Chapter 4Chapter 4

External AnalysisExternal AnalysisObjectiveObjective: analyzing the external factors : analyzing the external factors

(industry and environment) to make strategic (industry and environment) to make strategic judgmentsjudgments

Why to conduct industry Why to conduct industry analysis?analysis?

In external analysis, the next factor (after In external analysis, the next factor (after customer and competitors) to analyze is the customer and competitors) to analyze is the industry/market in which the company industry/market in which the company operates. For effective strategic planning, it operates. For effective strategic planning, it is a must to understand the industry forces is a must to understand the industry forces affecting the company, and the company’s affecting the company, and the company’s capabilities to deal with those forces.capabilities to deal with those forces.

Understanding the industry + anticipating its Understanding the industry + anticipating its future trends and directions give the future trends and directions give the company the knowledge it needs to react and company the knowledge it needs to react and control its portion of that industry. control its portion of that industry.

The industry analysis helps the company;The industry analysis helps the company; to identify threats and opportunities that to identify threats and opportunities that

may influence the company’s abilities to may influence the company’s abilities to reach its goals.reach its goals.

to focus in on any competitive advantages to focus in on any competitive advantages available. Since both the company and its available. Since both the company and its competitors are in the same industry, the competitors are in the same industry, the key to success is in finding the different key to success is in finding the different abilities between the company and the abilities between the company and the competitors in dealing with the industry competitors in dealing with the industry forces. If the company can identify abilities forces. If the company can identify abilities it has that are superior to competitors, it it has that are superior to competitors, it can use those abilities to establish a can use those abilities to establish a competitive advantage.competitive advantage.

Dimensions of an Industry Dimensions of an Industry AnalysisAnalysis

Industry analysis often include the Industry analysis often include the following dimensions;following dimensions;

Industry size and growthIndustry size and growth Industry forces (profitability)Industry forces (profitability) Industry attractivenessIndustry attractiveness Industry success factorsIndustry success factors

Industry Size and GrowthIndustry Size and Growth

A basic starting point for the analysis of an A basic starting point for the analysis of an industry is the total sales level (size).industry is the total sales level (size).

What are the important and potentially What are the important and potentially important submarkets? important submarkets?

What are their size and growth characteristics?What are their size and growth characteristics? What submarkets are or will soon decline? What submarkets are or will soon decline?

How fast?How fast? It is also useful to consider the potential It is also useful to consider the potential

market; a new use, new user group, or more market; a new use, new user group, or more frequent usage could change the size of the frequent usage could change the size of the market.market.

After the size of the market and its important After the size of the market and its important submarkets has been estimated, the focus turns to submarkets has been estimated, the focus turns to growth rate. growth rate.

What will be the market size in the future? Growth What will be the market size in the future? Growth often means more sales and profits even without often means more sales and profits even without increasing market share. increasing market share.

Identifying the driving forces, forecasting the rate Identifying the driving forces, forecasting the rate (predicting the market sales), detecting maturity (predicting the market sales), detecting maturity and declines (turning points in market sales and and declines (turning points in market sales and profit) are important considerations about market profit) are important considerations about market growth.growth.

Company can detect maturity or decline by Company can detect maturity or decline by checking if; there is price pressure caused by checking if; there is price pressure caused by overcapacity, lack of product differentiation, overcapacity, lack of product differentiation, increase in buyer sophistication and knowledge, increase in buyer sophistication and knowledge, and substitute products or technology, decline in and substitute products or technology, decline in first-time buyers, no further growth opportunities first-time buyers, no further growth opportunities for users or new users, and reduction in customer for users or new users, and reduction in customer interest. interest.

Industry ForcesIndustry Forces

As identified by Michael Porter, a As identified by Michael Porter, a Harvard economist, there are five basic Harvard economist, there are five basic forces at work within any industry which forces at work within any industry which influence profitability. The problem is to influence profitability. The problem is to estimate how profitable the average firm estimate how profitable the average firm will be (measured by the long-term will be (measured by the long-term return on investment of the average return on investment of the average firm). firm).

