Chapter 2
The External Environment: Opportunities,
Threats, Industry Competition, and Competitor Analysis
KNOWLEDGE OBJECTIVES
1. Explain the importance of analyzing and understanding the firm’s external environment.
2. Define and describe the general environment and the industry environment.
3. Discuss the four activities of the external environmental analysis process.
4. Name and describe the general environment’s six segments.
5. Identify the five competitive forces and explain how they determine an industry’s profit potential.
6. Define strategic groups and describe their influence on the firm.
7. Describe what firms need to know about their competitors and different methods (including ethical standards) used to collect intelligence about them.
CHAPTER OUTLINE
Opening Case Environmental Pressures on Wal-Mart
THE GENERAL, INDUSTRY, AND COMPETITOR ENVIRONMENTS
EXTERNAL ENVIRONMENTAL ANALYSIS Scanning Monitoring Forecasting Assessing
SEGMENTS OF THE GENERAL ENVIRONMENT The Demographic Segment The Economic Segment The Political/Legal Segment The Sociocultural Segment The Technological Segment The Global Segment
Strategic Focus Does Google Have the Market Power to Ignore External Pressures?
INDUSTRY ENVIRONMENT ANALYSIS Threat of New Entrants Bargaining Power of Suppliers Bargaining Power of Buyers Threat of Substitute Products Intensity of Rivalry among Competitors
INTERPRETING INDUSTRY ANALYSES
STRATEGIC GROUPS
Strategic Focus IBM Closely Watches Its Competitors to Stay at the Top of Its Game
COMPETITOR ANALYSIS
ETHICAL CONSIDERATIONS
SUMMARY
REVIEW QUESTIONS
EXPERIENTIAL EXERCISES
NOTES
LECTURE NOTES
Chapter Introduction: This chapter can be introduced with a general statement regarding the importance of understanding what is happening outside of the firm itself and how what is happening can affect the firm’s ability to achieve strategic competitiveness and earn above-average returns. This importance is illustrated by the Opening Case, which discusses the impact events in the external environment can have on a firm’s performance, despite efforts to adjust to industry dynamics.
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OPENING CASE
Environmental Pressures on Wal-Mart
Since the mid-1960s, Sam Walton has been nurturing his vision of what discount retailing should be. His dream is now a mega-giant of approximately 6500 discount stores and clubs employing 1.9 million associates in 15 countries. In addition to a phenomenal growth rate, Wal-Mart was designated the most admired retailer in 2006 by Fortune magazine.
But all is not happy in Bentonville, Arkansas. Wal-Mart has hit a speed bump in its growth pattern driven by its cost leadership strategy. Compared to some of Wal-Mart’s formidable competition, it has experienced the smallest percentage in new store sales. In November 2006, existing store sales growth actually netted negative growth. So why has a company that has experienced phenomenal growth and cited for outstanding performance recently found itself struggling to regain its proud growth posture?
Wall Street analysts feel that Wal-Mart’s growth strategy is relying too heavily on opening new stores to offset sagging same-store sales. So why are same-store sales sagging? The answer lies with legal and political troubles, public relation problems, and labor issues. The public, including Wal-Mart customers, has been “turned-off” by open criticism leveled at Wal-Mart. Thus, an anti-Wal-Mart movement has manifested itself with legal obstacles barring construction of new Wal-Mart stores in specific areas. The company has become notorious for low pay and poor benefits. Environmentalists have challenged Wal-Mart to become more “green.”
Everything mentioned above is part of the external environment in which the discount retail industry operates. People have perceptions of how they want suppliers to look within this environment. Wal-Mart has fallen short of buyers’ expectations, and is now having to deal with the consequences. Companies need to understand that “customer expectations” are an element of the external environment. People act and react to their perceptions and it appears that Wal-Mart is realizing just how powerful perceptual influences within the environment can be. Wal-Mart is being reactive through efforts to control the damage resulting from perceptions that it is not being as good a corporate citizen as potential and former customers desire.
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|1 |Explain the importance of analyzing and understanding the firm’s external | |
| |environment. | |
Teaching Note: Given that the external environment will continue to change—and that change may be unpredictable in terms of timing and strength—a firm’s management is challenged to be aware of, understand the implications of, and identify patterns represented in these changes by taking actions to improve the firm’s competitive position, improve operational efficiency, and to be effective global competitors.
External environmental factors—like the war in Iraq, variations in the strength of national economies, and new technologies—affects firm growth and profitability in the U.S. and beyond.
Environmental conditions in the current global economy differ from those previously faced by firms:
• Technological advances require more timely and effective competitive actions and responses.
• Rapid sociological changes abroad affect labor practices and product demand of diverse consumers.
• Governmental policies and laws affect where and how firms may choose to compete.
Understanding the external environment helps to build the firm’s base of knowledge and information which can (1) help to build new capabilities, (2) buffer the firm from environmental impacts, and (3) build bridges to influential stakeholders.
Teaching Note: This section introduces definitions, Figure 2.1 (which deals with the general environment), and the competitor/industry environment. Because of the chapter layout, it is best to delay a detailed presentation/discussion of the general environment until after discussing the external environmental analysis process because the characteristics of the general environment are presented in more detail later in the chapter.
|2 |Define and describe the general environment and the industry environment. | |
Teaching Note: The firm’s understanding of the external environment is matched with knowledge about its internal environment (discussed in Chapter 3) to form its vision, to develop its mission, and to take strategic actions that result in strategic competitiveness and above-average returns. This is an important point to make.
THE GENERAL, INDUSTRY, AND COMPETITOR ENVIRONMENTS
FIGURE 2.1
The External Environment
Figure 2.1 illustrates the three components of a firm’s external environment and the elements or factors that are part of each component. They are:
1. the general environment
|Demographic |Political/Legal |Sociocultural |
|Economic |Technological |Global |
2. the industry environment
|Threat of New Entrants |Power of Buyers |Power of Suppliers |
|Intensity of Rivalry |Product Substitutes | |
3. the competitor environment
(Note: These components of the external environment and their elements or factors and how they are related to each and to firm performance will be discussed in detail in later sections of the chapter.)
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The general environment is composed of elements in the broader society that can indirectly influence an industry and the firms within the industry. But firms cannot directly control the general environment’s segments and elements.
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TABLE 2.1
The General Environment: Segments and Elements
Table 2.1 lists elements that characterize each of the six segments of the general environment: demographic, economic, political/legal, sociocultural, technological, and global. Each of these segments will be discussed in more detail later in this chapter, following a discussion of the external environmental analysis process.
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The industry environment is the constellation of factors—threat of new entrants, suppliers, buyers, product substitutes, and the intensity of rivalry among competitors—that directly influence a firm and its competitive decisions and responses.
Competitor analysis represents the firm’s understanding of its current competitors. This understanding will complement information and insights derived from investigating the general and industry environments.
The following are important distinctions to make regarding different external analyses:
• Analysis of the general environment focuses on the future.
• Industry analysis focuses on factors and conditions influencing firm profitability within its industry.
• Competitor analysis focuses on predicting the dynamics of rivals’ actions, responses, and intentions.
Performance improves when the firm integrates the insights provided by analyses of the general environment, the industry environment, and the competitor environment.
Teaching Note: It should be noted that, while firms cannot directly control the elements of the general environment, they can influence—and will be influenced by—factors in their industry and competitor environments.
The strategic challenge is to develop an understanding of the implications of these elements and factors for a firm’s competitive position. Processes and frameworks for the analysis of the external environment are provided in this chapter.
Teaching Note: Global implications should be—and are—integrated into the discussion of the general environment while global issues related to a firm’s industry environment are integrated throughout the text. Students will find that Chapter 8 covers this topic in detail.
|3 |Discuss the four activities of the external environmental analysis process. | |
EXTERNAL ENVIRONMENTAL ANALYSIS
In addition to increasing a firm’s awareness and understanding of an increasingly turbulent, complex, and global general environment, external environmental analysis also is necessary to enable the firm’s managers to interpret information to identify opportunities and threats.
Opportunities represent conditions in the general environment that may help a company achieve strategic competitiveness by presenting it with possibilities, while threats are conditions that may hinder or constrain a company’s efforts to achieve strategic competitiveness.
Information used to analyze the general environment can come from multiple sources: publications, observation, attendance at trade shows, or conversations with customers, suppliers, and employees of public-sector organizations. And this information can be formally gathered by individuals occupying traditional “boundary spanning” roles (such as a position in sales, purchasing, or public relations) or by assigning information-gathering responsibility to a special group or team.
