Chapter

Two
External
Analysis:
The
Identification of
Opportunities
and Threats

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

External Analysis requires an assessment of:

Industry environment in which company operates
Competitive structure of industry
Competitive position of the company
Competitiveness and position of major rivals

The country or national environments

in which company competes
The wider socioeconomic or macroenvironment
that may affect the company and its industry
Social
Government

Legal
International

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Technological

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

Opportunities

Threats

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

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

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Industry Analysis:
Defining an Industry
Industry
A group of companies offering products or services that are
close substitutes for each other and that satisfy the same
basic customer needs
Industry boundaries may change as customer needs evolve
and technology changes

Sector
A group of closely related industries

Market Segments
Distinct groups of customers within an industry
Can be differentiated from each other with distinct attributes
and specific demands

Industry analysis begins by focusing on

the overall industry
before
considering market segment or sector-level issues

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The Computer Sector:

Industries and Market Segments
Figure 2.1

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Porters Five Forces Model

Figure 2.2

Source: 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.

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 Risk of Entry by Potential

Competitors

Potential Competitors are companies that are not

currently competing in an industry but have the capability

to do so if they choose. Barriers to new entrants include:
1. Economies of Scale as firms expand output unit costs fall via:
Cost reductions through mass production
Discounts on bulk purchases of raw material and standard parts
Cost advantages of spreading fixed and marketing costs over large volume

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

3. Absolute Cost Advantages relative to new entrants

Accumulated experience in production and key business processes
Control of particular inputs required for production
Lower financial risks access to cheaper funds

4. Customer Switching Costs for Buyers where significant

5. Government Regulation
May be a barrier to enter certain industries
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 Rivalry Among Established

Companies

Competitive Rivalry refers to the competitive struggle

between companies in the same industry to gain market

share from each other. Intensity of rivalry is a function of:
1. Industry Competitive Structure
Number and size distribution of companies
Consolidated versus fragmented industries

2. Demand Conditions
Growing demand tends to moderate competition and reduce rivalry
Declining demand encourages rivalry for market share and revenue

3. Cost Conditions
High fixed costs profitability leveraged by sales volume
Slow demand and growth can result in intense rivalry and lower profits

4. Height of Exit Barriers prevents companies from leaving industry

Write-off of investment in assets
Economic dependence on industry
Maintain assets - to participate
effectively in an industry
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High fixed costs of exit

Emotional attachment to industry
Bankruptcy regulations allowing
unprofitable assets to remain
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 Bargaining Power of Buyers

Industry Buyers may be the consumers or end-users who

ultimately use the product or intermediaries that distribute or

retail the products. These buyers are most powerful when:
1. Buyers are dominant.
Buyers are large and few in number.
The industry supplying the product is composed of many small companies.

2. Buyers purchase in large quantities.

Buyers have purchasing power as leverage for price reductions.

3. The industry is dependant on the buyers.

Buyers purchase a large percentage of a companys total orders.

4. Switching costs for buyers are low.

Buyers can play off the supplying companies against each other.

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

6. 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.
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 Bargaining Power of Suppliers

Suppliers are organizations that provide inputs such as
material and labor into the industry. These suppliers are
most powerful when:
1. The product supplied is vital to the industry and has few
substitutes.
2. The industry is not an important customer to suppliers.
Suppliers are not significantly affected by the industry.

3. Switching costs for companies in the industry are significant.

Companies in the industry cannot play suppliers against each other.

4. Suppliers can threaten to enter their customers industry.

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

5. Companies in the industry cannot threaten to enter suppliers

industry.
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 Substitute Products
Substitute Products are the products from

different businesses or industries that can satisfy

similar customer needs.
1. The existence of close substitutes is
a strong competitive threat.
Substitutes limit the price that companies
can charge for their product.

2. Substitutes are a weak competitive

force if an industrys products have few
close substitutes.

Other things being equal, companies in

the industry have the opportunity to raise
prices and earn additional profits.
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Strategic Groups
Within Industries
Strategic Groups are groups of companies that

follow a business model similar to other companies

within their strategic group but are different from
that of other companies in other strategic groups.
The basic differences between business models in
different strategic groups can be captured by a
relatively small number of strategic factors.
Implications of Strategic Groups
1. The closest competitors are within the same Strategic Group
and may be viewed by customers as substitutes for each other.
2. Each Strategic Group can have different competitive forces
and may face a different set of opportunities and threats.
Mobility Barriers factors within an industry that inhibit the
movement of companies between strategic groups
Include barriers to enter another group or exit existing group
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Strategic Groups in the

Pharmaceutical Industry
Figure 2.3

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Industry Life Cycle Analysis

Industry Life Cycle Model analyzes the affects of

industry evolution on competitive forces over time

and is characterized by five distinct life cycle stages:

1.

Embryonic industry just beginning to develop

2.

Growth first-time demand takes-off with new customers

3.

Rivalry intensifies with emergence of excess productive capacity.

Mature market totally saturated with low to no growth

5.

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

Shakeout demand approaches saturation, replacements

4.

Rivalry based on perfecting products, educating customers, and

opening up distribution channels.

Industry consolidation based on market share, driving down price.

Decline industry growth becomes negative

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

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Stages in the Industry Life Cycle

Strength and nature of five forces change as industry evolves

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Figure 2.4

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Growth in Demand and Capacity

Anticipate how forces will change and formulate appropriate strategy

Figure 2.5

Industry Shakeout:
Rivalry Intensifies
with growth in
excess capacity

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Limitations of Models
for Industry Analysis

Life Cycle Issues

Industry cycles do not always follow the life cycle generalization.

In rapid growth situations embryonic stage is sometimes skipped.
Industry growth revitalized through innovation or social change.
The time span of the stages can vary from industry to industry.

Innovation and Change

Punctuated Equilibrium occurs when an industrys long term stable
structure is punctuated with periods of rapid change by innovation.
Hypercompetitive industries are characterized by permanent and
ongoing innovation and competitive change.

Company Differences
There can be significant variances in the profit rates of individual
companies within an industry.
In addition to industry 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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Punctuated Equilibrium
and Competitive Structure
Figure 2.6

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

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The Role of the Macroenvironment

Figure 2.7

Changes in the
forces in the macroenvironment can
directly impact:
The Five Forces
Relative Strengths
Industry
Attractiveness

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