Chapter 3 Evaluating Company´s ... Enviroment

Evaluating a Company'sExternaI Environment

Chapter Leaming Objectives

LO1. Gain command of the basic concepts and analytica[ tools widely used

to diagnose a company's industry and competitive conditions.

LO2. Become adept at recognizing the factors that cause competition in an

industry to be fierce, more or less normal, or relatively weak.

LO3. Learn how to determine whether an industry's outlook presents a

company with sufficiently attractive opportunities for growth and

orofitab¡litv.

Part One: Section B: Core ConceDts and Anatvtical Tools

In the opening paragraph of Chapter 1, we said that one of the three centralquestions that managers must address in evaluating their company's businessprospects is "Wherc nre zuc now?" Two facets of the company's situation areespecially pertinent: (1) the industry and competitive environments in whichthe company operates and (2) the company's collection of competitively valu-able resources and capabilities, its strengths and weaknesses vis-á-vis rivals,and its windows of opportunity. Developing answers to the questions "Wlrcredo we tuant to go?" and " Hout are we going to get there?" without first gainingan understanding of the company's external environment and internal situa-tion hamstrings attempts to build competitive advantage and boost companyperformance. Indeed, the first test of a winning strategy inquires "Does the

strategy fit the contpany's situation?"This chapter presents the concepts and analytical tools for zeroing in on

a single-business company's external environment. Attention centers on thecompetitive arena in which the company operates, the drivers of marketchange, and rival companies' actions. In Chapter 4 we explore the methods ofevaluating a company's internal circumstances and competitiveness.

Company Performance and the"Macroenvironment"The performance of all companies is affected by such external factors as theeconomy at large, population demographics, societal values and lifestyles,governmental legislation and regulation, and technological factors. Strictlyspeaking, a company's "macroenvironment" includes all releuant factors andinfluences outside the company's boundaries; by reLeuant, we mean these fac-tors are important enough that they should shape management's decisionsregarding the company's long-term direction, objectives, strategy, and busi-ness modcl. Figure 3.1 p¡esents a depiction of macroenvironmental factorsr,r.ith a high potential to affect a company's business situation. The impactof outer-ring factors on a company's choice of strategy can range from bigto small. But even if the factors in the outer ring of the macroenvironmentchange slowly or are likely to have a low impact on the company's businesssituation, they still merit a watchful eye. Motor vehicle companies must adapttheir strategies to current customer conce¡ns about carbon emissions andhigh gasoline prices. The demographics of an aging population and longerlife expectancies will have a dramatic impact on the healih care and prescrip-tion drug industries in the ncxt feu' decades. As company managers scan theexternal environment, they must be alert for potentially important outer-ringdevelopments, assess their impact and influence, and adapt the company'sdirection and strategy as needed.

However, the factors and forces in a company's macroenvironment thathave the brggesf strategy-shaping impact gpñally pertain to the company'simmediate industry and competitive environment----competitive pressures,the actions of rivals firms, buyer behavior, supplier-related considerations,and so on. Consequently, it is on a company's industry and competitive envi-ronment that we concentrate our attention in this chaoter.

.llChapter 3 Evaluating a Company's ExternaI Environment

FIGURE S.l The components of a compan1/s ^lecro€nvironment

Assessing the Compan)/s lndustry andCompetitive EnvironmentThinking strategically about a company's industry and competitive environ-ment entails using some u'ell-validated concepts and analytical tools to get

clear answers to seven qucstions:

1. What are the industry's dominant economic characteris tics?

2. What kinds of competiti'r'e forces are industry members facing, and hon'strong is each force?

3. What forces are driving industry change, and what impact will thcse

changes have on competitive intensity and industry Profitability?.1. What market positions do industrv rivals occupy-who is strongly posi-

tioned and who is not?

5. What strategic moves are rivals likely to make next?

6. \{rhat are the key factors of competitive success?

7. Does the industry outlook offer good prospects for profitability?

Analysis-based answers to these questions are prerequisites for a stratcgyoffering good fit n,ith the external situation. The remainder of this chapter is

d.evoted to describing the methods of obtaining solid answers to the seven

ouestions above.

Question 1: What Are the Industr¡/s DominantEconom ic Characteristics?Analyzing a company's industry and competitive environment begins withidentifying the industry's dominant economic characteristics. An indus-try's dominant economic features are defined by such factors as market size

Part One: Section B: Core Conceots and Analvtical Tools

and growth rate, the number and size of buyers and sellers, the geographicboundaries of the market (which can extend f¡om local to worldn,ide),whether sellers' products are virtually identical or highly differentiated,number of rival sellers, thc pace of product innovation, market demand-supply conditions, the pace of technological change, the extent of verticalintegration, and the extent to which costs are affected by scale economies(i.e.. situations in which large-volume operations result in lower unit costs)and learning/experience curve effects (i.e., situations in which costs declineas a company gains knon'ledge and experience). Table 3.1 provides a sum-mary of analytical questions that define the industry's dominant economictearures.

Cetting a handle on an industry's distinguishing economic features notonly provides a broad overview of thc attractiveness of the industry, butalso promotes unclerstanding of the kinds of strategic moves that indus-try members are likely to employ. For example, industries characterized byrapid product innovations require substantial investments in R&D and thedevelopment of strong product innovation capabilities----continuous productinnovation is primarily a survival strategy in such inclustries as video games,computers, and pharmaceuticals. Industries with strong learning/experiencecurue effects are unlikely to experience entry of new competitors becauseany newcomer would bc at a competitive disadvantage for an extendedperiod of time. The microprocessor industrv is an excellent example of howIearning/experience curves put new entrants at a substantial cost disadvan-tage. Manufacturíng unit costs for microprocessors tend to decline about20 percent each timc cwnulatiae production volume doubles. With a 20 per-cent experience curve effect, if the first 1 million chips cost $100 each, onceproduction volume reaches 2 million the unit cost would fall to $80 (80 per-cent of $100), and by a production volume of 4 million the unit cost would be$64 (80 percent of $80).1 The bigger the learning or experience curve effect,the bigger the cost advantage of the company with the largest utmulatiueproduction volume.

Question 2: How Strong Are the Industr¡/sCompetitive Forces?After gaining an understanding of the industry's general economic charac-teristics, industry and competitive analysis should focus on the competitirredynamics of the industry. The nature and subtleties of competitive forces arenever the same from one industry to another and must be wholly understood toaccurately form answers to the question "Where are zue now?" Far and away themost pou'erful and widely used tool for assessing the strcngth of the industry's

'There are a large number of studies on the s¡ze of the cost reductions associated withexperience; the median cost reduction associated with a doubling of cumulative productionvolume is approxirnately 15%, but there is a wide variation from ¡ndustry to industry. For a goodd¡scuss¡on of the econom¡es of experience and learning, see Pankaj Ghemawat, "Buitding Strat-egy on the Experience Ctwe," Horvord Bus¡ness Review 64, no. 2 (March-April 1985),pp. 143-149.

Chapter 3 Evaluat¡ng a Company's External Environment

Table 3.1

TCONOMIC CHARACTTRISTIC QUESTTONS rO ANSWER

Market size and Browth rate

Number of riva ls

Scope of competitive riva lry

Number of buyers

Degree oÍ product differentiation

Product innovation

Demand-supply conditions

Pace of tech nologica I change

Vertical integration

Economies of sca le

How big is the industry and ho',v fast is it growing?What does the industry's positÍon in the life cycle (early

development, rapid growth and takeoff, early maturityand slowin¡¡ grorvth, saturation and stagnation, decline)reveal about the industry's growth prospects?

ls the industry fragmented into many small compa-nies or concentrated and domrnated by a few largecompanrcslls the industry going through a perlod of consolidationto a smaller number of competitors?

ls the geographic area over which most companiescompete local, regional, national, multinational, orglobal?

ls market denrand iragmented anrong many buy'ers?

Are the prc-rducts of rivals becoming more cliÍierenti-ated or less d itterentiated?

ls the industry characterzed by raprd product innova-tion and short product lrfc-cyclcs?How important is R&D and product ¡nnovat¡oniAre there opportunities to overt¿ke key rivals by, beingfirst to-market with next-Seneration products?

ls a surplus oÍ capacity pushing prices and profitmargins dorvn?

ls the industry overcrowded with too manycompetitors?

What role does advancing technology play in thisindustry?Do most industry members have or need strong tech-nological capabi I ities? Whyi

Do most competitors operate in only one stage of theindustry (parts and components productir.rn, manu-facturing and assembly, distribution, retailing) or dosome compctitors opcratc in mult¡ple stages?

ls there any cost or compctit¡vc advantagc or disadvantage associated with be¡ng fully or partiallyintegratecl?

ls the industry characterizecl by economies of scale inpurchasing, manufacturing, advertising, shipping, orother activ¡ties?Do companies w¡th large scale operations have an

imporlant cost advantage over small-scalc lirms?

Are certain industry activities characterized by strong

learning and experience curve etfects?

