MODULE 2

Strategic Management

SESSION TOPIC 2: External Analysis: The Identification of Opportunities and Threats

LEARNING OUTCOMES:
The following specific learning objectives are expected to be realized at the end of the session:
1. To understand the primary technique used to analyze competition in an industry environment: the Five Forces
model

KEY POINTS

Brand loyalty Economies of scale Opportunities Switching cost

Threats

CORE CONTENT
Introduction:
This module covers the discussion analysis of the external industry environment. It also includes concepts and
tools for analyzing the competitive structure of an industry and identifying industry opportunities and threats.

Strategy formulation begins with an analysis of the forces that shape competition within the industry in which a company is
based. The goal is to understand the opportunities and threats confronting the firm, and to use this understanding to
identify strategies that will enable the company to outperform its rivals. Opportunities arise when a company can take
advantage of conditions in its industry environment to formulate and implement strategies that enable it to become more
profitable. Threats arise when conditions in the external environment endanger the integrity and profitability of the
company’s business.

DEFINING AN INDUSTRY
An industry can be defined as a group of companies offering products or services that are close substitutes for
each other—that is, products or services that satisfy the same basic customer needs. A company’s closest competitors—
its rivals—are those that serve the same basic customer needs. For example, carbonated drinks, fruit punches, and
bottled water can be viewed as close substitutes for each other because they serve the same basic customer needs for
refreshing, cold, nonalcoholic beverages. Thus, we can talk about the soft drink industry, whose major players are Coca-
Cola, and PepsiCo. Similarly, desktop computers and notebook computers satisfy the same basic need that customers
have for computer hardware on which to run personal productivity software, browse the Internet, send e-mail, play games,
and store, display, or manipulate digital images. Thus, we can talk about the personal computer industry, whose major
players are Dell, Hewlett-Packard, Lenovo (the Chinese company that purchased IBM’s personal computer business), and
Apple.
External analysis begins by identifying the industry within
which a company competes. An industry is the supply side of a
market, and companies within the industry are the suppliers.
Customers are the demand side of a market, and are the buyers of
the industry’s products. The basic customer needs that are served
by a market define an industry’s boundaries. For example, Coca-
Cola long saw itself as part of the soda industry—meaning
carbonated soft drinks—whereas it actually was part of the soft drink
industry, which includes noncarbonated soft drinks.

Photo from thedrum.com

Industry and Sector
A distinction can be made between an industry and a sector. A sector is a group of closely related industries. For
example, the computer sector comprises several related industries: the computer component industries (for example, the

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disk drive industry, the semiconductor industry, and the computer display industry), the computer hardware industries (for
example, the personal computer [PC] industry; the handheld computer industry, which includes smartphones such as the
Apple iPhone and slates such as Apple’s iPad; and the mainframe computer industry), and the computer software
industry. Industries within a sector may be involved with one another in many different ways.
Companies in the computer component industries are the suppliers of firms in the computer hardware industries.
Companies in the computer software industry provide important complements to computer hardware: the software
programs that customers purchase to run on their hardware. Companies in the personal, handheld, and mainframe
industries indirectly compete with each other because all provide products that are, to one degree or another, substitutes
for each other.

Industry and Market Segments

It is also important to recognize the difference between an industry and the market segments within that industry.
Market segments are distinct groups of customers within a market that can be differentiated from each other on the basis
of their individual attributes and specific demands. In the beer industry, for example, there are three primary segments:
consumers who drink long-established mass-market brands (e.g., Budweiser); weight-conscious consumers who drink
less-filling, low-calorie, mass-market brands (e.g., Coors Light); and consumers who prefer premium-priced “craft beer”
offered by microbreweries and many importers. Similarly, in the PC industry, there are different market segments in which
customers desire desktop machines, lightweight portable machines, or servers that sit at the center of a network of
personal computers. Personal computer makers recognize the existence of these different segments by producing a
range of product offerings that appeal to customers in the different segments. Customers in all of these market segments,
however, share a common need for devices on which to run personal software applications.