Teaching Note: According to a recent comment by an industry analyst from a national firm, the Internet is becoming an increasingly valuable source of data and information for analyzing the general environment. Showing students how to do this in class or via an assignment can be a very helpful exercise.
One strategy that firms can use to enhance their awareness of conditions in the external environment is to establish an analysis process involving scanning, monitoring, forecasting, and assessing (see Table 2.2).
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TABLE 2.2
Components of the External Environmental Analysis
Table 2.2 identifies the four components of the external environmental analysis: scanning, monitoring, forecasting, and assessing.
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Scanning
Scanning entails the study of all segments in the general environment. Firms use the scanning process to either detect early warning signals regarding potential changes or to detect changes that are already underway. In most cases, information and data being collected or observed are ambiguous, incomplete, and appear to be unconnected. Scanning is most important in highly volatile environments, and the scanning system should fit the organizational context (e.g., scanning systems designed for volatile environments are not suitable for firms competing in a stable environment).
Teaching Note: Scanning may signal a future change in the needs and lifestyles of baby boomers as they approach retirement age. This may not only provide opportunities for financial institutions as they prepare for an increase in the number of retirees, but also may provide opportunities for packagers and marketers of retirement communities and other products specifically targeted to this segment.
The Internet provides significant opportunities to obtain information. For example, Amazon.com records significant information about individuals visiting its website, particularly if a purchase is made. Amazon then welcomes the individual by name when s/he visits the website again. It even sends messages to the individual about specials and new products similar to that purchased in previous visits. Additionally, many websites and advertisers on the Internet obtain information surreptitiously from those who visit their sites via the use of “cookies”.
Monitoring
Monitoring represents a process whereby analysts observe environmental changes (over time) to see if, in fact, an important trend begins to emerge.
The critical issue in monitoring is that analysts be able to detect meaning from the data and information collected during the scanning process. (Remind students that this data is generally ambiguous, incomplete and unconnected.) For example, in the United States, middle class African Americans are growing in number and wealth and are pursuing investment options, an opportunity in the economic segment that companies in the financial planning sector could monitor.
Effective monitoring requires the firm to identify important stakeholders. Because the importance of different stakeholders can vary over a firm’s life cycle, careful attention must be given to the firm’s needs and its stakeholder groups over time. Scanning and monitoring can also provide information about successfully commercializing new technologies.
Forecasting
The next step is for analysts to take the information and data gathered during the scanning and monitoring phases and attempt to project forward. Forecasting represents the process where analysts develop feasible projections of what might happen—and how quickly—as a result of the changes and trends detected through scanning and monitoring. Because of uncertainty, forecasting events and outcomes accurately is a challenging task.
Assessing
Assessing represents the step in the external analysis process where all of the other steps come together. The objective of assessing is to determine the timing and significance of the effects of changes and trends in the environment on the strategic management of a firm. Getting the strategy right will depend on the accuracy of the assessment.
Teaching Note: It is good to alert students to the fact that a major challenge for managers and firms engaging in the process of external analysis is to recognize biases and assumptions that may affect the analysis process. This is important, because these may limit the accuracy of forecasts and assessments. For example, managers may choose to disregard certain information, thus missing critical indicators of future environmental changes. Or, past experiences may prejudice the ways that opportunities or threats are perceived—if they are perceived at all. One solution might be to solicit multiple inputs so a single source is not able to manipulate the information and to seek frequent feedback regarding the accuracy or usefulness of forecasts and assessments.
|4 |Name and describe the general environment’s six segments. | |
SEGMENTS OF THE GENERAL ENVIRONMENT
As outlined in Table 2.1, the general environment consists of six segments: demographic, economic, political/legal, sociocultural, global, and technological. The challenge is to scan, monitor, forecast, and assess all six segments of the general environment, focusing the primary effort on those elements in each segment of the general environment that have the greatest potential impact on the firm.
Teaching Note: In the twenty-first century competitive landscape, analysts are cautioned against confining their analysis to domestic markets alone. Any analysis of the general environment and its segments should recognize global elements that may have an impact on the firm.
External analysis efforts should focus on segments most important to the firm’s strategic competitiveness to identify environmental changes, trends, opportunities, and threats that can be matched with the firm’s core competencies so that it can achieve strategic competitiveness and earn above-average returns.
The Demographic Segment
The demographic segment is concerned with a population’s size, age structure, geographic distribution, ethnic mix, and distribution of income.
Teaching Note: While each of the elements of this segment are discussed below, you might note that the challenge for analysts (and managers) is to determine what the changes that have been identified in the demographic characteristics or elements of a population imply for the future strategic competitiveness of the firm.
Population Size
While population size itself may be important to firms that require a “critical mass” of potential customers, changes in the specific make-up of a population’s size may have even more critical implications. One of the most important changes in a population’s size is changes in a nation’s birth rate and/or family size, as well as demographic changes in the population of developed versus developing countries.
Age Structure
Changes in a nation’s birth rate or life expectancy can have important implications for firms. Are people living longer? What is the life expectancy of infants? These will impact the health care system (and firms serving that segment) and the development of products and services targeted to an older (or younger) population.
Geographic Distribution
Population shifts—as have occurred in the U.S.—from one region of a nation to another or from metropolitan to non-metropolitan areas may have an impact on a firm’s strategic competitiveness. Issues that should be considered include:
• The attractiveness of a firm’s location may be influenced by governmental support, and a shrinking population may imply a shrinking tax base and a lesser availability of official financial support.
• Firms may have to consider relocation if tax demands require it.
• Advances in communications technology will have a profound effect on geographic distribution and the workforce.
Ethnic Mix
This reflects the changes in the ethnic make-up of a population and has implications both for a firm’s potential customers and for the workforce. Issues that should be addressed include:
• Will new products and services be demanded or can existing ones be modified?
• How will changes in the ethnicity of a population affect the composition of the workforce?
• Are managers prepared to manage a more culturally diverse workforce?
• How can the firm position itself to take advantage of increased workforce heterogeneity?
Income Distribution
Changes in income distribution are important because changes in the levels of individual and group purchasing power and discretionary income often result in changes in spending (consumption) and savings patterns. Tracking, forecasting, and assessing changes in income patterns may identify new opportunities for firms.
The Economic Segment
The economic segment of the general environment refers to the nature and direction of the economy in which a firm competes or may compete. Analysts must scan, monitor, forecast, and assess a number of key economic indicators or elements, including levels and trends of
• inflation rates and interest rates • trade deficits and surpluses • budget deficits and surpluses • personal savings rates • business savings rates • gross domestic product
for both domestic and key international markets. In addition, the implications of changes and trends in the economic segment may affect the political/legal segment both domestically and in other global markets. This may be of critical importance as nations eliminate or reduce trade barriers and integrate their economies.
The Political/Legal Segment
The political/legal segment is the arena in which organizations and interest groups compete for attention, resources, and a voice in overseeing the body of laws and regulations guiding the interactions among nations. In other words, this segment is concerned with how interest groups and organizations attempt to influence representatives of governments (and governmental agencies) and how they, in turn, are influenced by them.
Because of the influence that this segment can have on the nature of competition as well as on the overall profitability of industries and individual firms, analysts must assess changes and trends in administration philosophies regarding:
• Anti-trust regulations and enforcement • Tax laws • Industry deregulation • Labor training laws • Commitments to education • Free trade versus protectionism
Teaching Note: It would be good to comment (using examples from the text or examples that may be even more current) on strategies followed by firms as they attempt to manage or influence the political/legal segment. • How can firms in the electric utility industry manage the costs of deregulation, including write-offs of inefficient plants? Who will pay these costs? Consumers? Governmental units? Stockholders? Bondholders? • How can individual firms and industries manage the effects of free trade which will lower entry barriers for new, lower-cost competitors? How might firms position themselves to take advantage of emerging, free-market economies? • What is likely to be the competitive impact of loosening governmental controls in the entertainment industry? In the telecommunications industry? What strategies can firms use to manage or influence deregulation to their advantage?
The Sociocultural Segment
The sociocultural segment is concerned with different societies’ social attitudes and cultural values. This segment is important because the attitudes and values of society influence and thus are reflected in changes in a society’s economic, demographic, political/legal, and technological segments.
Analysts are especially cautioned to pay attention to sociocultural changes and effects that they may have on:
• Workforce composition—and the implications for managing—resulting from an increase in the number of women, and increased ethnic and cultural diversity
• Changes in attitudes about the growing number of contingency workers
• Shifts in population toward suburban life, and resulting transportation issues
• Shifts in work and career preferences, including a trend to work from home made possible by technology advances
The Technological Segment
As noted in many of the other segments of the general environment—and as discussed in Chapter 1 as a key driver of the new competitive landscape—technological changes can have broad effects on society. The technological segment includes institutions and activities involved with creating new knowledge and translating that knowledge into new outputs, products, processes, and materials.