Do any companies have significant cost advantagesbccausc of thcir learn ing/expenence in performingparticular act¡v¡tiesi

Learning and experience curve effects

Pa¡t One: Section B: Core Concepts and Analytical Tools

CompetitivepressufeS

$emm¡nEfrom

5€lEr-buyer

collaboralioñ

bargaining

FIGURE 3.9 T|¡c Erp.6ort¡¡ nodd d htdÚüñi,. r) irrlii: 'i' 'l

Compet¡tive pressüres com¡ng fuomthe market attemDts of outsideE towin buveE over to their oroducts

Compel¡tivepressures

stemmrngfrom

suppl¡er'seller

aollaborationand

barSa¡ning

Competitive pressures cominS ftomthe threat of entry of nerv dvals

Sou]te: Based on M¡chael E, Porter, 'How Conpet¡tive Forces Shape Stmtegh" Horvad 9us¡ness Rev¡ew 57, no, 2 (March-April 1979),pp. 137-45i and M¡chael E. Porter, "The Five Competitive Forces That Shape Stal?9y," HaNod Business Rev¡ew 86, no. r (lanuary zooS),pp. 80-86.

competitive fo rces is the fiae-forces ffiodel of competition.2 This model, as depictedin Figure 3.2, holds that competitive forces affecting industry attractivenessgo beyond rivalry among competing sellers and include pressures stemmingfrom four coexisting sources. The five competitive forces affecting industryattractiveness are üsted below.

1. Competitive pressures stemming fuom buyu bargaining power and seller-buyer collaboration.

2. Competitive pressures coming from companies in other industries to winbuyers over to substitute products.

'The five-forces model of comDet¡tion is the creation of Professor Michael Porter of the HarvardBusiness School, For his original presentation of the model, see M¡chael E. Porter, "How Compet¡tiveForces Shape Strategy," Haruord Business Rev¡ew 57, no. z (March-April ry79\, pp. 7J7-L45. A morcthorough discussion can be found in Michael E. Potte\ Compe Strotegy: Techn¡ques for Anolyz-ing Indust es and Compet¡tog (New York; Free Press, 1980), chapter r. Porte/s five-forces modelof competit¡on is reaffirmed and extended in "The F¡ve Competitive Forces That Shape Strategy,"HoMord Bus¡ness Review 86, no. r (anuary zooS), pp. 78-93.


Competitive pressures stemming irom supplier bargaining power andsupplier-seller collaboration.

Competitive pressures associated with the threat of new entraflts into themarket.

Compeütive pressures associated with rh:alry among competing sellers toattract customers. This is usually the strongest of the five competitive forces.

The Competitive Force of Buyer BargainingPower and Seller-Buyer CollaborationWhether seller-buyer relationships represent a minor or significant competitiveforce depends on (1) whether some or many buyers have sufficient bargain-ing leverage to obtain price concessions and other favorable terms, and (2) theextent and importance of seller-buyer strategic partnerships in the industry.

FACTORS AFFECTINC BUYER BARCAINING POWER ThC ICvCT-

age that buyers have in negotiating favorable terms of the sale can range fromweak to strong. Individual consumers, for example, rarely have much bar-gaining power in negotiating price concessions or other favorable terms withsellers. The primary exceptions irvolve situations in which price hagglingis customary such as the purchase of new and used motor vehicles, homes,and other big-ticket items like jewelry and pleasure boats. For most consumergoods and services, individual buyers have no bargaining leverage-theiroption is to pay the seller's posted price, delay their purchase until prices andterms improve, or take their business elsewhere.

In contrast, large retail chains like Walmart, Best Buy, Staples, and HomeDepot typically have considerable negotiating leverage in purchasing prod-ucts from manufacturers because retailers usually stock just two or threecompeting brands of a product and rarely carry all competing brands. In addi-tion, the strong bargaining power of major supermarket chains like Kroger,Safeway, and Albertsons allows them to demand promotional allowances andlump-sum payments (called slotting fees) from food products manufacturersin return for stocking certain brands or putting them in the best shelf locations.Motor vehicle manufacturers have strong bargaining power in negotiating tobuy original equipment tires from Goodyear, Michelin, Bridgestone/Firestone,Continental, and Pirelli not only because they buy in large quantities. butalso because tire makers have judged original equiprnent tires to be importantcontributors to brand awareness and brand loyalty.

Even if buyers do not purchase in large quantities or offer a seller importantmarket exposure or prestige, they gain a degree of bargaining ler-erage in thefollowing circumstances:3

' Ifbuyers' costs of switching to competing brands or substitutes are telatiztely

lozu-Buyers who can readily switch between several sellers have morenegotiating leverage than buyers who have high switching costs. Whenthe products of rival sellers are virtually identical, it is relatively easy for

l Pofteí Competitive Strotegy, pp. 24-27t and Porter, "The Five Competitive Forces That Shape

Strategy," pp. 83-84.


buyers to switch from seller to seller at little or no cost. For example, thescrews, rivets, steel, and capacitors used in the production of large homeappliances like washers and dryers are all commoditylike and availablefrom many sellers. The potential for buyers to easily switch from oneseller to another encourages sellers to make concessions to win or retain abuyer's business.

. If the number of buyers is small or if a customer is particularly important to a

seller-The smaller the number of buyers, the less easy it is for sellers tofind alternative buyers when a customer is lost to a competitor. The pros-pcct of losing a customer who is not easily replaced often makes a sellermore willing to grant concessions of one kind or another. Because of therelatively small number of digital camera brands, the sellers of lensesand other components used in the manufacture of digital cameras arein a weak bargaining position in their negotiations with buyers of theircomPonents.

. If buyer demand is weak-Weak or declining demand creates a "buyers'market"; conversely, strong or rapidly growing demand creates a "sellers'market" and shifts bargaining power to sellers.

. [f buyers are well-informed about sellers' products, prices, and costs-The moreinformation buyers have, the better bargaining position they are in. Themushrooming availability of product information on the Internet is givingadded bargaining power to individuals. It has become commonplace forautomobile shoppers to a¡rive at dealerships armed with invoice prices,dealer holdback information, a summary of incentives, and manufactur-ers' financing terms.

. If buyers pose a credible threat of integrating backward into the business ofsellcrs-Companies like Anheuser-Busch, Coors, and Heinz have inte-grated backward into metal can manufacturing to gain bargainingpower in obtaining the balance of their can requirements from otherwisepowerful metal can manufacturers.

Figure 3.3 provides a summary of factors causing buyer bargaining powerto be strong or weak.

A final point to keep in mind i s that not all buyers of an industry's product haae

equal degrees of bargaining power with sellers, and some may be less sensitivethan others to price, quality, or serwice differences. For example, apparel man-ufacturers confront significant bargaining power when selling to big retailerslike Macy's, T. J. Maxx, or Target, but they can command much better pricesselling to small owner-managed apparel boutiques.

S ELLER-BUYER PARTN ERSHTPS AND'I H E COMPETITIVE POWEROF BUYERS Partnerships between sellers and buyers are an increasinglyimportant element of the competitive picture in business-to-business relation-ships (as opposed to business-to-consumer relationships). Many sellers thatprovide items to business customers have found it in their mutual interestto collaborate closely with buyers on such matters as just-in-time deliveries,order processing, electronic invoice payments, and data sharing. Many pro-cessed food and household products sellers have entered into partnerships

Chapter I Evaluating a Company's External Environment

FIGURE 9.3 tactors Afftcüng tfic Sürn8lft of Buycr ü6delq

with large supermarket and discount store buyers to improve the efficienryof their outbound logistics and to boost sales volumes. Such partnershipsalso benefit buyers by ensuring merchandise is in stock and inventory costsare minimized. Walmart allows its vendors like Procter & Gamble, Sara Lee,and Unilever to monitor store bar code scanner data to determine when andwhat sized shipments to Walmart's distibution centers are needed. ln someinstances. sellers ship inventory directly to each Walmart store as merchan-dise is sold and shelves become depleted. Walmart's tra¡sition from using barcodes to radio frequenry identification (RFID) was welcomed by sellers whosaw an opportunity to boost sales of their products in Walmart stores. RFIDreceivers in each Walmart store or distribution center allowed sellers to trackRFlD-tagged invmtory by number and location. Procter & Gamble and othersellers could then connect to Walmart's computer networks to watch the real-time inventory flow of items sold to Walmart and make just-in-time shipmentsto orevent inventorv stockouts.

The Competitive Force of Substitute Products

Companies in one industry are vulnerable to competitive pressure from theactions of companies in another industry whenever buyers view the prod-ucts of the two industries as good substitutes. For instance, the producers ofsugar experience competitive pressures from the sales and marketing effortsof the makers of Equal, Splenda, and Sweet'N Low Similarly, the produc-ers of eyeglasses and contact lenses face competitive pressures from doctorswho do corrective laser surgery. First-run movie theater chains are feelingcompetitive heat as more and more consumers are attracted to simply watchvideo-on-demand or movie DVDs at home in media rooms equipped with


big-screery high definition TVs and surround sound. The producers of metalcans are becoming increasingly engaged in a battle with the makers of retortpouches for the business of companies producing packaged fruits, vegeta-bles, meats, and pet foods. Retort pouches, which are multilayer packagesmade from polypropylene, alumínum foil, and polyester, are more athac-tively priced than metal cans because they are less expensive to produce andship than cans.

Just how strong the competitive pressures are from the sellers of substituteproducts depends on three factors:

T. Whether substitutes are readily aaailable and attractiuely priced. The presenceof readily available and attractively priced substifutes creates competitivepressure by placing a ceiling on the príces industry members can charge.aWhen substitutes are cheaper than an industry's product, industry mem-bers come under heavy competitive pressure to reduce their prices andfind ways to absorb the price cuts with cost reductions.