Changing Industry Boundaries

Industry boundaries may change over time as customer needs evolve, or as emerging new technologies enable
companies in unrelated industries to satisfy established customer needs in new ways. We have noted that during the
1990s, as consumers of soft drinks began to develop a taste for bottled water and noncarbonated fruit-based drinks,
Coca-Cola found itself in direct competition with the manufacturers of bottled water and fruit-based soft drinks: all were in
the same industry. For an example of how technological change can alter industry boundaries, consider the convergence
that is currently taking place between the computer and telecommunications industries. Historically, the
telecommunications equipment industry has been considered an entity distinct from the computer hardware industry.
However, as telecommunications equipment has moved from analog technology to digital technology, this equipment
increasingly resembles computers. The result is that the boundaries between these different industries are now blurring. A
digital wireless smartphone such as Apple’s iPhone, for example, is nothing more than a small handheld computer with a
wireless connection and telephone capabilities. Thus, Samsung, which manufacture wireless phones, is now finding itself
competing directly with traditional computer companies such as Apple. Industry competitive analysis begins by focusing
upon the overall industry in which a firm competes before market segments or sector-level issues are considered.

COMPETITIVE FORCES MODEL

Once the boundaries of an industry have been identified, managers face the task of analyzing competitive forces
within the industry environment in order to identify opportunities and threats. Michael E. Porter’s well-known framework,
the Five Forces model, helps managers with this analysis. An extension of his model, shown below, focuses on six forces
that shape competition within an industry: (1) the risk of entry by potential competitors, (2) the intensity of rivalry among
established companies within an industry, (3) the bargaining power of buyers, (4) the bargaining power of suppliers, (5)
the closeness of substitutes to an industry’s products, and (6) the power of complement providers (Porter did not
recognize this sixth force).

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As each of these forces grows stronger, it limits the ability of established companies to raise prices and earn greater
profits. Within this framework, a strong competitive force can be regarded as a threat because it depresses profits. A weak
competitive force can be viewed as an opportunity because it allows a company to earn greater profits. The strength of
the six forces may change over time as industry conditions change. Managers face the task of recognizing how changes
in the five forces give rise to new opportunities and threats, and formulating appropriate strategic responses.

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. For example, in the last decade, cable television companies have recently emerged as potential
competitors to traditional phone companies. New digital technologies have allowed cable companies to offer telephone
and Internet service over the same cables that transmit television shows. Established companies already operating in an
industry often attempt to discourage potential competitors from entering the industry because as more companies enter, it
becomes more difficult for established companies to protect their share of the market and generate profits. A high risk of
entry by potential competitors represents a threat to the profitability of established companies.
The risk of entry by potential competitors is a function of the height of the barriers to entry, that is, factors that
make it costly for companies to enter an industry. The greater the costs potential competitors must bear to enter an
industry, the greater the barriers to entry, and the weaker this competitive force. High entry barriers may keep potential
competitors out of an industry even when industry profits are high. Important barriers to entry include economies of scale,
brand loyalty, absolute cost advantages, customer switching costs, and government regulation. An important strategy is
building barriers to entry (in the case of incumbent firms) or finding ways to circumvent those barriers (in the case of new
entrants).

 Economies of Scale Economies of scale arise when unit costs fall as a firm expands its output. Sources of scale
economies include: (1) cost reductions gained through massproducing a standardized output; (2) discounts on
bulk purchases of raw material inputs and component parts; (3) the advantages gained by spreading fixed

