Exploring the External Environment: Macro and Industry Dynamics

OBS 320: Chapter 4, Exploring the External Environment: Macro and Industry Dynamics Leave out:
The Value Curve (P. 152-156); and
When industry Divide and Collide (P.163-164)
1. Explain the importance of the external context for strategy and firm performance (P. 130-132)

A. The External Context of Strategy (Figure 4.1)

B. The External Context of Strategy (Explained)
It is crucial that the external environment is thoroughly understood in order to formulate an effective strategy that can help one in achieving company objectives.

The external environment provides the business opportunities to the firm as well as threats that may impede the successful implementation of a strategy.

Knowing what industry and firm specific factors affect a firm is critical to understand a firm’s competitive position and to determine what strategies are viable.

The proper use of tools to analyse the external environment will help to identify some of the major reasons industries differ so much in their long term profitability.

Characteristics of the external environment are the factors that are relevant to the firm’s performance at a given point in time so in order to avoid blind spots in an industry analysis, managers should always integrate their analysis of a firm’s industry with a broader stakeholder analysis.

Managers must remain focused on the industry and not on a particular firm operating in it.

C. The external environment has two major components:
i. The Macro Environment (Political, Economic, Sociocultural, Technological,
Environmental and Legal factors, known as PESTEL). ii. The industry environment which is comprised of strategic groups of firms that seem to be more similar in certain ways than other members of the larger industry.

2. Use PESTEL to identify the macro characteristics of the external context (P. 133-138)

A. What is PESTEL?
PESTEL is a tool for analysing the larger political, economic, sociocultural, technological, environment and legal issues that confront the firm.

A firm needs to understand the macro environment to ensure that their strategy is aligned with the powerful forces of change that are affecting their business landscape.

PESTEL helps managers to
Gain a better understanding of the opportunities and threats they face Build a better vision of the future business landscape and how the firm might operate profitably Avoid strategies that may be doomed to failure for reasons beyond their control Have a good starting point when entering a new country or region

B. PESTEL has three (3) steps, namely:
i. Consider the relevance of each PESTEL factors to your particular context ii. Identify and categorize the information that applies to these factors iii. Analyse the data and draw conclusions

C. PESTEL Analysed

1. Political Factors
Political factors influence businesses and consumer confidence as well as consumer and business spending The stability of the political environment is important for companies entering new markets. Political Factors include:

Government policies
Regulations
Taxations
Regional trading blocks
Fair-trade decisions
Tax programs
Minimum wage legislation
Pollution and pricing policies
For example:
How stable is the political environment?
What are the foreign-trade regulations?
Tax policies, etc.?

2. Economic Factors
Managers need to consider the macro-economic factors that will have a short and long term effect on the success of pursued strategies. Economic Factors include:
Inflation rates
Interest rates
Tariffs
Growth of local and foreign national economies
Exchange rates
Unemployment rates
Local labour costs
Availability of critical labour
Outsourcing
For example:
Projected interest rates?

3. Sociocultural Factors
Sociocultural Factors vary from country to country
Represents beliefs and values, attitudes and opinions, and lifestyles Sociocultural Factors include:
Local languages
Dominant religions
Leisure time
Age
Lifespan demographics
Attitudes towards:
Consumerism
Environmentalism
Role of men and women
For example:
Lifestyle trends?
Demographic changes?

4. Technological Factors
Technological factors have a major bearing on the threats and opportunities that firms encounter Technological factors include:
Lower costs
Better standard of quality
Opportunity for more innovation
Reduce communication costs
Increase remote working
Distribution of products and services
For Example:
Level of government research funding?
How mature is technology?

5. Environmental Factors
Refers to the relationships among human beings and other living things and the air, soil, and water that support them. Environmental factors include:
Environmental legislation
Loss of habitat and biodiversity
Waste
Pollution
Direct and indirect operating costs
Biodegradable or recyclable packaging
For example:
Eco-efficiency?
Environmental legislation?

6. Legal Factors
Legal factors reflect the laws and regulations relevant to the region and the organization. Legal factors include:
Law established
Change of laws and regulations
Cost of regulatory compliance
For example:
Is the intellectual property protected?
Relevant consumer laws?

