CHAPTER 3

The External Environment: Opportunities,

Threats, Industry Competition, & Competitor
Analysis

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 THE STRATEGIC MANAGEMENT
PROCESS

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 KNOWLEDGE OBJECTIVES

● Explain the importance of analyzing and

understanding the firm’s external
environment.

● Define and describe the general

environment and the industry environment.

● Discuss the four activities of the external

environmental analysis process.

● Name and describe the general

environment’s seven segments.

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 KNOWLEDGE OBJECTIVES

● Identify the five competitive forces and

explain how they determine an industry’s
profit potential.

● Define strategic groups and describe their

influence on the firm.

● Describe what firms need to know about

their competitors and different methods
(including ethical standards) used to collect
intelligence about them.

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 IMPORTANT DEFINITIONS

A firm’s EXTERNAL ENVIRONMENT is

broken down into three parts:

● General
● Industry
● Competitor

A firm’s strategic actions are influenced

by the conditions in all three parts.

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 IMPORTANT DEFINITIONS

● General Environment
MACRO Dimensions in the broader society that influence
an industry and the firms within it

● Industry Environment
Set of factors that directly influences a firm and
its competitive actions and response

● Competitor Environment
MICRO Focuses on each company against which a firm
directly competes

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 THE EXTERNAL ENVIRONMENT

FIGURE 2.1

The External
Environment

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 OPENING CASE
BRITISH PETROLEUM (
External environment affects a firm’s
strategic actions
●BP seeks to expand its oil reserves after the
Deepwater Horizon oil and gas drilling platform
disaster in the Gulf of Mexico by forming joint
ventures in Russia with Rosneft Corporation and in
India with Reliance Industries.
●BP’s strategic actions are also affected by
conditions in other segments of its general
environment: e.g., the political/legal, social/cultural,
and physical environment segments.

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 THE EXTERNAL ENVIRONMENT
A firm’s external environment creates:
● OPPORTUNITIES
e.g., the opportunity for BP to enter other global
markets, and
● THREATS
e.g., the possibility that additional regulations in its
markets will reduce opportunities for BP to extract oil
and gas

Collectively, opportunities and threats affect a firm’s

strategic actions.

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 THE EXTERNAL ENVIRONMENT

EXTERNAL
ENVIRONMENT
UNDERSTANDING

INTERNAL
ENVIRONMENT
KNOWLEDGE

VISION, MISSION, AND

STRATEGY

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 THE EXTERNAL ENVIRONMENT
GENERAL
●The General Environment is grouped into
seven environmental segments:
[1] Demographic
[2] Economic
[3] Political/Legal
[4] Sociocultural
[5] Technological
[6] Global
[7] Physical
●To successfully deal with uncertainty in the
external environment and achieve strategic
competitiveness, firms must be aware of and
understand these segments.
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 THE EXTERNAL ENVIRONMENT
GENERAL

● Firms cannot directly CONTROL the general

environment’s segments.

● However, these segments influence the

actions that firms take.

● Successful firms learn how to gather the

information needed to understand all
segments and their implications for selecting
and implementing the firm’s strategies.

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 THE EXTERNAL ENVIRONMENT
GENERAL SEGMENTS AND ELEMENTS

THE DEMOGRAPHIC SEGMENT

Demographic segments are commonly analyzed on a global
basis because of their potential effects across countries’
borders and because many firms compete in global
markets.

Demographic Segment
• Population size
• Age structure
• Geographic distribution
• Ethnic mix
• Income distribution

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 THE EXTERNAL ENVIRONMENT
GENERAL SEGMENTS AND ELEMENTS

THE ECONOMIC SEGMENT

This segment refers to the nature and direction of the economy in
which a firm competes or may compete. Firms generally seek to
compete in relatively stable economies with strong growth
potential. With globalization and the interconnectedness of
nations, firms must scan, monitor, forecast, and assess the
health of their host nation and the health of the economies
outside their host nation.

Economic Segment • Budget deficits or surpluses

• Inflation rates • Personal savings rate
• Interest rates • Business savings rates
• Trade deficits or surpluses • Gross domestic product

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 THE EXTERNAL ENVIRONMENT
GENERAL SEGMENTS AND ELEMENTS

THE POLITICAL/LEGAL SEGMENT

This segment represents how organizations and governments
mutually try to influence each other, and how firms try to
understand these influences (current and projected) on their
strategic actions.