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 production costs over a large production volume; and (4) the cost savings associated with distributing, marketing,
and advertising costs over a large volume of output. If the cost advantages from economies of scale are
significant, a new company that enters the industry and produces on a small scale suffers a significant cost
disadvantage relative to established companies. If the new company decides to enter on a large scale in an
attempt to obtain these economies of scale, it must raise the capital required to build large-scale production
facilities and bear the high risks associated with such an investment. In addition, an increased supply of products
will depress prices and result in vigorous retaliation by established companies, which constitutes a further risk of
large-scale entry. For these reasons, the threat of entry is reduced when established companies have economies
of scale.
 Brand Photo from askattest.com
Loyalty Brand
A company can create brand loyalty by
continuously advertising its brand-name
products and company name, patent
protection of its products, product
innovation achieved through company
research and development (R&D)
programs, an emphasis on high-quality
products, and exceptional after-sales
service. Significant brand loyalty makes it
difficult for new entrants to take market
share away from established companies.
Thus, it reduces the threat of entry by
potential competitors; they may see the
task of breaking down well-established
customer preferences as too costly.

 Absolute Cost Advantages Sometimes established companies have an absolute cost advantage relative to
potential entrants, meaning that entrants cannot expect to match the established companies’ lower cost structure.
Absolute cost advantages arise from three main sources: (1) superior production operations and processes due to
accumulated experience, patents, or trade secrets; (2) control of particular inputs required for production, such as
labor, materials, equipment, or management skills, that are limited in their supply; and (3) access to cheaper
funds because existing companies represent lower risks than new entrants. If established companies have an
absolute cost advantage, the threat of entry as a competitive force is weaker.
 Customer Switching Costs Switching costs arise when a customer invests time, energy, and money switching
from the products offered by one established company to the products offered by a new entrant. When switching
costs are high, customers can be locked in to the product offerings of established companies, even if new
entrants offer better products. Thus, the higher the switching costs, the higher the barrier to entry for a company
attempting to promote a new computer operating system.
 Government Regulations The competitive forces model predicts that falling entry barriers due to government
deregulation will result in significant new entry, an increase in the intensity of industry competition, and lower
industry profit rates, and that is what occurred here.

Rivalry Among Established Companies

The second competitive force is the intensity of rivalry among established companies within an industry. Rivalry
refers to the competitive struggle between companies within an industry to gain market share from each other. The
competitive struggle can be fought using price, product design, advertising and promotional spending, direct-selling
efforts, and after-sales service and support. Intense rivalry implies lower prices or more spending on non-price-
competitive strategies, or both. Because intense rivalry lowers prices and raises costs, it squeezes profits out of an
industry. Thus, intense rivalry among established companies constitutes a strong threat to profitability. Alternatively, if
rivalry is less intense, companies may have the opportunity to raise prices or reduce spending on non-price competitive
strategies, leading to a higher level of industry profits. Four factors have a major impact on the intensity of rivalry among
established companies within an industry:

 Industry Competitive Structure The competitive structure of an industry refers to the number and size
distribution of companies in it, something that strategic managers determine at the beginning of an industry
analysis. Industry structures vary, and different structures have different implications for the intensity of rivalry. A

