External Analysis: The Identification of Opportunities and Threats

GARETH R. JONES /CHARLES W. L.
HILL
Theory of Strategic Management 10th ed.
Chapter
External Analysis:
2
The Identification of
Opportunities and
Threats
Student Version
© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as Prepared by C. Douglas Cloud
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Professor Emeritus of Accounting
Pepperdine University
Learning Objective: After reading this chapter you
should be able to review the primary technique
used to analyze competition in an industry
environment: the Competitive Forces model.
COMPETITIVE FORCES MODEL

 Michael E. Porter’s “The Five Forces Model”
assumes that as the forces grow stronger,
they limit the ability of companies to raise
prices.
 A weak competitive force allows a company
to earn greater profits.
© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
 A strong competitive force can be regarded

as a threat because it depresses profits.
 A weak competitive force can be viewed as
an opportunity because it allows a company
to earn greater profits.
 The strength of the forces may change over
time as industry conditions change.
 Managers face the task of recognizing how
changes in the forces give rise to new
opportunities and threats.
1) The first of Porter’s Five Forces is the risk of

entry by potential competitors (companies
that are not currently competing in the industry).
a) The risk of entry by potential competitors is a
function of the height of barriers to entry, that is,
factors that make it costly for companies to enter
an industry.
b) Economies of scale occur when unit costs fall as
a firm expands its output.
c) Brand loyalty exists when consumers have a
preference for the product of an established
company.
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c) An absolute cost advantage means that

entrants cannot expect to match
established companies lower cost.
d) Customer switching costs occur when a
customer invests time, energy, and money
switching from the products offered by
one established company to the products
of a new entrant.
e) Historically, government regulations

have constituted major entry barrier into
many industries.
i) Until the mid-1990s, providers of long-
distance telephone service could not
compete for local telephone services.
ii) The Motor Carrier Act of 1980, among
other things, deregulated the routes that
carrier could use.
2) The second of Porter’s Five Forces is the

intense rivalry among established
companies.
a) The industry competitive structure refers
to the number and size distribution of
companies in it.
i) A fragmented industry consists of a large
number of companies that cannot determine
industry price.
ii) A consolidated industry is dominated by a
small number of large companies.
b) The level of industry demand is the

second determinant of the intensity of
rivalry.
i) Growing demand tends to reduce rivalry
because all companies can sell more
without taking market share away from other
companies.
ii) When demand declines, a company can
only grow by taking market share away from
other companies.
c) The cost structure is a third determinant

of rivalry.
i) When fixed costs are high, profitability
tends to be highly leveraged to sales
volume, and the desire to grow can spark
intense rivalry.
ii) Research suggests that when sales
volume is low, weaker firms cut prices
and/or raise promotional spending as
they struggle to cover fixed cost.
d) Exit barriers are economic, strategic, and

emotional factors that prevent companies
from leaving an industry. Common exit
barriers include the following:
i) Investment in fixed assets that are of little or no
value in alternate uses, or cannot later be sold.
ii) Severance pay, health benefits, or pensions that
must be paid to workers when a company
ceases to operate.
iii) Emotional attachment to an industry.
iv) Bankruptcy regulations.
3) The bargaining power of buyers is the third of

Porter’s Five Forces. It is the ability of buyers to
bargain down prices or demand better service.
Some examples of when buyers are most
powerful are:
a) When there are many small sellers of the particular
product and the buyers are large and few in
number.
b) When the buyer purchases in large quantities and
uses its power to bargain for price reductions.
c) When the supplier industry depends on the buyers
for a large percentage of total orders.
4) The fourth of Porter’s Five Forces is the

bargaining power of suppliers. Examples of
when suppliers are most powerful include:
a) The product that suppliers sell has few
substitutes and is vital to the buyer.
b) The industry is not an important customer
to the supplier.
c) Suppliers threaten to enter their customers’
industry.
5) The final force in Porter’s model is the threat

of substitute products: products of different
businesses that can satisfy similar customer
needs.
a) Tea versus coffee versus soft drink
b) Margarine versus butter
6) Andrew Grove argued that power, vigor, and
competence of complementors comprised a
sixth force.
Learning Objective: After reading this chapter
you should be able to explore the concept of
strategic groups and illustrate the implications
for industry analysis.
STRATEGIC GROUPS WITHIN INDUSTRIES
 Within most industries, it is possible to

observe groups of companies that follow a
business model similar to companies in other
groups.
 These different groups of companies are
known as strategic groups.
Implications of Strategic Groups