Firms should pay careful attention to the technological segment, since early adopters can gain market share and above average returns.
Important technology-related issues that might affect a broad variety of firms include: • Increasing plant automation
• Internet technologies and their application to commerce and data gathering
• Uses of wireless technology
The Global Segment
As discussed in Chapter 1, the 21st-century competitive landscape requires that firms also must analyze global factors. Among the global factors that should be assessed are:
• The potential impact of significant international events such as peace in the Middle East or the recent entry of China into the WTO
• The identification of both important emerging global markets and global markets that are changing
• The trend toward increasing global outsourcing
• The differences between cultural and institutional attributes of individual global markets (the focus in Korea on inhwa, or harmony, based on respect for hierarchical relationships and obedience to authority; the focus in China on guanxi, or personal relationships; the focus in Japan on wa, or group harmony/social cohesion)
• Global market expansion opportunities
• The opportunities to learn from doing business in other countries
• Expanding access to the resources firms need for success (e.g., capital)
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STRATEGIC FOCUS
Does Google Have the Market Power to Ignore External Pressures?
Google has become a “generic” like Kleenex, Xerox, and Jell-O. Internet users of all ages “Google” regardless of the search engine used. Currently, Google is the most widely used Internet search engine. However, has its strategy of “search with content” been the catalyst to return Google to the real world? Viacom has filed a $1 billion copyright infringement lawsuit against Google and YouTube, a subsidiary of Google. In addition to Viacom, a number of other firms, including Microsoft, have filed copyright infringement lawsuits. Google’s image has been tarnished. The investment community no longer considers Google to be a hot company. As a result, Google’s stock price has fallen. Google now has rivals, and it is getting attention from the government.
There is strong similarity between Google’s above plight and that of Wal-Mart referenced earlier in this chapter. Both firms have been challenged with pressure from their respective political and legal environments. Google’s competitors will realize the benefits of alleged copyright snafus, as Google’s advertiser customer-base begins to jump ship. Investor interests reflect the same concerns as those of advertisers. Both cases reflect that elements of the environment can change rather quickly and consequently change a firm’s perceived competitive advantage.
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|5 |Identify the five competitive forces and explain how they determine an | |
| |industry’s profit potential. | |
INDUSTRY ENVIRONMENT ANALYSIS
An industry is a group of firms producing products that are close substitutes for each other. As they compete for market share, the strategies implemented by these companies influence each other and include a broad mix of competitive strategies as each company pursues strategic competitiveness and above-average returns.
It should be noted that, unlike the general environment which has an indirect effect on strategic competitiveness and firm profitability, the effect of the industry environment is more direct. Industry—and individual firm—profitability and the intensity of competition in an industry are a function of five competitive forces as presented in Figure 2.2.
Figure Note: Students should refer to Figure 2.2 as it provides a framework that can be used to analyze competition in an industry. A broader discussion of the five competitive forces and other factors follows Figure 2.2.
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FIGURE 2.2
The Five Forces Model of Competition
The Five Forces Model of Competition indicates that these forces interact to determine the intensity or strength of competition, which ultimately determines the profitability of the industry.
• Threat of New Entrants • Threat of Substitute Products • Bargaining Power of Buyers (Customers) • Bargaining Power of Suppliers • Rivalry Among Competing Firms in an industry
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Assessing the relative strength of the five competitive forces is important to a firm’s ability to achieve strategic competitiveness and earn above-average returns.
Viewed differently, competition should be seen as groupings of alternative ways that customers can obtain desired results. Thus, any analysis of an industry must expand beyond the traditional practice of concentrating on direct competitors to include potential competitors. For example:
• Suppliers can become competitors by integrating forward.
• Buyers or customers can become competitors by integrating backward.
• Firms that are not competitors today could produce products that serve as substitutes for existing products offered by firms in an industry, transforming themselves into competitors.
Threat of New Entrants
New entrants to an industry are important because, with new competitors, the intensity of competitive rivalry in an industry generally increases. This is because new competitors may bring substantial resources into the industry and may be interested in capturing a significant market share. If a new competitor brings additional capacity to the industry when product demand is not increasing, prices that can be charged to consumers generally will fall. One result may be a decline in sales and lower returns for many firms in the industry.
Teaching Note: To help students grasp the potential impact of new entrants on an industry, it is helpful to illustrate this effect by referring to a number of examples that may be familiar to them, such as: • the transformation of the steel industry when mini-mills (such as Nucor and Birmingham Steel) entered the industry in competition with integrated domestic producers such as U.S. Steel and Bethlehem Steel • the impact of the increase in the number of cell phone providers on the cost of having a cell phone (and the long-range, potential impact on the cost of local telephone service) • the increase in the number of Internet access providers and the effects of increased competition on such firms as CompuServe and America Online
The seriousness or extent of the threat of new entrants is affected by two factors: barriers to entry and expected reactions from—or the potential for retaliation by—incumbent firms in the industry.
Barriers to Entry
Barriers to entering an industry are present when entry is difficult or when it is too costly and places potential entrants at a competitive disadvantage (relative to firms already competing in the industry). There are seven factors that represent potentially significant entry barriers that can emerge as an industry evolves or might be explicitly “erected” by current participants in the industry to protect profitability by deterring new competitors from entry.
Economies of Scale refers to the relationship between quantity produced and unit cost: As the quantity of a product produced during a given time period increases, the cost of manufacturing each unit declines.
Economies of scale can serve as an entry barrier when existing firms in the industry have achieved these scale economies and a potential new entrant is only able to enter the industry on a small scale (and produce at a higher cost per unit).
Economies of scale can be overcome as a potential entry barrier by firms that produce multiple customized products or that enter an industry on a large-enough scale. New manufacturing technology facilitated by advanced information systems has allowed the development of “mass customization” in an increasing number of industries, and online ordering has enhanced the ability of customers to obtain customized products (often referred to as “markets of one.”)
Product Differentiation: Customers may perceive that products offered by existing firms in the industry are unique as a result of service offered, effective advertising campaigns, or being first to offer a product of service to the market. If customers perceive a product or service as unique, they generally are loyal to that brand. Thus, new entrants may be required to spend a great deal of money over a long period of time to overcome customer loyalty to existing products.
While new entrants may be able to overcome perceived uniqueness and brand loyalty, the cost of such strategies generally will be high: offering lower prices, adding additional features, or allocating significant funds to a major advertising and promotion campaign. In the short run, new entrants that try to overcome uniqueness and brand loyalty may suffer lower profits or may be forced to operate at a loss.
Capital Requirements: Firms choosing to enter any industry must commit resources for facilities, to purchase inventory, to pay salaries and benefits, etc. While entry may seem attractive (because there are no apparent barriers to entry), a potential new entrant may not have sufficient capital to enter the industry.
Switching Costs: These are the one-time costs customers will incur when buying from a different supplier. These can include such explicit costs as retraining of employees or retooling of equipment as well as the psychological cost of changing relationships. Incumbent firms in the industry generally try to establish switching costs to offset new entrants that try to win customers with substantially lower prices or an improved (or, to some extent, different) product.
Access to Distribution Channels: As existing firms in an industry generally have developed effective channels for distributing products, these same channels may not be available to new firms entering an industry. Thus, access (or lack thereof) may serve as an effective barrier to entry.
This may be particularly true for consumer nondurable goods (e.g., because of the limited amount of shelf space available in retail stores) and in international markets. In the case of some durable goods or industrial products, to overcome the barrier, new entrants must again incur costs in excess of those paid by existing firms, either through lower prices or price breaks, costly promotion campaigns, or advertising allowances. New entrants may have to incur significant costs to establish a proprietary distribution channel. As in the case of product differentiation or uniqueness barriers, new entrants may suffer lower profits or operate at a loss as they battle to gain access to distribution channels.
Cost Disadvantages Independent of Scale: Existing firms in an industry often are able to achieve cost advantages that cannot be costlessly duplicated by new entrants (i.e., other than those related to economies of scale and access to distribution channels). These can include proprietary process (or product) technology, more favorable access to or control of raw materials, the best locations, or favorable government subsidies.
Potential entrants must find ways to overcome these disadvantages to be able to effectively compete in the industry. This may mean successfully adapting technologies from other industries and/or non-competing products for use in the target industry, developing new sources of raw materials, making product (or service) enhancements to overcome location-related disadvantages, or selling at a lower price to attract customers.