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 fragmented industry consists of a large number of small or medium-sized companies, none of which is in a
position to determine industry price. A consolidated industry is dominated by a small number of large
companies (an oligopoly) or, in extreme cases, by just one company (a monopoly), and companies often are in a
position to determine industry prices. Examples of fragmented industries are agriculture, dry cleaning, health
clubs, real estate brokerage, and sun-tanning parlors. Consolidated industries include the aerospace, soft drink,
wireless service, and small package express delivery industries.
A fragmented industry structure, then, constitutes a threat rather than an opportunity. Economic boom
times in fragmented industries are often relatively short-lived because the ease of new entry can soon result in
excess capacity, which in turn leads to intense price competition and the failure of less efficient enterprises. In
consolidated industries, companies are interdependent because one company’s competitive actions (changes in
price, quality, etc.) directly affect the market share of its rivals, and thus their profitability. When one company
makes a move, this generally “forces” a response from its rivals, and the consequence of such competitive
interdependence can be a dangerous competitive spiral. Rivalry increases as companies attempt to undercut
each other’s prices, or offer customers more value in their products, pushing industry profits down in the process.
 Industry Demand The level of industry demand is another determinant of the intensity of rivalry among
established companies. Growing demand from new customers or additional purchases by existing customers tend
to moderate competition by providing greater scope for companies to compete for customers. Growing demand
tends to reduce rivalry because all companies can sell more without taking market share away from other
companies. High industry profits are often the result. Conversely, declining demand results in increased rivalry as
companies fight to maintain market share and revenues. Demand declines when customers exit the marketplace,
or when each customer purchases less. When this is the case, a company can only grow by taking market share
away from other companies. Thus, declining demand constitutes a major threat, for it increases the extent of
rivalry between established companies.
 Cost Conditions The cost structure of firms in an industry is a third determinant of rivalry. In industries where
fixed costs are high, profitability tends to be highly leveraged to sales volume, and the desire to grow volume can
spark intense rivalry. Fixed costs are the costs that must be paid before the firm makes a single sale. For
example, before they can offer service, cable TV companies must lay cable in the ground; the cost of doing so is a
fixed cost. Similarly, to offer express courier service, a company such as FedEx must first invest in planes,
package-sorting facilities, and delivery trucks—all fixed costs that require significant capital investments. In
industries where the fixed costs of production are high, firms cannot cover their fixed costs and will not be
profitable if sales volume is low. Thus they have an incentive to cut their prices and/or increase promotional
spending to drive up sales volume in order to cover fixed costs. In situations where demand is not growing fast
enough and too many companies are simultaneously engaged in the same actions, the result can be intense
rivalry and lower profits. Research suggests that the weakest firms in an industry often initiate such actions,
precisely because they are struggling to cover their fixed costs.
 Exit Barriers Exit barriers are economic, strategic, and emotional factors that prevent companies from leaving an
industry. If exit barriers are high, companies become locked into an unprofitable industry where overall demand is
static or declining. The result is often excess productive capacity, leading to even more intense rivalry and price
competition as companies cut prices, attempting to obtain the customer orders needed to use their idle capacity
and cover their fixed costs.

The Bargaining Power of Buyers

The third competitive force is the bargaining power of buyers. An industry’s buyers may be the individual
customers who consume its products (end-users) or the companies that distribute an industry’s products to end-users,
such as retailers and wholesalers. The bargaining power of buyers refers to the ability of buyers to bargain down prices
charged by companies in the industry, or to raise the costs of companies in the industry by demanding better product
quality and service. By lowering prices and raising costs, powerful buyers can squeeze profits out of an industry. Powerful
buyers, therefore, should be viewed as a threat. Alternatively, when buyers are in a weak bargaining position, companies
in an industry can raise prices and perhaps reduce their costs by lowering product quality and service, thus increasing the
level of industry profits. Buyers are most powerful in the following circumstances:
 When the buyers have choice of who to buy from. If the industry is a monopoly, buyers obviously lack choice. If
there are two or more companies in the industry, the buyers clearly have choice.
 When the buyers purchase in large quantities. In such circumstances, buyers can use their purchasing power as
leverage to bargain for price reductions.
 When the supply industry depends upon buyers for a large percentage of its total orders.

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  When switching costs are low and buyers can pit the supplying companies against each other to force down
prices.
 When buyers can threaten to enter the industry and independently produce the product, thus supplying their own
needs, also a tactic for forcing down industry prices.

The Bargaining Power of Suppliers

The fourth competitive force is the bargaining power of suppliers—the organizations that provide inputs into the
industry, such as materials, services, and labor (which may be individuals, organizations such as labor unions, or
companies that supply contract labor). The bargaining power of suppliers refers to the ability of suppliers to raise input
prices, or to raise the costs of the industry in other ways—for example, by providing poor-quality inputs or poor service.
Powerful suppliers squeeze profits out of an industry by raising the costs of companies in the industry. Thus, powerful
suppliers are a threat. Conversely, if suppliers are weak, companies in the industry have the opportunity to force down
input prices and demand higher-quality inputs (such as more productive labor). As with buyers, the ability of suppliers to
make demands on a company depends on their power relative to that of the company. Suppliers are most powerful in
these situations:
 The product that suppliers sell has few substitutes and is vital to the companies in an industry.
 The profitability of suppliers is not significantly affected by the purchases of companies in a particular industry, in
other words, when the industry is not an important customer to the suppliers.
 Companies in an industry would experience significant switching costs if they moved to the product of a different
supplier because a particular supplier’s products are unique or different. In such cases, the company depends
upon a particular supplier and cannot pit suppliers against each other to reduce prices.
 Suppliers can threaten to enter their customers’ industry and use their inputs to produce products that would
compete directly with those of companies already in the industry.
 Companies in the industry cannot threaten to enter their suppliers’ industry and make their own inputs as a tactic
for lowering the price of inputs.

