Chapter 3 Assessing Opportunities and Threats: Doing An External Analysis

Moses Acquaah, Ph. D. 377 Bryan Building Phone: (336) 334-5305 Email: acquaah@uncg.edu

Lecture Objectives
(1) Explain the importance of studying the firms external environment (2) Differentiate between external environmental opportunities and threats (3) Explain the different perspectives on firms environments (4) Define and describe firms general and specific (industry) environments (5) Explain the dominant economic characteristics in an industry (6) Identify each of Porters five competitive forces and explain how they determine an industrys profit potential (7) Explain how to cope with Porters five competitive forces (8) Define and explain the drivers of change in an industry (9) Define and explain the key success factors (KSFs) in an industry (10) Explain the responsibilities of different managerial levels for external analysis (11) Explain the benefits and challenges of doing an external analysis

Organizations as Open System

An organization is an open system that interacts with and responds to its external environment

Organizations function as systems Organizations are affected by the environment and can also impact the environment Need to examine external environment of organizations

Closed systems?

What is an External Analysis?

The process of scanning and evaluating an organizations various external sectors impacting on performance Environmental scanning

Monitoring & interpreting sweep of social, political, economic, environmental, & technological events to spot budding trends that could eventually impact the industry Allow decision makers to know whats happening in the external environment Recognize and anticipate external environmental changes

What is an External Analysis?

Evaluating external sectors:

Evaluating various data trends & information and what they mean to the organization Assessing the impact on organization by determining the opportunities and threats facing the organization

What is an External Analysis?

(1)

(2)

Evaluating external sectors involves looking for: Opportunities: Positive external environmental trends that improve the organizations performance Threats: Negative external environmental trends that hinder the organizations performance

Perspectives on Organizational Environments

(1) Environment as Source of Information
The environment is viewed as a source of information for decision-making (a) Environmental uncertainty

The amount of change & complexity of an organizations environment (1) Environmental stability: Amount of change in an organizations environment

Dynamic: rapid change Stable: minimal or slow change

Perspectives on Organizational Environments

Environmental Uncertainty (contd)

(2) Environmental complexity: Number of components in environment that decision makers must monitor

Complex: Many environmental components Simple: Few environmental components The more complex and dynamic the environment, the more uncertain it is and the more information that decision makers need about the environment to be able to make appropriate decisions

(3) Implications of dynamic and complex environment:

Perspectives on Organizational Environments

(2) Environment as Source of Resource

Environment viewed as a source of scarce and necessary resource, sought for by competing organizations The scarcer a resource, the harder it is to maintain control over resources

The more uncertainty decision makers face

Environmental hostility: An environment is hostile when

Resources become harder to obtain & control Organizations are subjected to greater uncertainty

How Do You Do An External Analysis

External environmental sectors

External vs. Internal Environment

External environment affects all competitors Internal environment affects only the decision makers firm External sectors that directly impact decisions and actions by opening up opportunities or threats External sectors that indirectly affect decisions and actions and may present opportunities or threats

Specific or Task Environment

General Environment

How Do You Do An External Analysis

General Environment Tech

Specific Environment Political Legal

Socio-cultural Organization Economic

Demographic

General Environment

Five main general environmental sectors

Economic

All macroeconomic data, current statistics, trends & changes Interest rates; exchange rates; inflation rates; budget deficit-surplus; trade deficits-surplus; consumer income, spending, & debt levels; employment-unemployment rates, workforce productivity, etc.

General Environment

Demographic

Current statistical data and trends in population characteristics Gender; Age; Income levels; Ethnic makeup; Education; Family composition; Geographic location; Birthrates; Employment status

Technological

Improvements, advancements, and innovations that create opportunities & threats Communications; computing; transportation; robotics; manufacturing; telecom; consumer electronics, etc.

General Environment

Socio-Cultural

Nature of the countrys culture and how its changing Societys traditions, values, attitudes, beliefs, tastes, patterns of behavior, and how they are changing The various laws, regulations, judicial decisions, and political forces that are currently in effect at the federal, state, and local levels of government Regulations enacted by professional associations, e.g. FASB Potential legal, regulatory, & political changes, or pending judicial decisions that might take place & could impact firms

Political-Legal

Specific Environment

Include industry and competitive variables What is an industry?

