Analyzing the External Environment of the Firm: Creating Competitive Advantages chapter 2

Creating the Environmentally Aware Organization So how do managers become environmentally aware? By doing scanning, monitoring, and gathering competitive intelligence, and using these inputs to develop forecasts. Then scenario planning and SWOT analysis can be used to help anticipate major future changes in the external environment, preparing the firm to do more extensive analysis of the forces in the general environment and the industry or competitive environment. Exhibit 2.1 Inputs to Forecasting

Environmental Scanning & Monitoring Environmental scanning involves surveillance of a firm’s external environment Predicts environmental changes to come Detects changes already under way Allows firm to be proactive Environmental monitoring tracks evolution of environmental trends Hard trends – measurable facts/events Soft trends – estimated, probable events Environmental scanning = surveillance of a firm’s external environment to predict environmental changes and detect changes already under way. Is a BIG PICTURE viewpoint of the industry/competition, looking for key indicators of emerging trends – what catches your eye? Alerts the firm to critical trends before changes have developed a discernible pattern and before competitors recognize them. Environmental monitoring = a firm’s analysis of the external environment that tracks the evolution of environmental trends, sequences of events, or streams of activities. Monitor the trends that have the potential to change the competitive landscape – what do you want to track? Firms need to CHOOSE the trends identified via the scanning activity, and regularly monitor or track these specific trends to evaluate the impact of these trends on their strategy process, i.e. Johnson & Johnson tracking % of GDP spent on health care, or # of active hospital beds. Hard trends = a projection based on measurable facts, events, or objects. It is something that WILL happen. Soft trends = something that MIGHT happen; and the probability with which it might happen can be estimated.

Competitive Intelligence Helps firms define & understand their industry Identify rivals’ strengths & weaknesses Collect data on competitors Interpret intelligence data Helps firms avoid surprises Anticipate competitors’ moves Decrease response time Beware of the potential for unethical behavior while gathering intelligence Competitive intelligence = a firm’s activities of collecting and interpreting data on competitors, defining and understanding the industry, and identifying competitors’ strengths and weaknesses. Be careful - aggressive efforts to gather competitive intelligence may lead to unethical or illegal behaviors. Note Strategy Spotlight on Ethical Guidelines on Competitive Intelligence: United Technologies.

Environmental Forecasting Environmental forecasting predicts change Plausible projections about Direction of environmental change? Scope of environmental change? Speed of environmental change? Intensity of environmental change? Scenario analysis involves detailed assessments of the ways trends may affect an issue & development of alternative futures based on these assessments Environmental forecasting = the development of plausible projections about the direction, scope, speed, and intensity of environmental change. Scenario analysis = an in-depth approach to environmental forecasting that involves experts’ detailed assessments of societal trends, economics, politics. technology, or other dimensions of the external environment. Asks what would happen if the environment should change dramatically? Addresses the need to consider a wider context than the narrow, traditional markets, laying down guidelines for at least 10 years in the future to anticipate rapid change.

SWOT Analysis SWOT analysis is a basic technique for analyzing firm and industry conditions Firm or internal conditions = Strengths & Weaknesses Where the firm excels or where it may be lacking Environmental or external conditions = Opportunities & Threats Developments that exist in the general environment Activities among firms competing for the same customers Once environmental scanning, monitoring, intelligence gathering, and forecasting have been done, the firm must do a more in-depth analysis to see how all this affects its strategy. SWOT analysis = a framework for analyzing a company’s internal and external environment and that stands for strengths, weaknesses, opportunities, and threats. The firm’s strengths come from within, and are where your firm excels; while the weaknesses are where your firm is lacking relative to competitors. The opportunities and threats can come from the general environment and/or from the specific industry’s competitive environment.

The General Environment The general environment is composed of factors that are both hard to predict and difficult to control: Demographic Sociocultural Political/Legal Technological Economic Global General environment = factors external to an industry, and usually beyond a firm’s control, that affect a firm’s strategy. Although the effects of these factors can vary across industries, EVERY industry has to anticipate the affect of each factor on its firm’s long-term strategies. See Exhibit 2.3 for effects of these various trends on certain industries. In addition, there are many reciprocal relationships among the various elements. For instance, the aging of the U.S. population has important implications for the economic segment.

