Chapter Two

External Analysis
The Identification of Opportunities and Threats

Strategy is a choice
on how to compete.
- Michael
Porter

EXTERNAL ANALYSIS

The purpose of external analysis is to identify the strategic opportunities and threats in the
organizations operating environment that will affect how it pursues its mission.

We assess 1

Industry environment in which company operates

Competitive structure of industry
of co's

- The no. and size distribution

- Fragmented, Consolidated (Oligopoly),

Monopoly

What are the implications ?

Competitive position of the company
Competitiveness and position of major rivals
2

The national environments in which company competes.

3
The wider socioeconomic or macro environment that may affect the company and
its industry
Social
Government

Legal

Technological
International

COMPETITIVE STRUCTURE : IMPLICATIONS

Characteristics of Fragmented Ind.

Characteristics of Consolidated Ind.

Typically Commodity type products/ services

Entry barriers low

Companies are interdependent as ones actions

(price, quality, responsiveness etc) impacts the rest

As industry profits rise

Market share & profitability of rivals directly

impacted

New companies rush in

Excess capacity
Depressed prices
Undercutting prices to survive
More commodity like, more vicious price war
Booms are short-lived
Boom-n-Bust cycles
as industry profits rise and fall.
Bankruptcies and exits brings capacity in line with
demand slowly and cycle starts once again.

Therefore it is more a threat than an

opportunity.

Hence it generally forces a move from its rivals

Leading to a dangerous spiral,
Undercutting prices, offer customers more value
Profits down
(Airlines, Telecom, Cereals etc)
The Solution
Acceptance of dominant company as the leader
and set prices by watching, interpreting,
anticipating..
Tacit price agreements exist
and break down under adverse conditions
Case Study : Price Wars in Breakfast Cereal industry.

INDUSTRY ANALYSIS :

DEFINING AN INDUSTRY

Industry
A group of companies offering products or services that are close
substitutes for each
other and that satisfy the same basic
customer needs.
Industry boundaries
The basic customer needs that are served by a market
define industry boundary.
May change as customer needs evolve and technology changes.

Non-Carbonated drinks)

Sector

Coca-Cola Mid-90s : Soda market (carbonated soft drinks) or Soft Drinks (incl.

A group of closely related industries.

Market Segments

Distinct groups of customers within an industry.

Can be differentiated from each other with distinct attributes and
specific demands.

The Computer Sector, Industries and Market

Segments

PORTERS FIVE FORCES MODEL HOW THEY SHAPE COMPETITION WITHIN AN

INDUSTRY ?
The stronger that each of these five forces is, the more limited is the ability of
established companies to raise prices and earn greater profits within their industry i.e. a
Threat.
The weaker that each of these five forces is, the more pronounced is the ability of
established companies to raise prices and earn greater profits within their industry i.e. an
Opportunity.

The systematic analysis of forces is a

powerful tool that helps managers think
strategically.

Through its choice of strategies a

company may alter the strength of one
or more of the five forces to its
advantage.

It is important to recognize that one

competitive force often affects the
others, so all forces need to be considered
and thought about when doing industry
analysis.
It leads managers to think systematically
about how their strategic choices will be
affected by 5 forces and also how their
choices will in turn affect 5 forces and
change conditions in industry.

RISK OF ENTRY BY POTENTIAL COMPETITORS

Potential Competitors are companies that are not currently competing in an industry
but have the capability to do so if they choose.
Barriers to new entrants include:
1.

Economies of Scale as firms expand output unit costs fall via:

Cost reductions through mass production.
Bulk purchases of raw material and standard parts.
Cost advantages of spreading fixed and marketing costs over large volume.

2.

Brand Loyalty
By creating well-established customer preferences.
Difficult for new entrants to take market share from established brands.

3.

Absolute Cost Advantages relative to new entrants

Accumulated experience in production and key business processes (Learning/
Experience Curve).
Control of particular inputs required for production.
Lower financial risks access to cheaper funds.

4.

Customer Switching Costs for Buyers where significant.

5.

Government Regulation may be a barrier to enter certain industries.

RIVALRY AMONGST ESTABLISHED COMPANIES

Competitive Rivalry refers to the competitive struggle between companies in the same
industry to gain market share from each other. Intensity of rivalry is a function of:
1. Industry Competitive Structure
Number and size distribution of companies.
Consolidated vs. fragmented.
2. Demand Conditions
Growing demand - tends to moderate competition and reduce rivalry.
Declining demand - encourages rivalry for market share and revenue.
3. Cost Conditions
High fixed costs profitability leveraged by sales volume (Shipping, Airlines, Telecom,

Air Express etc).

Slow demand and growth can result in intense rivalry and lower profits.
4. Height of Exit Barriers prevents companies from leaving industry even when
4.
High fixed costs of exit severance pay,
unprofitable, demand declining..
health
1.
2.
3.

