External Analysis: The Identification of Opportunities and Threats2ChapterTheory of Strategic Management 10th ed.GARETH R. JONES /CHARLES W. L. HILL

AIRLINE INDUSTRY WOESThe airline industry lost $35 billion between 2001 and 2006.It earned meager profits in 2006 and 2007.It lost $24 billion in 2008 and $4.7 billion in 2009.In 2010, the industry managed a slim $3.7 billion net profit.Why are the new entrants doing better?

2-*Why Are the New Entrants Doing Better?Airlines such as Southwest and Virgin America use nonunion labor.They fly one type of aircraft and focus on more lucrative routes.They took a share of the market from the incumbent airlines; Delta, Northwest, United, and U.S. Airways went bankrupt.Read more about airline industry woes:http://boardingarea.com/blogs/viewfromthewing/2008/11/21/an-academic-theory-of-airline-industry-woes/

External Analysis requires an assessment of:Industry environment in which company operatesCompetitive structure of industryCompetitive position of the companyCompetitiveness and position of major rivalsThe country or national environments in which company competesThe wider socioeconomic or macroenvironment that may affect the company and its industrySocialGovernment Legal International Technological

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

External Analysis: Opportunities and ThreatsAnalyzing the dynamics of the industry in which an organization competes to help identify:Opportunities

Conditions in the environment that a company can take advantage of to become more profitableThreats

Conditions in the environment that endanger the integrity and profitability of the companys business

OVERVIEWAn industry can be defined as a group of companies offering products or services that are close substitutes for each other.Serve the same basic customer needsCoca-Cola, PepsiCo, and Cadbury Schweppes in the soft drink industry.Dell, Hewlett-Packard, Lenovo, and Apple in the personal computer industry.http://cokevspepsi.net/Read more about Coke versus Pepsi consumer preference:

2-*OVERVIEWA sector is a group of closely related industries.Market segments are distinct groups of customers within a market that can be differentiated from each other on the basis of individual attributes and specific demands.http://en.wikipedia.org/wiki/Market_segmentRead more about market segments:Industry analysis begins by focusing on the overall industry before considering market segment or sector-level issues

The Computer Sector:Industries and Market Segments

Learning Objective: After reading this chapter you should be able to review the primary technique used to analyze competition in an industry environment: the Competitive Forces model.COMPETITIVE FORCES MODELMichael E. Porters The Five Forces Model. ideal: mkg decision to your company either it is up in running/new companyAn extension of his model is to add the power of complement providers as another factor to consider in analyzing competition.;

Porters Five Forces ModelSource: Adapted and reprinted by permission of Harvard Business Review. From How Competitive Forces Shape Strategy, by Michael E. Porter, Harvard Business Review, March/April 1979 by the President and Fellows of Harvard College. All rights reserved.

How the Five Forces Shape Competition within an IndustryThe stronger that each of these five forces is, the more limited is the ability of established companies to raise prices and earn greater profits within their industry.A weak competitive force may be viewed as an opportunityas it allows company to earn greater profitsA strong competitive force may be viewed as a threatas it depresses industry profitsStrength of forces may change As industry conditions change

Through its choice of strategies, a company may alter the strength of one or more of the five forces to its advantage.

Potential Competitors are companies that are not currently competing in an industry but have the capability to do so if they choose. Barriers to new entrants include: Risk of Entry by Potential CompetitorsEconomies of Scale as firms expand output unit costs fall via:Cost reductions through mass production (large amount of standardize product)Discounts on bulk purchases of raw material and standard /component partsCost advantages of spreading fixed and marketing costs over large volume

Brand Loyalty exists when consumers have a preference for the product of an established company.Achieved by creating well-established customer preferencesDifficult for new entrants to take market share from established brands

Risk of Entry by Potential CompetitorsAbsolute Cost Advantages relative to new entrants - means that entrants cannot expect to match established companies lower costAccumulated experience in production and key business processesControl of particular inputs (raw material etc) required for productionLower financial risks established company have access to cheaper funds

Customer Switching Costs for Buyers arise when a customer invests time, energy, and money switching from the products offered by one established company to the products of a new entrant.eg: computer operating system

Risk of Entry by Potential CompetitorsHistorically, government regulations have established major entry barrier into many industries.i)Until the mid-1990s, providers of long-distance telephone service could not compete for local telephone services.Could earn higher profit.