Government Policy: Governments (at all levels) are able to control entry into an industry through licensing and permit requirements. For example, at the firm level, entry into the banking industry is regulated at both the federal and state levels, while liquor sales are regulated at the state and local levels. In some cases, state and/or federal licensing requirements limit entry into the personal services industry (securities sales and law), while in others only state requirements may limit entry (barbers and beauticians).
Teaching Note: Students should be reminded of the monopolistic nature (on a market-by-market basis) of the public utility industry, including local telephone service, water, electric power, and cable television. The “regulated monopolies” will provide helpful illustrations to make sense of this section.
Expected Retaliation
Even if a firm concludes that it can successfully overcome all of the entry barriers, it still must take into account or anticipate reactions that might be expected from existing firms.
Strong retaliation is likely when existing firms have a heavy investment in fixed assets (especially when there are few alternative uses for those assets) or when industry growth is slow or declining. Retaliation could take the form of announcements of anticipated future investments to increase capacity, new product plans, price-cutting or a study to assess the impact of lower prices (this might imply price-cutting as a “promised” entry barrier-creation strategy by existing firms).
Small entrepreneurial firms can avoid retaliation by identifying and serving neglected market segments. For example, Honda first entered the U.S. market by concentrating on small-engine motorcycles, a market that firms such as Harley-Davidson ignored. After consolidating its position, Honda went on the offensive by introducing larger motorcycles and competing in the broader market.
Teaching Note: To illustrate competitive retaliation, consider the example of the potential for increased competition in the 24-hour news market that had at one time been monopolized by CNN (Cable News Network). • The BBC is establishing a global news network. • NBC formed an alliance with Microsoft to implement its 24-hour news network, MSNBC, including a parallel site on the World Wide Web. • Capital Cities/ABC launched a 24-hour news service, using ABC News anchors and correspondents.
Bargaining Power of Suppliers
The bargaining power of suppliers depends on suppliers’ economic bargaining power relative to firms competing in the industry. Suppliers are powerful when firm profitability is reduced by suppliers’ actions. Suppliers can exert their power by raising prices or by restricting the quantity and/or quality of goods available for sale.
Suppliers are powerful relative to firms competing in the industry when:
• the supplier segment of the industry is dominated by a few large companies and is more concentrated than the industry to which it sells
• satisfactory substitute products are not available to industry firms
• industry firms are not a significant customer group for the supplier group
• suppliers’ goods are critical to buyers’ marketplace success
• effectiveness of suppliers’ products has created high switching costs for buyers
• suppliers represent a credible threat to integrate forward into the buyers’ industry, especially when suppliers have substantial resources and provide highly differentiated products
In the airline industry, suppliers’ bargaining power is changing. There are few suppliers, but demand for the major aircraft is also low. Boeing and Airbus compete strongly for most orders of major aircraft. However, China recently announced plans to enter the market by building large commercial aircraft, significant in a country which is projected to purchase thousands.
Bargaining Power of Buyers
While firms seek to maximize their return on invested capital, buyers are interested in purchasing products at the lowest possible price (the price at which sellers will earn the lowest acceptable return). To reduce cost or maximize value, customers bargain for higher quality or greater levels of service at the lowest possible price by encouraging competition among firms in the industry.
Buyer groups are powerful relative to firms competing in the industry when:
• buyers are important to sellers because they purchase a large portion of the supply industry’s total sales
• products purchased from a supply industry represent a significant portion of the seller’s annual revenues
• buyers are able to switch to another supplier’s product at little, if any, cost
• suppliers’ products are undifferentiated and standardized, and the buyers represent a real threat to integrate backwards into the suppliers’ industry using resources or expertise
Armed with greater amounts of information about the manufacturer’s costs and the power of the Internet as a shopping and distribution alternative, consumers appear to be increasing their bargaining power in many industries. One reason for this shift is that individual buyers incur virtually zero switching costs when they decide to purchase from one manufacturer rather than another or from one dealer as opposed to a second or third one.
Threat of Substitute Products
All firms must recognize that they compete against firms producing substitute products, those products that are capable of satisfying similar customer needs but come from outside the industry and thus have different characteristics. In effect, prices charged for substitute products represent the upper limit on the prices that suppliers can charge for their products.
The threat of substitute products is greatest when:
• buyers or customers face few, if any switching costs
• prices of the substitute products are lower
• quality and performance capabilities of substitutes are equal to/greater than those of the industry’s products
Firms can offset the attractiveness of substitute products by differentiating their products in ways that are perceived by customers as relevant. Viable strategies might include price, product quality, product features, location, or service level.
Examples of Traditional and Substitute Products, and Their Usage
Traditional product Substitute product Usage Overnight delivery Fax machines/e-mail Document delivery Sugar NutraSweet Sweetener Glass Plastic Containers Coffee Tea Beverages Paper bags Plastic bags Flexible packaging
Intensity of Rivalry among Competitors
The intensity of rivalry in an industry depends upon the extent to which firms in an industry compete with one another to achieve strategic competitiveness and earn above-average returns because success is measured relative to other firms in the industry. Competition can be based on price, quality, or innovation.
Because of the interrelated nature of firms’ actions, action taken by one firm generally will result in retaliation by competitors (also known as competitive response). In addition to actions and reactions that result as firms attempt to offset the other competitive forces in the industry—threat of new entry, power of suppliers and buyers, and threat of substitute products—the intensity of competitive rivalry is also a function of a number of other factors.
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Numerous or Equally Balanced Competitors
Industries with a high number of firms can be characterized by intense rivalry when firms feel that they can make competitive moves that will go unnoticed by other firms in the industry. However, other firms will generally notice these moves and offer countermoves of their own in response. Patterns of frequent actions and reactions often result in intense rivalry, such as in local restaurant, retailing, or dry-cleaning industries.
Rivalry also will be intense in an industry that has only a few firms of equivalent resources and power. The firms’ resource bases enable each to take frequent action to improve their competitive positions which, in turn, produces a reaction or countermove by competitors. Battles for market share in the fast food industry between McDonald’s and Burger King; in the automobile industry between such firms as General Motors, Ford, and Toyota; and in athletic shoes between Nike and Reebok are examples of intense rivalry between relatively equivalent competitors. Of course, Boeing versus Airbus is an especially useful example.
Slow Industry Growth
When a market is growing at a level where there seem to be “enough customers for everyone,” competition generally centers around effective use of resources so that a firm can effectively serve a larger, growing customer base. Because of sufficient growth in the market, firms do not concentrate on taking customers away from other firms.
The intensity of competition often results in a reduction in industry profitability as observed in the fast food industry with the battle for a slower growing traditional, U.S. customer base between McDonald’s, Burger King, and Wendy’s. The intensity of competition can be illustrated by the various competitive strategies followed by firms in the fast food industry:
• rapid and continuous introduction of new products and new packaging schemes • the introduction of innovative-pricing strategies • product and/or service differentiation
High Fixed Costs or High Storage Costs
When an industry is characterized by high fixed costs relative to total costs, firms produce in quantities that are sufficient to use a large percentage, if not all of their production capacity so that fixed costs can be spread over the maximum volume of output. While this may lower per unit costs, it also can result in excess supply if market growth is not sufficient to absorb the excess inventory. The intensity of competitive rivalry increases as firms use price reductions, rebates, and other discounts or special terms to reduce inventory as observed in the automobile industry from the 1980s to the present.
High storage costs, especially those related to perishable or time-sensitive products (such as fruits and vegetables) also can result in high levels of competitive intensity as such products rapidly lose their value if not sold within a given time period. Pricing strategies often are used to sell such products.
Lack of Differentiation or Low Switching Costs
Products that are not characterized by brand loyalty or perceived uniqueness are generally viewed by buyers as commodities. For such products, industry rivalry is more intense and competition is based primarily on price, service, and other features of interest to consumers.
Switching costs can be used to decrease the likelihood that customers will switch to competitors’ products. Products for which customers incur no or few switching costs are subject to intense price- and service-based competition, similar to undifferentiated products.
High Strategic Stakes
The intensity of competitive rivalry increases when success in an industry is important to a large number of firms (such as the domestic airline industry following deregulation). For example, the success of a diversified firm may be important to its effectiveness in other industries, especially when the firm is in interdependent or related industries.
Geographic stakes may also be high. The importance of geographic stakes can be illustrated by the intense rivalry in the U.S. automobile industry as Japanese manufacturers recognized the strategic importance of a U.S. marketplace presence and U.S. manufacturers responded.
