The purpose of this chapter is to familiarize students with techniques for evaluating a firm's external environment. This chapter focuses on the value managers add when they have a sense of events outside the company. By focusing on external events, managers are able to stay a step ahead of competitors by accurately anticipating and promptly responding to actions that can impact the organization. The chapter is organized into three sections.
1. The environmentally aware organization. Emphasize that managers use scanning, monitoring, and competitive intelligence to develop forecasts. Also, the role of scenario planning is discussed.
2. The influence of the six broad segments (demographic, sociocultural, political/legal, technological, macroeconomic, global) of the general environment of the firm.
3. The role of the competitive (also called the task or industry) environment and its analysis through the application of Porter's five forces model. We also address the concept of strategic groups. Managers use strategic groups to identify who its main competitors are and how a company fits in with the overall industry in which it competes.
The introductory case is Interstate Bakeries Corporation's failure to respond to trends in the baking industry. Use the example to illustrate how a firm's failure to recognize trends in consumer preference, the industry, and among competitors can cause business failures. Explain that scanning, monitoring, and competitive intelligence are all separate, discrete techniques that lead to business forecasts.
q What are the key points in the case?
q What other organizations have misread their external environment? What were the consequences?
I. THE ENVIRONMENTALLY AWARE ORGANIZATION
We address three important processes—scanning, monitoring, and gathering competitive intelligence—which managers use to develop forecasts. EXHIBIT 2.1 depicts relationships among these activities. Also, we address scenario planning and its role in anticipating future major changes in the external environment as well as the role of SWOT analysis.
The SUPPLEMENT below provides an historical perspective of the need for environmental awareness from the computer industry. This is, of course, an industry with which the students should be more familiar. (The authors are consultants with McKinsey & Company in Palo Alto, California.)
A. ENVIRONMENTAL SCANNING
Environmental scanning involves surveillance of the firm's external environment to predict environmental changes to come and detect changes that are already underway. We discuss the examples of (1) BP Amoco and (2) three of the eight "key issues" (globalization; time to market; and shifting roles and responsibilities) facing the automobile industry according to A. T. Kearney.
q Why would an automobile executive be at a disadvantage if s/he were not aware of such trends?
B. ENVIRONMENTAL MONITORING
Environmental monitoring tracks the evolution of trends, events, or streams of activities
in the external environment. In this section, we present some of the factors monitored by three organizations: Motel 6, Pier 1 Imports, and Johnson and Johnson Medical Products. Such factors are vital for managers in determining their firm's strategic direction and resource allocations.
The SUPPLEMENT below represents the factors that the Director of Planning of Vought Aircraft considered critical. You may initially ask the students:
q What indicators do you believe a firm should monitor that produces both (1) weapon systems for the military, and, (2) key components for the commercial aircraft industry?
C. COMPETITIVE INTELLIGENCE
Competitive intelligence helps firms define and understand their industry and identify rivals' strengths and weaknesses. Done properly, competitive intelligence helps a company to avoid surprises by effectively anticipating and responding to competitors' moves.
We briefly address the importance of competitive intelligence to firms in the banking, airline, and automobile industry.
q What are other industries where competitive intelligence is extremely important? How might such information be collected?
We address how the Internet has accelerated the speed at which firms can find competitive intelligence.
The following SUPPLEMENT provides an interesting perspective by Tracey Scott, past president of the Society of Competitive Intelligence Professionals:
q Do you agree with Ms. Scott's perspective? Do you feel she overstates her case? Why? Why not?
EXHIBIT 2.2 further clarifies what competitive intelligence (CI) is all about. It provides four contrasting issues on what CI "is" and "is not."
STRATEGY SPOTLIGHT 2.1 discusses some of the ethical guidelines that United Technologies has implemented.
q Are you aware of ethical guidelines that other companies have developed? Were they effective? Why? Why not?
Teaching Tip: The discussion of Competitor Intelligence provides the instructor with an opportunity to introduce the subject of ethics into the classroom. We suggest presenting scenarios that are not "black and white." For example, a firm advertises a position in order to get a chance to interview employees of a rival company with no intention to hire them. While this may not be illegal, clearly it is difficult to justify morally. The ensuing discussion will help to clarify the distinction between illegal and unethical behavior.
D. ENVIRONMENTAL FORECASTING
Environmental scanning, monitoring, and competitive intelligence are important inputs for analyzing the external environment. However, they are of little use unless they provide raw material that is accurate enough to help managers make accurate forecasts.