2, Whether buyers aiew the substitutes as comparable or better in tenns of quality,performance, and other rcIez¡ant attríbutes. Customers are prone to compareperformance and other attributes as well as price. For example, consum-ers have found digital cameras to be a superior substitute to film camerasbecause of the superior ease of use, the ability to download images to ahome computer, and the ability to delete bad shots without paying forfílm developing.

3. Whether the costs that btryers incur in switching to the substitutes are high orlow. F{igtt switching costs deter switching to substitutes while low switch-ing costs make it easier for the sellers of att¡active substitutes to lurebuyers to their products.s Typical switching costs include the inconve-nience of switching to a substitute, the costs of additional equipment, thepsychological costs of severing old supplier relationships, and employeeretraining costs.

Figure 3.4 summarizes the conditions that determine whether the competi-tive pressures from substitute products are strong, moderate, or weak. As arule, the lower the price of substitutes, the higher their quality and perfor-mance, and the lower the user's switching costs, the more intense the competi-tive pressures posed by substitute products.

The Competitive Force of Supplier Bargaining Powerand Supplier-Seller CollaborationWhether supplier-seller relationships represent a weak or strong competitiveforce depends on (1) the extent to which suppliers are able to shape the termsand conditions of sales of the items they supply to an industry and (2) thenatu¡e and extent of supplier-seller collabo¡ation in the industry.

( Porter, "How Competit¡ve Forces Shape Strategy," p. 142; Porter, Competitive Strotegy,pp. 23-24; and Porter, "The F¡ve Competit¡ve Forces That Shape Strategy," pp. 82-83.5 Pofter, Competitive Strategy, p. ro; and Porter, "The Flve Compet¡t¡ve Forces That Shape

Strategy," p. 85.


FIGU RE .3.4 Factors Affecting competition from Substitute ProducB

Slgns that Competltlon ftomSubdü¡tss ls Strong. Sales of substitutes are

growing faster than sales ofthe industry being analyzed(an indication that thesellers of substitutes aredrawing customers awayfrom the industry in question).

. ProduceB of subst¡tutes aremoving to add new capacity.

. Profits of the oroducers ofsubstltutes are on the rise.

eno|ltComp6üng*")

FACIORS INFLUENCI\G SUPPTIER BARCAINING PO!!tR Certainconditions exist that make it Possible for industry suPpliers to exert comPeti-tive pressure on one or more rival sellers. For instance, Microsoft and Intel,both of whom supply PC makers with essential comPonents. have been knownto use thcir dominant market status not only to charge PC makers premiumprices but also to leverage PC makers in other ways. The bargaining powerpossessed by Microsoft and Intel when negotiating rt'ith customers is so great

that both companies have faced antitrust charges on numerous occaslons.

Pnor to a legal agreement ending the practice in 2001, Microsoft pressured PC

makers to load only Microsoft products on the PCs they shippecl. Intel has also

defended against antitrust charges resulting from its bargaining strength, butcontinucs to give PC makers who use the biggest percentages of Intel chips intheir PC models top priority in filling orders for newly introduced Intel chips.Bein¡; on Intel's list of preferred customers helps a PC maker get an early allo-cation of Intel's latest chips and thus allort's a PC maker to get new models tomarket ahead of rivals.

Part Oner Sect¡on B: Core Concepts and AnalvticaI Tools

The factors that determine whether any of the industry suppliers arein a position to exert substantial bargaining power or leverage are fairlyclear-cut:6

' lf the item being supplied is a commoditt¡ thnt is readily naailable from manysuppliers. Suppliers have little or no bargaining power or leverage when-ever industry members have the ability to source from any of severalalternative and eager suppliers.

. The ability of industry members to switch their purchases from one supplier toanother or to switch to attractiae substitutes. High switching costs increasesupplier bargaining power, whereas low switching costs and the readyavailability of good substitute inputs weaken supplier bargaining power.

. If certain inputs are in short supply. Suppliers of items in short supply havesome degree of pricing power.

. If certain suppliers prouide a differentiated input that enhances the perfor-mance, quality, or image of the industry's product. The greater the ability ofa particular input to enhance a product's performance, quality, or image,the more bargaining leverage its suppliers are likely to possess.

. Whether certain suppliers prooide equipment or seruices tlmt deliaer cost saaingsto industry members in conducting their operations. Suppliers who providecost-saving equipment or services are likely to possess some degree ofbargaining ieverage.

. The f'raction of the costs of the industry's product accounted for by the cost of aparticular input. The bigger the cost of a specific part or component, themore opportunity for competition in the marketplace to be affected by theactions of suppliers to raise or lower their prices.

' If industry mentbers are major customers of suppliers. As a rule, suppiiershave less bargaining leverage when their sales to members of this oneindustry constibute a big percentage of their total sales. In such cases,the well-being of suppliers is closely tied to the well-being of their majorcustomers.

o Whether it makes good economic sense for industry members to oertically inte-grate backward. The make-or-buy decision generally boils down to whethersuppliers are able to supply a particular component at a lower cost thanindustry members could achieve if they were to integrate backward.

Figure 3.5 summarizes the conditions that tend to make supplíer bargain-ing power strong or weak.

HOW SELLER-SUPPLIER PARTNERSHIPS AFFECT CONlPETITIVEPRESS URES Just as sellers benefit from shategic partnerships with buyers,collaboration with suppliers may also prove rewarding for sellers. In manyindust¡ies, strategic partnerships with suppliers allow sellers to (1) reduceinventory and logistics costs (e.g., through just-in-time deliveries), (2) speedthe availability of next-generation components, (3) enhance the quality of the

6 Poner, Competitive Strotegy, pp. z7-28; and Porter, "The Five Competitive Forces That ShapeStrategy," pp. 82-81.


ITIGURE .3.5 Factors Affecting the Strengfh of Supptler Bargalnlng Foüyer

parts and components being supplied, and (4) squeeze out imPortant cost

savings for both themselves and their suppliers. Dell Computer has enteredinto strategic partnerships with its key suppliers to ensure its just-in-time deliv-eries of PC components arrive when needed. In some instances, Dell receivesjust-in-time delivery of computer pa¡ts every few hours. Many of Dell's keysuppliers have built plants and distribution centers within a few miles of Del1

assembly plants to mect these demanding delivery requirements. In addition,close rclationships r,r.ith suppliers allow Dell Computer to reduce the likeli-hood of recalled computers or production slowdowns. Many Dell suppliersassign engirreers to Dell assembly plants to quickly resolve production-relatedproblems as they occur. The more opportunities that exist for win-win effortsbetween a company and its suppliers, the less their relationship is character-ized by who has the upper hand in bargaining with the other.

The Competitive Force of Potential New Entrants

Several factors determine whether the threat of new companies entering themarketplace presents a significant competitive Pressure. One factor relates

to the size of the pool of likely entry candidates and the resources at theircommand. As a rule, the bigger the pool of entry candidates, the stronger thethreat of potential entry. This is especially true when some of the likely entrycandidates have ample resources to support entry into a ne¡¡' line of busi-ness. Frequently, the strongest competitive pressures associated with potentialentry come not from outsiders but from current industry participants lookingfor growth opportunities. Existittg irtdustry members are often strong candidates to

Buycrs

Part One: Section B: Core Conceots and Analvticat Tools

enter market segments or geographic nreas uhere they currently do ttot haae a marketpresence.

A second factor concerns whether the likely cntry candidates face high orlow entry barriers. High barriers reduce the competitive threat of potentialentry, while low barriers make entry more likely, especially if the industry isgrowing and offers attractive profit opportunities. The most lvidely encoun-tered barriers that entry candidates must hurdle include:7

. The presence of siznble economies of scale in production or other areas ofoperation-When incumbent companies eryoy cost advantages associatedwith large-scale operations, outsiders must either enter on a large scale (acostly and perhaps risky move) or accept a cost disadvantage and conse-quently lower profitability.

. Cost and reslltrce disadttantnges not reloted to scale oJ opernfion-Aside fromenjoying econornies of scale, índustry incumbents can ha"'e cost advan-tages that stem from cxperience/learning curve effects, the possession ofproprietary technology, partnerships with the best and cheapest suppli-ers, and low fixed costs (because thev have older facilities that have beenmostly depreciated).

. Strong brnnd preferences nnd high degrees of customer loyalty-The strongerthe attachmcnt of buyers to established brands, the harder it is for a new-comer to break into the marketplace.

. High capital requirements-The larger ihe total dollar investment neededto enter the market successfully, the more limited the pool of potentialentrants. The most obvious capital requirements for new entrants relateto manufacturing facilities and equipment, introductory advertising andsales promotion campaigns, working capital to finance inventories andcustomer credit, and sufficient cash to cover start-up costs.

. The difficulties of bttilding a netztork of distributors-retnilers and securingadequate space on retailers' shelaes-A potential entrant can face numerousdistribution chamel challenges. Wholesale distributors may be reluctantto take on a product that lacks buyer recognition. Retailers have to berecruited and convinced to give a new brand ample display space and anadequate trial period. Potential enhants sometimes have to "buy" theirway into wholesalc or retail chan¡els by cutting their prices to providedealers and distributors with higher markups and profit margins or bygiving them big advertising and promotional allowances.