Factor
Description
Factors include
Example
Political
Influence businesses and consumer confidence and also consumer/business spending Government policies
Tax programs
Min. wage legislation
How stable is the political environment?
Economic
Consider macro-economic factors that have a short and long term effect on success of strategies Inflation rates
Interest rates
Growth of local and foreign national economies
Unemployment rates
Availability of labour
What is the projected interest rate?
Sociocultural
Represents values and beliefs, attitudes and opinions, and lifestyles in a specific country Dominant Religions
Demographics
Age
Leisure time
Lifestyle trends?
Demographic changes?
Technological
Have a major bearing on the threats and opportunities firm encounter Lower costs
Better standard of quality
Reduce communication costs
Distribution of products/services
What are the new technological capabilities and their probable impacts? Environmental
Relationships among human beings and other living things and the air, soil, and water that support them. Waste
Pollution
Access to raw materials
Direct and indirect operating costs
What is the environmental legislation?
Legal
Laws and regulations relevant to the region and the organization Law established
Change of laws and regulations
Cost of regulatory compliance
Is the intellectual property protected?

3. Identify the major features of an industry and the forces that affect industry profitability (P. 138-156)

A. The Industry Environment (Porters 5 forces model)

Porter’s model explains the five forces that shape competition in an industry (these forces are never static).

In short, Porters five forces model is a framework for evaluating industry structure according to the effects of: Rivalry;
Threat to entry;
Supplier power;
Buyer power; and
Threats to substitute.

Helps managers to evaluate the general attractiveness of an industry and specific opportunities as well as threats firms face in their local segment

An high quality strategy will help to:
Minimize buyer power
Offset supplier power
Avoid excessive rivalry
Raise the barriers to entry; and
Reduce the threat of substitutions.

B. Porter’s Five Forces Model

Force
Description
Role Players
Effect
Example
Rivalry
Is the intensity of competition

Most aggressive forms of competition include price wars
Rivalry among competing sellers:

Competitive pressures created by jockeying for better market position, increased sales and market share, and competitive advantage Higher degrees of rivalry result in lower levels of average industry profitability (as price competition increase, the average price declines, resulting in lower levels of profit)

When competitors are of relatively equal size and power, so rivalry is affected not only by the number of firms competing but also by how similar they are Threat of Entry
The degree to which new competitors can enter an industry and the intensity of rivalry

Barriers/conditions that make it difficult to enter the industry Potential New Entrants:

Competitive pressures coming from the threat of entry of new rivals Industries with consistently high average profitability tend to be the most difficult to enter

The higher the degree of entry in an industry, the lower the potential competition by limiting supply and reducing rivalry Industry Characteristics that affects barriers to entry:
Strong Brands
Proprietary technologies
Product differentiation
Restricted access to investment capital
Distribution channels constitutes
Supplier Power
The degree to which firms in the supply industry are able to dictate favourable contract terms and thereby extract some of the profit that would otherwise be available to competitors in the local industry

Suppliers are powerful when they control factors such as:
Price
Delivery lead times
Minimum orders
Post-purchase service
Payment terms
Suppliers of Raw Materials, Parts, Components, or Resource inputs:

Competitive pressures stemming from supplier bargaining and supplier seller collaboration Supplier power is increased when:
The suppliers are relatively concentrated, controls scare input, or are simply bigger than their customers Firms in the local industry face
significant switching costs when changing suppliers When firms in the supply industry present a threat of forward integration manufacturing finished products instead of just selling the components to manufacturers. Force

Description
Role Players
Effect
Example
Buyer Power
Mirror image of supplier power

The degree to which firms in the buyers industry are able to dictate favourable terms on purchase agreements that extract some of the profit that would otherwise be available to competitors in the local industry Buyers

Competitive pressures stemming from buyer bargaining power and buyer-seller collaboration Many suppliers + few buyers = buyers capture greater share of profits

In industries characterized with many suppliers and few buyers, buyers often capture a greater share of profits

Factors that increases buyer power:
When buyers are prestigious and when their purchases represent a significant portion of the sellers sales When prices and products are easy to compare
When buyers have numerous choices
Access to information
Threat of Substitutes
The degree to which products of one industry can satisfy the same demand as those of another