(1) Ease of entry, (2) Supplier power, (3) (1) Ease of entry, (2) Supplier power, (3) Buyer power, (4) Product substitutes, (5) Buyer power, (4) Product substitutes, (5) Industry competitors.Industry competitors.

1 - Ease of Entry1 - Ease of Entry

Ease of entry refers to the relative Ease of entry refers to the relative degree of difficulty for a new firm to degree of difficulty for a new firm to enter the industry. This force affects enter the industry. This force affects the company because each new the company because each new entrant means a new competitor.entrant means a new competitor.

If it is easy to enter the industry, If it is easy to enter the industry, competitive advantages that the competitive advantages that the company have today may quickly company have today may quickly disappear with each new competitor. disappear with each new competitor.

However, if ease of entry is difficult, However, if ease of entry is difficult, the company benefits because;the company benefits because; The competitive advantages the The competitive advantages the

company may have greater longevitycompany may have greater longevity The company’s set of competitors will The company’s set of competitors will

remain fairly constant.remain fairly constant. Two factors influence ease of entry Two factors influence ease of entry

into an industry. Those are;into an industry. Those are; Barriers to entry that currently existBarriers to entry that currently exist Reaction of existing competitors to each Reaction of existing competitors to each

new entrantnew entrant

Barriers to entryBarriers to entry

What barriers to entry may exist?What barriers to entry may exist? Product differentiationProduct differentiation: Does a new firm need : Does a new firm need

to offer distinct product advantages in order to to offer distinct product advantages in order to capture business?capture business?

Capital requirements and existence of high Capital requirements and existence of high fixed costsfixed costs: Are large amounts of capital : Are large amounts of capital required to set up a business within the required to set up a business within the industry?industry?

Switching costs for the customerSwitching costs for the customer: Will : Will customers incur high expenses in order to customers incur high expenses in order to switch to a competitor?switch to a competitor?

Access to distribution channelsAccess to distribution channels: Can new : Can new competitors access distribution channels competitors access distribution channels easily?easily?

Reaction of competitionReaction of competition

How will the existing companies react to a How will the existing companies react to a new layer in the market? There are several new layer in the market? There are several factors to look at;factors to look at;

HistoryHistory: How have they reacted in the past?: How have they reacted in the past? Strength of existing firmsStrength of existing firms: Do existing firms : Do existing firms

have substantial resources or large have substantial resources or large commitments to the industry?commitments to the industry?

Industry growth rateIndustry growth rate: Is the industry : Is the industry limited in its ability to accept new firms limited in its ability to accept new firms because of a slow growth rate? because of a slow growth rate?

2 - Supplier Power2 - Supplier Power

Supplier power (suppliers may influence Supplier power (suppliers may influence the relationship that company has with its the relationship that company has with its customers, e.g. dictate the quality company customers, e.g. dictate the quality company offers, control the price, conditions) exists;offers, control the price, conditions) exists;

when the industry sells products when the industry sells products manufactured by just a few suppliersmanufactured by just a few suppliers

when the product they supply is unique or when the product they supply is unique or do not have substitutesdo not have substitutes

when the company is not a significant part when the company is not a significant part of the supplier’s businessof the supplier’s business

When the supplier has intention to move When the supplier has intention to move forward on the distribution chain and forward on the distribution chain and displace the company.displace the company.

3 - Buyer Power3 - Buyer Power

Buyer power exists when the purchasers Buyer power exists when the purchasers (intermediaries) of the company’s product (intermediaries) of the company’s product can exert influence on the company e.g. can exert influence on the company e.g. through customers demanding lower prices, through customers demanding lower prices, demanding higher quality or more services demanding higher quality or more services or playing competitors each other. Factors or playing competitors each other. Factors that give purchasers buying power;that give purchasers buying power;

Single buyer purchases high volumes of the Single buyer purchases high volumes of the company’s productcompany’s product

The company’s products are The company’s products are undifferentiated or subject to substitutionundifferentiated or subject to substitution

It is relatively easy and inexpensive for a It is relatively easy and inexpensive for a buyer to switch from the company to a buyer to switch from the company to a competitorcompetitor

The company’s product is unimportant to The company’s product is unimportant to the quality of the buyer’s product.the quality of the buyer’s product.