High Exit Barriers
Exit barriers—created by economic, strategic, and emotional factors that cause companies to remain in an industry, even though the profitability of doing so is in question—also can increase the intensity of competition in an industry. The higher the barriers to exit, the greater the probability that competitive actions and reactions will include price cuts and extensive promotions.
Some sources of exit barriers include:
• investments in specialized assets, or assets whose value is linked to use in a particular industry or location, with little or no value as salvage or in other uses
• fixed costs of exit, such as labor agreements or a requirement to repay federal, state or local aid packages
• strategic relationships, interdependencies within the organization (e.g., shared facilities, market access)
• emotional barriers, such as loyalty to employees or fear for one’s own career
• government and/or social restrictions based on concern for job losses or the economic impact of exit
Teaching Note: The firm that was formerly Greyhound Corporation has been transformed over the years into what is today a very different looking Dial Corporation. Of course, the firm was at one time so well known for its bus lines that we now use the term “greyhound bus” as a generic term referring to a general design of bus. Dial Corp. sold the bus lines to a Dallas, Texas concern a number of years ago, but in fact the firm held on to the transportation unit through a number of years of poor performance, long after the unit lost its fit with the Dial portfolio. Why did the firm do this? Some would say it was because the firm had an emotional attachment to the business that got it all started.
Teaching Note: One way to get students to recognize the industry forces Porter presents is to allow them to learn about a given industry and report on these forces as they see them and assess their strength. For example, one adopter of the text shows students the first segment of a PBS video series by Daniel Yergin called “The Prize.” This one-hour video profiles the formation of the oil industry and its rapid transformation in the early days. Students are asked to identify as many illustrations of “Porter’s Five Forces in action” as they watch the video (e.g., profits were much greater early in the first part of the industry’s first decade than in the last years of that period because barriers to entry were low and the rapid influx of new entrants expanded supply and depressed prices). As an incentive for diligent observation, the student who identifies the greatest number of legitimate illustrations is rewarded with bonus points.
Interpreting Industry Analyses
Effective industry analyses are products of careful study and interpretation of data from multiple sources. Because of globalization, international markets and rivalry must be included in the firm’s analyses; in fact, research shows international variables may have more impact on strategic competitiveness than domestic ones, in some cases.
Following study of the five industry forces, the firm has the insights required to determine an industry’s attractiveness in terms of the potential to earn adequate or superior returns on its invested capital. In general, the stronger the competitive forces, the lower the profit potential for an industry’s firms. An unattractive industry has low entry barriers, suppliers and buyers with strong bargaining positions, strong competitive threats from product substitutes, and intense rivalry among competitors, which make it difficult for firms to achieve strategic competitiveness and earn above-average returns. An attractive industry has the mirror image of these features and offers little potential for favorable performance.
Teaching Note: A good example of the need to understand the global structure of the industry and the implications for competitive strategy is illustrated by the intensity of global competition for market share between Kimberly-Clark and Procter & Gamble (P&G). The former attempts to compete more effectively with P&G in Europe, as well as in emerging markets, while maintaining its dominant U.S. position.
Characteristics of attractive and unattractive industries are summarized below.
Industry Characteristic Attractive Unattractive Threat of New Entry Low High Bargaining Power of Suppliers Low High Bargaining Power of Buyers Low High Threat of Substitute Products Low High Intensity of Competitive Rivalry Low High
Teaching Note: It may be helpful to explain that the relationship between the strength of industry forces and prices/profits in the industry is an inverse one. When the forces are strong, prices/profits in the industry tend to be low, whereas weak forces usually lead to higher prices/profits. The mental image is one of a playground “teeter-totter” or balance scale.
|6 |Define strategic groups and describe their influence on the firm. | |
Strategic Groups
As implied by the previous discussion, not all firms in an industry may adopt the same strategies in their quest for strategic competitiveness and above-average returns. However, many firms in an industry may follow similar strategies. These firms are generally classified as strategic groups, or groups of firms in an industry following the same or similar strategies along the same strategic dimensions.
Membership in a particular strategic group is determined by the essential characteristics of a firm’s strategy, which may include the
• extent of technological leadership
• degree of product quality
• pricing policies
• choice of distribution channels
• degree and type of customer service
Teaching Note: It may be helpful to assign students (or students teams) the task of developing a strategic group map of an industry with which they are familiar (e.g., fast food, automobile manufacturing, computers, or the financial services industry).
Teaching Note: Many strategy experts believe that the strategic group concept provides a useful tool for analyzing an industry from firm-specific perspectives in order to learn how to compete successfully. However, some critics indicate that there is no convincing evidence that (1) strategic groups exist or (2) that firm performance is dependent upon membership in a particular group. Others contend that little additional understanding can be gained from industry analysis by looking at strategic groups, but recent research provides some evidence to support the usefulness of this analysis.
The strategic group concept can be useful in analyzing the competitive structure of an industry and can serve as a framework for assessing competition, positioning alternatives, and potential profitability of firms in an industry.
High mobility barriers, high rivalry, and low resources among the firms within an industry will limit the formation of strategic groups. However, research suggests that once formed, strategic group membership remains relatively stable over time, making analysis easier and more useful.
Use of the strategic group concept requires that analysts be aware of several implications:
• A firm’s major or primary competitors are those in its strategic group, thus competitive rivalry within the strategic group is expected to be more intense than rivalry with other firms in the industry.
• The relative strengths of the five competitive forces will differ among groups, thus firms in different groups may adopt different competitive strategies.
• The closer the strategic groups on the relevant dimensions, the greater the likelihood of their rivalry.
|7 |Describe what firms need to know about their competitors and different methods | |
| |(including ethical standards) used to collect intelligence about them. | |
STRATEGIC FOCUS
IBM Closely Watches Its Competitors to Stay at the Top of Its Game
Here’s an excellent example of effective competitive intelligence. You’ll realize that there are no cloak and dagger tactics involved, nor is there anything clandestine about competitive information gathering. IBM has effectively monitored and analyzed marketing strategies that its key competitors are applying in the market place. IBM not only manufactures and sells mainframes, servers, storage systems, and peripherals but also has the largest computer service operation in the world. Service accounts for over 50 percent of IBM’s total revenue. IBM has established a competitive analysis team for the sole purpose of monitoring and analyzing its competitors. The output from this group allows IBM to adjust strategies and business plans to effectively compete with competitors such as Sun Microsystems and Hewlett-Packard. Examples of meaningful information generated by this team include learning that Sun’s direct sales team focuses on the top 1500 accounts in its customer base and that the remaining installed base is served by Sun’s business partners. Another significant finding that affects IBM marketing strategy is that Sun also concentrates on hardware sales rather than selling solutions. The IBM team also determined that HP operates in a similar fashion as an equipment supplier relying on its hardware customers to seek support from third parties such as Cisco, Accenture, EDS, and HP retailers.
Existing competitors often try to develop barriers to entry to protect their commercial interests, but sometimes the rivalry comes from outside the established set of players. As seen in this Strategic Focus, cable firms are entering the phone service business, and local firms such as SBC Communications are taking measures to prevent customer loss/turnover. What can be done to protect the firm from outside attacks? Differentiating a product along dimensions that customers value (such as price, quality, service after the sale, and location) reduces a substitute’s attractiveness. Local phone server companies have lost significant subscriber base to cable companies offering phone services. Similarly, cable companies have lost TV subscriber base to satellite TV operators. Each company has been using a bundling approach to increase switching costs to forestall these substitutions. But it could be argued that the focus should be on creating value for the customer, rather than simply blocking them from accessing greater value from some other option.
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Competitor Analysis
Competitor analysis represents a necessary adjunct to performing an industry analysis. An industry analysis provides information regarding potential sources of competition (including the possible strategic actions and reactions and effects on profitability for all firms competing in an industry). However, a structured competitor analysis enables the firm to focus its attention on those firms with which it will directly compete, and is especially important when a firm faces a few powerful competitors.
Competitor analysis is interested ultimately in developing a profile on how competitors might be expected to respond to a firm’s strategic moves. The process involves developing answers to a series of questions about:
• the firm’s and its competitors’ future objectives
• current strategy
• assumptions
• capabilities
Teaching Note: To help students understand the usefulness of competitor analysis, have them develop a profile of another university or college, assume the role of a Pepsi product manager and develop a competitive profile of Coca-Cola, or take the perspective of Intel and describe AMD’s competitive characteristics. A specific case that contains the bulk of the required information also could be used to perform an in-class competitor analysis.