The Competitive Environment The competitive environment consists of factors in the task or industry environment that are particularly relevant to a firm’s strategy: Competitors (existing or potential) Including those considering entry into an entirely new industry Customers (or buyers) Suppliers Including those considering forward integration Competitive environment = factors that pertain to an industry and affect a firm’s strategies. Industry = a group of firms that produce similar goods or services. Forward integration = a form of vertical integration whereby a firm expands activities to include control of the direct distribution of its products, e.g. a farmer sells his/her crops at the local market rather than to a distribution center for eventual sale to a supermarket (This definition is not in the textbook, but comes from http://www.investopedia.com/terms/f/forwardintegration.asp See more about vertical integration in Chapter 6. )

Porter’s Five-Forces Model of Industry Competition Porter’s five-forces model of industry competition = a tool for examining the industry-level competitive environment, especially the ability of firms in that industry to set prices and minimize costs. Includes the threat of new entrants; the bargaining power of buyers; the bargaining power of suppliers; the threat of substitute products and services; the intensity of rivalry among competitors in an industry. Each of these forces affects a firm’s ability to compete in a given market. Together they determine the profit potential for a particular industry. Exhibit 2.4 Porter’s Five-Forces Model of Industry Competition Source: Adapted and reprinted with permission of The Free Press, a division of Simon & Schuster Adult Publishing Group, from Competitive Strategy: Techniques for Analyzing Industries and Competitors by Michael E. Porter. Copyright © 1980, 1998 by The Free Press. All rights reserved.

How the Internet and Digital Technologies Affect Competitive Forces The Internet = a global network of linked computers that use a common transmission format, exchange information and store date. The Internet and other digital technologies have fundamentally changed the ways businesses interact with each other and with consumers. These changes have affected industry forces in ways that have created many new strategic challenges.

Using Industry Analysis: A Few Caveats Managers must not always avoid low profit industries – these can still yield high returns for players who pursue sound strategies Five forces analysis implicitly assumes a zero- sum game – yet mutually beneficial relationships can still be established with buyers & suppliers Five forces analysis is essentially a static analysis – yet external forces can still change the structure of all industries See the value net Vertical dimension = suppliers & customers Horizontal dimension = substitutes & complements Industry analysis helps a firm evaluate the profit potential of an industry and consider various ways to strengthen its competitive position. However, strategists must be wary – it’s not always simple. Zero-sum game = a situation in which multiple players interact, and winners win only by taking from other players. Complements = products or services that have an impact on the value of a firm’s products or services. For instance, Apple’s iTunes was software that made the iPod hardware such a popular product.

The Value Net Exhibit 2.6 The Value Net The value net is based on game-theory, and represents all the players in the game, analyzing how their interactions affect a firm’s ability to generate and appropriate value. The vertical dimension of the net includes suppliers and customers. The firm has direct transactions with them. On the horizontal dimension are substitutes and complements, players with whom a firm interacts but may not necessarily transact. Yet complements are products or services that have a potential impact on the value of a firm’s own products or services. A firm must acknowledge its potential partnerships here. See the Strategy Spotlight 2.8 on Apple and the iPod. Exhibit 2.6 The Value Net Source: reprinted by permission of Harvard Business Review. Exhibit from “The Right Game: Use Game Theory to Shape Strategy,” by A. Brandenburger and B.J. Nalebuff, July-August 1995. Copyright © 1995 by the Harvard Business School Publishing Corporation. All rights reserved.

Strategic Groups Within Industries Two unassailable assumptions in industry analysis: No two firms are totally different No two firms are exactly the same Strategic groups – clusters of firms that share similar strategies: Breadth of product & geographic scope Price/quality Degree of vertical integration Type of distribution Some groups of firms are more similar to each other than other firms. Rivalry will be greater in firms that are alike. Strategic groups = clusters of firms that share similar strategies. Dimensions should be considered that reflect the variety of strategic combinations in an industry.

Strategic Groups Within Industries Here is a strategic grouping of the worldwide auto industry. Note not all firms are included, only the four major groups: high-end luxury (those with exclusive clientele, and little rivalry from other groups), low-price/quality (those with a narrow market of bargain shoppers who aren’t that concerned with quality), high-price/quality (with some product-line breadth), and firms with a broad range of products/multiple price points (products that compete at both the lower end and higher end of the market). Consider how Ford and General Motors must monitor trends in this industry. The movement of the various strategic groups can help predict the future volatility and intensity of competition. Members of a strategic group can consider overcoming mobility barriers and migrate to other groups that they find attractive if they are willing to commit time and resources. Exhibit 2.7 The World Automobile Industry: Strategic Groups Note: Members of each strategic group are not exhaustive, only illustrative.

Strategic Groups Within Industries Strategic groups as an analytical tool Helps identify barriers to mobility that protect a group from attacks by other groups Helps identify groups whose competitive position may be marginal or tenuous Helps chart the future direction of firms’ strategies Helps to think through the implications of each industry trend for the strategic group as a whole The question is how to group firms in an industry on the basis of similarities in their resources and strategies. Identifying the strategic group your organization is in helps to decide where threats or opportunities may lie.