The key in the buyer-power scenario is the The key in the buyer-power scenario is the needs of the customer. Buyers of the needs of the customer. Buyers of the company’s products or the company can company’s products or the company can gain power in the relationship by gain power in the relationship by influencing the customer’s decision.influencing the customer’s decision.

4 - Product Substitution4 - Product Substitution

A substitute product is one that can A substitute product is one that can perform the same function as the perform the same function as the company’s product. company’s product.

It becomes a substitute when, in the It becomes a substitute when, in the mind of the customer, it performs the mind of the customer, it performs the same function at an equal or better same function at an equal or better price-performance ratio.price-performance ratio.

The solution is; differentiating the The solution is; differentiating the product by understanding the customer. product by understanding the customer.

5 - Industry Competitors5 - Industry Competitors

The battle between the company and its The battle between the company and its competitors is about getting a superior competitors is about getting a superior position in the mind of the customer. position in the mind of the customer.

The intensity and form (e.g. price war, ad The intensity and form (e.g. price war, ad campaigns, expanded service offerings, new or campaigns, expanded service offerings, new or improved product introductions) of this battle improved product introductions) of this battle affects the company’s ability to win that affects the company’s ability to win that position and sustain it.position and sustain it.

Several industry factors dictate the intensity Several industry factors dictate the intensity and form of the battle; (1) the number of and form of the battle; (1) the number of competitors, (2) the rate of industry growth, competitors, (2) the rate of industry growth, (3) the rate of differentiation.(3) the rate of differentiation.

Industry AttractivenessIndustry Attractiveness Industry attractiveness is the presence Industry attractiveness is the presence

or absence of threats displayed by each or absence of threats displayed by each of the industry forces. of the industry forces.

The greater a threat posed by an The greater a threat posed by an industry force, the less attractive the industry force, the less attractive the industry becomes (the industry forces industry becomes (the industry forces should be rated).should be rated).

Industry attractiveness should be Industry attractiveness should be evaluated at each SBU base. This is evaluated at each SBU base. This is important in order to rank each SBU’s important in order to rank each SBU’s importance for the company. importance for the company.

Industry Success FactorsIndustry Success FactorsBases of CompetitionBases of Competition

Success factors are indicators of why a Success factors are indicators of why a company succeeds or fails within an company succeeds or fails within an industry. industry.

Identifying success factors is a subjective Identifying success factors is a subjective process since qualified judgments are made process since qualified judgments are made based on the collected information. based on the collected information.

Some examples for industry success factors; Some examples for industry success factors; ability to quickly respond to marketplace, ability to quickly respond to marketplace, good credit arrangements, excellent good credit arrangements, excellent product quality/performance/reliability, product quality/performance/reliability, excellent support after sale, knowledgeable excellent support after sale, knowledgeable personnel, strong financial foundation etc.personnel, strong financial foundation etc.

Risks in High-Growth Risks in High-Growth Markets Markets

The conventional wisdom that the growing The conventional wisdom that the growing markets are better, neglects the risks involved in markets are better, neglects the risks involved in those markets. The following risks are important those markets. The following risks are important to consider before the company decides to enter to consider before the company decides to enter a growing market;a growing market;

Competitive overcrowdingCompetitive overcrowding; too many competitors ; too many competitors with unrealistic expectations would get with unrealistic expectations would get attracted. But in reality there may not be attracted. But in reality there may not be sufficient sales volume to support all those firms. sufficient sales volume to support all those firms.

A superior competitive entryA superior competitive entry; a competitor would ; a competitor would enter with a superior product or low-cost enter with a superior product or low-cost advantage.advantage.

Changing key success factorsChanging key success factors; key success ; key success factors would change and the company factors would change and the company cannot adapt.cannot adapt.

Changing technologyChanging technology; technology would ; technology would change. A safe strategy is to wait until it change. A safe strategy is to wait until it becomes clear which technology will becomes clear which technology will dominate and then attempt to improve it dominate and then attempt to improve it with a compatible entry.with a compatible entry.

Disappointing market growthDisappointing market growth; the market ; the market growth would fail to meet expectations.growth would fail to meet expectations.

