Chapter 2 The External Environment: Opportunities, Threats, Industry Competition and Competitor Analysis

Skate to where the puck is going, not to where the puck has been. Competitive strategy must grow out a sophisticated understanding of the rules of competition that determine industry attractiveness. Michael Porter When an industry with a reputation for bad economics meets a manager with a reputation for excellence, it’s usually the industry that leaves with its reputation intact. Warren Buffett Skate to where the puck is going, not to where the puck has been. Wayne Gretsky

External Analysis It’s not recognizing that change will occur that is the problem, it’s figuring out: what will happen? how it will affect us? what to do about it? Therefore, forecasting is necessary to predict direction and the effect of change

External Analysis 1) Analyze the environments General Industry Competitive 2) Identification of key success factors

Components of External Analysis Scanning – Monitoring – Forecasting – Assessing –

General Environment Industry Environment Potential Entrants Economic Technical Substitute Products Competitive Rivalry Demographic Political & Legal Bargaining Power of Suppliers Bargaining Power of Buyers Global Sociocultural

General Environment Demographic Economic Political Socioculture Technical Global

1) Demographic Segment Characteristics of the population e.g., age, race, gender, sexual orientation and social classes Ethnic structure Income distribution Geographic distribution

2) Economic Segment General health/wellbeing of the local, regional, national or global economy. e.g., Interest rates, unemployment rates, consumer spending, confidence and savings, energy costs, personal disposable income, inflation rates, housing costs

3) Political/Legal Segments Tax laws, minimum wages, environmental laws, labor laws, consumer protection, product liability, etc.

4) Sociocultural Segment Attitudes of society towards work, careers, products, services and consumer activism. e.g., concern for quality of life, birth rates, woman in the work force, low-carb dieting, health consciousness, respect for intellectual property, desire for “green retailing”, savings rates, etc.

5) Technological Segment Changes in technology that affect the workplace, and the products and services consumers expect e.g., Information technologies, entertainment technologies, product technologies.

6) Global Segment New and existing markets around the world, and changes in the political, cultural and institutional terrain.

General Environment Firms can not influence them, but they can have a significant influence on the firm, its industry, its strategy, and its performance Cast a wide net and to identify the emerging trends Then determine which factors are relevant, and how these changes will have an effect upon the firm.

General Environment Industry Environment Potential Entrants Economic Technical Substitute Products Competitive Rivalry Demographic Political & Legal Bargaining Power of Suppliers Bargaining Power of Buyers Global Sociocultural

ROIC Across Industries 1995-2004

Each of these forces affect costs/prices, therefore, profitability Porter’s Five Forces Competitive Rivalry Power of Buyers Power of Suppliers Potential Entrants Substitute Products Each of these forces affect costs/prices, therefore, profitability

Substitute Products Rivalry Among Suppliers of Buyers Competing (of firms in other industries) Rivalry Among Competing Sellers Suppliers of Key Inputs Buyers Potential New Entrants

{ Porter’s 5-forces is all about margins Price What factors increase/decrease margins within an industry, thus affecting profitability. Profits Costs

When industry structural variables are weak…... Prices can be kept high { Profits can soar Costs can be kept low

When industry structural variables are strong Prices will be pushed down { Profits shrink Costs will rise

What kind of businesses might you start? Suppose you had to start a new business and start generating revenues… … today … in a week … in 2 months … in 1 year What kind of businesses might you start?

Potential New Entrants Firms enter when industries are attractive, unless they find themselves at an immediate disadvantage relative to incumbents. Firms can create “barriers to enter” Barriers of entry are desirable for entrenched firms

Barriers to Entry

Suppliers Who are you key suppliers? Suppliers are a strong competitive force when: Only a few suppliers exist and is more concentrated than industry to which it is selling Few substitutes available to the industry firm Industry not important buyers to supplier group Supplier group provides a product crucial to production process, and/or significantly affects buyers’ product quality It is costly for buyers to switch suppliers Forward integration by suppliers is a credible threat Suppliers can supply at a lower cost

Buyers Who are your key buyers? - who provides our revenues? Can they force: lower prices, higher quality and service – affect the terms and conditions of the exchange? When do you, as a consumer, have power? Two issues

Buyers What affect buyers’ power? Volume/Frequency of purchase When buyers represent a large portion of sellers revenues When buyers can easily switch to another product When the product the buyers are buying is undifferentiated When buyers can self-source or backwards integration Criticality Buyers’ knowledge Buyers’ profitability

Substitutes Product/service which fulfills similar need Price cap 3 Questions Are they available? Can we switch? Price-performance relationship?

Rivalry and Profitability Industry profitability is a collective good. Collective good is served by coordination Are there industries were pricing is coordinated? Incentive to violate

Usually the most powerful of the five forces How actively and aggressively are rivals employing competitive weapons in jockeying for a stronger market position and increasing sales? Is price competition vigorous? Active efforts to improve quality? Are rivals racing to offer better performance features? better customer service? Lots of advertising/sales promotions? Active efforts to build a stronger dealer network? Active product innovation? Active use of other weapons of rivalry?

Rivalry – What drives it?

Exit Barriers Specialized assets Fixed costs of exit Strategic interrelationships among business units Emotional barriers

Industries and Segments What is a segment? Different segments….. posses different combinations of 5-forces therefore: reward different strategies possess different levels of profitability

Porter’s..in conclusion Attractiveness of industry/segment current industry adjacent segments industries you might consider entering Which forces possess the greatest influence? Can we influence them?

Static model & Hypercompetition If the pace of transformation is rapid, if entry rapidly undermines the market power of dominant firms, if innovation speedily transforms industry structure by changing process technology, creating new substitutes, and by shifting the basis on which firms compete, then there is little merit in using industry structure as a basis for analyzing competition and profit.

Competitor Analysis

Strategic group mapping A strategic group consists of those rivals with similar competitive approaches in an industry

National Jewelry Retailers Cartier Tiffany Nordstroms Sachs Price National Jewelry Retailers Cartier Tiffany Nordstroms Sachs Burdines Dillards Jerrods Marks & Morgan Sears JCP Zales Kay Target Pawn Shop Chain-by-the-Foot Carts WalMart Kmart Breadth of Product Line

Other Dimensions for Strategic Group Maps Vertical integration Geographic scope R&D Expenditures Customer Service Number of outlets Reputation Can even be categorical (e.g., Mexican, Italian, pizza, subs, chicken)

Four Steps of CA Identify their future objectives Identify their current strategy Identify their assumptions Identity their capabilities Strategy Objectives Assumptions Capabilities Strategic Action

Competitive Analysis Important in concentrated industries (few, large share competitors) Benefits forecast future actions, predict reactions can we influence rivals’ behavior?

Identification of Key Success Factors? KSFs are product attributes, competencies, competitive capabilities, and market achievements with the greatest direct bearing on profitability opportunities for competitive advantage

Example: KSFs for Beer Industry Utilization of brewing capacity -- to keep manufacturing costs low Strong network of wholesale distributors -- to gain access to retail outlets Clever advertising -- to induce beer drinkers to buy a particular brand