External Analysis

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Chapter 4

• External Analysis
• Objective analyzing the external factors
  (industry and environment) to make strategic
  judgments

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Why to conduct industry analysis?

• In external analysis, the next factor (after
  customer and competitors) to analyze is the
  industry/market in which the company operates.
  For effective strategic planning, it is a must to
  understand the industry forces affecting the
  company, and the companys capabilities to deal
  with those forces.
• Understanding the industry anticipating its
  future trends and directions give the company the
  knowledge it needs to react and control its
  portion of that industry.

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• The industry analysis helps the company
• to identify threats and opportunities that may
  influence the companys abilities to reach its
  goals.
• to focus in on any competitive advantages
  available. Since both the company and its
  competitors are in the same industry, the key to
  success is in finding the different abilities
  between the company and the competitors in
  dealing with the industry forces. If the company
  can identify abilities it has that are superior
  to competitors, it can use those abilities to
  establish a competitive advantage.

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Dimensions of an Industry Analysis

• Industry analysis often include the following
  dimensions
• Industry size and growth
• Industry forces (profitability)
• Industry attractiveness
• Industry success factors

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Industry Size and Growth

• A basic starting point for the analysis of an
  industry is the total sales level (size).
• What are the important and potentially important
  submarkets?
• What are their size and growth characteristics?
• What submarkets are or will soon decline? How
  fast?
• It is also useful to consider the potential
  market a new use, new user group, or more
  frequent usage could change the size of the
  market.

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• After the size of the market and its important
  submarkets has been estimated, the focus turns to
  growth rate.
• What will be the market size in the future?
  Growth often means more sales and profits even
  without increasing market share.
• Identifying the driving forces, forecasting the
  rate (predicting the market sales), detecting
  maturity and declines (turning points in market
  sales and profit) are important considerations
  about market growth.
• Company can detect maturity or decline by
  checking if there is price pressure caused by
  overcapacity, lack of product differentiation,
  increase in buyer sophistication and knowledge,
  and substitute products or technology, decline in
  first-time buyers, no further growth
  opportunities for users or new users, and
  reduction in customer interest.

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Industry Forces

• As identified by Michael Porter, a Harvard
  economist, there are five basic forces at work
  within any industry which influence
  profitability. The problem is to estimate how
  profitable the average firm will be (measured by
  the long-term return on investment of the average
  firm).
• (1) Ease of entry, (2) Supplier power, (3) Buyer
  power, (4) Product substitutes, (5) Industry
  competitors.

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1 - Ease of Entry

• Ease of entry refers to the relative degree of
  difficulty for a new firm to enter the industry.
  This force affects the company because each new
  entrant means a new competitor.
• If it is easy to enter the industry, competitive
  advantages that the company have today may
  quickly disappear with each new competitor.

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• However, if ease of entry is difficult, the
  company benefits because
• The competitive advantages the company may have
  greater longevity
• The companys set of competitors will remain
  fairly constant.
• Two factors influence ease of entry into an
  industry. Those are
• Barriers to entry that currently exist
• Reaction of existing competitors to each new
  entrant

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Barriers to entry

• What barriers to entry may exist?
• Product differentiation Does a new firm need to
  offer distinct product advantages in order to
  capture business?
• Capital requirements and existence of high fixed
  costs Are large amounts of capital required to
  set up a business within the industry?
• Switching costs for the customer Will customers
  incur high expenses in order to switch to a
  competitor?
• Access to distribution channels Can new
  competitors access distribution channels easily?

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Reaction of competition

• How will the existing companies react to a new
  layer in the market? There are several factors to
  look at
• History How have they reacted in the past?
• Strength of existing firms Do existing firms
  have substantial resources or large commitments
  to the industry?
• Industry growth rate Is the industry limited in
  its ability to accept new firms because of a slow
  growth rate?

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2 - Supplier Power

• Supplier power (suppliers may influence the
  relationship that company has with its customers,
  e.g. dictate the quality company offers, control
  the price, conditions) exists
• when the industry sells products manufactured by
  just a few suppliers
• when the product they supply is unique or do not
  have substitutes
• when the company is not a significant part of the
  suppliers business
• When the supplier has intention to move forward
  on the distribution chain and displace the
  company.

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3 - Buyer Power

• Buyer power exists when the purchasers
  (intermediaries) of the companys product can
  exert influence on the company e.g. through
  customers demanding lower prices, demanding
  higher quality or more services or playing
  competitors each other. Factors that give
  purchasers buying power
• Single buyer purchases high volumes of the
  companys product
• The companys products are undifferentiated or
  subject to substitution

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• It is relatively easy and inexpensive for a buyer
  to switch from the company to a competitor
• The companys product is unimportant to the
  quality of the buyers product.
• The key in the buyer-power scenario is the needs
  of the customer. Buyers of the companys products
  or the company can gain power in the relationship
  by influencing the customers decision.

