Chapter 3

THE EXTERNAL ENVIRONMENT

INTRODUCTION

A host of external influence a firmís choice of direction and action and, ultimately, its organizational structure and internal processes. These factors, which constitute the external environment, can be divided into three interrelated subcategories: factors in the remote environment, factors in the industry environment, and factors in the operating environment. Exhibit 3Ė1 suggests the interrelationship between the firm and its remote, industry, and operating environments. In combination, these factors form the basis of the opportunities and threats that a firm faces in its competitive environment.

REMOTE ENVIRONMENT

The remote environment comprises five factors that originate beyond, and usually irrespective of, any single firmís operating situationóeconomic, social, political, technological, and ecological factors.

      1.††† Economic Factors

Economic factors concern the nature and direction of the economy in which a firm operates. On both the national and international level, it must consider the general availability of credit, the level of disposable income, and the propensity of people to spend.

      2.††† Social Factors

The social factors that affect a firm involve the beliefs, values, attitudes, opinions, and lifestyles of persons in the firmís external environment, as developed from cultural, ecological, demographic, religious, educational, and ethnic conditioning. Exhibit 3-2 gives an example of the problems in monitoring social changes in international markets.

      3.††† Political Factors

The direction and stability of political factors is a major consideration for managers in formulating company strategy. Political factors define the legal and regulatory parameters within which firms must operate. As described in Exhibit 3-3, the direction and stability of political factors are a major consideration when evaluating the remote environment.

      4.††† Technological Factors

The fourth set of factors in the remote environment involves technological change. To avoid obsolescence and promote innovation, a firm must be aware of technological changes that might influence its industry. Exhibit 3-4 discusses how Bertelsmann benefited from Internet technologies.

      5.††† Ecological Factors

The most prominent factor in the remote environment is often the reciprocal relationship between business and the ecology. The term ecology refers to the relationships among humans and other living things and the air, soil, and water that support them. Useful Web site: www.epa.gov (Environmental Protection Agency). Exhibit 3-5 describes how Patagonia judged itself to be guilty of water pollution.Exhibit 3-6 takes a look at the costs of environmental regulation, Exhibit 3-7 describes one approach to environmental activism, and Exhibit 3-8 lists the various federal ecological regulations.

INTERNATIONAL ENVIRONMENT

The monitoring of the international environment involves assessing each non-domestic market on the same factors that are used in a domestic assessment. While the importance of factors will differ, the same set of considerations can be used for each country. Exhibit 3-9 lists the economic, political, legal, and social factors used to assess international environments.

INDUSTRY ENVIRONMENT

The nature and degree of competition in an industry hinge on five forces: the threat of new entrants, the bargaining power of customers, the bargaining power of suppliers, the threat of substitute products or services (where applicable), and the jockeying among current contestants.

HOW COMPETITIVE FORCES SHAPE STRATEGY

The essence of strategy formulation is coping with competition. The state of competition in an industry depends on five basic forces, which are diagrammed in Exhibit 3Ė10.

CONTENDING FORCES

Threat of Entry

New entrants to an industry bring new capacity, the desire to gain market share, and often substantial resources. The seriousness of the threat of entry depends on the barriers present and on the reaction from existing competitors that the entrant can expect. The six major sources of barriers to entry are: economies of scale, product differentiation, capital requirements, cost disadvantages independent of size, access to distribution channels, and government policy. Exhibit 3-11 looks at how experience curve acts as a barrier to entry.

Powerful Suppliers

Suppliers can exert bargaining power on participants in an industry by raising prices or reducing the quality of purchased goods and services. The power of each important supplier (or buyer) group depends on a number of characteristics of its market situation and on the relative importance of its sales or purchases to the industry compared with its overall business. A supplier group is powerful if:

         It is dominated by a few companies and is more concentrated than the industry it sells to.

         Its product is unique or at least differentiated, or it has built up switching costs.

         It is not obliged to contend with other products for sale to the industry.