Another significant component are the complementors of a firm’s products and strategy. These are the networks of companies that sell goods and services compatible with the firms own product or service.
ETHICAL CONSIDERATIONS
A major concern of many managers is the methods that are used to gather data on competitors, a process generally referred to as competitor intelligence. The illustration of Microsoft’s struggle to understand Google is especially helpful in explaining this concept. It is a great managerial challenge to ensure that all data and information related to competitors is gathered both legally and ethically. This is important because many employees may feel pressure to rely on techniques that are questionable from an ethical perspective to gather information that may be valuable to their firm, especially if they perceive value to their own careers from successfully obtaining such information.
It seems obvious that information that (1) is either publicly available (annual reports, regulatory filings, brochures, advertising and promotional materials) or (2) is obtained by attending trade shows and conventions can be used without ethical or legal implications. However, information obtained illegally (as a result of activities such as theft, blackmail, or eavesdropping) cannot—or, at least, should not—be used since its use is unethical as well as illegal.
Teaching Note: It might be useful and insightful to require students to develop (and bring to class) their own lists of questionable intelligence-gathering techniques or formulate an argument as to the circumstances (if any) under which these techniques might be considered ethical. This could make for a lively discussion of the issue.
|— |ANSWERS TO REVIEW QUESTIONS | |
1. Why is it important for a firm to study and understand the external environment? (pp. 34-35)
The external environment influences the firm’s strategic options as well as the decisions made in light of them. The firm’s understanding of the external environment is especially useful when it is matched with knowledge about its internal environment. Matching the conditions of the two environments is the foundation the firm needs to form its vision, mission, and to take strategic actions in the pursuit of strategic competitiveness and above-average returns. The importance of understanding the external environment is further underscored by the fact that the environmental conditions facing firms in the global economy of the 21st century differ from those firms faced previously. For example, technological changes and the explosion in information gathering and processing capabilities demand more timely and effective competitive actions and responses. The rapid sociological changes occurring in many countries affect labor practices and the nature of products demanded by increasingly diverse consumers. Governmental policies and laws affect where and how firms choose to compete. Competitive advantage goes to those firms who know their external environment and plan their strategies so they are relevant to these conditions.
2. What are the differences between the general environment and the industry environment? Why are these differences important? (pp. 35-36)
The general environment represents those elements in the broader society that can influence all (or most) industries and the firms that compete in those industries; it represents elements or segments that firms cannot directly control. The general environment is composed of the following segments: demographic, economic, political/legal, sociocultural, technological, and global segments.
The industry environment is the constellation of factors that directly influences a firm and its competitive actions and responses. Firms are influenced by these factors and should attempt to establish a position in the industry that enables the firm to favorably influence the factors or to successfully defend against the factors’ influence. These factors are: threat of new entrants, bargaining power of suppliers, bargaining power of buyers, threat from substitute products, and intensity of rivalry among competitors.
3. What is the external environmental analysis process? What does the firm want to learn when using this process? (p. 37-39)
The environmental analysis process represents an organized attempt by the firm to better understand turbulent, complex, and global environments. This is achieved by scanning (studying all segments of the general environment to identify existing or potential changes), monitoring (observing the pattern of changes over time in an attempt to detect meaning or identify trends), forecasting (developing feasible projections of what might happen, and how quickly, as a result of changes and trends identified from scanning and monitoring activities) and assessing (determining the timing and significance of environmental changes and trends on the strategic management of the firm). Stated differently, this analysis should examine and process external data on a continuous basis.
An important objective of the environmental analysis process is to identify potential threats (conditions that may hinder the firm’s efforts to achieve strategic competitiveness) and opportunities (that may assist or help the firm in its efforts to achieve strategic competitiveness).
4. What are the six segments of the general environment? Explain the differences among them. (pp. 40-47)
The demographic segment is concerned with characteristics of the population or society that makes up the general environment. Characteristics of interest are size, age, structure, geographic distribution, ethnic mix, and income distribution.
The economic segment refers to the nature and direction of the economy in which a firm competes or may compete in the future. Important characteristics include inflation and interest rates, trade deficits (or surpluses), budget deficits (or surpluses), individual and business savings and investment rates, and gross domestic product.
The political/legal segment is the arena in which organizations and interest groups compete for attention, resources, and a voice in overseeing the body of laws and regulations guiding interactions between nations. In other words, this segment is concerned with how firms and other organizations attempt to influence government and how governmental entities in turn influence them.
The sociocultural segment is concerned with the social attitudes and cultural values of different societies.
The technological segment is made up of the institutions and activities involved with creating new knowledge and translating that knowledge into new outputs, products, processes, or materials.
The global segment includes relevant new global markets and existing ones that are changing, important international political events, and critical cultural and institutional characteristics of relevant global markets. This segment recognizes that firms now compete in a competitive landscape where both competitors and customers are global, due in part to the rapid diffusion of both information and technology. Competitors will no longer be domestic; they can originate from industrialized, newly industrialized, or emerging countries. Customer demands and expectations have changed; they are based on an ever-increasing awareness of global products and services.
5. How do the five forces of competition in an industry affect its profit potential? Explain. (pp. 48-55)
An industry’s competitive intensity and profit potential can be determined by the relative strengths of five competitive forces. This model of industry competition recognizes that suppliers can influence industry profitability by raising prices or reducing the quality of goods sold if industry participants are unable to recover cost increases through pricing structures. Buyers can influence the profit potential of an industry if the buyer group is able to successfully bargain for higher quality, greater levels of service, and lower prices. Substitute products influence an industry’s profit potential by placing an upper limit on prices that can be charged. New entrants to an industry influence industry profitability because they bring additional production capacity to the industry. Unless product demand is increasing, additional capacity holds down (or reduces) buyers’ costs, reducing profitability for all firms in the industry. The intensity of rivalry among competitors reflects competitor actions and responses as firms initiate moves to improve their competitive position or when they act in retaliation for competitive pressures brought about by the strategic actions of rival firms. Generally, the greater the intensity of competitive rivalry, the lower the overall profitability of an industry.
6. What is a strategic group? Of what value is knowledge of the firm’s strategic group in formulating that firm’s strategy? (pp. 55-56)
A strategic group is a group of firms within an industry that generally follow the same (or a similar) strategy, competing along the same strategic dimensions (such as product quality, pricing policy, distribution channels, or level of customer service).
The strategic group concept is valuable to a firm’s strategic decision makers because a firm’s primary competitors are those within its strategic group (all group members are selling similar products to a similar group of customers), the strengths of the five competitive forces varies across strategic groups, and strategic groups that are similar (in terms of strategies followed and competitive dimensions emphasized) increases the possibility of increased competitive rivalry between the groups.
The notion of strategic groups can be useful for analyzing an industry’s competitive structure. Such analyses can be helpful in diagnosing competition, positioning, and the profitability of firms within an industry. Strategic group analysis shows which companies are competing similarly in terms of how they use similar strategic dimensions. At the same time, research has found that strategic groups differ in performance, suggesting their importance. Strategic group membership also remains relatively stable over time, making analysis easier and more useful.
Strategic groups have several implications. First, because firms within a group offer similar products to the same customers, the competitive rivalry among them can be intense. The more intense the rivalry, the greater the threat to each firm’s profitability. Second, the strengths of the five industry forces (the threats posed by new entrants, the power of suppliers, the power of buyers, product substitutes, and the intensity of rivalry among competitors) differ across strategic groups. Third, the closer the strategic groups are in terms of their strategies, the greater is the likelihood of rivalry between the groups. In the end, having a thorough understanding of primary competitors helps a firm formulate and implement an appropriate strategy.
7. What is the importance of collecting and interpreting data and information about competitors? What practices should a firm use to gather competitive intelligence and why? (pp. 58-60)
Competitor analysis can help the firm to understand and better anticipate competitors’ future objectives, current strategies, assumptions, and capabilities. The firm should gather intelligence about its competitors as well as about public policies in countries across the world, which can serve as an early warning of threats and opportunities emerging from the global public policy environment that may affect the achievement of the company’s strategy. Through effective competitive and public policy intelligence, the firm gains the insights needed to create a competitive advantage and to increase the quality of the strategic decisions it makes when deciding how to compete against its rivals.
Firms want to know how competitor intelligence is gathered to determine whether the practices employed are legal and, further, to assess whether these methods are ethical, given the firm’s culture and the image it desires as a corporate citizen. The line between legal and ethical practices can be difficult to ascertain, especially when it comes to electronic transmissions. Often it is difficult for a firm to know how to gather intelligence and how to prevent competitors from gathering competitive intelligence that may threaten its own competitive advantage.