Political/Legal Segment
• Antitrust laws
• Taxation laws
• Deregulation philosophies
• Labor training laws
• Educational philosophies and policies

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 THE EXTERNAL ENVIRONMENT
GENERAL SEGMENTS AND ELEMENTS

THE SOCIOCULTURAL SEGMENT

The sociocultural segment is concerned with a society’s
attitudes and cultural values. Because attitudes and values
form the cornerstone of a society, they often drive
demographic, economic, political/legal, and technological
conditions and changes.
Sociocultural Segment
• Women in the workforce
• Workforce
• Diversity attitudes about the quality of work life
• Shifts in work and career preferences
• Shifts in product and service preference characteristics

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 THE EXTERNAL ENVIRONMENT
GENERAL SEGMENTS AND ELEMENTS

THE TECHNOLOGICAL SEGMENT

Technological changes occur through new products, processes,
and materials. The technological segment includes the activities
involved in creating new knowledge and translating that
knowledge into new outputs, products, processes, and materials.
Given the rapid pace of technological change and risk of
disruption, it is vital for firms to study this segment.

Technological Segment
• Product innovations • Applications of knowledge
• New communication • Focus of private and
technologies government-supported R&D
expenditures

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 THE EXTERNAL ENVIRONMENT
GENERAL SEGMENTS AND ELEMENTS

THE GLOBAL SEGMENT

Markets and consumers are more global. This segment
includes relevant new global markets, existing markets that
are changing, important international political events, and
critical cultural and institutional characteristics of global
markets.

Global Segment
• Important political events
• Critical global markets
• Newly industrialized countries
• Different cultural and institutional attributes

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 THE EXTERNAL ENVIRONMENT
GENERAL SEGMENTS AND ELEMENTS

THE PHYSICAL ENVIRONMENT

SEGMENT
Concerned with trends oriented to sustaining the world’s physical
environment, firms recognize that ecological, social, and economic
systems interactively influence what happens in this particular segment.
This segment refers to potential and actual changes in the physical
environment and business practices that are intended to positively
respond to and deal with those changes.

Physical Environment Segment

• Energy consumption
• Practices used to develop energy sources
• Renewable energy efforts
• Minimizing a firm’s environmental footprint
• Availability of water as a resource
• Producing environmentally friendly products
• Reacting to natural or man-made disasters
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 THE EXTERNAL ENVIRONMENT
GENERAL SEGMENTS AND ELEMENTS

THE PHYSICAL ENVIRONMENT

SEGMENT
EXAMPLE Strategic Focus: Firms’ Efforts to Take Care of the Physical Environment
in Which They Compete
● The examples noted in this Strategic Focus: Siemens AG, McDonald’s,
Procter & Gamble, and GE signify a growing commitment by firms
around the globe in response to emerging trends in the physical
environment segment.

● In addition to positively responding to the observed trends in this

segment of the general environment, there is some evidence that firms
engaging in these types of behaviors outperform those failing to do so.

● This emerging evidence suggests that these behaviors benefit

companies, their stakeholders, and the physical environment in which
they operate.

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 EXTERNAL ENVIRONMENTAL
ANALYSIS
External environments are:
• Turbulent (unstable)
• Complex
• Global
• Uncertain
• Ambiguous (confusing)
• Incomplete

• Firms engage in external environmental analysis

to better understand and cope with their
environments.
• This analysis has four parts:
scanning, monitoring, forecasting, and assessing.
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 EXTERNAL ENVIRONMENTAL
ANALYSIS

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 EXTERNAL ENVIRONMENTAL
ANALYSIS
● Identifying opportunities and threats is an
important objective of studying the general
environment.

● OPPORTUNITY is a condition in the general

environment that if exploited effectively, helps
a company achieve strategic competitiveness.
EXAMPLE: Procter & Gamble (P&G) is reorienting
beauty products to better serve both men and women.

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 EXTERNAL ENVIRONMENTAL
ANALYSIS

● THREAT is a condition in the general

environment that may hinder a company’s
efforts to achieve strategic competitiveness.

EXAMPLE: Microsoft is experiencing a severe

external threat as smartphones are expected to
surpass personal computer (PC) sales in the near
future.

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 EXTERNAL ENVIRONMENTAL
ANALYSIS
Firms use several sources to analyze the general environment:
 trade publications
 newspapers
 business publications
 academic research
 public polls
 trade shows
 suppliers
 customers
 employees

People in boundary-spanning positions can obtain a great deal of

this type of information.