         It poses a threat of integrating forward into the industryís business.

         The industry is not an important customer of the supplier group.

Powerful Buyers

Customers likewise can force down prices, demand higher quality or more service, and play competitors off against each otheróall at the expense of industry profits. A buyer group is powerful if:

         It is concentrated or purchases in large volumes.

         The products it purchases from the industry are standard or undifferentiated.

         The products it purchases from the industry form a component of its product and represent a significant fraction of its cost.

         It earns low profits, which create great incentive to lower its purchasing costs.

         The industryís product is unimportant to the quality of the buyersí products or services.

         The industryís product does not save the buyer money.

         The buyers pose a credible threat of integrating backward to make the industryís product.

Substitute Products

By placing a ceiling on prices it can charge, substitute products or services limit the potential of an industry. They not only limit profits in normal times, they also reduce the bonanza an industry can reap in boom times. Substitute products that deserve the most attention strategically are those that (a) are subject to trends improving their price-performance trade-off with the industryís product or (b) are produced by industries earning high profits.

Jockeying for Position

Rivalry among existing competitors takes the familiar form of jockeying for positionóusing tactics like price competition, product introduction, and advertising slugfests. This type of intense rivalry is related to the presence of a number of factors:

         Competitors are numerous or are roughly equal in size and power.

         Industry growth is slow, precipitating fights for market share that involve expansion-minded members.

         The product or service lacks differentiation or switching costs, which lock in buyers and protect one combatant from raids on its customers by another.

         Fixed costs are high or the product is perishable, creating strong temptation to cut prices.

         Capacity is normally augmented in large increments. Such additions, as in the chlorine and vinyl chloride businesses, disrupt the industryís supply-demand balance and often lead to periods of overcapacity and price-cutting.

         Exit barriers are high. Exit barriers keep companies competing even though they may be earning low or even negative returns on investment.

         The rivals are diverse in strategies, origins, and ďpersonalities.Ē

INDUSTRY ANALYSIS AND COMPETITIVE ANALYSIS

Designing viable strategies for a firm requires a thorough understanding of the firmís industry and competition. The firmís executives need to address four questions:

         What are the boundaries of the industry?

         What is the structure of the industry?

         Which firms are our competitors?

         What are the major determinants of competition?

 

INDUSTRY BOUNDARIES

An industry is a collection of firms that offer similar products or services. By ďsimilar products,Ē we mean products that customers perceive to be substitutable for one another. Why is a definition of industry boundaries important? First, it helps executives determine the arena in which their firm is competing. Second, a definition of industry boundaries focuses attention on the firmís competitors. Defining industry boundaries enables the firm to identify its competitors and producers of substitute products. Third, a definition of industry boundaries helps executives determine key factors for success. Finally, a definition of industry boundaries gives executives another basis on which to evaluate their firmís goals.

Defining industry boundaries is a very difficult task. The difficulty stems from three sources:

      1.††† The evolution of industries over time creates new opportunities and threats.

      2.††† Industrial evolution creates industries within industries.

      3.††† Industries are becoming global in scope.

      4.††† Developing a Realistic Industry Definition

To realistically define their industry, executives need to examine five issues:

      1.††† Which part of the industry corresponds to our firmís goals?

      2.††† What are the key ingredients of success in that part of the industry?

      3.††† Does our firm have the skills needed to compete in that part of the industry? If not, can we build those skills?

      4.††† Will the skills enable us to seize emerging opportunities and deal with future threats?

      5.††† Is our definition of the industry flexible enough to allow necessary adjustments to our business concept as the industry grows?

INDUSTRY STRUCTURE

Defining an industryís boundaries is incomplete without an understanding of its structural attributes. Structural attributes are the enduring characteristics that give an industry its distinctive character. To explain variations among industries, firms must examine the four variables that industry comprises: (1) concentration, (2) economies of scale, (3) product differentiation, and (4) barriers to entry. Useful Web site: www.bmw.com (BMW). Exhibit 3-12 presents some key principles that enable corporations to abide by the ever-increasing regulations while keeping costs down, maintaining competitiveness, and enhancing creativity.