Resource constraintsResource constraints; resources may be ; resources may be inadequate to maintain a high growth rate.inadequate to maintain a high growth rate.

Distribution constraintsDistribution constraints; adequate ; adequate distribution may not be available.distribution may not be available.

Environmental AnalysisEnvironmental Analysis

After the market/industry is After the market/industry is analyzed, the focus shifts to the analyzed, the focus shifts to the environment surrounding the environment surrounding the market. market.

Why to conduct environmental Why to conduct environmental analysis? The environmental analysis analysis? The environmental analysis is used to locate current and future is used to locate current and future trends or events that represent trends or events that represent potential opportunities or threats to potential opportunities or threats to the business. the business.

Opportunities and Opportunities and ThreatsThreats

The goal of the environmental analysis is to The goal of the environmental analysis is to allow the company to locate the allow the company to locate the opportunitiesopportunities (represent a chance for the company to (represent a chance for the company to increase its sales, growth, or competitive increase its sales, growth, or competitive position – anything that would have a positive position – anything that would have a positive impact on the business) that the company impact on the business) that the company should attempt to take advantage of, and the should attempt to take advantage of, and the threatsthreats (anything that can cause a decrease in (anything that can cause a decrease in sales, represent an obstacle to success or sales, represent an obstacle to success or endanger the company’s survival) that have endanger the company’s survival) that have greatest potential to negatively affect the greatest potential to negatively affect the future of the business and therefore the future of the business and therefore the company should decide to develop strategy to company should decide to develop strategy to defend against it. defend against it.

Which data to collect?Which data to collect? Since there are millions of changes taking Since there are millions of changes taking

place in the environment, each company must place in the environment, each company must decide which data will have the greatest decide which data will have the greatest impact on its success and survival and impact on its success and survival and therefore have significant impact on strategy.therefore have significant impact on strategy.

Ideally, the data should represent both Ideally, the data should represent both current and future (anticipating + current and future (anticipating + forecasting) critical environmental factors; forecasting) critical environmental factors; those that will likely impact the company, its those that will likely impact the company, its customers, and its competitorscustomers, and its competitors

The environmental analysis is not complied The environmental analysis is not complied on an annual basis, it is an ongoing process.on an annual basis, it is an ongoing process.

Dimensions of Dimensions of Environmental AnalysisEnvironmental Analysis

Environmental analysis is usually Environmental analysis is usually divided into the following four areas:divided into the following four areas:

PoliticalPolitical EconomicEconomic SocialSocial TechnologicalTechnological

Political Regulation and Political Regulation and ActionsActions

The introduction or removal of legislative or The introduction or removal of legislative or regulatory constraints can represent major regulatory constraints can represent major strategic threats and opportunities. E.g. the ban strategic threats and opportunities. E.g. the ban of some ingredients in food products or of some ingredients in food products or cosmetics.cosmetics.

One research indicated that governmental One research indicated that governmental issues tend to follow an eight-year cycle. For the issues tend to follow an eight-year cycle. For the first five years, the issues carry less importance first five years, the issues carry less importance but can be detected in the press and in some but can be detected in the press and in some polls. In the fifth or six year, the national press polls. In the fifth or six year, the national press becomes interested and finally, government becomes interested and finally, government action results. Of course, the earlier a company action results. Of course, the earlier a company becomes involved, the better.becomes involved, the better.

Economic ConditionsEconomic Conditions Some strategies will be affected by judgments Some strategies will be affected by judgments

made about the economy, particularly inflation made about the economy, particularly inflation and general economic health as measured by and general economic health as measured by unemployment and economic growth. E.g. heavy unemployment and economic growth. E.g. heavy investment in a capital-intensive industry needs investment in a capital-intensive industry needs to be matched with a strong economy to avoid a to be matched with a strong economy to avoid a possibly damaging period of losses.possibly damaging period of losses.

Usually it is better to look beyond the general Usually it is better to look beyond the general economy and consider the health of the specific economy and consider the health of the specific industry.industry.