A substitute is any product that satisfies a common need or desire Firms in other industries offering substitute products:

Competitive pressures coming from the attempts of companies outside the
industry to win buyers over their products. The prevalence of viable substitute products from other industries places pressure on the prices that can be changed in the local industry When there are no viable substitutes, there is less pressure on price

C. Complementors
Complementors are firms in an industry that provides products or services which tend to increase sales in another. Complementor: Any factor that makes it more attractive for suppliers to supply an industry on favourable terms or that makes it more attractive for buyers to purchase products or services from an industry at prices higher than it would pay absent the Complementor. For Example:

Hot Dogs + Buns = More Sales
Music + MP3 Player = More attractive offering

D. Exit Barriers
Exit barriers are obstacles or impediments that prevent a company from exiting a market. Typical barriers to exit include:
Highly specialized assets, which may be difficult to sell or relocate Huge exit costs, such as asset write-offs and closure costs
Loss of customer good will.
In short, exit barriers make it infeasible to sell a firm in a particular industry. E. Porter’s Five Forces of Industry Structure

4. Understand the dynamic characteristics of the external context (P. 157-163)

Drivers of Change: Making the Five-Forces Model Dynamic

A. The Industry Life Cycle (ILC)
The ILC is a model that describes the evolution from inception through to its current state and possible future states New industries emerge when entirely new products are developed that satisfy customer demands in ways that existing products and technologies could not The ILC is a powerful driver of industry dynamics because it’s a phenomenon characterized by change

Commoditization:
Is the process during industry evolution by which sales eventually come to depend less on unique product features and more on price

Disruptive Technology:
Breakthrough product- or process related technology that destroys the competencies of incumbent firms in an industry A disruptive change introduced by a new technology also has the effect of altering the industry life cycle. The industry is reinvigorated and rather than proceeding into decline accelerates into new phases of growth Disruptive technologies can be process-related (TQM) as well as product related.

Innovator’s Dilemma
When incumbents avoid investing in innovative and disruptive technologies because those innovations do not satisfy the needs of their mainstream and most profitable clients Occurs in established industries when incumbents continue to develop competency-enhancing innovations, while new entrants develop disruptive innovations

B. The Industry Life Cycle:

C. Dynamics of Industry Structure
Porter’s Five Forces
Cause
Effect
Industry Rivalry
Increase in industry growth

Globalization of industry
Reduced rivalry and less pressure on prices

Increased rivalry as new foreign players enter the market, pressure for scale economies leading to consolidation, and market domination by fewer but larger companies Threat of new entrants
Decline in scale necessary to compete effectively

Increases in customer heterogeneity

Increased customer concentration
Increased rivalry because its easier for start-ups to enter and compete

Easier entry because some customer segments are likely to be underserved

Reduces threat of entry, causing less pressure to compete on price Bargaining Power of Suppliers
Increase concentration of firms in supply industries

Forward integration by key suppliers

Emergence of substitute inputs that satisfy basic needs
Greater supplier power and possibly reduced profitability in focal industry

Loss of power in focal industry because of reduction in number of viable suppliers

Reduction of supplier power and increased profits for focal industry

Bargaining Power of Buyers
Improvement in buyer information

Emergence of new distribution channels

Increased fragmentation of buyers’ industry

Increased buyer power because of ability to compare

Reduction in buyer power because focal industry has more options

Reduction in buyer power as nr of potential buyers increase and size of buyer
industry declines relative to size of focal industry Threat of Substitute
Emergence of a new substitute

Decline in the relative price performance of a substitute
Reduced ability to maintain high prices due to more buyer alternatives

Reduces threat of substitutes and pressure to maintain lower prices Role of Complementors
Emergence of new Complementors

Higher barriers to entry in Complementor industry

Lower barriers to entry in Complementor industry
Increase demand and less pressure on prices in focal industry

Greater Complementor leverage and ability to profit from complementary relationship

Reduction in Complementor leverage leading to net increase of possible firms who can serve as Complementors and increase demand

5. Show how industry dynamics may redefine industries (P. 157-163) As indicated above.