Examples: salespersons, purchasing managers, public relations

directors, and customer service representatives, each of whom
interacts with external constituents
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 EXTERNAL ENVIRONMENTAL
ANALYSIS: SCANNING

Scanning often
Scanning: the study of reveals ambiguous, Many firms use special
all segments in the incomplete, or software to reduce the
general environment; unconnected data and trade-off between an
through scanning, firms information. important missed
identify early signals of Environmental event and false alarm
potential changes in scanning is challenging rates. Also, the Internet
the general but critically important provides significant
environment and for firms, especially opportunities for
detect changes that those competing in scanning.
are already underway highly volatile
environment.

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 EXTERNAL ENVIRONMENTAL
ANALYSIS: MONITORING

Effective monitoring
requires the firm to
Monitoring: analysts Scanning and
identify important
observe MEANINGFUL monitoring are
stakeholders and
environmental changes particularly important
understand its
to see if an important when a firm competes
reputation among
trend is emerging from in an industry with high
these stakeholders as
among those spotted technological
the foundation for
through scanning uncertainty.
serving their unique
needs.

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 EXTERNAL ENVIRONMENTAL
ANALYSIS: FORECASTING

Forecasting: feasibility
projections developed Technology trends are
for what might happen, continually driving
and how quickly, as a product life cycles During an economic
result of the changes shorter, which makes downturn, forecasting
and trends detected forecasting demand for becomes more difficult
through scanning and new technological and more important.
monitoring, both of products that much
which focus on events more challenging.
at a point in time

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 EXTERNAL ENVIRONMENTAL
ANALYSIS: ASSESSING

Assessing: determining Gathering and

the timing and organizing information
INTERPRETATION IS
significance of the is important, BUT
KEY. Even if formal
effects of appropriately
assessment is
environmental trends interpreting that
inadequate, the
that have been intelligence to
appropriate
identified; specifying determine if an
interpretation of that
the implications of the identified trend in the
information is
understanding external environment is
important.
gathered in the an opportunity or
previous stages threat is PARAMOUNT.

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 INDUSTRY ENVIRONMENT ANALYSIS

An INDUSTRY is a group of firms that produce

similar products or offer similar services
that are close substitutes.

Compared with the general environment, the

industry environment has a more direct
effect on the firm’s:
■ Strategic competitiveness
■ Ability to earn above-average
returns
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 INDUSTRY ENVIRONMENT ANALYSIS

An industry’s profit potential is a function

of the five forces of competition:
■ The threats posed by new entrants
■ The power of suppliers
■ The power of buyers
■ Product substitutes
■ The intensity of rivalry among competitors

Strategies are chosen, in part, because of

the influence of an industry’s
characteristics.

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 INDUSTRY ENVIRONMENT ANALYSIS

FIGURE 2.2

The Five
Forces of
Competition
Model

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 PORTER’S FIVE FORCES ANALYSIS

Threat of New Entry

• Economies of scale • Capital requirements
• Proprietary product • Access to distribution
differences • Absolute cost advantages
• Brand identity • Government policy
• Switching costs • Expected retaliation
Bargaining Power Bargaining Power
of Suppliers of Customers
• Differentiation of inputs • Buyer concentration
• Switching costs
Rivalry Among • Buyer volume
• Presence of substitute Existing Competitors • Buyer switching costs
inputs • Industry growth • Switching costs • Buyer information
• Supplier concentration • Fixed costs / value • Concentration and balance • Ability to integrate
• Importance of volume to added • Informational complexity backward
supplier • Overcapacity • Diversity of competitors • Substitute products
• Cost relative to total • Product differences • Corporate stakes • Price / total purchases
purchases • Brand identity • Exit barriers • Product differences
• Impact of inputs on cost or • Brand identity
differentiation • Impact of quality /
• Threat of forward performance
integration • Buyer profits
Threat of Substitutes
• Relative price performance of substitutes
• Switching costs
• Buyer propensity to substitute

Source: Michael E. Porter, Competitive Advantage (New York: Free Press, 1985)
 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

● The five forces model of competition expands
the arena for competitive analysis. Historically,
firms concentrated only on direct competitors.
● Today, firms must study many industries, as
competitors are defined more broadly. For
example, the communications industry now
encompasses media companies, telecoms,
entertainment companies, and smartphone
producers.
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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

1/5 THREAT OF NEW ENTRANTS: BARRIERS TO ENTRY

● Can threaten market share of existing competitors

● May stimulate additional production capacity
● New competitors may force existing firms to be
more efficient and to learn how to compete on new
dimensions
● Entry barriers make it difficult for new firms to
enter an industry and often place them at a
competitive disadvantage even when they are able
to enter
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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