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4 - Product Substitution

• A substitute product is one that can perform the
  same function as the companys product.
• It becomes a substitute when, in the mind of the
  customer, it performs the same function at an
  equal or better price-performance ratio.
• The solution is differentiating the product by
  understanding the customer.

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5 - Industry Competitors

• The battle between the company and its
  competitors is about getting a superior position
  in the mind of the customer.
• The intensity and form (e.g. price war, ad
  campaigns, expanded service offerings, new or
  improved product introductions) of this battle
  affects the companys ability to win that
  position and sustain it.
• Several industry factors dictate the intensity
  and form of the battle (1) the number of
  competitors, (2) the rate of industry growth, (3)
  the rate of differentiation.

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Industry Attractiveness

• Industry attractiveness is the presence or
  absence of threats displayed by each of the
  industry forces.
• The greater a threat posed by an industry force,
  the less attractive the industry becomes (the
  industry forces should be rated).
• Industry attractiveness should be evaluated at
  each SBU base. This is important in order to rank
  each SBUs importance for the company.

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Industry Success FactorsBases of Competition

• Success factors are indicators of why a company
  succeeds or fails within an industry.
• Identifying success factors is a subjective
  process since qualified judgments are made based
  on the collected information.
• Some examples for industry success factors
  ability to quickly respond to marketplace, good
  credit arrangements, excellent product
  quality/performance/reliability, excellent
  support after sale, knowledgeable personnel,
  strong financial foundation etc.

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Risks in High-Growth Markets

• The conventional wisdom that the growing markets
  are better, neglects the risks involved in those
  markets. The following risks are important to
  consider before the company decides to enter a
  growing market
• Competitive overcrowding too many competitors
  with unrealistic expectations would get
  attracted. But in reality there may not be
  sufficient sales volume to support all those
  firms.
• A superior competitive entry a competitor would
  enter with a superior product or low-cost
  advantage.

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• Changing key success factors key success factors
  would change and the company cannot adapt.
• Changing technology technology would change. A
  safe strategy is to wait until it becomes clear
  which technology will dominate and then attempt
  to improve it with a compatible entry.
• Disappointing market growth the market growth
  would fail to meet expectations.
• Resource constraints resources may be inadequate
  to maintain a high growth rate.
• Distribution constraints adequate distribution
  may not be available.

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Environmental Analysis

• After the market/industry is analyzed, the focus
  shifts to the environment surrounding the market.
  
• Why to conduct environmental analysis? The
  environmental analysis is used to locate current
  and future trends or events that represent
  potential opportunities or threats to the
  business.

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Opportunities and Threats

• The goal of the environmental analysis is to
  allow the company to locate the opportunities
  (represent a chance for the company to increase
  its sales, growth, or competitive position
  anything that would have a positive impact on the
  business) that the company should attempt to take
  advantage of, and the threats (anything that can
  cause a decrease in sales, represent an obstacle
  to success or endanger the companys survival)
  that have greatest potential to negatively affect
  the future of the business and therefore the
  company should decide to develop strategy to
  defend against it.

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Which data to collect?

• Since there are millions of changes taking place
  in the environment, each company must decide
  which data will have the greatest impact on its
  success and survival and therefore have
  significant impact on strategy.
• Ideally, the data should represent both current
  and future (anticipating forecasting) critical
  environmental factors those that will likely
  impact the company, its customers, and its
  competitors
• The environmental analysis is not complied on an
  annual basis, it is an ongoing process.

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Dimensions of Environmental Analysis

• Environmental analysis is usually divided into
  the following four areas
• Political
• Economic
• Social
• Technological

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Political Regulation and Actions

• The introduction or removal of legislative or
  regulatory constraints can represent major
  strategic threats and opportunities. E.g. the ban
  of some ingredients in food products or
  cosmetics.
• One research indicated that governmental issues
  tend to follow an eight-year cycle. For the first
  five years, the issues carry less importance but
  can be detected in the press and in some polls.
  In the fifth or six year, the national press
  becomes interested and finally, government action
  results. Of course, the earlier a company becomes
  involved, the better.

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Economic Conditions

• Some strategies will be affected by judgments
  made about the economy, particularly inflation
  and general economic health as measured by
  unemployment and economic growth. E.g. heavy
  investment in a capital-intensive industry needs
  to be matched with a strong economy to avoid a
  possibly damaging period of losses.
• Usually it is better to look beyond the general
  economy and consider the health of the specific
  industry.
• Multinational companies must forecast the
  relative valuation of currencies. Thus, an
  analysis of balance of payments and other factors
  affecting currency valuations might be needed.