We address the twin problems of either assuming that the world is certain and open to precise predictions, or the assumption that it is uncertain and totally unpredictable. And, we provide the famous example of poor forecasting of the British/French supersonic transport, the Concorde.
q What are some other errors in forecasting with which you are familiar?
The SUPPLEMENT below provides an example of how a retail firm, Japan-based World Company and Spain-based Zara estimate future demand for their products:
Scenario planning provides a set of tools that enable managers to imagine threats and opportunities the future may bring. As a general rule, scenarios should be used by businesses whose external environments are prone to fundamental or sudden change and whose anticipation of such change is of vital strategic importance.
It is important to note that scenario planning draws on a wide range of disciplines and interests, among them economics, psychology, sociology, and demographics.
q Why must scenario planning draw on a variety of disciplines and interests?
We provide the example of Lego, and how its position in the toy industry may become eroded if they define their industry—and its future—in a very narrow context.
STRATEGY SPOTLIGHT 2.2 includes the example of Shell Oil Company has benefited from the use of scenario analysis.
F. SWOT Analysis
We briefly address SWOT Analysis at this point. SWOT stands for strengths, weaknesses, opportunities, and threats. SWOT analysis provides a framework for analyzing these four elements of a company's internal and external environment.
It is important to note that SWOT analysis provides the "raw material", that is, a basic listing of conditions and factors inside and outside of a company.
q What do you consider to be some of the major advantages and disadvantages of SWOT analysis? (This issue is addressed in more detail in Chapter 3, but you should point out that a key disadvantage is that strengths may not necessarily convert to sources of competitive advantage that are sustainable in the marketplace.)
II. THE GENERAL ENVIRONMENT
The general environment consists of factors that can have a dramatic effect on a firm's strategy. Typically, a firm has little ability to predict trends and events in the general environment, and even less ability to control them.
We divide the general environment into six segments: demographic, sociocultural, political/legal, technological, economic, and global.
EXHIBIT 2.3 provides examples of key trends and events in each of the six segments of the general environment
q How will the factors in Exhibit 2.3 affect specific industries?
q Which factors are more difficult to predict than others? (e.g., macroeconomic changes are typically more difficult to predict than demographic changes)
q How are these factors interrelated?
q What factors do you feel are important that are not listed in this exhibit?
A. THE DEMOGRAPHIC SEGMENT
Demographics are the most easily understood and quantifiable elements of the general environment. Demographics include elements such as the aging population, rising or declining affluence, changes in ethnic composition, geographic distribution of the population, and income level disparities.
q What are the implications of ethnic diversity for the work place?
q What implications do the migration to the South and West in the United States have for individual businesses?
q How does the "graying of America" affect U. S. companies?
Among the trends we discuss are the aging of the population and how it may differentially affect a wide variety of industries. We also discuss the increasing number of wealthy Americans as well as changes in the geographic population of the United States.
The SUPPLEMENT below, building upon STRATEGY SPOTLIGHT 2.3, addresses some interesting projections on the "aging" workforce and its implications:
q It might be interesting to ask what the implications are for today's organization (e.g., how can firms attract and retain older workers, changes in financial and non-financial incentives, etc.) as well as for public policy (e.g., changes in tax policies, increasing the number of immigrants, etc.).
STRATEGY SPOTLIGHT 2.3 discusses an important demographic trend – older employees in the workforce.
B. THE SOCIOCULTURAL SEGMENT
Sociocultural forces influence the values, beliefs, and lifestyles of a society. Examples include a higher percentage of women in the workforce, dual-income families, increases in the number of temporary workers, greater concern for healthy diets and physical fitness, greater interest in the environment, and families postponing having children.
q Name two industries that have benefited from the growing awareness about health and fitness. Also name two that have been adversely affected by this trend.
q What must firms do to attract and retain women employees? Why are such efforts becoming increasingly important?
The section also addresses the increased educational attainment of women in the workplace. We discuss increases in both the number of degrees granted to women as well as the increased formation of businesses by women.
STRATEGY SPOTLIGHT 2.4 discusses the significant role that women play in the making of important consumer decisions.
q Can you think of any other important implications this trend has for businesses in a specific industry?