Substitute Products
The final force in Porter’s model is the threat of substitute products: the products of different businesses or
industries that can satisfy similar customer needs. For example, companies in the coffee industry compete indirectly with
those in the tea and soft drink industries because all three serve customer needs for nonalcoholic drinks. The existence of
close substitutes is a strong competitive threat because this limits the price that companies in one industry can charge for
their product, which also limits industry profitability. If the price of coffee rises too much relative to that of tea or soft drinks,
coffee drinkers may switch to those substitutes. If an industry’s products have few close substitutes (making substitutes a
weak competitive force), then companies in the industry have the opportunity to raise prices and earn additional profits.
There is no close substitute for microprocessors, which thus gives companies like Intel and AMD the ability to charge
higher prices than if there were available substitutes.

Complementors
Andrew Grove, the former CEO of Intel, has argued that Porter’s original formulation of competitive forces ignored
a sixth force: the power, vigor, and competence of complementors. Complementors are companies that sell products that
add value to (complement) the products of companies in an industry because, when used together, the use of the
combined products better satisfies customer demands. For example, the complementors to the PC industry are the
companies that make software applications to run on the computers. The greater the supply of high-quality software
applications running on these machines, the greater the value of PCs to customers, the greater the demand for PCs, and
the greater the profitability of the PC industry.

INDUSTRY LIFE-CYCLE ANALYSIS

A useful tool for analyzing the effects that industry evolution has on competitive forces is the industry life-cycle model.
This model identifies five sequential stages in the evolution of an industry that lead to five distinct kinds of industry
environment: embryonic, growth, shakeout, mature, and decline.

Embryonic Industries
An embryonic industry refers to an industry just beginning to develop (for example, personal computers and biotechnology
in the 1970s, wireless communications in the 1980s, Internet retailing in the 1990s, and nanotechnology today). Growth at
this stage is slow because of factors such as buyers’ unfamiliarity with the industry’s product, high prices due to the
inability of companies to reap any significant scale economies, and poorly developed distribution channels. Barriers to

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entry tend to be based on access to key technological knowhow rather than cost economies or brand loyalty. If the core
know how required to compete in the industry is complex and difficult to grasp, barriers to entry can be quite high, and
established companies will be protected from potential competitors. An embryonic industry may also be the creation of
one company’s innovative efforts, as happened with microprocessors (Intel), vacuum cleaners (Hoover), photocopiers
(Xerox), small package express delivery (FedEx), and Internet search engines (Google). In such circumstances, the
developing company has a major opportunity to capitalize on the lack of rivalry and build a strong hold on the market.

Growth Industries
Once demand for the industry’s product begins to increase, the industry develops the characteristics of a growth industry.
In a growth industry, first-time demand is expanding rapidly as many new customers enter the market. Typically, an
industry grows when customers become familiar with the product, prices fall because scale economies have been
attained, and distribution channels develop.

Industry Shakeout
Explosive growth cannot be maintained indefinitely. Sooner or later, the rate of growth slows, and the industry enters the
shakeout stage. In the shakeout stage, demand approaches saturation levels: more and more of the demand is limited to
replacement because fewer potential first-time buyers remain. As an industry enters the shakeout stage, rivalry between
companies can become intense. Typically, companies that have become accustomed to rapid growth continue to add
capacity at rates consistent with past growth. However, demand is no longer growing at historic rates, and the
consequence is the emergence of excess productive capacity. In an attempt to use this capacity, companies often cut
prices. The result can be a price war, which drives the more inefficient companies into bankruptcy and deters new entry.