. Restrictiue regulatory polici¿s 4overnment agencies can limit or even barentry by requiring licenses and permits. Regulated industries iike cableTV, telecommunications, electric and gas utilitics, and radio and televisionbroadcasting entail government-controlled entry

¡ The role of entry barriers in shaping the strength of competition in a particular market has longbeen a standard top¡c in the literature of microeconomics. For a discussion of how entry barriersaffect compet¡tive pressures associated with potentiaI entry, see J. S. Bain, Barr¡ers to New Com-pefifion (Cambr¡dge, MA: Harvard University Press, r956); F. M. Scherer, lndustrial Morket Structurcond Econom¡c Performance (Chicago: Rand McNally & Co., 1921), pp.216 22o, 226 2?3; Pofte\Compet¡t¡ve Strategy, pp. l-17i and Porter, "The Five Competit¡ve Forces That Shape Strategy,"oD.80-82.

Chapter 3 EvaLuating a Company's External Environment

. Tariffs nnd internationnl trade restrictiolrs-National governments commonlyuse tariffs and trade restrictions (antidumping rules, local content require-ments, local ownership requirements, quotas, etc.) to raise entry barriersfor foreign firms and protect domestic producers from outside competition'

. The ability and willingness of industry incumbents to launch aigorous initiatiuesto block a newcomer's successful entry-Even if a potential entrant has or can

acquire the needed competencies and resources to attemPt entry, it muststill worry about the reaction of existing firms.s Sometimes, there's littlethat incumbents can do to throw obstacles ín an entrant's path. But thereare times when incumbents use price cuts, increase advertising, introduceproduct improvements, and launch legal attacks to Prevent the entrantfrom building a clientele. Cable TV companies have vigorously fought the

entry of satellite TV into the industry by seeking government interventionto delay satellíte providers in offering local stations, offering satellite cus-

tomers díscounts to switch back to cable, and charging satellite customershigh monthly rates for cable lnternet access.

In evaluating the overall effect of barriers io entry in preventing newcomers

from entering the indusiry. company managers must also look at how attrac-

tive the growth and profit prospects are for new entrants. Rapidly grouing mar-

ket dentand and high potential profits act as mttgnets, motiaatíng potential entrants to

comrtit the resources needed to hurdle entry barriers.'qWhen profits are sufficientlyattractive, entry barriers are unlikely to be an effective entry deterrent. Hence,

the best test of whether potential entry is a strong or zueak competitiae force in the

marketplace is to ask if the inttustry's growth and profit prospects are strongly atttac-

tiue to potential entry candidates.

Figure 3.6 summarizes conditions making the th¡eat of entry strong orweak.

The Competitive Force of Rivalry among Competing Sellers

The strongest of the five competitive forces is nearly always the rivalry amongcompeting sellers of a product or service. In effect, a market is a competitizte bat-

tlefield where there's no end to the campaign for buyer patronage. Rival sellers

are prone to employ whatever weapons thcy have in their business arsenal toimprove their market positions, strengthcn their market position with buyers,and earn good profits. The strategy-making challenge is to craft a competitivestrategy that, at the very least, allows a comPany to hold its own against rivalsand that, ideally, produces a competitiae edge orter riaals. But comPetitive con-tcsts are ongoing and dynamic. When one firm makes a strategic move thatproduces good results, its rivals typically respond with offensive or defen-sive countermoves of their own. This Pattetn of action and reaction produces

a continually evolving competitive landscape where the market battle ebbs

and flows and produces winners and losers. But the current market leaders

have no guarantees of continued leadership. In every industry, the ongoing

3 Porter, "How Competitive Forces Shape Strategy, p. 14o; Porter, Compet¡t¡ve Strotegy, pp. 74-15|

and Porter, "The Five Compet¡t¡ve Forces That Shape Strategy," p. 82.e For a good discussion of th¡s po¡nt, see George S. Y¡p, 'Gateways to Entry," HoNard Bus¡ness

Review 60, no. 5 (September October 1982), pp. 85-93.

B: Core Concepts and Analytical Tools

FIGURE 5.6 Factors Affecting the Thr€at of Enby

jockeying of rivals leads to one or another companies gaining or losing momen-tum in the marketplace according to whether their latest strategic maneuverssucceed or fail.lo

Figure 3.7 shows a sampling of competitive weapons that firms can deployin battling rivals and indicates the factors that influence the intensity of theirrivalry. Some of the factors that influence the tempo of rivalry among industrycompetitors include:I

. Riualry intensifies when competing sellers regularly launch fresh actions to boosttheir market standing and business performance. Normally, competitive jock-eying among rival sellers is fairly intense. Indicators of strong competitive

'"The tendency of firms to counter compet¡tive moves of rival firms can cause escalating compet¡-tive pressures that affect the prof¡tability of rivals; see Pamela J. Derfus, patrick G. Maggitti, CurtisM. Grimm, and Ken G. Smith, "The Red Queen Effuct: Competitive Actions and Firm performance,',

Academy of Manogement lournol 5t, no. r (February 2oo8), pp. 61-80." Many of these ¡ndicators of whether rivalry produces intense competitive Dressures are basedon Porter, Competitive Strotegy, pp- t7-27i and Porter, "The Five Competit¡ve Forces That ShapeStrategy," pp. 85-86.

HYeLy¡mong

CompsdrUSolbrt

Chapter I Evaluating a Company's External Env¡ronment

3;? ,.Ircbo lfft<dng th. Str€ngth of

rivalry include lively price competition, the rapid introduction ofnext-generation products, and moves to differentiate products by offeringbetter performance features, higher quality, improved customer service,or a wider product selection. Other common tactics used to temporarilyboost sales include special sales promotions, heavy advertising. rebates,

or low-interest-rate financin g.

Riaalry is stronger in industries where competitors are equnl in size and capabili$.Competitive rivalry in the quick-service restaurant industry is particu-larly strong, where there are numerous relatively equal-sized hamburger,deli sand.wich, chicken, and taco chains. For the most part, McDonald's,Burger King, Taco Bell, KFC, Arby's, and other national fast food chainshave comparable capabilities and are required to compete aggressively tohold their orvn in the industry.

Riaalry is usually stronger in slout-grouing markets and weaker in fast-groToingmarkets. Rapidly expanding buyer demand produces enough new businessfor all industry members to grow. But in markets where growth is slug-gish or where buyer demand drops off unexpectedly, it is not uncorrunon

Part One: Section B: Core Concepts and Anatvtical Tools

for competitive rivalry to intensif significantly as rivals battle for marketshare and. volume gains.

Ríaalry is usually weaker in industries comprised of aast numbers of small rittals;Iikewise, it is often weak when there are fewer than fiae compeflfors. Head-to-head rivalry tends to be weak once an industry becomes populated withso many rivals that the strategic moves of any one competitor have littlediscernible impact on the success of rivals. Rivalry also tends to be weak ifan industry consists of just two to four sellers. In a market with few rivals.each competitor soon learns that aggressive moves to grow its sales andmarket share can have an immediate adverse impact on rivals' businesses,almost certainly provoking vigorous retaliation. However, some cautionmust be exercised in concluding that rivalry is weak just because there areonly a few competitors. The fierceness of the current battle between Linuxand Microsoft and the decades-long war between Coca-Cola and Pepsiare prime examples.

Riaalry increases zuhen huyer demand falls off and sellers find themselaes withcxcess capacity and/or inoentory. Excess supply conditions create a "buyers'market," putting added competitive pressure on industry rivals to scram-ble for profitable sales levels (often by price discounting).

Riztalry increases as it becomes less costly for buyers to szuitch brnnds. The lessexpensive it is for buyers to switch their purchases from the seller of onebrand to the seller of another brand, the easier it is for sellers to stealcustomers away from rivals.

Riztalry increases as the products of riaal sellers become morc standardized anddiminishes as the products of industry riuals become more differentiated. i/y'}lren

the offerings of rivals are identical or weakly differentiated, buyers haveless reason to be brand loyal-a condition which makes it easier for rivalsto convince buyers to switch to their offering. On the other hand, stronglydifferentiated product offerings among rivals breed high brand loyalty onthe part of buyers.

Riaalry is more intense when industry conditions tempt competitors to use pricecuts or other competitiae weapons to boost uttit uolume, When a product isperishable, seasonal, or costly to hold in inventory, competitive pressuresbuild quickly any time one or more firms decide to cut prices and dumpsupplies on the market. Likewise, whenever fixed costs account for a

large fraction of total cost, so that unit costs tend to be lowest at or nearfull capacity, firms come under significant pressure to cut prices or other-wise try to boost sales whenever they are operating below full capacity.

Riaalry increnses when one or moÍe competitors become dissatisJied with theirmarket position Firms that are losing ground or are in fina¡rcial troubleoften pursue aggressive (or perhaps desperate) tumaround strategies thatcan involve price discounts, greater advertising, or merger with otherrivals. Such strategies can turn competitive pressures up a notch.

Riaalry increases when strong companies outside the mdustry acquire zueak firmsin the industry and launch aggressiae, well-funded moaes to build market share.

A concerted effort to turn a weak rival into a rnarket leader nearly alwaysentails launching well-financed strategic initiatives to dramatically

Chapter 3 Evaluating a Company's External Environment

improve the competitor's product offering, excite buyer interest, and \^.ina much bigger market share-actions that,, if successful, put added pres-sure on rivals to counter with fresh strategic moves of their own.