1) Because all companies in a strategic group are
pursuing a similar business model, customers tend to
view such enterprises as direct substitutes for each
other (for example, Wal-Mart, Kmart, and Target).
2) Each strategic group may face a set of opportunities
and threats.
 Risk of new entrants
 Degree of rivalry among companies in the group
 Bargaining power of suppliers or buyers
The Role of Mobility Barriers
 Mobility barriers are within-industry factors that

inhibit the movement of companies between
strategic groups.
 These barriers could bar entry into a group or
bar exit from the company’s existing group.
 Managers must determine if it is cost-effective to
overcome mobility barriers before deciding
whether the move is worthwhile.
you should be able to discuss how industries
evolve over time, with reference to the
industry life-cycle model.
INDUSTRY LIFE-CYCLE ANALYSIS

 There are five stages in the industry life-cycle.
1) Embryonic
2) Growth
3) Shakeout
4) Mature
5) Decline
Embryonic Industries
 An embryonic industry refers to an industry just
beginning to develop.
 Examples are personal computers in the 1970s,
wireless communication in the 1980s, and Internet
retailing in the 1990s.
 Growth at this stage is slow.
 Rivalry is based not so much on price as on
educating customers, opening up distribution
channels, and perfecting the design of the product.
 Such rivalry can be intense.
Growth Industries
 In a growth industry, first-time demand is
expanding rapidly.
 Prices fall because experience and scale
economies have been attained, and distribution
channels developed.
 The importance of control over technological
knowledge as a barrier to entry has diminished.
 New entrants can be absorbed into an industry
without a marked increase in the intensity of
rivalry.
Industry Shakeout
 Explosive growth cannot be maintained indefinitely.

 In the shakeout stage, rivalry between companies
becomes intense.
Mature Industries
 The market is totally saturated, demand is limited to

replacement demand, and growth is low or zero.
 In the mature stage, barriers to entry increase, and the
threat of entry from potential competitors decreases.
Declining Industries
 In a declining industry growth becomes

negative.
 Falling demand leads to the emergence of excess
capacity.
 Companies in this category cut prices, thus
sparking a price war.
 The greater the exit barriers, the harder it is for
companies to reduce capacity, e.g. airline industry
and steel industry.
you should be able to show how trends in the
macroenvironment can shape the nature of
competition in an industry.
THE MACROENVIRONMENT
Macroeconomic Forces
 The four most important macroeconomic

forces are the growth rate of the economy,
interest rates, currency exchange rates, and
inflation (deflation) rates.
Global Forces
 Economic growth in places such as Brazil,
China, and India have created large new
markets.
 It is easier for foreign enterprises to enter the
domestic markets of many companies, thereby
increasing the intensity of competition and
lowering profitability.
Political and Legal Forces
 Political and legal forces are outcomes of changes

in laws and regulations, and significantly affect
managers and companies.
Technological Forces
 Technological change can make established
products obsolete overnight and simultaneously
create a host of new product possibilities.
 It can impact the height of the barrier to entry and
radically reshape industry structure.
Demographic Forces
 Demographic forces are outcomes of changes in the

characteristics of a population, such as age, gender,
ethnic origin, race, and social class.
Social Forces
 Social forces refer to the way in which changing social
mores and values affect an industry.
 One of the major social movements of recent decades
has been the trend toward greater health
consciousness.

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GARETH R. JONES /CHARLES W. L.

Theory of Strategic Management 10th ed.

COMPETITIVE FORCES MODEL

 A strong competitive force can be regarded

1) The first of Porter’s Five Forces is the risk of

c) An absolute cost advantage means that

e) Historically, government regulations

2) The second of Porter’s Five Forces is the

b) The level of industry demand is the

c) The cost structure is a third determinant

d) Exit barriers are economic, strategic, and

3) The bargaining power of buyers is the third of

4) The fourth of Porter’s Five Forces is the

5) The final force in Porter’s model is the threat

STRATEGIC GROUPS WITHIN INDUSTRIES

 Within most industries, it is possible to

Implications of Strategic Groups

The Role of Mobility Barriers

 Mobility barriers are within-industry factors that

INDUSTRY LIFE-CYCLE ANALYSIS

 Explosive growth cannot be maintained indefinitely.

 The market is totally saturated, demand is limited to

 In a declining industry growth becomes

 The four most important macroeconomic

Political and Legal Forces

 Political and legal forces are outcomes of changes

 Demographic forces are outcomes of changes in the

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