Mature Industries
The shakeout stage ends when the industry enters its mature stage: the market is totally saturated, demand is limited to
replacement demand, and growth is low or zero. Typically, the growth that remains comes from population expansion,
bringing new customers into the market, or increasing replacement demand. As an industry enters maturity, barriers to
entry increase, and the threat of entry from potential competitors decreases.

Declining Industries
Eventually, most industries enter a stage of decline: growth becomes negative for a variety of reasons, including
technological substitution (for example, air travel instead of rail travel), social changes (greater health consciousness

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impacting tobacco sales), demographics (the declining birthrate damaging the market for baby and child products), and
international competition. Within a declining industry, the degree of rivalry among established companies usually
increases. The largest problem in a declining industry is that falling demand leads to the emergence of excess capacity. In
trying to use this capacity, companies begin to cut prices, thus sparking a price war.

LIMITATIONS OF MODELS FOR INDUSTRY ANALYSIS

Life-Cycle Issues
It is important to remember that the industry life-cycle model is a generalization. In practice, industry life-cycles do not
always follow the pattern illustrated earlier. In some cases, growth is so rapid that the embryonic stage is skipped
altogether. In others, industries fail to get past the embryonic stage. Industry growth can be revitalized after long periods
of decline through innovation or social change. For example, the health boom brought the bicycle industry back to life after
a long period of decline. The revenues of wireless service providers are also now growing at a healthy clip despite a
nominally mature market due to the introduction of enhanced products—smartphones—that has resulted in a rapid
increase in revenues from data services.
The time span of these stages can also vary significantly from industry to industry. Some industries can stay in
maturity almost indefinitely if their products are viewed as basic necessities, as is the case for the car industry. Other
industries skip the mature stage and go straight into decline, as in the case of the vacuum tube industry. Transistors
replaced vacuum tubes as a major component in electronic products despite that the vacuum tube industry was still in its
growth stage. Still other industries may go through several shakeouts before they enter full maturity, as appears to
currently be happening in the telecommunications industry.

Innovation and Change

Over any reasonable length of time, in many industries competition can be viewed as a process driven by innovation.
Innovation is frequently the major factor in industry evolution and causes a company’s movement through the industry life
cycle. Innovation is attractive because companies that pioneer new products, processes, or strategies can often earn
enormous profits.

Company Differences
Another criticism of industry models is that they overemphasize the importance of industry structure as a
determinant of company performance, and underemphasize the importance of variations or differences among companies
within an industry. Studies suggest that a company’s individual resources and capabilities may be more important
determinants of its profitability than the industry of which the company is a member. In other words, there are strong
companies in tough industries where average profitability is low, and weak companies in industries where average
profitability is high.

THE MACROENVIRONMENT
Just as the decisions and actions of strategic managers can often change an industry’s competitive structure, so
too can changing conditions or forces in the wider macroenvironment, that is, the broader economic, global, technological,
demographic, social, and political context in which companies and industries are embedded.

Macroeconomic Forces
Macroeconomic forces affect the general health and well-being of a nation or the regional economy of an
organization, which in turn affect companies’ and industries’ ability to earn an adequate rate of return. The four most
important macroeconomic forces are the growth rate of the economy, interest rates, currency exchange rates, and
inflation (or deflation) rates. Economic growth, because it leads to an expansion in customer expenditures, tends to ease
competitive pressures within an industry. This gives companies the opportunity to expand their operations and earn higher
profits. Because economic decline (a recession) leads to a reduction in customer expenditures, it increases competitive
pressures. Economic decline frequently causes price wars in mature industries.