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Industry Competitive StructureNumber and size distribution of companiesA fragmented industry consists of a large number of companies that cannot determine industry price. Eg: agriculture, dry cleaning, health clubs, video rental etcA consolidated industry is dominated by a small number of large companies or just one company (monopoly) and companies often are in ta position to determine industry price. Eg: aerospace, soft drink, automobile, pharmaceutical, stockbrokerage Demand ConditionsGrowing demand tends to reduce rivalry because all companies can sell more without taking market share away from other companies. = high profitwhen demand declines, a company can only grow by taking market share away from other companies. Rivalry Among Established CompaniesCompetitive Rivalry refers to the competitive struggle between companies in the same industry to gain market share from each other. Intensity of rivalry is a function of:

Cost ConditionsHigh fixed costs profitability leveraged by sales volumeSlow demand and growth cut prices and or raise promotional spending to cover fixed cost all do the same things - can result in intense rivalry and lower profits

Height of Exit Barriers prevents companies from leaving industryWrite-off of investment in assetsEconomic dependence on industryMaintain assets - to participate effectively in an industry Rivalry Among Established CompaniesCompetitive Rivalry refers to the competitive struggle between companies in the same industry to gain market share from each other. Intensity of rivalry is a function of: High fixed costs of exit Emotional attachment to industry Bankruptcy regulations allowing unprofitable assets to remain

Strategy in Action 2.2 Price Wars in the Breakfast Cereal IndustryThe breakfast cereal industry in the U.S. was one of the most profitable and desirable competitive environments, with steadily rising demand, brand loyalty, and close relationships with buyers (grocery retailers). Best of all, the industry was dominated by just three competitors, and one, Kelloggs, controlled 40% of the market share. Kelloggs was a price leader, raising prices a bit each year, and the smaller companies followed suit. Then the industry structure changed. Huge discounters began to promote cheaper private brands, just as bagels or muffins replaced cereal as the preferred breakfast food. Under pressure, the big manufacturers began a price war, ending the silent price conspiracy that had kept the industry stable and profitable. Although profit margins were slashed in half, the big three continued to lose market share to private brands. What was once a desirable industry is now exactly like most otherscompetitive, unstable, and far less profitable.2-*

Industry Buyers may be the consumers or end-users who ultimately use the product or intermediaries that distribute or retail the products. These buyers are most powerful when: Bargaining Power of BuyersBuyers are dominant. Buyers are large and limited in number.The industry supplying the product is composed of many small companies.Buyers purchase in large quantities.Buyers have purchasing power as leverage for price reductions.The industry is dependant on the buyers. Buyers purchase a large percentage of a companys total orders.Switching costs for buyers are low.Buyers can play off the supplying companies against each other.Buyers can purchase from several supplying companies at once. Buyers can threaten to enter the industry themselves.Buyers produce themselves and supply their own product.Buyers can use threat of entry as a tactic to drive prices down.

Suppliers are organizations that provide inputs such as material and labor into the industry. These suppliers are most powerful when: Bargaining Power of SuppliersThe product supplied is vital to the industry and has few substitutes.The industry is not an important customer to suppliers.Suppliers' profitabilities are not significantly affected by the industry.Switching costs for companies in the industry are significant.Companies in the industry cannot play suppliers against each other.Suppliers can threaten to enter their customers industry.Suppliers can use their inputs to produce and compete with companies already in the industry.Companies in the industry cannot threaten to enter suppliers industry.

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

Substitutes are a weak competitive force if an industrys products have few close substitutes.Other things being equal, companies in the industry have the opportunity to raise prices and earn additional profits.

Learning Objective: After reading this chapter you should be able to explore the concept of strategic groups and illustrate the implications for industry analysis.STRATEGIC GROUPS WITHIN INDUSTRIESWithin most industries, it is possible to observe groups of companies that follow a business model similar to companies in other groups. These different groups of companies are known as strategic groups.