C. THE POLITICAL/LEGAL SEGMENT
Political processes and legislation influence the regulations with which industries must comply. Some important elements of the political/legal arena include tort reform, the Americans with Disabilities Act (ADA), the repeal of the Glass-Stegall Act in 1999 (now banks may offer brokerage services), deregulation of utilities and other industries, and increases in the federally mandated minimum wage.
q What do you see as some of the pros/cons of the Americans with Disabilities (ADA) Act?
q Do you think the federally mandated minimum wage should be increased? What are the implications?
q Should there be tort reform—such as setting limits on the amounts that juries can award in personal injury cases?
Another area where visa restrictions is having an important impact is "very close to home" — universities. In the SUPPLEMENT below we provide an example of one student who elected to attend an M.B.A. program in China (because of visa concerns in the United States) and the fact that applications from Asian students have declined by as much as 50 percent at some U.S. business schools.
In this section we address some of the implications of tort reform. We also discuss some of the implications of legislation that may expand the number of temporary visas available for highly skilled foreign professionals. (It may be interesting to pose questions on this issue given the September 11, 2001 terrorist attacks, i.e., whether or not the number of visas should be restricted in some manner.)
D. THE TECHNOLOGICAL SEGMENT
Developments in technology lead to new products and services and improve how they're produced and delivered to the end user. Innovations can create entirely new industries and alter existing industries.
q Ask students to speculate on the impact of the following technologies on American industry: (1) the Internet, (2) manufacturing innovations (e.g., robotics), (3) genetic engineering/designer genes. (The last items may provoke some heated discussion regarding the ethical implications.)
We discuss the key implications that the Internet has had on industry — in particular, its impact on productivity gains.
EXHIBIT 2.4 addresses a fascinating issue: some of the promising future applications of nanotechnology and how it will impact some industries.
The SUPPLEMENT below discusses how technology developed by NASA is making important contributions outside of the space program.
We close out the section by addressing some of the "downsides" of technology. In addition to ethical issues, we discuss environmental damage, such as the emission of greenhouse gases. We discuss BP Amoco's innovative approach to this matter.
E. THE ECONOMIC SEGMENT
The economy has an impact on all industries, from suppliers of raw materials to manufacturers of finished goods and services, as well as all organizations in the service, wholesale, retail, government, and nonprofit sectors of economies. Key indicators include interest rates, unemployment rates, the consumer price index (CPI), the Gross Domestic Product (GDP), and net disposable income.
q Compare the impact of rising (or declining) interest rates on the overall demand for the following industries: (1) housing (will have a significant impact), (2) automobiles (will have a significant impact), (3) fast food (will have very little effect).
F. THE GLOBAL SEGMENT
Globalization provides both opportunities to access larger potential markets and a broad base of factors of production such as raw materials, labor, skilled managers, and technical professionals. However, such endeavors carry many political, social, and economic risks. Examples of important elements in the global segment include currency exchange rates, increasing global trade, the economic emergence of India, China's admittance to the World Trade Organization, trade agreements among regional blocs (e.g., EC), and the GATT Agreement (lowering of tariffs).
q Provide examples of firms that have succeeded (stumbled) in their efforts to expand into international markets. What factors can explain their success (failure)?
We discuss the globalization of the automobile industry — in particular, the attraction of developing markets. We provide the example of the Norwegian shipping industry to illustrate its global nature.
The SUPPLEMENT below addresses some of the issues pertaining to the global impact of the September 11, 2001 terrorist attacks in the United States and the "War on Terror." (You may consider posing a question on this issue prior to discussing the supplement)
G. RELATIONSHIPS AMONG ELEMENTS OF THE GENERAL ENVIRONMENT
In our discussion of the general environment, we have addressed many relationships among the various elements.
EXHIBIT 2.5 provides many examples of how the impact of trends or events in the general environment can vary across industries.
III. THE COMPETITIVE ENVIRONMENT
Here, we draw upon a well-known analytic tool, Michael Porter's five forces model of industry competition. We introduce this model and discuss examples of each force. We then address the strategic groups concept and its implications for studying rivalry and competition.
A. PORTER'S FIVE FORCES MODEL OF INDUSTRY COMPETITION
EXHIBIT 2.6 illustrates Porter's five forces model of industry competition
When introducing this model, it is useful to show how the model provides insight into an industry's dynamics and expected profit levels. The SUPPLEMENT below provides such an analysis on the paint and allied products industry. The analysis is restricted to the trade sales (i.e., house paint) segment of the industry. The competitive forces are very different for other segments such as the specialized high-tech automobile finishes.