1/5 THREAT OF NEW ENTRANTS: BARRIERS TO ENTRY

● High entry barriers tend to increase the

returns for existing firms in the industry and
may allow some firms to dominate the
industry
● Industry incumbents want to maintain high
entry barriers in order to discourage potential
competitors from entering the industry

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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

1/5 THREAT OF NEW ENTRANTS: BARRIERS TO ENTRY

FUNCTION OF TWO FACTORS

1 BARRIERS TO ENTRY
● Economies of scale
● Product differentiation
● Capital requirements
● Switching costs
● Access to distribution channels
● Cost disadvantages independent of scale
● Government policy
2 EXPECTED RETALIATION (revenge)
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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

1/5 THREAT OF NEW ENTRANTS: BARRIERS TO ENTRY

ECONOMIES OF SCALE
● Marginal improvements in efficiency that a
firm experiences as it incrementally
increases its size
● Economies of scale can be developed in
most business functions, such as marketing,
manufacturing, research and development,
and purchasing
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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

1/5 THREAT OF NEW ENTRANTS: BARRIERS TO ENTRY

ECONOMIES OF SCALE (cont’d)

FACTORS (advantages/disadvantages)
related to large- and small-scale entry
● Flexibility in pricing and market share
● Costs related to scale economies
● Competitor retaliation
● Flexible manufacturing systems diminishes
the effectiveness of economies scale to act
as a barrier
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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

1/5 THREAT OF NEW ENTRANTS: BARRIERS TO ENTRY

PRODUCT DIFFERENTIATION
● Unique products
● Customer loyalty
● New entrants frequently offer products
at lower prices

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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

1/5 THREAT OF NEW ENTRANTS: BARRIERS TO ENTRY

CAPITAL REQUIREMENTS
● Differ according to industry
● Availability of capital
● Physical facilities/Inventories/Marketing
activities
● Knowledge requirements

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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

1/5 THREAT OF NEW ENTRANTS: BARRIERS TO ENTRY

SWITCHING COSTS
One-time costs customers incur when they
buy from a different supplier
■ New equipment
■ Retraining employees
■ Psychological costs of ending a
supplier relationship

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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

1/5 THREAT OF NEW ENTRANTS: BARRIERS TO ENTRY

ACCESS TO DISTRIBUTION CHANNELS

● Stocking or shelf space
● Price breaks/Cooperative advertising
allowances
● Less of a barrier for products that can
be sold on the Internet

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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

1/5 THREAT OF NEW ENTRANTS: BARRIERS TO ENTRY

COST DISADVANTAGES INDEPENDENT OF

SCALE
● Proprietary product technology
● Favorable access to raw materials
● Desirable locations

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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

1/5 THREAT OF NEW ENTRANTS: BARRIERS TO ENTRY

GOVERNMENT POLICY
● Licensing and permit requirements
● Regulation/Deregulation of industries
● Antitrust violations resulting from
industry dominance

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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

1/5 THREAT OF NEW ENTRANTS: BARRIERS TO ENTRY

EXPECTED RETALIATION
Vigorous retaliation can be expected when the existing firm
has a major stake in the industry.
■ It has fixed assets with few, if any, alternative uses
■ It has substantial resources
■ When industry growth is slow or constrained
● Locating market niches not being served by incumbents
allows the new entrant to avoid entry barriers
● Small entrepreneurial firms are generally best suited for
identifying and serving neglected market segments
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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

2/5 BARGAINING POWER OF SUPPLIERS

SUPPLIER POWER INCREASES WHEN:

● Suppliers are large and few in number
● Suitable substitute products are not
available
● Industry firms are not a significant customer
for the suppliers
● Suppliers’ goods are critical to buyers’
marketplace success
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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

2/5 BARGAINING POWER OF SUPPLIERS

SUPPLIER POWER INCREASES WHEN (cont’d):

● Suppliers’ products create high switching
costs
● Suppliers have substantial resources and
provide a highly differentiated product
● Suppliers pose a credible threat to integrate
forward into the buyers’ industry

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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

3/5 BARGAINING POWER OF BUYERS

BUYER POWER INCREASES WHEN:

● Buyers purchase a large portion of an
industry’s total output
● Buyers’ purchases are a significant
portion of a seller’s annual revenues
● Switching costs are low (to other industry
product)

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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

3/5 BARGAINING POWER OF BUYERS

BUYER POWER INCREASES WHEN (cont’d):