A group or groups of organizations producing (offering) similar or identical products (services) Compete for customers to purchase their products & services Compete for the necessary resources (or inputs) that are converted (or processed) into products (or outputs)

Competitive variables

Specific Environment

Analyzing specific environment involves

Industrys dominant economic characteristics The nature and intensity of competition

Porters

Five Forces Model

Drivers of Industry change Industry Key Success Factors

Industrys dominant economic characteristics

Market size & growth rate

Small markets dont tend to attract big/new competitors as large markets; Faster growth breads new entry Local, regional, national, or global?

Scope of competitive rivalry

Number of competitors & their relative sizes Prevalence of backward or forward integration

Raises capital requirements; create differences in costs High barriers protect positions & profits of existing firms Big resource requirements make investment decisions critical

Entry/exit barriers & resource requirements

Industrys dominant economic characteristics

Nature & pace of technology

Raises risk because investments in tech. facilities may become obsolete before they wear out

Product & customer characteristics Scale economies & experience curve effects

Increases volume & market share needed to be cost competitive Surpluses push prices & profit margins down; shortages pull them up High profit industries attract new entrants; depressed conditions encourage exit.

Capacity utilization

Industry Profitability

The nature and intensity of competition

What to identify

Main SOURCES of competitive forces

Rivals, suppliers, customers/buyers, types of products or services offered, government, entry barriers, etc Strong, moderate, weak, etc.

STRENGTH of competitive forces

Key analytical tool

Porters FIVE FORCES MODEL of competition

Porters Five Forces Model

Assess strength of each competitive force (Strong? Moderate? Weak?)

Rivalry among existing competitors Substitute products Threat of potential entrants Bargaining power of suppliers Bargaining power of buyers

Explain how each force acts to create competitive pressure Decide whether overall competition is brutal, fierce, strong, moderate, or weak

Porters Five Forces Model

Threat of Potential Entrants Bargaining Power of Suppliers Rivalry among Competitors Bargaining Power of Buyers

Threat of Substitutes

Porters Five Forces Model

(1) Rivalry among existing competitors

Existing firms in an industry are organization's current & direct competitors Usually the most powerful of the five forces Check for weapons of competition used by rivals in jockeying for position

Price Quality and/or product innovation Customer service Performance features offered Advertising/promotions Dealer networks and/or distribution channels Warranties/guarantees

Porters Five Forces Model

What causes rivalry to be stronger?

Lots of firms, more equal in size & capability Slow growth in market Industry conditions tempt rivals to use price cuts and other offensive weapons to boost volume & market shares Customers have low switching costs One or more firms initiate moves to bolster their position position at the expense of rivals A successful strategic move carries a big payoff Costs more to get out of business than to stay in Firms have diverse strategies, corporate priorities, resources and countries of origin

Porters Five Forces Model

Strategic group is a set of firms competing within an industry the have similar strategies and resources Firms in same strategic group have two or more competitive characteristics in common:

Sell in same price/quality range Cover same geographic areas Be vertically integrated to the same degree Have comparable product line breath Emphasize same types of distribution channels Offer buyers similar services Use identical technological approaches

Porters Five Forces Model

(2) Threat of Potential Entrants

Seriousness of threat depends on

Barriers

to entry Reactions of existing firms to new entrants

Barriers exist in an industry when

Newcomers

confront obstacles Economic factors put potential entrants at a disadvantage relative to established firms in an industry

Porters Five Forces Model

Common Barriers to Entry

Economies of scale Inability to gain access to specialized technology & know-how Existence of learning/experience curve effects Strong brand preferences and customer loyalty High capital and/or specialized resource requirements Costs disadvantages independent of size Access to distribution channels Regulatory policies, tariffs, trade restrictions

Porters Five Forces Model

Threat of potential entry is stronger when:

Entry barriers are low Sizeable pool of potential entrants exists Established firms are unwilling or unable to contest a newcomer's entry efforts Newcomers can expect to earn attractive profits

Porters Five Forces Model

(3) Bargaining Power of Buyers Buyers are a strong competitive force when:

They are large and purchase a sizeable %age of industrys product They buy in bulk They can integrate backwards Industrys product is standardized Switching costs to substitutes or other brands are low They can purchase from several suppliers The product purchased does not save the buyer money

Porters Five Forces Model

Buyers are a stronger competitive force the more they have leverage to bargain over:

Price Quality Service Other terms and conditions of sales (e.g., warranties/guarantees)

Porters Five Forces Model

(4) Bargaining Power of Suppliers Suppliers are a strong competitive force when:

Items makes up large portion of product costs, is crucial to production process, and/or significantly affects product quality It is costly for buyers to switch suppliers They have good reputations & growing demand They can supply a component cheaper than industry members can make it themselves They do not have to contend with substitutes Buying firms are not important customers

Porters Five Forces Model

Suppliers are a stronger competitive force the more they can exercise power over:

Prices charged Quality and/or performance of items supplied Amounts and delivery times

Porters Five Forces Model

Substitute Products Substitutes matter when customers are attracted to the products of firms in other industries - satisfy the same need Limit potential returns (profitability) of an industry

Place ceiling on prices firms can charge

Porters Five Forces Model

When are substitutes a stronger force?

Sale of substitute are growing rapidly Producers of substitutes are planning to add new capacity Profits of substitute producers are increasing

The competitive threat of substitutes is stronger when they are:

Readily available Attractively priced Believed to have comparable or better performance features Customer switching costs are low

Strategic Implications of Porters Five Forces Model

An industry environment is unattractive when

Rivalry is strong Entry barriers are low Competition from substitutes are strong Suppliers and buyers have considerable bargaining power

Strategic Implications of Porters Five Forces Model

Industry industry is attractive when:

Rivalry is moderate or low Entry barriers are high Good substitutes do not exist Suppliers and buyers are in a weak bargaining position

How to Cope with the Five Competitive Forces

Craft a strategy that will:

Insulate firm from competitive forces Influence competitive pressures in ways that will favor company Build sustainable competitive advantage

Drivers of Change in an Industry

Industries change because forces are driving industry participants to alter their actions What are driving forces

The major underlying causes of changing industry and competitive conditions

Identify forces likely to exert greatest influence over next 1-3 years usually not more than 3-4 factors Assess their impact difference they make Environmental scanning a pre-requisite

Analyzing Driving Forces

Common Types of Driving Forces

Changes in long-term industry growth rate Changes in buyers of the product & how they use it Product innovation Technological change/process innovation Marketing innovation Entry or exit of major firms Diffusion of technical knowledge Changes in costs and efficiency

Common Types of Driving Forces

Increasing globalization of industry Market shift from standardized to differentiated products New regulatory policies and/or government legislation Changing societal concerns, attitudes, and risk lifestyles Changes in the degree of uncertainty and business risk

Key Success Factors (KSFs) in an Industry

What are industry KSFs?

The competitive elements that every industry member must be competent at doing or concentrate on achieving in order to be competitive and financially successful in the marketplace

Specific strategy elements Product attributes Resources,Competencies & Competitive capabilities

Identifying Industry KSFs

KSFs in an industry spell difference between

Profits and loss Competitive success or failure

Answers to three questions pinpoint KSFs

(1) On what basis do customers choose between competing brands or sellers? (2) What must a seller do to be competitively successful what resources and competitive capabilities does it need? (3) What does it take for sellers to achieve a sustainable competitive advantage? KSFs consist of 3-5 major determinants of financial & competitive success in an industry

Common Types of KSFs

Technology-related

Scientific research expertise; product innovation capability; expertise in a given technology; etc. Low-cost production efficiency; low cost plant location; Quality of manufacture, low-cost product design & engineering, etc Strong network of wholesaler distributors/dealers; ability to gain ample space on retail shelves; accurate filling of customer orders; short delivery times, etc.

Manufacturing-related

Distribution-related

Common Types of KSFs

Marketing-related

Customer service; merchandising skills; clever advertising; attractive styling or packaging, Guarantees & warrantees Superior workforce talent; quality control know-how; design expertise; technological expertise, etc. Superior information systems; ability to employ internet to conduct business; managerial expertise

Skills-related

Organizational capability

Responsibilities for External Analysis

Lower level or supervisory managers

Encourage workers to observe and interact with external parties (customers & supplier reps) Collect & consolidate information from workers Coordinate external information Share information with other organizational units Act as information gatherer & disseminator Monitor general information Make neede strategic changes Evaluate opportunities & threats

Middle managers

Upper Management

Benefits of Doing an External Analysis

Proactive Managers anticipate changes and plan accordingly

Provide information for

Planning Decision making Strategy formulation

Acquire and control needed resources Cope effectively with increasingly dynamic environment Make a difference with higher performance

Challenges of Doing an External Analysis

Rapid environmental changes are difficult to keep up with Amount of time that the analysis can consume Identifying accurate forecasts and trends Availability of data and information