Note: For our purposes of illustrating the "basics" of the "five forces," the analysis has been simplified. We assume buyers to be consumers, although there are, of course, other distinct groups such as hardware stores, and large discounters such as Wal-Mart. Obviously firms' bargaining power vis-à-vis paint manufacturers vary significantly. Similarly, our analysis assumes the industry's products to be commodity products. However, there are exceptions, such as Olympic Stain, that have successfully differentiated their products on the basis of quality.
It is useful to point out that there can also be very profitable opportunities to compete in industries that have overall low profits, overall. For example, in the paint industry, Olympic Stain has typically been a very successful and highly-profitable firm because they have found an attractive niche in the market and developed a differentiated product (through product development and advertising). The SUPPLEMENT below provides two examples of how attractive opportunities were exploited in what seemed to be unattractive market segments.
1. THREAT OF NEW ENTRANTS
After summarizing the major barriers to entry, ask students to provide examples of industries characterized by each of these entry barriers. This may help them to understand what initially may appear to be rather complex ideas.
We discuss the example of ProCD — a firm (producing electronic telephone books) that failed because of low entry barriers.
Teaching Tip: The chapter explains how economies of scale and economies of experience (learning curve) erect significant entry barriers. In the auto industry, U.S. manufacturers such as Ford and G.M. have high economies of scale (being the biggest producers) and all the benefits of learning curve (having been in the business for almost a century). Despite these advantages, foreign auto producers have entered the U.S. market and have increasingly gained market share over the past few decades. Ask the students why this happened? Does this prove that the concepts we discussed are wrong? Or does it point out that additional factors have to be considered? Point out that foreign producers have the benefits of lower labor costs and/or have developed better manufacturing technologies (such as Toyota's lean manufacturing).
2. BARGAINING POWER OF BUYERS
Briefly summarize some of the conditions under which a supplier group may become powerful. It may be interesting how things have changed (if they have) with regard to the power of buyers of talent (i.e., businesses of varying sizes and industries) and suppliers of talent (i.e., business school graduates—either undergraduate or MBA).
3. BARGAINING POWER OF SUPPLIERS
Briefly discuss some of the conditions under which a supplier group may become powerful. The bargaining power of suppliers can be presented as the mirror opposite of the bargaining power of suppliers. For example, the relative sizes and concentrations largely determine the bargaining power of the two parties involved in the transaction.
The section discusses the relative power of the providers of talent — ranging from unskilled labor (low) to highly skilled professionals (high). Especially hard hit will be several unions such as those in declining industries such as steel manufacturing.
STRATEGY SPOTLIGHT 2.7 discusses how a group of catfish farmers formed a cooperative, Delta Pride Catfish, to process their own catfish – an example of forward integration by suppliers.
4. THE THREAT OF SUBSTITUTE PRODUCTS AND SERVICES
Emphasize that the viability of a substitute product depends largely on its relative price-performance trade-off, i.e., more value for the same price or the same value for a lower price. Examples are electronic security systems versus security guards, and the use of steel versus plastic for components in the manufacture of automobiles.
We discuss substitutes and give the example of IBM's use of teleconferencing. Clearly, this technology poses a threat to the airline industry.
The SUPPLEMENT below addresses important substitute products/services that threaten to erode the surplus of the United States Postal Service (USPS). These substitutes are e-mail and online bill paying.
5. THE INTENSITY AMONG COMPETITORS IN AN INDUSTRY
After discussing the factors that lead to intense rivalry in an industry, provide an example of an industry in which competition has recently been intense. For example, most students are familiar with the recurring price wars in the U. S. airline industry. Ask them to explain this using the factors discussed (e.g., undifferentiated service, low switching costs, slow industry growth, numerous competitors, etc.) You might point out that this industry was expected to report huge losses in 2001 even before the September 11, 2001 terrorist attack. Beginning in late 2005, the airlines' problems were further aggravated by extremely high fuel costs.
In this section we discuss the intense rivalry between Pfizer's Viagra (impotence treatment product) and a competing product developed by Eli Lilly & Company and Icos—Cialis. This provides an example that intense rivalry can take place on factors other than pricing in an industry that is highly profitable.
The SUPPLEMENT below is Michael Porter's response to a question as to whether or not he would add a "sixth force" if he were developing his framework today.
B. USING INDUSTRY ANALYSES: A FEW CAVEATS
This section was written as a "caveat" to address some limitations of Porters five forces model. First is the idea that business is not always a "zero-sum game"— which is an assumption that is implicit in Porter's five forces model. We discuss how companies can collaborate with each other for mutually beneficial outcomes.