● The industry’s products are
undifferentiated or standardized

● Buyers pose a credible threat to integrate

backward into the sellers’ industry

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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

4/5 THREAT OF SUBSTITUTE PRODUCTS

THREAT OF SUBSTITUTE PRODUCTS

INCREASES WHEN:
● Buyers face few switching costs
● The substitute product’s price is lower
● Substitute product’s quality and performance
are equal to or greater than the existing
product
● Differentiated industry products that are
valued by customers reduce this threat
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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

4/5 THREAT OF SUBSTITUTE PRODUCTS

FUNCTION OF A SUBSTITUTE
● Places a ceiling on prices firms can charge

● Goods or services outside a given industry

perform the same or similar functions at a
competitive price (e.g., plastic has replaced
steel in many applications)
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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

5/5 INTENSITY OF RIVALRY AMONG COMPETITORS

INDUSTRY RESTRUCTURED THROUGH

COMPETITORS
STRATEGIC FOCUS: The Multi-Industry Battle for Mobile
and Home Digital Computing and Entertainment
● The process of new technology creation, utilization,
and commercialization ultimately leads to changes in
organizational patterns, and in particular, strategic
alliances and mergers and acquisitions as firms
restructure themselves around the opportunities being
created.
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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

5/5 INTENSITY OF RIVALRY AMONG COMPETITORS

INDUSTRY RESTRUCTURED THROUGH

COMPETITORS (cont’d)
● Competitor analysis must examine how such
technological changes will lead to convergence
of competitors or other firms and associated
organizational changes and the possible re-
creation of a new set of industry competitors,
buyers, and suppliers.

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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

5/5 INTENSITY OF RIVALRY AMONG COMPETITORS

INDUSTRY RIVALRY
● Competitors are rarely homogeneous; they differ in
resources and capabilities and seek to differentiate
themselves from competitors
● Firms seek to differentiate their products in ways that
customers value and in which the firms have a competitive
advantage
● Common rivalry dimensions:
■ Price
■ Service after the sale
■ Innovation
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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

5/5 INTENSITY OF RIVALRY AMONG COMPETITORS

INDUSTRY RIVALRY INTENSIFIES WITH:

● Numerous or equally balanced competitors
● Slow industry growth
● High fixed costs or high storage costs
● Lack of differentiation opportunities or low
switching costs
● High strategic stakes
● High exit barriers
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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

5/5 INTENSITY OF RIVALRY AMONG COMPETITORS

EXIT BARRIERS
High exit barriers prevent competitors from
leaving the industry
EXAMPLES
■ Specialized assets: assets with values linked
to a particular business
■ Fixed costs of exit: such as labor agreements
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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

5/5 INTENSITY OF RIVALRY AMONG COMPETITORS

EXIT BARRIERS (examples cont’d):

■ Strategic interrelationships: relationships of

mutual dependence, such as those between
one business and other parts of a company’s
operations, including shared facilities and
access to financial markets

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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

5/5 INTENSITY OF RIVALRY AMONG COMPETITORS

EXIT BARRIERS (examples cont’d):

:

■ Emotional barriers: aversion to economically

justified business decisions because of fear for
one’s own career, loyalty to employees, etc.
■ Government and social restrictions: often
based on government concerns for job losses
and regional economic effects; more common
outside the United States
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 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

INTERPRETING INDUSTRY ANALYSES

Low entry barriers

Suppliers and buyers

have strong positions Unattractive
Strong threats from Industry
substitute products

Intense rivalry among

competitors LOW PROFIT POTENTIAL
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 INDUSTRY ENVIRONMENT ANALYSIS

THE FIVE FORCES OF COMPETITION MODEL

INTERPRETING INDUSTRY ANALYSES

High entry barriers

Suppliers and buyers

have weak positions
Attractive
Few threats from Industry
substitute products

Moderate rivalry
among competitors HIGH PROFIT POTENTIAL
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 COMPETITOR ANALYSIS
COMPETITOR INTELLIGENCE
■ Set of data and information the firm gathers to better
understand and anticipate competitors' objectives,
strategies, assumptions, and capabilities
■ The ethical and legal gathering of needed information
and data that provides insight into:
● What drives competitors
■ Shown by organization's future objectives
● What the competitor is doing and can do
■ Revealed in organization's current strategy
● What the competitor believes about the industry
■ Shown in organization's assumptions
● What the competitor’s capabilities are
■ Shown by organization's strengths and weaknesses

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 COMPETITOR ANALYSIS COMPONENTS

FIGURE 2.3
Competitor
Analysis
Components

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