Openly discussing intelligence-gathering techniques that the firm employs goes a long way toward assuring that people understand the firm’s convictions about what is ethical and acceptable for use and what is not ethical and is unacceptable for use when gathering competitor intelligence. The firm can frame these practices in terms of respect for the principles of common morality and the right of competitors not to reveal information about their products, operations, and strategic intentions.
Despite its importance, evidence suggests that a relatively small percentage of firms use formal processes to study competitors. Beyond this, some firms fail to analyze a competitor’s future objectives when trying to understand its current strategy, assumptions, and capabilities, but it is important to study the present and the future when examining competitors. Failure to do so may lead to incomplete or distorted insights about competitors.
|— |EXPERIENTIAL EXERCISES | |
Exercise 1: Airline Competitor Analysis
The International Air Transport Association (IATA) reports statistics on the number of passengers carried each year by major airlines. Passenger data for 2006 is reported for the top ten fliers in three categories:
← Domestic flights
← International flights
← Combined traffic, domestic and international flights
The table below lists both passenger data and rankings for each category.
| |Int'l |Int'l |Domestic |Domestic |Combined |Combined |
|Airline |Ranking |Passengers |Ranking |Passengers |Ranking |Passengers |
|Air France |3 |30,417 | | |7 |49,411 |
|All Nippon Airlines | | |6 |45,328 |8 |49,226 |
|American Airlines |7 |21,228 |2 |78,607 |1 |99,835 |
|British Airways |4 |29,498 | | | | |
|Cathay Pacific |10 |16667 | | | | |
|China Southern Airlines | | |7 |45,249 |10 |48,512 |
|Continental Airlines | | |9 |35,852 | | |
|Delta Airlines | | |3 |63,446 |3 |73,584 |
|Easyjet |6 |21,917 | | | | |
|Emirates |9 |16,748 | | | | |
|Japan Airlines Int'l | | |8 |37,154 |9 |48,911 |
|KLM |5 |22,322 | | | | |
|Lufthansa |2 |38,236 | | |6 |51,213 |
|Northwest Airlines | | |5 |45,743 |5 |55,925 |
|Ryanair |1 |40,532 | | | | |
|Singapore Airlines |8 |18,022 | | | | |
|Southwest Airlines | | |1 |96,277 |2 |96,277 |
|United Airlines | | |4 |58,801 |4 |69,265 |
|US Airways | | |10 |32,094 | | |
For this exercise, you will develop competitor profiles of selected air carriers.
Part One
Working in groups of five to seven people, each team member selects one airline from the table. The pool of selected airlines should contain a roughly even balance of three regions: North America, Europe/Middle East, and Asia. Using outside resources, answer the following questions:
← What drives this competitor (i.e., what are their objectives)?
← What is their current strategy?
← What does this competitor believe about their industry?
← What are their strengths and weaknesses?
When researching your companies, you should use multiple resources. The company’s Website is a good starting point. Public firms headquartered in the U.S. will also have annual reports and 10-K reports filed with the Securities and Exchange Commission.
Part Two
As a group, summarize the results of each competitor profile into a single table. Then, discuss the following topics:
← Which airlines in your group had the most similar strategies? The most different? Would you consider any of the firms you studied to be in the same strategic group – i.e., a group of firms that follow similar strategies along similar dimensions?
← Create a composite five forces model based on the firms you reviewed. How might these elements of industry structure (e.g., substitutes, or bargaining power of buyers) differ from the perspective of individual airlines?
← How well do the strategies of these airlines fit with their industry and general environments? Which airlines do you expect to advance in passenger rankings, and which will lose ground?
Exercise 2: The Oracle at Delphi
In ancient Greece, people traveled to the temple at Delphi when they had important questions about the future. A priestess, who was ostensibly a direct connection to the god Apollo, would answer these questions in the form of a riddle. Today, executives are still faced with significant challenges in predicting the future, albeit with very different processes.
Many strategies rely in part on qualitative forecasts and untested assumptions, simply because hard data may not exist, or because the data may be of poor quality. Such problems are particularly common in new product segments (e.g., early stages of the Internet), or in emerging economies (e.g., when Western firms first started selling in China). When making a subjective forecast, it is often helpful to rely on multiple opinions and perspectives. However, group discussions can often be skewed if some participants are more vocal than others, or if group members differ by status. The Delphi Method provides a process for helping a group to reach consensus while minimizing individual biases.
The decision process starts with the selection of a question, or set of questions. A facilitator is designated to manage the process, and a group of experts is selected to provide input. The facilitator polls each expert, and creates a summary of the responses. The summary is then sent back to the expert pool, and each person is given the opportunity to revise their estimates. This process repeats until the summary scores have stabilized.
Part One
Select one group member to serve as facilitator. The facilitator’s role is to select an issue currently in the news that has implications for a specific industry. Once a topic has been selected, the facilitator should prepare a couple of survey questions that can be numerically ranked by the expert panel (i.e., the rest of the team). For example, assume that the topic was an upcoming election, and how the results of that election might affect the attractiveness of an industry. If there were three candidates, the sample questions might look like this:
What is your assessment of the likelihood of Candidate Smith being elected?
What is your assessment of the likelihood of Candidate Jones being elected?
What is your assessment of the likelihood of Candidate Doe being elected?
(Scale 1 = extremely unlikely 3 = moderately likely 5 = extremely likely)
If Candidate Smith is elected, what is the likely effect on industry growth and profitability?
If Candidate Jones is elected, what is the likely effect on industry growth and profitability?
If Candidate Doe is elected, what is the likely effect on industry growth and profitability?
(Scale 1 = worsened substantially 3 = unchanged 5 = improved substantially)
Part Two
The facilitator should administer the survey to each group member. Prepare a summary that includes the average score and range for each item. Repeat the survey, using the same questions two more times following this process.
Part Three
As a group, discuss the following questions:
← How much did the feedback of composite scores affect your assessment?
← In your opinion, were the final scores an improvement over the initial scores? Why or why not?
← How might a Delphi process lead to low quality results? What steps could you take to help ensure a more accurate forecast?
← Bonus question: How is the logic of the Delphi forecast similar to that of the book Wisdom of Crowds, by James Surowiecki?
|INSTRUCTOR'S NOTES FOR EXPERIENTIAL EXERCISES | |
Exercise 1: Airline Competitor Analysis
The goals of this exercise are to develop skills in analyzing companies, and to gain experience in researching non-U.S. firms. Working in teams, each student is asked to choose one firm from a list of airlines. As a group, there should be a roughly even mix of airlines representing North America, Europe/Middle East, and Asia. Each student is asked to answer the following questions for their respective target firms:
← What drives this competitor (i.e., what are their objectives)?
← What is their current strategy?
← What does this competitor believe about their industry?
← What are their strengths and weaknesses?
Next, teams are requested to develop an integrative table that summarizes the results of the individual analyses. The table should look something like this:
|Firm |Objectives |Current |Beliefs |Strengths |Weaknesses |
| | |Strategy | | | |
|Air France | | | | | |
|Cathay Pacific | | | | | |
|Southwest Airlines | | | | | |
|Etc | | | | | |
An effective way to debrief this assignment is to have students discuss Part Two questions in class. To facilitate this discussion, it can be helpful for teams to share their summary tables. One option is to ask teams to bring enough copies of their table to share in class. Alternately, they can create tables on flip chart paper, and hang all of the tables side-by-side on the wall. Having all of the tables together on the wall makes it easier to identify similarities and differences in the assessment of a particular firm across teams.
Teams are given a series of questions to discuss once they have created their integrative table. When doing the debrief in class, the instructor will cover the same questions, allowing students to compare their conclusions to those of other teams. The questions are:
← Which airlines in your group had the most similar strategies? The most different? Would you consider any of the firms you studied to be in the same strategic group?
← Create a composite five forces model based on the firms you reviewed. How might these elements of industry structure (e.g., substitutes, or bargaining power of buyers) differ from the perspective of individual airlines?
← How well do the strategies of these airlines fit with their industry and general environments? Which airlines do you expect to advance in passenger rankings, and which will lose ground?
The first discussion question aims to identify airlines with common strategies to one another, as well as airline with unique strategies. In some cases (e.g., RyanAir and Southwest), an airline may have adopted a particular strategy in direct emulation of another firm. In other cases, two firms may have independently arrived at similar strategies. Topics that should be addressed for this question include geographic scope (emphasis on domestic versus international flights), positioning and competencies (emphasis on price, service, and timeliness), and target customers.