The SUPPLEMENT below provides a more detailed example of "win-win" relationships in the supermarket industry.
The second issue we raise is that the five forces analysis has often been criticized for being a static — rather than a dynamic analysis. Brandenberger and Nalebuff introduced the concept of the value net which we include in Exhibit 2.7.
The concept of complementors is often considered to be the single most important contribution of value net analysis. Complements typically are products or services that have a potential impact on the value of the firms' own product and services. We provide the examples of complements (software and microprocessors) in the personal computer industry and the video game industry. (As we noted in an earlier supplement, Professor Michael Porter would not add complements to the "five forces" because they don't have a direct linear relationship to industry profitability. However, they clearly can have an impact on an industry's profitability.)
C. INDUSTRY ANALYSIS: A DYNAMIC PERSPECTIVE
In this section, we draw on Professor Anita McGahan's work on the analysis of industry evolution. Her analysis is based on the identification of the core activities and core assets of an industry and the threats that they face. Her framework provides a two-by-two typology to form four possible types of evolutionary trajectories — radical change, creative change, intermediating change, and progressive change. It is shown in Exhibit 2.8.
In addition to the implications discussed in the text, it may be helpful to address some of the implications for diversification. These are included in the SUPPLEMENT below:
Teaching Tip: Even when industry analysis shows that an industry is unattractive, there are a few firms that seem to be able to earn high returns. For example, Southwest Airlines has been consistently profitable in an otherwise unattractive industry over the past several years. Does this mean that industry analysis is misleading? You may point out that industry analysis is useful to predict an industry's average profitability, but not necessarily, a single firm's profitability. This is a good opportunity to introduce the role of the strategist in outperforming industry norms.
C. STRATEGIC GROUPS WITHIN INDUSTRIES
Most of your students are probably very interested in the automobile industry. EXHIBIT 2.9 provides a strategic grouping of the worldwide automobile industry. It is rather clear from the discussion in the text that the intensity of competition within strategic groups is much more intense than competition across groups.
Point out four benefits of strategic groups as an analytical tool:
1. Strategic groupings help a firm identify mobility barriers that protect a group from attacks by other groups.
2. It helps a firm to identify groups whose competitive position may be marginal or tenuous.
3. It helps chart the future directions of firms' strategies.
4. It helps in thinking through the implications of each industry trend for the strategic group as a whole.
It may be interesting to ask the students what dynamics they envision in the automobile industry, i.e., how membership in strategic groups may change and if new strategic groups may emerge.
q What are some of the strategic groups in other industries with which you may be familiar? What are the implications? (e.g., retailing)
Managers must analyze the external environment to minimize or eliminate threats and exploit opportunities. This involves a continuous process of environmental scanning and monitoring as well as obtaining competitive intelligence on present and potential rivals. These activities provide valuable inputs for developing forecasts. In addition, many firms use scenario planning to anticipate and respond to volatile and disruptive environmental changes.
We identified two types of environment: the general environment and the competitive environment. The six segments of the general environment are demographic, sociocultural, political/legal, technological, economic, and global. Trends and events occurring in these segments, such as the aging of the population, higher percentages of women in the workplace, governmental legislation, and increasing (or decreasing) interest rates, can have a dramatic effect on your firm. A given trend may have a positive impact on some industries and a negative or neutral impact, or none at all on others.
The competitive environment consists of industry-related factors and has a more direct impact than the general environment. Porter's five forces model of industry analysis includes the threat of new entrants, buyer power, supplier power, threat of substitutes, and rivalry among competitors. The intensity of these factors determines, in large part, the average expected level of profitability in an industry. A sound awareness of such factors, both individually and in combination, is beneficial not only for deciding what industries to enter but also for assessing how a firm can improve its competitive position. We also addressed some of the limitations of Porter's five forces model, including its "zero-sum perspective" and its omission of the key role of complements. Although we discussed the general environment and competitive environment in separate sections, they are quite interdependent. A given environmental trend or event, such as changes in the ethnic composition of a population or a technological innovation, typically has a much greater impact on some industries than on others.
The concept of strategic groups is also very important to the external environment of a firm. No two organizations are completely different nor are they exactly the same. The question is how to group firms in an industry on the basis of similarities in their resources and strategies. The strategic groups concept is valuable for determining mobility barriers across groups, identifying groups with marginal competitive positions, charting the future directions of firm strategies, and assessing the implications of industry trends for the strategic group as a whole.