Strategic Groups in the Pharmaceutical IndustryHigh Risk High ReturnFocus on developing new proprietary drugsHeavy R&D spendingLow Risk Low ReturnFocus on low-cost copies of drugs with expired patentsProduction efficiency

STRATEGY DECISION MAKINGImplications of Strategic GroupsBecause all companies in a strategic group are pursuing a similar business model, customers tend to view such enterprises as direct substitutes for each other (for example, Wal-Mart, Kmart, and Target).Each strategic group may face a set of opportunities and threats.Risk of new entrantsDegree of rivalry among companies in the groupBargaining power of suppliers or buyers

2-*STRATEGY DECISION MAKINGThe Role of Mobility BarriersMobility barriers are within-industry factors that prevent the movement of companies between strategic groups.These barriers could bar entry into a group or bar exit from the companys existing group.Managers must determine if it is cost-effective to overcome mobility barriers before deciding whether the move is worthwhile.Read more about the role of mobility barriers:http://www.allbusiness.com/north-america/united-states/479850-1.html

Strategic Barriers in the Pharmaceutical IndustryStrategic BarrierLack of R&D Skills to develop new proprietary drugs

2-*INDUSTRY LIFE-CYCLE ANALYSISLearning Objective: After reading this chapter you should be able to discuss how industries evolve over time, with reference to the industry life-cycle model.

2-*INDUSTRY LIFE-CYCLE ANALYSISEmbryonic IndustriesAn embryonic industry refers to an industry just beginning to develop.Examples are personal computers in the 1970s, wireless communication in the 1980s, and internet retailing in the 1990s.Growth at this stage is slow.Rivalry is based not so much on price as on educating customers, opening up distribution channels, and perfecting the design of the product.Such rivalry can be intense.

2-*INDUSTRY LIFE-CYCLE ANALYSISGrowth IndustriesIn a growth industry, first-time demand is expanding rapidly.Prices fall because experience and scale economies have been attained, and distribution channels developed.The importance of control over technological knowledge as a barrier to entry has diminished.New entrants can be absorbed into an industry without a marked increase in the intensity of rivalry.

2-*INDUSTRY LIFE-CYCLE ANALYSISExplosive growth cannot be maintained indefinitely.In the shakeout stage, rivalry between companies becomes intense.Industry ShakeoutThe market is totally saturated, demand is limited to replacement demand, and growth is low or zero.In the mature stage, barriers to entry increase, and the threat of entry from potential competitors decreasesCompanies no longer maintain historic growth competition for market develops; price warMature Industries

2-*INDUSTRY LIFE-CYCLE ANALYSISIn a declining industry growth becomes negative.Technological substitution, social change, demographic, international competitionFalling demand leads to the emergence of excess capacity.Companies in this category cut prices, thus sparking a price war.The greater the exit barriers, the harder it is for companies to reduce capacity (e.g., airline industry and steel industry).Declining Industries

Limitations of Models for Industry Analysis Life Cycle IssuesIndustry cycles do not always follow the life cycle generalization.In rapid growth situations embryonic stage is sometimes skipped. Industry growth revitalized through innovation or social change.The time span of the stages can vary from industry to industry. Innovation and ChangePunctuated Equilibrium occurs when an industrys long term stable structure is punctuated with periods of rapid change by innovation.Hypercompetitive industries are characterized by permanent and ongoing innovation and competitive change. Company DifferencesThere can be significant differences in the profit rates of individual companies within an industry.In addition to industry attractiveness, company resources and capabilities are also important determinants of its profitability.Models provide useful ways of thinking about competition within an industry but be aware of their limitations.

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Learning Objective: After reading this chapter you should be able to show how trends in the macroenvironment can shape the nature of competition in an industry.

2-*THE MACROENVIRONMENTMacroeconomic ForcesThe four most important macroeconomic forces are the growth rate of the economy, interest rates, currency exchange rates, and inflation (deflation) rates.Global ForcesImportant point barriers to international trade and investment have drop.Economic growth in places such as Brazil, China, and India have created large new markets.It is easier for foreign enterprises to enter the domestic markets of many companies, thereby increasing the intensity of competition and lowering profitability.

2-*THE MACROENVIRONMENTPolitical and Legal ForcesPolitical and legal forces are outcomes of changes in laws and regulations, and significantly affect managers and companies.Technological ForcesTechnological change can make established products obsolete overnight and simultaneously create a host of new product possibilities.It can impact the height of the barrier to entry and radically reshape industry structure.Read more about political risk:http://en.wikipedia.org/wiki/Political_risk

2-*THE MACROENVIRONMENTDemographic ForcesDemographic forces are outcomes of changes in the characteristics of a population, such as age, gender, ethnic origin, race, and social class.Eg: increase in aging populationSocial ForcesSocial forces refer to the way in which changing social mores and values affect an industry.One of the major social movements of recent decades has been the trend toward greater health consciousness.