COMPETITIVE ANALYSIS

In identifying their firmís current and potential competitors, executives consider several important variables:

         How do other firms define the scope of their market?

         How similar are the benefits the customers derive from the products and services that other firms offer?

         How committed are other firms to the industry?

 

Identifying competitors is a milestone in the development of strategy.But it is a process laden with uncertainty and risk, a process in which executives sometimes make costly mistakes.

OPERATING ENVIRONMENT

The operating environment, also called the competitive or task environment, comprises factors in the competitive situation that affect a firmís success in acquiring needed resources or in profitably marketing its goods and services.

Competitive Position

Assessing its competitive position improves a firmís chances of designing strategies that optimize its environmental opportunities. Although the exact criteria used in constructing a competitorís profile are largely determined by situational factors, the following criteria are often included:

      1.††† Market share

      2.††† Breadth of product line

      3.††† Effectiveness of sales distribution

      4.††† Proprietary and key-account advantages

      5.††† Price competitiveness

      6.††† Advertising and promotion effectiveness

      7.††† Location and age of facility

      8.††† Capacity and productivity

      9.††† Experience

  10.††† Raw materials costs

  11.††† Financial position

  12.††† Relative product quality

  13.††† R&D advantage/position

  14.††† Caliber of personnel

  15.††† General images

  16.††† Customer profile

  17.††† Patents and copyrights

  18.††† Union relations

  19.††† Technological position

  20.††† Community reputation

Once appropriate criteria have been selected, they are weighted to reflect their importance to a firmís success. Then the competitor being evaluated is rated on the criteria, the ratings are multiplied by the weight, and the weighted scores are summed to yield a numerical profile of the competitor, as in Exhibit
3Ė13.

Customer Profiles

Developing a profile of a firmís present and prospective customers improves the ability of its managers to plan strategic operations, to anticipate changes in the size of markets, and to reallocate resources so as to support forecast shifts in demand patterns. Useful Web site: www.americanexpress.com. Exhibit 3-14 illustrates the traditional approach to segmenting customers.

A second approach to identifying customer groups is by segmenting industrial markets. As shown in Exhibit 3Ė15, there is considerable overlap between the variables used to segment individual and industrial consumers, but the definition of the customer differs.

Suppliers

In assessing a firmís relationships with its suppliers, several factors other than the strength of that relationship should be considered. With regard to its competitive position with its suppliers, the firm should address the following questions:

         Are the suppliersí prices competitive? Do the suppliers offer attractive quantity discounts?

         How costly are their shipping charges? Are the suppliers competitive in terms of production standards?

         In terms of deficiency rates? Are the suppliersí abilities, reputations, and services competitive?

         Are the suppliers reciprocally dependent on the firm?

Creditors

Because the quantity, quality, price, and accessibility of financial, human, and material resources are rarely ideal, assessment of suppliers and creditors is critical to an accurate evaluation of a firmís operating environment. With regard to its competitive position with its creditors, among the most important questions that the firm should address are the following:

         Do the creditors fairly value and willingly accept the firmís stock as collateral?

         Do the creditors perceive the firm as having an acceptable record of past payment?

         A strong working capital position? Little or no leverage?

         Are the creditorsí loan terms compatible with the firmís profitability objectives?

         Are the creditorsí able to expand the necessary lines of credit?

Human Resources: Nature of the Labor Market

A firmís ability to attract and hold capable employees is essential to its success. However, a firmís personnel recruitment and selection alternatives are often influenced by the nature of its operating environment. A firmís access to needed personnel is affected primarily by three factors: the firmís reputation as an employer, local employment rates, and the ready availability of people with the needed skills.

Exhibit 3-16 provides a set of key strategic forecasting issues for each level of environmental assessment.