Multinational companies must forecast the Multinational companies must forecast the relative valuation of currencies. Thus, an analysis relative valuation of currencies. Thus, an analysis of balance of payments and other factors of balance of payments and other factors affecting currency valuations might be needed. affecting currency valuations might be needed.

Social TrendsSocial Trends

Shifts in the makeup of the population have Shifts in the makeup of the population have great effect on the companies. great effect on the companies.

Social, cultural and demographic (age, Social, cultural and demographic (age, income, education, geographic location) income, education, geographic location) trends can represent both threats and trends can represent both threats and opportunities for a wide variety of companies. opportunities for a wide variety of companies. E.g. the change in women’s life styles E.g. the change in women’s life styles influences dress designer’s product lines and influences dress designer’s product lines and pricing strategies. E.g. the rise in the ageing pricing strategies. E.g. the rise in the ageing population influences the type of food offered population influences the type of food offered in the restaurants. in the restaurants.

TechnologyTechnology

Technological trends or technological events Technological trends or technological events occurring outside the market/industry have occurring outside the market/industry have potential to impact strategies.potential to impact strategies.

Impact of new technologiesImpact of new technologies; introduction of a ; introduction of a new technology does not always mean that new technology does not always mean that businesses with prior technology will businesses with prior technology will suddenly become unhealthy. Generally, the suddenly become unhealthy. Generally, the sales of the old technology continues for sales of the old technology continues for some time, since (1) companies continue to some time, since (1) companies continue to improve it and (2) it is difficult to predict the improve it and (2) it is difficult to predict the outcome of the new technology.outcome of the new technology.

The technology life cycleThe technology life cycle; many technologies ; many technologies have life-cycles. E.g. computer printer have life-cycles. E.g. computer printer industry. The key to manage the transition industry. The key to manage the transition from one technology to another is to detect from one technology to another is to detect when the original technology is in the when the original technology is in the decline phase (indicators; (1) if performance decline phase (indicators; (1) if performance levels are approaching physical barriers, (2) levels are approaching physical barriers, (2) R&D efforts are becoming less effective, (3) R&D efforts are becoming less effective, (3) small competitors are experiencing with small competitors are experiencing with alternative technologies).alternative technologies).

Forecasting new technologiesForecasting new technologies; studies ; studies indicate that reviewing articles, magazines indicate that reviewing articles, magazines etc help in forecasting technological trends etc help in forecasting technological trends and events.and events.

Forecasting Environmental Forecasting Environmental Trends and Events Trends and Events

Expert opinions often are helpful in Expert opinions often are helpful in environmental forecasting.environmental forecasting.

Another method of forecasting is trend Another method of forecasting is trend extrapolation. However, departures from extrapolation. However, departures from an extrapolated trend carry more an extrapolated trend carry more interest. interest.

It is important to consider the cross-It is important to consider the cross-impact of one environmental impact of one environmental development on others. In cross-impact development on others. In cross-impact analysis, the impact of one event on the analysis, the impact of one event on the probability of another is determined.probability of another is determined.

Scenario AnalysisScenario Analysis

Forecasting the individual events Forecasting the individual events and trends would be too simplistic in and trends would be too simplistic in a complex environment where some a complex environment where some key area of uncertainty and key area of uncertainty and complexity may not be resolved.complexity may not be resolved.

Scenario analysis is one way to deal Scenario analysis is one way to deal with both complexity and with both complexity and uncertainty in the environment. uncertainty in the environment.

How to conduct scenario analysis?How to conduct scenario analysis?

Scenario analysis involves;Scenario analysis involves; the development (identification) of a set of total the development (identification) of a set of total

scenarios of what the future environment will scenarios of what the future environment will contain (based on optimistic, pessimistic, and contain (based on optimistic, pessimistic, and most likely scenarios). most likely scenarios).

relating those identified scenarios to strategies relating those identified scenarios to strategies (strategy development). Major purpose here is (strategy development). Major purpose here is to create new strategic options.to create new strategic options.

evaluating alternative scenarios by determining evaluating alternative scenarios by determining the scenario probabilities (asking experts). the scenario probabilities (asking experts).

comparing the expected outcomes of each comparing the expected outcomes of each strategy if the wrong scenario emerges (regret strategy if the wrong scenario emerges (regret analysis)analysis)

Impact AnalysisImpact Analysis Throughout the entire external analysis, Throughout the entire external analysis,

the problem of information overload the problem of information overload occurs.occurs.

