five forces Focuses on the interactions of industry participants with a particular (focal) company Defines the category of competitors to include the focal firm’s direct competitors, industry rivals, the sellers of substitute products, and potential entrants Introduces a new category of industry participant—complementors—producers of products that enhance the value of the focal firm’s products when they are used together © McGraw-Hill Education. 28 FIGURE 3.9 The Value Net Jump to Appendix 10 long image description © McGraw-Hill Education. CORE CONCEPT (4 of 7) 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. © McGraw-Hill Education. 30 INDUSTRY DYNAMICS AND THE FORCES DRIVING CHANGE Driving forces analysis has three steps Identifying what the driving forces are Assessing whether the drivers of change are, on the whole, acting to make the industry more or less attractive Determining what strategy changes are needed to prepare for the impact of the driving forces © McGraw-Hill Education. CORE CONCEPT (5 of 7) Driving forces are the major underlying causes of change in industry and competitive conditions. © McGraw-Hill Education. 32 THE MOST COMMON DRIVERS OF INDUSTRY CHANGE Changes in the long-term industry growth rate Increasing globalization Emerging new Internet capabilities and applications Shifts in buyer demographics Technological change and manufacturing process innovation Product and marketing innovation Entry or exit of major firms Diffusion of technical know-how across companies and countries Changes in cost and efficiency Reductions in uncertainty and business risk Regulatory influences and government policy changes Changing societal concerns, attitudes, and lifestyles © McGraw-Hill Education. STRATEGIC MANAGEMENT PRINCIPLE (3 of 8) The most important part of driving forces analysis is to determine whether the collective impact of the driving forces will increase or decrease market demand, make competition more or less intense, and lead to higher or lower industry profitability. © McGraw-Hill Education. 34 ASSESSING THE IMPACT OF THE FACTORS DRIVING INDUSTRY CHANGE Are the driving forces, on balance, acting to cause demand for the industry’s product to increase or decrease? Is the collective impact of the driving forces making competition more or less intense? Will the combined impacts of the driving forces lead to higher or lower industry profitability? © McGraw-Hill Education. STRATEGIC MANAGEMENT PRINCIPLE (4 of 8) The real payoff of driving-forces analysis is to help managers understand what strategy changes are needed to prepare for the impacts of the driving forces. © McGraw-Hill Education. 36 ADJUSTING STRATEGY TO PREPARE FOR THE IMPACTS OF DRIVING FORCES What strategy adjustments will be needed to deal with the impacts of the driving forces? What adjustments must be made immediately? What actions currently being taken should be halted or abandoned? What can we do now to prepare for adjustments we anticipate making in the future? © McGraw-Hill Education. STRATEGIC GROUP ANALYSIS Strategic group Consists of those industry members with similar competitive approaches and positions in the market Having comparable product-line breadth Emphasizing the same distribution channels Depending on identical technological approaches Offering the same product attributes to buyers Offering similar services and technical assistance © McGraw-Hill Education. CORE CONCEPT (6 of 7) A strategic group is a cluster of industry rivals that have similar competitive approaches and market positions. Strategic group mapping is a technique for displaying the different market or competitive positions that rival firms occupy in the industry. © McGraw-Hill Education. 39 USING STRATEGIC GROUP MAPS TO ASSESS THE MARKET POSITIONS OF KEY COMPETITORS Constructing a strategic group map Identify the competitive characteristics that delineate strategic approaches used in the industry. Plot the firms on a two-variable map using pairs of competitive characteristics. Assign firms occupying about the same map location to the same strategic group. Draw circles around each strategic group, making the circles proportional to the size