Global Forces
Over the last half-century there have been enormous changes in the world’s economic system. The important
points to note are that barriers to international trade and investment have tumbled, and more and more countries have
enjoyed sustained economic growth. Economic growth in places like Brazil, China, and India has created large new
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companies’ goods and services and is giving companies an opportunity to grow their profits faster by entering these
nations. Falling barriers to international trade and investment have made it much easier to enter foreign nations.

Technological Forces
Over the last few decades the pace of technological change has accelerated. This has unleashed a process that
has been called a “perennial gale of creative destruction.” Technological change can make established products obsolete
overnight and simultaneously create a host of new product possibilities. Thus, technological change is both creative and
destructive—both an opportunity and a threat.

Demographic Forces
Demographic forces are outcomes of changes in the characteristics of a population, such as age, gender,
ethnic origin, race, sexual orientation, and social class. Like the other forces in the general environment,
demographic forces present managers with opportunities and threats and can have major implications for
organizations. Changes in the age distribution of a population are an example of a demographic force that
affects managers and organizations. As the population ages, opportunities for organizations that cater to older
people are increasing; the home-health-care and recreation industries, for example, are seeing an upswing in
demand for their services.

Social Forces
Social forces refer to the way in which changing social mores and values affect an industry. Like the other
macroenvironmental forces discussed here, social change creates opportunities and threats. One of the
major social movements of recent decades has been the trend toward greater health consciousness. Its impact
has been immense, and companies that recognized the opportunities early have often reaped significant gains.
Philip Morris, for example, capitalized on the growing health consciousness trend when it acquired Miller Brewing
Company, and then redefined competition in the beer industry with its introduction of low-calorie beer (Miller
Lite). Similarly, PepsiCo was able to gain market share from its rival, Coca- Cola, by being the first to introduce diet
colas and fruit-based soft drinks. At the same time, the health trend has created a threat for many industries. The tobacco
industry, for example, is in decline as a direct result of greater customer awareness of the health implications of smoking.

Political and Legal Forces

Political and legal forces are outcomes of changes in laws and regulations, and significantly affect managers and
companies. Political processes shape a society’s laws, which constrain the operations of organizations and managers and
thus create both opportunities and threats.

IN-TEXT ACTIVITY
Brand loyalty
The tendency of consumers to continuously purchase one brand's products over another.

Economies of scale
Cost advantages that enterprises obtain due to their scale of operation, with cost per unit of output decreasing with
increasing scale.

Opportunities
Favorable external factors that could give an organization a competitive advantage. For example, if a country cuts tariffs,
a car manufacturer can export its cars into a new market, increasing sales and market share.

Switching costs
The costs that a consumer incurs as a result of changing brands, suppliers, or products.

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Threats
Factors that have the potential to harm an organization. For example, a drought is a threat to a wheat-producing
company, as it may destroy or reduce the crop yield. Other common threats include things like rising costs for materials,
increasing competition, tight labor supply and so on.

SESSION SUMMARY
An industry can be defined as a group of companies offering products or services that are close substitutes for each other.
Close substitutes are products or services that satisfy the same basic customer needs. The main technique used to
analyze competition in the industry environment is the competitive forces model. The six forces are: (1) the risk of new
entry by potential competitors, (2) the extent of rivalry among established firms, (3) the bargaining power of buyers, (4) the
bargaining power of suppliers, (5) the threat of substitute products, and (6) the power of complement providers. The
stronger each force is, the more competitive the industry and the lower the rate of return that can be earned.

SELF-ASSESSMENT
Case study:
You are a strategic analyst at a successful hotel enterprise that has been generating substantial excess cash flow. Your
CEO instructed you to analyze the competitive structure of closely related industries to find one that the company could
enter, using its cash reserve to build up a sustainable position. Your analysis, using the competitive forces model,
suggests that the highest profit opportunities are to be found in the gambling industry. You realize that it might be possible
to add casinos to several of your existing hotels, lowering entry costs into this industry. However, you personally have
strong moral objections to gambling. Should your own personal beliefs influence your recommendations to the CEO?

REFERENCES
Refer to the references listed in the syllabus of the subject.

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