So, it is crucial to determine not only So, it is crucial to determine not only which information is needed, but also which information is needed, but also which information has priority.which information has priority.

For this purpose, the creation of an For this purpose, the creation of an “impact matrix” which identify and “impact matrix” which identify and evaluate the various information need evaluate the various information need areas and also quantify their impact on areas and also quantify their impact on each SBU, can be useful.each SBU, can be useful.

““Impact Matrix”Impact Matrix”Impact of an information-need Impact of an information-need

areaarea On the matrix, the vertical axis lists potential On the matrix, the vertical axis lists potential

information needs areas, areas in which information needs areas, areas in which information could be gathered and organized. information could be gathered and organized. They can be drawn not only from an They can be drawn not only from an environmental analysis, but also from analyses of environmental analysis, but also from analyses of the customer, competitor and market. the customer, competitor and market.

The horizontal axis represents the present SBUs, The horizontal axis represents the present SBUs, may also include proposed and potential SBUs. may also include proposed and potential SBUs.

The entries in the matrix represent the relative The entries in the matrix represent the relative impact that trends or events associated with impact that trends or events associated with information-need areas will have on the SBUs. information-need areas will have on the SBUs. The impact can be positive or negative (as the The impact can be positive or negative (as the scale on the bottom of the example show).scale on the bottom of the example show).

The listing and assessing the impact of The listing and assessing the impact of information need areas on SBUs can help information need areas on SBUs can help (1) identify and (2) prioritize the (1) identify and (2) prioritize the information need areas for each SBU. The information need areas for each SBU. The areas with greatest impact are those with areas with greatest impact are those with the highest scale values. the highest scale values.

The column at the right (which adds the The column at the right (which adds the positive and negative entries for each row) positive and negative entries for each row) provides a summary measure of the impact provides a summary measure of the impact associated with an information-need area.associated with an information-need area.

On the other hand, the vertical column On the other hand, the vertical column totals at the lower section indicate the totals at the lower section indicate the SBUs sensitivity to trends and events in the SBUs sensitivity to trends and events in the environment. The relative importance of environment. The relative importance of each SBU is also shown. each SBU is also shown.

““Immediacy/Impact Matrix”Immediacy/Impact Matrix”Immediacy of an information-need Immediacy of an information-need

areaarea When the information-need areas have When the information-need areas have

high impact but such a low probability of high impact but such a low probability of occurrence, then it is not worth gathering occurrence, then it is not worth gathering and analyzing that information.and analyzing that information.

Similarly, when occurrence is far in the Similarly, when occurrence is far in the future, then it may also be of little concern.future, then it may also be of little concern.

The following matrix is helpful in The following matrix is helpful in identifying “how much” information will be identifying “how much” information will be sufficient, after an information need is sufficient, after an information need is crystallized. crystallized.

HighHigh

““Impact”Impact”

LowLow

LowLow High High““Immediacy”Immediacy”

Monitor and In-depth analysis;

analysis,strategy

contingent development

strategies

considered

MonitorMonitor and

analysis

If both the immediacy and impact are low, then If both the immediacy and impact are low, then a low level of monitoring may be sufficient.a low level of monitoring may be sufficient.

If the impact is thought to be low but the If the impact is thought to be low but the immediacy is high, the area deserves immediacy is high, the area deserves monitoring and analysis.monitoring and analysis.

If the immediacy is low and the impact is high, If the immediacy is low and the impact is high, then the area may require monitoring and then the area may require monitoring and analysis in more depth, and contingent analysis in more depth, and contingent strategies may be considered but not strategies may be considered but not necessarily developed and implemented.necessarily developed and implemented.

If both the immediacy and potential impact of If both the immediacy and potential impact of the underlying trends and events are high, then the underlying trends and events are high, then an in-depth analysis will be appropriate, as will an in-depth analysis will be appropriate, as will be the development of reaction plans or be the development of reaction plans or strategies. strategies.