Rivalry can be characterized as cuttfuoat or brutnl when competitors engagein protracted price wars or habitually employ other aggressive tactics thatare mutually destructive to profitability. Rivalry can be considered fierce Lo

s/rong when the battle for market share is so vigorous that the profit marginsof most industry members are squeezed to bare-bones levels. Rivalry can becharacterized as modernte <>t rtonnaL when ihe maneuvering among industrymembers, n'hile lively and healthy, still allows most industry members to earnacceptable profits. Rivalry is ztteak r,r.hen most companies in the industry arerelatively weli satisfied with their sales growth and market share and rarelyundertake offensives to steal customers awav from one another.

The Collective Strengths of the Five Competitive Forcesand Industry ProfitabitityScrutinizing each of the five competitive forces one by one provides a power-ful diagnosis of il'hat competition is like in a given market. Once the strate-gist has gained an understanding of the competitive pressures associated witheach of the five forces, the next step is to evaluate the collective strength ofthe five forces and determine if companies in this industry should reasonablyexpect to earn decent profits.

As n rule, tlrc stronger the collectiue impact of the fi-L)e competitiae forces, the lowertlrc combined profitability of industry pnrticipnnts. The most extreme case of a

"competitively unattractir¡e" indr-rstry is when all five forces are producingstrong competitive pressures: Rivalry among seliers is vigorous, iow entry bar-riers allow new rivals to gain a market foothold, competition from substitutesis intense, and both suppliers and customers are able to exercise considerablebargaining leverage. Fierce to strong competitive pressures coming from allfive directions nearly always drivc industry profitability to unacceptably lowlevels, frequently producing losses for many industry members and forcingsome out of business. But an industry can be competitively unattractive with-out all five competitive forces being strong. Intense competitive pressures fromjust tw'o or three of the five forces may suffice to destroy the conditions forgood profitability. Unattractive competiüvc conditions that includc strong sub-stitutes, fierce competitive rivalry, and lor'r, buyer switching costs, for example,have created a d.ismal outlook for the video rental business. ln 2008, Block-buster recorded a net loss of $374 million on revenues of S5.3 billion, whileindustry runner-up, Movie Gallery, entered into bankruptcy in October 2007

after recording losses for three consecutive years. Movie Callery lost an addi-tional $70 million by the end of 2007 and its shares weredelisted by NASDAQ in 2008. The stronger the forces of competition, the

In contrast, when the collective impact of the five harder it becomes for industry members to earncompetitive forces is moderate t<t weak, an industry athactive profits.

is competitively attractive in the sense that industrymembers can reasonably expect to earn good profits and a nice retlun oninvestment. The ideal cornpetitive environment for earning superior profits is


one in which both suppliers and customers are in weak bargaining positions,there a¡e no ¡;ood substitutes, high barriers block further entry, and rivalrvamong present sellers generates only moderate competitive pressures. Weak

competition is the best of all possible worlds for companies with mediocrestrategies and second-rate implementation because even they can expcct a

,-lo¡on r nrnfi+

Question 3: What Are the Indust4/sDriving Forces of Change andWhat lmpact Witl They Have?

The intensity of competitive forces and the level of industry attractiveness arealmost alwavs fluid and subject to change. It is essential for strategy makers tounderstand the current competitive dynamics of the industrrv, but it is equailyimportant for strategy makers to considcr how the industry is changing andthe effect of industry changcs that are under way. Any strategies devised bvmanagement will play out in a dynamic industry environment, so it's impera-tive that such plans consider what the industry environment might look likedurinq the near term.

The Concept of Industry Driving Forces

Industry and competitive conditions chan¡;e because forces are enticrng orpressuring certain industry participants (competitors, customers, suppliers) to

alter their actions in important ways.12 The most pow-

Drgng forces are üre major underlying causes erful of the change agents are called driving forces

of change in industry and competitive cond¡tions. because they have the biggest influences in reshapingthe industry landscape and altcring competitive con-

ditions. Some driving forces originate in the outer ring of the company's macro-environment (see Figure 3.1) but most originate in the company's moreimmediate industry and competitive environment.

Driving forces analysis has th¡ee steps: (1) identifying what the drivingforces are, (2) assessing whether the drivers of change are, individually orcollectively, acting to make the industry more or less attractive, and (3) detcr-mining what strategy changes are needed to prepare for thc impact of thedrivinq forces.

ldentiffing an Indust4/s Driving Forces

Many developments can affect an industrv powerfullv enough to qualify as

driving forces, but most drivers of industry and competitivc change fall intoone of the follor,r'ing categories:r:'

' Changes in an industry's long-term groztth rate-Shifts in industry growthhave the potential to affect the balance between inclustry supply and buyer

" Pofter, Competitíve Strategy, p. 162.

'r Most of the driving forces described here are based on the discussion in Poftel CompetitiveStrategy, pp. 164-183.

Chapter 3 Evaluating á Company's External Environment

demand, entry and exit, and the character and strength of competition.An upsurge in buyer demand triggers a race among estabüshed firmsand newcomers to capture the new sales opportunities. A slowdown inthe growth of demand nearly always brings an increase in rivalry andincreased efforts by some firms to maintain their high rates of growth bytaking sales and market share away from rivals.

Increasing globalization-Competition begins to shift from primarilya regional or national focus to an international or global focus whenindustry members begin seeking out customers in foreign markets orwhen production activities begin to migrate to countries where costs arelowest. The forces of globalization are sometimes such a strong driverthat companies find it highly advantageous, if not necessary, to spreadtheir operating reach into more and more country markets. Globaliza-tion is very much a driver of industry change in such industries as creditcards, mobile phones, digital cameras, golf and ski equipment, motorvehicles, steel, petroleum, personal computers, and videogames.

Emerging nau Intern et capabilities and applications-Mushrooming Intemetuse and an ever growing series of Intemet applications and capabilities havebeen major drivers of cha¡rge in industry after industry The ability of com-panies to reach consumers via the Intemet increases the number of rivalsa company faces and often escalates rivalry by pitting pure online sellersagainst local brick-and-mortar sellers. The lntemet gives buyers unprec-edented ability to research the product offerings of competitors and shopthe market for the best value. Widespread use of e-mail has foreve¡ erodedthe business of providing fax services and the first-class mail delivery rev-enues of govemmental postal services wo¡ldwide- Video<onferencing viathe Intemet erodes the demand for business travel. Online course offeringsare profoundly affecting highe¡ education. The Intemet of the future willfeature faster speeds, dazzhng applications, and over a billion connectedgadgets performing an array of functions, thus driving further industry andcompetitive changes. But lntemet-related impacts vary from industry toindustry. The challenges here are to assess precisely how emerging Intemetdevelopments are alter.ing a particular industry's landscape and to factorthese impacts into the strategy-making equation.

Changes in who buys the product and how they use if-Shifts in buyer dcmo-graphics and the ways products a¡e used can alter competition by affect-ing how customers perceive value, how customers make purchasingdecisions, and where customers purchase the product. The burgeoningpopularity of downloading music from the Internet has significantlychanged the recording industry. Consumers often consider format com-patibility with iPods, MP3 players, or mobile phones, and may acquirethe track either legally through an online store or illegally through a filesharing network. According to Nielsen SoundScan, album sales havedeclined from 785.1 million units in 2000 to 428 million units ir 2008. Thechanging nature of consumer music purchases led to digital single saiesby Web sites such as iTünes Store, Rhapsody, Napster, and Walmart.comto exceed 1 billion in 2008.

Part One; Section B: Core Concepts and Analytical Tools

Product innoontion-An ongoing stream of product innovations tends toalter the pattem of competition in an industry by athacting more first-timebuyers, rejuvenating industry growth, and/or creating wider or narrowerproduct differentiation among rival sellers. Product innovation has been a

key driving force in such industries as computers, digital cameras, televi-sions, video games, and prescription drugs.

Technological change and rnanufact uring process innoaation-Advances intechnology can dramatically alter an industry's landscape, making ii pos-sible to produce new and better products at lower cost and opening upwhole new industry frontiers. For instance, Voice over lnternet Protocoltechnology (VoIP) has spawned low-cost, Internet-based phone networksthat have begun competing with traditional telephone companies world-wide (whose higher cost technology depends on hard-wire connectionsvia overhead and underground telephone lines).

Marketing innoztation-When firms are successful in introducing nexu ways

to market their products. they can spark a burst of buyer interest, widenindustry demand, increase product differentiation, and lower unit costs-any or all of which can alter the competitive positions of rival firms andforce strategy revisions.

Entry or exit of major firms-lhe entry of one or more foreign companiesinto a geographic market once dominated by domestic firms nearlyalways shakes up competitive conditions. Likewise, when an establisheddomestic firm from another rndustry attemPts entry either by acquisitionor by launching its own start-up venture, it usually pushcs competition innew directions.

Difusion of technical know-hou: across more companies and more cottntries-Asknowledge about how to perform a partícular activity or execute a particu-lar manufacturing technology spreads, the competitive advantage held byfirms originally possessing this know-how erodes. Knowledge diffusioncan occur through scientific journals, t¡ade publications, onsite plant tours,word of mouth among suppliers and customers, employee migration, andInternet sources.

