Copyright ©2011 Taylor & Francis Group, an informa business

Chapter 4

ANALYZING THE ENVIRONMENT

A Key Driver of Strategic Success

Businesses are open systems, interacting with and dependent upon their environments.

Strategy can be understood as “pre-action” to anticipated conditions and events.

Extent the strategy “fits” the environment = Success!

A Key Driver of Strategic Success

A common mistake—Looking just at the present.What is the size of the market? What are the strengths of the competition? What are the costs of the raw materials or

what is the status of pending regulation?

These all are important but they look only at static conditions.

Analyzing the Environment

Outputs from good environmental analysis:Provide more than understanding of the

present but also provide insight into how the current environment evolved and how that ongoing evolution affects the future.

“Life can only be understood backwards, but it must be lived forwards.” For strategists, the implication is that the knowledge of how the environment is moving forward is best discerned in understanding the patterns of the past.

Analyzing the Environment

Three key steps in environment analysis:

1. Accurate definition of the environment

2. Analysis of the current conditions – “Five-forces model”, PESTEL, and business/industry lifecycle

3. Analysis of how the various forces at work in the environment have been and are continuing to change

The Competitive or Industrial Environment Includes:

-Competitors-Customers-Suppliers-Regulators-Financiers

The General or Macro Environment Includes:

-Politics-Economy-Social Trends-Technology-Environment (Natural)-Laws

The Firm

Defining the Business and the Environment

Defining the Business and the Environment

Like living organisms, firms survive and prosper as they fit themselves into and interact successfully with their environments.

A firm’s capabilities for transformation must match the available inputs.

Environmental analysis must recognize multiple factors. Competitors often affect the firm’s relationship to its suppliers

(inputs) and its customers (outputs). Trends in the general macro-environment often affect a

variety of business components Lifecycle conditions affect competition and strategic

formulation

Defining the Business and the Environment

Each firm has its own unique environment; no two firms, no matter how similar, share exactly the same environment.

Good environmental analysis should be firm-specific Focused on the relationships between a particular firm,

its customers, competitors, and suppliers.

Each environment includes the various actors that affect the firm’s survival and success. GOAL = Identify and explain these various actors.

Defining the Business and the Environment Defining the business enables a firm to identify its customers.

Identifying the customers and suppliers of substitute products and services allows the firm to identify its competitive environment.

Competitors are threats to the firm because they can disrupt the flow of inputs and outputs.

Who are the competitors? They are the firms whose products and services lure away customers. They are

the firms whose products and services are the benchmarks, in the mind of the customer, against which a firm’s products and services are judged. Identify the customer and you will identify this group of firms.

Identifying these competitors will help to identify the competitive environment.

Porter’s 5 Forces Model

RivalryAmong

Competitors

Bargaining

Power ofBuyers

Bargaining

Power ofSellers

AvailabilityOf

Substitutes

Threat of New Entrant

s

Porter’s 5 Forces: Power of Sellers

Bargaining power of sellers can come from:Attractiveness and availability of particular

products and services, in relation to available options

Quality or perceived quality Absence of competition The importance of the product or service Exclusivity or prestige

These sorts of conditions shift bargaining power away from the buyer and to the seller by limiting the ability of customers to go elsewhere.

Porter’s 5 Forces: Power of Buyers

Bargaining power of buyers can come from:The same forces that affect bargaining power

of sellers Relatively unimportant products such as

blank CDs or pencilsReady availabilityAbsence of intense needBuying in bulk or by ordering in advanceDeveloping alternate sources of supply

Porter’s 5 Forces: Threat of SubstitutesAvailability of substitutes impacts bargaining power:

Bargaining power is about options, which afford buyers greater elasticity in purchasing.

Substitutability lies in the eye of the beholder. Are Coke and Pepsi substitutes?

Because two products “look” alike doesn’t mean that they are truly substitutable.

Substitutes need not look like the product or service that they are substituting. Natural gas is a substitute for electricity

There is one common alternative for just about every product or service—the option of doing nothing at all.

Porter’s 5 Forces: Threat of New EntrantsThe threat of new entrants can impact bargaining

power: New entrants to an industry can offer alternatives to

customers, reducing the bargaining power of the sellers. Southwest Airlines in the ATL travel market

Potential for profit attracts new entrants. Those entrants, in turn, provide options and increase bargaining power of buyers.

Incumbent firms can deter new entry by making the market appear less attractive.

New entrants shift bargaining power to the buyers. Where there is little potential for new entry, sellers retain greater bargaining power.

Porter’s 5 Forces: Threat of New Entrants

When is it difficult for new firms to enter a market? Some legal or structural impedimentPatents and copyrights Licensed monopolies, such as exist in cable television

or retail electrical power marketsWhen there are switching costs, the costs to the buyer

to change from one provider to anotherBrand preferences, shared usage, network

connectivity, and distribution channel saturation can all deter entry

This deterrence can help incumbent sellers to retain bargaining power.