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Social Trends

• Shifts in the makeup of the population have great
  effect on the companies.
• Social, cultural and demographic (age, income,
  education, geographic location) trends can
  represent both threats and opportunities for a
  wide variety of companies. E.g. the change in
  womens life styles influences dress designers
  product lines and pricing strategies. E.g. the
  rise in the ageing population influences the type
  of food offered in the restaurants.

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Technology

• Technological trends or technological events
  occurring outside the market/industry have
  potential to impact strategies.
• Impact of new technologies introduction of a new
  technology does not always mean that businesses
  with prior technology will suddenly become
  unhealthy. Generally, the sales of the old
  technology continues for some time, since (1)
  companies continue to improve it and (2) it is
  difficult to predict the outcome of the new
  technology.

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• The technology life cycle many technologies have
  life-cycles. E.g. computer printer industry. The
  key to manage the transition from one technology
  to another is to detect when the original
  technology is in the decline phase (indicators
  (1) if performance levels are approaching
  physical barriers, (2) RD efforts are becoming
  less effective, (3) small competitors are
  experiencing with alternative technologies).
• Forecasting new technologies studies indicate
  that reviewing articles, magazines etc help in
  forecasting technological trends and events.

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Forecasting Environmental Trends and Events

• Expert opinions often are helpful in
  environmental forecasting.
• Another method of forecasting is trend
  extrapolation. However, departures from an
  extrapolated trend carry more interest.
• It is important to consider the cross-impact of
  one environmental development on others. In
  cross-impact analysis, the impact of one event on
  the probability of another is determined.

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Scenario Analysis

• Forecasting the individual events and trends
  would be too simplistic in a complex environment
  where some key area of uncertainty and complexity
  may not be resolved.
• Scenario analysis is one way to deal with both
  complexity and uncertainty in the environment.

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How to conduct scenario analysis?

• Scenario analysis involves
• the development (identification) of a set of
  total scenarios of what the future environment
  will contain (based on optimistic, pessimistic,
  and most likely scenarios).
• relating those identified scenarios to strategies
  (strategy development). Major purpose here is to
  create new strategic options.
• evaluating alternative scenarios by determining
  the scenario probabilities (asking experts).
• comparing the expected outcomes of each strategy
  if the wrong scenario emerges (regret analysis)

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Impact Analysis

• Throughout the entire external analysis, the
  problem of information overload occurs.
• So, it is crucial to determine not only which
  information is needed, but also which information
  has priority.
• For this purpose, the creation of an impact
  matrix which identify and evaluate the various
  information need areas and also quantify their
  impact on each SBU, can be useful.

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Impact MatrixImpact of an information-need area

• On the matrix, the vertical axis lists potential
  information needs areas, areas in which
  information could be gathered and organized. They
  can be drawn not only from an environmental
  analysis, but also from analyses of the customer,
  competitor and market.
• The horizontal axis represents the present SBUs,
  may also include proposed and potential SBUs.
• The entries in the matrix represent the relative
  impact that trends or events associated with
  information-need areas will have on the SBUs. The
  impact can be positive or negative (as the scale
  on the bottom of the example show).

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• The listing and assessing the impact of
  information need areas on SBUs can help (1)
  identify and (2) prioritize the information need
  areas for each SBU. The areas with greatest
  impact are those with the highest scale values.
• The column at the right (which adds the positive
  and negative entries for each row) provides a
  summary measure of the impact associated with an
  information-need area.
• On the other hand, the vertical column totals at
  the lower section indicate the SBUs sensitivity
  to trends and events in the environment. The
  relative importance of each SBU is also shown.

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Immediacy/Impact MatrixImmediacy of an
information-need area

• When the information-need areas have high impact
  but such a low probability of occurrence, then it
  is not worth gathering and analyzing that
  information.
• Similarly, when occurrence is far in the future,
  then it may also be of little concern.
• The following matrix is helpful in identifying
  how much information will be sufficient, after
  an information need is crystallized.

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• High
• Impact
• Low
• Low High
• Immediacy

Monitor and In-depth analysis analysis, strate
gy contingent development strategies
considered Monitor Monitor and analysis
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• If both the immediacy and impact are low, then a
  low level of monitoring may be sufficient.
• If the impact is thought to be low but the
  immediacy is high, the area deserves monitoring
  and analysis.
• If the immediacy is low and the impact is high,
  then the area may require monitoring and analysis
  in more depth, and contingent strategies may be
  considered but not necessarily developed and
  implemented.
• If both the immediacy and potential impact of the
  underlying trends and events are high, then an
  in-depth analysis will be appropriate, as will be
  the development of reaction plans or strategies.