Changes in cost and efficiency-Widen;ng or shrinking differences in the

costs among key competitors tend to dramatically alter the state ofcompetition. Declining costs to produce PCs have enabled price cuts andspurred PC sales (especialiy lower-priced models) by making them moreaffordable to lower income households worldu'ide.

Growing buyer preferences for differentiated prodttcts instead of a commoditypro.luct (or for a more standardized product insLead of strongly dffirentiatedproducts)-When a shift from standardized to differentiated productsoccurs, rivals must adopt strategies to outdifferentiate one another.However, buyers sometimes decide ihat a standardized. budget-pricedproduct suits their requirements as well as a premium-priced productwith lots of snappy features and personalized services.

Regulatory influences and goaernment policy changcs-Government regula-tory acüons can often forcc significant changes in industry practices and

Chapter 3 Evaluating a Company's External Env¡ronment

strategic approaches. Passage of the "Do Not Call Registry" in 2003 hasmade it difficult for many businesses relying on telemarketing-based sales

approaches to generate new customers. For example, Scholastic, Inc., theworld's largest publisher and distributor of children's books (includingHarry Potter and The Baby-Sitters C/ub), announced i¡ 2008 that it woulddivest its direct-to-home book club business unit because of challengescreated by the "Do Not CaIl" legislation. Scholastic's book-club divisionhad for years relied on telemarkcting to sign up ncw book club mem-bers. (Note that this driving force is spawned by forces in a company'smacrocnvironment. )

. Changing societal concerns, attitudes, and lifestyles-Emerging social issuesand changing attitudes and lifestyles can be powerful instigators of indus-try change. Consumer concerns about salt, sugar, chemical additives, sat-urated fat, cholesterol, carbohydrates, and nutritional value have forcedfood producers to revamp food-processing techniques, redirect R&Defforts into the use of healthier ingredients, and compete in deveklpingnutritious, good-tasting products.

While many forces of change may be at r+'ork in a given industry, no more

than tfuee or four are likely to be true driving forces powerful enough to qualifyas lhe major determinants of why and how the industry is changing. Thus com-pany strategists must resist the temptation to label every change they see as a

driving force. Table 3.2 lists the most common driving forces.

Assessing the lmpact of the Industry Driving Forces

The second step in driving forces analysis is to determine whether the prevail-ing clriving forces are acting to make the industry environment more or

1. Changes in the long-term rndustry growth rate.

2. Increasing globalization.3. Emerging new Internet capabilities and applications.4. Changes in '"vho buys the product ¿nd hou,,they use it.5 Product innovation.6. Technological change and manufacturing process innovation.7. Marketing ¡nnovat¡on,8. Entrv or cxit of maior irrms.9. Ditiusion of technical know-horv across more comnanies and more countries.

10. Changes in cost and efficiency,1 1. Crowing buyer pret'erences for differentiated products instead of a standardized

commodity product (or for a more standardized product instead of stronglydifferentiated products).

12. Rcgulatory influcnccs and govcrnmcnt polrcy changcs.13. Changing societal concerns, att¡tudes, and lilestyles.

Table 3.2

An important part of driving forces analysis is todetermine whether the individual or collective

impact of the driving forces will be to increase

or decrease market demand, make competitionmore or less intense, and lead to higher or

lower industry profr tability.

Part One: Section B: Core Conceots and Analvl¡cal TooLs

less attractive. Getting a handle on the collective impact of the driving forcesusually requires looking at the likely effects of each force separately, because

the driving forces may not all be pushing change in thesame direction. For exarnple, two driving forces maybe acting to spur demand for the industry's productvr'hile one driving force may be working to curtaildemand. Whether the net effect on industry demand isup or down hinges on which driving forces are themore pou'erful.

Determining Strategy Changes Needed to Prepare for thelmpact of Driving Forces

The third step of driving forces analvsis-u,'here the real payoff for strategymakin¡; cornes-is for rnanagers to dralv some conclusions about n hat strat-egy adjustments will be needed to deal with the impact of the driving forces.Without understanding the forces driving industry change and the impacts

these forces will have on the industry environment

The real payoff of driving forces analysis is to over the next one to three years, managers are ill pre-

help managers understand what strategy pared to craft a strategy tightly matched to cmcrgingchanges are needed to prepare for the impacts conditions. Similarly, if managers are uncertain ab<>ut

of the driving forces. the implications of one or more clriving forces, or iftherr vier,vs are off-base, it rvill be difficult for them to

craft a strategy that is responsive to the consequences of driving forces. So

driving forces analysis is not something to take lightly; it has practical valueand is basic to the task of thinking strategicallv about where the industry isheadcd and how to prcparc for the changcs ahcad-

Question 4: How Are Industry Rivals Positioned?The nature of competitive strategv irrherently Lrositions companies competingin an industry into strategic groups with diverse price,/quality ranges, differ-cnt distribution channels, varying product fcaturcs, and diffcrcnt gcographiccoverages. The best technique for revealing the market positions of indus-try competitors is strategic group mapping.r I This analytical tool is usefulfor comparing the market positions of industry competitors or for groupingindustry cr>mbatants into like positions.

Using Strategic Group Maps to Assess the Positioning ofKey Competitors

A strategic group consisis of those industrv membersA süategic group is a cluster of industry rivals with similar competitive approaches and positions inthat have similar competitive approaches and the market.rs Companies in the same strategic gror-Lpmarket positions' can resemble one another rn anv of se,reral *iys:tlley

may have comparable product-line breadth, sell rnthe same price/quality range, emphasize the same distribution channels, use

essentially the same product attributes to appeal to similar typcs of buyers,

'a Pofter, Competitive Strotegy, chapter 7.

'5 lbid., pp. 129-30.

^,.rnu, ,nu,ron."n, UU

COMPARATIVE MARKET POSITIONS OF SELECTED AUTOMOBITE MANUFACTURERS: ASTRATEGIC GROUP MAP APPLICATION

H igh

Few Models Many Models

Model Varietv (compact. futl-size, SUvs, trucks)

Note: Circles are drawn roughly proportionaL to the total revenues oF manufacturers ¡ncluded in each strategic group.

dcpcnd on identical tcchnological approachcs, or offer buyers similar servicesand technical assistance. n An industry rvith a commoditylike product ma,v corr-

tairr only one str¡rtegic group rvherebv all sellers pursr-re esser-rtiallv iclenticalstrategies and have com¡rarable market posrtions. But er.en rvitl-r commodityproducts, there is hkelv some attempt at differentiation taking placc in thc formof varving delivery times, fínancing terms, or lcvcls of customer service. Mostinclustrie.s offcr a host of compctitivc approaches that allorv companies kr findunique industry positioning and avoid fierce competition in a cror,r,ded strate-gic group. Evaluating strategy options entails eramining rvhat strategic groLrps

'úFor an excellent discussio¡ of how to ¡dentiñ,, the factors that define strategic groups, see

lvlary Etlen Gordon and George R lvl¡lne, "5electing the Dimensions That Defrne Strateg¡c Groups:

A Novel [4arket-Driven Approach," /ournal of Managerial lssues r, no z (Summer ry99), pp.

2r3 23J.

BMWllercedesBenz

VollswagrnHonda

General MotorsFord

Part One: Section B: Core Concepts and Analyt¡cal Tools

exist, identi$ring which companies exist within each group, and determiningif a competitive "white space" exísts where ir-rdustry competitors are able tocreate and capture altogether new demand.

The procedure for constructing a strategic group map rs straightforward:

. Identify the competitive characteristics that delincate strategic approachesused in the industry. Typical variables used in creating strategic groupmaps are the price/quality range (high, medium, low), geographic cover-age (local, regional, national, global), degree of vertical integration (none,

partial, full), product-line breadth (wide, narrow), choice of distributionchannels (retail, wholesale, Internet, multiple channels), and degree ofservice offered (no-frills, Iimited, full).

. Plot firms on a two-variable map based upon their strategic approaches.

. Assign firms occupying the same map location to a common strategic

8rouP.. Draw circles around each strategic group, making the circies proportional

to the size of the group's share of total industry sales revenues.

This produces a two-dimensional diagram like the one for the world auto-mobile industry in Concepts & Connections 3.1.

Several guidelincs need to bc obscrvcd in creating strategic group maps.l7First, the two variables selected as axes for the map should nof be hi¡;hly corre-lated; if they are, the circles on the map will fall along a diagonal and strategymakers will learn nothing more about the relative positions of competitorsthan they would bv considering just one of the variables. For instance, if com-panies with broad product lines use multiple distribution channels while com-panies with narrow lines use a single distribution channel, then looking atproduct line breadth reveals just as much about industry positioning as iook-ing at the two competitive variables. Second, the variables chosen as axes forthe map should reflect key approaches to offering value to customers andexpose big differences in how rivals position themselves in the markebplace.Third, the variables used as axes don't have to be either quantitative or con-tinuous; rather, they can be discrcte va¡iables or dcfined in tcrms of distinctclasses and combinations. Fourth, drawing the sizes of the circles on the mapproportional to the combined sales of the firms in each strategic group allowsthe map to reflect the relative sizes of each strategic group. Fifth, if more thantwo good competitive variables can be used as axes for the map, multiplemaps can be drawn to give different exposures to the competitive positioningin the industry. Because there is not necessarily one best map for portrayinghorv competing firms are positioned in the market, it is advisable to experi-ment with different pairs of competitive variables.