The second question is used to create a composite five forces model. The purpose of this discussion is to illustrate that industry structure is not monolithic. Instead, individual five forces elements can vary across regional segments or for different strategic groups. Additionally, the salience of particular industry constraints may be different across firms. One way to illustrate these differences is to develop a table on the board which illustrates the variability of the five forces:
| |Buyer |Supplier |Threat of entrants |Threat of substitutes|Rivalry |
| |power |power | | | |
|Strong pressure | | | | | |
|Moderate pressure | | | | | |
|Minimal pressure | | | | | |
Based on class discussion, the instructor would highlight different market segments where each of the five forces vary in importance. For example, differences in distance and alternate modes of transportation would lead to a higher threat of substitution in Europe than for Australia. Similarly, the scarcity of airline choices in Australia versus the U.S. or Europe will affect the intensity of rivalry and buyer leverage.
Finally, the instructor should conclude the discussion by asking which airlines are best positioned for the future. Students should explain why certain bundles of firm resources are a good match to a specific strategy and market structure. Since this is only the second chapter in the book, instructors should not set the expectations for this question too high. Rather, the question can be used as a bridge to the topics that will be covered in subsequent chapters.
Exercise 2: The Oracle at Delphi
The purpose of this exercise is to illustrate how managers can use a structured decision process to make forecasts and recommendations in the absence of hard data. The Delphi method is a tool to help experts on a topic share their opinions, and to help revise their views after hearing different perspectives.
A limitation of this exercise is that a group of students will not constitute a true expert panel. However, the exercise is still a useful mechanism to explain the basic Delphi process. To compensate for a lack of expertise, the instructor should choose a current topic that students would be familiar with, in order to facilitate discussion. The topic choice should be something that has implications for a particular industry. A quick scan of publications such as Fortune, Business Week, or the Wall Street Journal should provide a range of possible topics. The example provided to students in the textbook concerns a hypothetical election, and how the results of that election might affect a particular industry.
Once a topic has been selected, the instructor should create two or three survey questions that can be numerically ranked. Following is another sample topic and survey questions:
Topic: Illegal immigration. Assume that some new system is being proposed to control the flow of undocumented workers into the US.
Q1: What is the likelihood of the new system being enacted?
(Scale 1 = extremely unlikely 3 = moderately likely 5 = extremely likely)
Q2: If passed, what is the likely effectiveness of this new system?
(Scale 1 = completely ineffective 3 = moderately effective 5 = completely effective)
Q3: How will the effectiveness of this system affect the cost structure and profit margin in Industry X?
(Scale 1 = an effective system will have no to minimal affect on cost structure and profit margin
3 = an effective system will moderately affect cost structure and profit margin
5 = an effective system will have a large effect on cost structure and profit margin)
Using these survey items, the Delphi process is executed within teams. One team member should be selected in advance to serve as the group’s facilitator. The facilitator’s duties are as follows:
1. Distribute a copy of the survey items to each other team member. 2. Prepare a summary report with descriptive statistics for each item. The summary should list the high and low score, and the mean score for each question. Scores of individuals are anonymous. 3. After receiving the summary report, each member is asked to complete the survey a second time, with the opportunity to revise their scores from the prior iteration. 4. Another summary report is issued.
The instructor may decide whether to have students complete this process for a specific set of iterations (three rounds are recommended), or to continue until there is no more change in individual scores.
A helpful way to debrief this activity is to ask students for other situations where they have relied on consensus opinions. One example that works well to illustrate this topic is movie reviews: Ask who relies on Yahoo or other compilations of movie critic reviews when deciding what film to attend. Other examples may include Amazon book reviews; this is a good option as well since there is likely a much broader variation in the ‘expert’ nature of the reviews. Car buyer reviews, and the Jaywalk Consensus[1] ‘buy/sell/hold’ ratings are also good topics. Questions to ask on these topics include:
← How much emphasis do you place on the average score, best score, and worst score? Some students may rely heavily on the ‘typical’ score. Others may place more emphasis on the outliers – e.g., a movie with a below average score but lots of ‘A’ ratings could be seen as risky but with good potential. Similarly, other students might be influenced by the smallest number of ‘F’ scores – minimizing downside risk, essentially. Based on discussion of this question, ask students how much and how often they changed their own scores in subsequent rounds of the Delphi exercise, and what factors drove these changes.
← How influential is the source of the rating? In the context of a movie review, students might place a great deal of emphasis – or none at all – based on a particular source (e.g., “he’s never right” or “I have always agreed with that newspaper’s reviews” or “I’ve heard her reviews on TV”). Some students will be very influenced by a prominent reviewer, and others not at all. In cases of the former, inquire whether the influence is due to that person’s prestige, or the actual rationale for the rating. An important part of the Delphi process is that the scores are anonymous, specifically to minimize such biases.
← How do you react when you see two reviews which are diametrically opposed? The purpose of this question is to bring out the processes that people use to integrate very different perspectives.
Based on this framing, the instructor should revisit the questions in class that were previously discussed within the teams:
← How much did the feedback of composite scores affect your assessment?
← In your opinion, were the final scores an improvement over the initial scores? Why or why not?
← How might a Delphi process lead to low quality results? What steps could you take to help ensure a more accurate forecast?
← Bonus question: How is the logic of the Delphi forecast similar to that of the book Wisdom of Crowds, by James Surowiecki?
Additional material for the bonus question:
The question on the Wisdom of Crowds book can be used as a follow-up assignment, or simply used for additional debrief in class. Surowiecki’s book starts with a story of the 1906 West of England Fat Stock and Poultry show. At the show, several hundred people placed wagers on the weight of a certain ox. Many of the bettors were neither butchers nor farmers. Yet, on average, the consensus weight was remarkably close to the actual weight of the ox. In the remainder of the book, Surowiecki outlines four criteria that can lead to the creation of ‘wise’ crowds:
← Diverse opinions among group members
← Independence of member
← Decentralization
← Presence of a good mechanism for aggregating opinions.
|— |ADDITIONAL QUESTIONS AND EXERCISES | |
The following questions and exercises can be presented for in-class discussion or assigned as homework.
Application Discussion Questions
1. Given the importance of understanding the external environment, why do some firms fail to do so? Students can provide examples of firms that did not understand their external environment. What were the implications of the firm’s failure to understand that environment?
2. Have the students select a firm and describe its external environment. What actions do you believe the firm should take, given its external environment, and why?
3. How is it possible that one firm could see a condition in the external environment as an opportunity while a second firm sees it as a threat?
4. Select a firm in the local community. What materials would help one understand the firm’s external environment? How could the Internet be used to complete this activity?
5. Have the students select an industry that is of interest to them. What actions could firms take to erect barriers of entry to this industry?
6. What conditions would cause a firm to retaliate aggressively against a new entrant to the industry?
Ethics Questions
1. How can a firm use its “code of ethics” to analyze the external environment?
2. What ethical issues, if any, may be relevant to a firm’s monitoring of its external environment? Does use of the Internet to monitor the environment lead to additional ethical issues? If so, what are they?
3. Think of each segment in a firm’s general environment. What is an ethical issue associated with each segment? Are firms across the globe doing enough to deal with the issue?
4. What is the importance of using ethical practices between a firm and its suppliers?
5. In an intense rivalry, especially one that involves competition in the global marketplace, how can the firm gather competitor intelligence ethically while maintaining its competitiveness?
6. Ask the class what they believe determines whether an intelligence-gathering practice is or is not ethical? Do they see this changing as the world’s economies become more interdependent? If so, why? Do they see this changing because of the Internet? If so, how?
Internet Exercise
Firms rely on gathering and analyzing the general, industry, and competitor environments to assess their potential for global growth and profitability. Go to the website for the U.S. retail chain Wal-Mart at http://www.wal-mart.com. Wal-Mart’s global expansion plans are extensive. List how each of the six segments of the general environment prompted Wal-Mart to expand into the markets that it has. Target is a major U.S. competitor of Wal-Mart. Check out the Target website at http://www.target.com. What are the firm’s plans for global expansion? What types of opportunities and threats would prohibit Target from taking Wal-Mart’s route? Would the students consider Target a future key global rival of Wal-Mart?
*e-project: What U.S. firms offer global Web shopping in other countries’ currencies and shipping specifications? How do their non-U.S. Websites compare with their U.S. Websites?
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[1] BNY Jaywalk develops consensus views based on the ratings of a group of financial experts. These results are referred to various as ‘Jaywalk consensus’ or ‘Jaywalk universe’, and are included in many analyst reports. More information is available from the company at:
http://www.jaywalkinc.com/Jaywalk/Jaywalk.html 