Write-off of investment in assets

5.
Economic dependence on industry if in single industry
6.
Maintain assets - to participate effectively in an industry
UPS, FedEx to maintain nationwide n/w

benefits, pensions etc

Emotional attachment sentiments/ pride
Bankruptcy regulations allowing
unprofitable assets
to remain (Chapter 11 in

BARGAINING POWER OF THE BUYERS

Industry Buyers may be the consumers or end-users who ultimately use the product
or intermediaries that distribute or retail the products. These buyers are most
powerful when:
1. Buyers are dominant.
Buyers are large and few in number.
Auto, Aircraft Manu
The industry supplying the product is composed of many small companies
Component Manu

Large

2. Buyers purchase in large quantities.

Buyers have purchasing power as leverage for price reductions
Mart, Reliance

Wal-

3. The industry is dependant on the buyers.

Buyers purchase a large percentage of a industrys produce.
___

______

4. Switching costs for buyers are low.

Buyers can play off the supplying companies against each other.
___

5. Buyers can purchase from several supplying companies at once.

________

______

BARGAINING POWER OF THE SUPPLIERS

Suppliers are organizations that provide inputs such as material and labor into the
industry. These suppliers are most powerful when:

1. The product supplied is vital to the industry and has few substitutes.
e.g. Intel Microprocessors

2. The industry is not an important customer to suppliers.

________
Suppliers are not significantly affected by the industry.
3. Switching costs for companies in the industry are significant.
IBM, HP .. Datacenters

Companies in the industry cannot play suppliers against each other.

4. Suppliers can threaten to enter their customers industry.
Backward Integration

Suppliers can use their inputs to produce and compete with companies already
in the industry.

SUBSTITUTE PRODUCTS

Substitute Products are the products from different businesses or industries that can
satisfy similar customer needs.
1. The existence of close substitutes is a strong competitive threat.
Substitutes limit the price that companies can charge for their product.

e.g. Intel, AMD etc.

Coffee

Soft Drinks, Tea,

2. Substitutes are a weak competitive force if an industrys products have few

close substitutes.
Other things being equal, companies in the industry have the opportunity to
raise prices and earn additional profits.

STRATEGIC GROUPS WITHIN INDUSTRIES

Strategic Groups are groups of companies that follow a business model similar to
other companies within their strategic group but are different from that of other
companies in other strategic groups.
The basic differences between business models in different strategic groups can be
captured by a relatively small number of strategic factors.

1. Implications of Strategic
Groups
The closest competitors are within
the same Strategic Group and may
be viewed by customers as
substitutes for each other.
Each Strategic Group can have
different
competitive forces and may face a
different set of opportunities and
threats.

High Risk High

Return
Focus on developing
new proprietary drugs
Heavy R&D spending

Low Risk Low

Return
Focus on low-cost
copies of
drugs with expired
patents.
Production efficiency

2. Mobility Barriers Factors

within an industry that inhibit
the movement of companies
between strategic groups

Strategic Barriers in the Pharmaceutical Industry

Strategic Barrier
Lack of R&D Skills to
develop new
proprietary drugs

Industry Life Cycle Analysis

The Model analyzes the affects of industry evolution on competitive forces over
time and is characterized by five distinct life cycle stages:

1.

Embryonic industry just beginning to develop

Rivalry based on perfecting products,
educating customers, and opening up distribution channels.

2.

Growth first-time demand takes-off with new customers

Low rivalry as focus is on keeping up with high industry growth.

3.

Shakeout demand approaches saturation, replacements

Rivalry intensifies with emergence of excess productive capacity.

4.

Mature market totally saturated with low to no growth

Industry consolidation based on market share, driving down price.

5.

Decline industry growth becomes negative

Rivalry further intensifies based on rate of decline and exit barriers.

Growth in Demand and Capacity

Anticipate how forces will change and formulate appropriate strategy

Industry Shakeout:
Rivalry Intensifies with
growth in excess
capacity

Models provide useful ways of thinking about

competition within an industry but be aware of
their limitations.

Limitations of Models for

Industry Analysis
Life Cycle Issues
Industry cycles do not always
follow
the
life
cycle
generalization.
In rapid growth situations
embryonic stage is sometimes
skipped.
Industry growth revitalized
through innovation or social
change.
The time span of the stages
can vary from industry to
industry.
Innovation and Change
Punctuated
Equilibrium
occurs when an industrys
long term stable structure is
punctuated with periods of
rapid change by innovation.
Hypercompetitive
industries are characterized
by permanent and ongoing
innovation and competitive
change.
Company Differences
There can be significant
variances in the profit rates of
individual companies within
an industry.
In

addition

to

industry

Punctuated Equilibrium and Competitive Structure

Industry Structure
revolutionized by
innovation
Periods of
long term
stability
Periods of
long term
stability

The Role of the Macro environment

Changes in the forces in the

macro-environment can
directly impact:
The Five Forces
Relative Strengths
Industry
Attractiveness

Andrew Grove, forcer CEO of Intel argues

that Porters Model ignores a sixth force The power, vigor
Complementors.

and

competence

of

These are companies that sell products that add

value to (complement) the products of the industry
because when used together, the products best
satisfy customer needs.
e.g. software applications