The Value of Strategic Group MapsStrategic group maps are revealin¡; in several respects. The nrosf irnportnnthas to do with identifying which rivals are similarly positioned and are thus

'/ Pol.eí Compet¡t¡ve Strategy, pp. 152-154.

Chapter.S Evaluating a Company's External Env¡ronment

close rivals and which are distant rivals. Generally spe aking, the closer strategicgloups are to each other on the map, the stronger the cross group competitiue riaalrytends to &e. Although firms in the same strategic group are the closest rivals,the next closest rivals are in the immediatcly adjacent groups.ls Often, firmsin strategic groups that are far apart on the map hardly compete at all. Forinstance, Walmart's clientele, merchandise selection, and pricing points aremuch too different to justify calling them close competitors of Neiman Marcusor Saks Fifth Avenue in retailing. For the same reason, Timex is not a meaning-ful competitive rival of Rolex, and Kia is not a close competitor of Porsche o¡Lexus.

The second thing to be gleaned from strategic group mapping is that not allposit¡otls on the mlp are equally attracthte. Two reasons account for why somepositions can be more attractive than others:

1.. btdustry driuing forces may faaor some strategic groups and hurt others.tu

Driving forces in an industry may be acting to grow the demand forthe products of firms in some strategic groups and shrink the demandfor the products of firms in other strategic Broups-as is the case in thenews industry where Internet news services and cable news networksare gaining ground at the expense of newspapers and netwo¡k televi-sion. The industry driving forces of emerging Internet capabilities andapplications, changes in who buys the product and how they use it, andchanging societal concerns. attitudes, and lifestyles are making it increas-ingly difficult for traditional media to increase audiences and attract newadvertisers.

2. Competitiue Fressures may cnL$e Lhe profif ¡totential of different strategicgloups to aary. The profit prospects of firms in different strategic groupscan vary from good to poor because of differing degrees of competitiverivalry within strategic groups, differing degrees of exposure to com-petition from substitute products outside the industrv and differingdegrees of suppiier or customer bargaining power from group to Broup.For instance, the competitive battle between Walmart and Target is moreintense (with consequently smaller profit margins) than the rivalry amongVersace, Chanel, Fendi, and other high-end fashion retailers.

Thus, part of strategic group analysis always entails drawing conclusionsabout where on the map is the "best" place to bc and why. Which companiesor strategic groups are in the best positions to prosper and which might be

expected to struggle? And equally important, how might firms in poorly posi-tioned strategic groups reposition themselves to improve their prospects forgood financial performance?

'3 Strategic groups act as good reference points for pred¡cting the evolution of an ¡ndustry's

competitive structure. See Avi Fiegenbaum and Howard Thomas, "Strategic Groups as Reference

Groups: Theory Modeling and Emp¡rical Exam¡nation of Industry and Competitive Strategy," Sfr¿te-gk Monogement Journol t6 Ggq:), pp. 467-476. Fo( a study of how strategic group analysis helps

identify the variabtes that lead to sustainable competitive advantage, see S. Ade 0lusoga, Michael

P lv]okwa, and Charles H. Noble, "Strategic Groups, Mobility Barriers, and Compet¡tive Advantage,"

Journol of Bus¡ness Reseorch jJ b99), pp. r53 164.

', lbid., Porter, Compet¡t¡ve Str1tegy, pp. 130,132 138, and r54 155.

Part One: Section B; Core Conceots and Analvtical Tools

Question 5: What Strategic Moves Are RivalsLikety to Make Next?As in sports, scouting the busincss opposition is an essential part of game plandevelopment. Competitive intelligence about rivals' strategies, their latestactions and announcements, their resource strengths and weaknesses, and thethinking and ieadership styles of their executives is valuable for predicting thestrategic moves competitors are likely to make next. Having good informationto predict the likel¡r moves of key competitors allows a company to preparedefensive countermoves and to exploit any openings that arise from competi-tors'missteps.

Predicting the Moves of Industry Rivals

Considerations in trying to predict what strategic moves rivals are likely tomake next include the following:

. What executives are saying about vr.here the industry is headed, the firm'ssibuation, and their past actions and leadership styles.

. Identifying trends in the timing of new product launches or marketin¡;

Promotlons.. Determining lvhich rivals badly need to increase unit sales and market

share.

. Considering which rivals have a strong incentive, along with theresources, to make major strategic changes.

. Knowing which rivals are likely to enter new geographic markcts.

. Deciding n'hich rivals are strong candidates to expand their procluctofferings and enter new product segments.

To succeed in predicting a competitor's next moves,Studying competitors' past behavior, and company strategists need to have a goocl understandingpreferences provides a valuable assist in of cach rival's si-tuation, its pattem ofbehavior and pref-anticipaüng what moves rivals are likely to make erences i. respondingnext and outmaneuvering them in the ;^-;:^.',marketplace. best strategic options

measures success. Docan be tedious and time-consuming, but scouting com-

petitors well enough to anticipate their next moves allows managers to prepareeffective cor.rntermoves and to take rivals' probable actions into account in craft-ing their own offensive strategies.2(r

BUSINESS ETHICS ,,\\D CO]VIPETITIVE INTELLICENCE ThOSC

who gather competitive intelligence on rivals, however, can sometrmes crossthe fine line betrveen honest inquiry and unethical or even illegal behavior.For example, callir-rg rivals to get information about prices, the dates of r-rew

'" For an excellent discussion of an effect¡ve methodology that may be used to predict rivals'next moves, see Kev¡n P. Coyne and John Horn, "Predicting Your Competitor's Reaclion," HarvardBus¡ness Review 87, no. 4 (April 2oo9), pp. 90-97.

67Chapter s Evaluat¡ng a Company's External Environment

product inttrductions, or wage and salary levels is legal, but misrepresentingone's company affiliation during such calls is unethical. Pumping rivals'representatives at trade shows is ethical only if one wears a name tag withaccurate company affiliation ind.icated. Avon Products at one point secured

information about its biggest ri'r'al, Mary Kay Cosmetics (MKC), by havingits personnel search through the garbage bins outside MKC's headquar-ters.2l When MKC officials learned of the action and sucd, Avon claimed itdid nothing illegal, since a 1988 Suprcmc Court case had ruled that trashleft on public property (in this case, a sidewalk) was anyone's for the tak-ing. Avon even produccd a videotape of its removal of the trash at the MKCsite. Avon won the lawsuit-but Avon's action, while legal, scarcelv qualifiesas ethical.

Question 6: What Are the lndustryKey Success Factors?An industry's key success factors (KSFs) are those competitive factors thatmost affect industry members' ability to prosper in the marketplace. Keysuccess factors may include particular strategy ele-ments, product attributes, tesources, competitive capa- Key success factors are the strategy ele'

bilities, or intangible assets. KSFs by their very nature ments, product attr¡butes, competitive capab¡l¡-

are so importar,i to futur" competiiive succesi that all ties, or intangible assets with the greatest

firnts in thc industry must pay ckrse attention to them impact on future success in the marketplace

or risk an er.entual exit from the inclustry.ln the ready-to-wear apparel industry, the KSFs are appealing designs and

color combinations, low-cost manufacturing, a strollg network of retailersor company-owned stores, distribution capabilities that allow stores to keeP

the best-selling items in stock, and advertisements that effectivcly convey the

brand's image. These attríbutes and capabilitics apply to all brands of apparelranging from private-label brands sold by discounters to premium-pricedready-to-wear brands sold by upscale department stores. Table 3.3 lists themost common types of industry key success factors.

An industry's key success factors can usually be deduced through identi-fying the industry's dominant characteristics, assessing the five comPetitiveforces, considering the impacts of the driving forces, comparing the marketpositions of industrr¡ members, and fo¡ecasting thc likely next moves of keyri'r'als. In addition, the ansrvers to the following thrcc questions help identifvan industry's key success factors:

1. C)n what basis do buvers of the industry's product choose betweenthe competing brands of sellers? That is, what product attributes are

c¡ucial?

2. Given the nature of the competitive forces prevailing in the marketplace,r.r'hat resources and cornpetitive capabilities does a company need to haveto be competitivelv successful?

" Larry Kahaner, Compet¡t¡ve lntell¡gence (New York: Simon and Schuster, 1996), pp. 84-85.

