Analyzing External Environment - Porter's Five Forces PDF

Analyzing the External Environment, cont’d Competitive environment of an industry Porter’s Five Forces Model of Industry Competition Strategic groups How the Internet and Digita...

Analyzing the External Environment, cont’d Competitive environment of an industry Porter’s Five Forces Model of Industry Competition Strategic groups How the Internet and Digital Technologies Affect Competitive Forces ©McGraw-Hill Education.  The Competitive Environment The competitive environment consists of factors in the industry environment that are particularly relevant to a firm’s strategy. Competitors (existing or potential) Including those considering entry into an entirely new industry Customers (or buyers) Suppliers Including those considering forward integration ©McGraw-Hill Education.  Porter’s Five Forces Model of Industry Competition Exhibit 2.4 Porter’s Five Forces Model of Industry Competition Source: From Michael E. Porter, “The Five Competitive Forces That Shape Strategy,” Special Issue on HBS Centennial.. Harvard Business Review 86, No. 1 (January 2008), 78-93. Reprinted with permission of Michael E. Porter. ©McGraw-Hill Education.  The Threat of New Entrants The threat of new entrants – possibility that the profits of established firms in the industry may be eroded by new competitors. Depends on existing barriers to entry: Economies of scale Product differentiation Capital requirements Switching costs Access to distribution channels Cost disadvantages independent of scale e.g. proprietary products, favorable access to raw materials, gov. subsidies & policies ©McGraw-Hill Education.  The Bargaining Power of Buyers Buyers have bargaining power. Buyers can force down prices, bargain for higher quality or more services, or play competitors against each other. ▪ Buyers are oftentimes not the end consumers! Buyer groups are powerful when: Purchasing products in large volumes. Product is standardized Profits are low & switching costs are few. Backward integration is possible. Buyer’s product quality is not affected by industry product. ©McGraw-Hill Education.  The Bargaining Power of Suppliers Suppliers can exert bargaining power by threatening to raise prices or reduce the quality of purchased goods and services. Supplier groups are powerful when: Only a few firms dominate the industry. Competition from substitute products is low. Suppliers sell to several industries. Buyer quality is affected by industry product. Products are differentiated & have switching costs. Forward integration is possible. ©McGraw-Hill Education.  The Threat of Substitute Products & Services Substitute products & services limit the potential returns of an industry. Substitutes perform the same function as the industry’s offerings. Substitutes come from another industry, not the same industry. Substitutes place a ceiling on prices that firms in an industry can profitably charge. § The more attractive the price/performance ratio, the more the substitute erodes industry profits. ©McGraw-Hill Education.  The Intensity of Rivalry among Competitors in an Industry Rivalry tactics include price competition, advertising battles, new product introductions, increased customer service or warranties. Interacting factors lead to intense rivalry when: Numerous or equally balanced competitors Slow industry growth High fixed and/or storage costs Lack of differentiation or switching costs Capacity augmented in large increments High exit barriers ©McGraw-Hill Education.  Doing a Good Industry Analysis Good industry analysis looks rigorously at the structural underpinnings & root causes of profitability. Must choose the appropriate time frame Consider the industry business life cycle Average profitability over 3-5 years or longer Must consider quantitative factors as well as qualitative Get numbers to quantify five forces factors Percentages of total cost or sales accounted for by the industry, actual switching costs ©McGraw-Hill Education.  Using Industry Analysis: A Few Caveats Managers must not always avoid low profit industries; these can still yield high returns for players who pursue sound strategies. Five forces analysis implicitly assumes a zero- sum game. Yet mutually beneficial relationships can still be established with buyers & suppliers. Five forces analysis is essentially a static analysis, yet external forces can still change the structure of all industries. Complementors / Value net extension of five forces analysis. ©McGraw-Hill Education.  The Value Net Exhibit 2.6 The Value Net Source: Adapted from “The Right Game: Use Game Theory to Shape Strategy,” by A. Brandenburger and B.J. Nalebuff, July-August 1995 Harvard Business Review. Jump to Appendix 2 for long description. ©McGraw-Hill Education.  Strategic Groups within Industries Two unassailable assumptions in industry analysis: No two firms are totally different. No two firms are exactly the same. Strategic groups – clusters of firms that share similar strategies: Breadth of product & geographic scope Price/quality Degree of vertical integration Type of distribution ©McGraw-Hill Education.  Example: Strategic Groups within Industries Exhibit 2.7 The World Automobile Industry: Strategic Groups Note: Members of each strategic group are not exhaustive, only illustrative. ©McGraw-Hill Education.  Strategic Groups as an Analytic Tool Strategic groups are an analytical tool. Helps identify barriers to mobility that protect a group from attacks by other groups Helps identify groups whose competitive position may be marginal or tenuous Helps chart the future direction of firms’ strategies Helps to think through the implications of each industry trend for the strategic group as a whole ©McGraw-Hill Education.  How the Internet and Digital Technologies Affect Competitive Forces Competitive Forces Benefits to Industry Disadvantages to Industry Threat of New Entrants Lower barriers to entry increases number of new entrants. Many Internet-based capabilities can be easily imitated. Bargaining Power of Buyers Reduces the power of buyer Switching costs decrease. intermediaries in many distribution Information availability online channels. empowers end users. Bargaining Power of Suppliers Online procurement methods can The Internet gives suppliers access increase bargaining power over to more customers and makes it suppliers. easier to reach end users. Online procurement practices deter competition and reduce differentiating features. Threat of Substitutes Internet-based increases in overall Internet-based capabilities create efficiency can expand industry sales. more opportunities for substitution. Intensity of Rivalry Since location is less important, the number of competitors increases. Differences among competitors are harder to perceive online. Rivalry tends to focus on price and differentiating features are minimized. Sources: Bodily, S., & Venkataraman, S. 2004. Not walls, windows: Capturing value in the digital age. Journal of Business Strategy. 25(3): 15-25; Lumpkin, G.T. Droege, S.B., & Dess, G.G. 2002. E-commerce strategies: Achieving sustainable competitive advantage and avoiding pitfalls. Organizational Dynamics, 30 (Spring): 1-17. ©McGraw-Hill Education.