Porter’s 5 Forces: Rivalry among CompetitorsRivalry among competitors impacts bargaining power:

Existing firms may compete… by offering substitute products by offering inducements for customers to switch (quality, new features, etc.) by working to convince customers that their products or services are better

than available options (marketing!)

Rivalry reflects the balance of supply and demand.

Mature markets have higher levels of rivalry as: Sales growth is slow or non-existent Populated with large firms, with substantial capacity. Such firms often have

low marginal costs and so great incentive to increase volume Substitutability is often high as customers frequently see little meaningful

distinction among the products and services of the leading firms Firms have invested in the specialized plant and equipment necessary to

compete effectively. Those investments become exit barriers, locking the firm into the particular business, despite marginal profitability

PESTEL AnalysisA popular framework for organizing trends in the general

macro-environment

Political—e.g. Δ in tax policies, trade restrictions, government stability, etc.

Economic—e.g. Δ in interest rates, inflation, GDP, unemployment, general economic growth/decline

Social—e.g. Δ in demographics such as size, age, ethnicity, culture, attitudes toward trends such as obesity, activism, etc.

Technological—e.g. Δ in rate of new product development, automation, delivery, computing power (Moore’s Law), etc.

Environmental—e.g. Δ in weather patterns, disasters, etc.

Legal—e.g. Δ in employment laws, health care, discrimination laws, anti-trust legislation, property rights, etc.

Competitive Analysis and the Lifecycle Model

EmbryonicStage

GrowthStage

MaturityStage

Decline

Time

Demand

The Product/Industry Lifecycle

Product/Industry Lifecycle ModelDepicts a common pattern by which the market for

given products evolves and changes over time

Embryonic Stage-start-up phase; new product(s) are introduced

Growth Stage-manufacturing/industry standards emerge; increased acceptance and demand

Maturity Stage-supply catches up to demand, overcapacity begins to build, sales growth flattens

Decline Stage-growth becomes negative and volume begins to decline

Together with the Five-forces, these models provide complementary information that, when combined, provide an incisive view of the environment, how it has evolved, and how it is evolving.

What do you think would be the principal competitive challenges in each phase?These tools are meant to be integrated, not

seperated

Competitive Analysis and the Lifecycle Model

So, what happens after growth? Death? Re-birth?

Punctuated equilibrium suggests that periods of relative stability are interrupted periodically by instances of intense revolutionary change

Following revolution, an industry may re-emerge, sometimes with similar characteristics, other times completely different

Joseph Schumpeter (1942) described this process as “creative destruction” The introduction of something new often destroys something old Its also why old people are afraid of young people…maybe…

Ongoing Evolution in the Environment

Ongoing Evolution in the Environment

Time

Activity

Environmental Evolution and Punctuated Equilibrium

This image can represent a series of sequential life-cycles whereby: Each grows and evolves following the familiar pattern.

Each follows that pattern, with clear implications for the evolution of the competitive forces and bargaining power.

Over time, these familiar forces produce changes that trigger innovation and the emergence of new technologies, products, and processes. Those innovations initiate again the cycle of emergence, development, and maturity.

Thus, industries appear to evolve, changing through iterative periods of predictable, regular, and incremental change, and brief, tumultuous, and radical change.

Ongoing Evolution in the Environment

Every industry evolves uniquely and competitors, customers, and suppliers can be difficult to identify and evaluate in practice.

Like strategy itself, environmental analysis can be a

messy and irregular process. Information is often unclear and ambiguous; various actors are hard to identify and the pace of events is hard to predict.

Rather than making environmental analysis less important, this complexity and ambiguity makes all the more important the use of accepted frameworks and principles.

Final Thoughts & Caveats

Refers to how the evolutionary cycle in some industries, from emergence to maturity and again to reemergence, has accelerated to the point that these stages are almost indistinguishable.

The speed of innovation, the pace of competitive reaction, and the intensity of market forces are greater now than a decade ago. And, they will be greater still in the future.

There will always be new and exciting events emerging; there will always be a sense that the pace of change is increasing and that things were simpler and slower in the past.

Hypercompetition

The process of defining an industry is problematic.

The North American Industry Classification Systems (NAICS) and its forerunner, the Standard Industrial Classification (SIC) system, fail to practically deliver precise definitions.

NAICS or SIC classifications are good “rules of thumb”, but are not necessarily appropriate for defining an industry in an environmental analysis

Clear understanding of the industry facilitates environmental analysis by going beyond general categories and focusing on those forces that actually affect the relationship between the firm, its customers, competitors, and suppliers.

Industry Definition

All competition is local:

It occurs in the minds and hearts of customers.

Customers can consider only those products and services that fall within their field of vision, about which they have heard and to which they have some access.

Customers are motivated to act in their own best interests; to buy those products and services that offer them the greatest consumer surplus.

The Locus of Competition

It is important to remember that:

Aggregate data are the result of many individual actions. Individual actions are not the result of aggregate data.

It is important not to focus just on data that is accessible, easy to gather, and easy to manage.

All competition is local and occurs around specific transactions between specific buyers and specific sellers. Understanding the environment means understanding the context in which these individual transactions take place.

The Locus of Competition