Paft Onc: Section Core ConceDts and Anatvt¡cal Tools

Table 3.3

Technology-related KSFs

Manufacturing-related KSFs

Dist¡ibution-related KSFs

Marketing-related KSts

Skills- and capability-relatedKSFs

Other types of KSFs

Expertise in a particular technology or in scicntiflc rcscarch (impoftantin pharmaceutica ls, lntcrnct applications, mobile conrmu n ications, andmost "h¡gh{ech" industries)Proven ability to improve production processes (important ¡n industneswhere advancing technology opens the way for higher manufacturingeflicrency and lower production costs)

Ability to achieve scale economies and,/or capture experience curveetfects (important to achieving low production costs)

Quality control knor'r-how (important in industries where customersinsist on oroduct reliabilitvlHigh utilization of fixcd asscts (¡mportant in capita l-intensive/h igh-fixed-cost industries)Access to attractive suoolies of skilled laborHigh labor productivity (¡mportant t,or items with high labor content)Low-cost product design and engrneering (reduces manufacturing costs)Ability to manufacture or assemblc products that arc cusfomized tobuvcr spccrfications

A strong network of wholesale d istributc¡rs/dea lersStrong direct sales capabilities via the Internet and/or having companyowned retail outletsAb¡l¡ty to secure favorable display spacc on rctailcr shelves

Breadth of product lrnc and product selectionA well-known and ,,vell-respected brand nameF¿st. accurate techn ical assistanceCourteous, persona lized customer servtceAccurate filling of buyer orders (few back orders or mistakes)Customer guarantees and warranties (impoftant rn mail-ordcr andonline retailing, brg-ticket purchases, and nerv product introductions)Clcver advertisins

A tale¡rted workforce (superior talent ;s important in professional ser-

vices like accounting and investment banking)National or global distribution capabilit¡esProduct innovatron capabilities (important ¡n industries rvhere riv¿ls areracing to be first-to-market with new,procluct attributes or performancefe¿tures)Design expertise (¡mportant in fashion and apparel industries)Short delivery tlme capabilit.vSupply chain management capabrliticsStrong e-commcrce capabilitles-a user-friendly Web site and,/orskills in using Internet technoiogy applications to streamline intern¿looer¿ tions

Overall low costs (not iust in manufacturing) to be able to meet lowprice expectations of customersConvenient locations (important in many retailing businesses)Abilitv to provide iast, conven¡ent, after-the-sale repairs and serviceA strong balance sheet and access to financial capital (important innervly emerging industries with high degrees of business risk and incapital-i ntensive industries)Patent protection

Chapter I Evaluating a Company's External Environment

3. What shortcomings are almost certain to put a company at a significantcompetitive disadvantage?

Only rarely are there more than five or six kev factors for future competitivesuccess. Managers should therefore resist the temptation to label a factor thathas only minor importance a KSF. To compile a list of every factor that matterseven a little bit defeats the purpose of concentrating managemeni attentioll onthe factors truly critical to long-term competitive success.

Question Z: Does the Industry Offer GoodProspects for Attractive Profits?The final step rn evaluating the industry and competitive environment is boil-ing down the results of the analyses performed in Questions l-ó to determineif the industry offers a company strong prospects for attractivc profits-

The important factors on which to base such a conclusion include:

. The industry's growth potential.

. Whether pou'erful competitive forces are squeezing industry profitabilityto subpar levels and whcthcr competition appears destined to grort'stron-ger or weaker.

. Whether industry profitability will be favorably or unfavorably affectedby the prevailing driving forces.

. The company's competitive position in the industry vis-á-vis rivals. (Well-entrenched leade¡s or strongly positioned contenders have a much betterchance of earning attractive margins than those fighting a steep uphillbattle.)

. Hou, competently the company performs industry key success factors.

It is a mistake to think of a particular industry as being equally attractiveor unattractive to all industry participants and all potential entrants. Conclu-sions have to be drawn fromticular company. Industries a The degree to which an industry is attractive or

be unattractive to outsiders. unattractive is not the same for all industry

unattractive to wcak compctitors may bc attracstrong competitors. A favorably positioned co

may survey a business environment and see a

opportunities that weak competitors cannot capWhen a company decides an industry is fundamen-

tally attractive, a strong case can be made that it should invest aggrcssivclyto capture the opportunities it sees. When a strong competitor concludes anindustry is relatively unatt¡active, it may elect to simply protect its presentposition, investing cautiouslv if at all, and begin looking for opportr-rnities inother industries. A competitively weak company in an ur-rattractive indus-try may see its best option as finding a buyer, perhaps a rival, to acquire itsbusiness.

I ti,]¡r'14

-,.f

.j;

I 1: ,

I (;4u- _

II

I

I

Kev PointsThinking strategically about a company/s extemal situation involves probing foranswers to the following seven questions:

1. tNhat are the industry's dominant economic features? Industries differ significantlyon such factors as ma¡ket size and growth rate, the number and relative sizes ofboth buyers and sellers, the geographic scope of competitive rivalry the degreeof product differenüatiorL the speed of product irLnovatiory demand-supplyconditions, the extent of vertical integration, and the extent of scale economiesand learning curve effects.

2. What kinds of competitiae forces are industry ffiemberc facíng, and how strong is uchforce? The strength of competition is a composite of Éive forces: (1) competiüvepressures stemrning from buyer bargaining power and seller-buyer collaboration,(2) competitive pressures associated with the sellers of substitutes, (3) competitivepressures stemming from supplier bargaining power and supplier-seller collaboration, (4) competitive pressures associated with the threat of new entrants intothe market, and (5) competitive pressures stemming from the competitive jockey-ing among indushy rivals.

3. What forces arc driaing changes in the industry, and what impact will these changes haoe

on compeütiae intmsity and industry profitability? lndustry and competitive conditionschange because fortes are in motion that create incentives or pressures for change.The first phase is to identrfy the forces that are d¡iving industry change. The secondphase of driving forces analysis is to determine whether the driving forces, takentogether, are acting to make the industry environment more or less attractive.

4. What market positions do industry riaals occupy-who is strongly positinned and whols nof ? Strategic group mapping is a valuable tool for unde¡standing the similari-ties and differences i¡herent in the market positions of rival companies. Rivals inthe same or nearby süategic groups are close competitors, whereas companies indistant strategic groups usually pose little or no immediate threat. Some strategicgroups are mo¡e favorable than others. The profit potential of different strategicgroups may not be the same because industry driving forces and competitiveforces iikely have varying effects on the industry's distinct skategic groups.

5. INhnt strntegic moaes are riaals lilely to mafu nerf ? Scouting competitors well enoughto anticipate their actions can help a company prepare effective countermoves (per-haps even beating a rival to ttre punch) and allows managers to take rivals' prob-able actions into account in designing their own company's best course of action.

6. IMat are the key factors for competitiue success? An industry's key success factors(KSFs) are the particular product attributes, competitive capabilities, and intangi-ble assets that spell the difference between being a strong competitor and a weakcompetitor-and sometimes between profit and loss. KSFs by their very natureare so important to competitive success that a/lfnr¡s in the industry must payclose attention to them or risk being drivm out of the industry.

7. Does the outlook for the industry present the company with sufriciently attractiue pros-pects for profitabili{r? Conclusions regarding industry attractiveness are a majordriver of company strategy- When a company decides an industry is fundamen-tally attractive and presents good opportuniües, a strong case can be made thatit should invest aggressively to capture the opportunities it sees. When a strongcompetitor concludes an industry is relatively unattracüve and lacking in oppor-tunity, it may elect to simply protect its present position, investing cautiouslyif at all and looking for opportunities in other industries. A competitively weak

LOI'r.LO2

LOl z

101 3

companv in an unattractive industry may see its best option as finding a buyer,perhaps a rival, to acquirc its business. On occasion, an industry that is unat-tractive overall is still very attractivc to a favorably sltuated company lvith theskills and resources to take business away from n'eaker rir.als.

Prepare a bricf analysis of the snack food industry using the information pro-vided on industry tradc association Web sites. Based upon information providedon the Web s¡tes of these associations, draw a five-forces diagram for the snack

food inclustry and briefly discuss the nature and strength of each of the five com-petitive forces. What driving forces of change are taking shape in the indushy?

Based on the strategic group map in Concepts & Connections 3.1, who are

Toyota's closest competitors? Between which trvo strategic groups is competitionthe strongest? Why do you think no automobile manufacturers are positionedrn the upper right corner of the map? Which company/strategic group faces the

n eakest competition from the members of other strategic groups?

Using tl-re informatiorr provided in Table 3.3 and your knowledge as a casualclimng patron, what are the key success factors for rcstaurants such as OutbackSteakhouse or Carrabba's Ttalian Grill? Your list should contain no more thansix industry key success factors. In deciding on your list, it's important to distin-guish betrveen factors critical to success in the industry and factors that enhance

a company's overall well-being.

Which of the five competitive forces is creating the strongest competitivepressLrres for your company?

What arc thc "weapons of cornpetition" that rival companies in your industrycan use to gain sales and market share? See Figure 3.7 to help you identify thevarious competitive f actors.

What are the factors affecting the intensity of rivalry in the industry in whichyour company is competing? Use ligure 3.7 and the accompanying discussion tohelp you in pinpointing the specific factors most affecting competitive intensity.Would you characterize the rivalry and jockeying for better market position,increased sales, and market share among the companies in your industry as

fierce, very strong, strong, moderate, or relatively weak? Why?

Are there any driving forces in the industry in which your company is compet-ing? What impact will these driving forces have? Will they cause competition tobe more or less intense? Will they act to boost or squeeze profit margins? List atleast rrt'o actions your companv should consider taking in order to combat anynegative impacts of the driving forces.

Draw a strategic group map showing the market positions of the companies inyour industry. Which companies do you believe are in the most attractive posi-tion on the map? Which companies are the most weakly positioned? \ y'hich

companies do you believe are likely to try to move to a different position on thestratcgic group map?

What do you see as the key factors for being a successful compehtol in yourindustry? List at least three.

Assuranceof Learning

Exercises

Exercises forSimulation

Participants

LOILO2LO3

1.

3

5

Chapter 3 Evaluating Company´s ... Enviroment

Documents

Transcript of Chapter 3 Evaluating Company´s ... Enviroment