Analysis of Firm's External Environment for Strategy Making

Analysis of  a company's external situation involves finding answers to the following seven  main aspects or questions:

1. What are the industry's dominant economic features? 

Industries differ significantly on such factors as market size and growth rate, the number and relative sizes of both buyers and sellers, the geographic scope of competitive rivalry, the degree of product differentiation, the speed of product innovation, demand–supply conditions, the extent of vertical integration, and the extent of scale economies and experience/learning curve effects.

In addition to setting the stage for the analysis to come, identifying an industry's economic features also promotes understanding of the kinds of strategic moves that industry members are likely to employ (Question 5).

2. What kinds of competitive forces are industry members facing, and how strong is each force? 

Porter's five force analysis is the basis for this step.

The strength of competition is a composite of five forces:
(1) competitive pressures stemming from the competitive maneuvering among industry rivals,
(2) competitive pressures associated with the market inroads being made by the sellers of substitutes, (3) competitive pressures associated with the threat of new entrants into the market,
(4) competitive pressures stemming from supplier bargaining power and supplier–seller collaboration, and
(5) competitive pressures stemming from buyer bargaining power and seller–buyer collaboration.

The nature and strength of the competitive pressures associated with these five forces have to be examined force by force to identify the specific competitive pressures they each comprise and to decide whether these pressures constitute a strong or weak competitive force.

The next step in competition analysis is to evaluate the collective strength of the five forces and determine whether the state of competition is conducive to good profitability.

Working through the five-forces model step by step not only aids strategy makers in assessing whether the intensity of competition allows good profitability but also promotes sound strategic thinking about how to better match company strategy to the specific competitive character of the marketplace. Effectively matching a company's strategy to the particular competitive pressures and competitive conditions that exist has two aspects: (1) pursuing avenues that shield the firm from as many of the prevailing competitive pressures as possible, and (2) initiating actions calculated to produce sustainable competitive advantage, thereby shifting competition in the company's favor, putting added competitive pressure on rivals, and perhaps even defining the business model for the industry.

3. What forces are driving changes in the industry, and what impact will these changes have on competitive intensity and industry profitability? 

In this step, variables in the economy that are driving the industry variables are analyzed.

Industry and competitive conditions change because forces are in motion that create incentives or pressures for change. The first phase is to identify the forces that are driving change in the industry; the most common driving forces include changes in the long-term industry growth rate, globalization of competition in the industry, emerging Internet capabilities and applications, changes in buyer composition, product innovation, technological change and manufacturing process innovation, marketing innovation, entry or exit of major firms, diffusion of technical know-how, changes in cost and efficiency, growing buyer preferences for differentiated versus standardized products (or vice versa), reductions in uncertainty and business risk, regulatory influences and government policy changes, and changing societal and lifestyle factors. The second phase of driving-forces analysis is to determine whether the driving forces, taken together, are acting to make the industry environment more or less attractive. Are the driving forces causing demand for the industry's product to increase or decrease? Are the driving forces acting to make competition more or less intense? Will the driving forces lead to higher or lower industry profitability?

4. What market positions do industry rivals occupy—who is strongly positioned and who is not? 

This is a competitor position analysis most focused on individual players.

Strategic group mapping is a valuable tool for understanding the similarities, differences, strengths, and weaknesses inherent in the market positions of rival companies. Rivals in the same or nearby strategic groups are close competitors, whereas companies in distant strategic groups usually pose little or no immediate threat. The lesson of strategic group mapping is that some positions on the map are more favorable than others. The profit potential of different strategic groups varies due to strengths and weaknesses in each group's market position. Often, industry driving forces and competitive pressures favor some strategic groups and hurt others.

5. What strategic moves are rivals likely to make next? 

This competitor strategy analysis.

This analytical step involves identifying competitors' strategies, deciding which rivals are likely to be strong contenders and which are likely to be weak, evaluating rivals' competitive options, and predicting their next moves. Scouting competitors well enough to anticipate their actions can help a company prepare effective countermoves (perhaps even beating a rival to the punch) and allows managers to take rivals' probable actions into account in designing their own company's best course of action. Managers who fail to study competitors risk being caught unprepared by the strategic moves of rivals.

6. What are the key factors for competitive success? 

An industry's key success factors (KSFs) are the particular strategy elements, product attributes, competitive capabilities, and business outcomes that spell the difference between being a strong competitor and a weak competitor—and sometimes between profit and loss. KSFs by their very nature are so important to competitive success that all firms in the industry must pay close attention to them or risk becoming an industry also-ran. Correctly diagnosing an industry's KSFs raises a company's chances of crafting a sound strategy. The goal of company strategists should be to design a strategy aimed at stacking up well on all of the industry KSFs and trying to be distinctively better than rivals on one (or possibly two) of the KSFs. Indeed, using the industry's KSFs as cornerstones for the company's strategy and trying to gain sustainable competitive advantage by excelling at one particular KSF is a fruitful competitive strategy approach.

7. Does the outlook for the industry present the company with sufficiently attractive prospects for profitability? 

If an industry's overall profit prospects are above average, the industry environment is basically attractive; if industry profit prospects are below average, conditions are unattractive. Conclusions regarding industry attractive are a major driver of company strategy. When a company decides an industry is fundamentally attractive, a strong case can be made that it should invest aggressively to capture the opportunities it sees and to improve its long-term competitive position in the business. When a strong competitor concludes an industry is relatively unattractive, it may elect to simply protect its present position, investing cautiously if at all and looking for opportunities in other industries. A competitively weak company in an unattractive industry may see its best option as finding a buyer, perhaps a rival, to acquire its business. On occasion, an industry that is unattractive overall is still very attractive to a favorably situated company with the skills and resources to take business away from weaker rivals.

A competently conducted industry and competitive analysis generally tells a clear, easily understood story about the company's external environment. Different analysts can have different judgments about competitive intensity, the impacts of driving forces, how industry conditions will evolve, how good the outlook is for industry profitability, and the degree to which the industry environment offers the company an attractive business opportunity. However, while no method can guarantee a single conclusive diagnosis about the state of industry and competitive conditions and an industry's future outlook,  Managers become better strategists when they know  the answers given to the questions posed by experienced professionals.  There's no substitute for doing cutting-edge analysis of company's external situation—anything less weakens managers' ability to craft strategies that are well matched to industry and competitive conditions.


Summary of the chapter in Student Resources of the Thompson and Strickland Text.
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