THE EXTERNAL

FORCES
EVALUATION
 The Nature of an External Audit
 Reveals key opportunities and threats confronting an
organization so that managers can formulate strategies
to take advantage of the opportunities and avoid or
reduce the impact of threats

 The external audit is aimed at identifying key variables

that offer actionable responses

 Firms should be able to respond either offensively or

defensively to the factors by formulating strategies that
take advantage of external opportunities or that
minimize the impact of potential threats.
 A Comprehensive Strategic-Management Model

Global / International Issues

 Key External Forces

External forces can be divided into five broad

categories:
• economic forces
• social, cultural, demographic, and natural
environment forces
• political, governmental, and legal forces
• technological forces
• competitive forces
Relationships Between Key External
Forces and an Organization

competitive intelligence is the first step in assessment

With this construct,
what are models
- Industrial Organization I / O overview
- PESTLE Framework
- Structures-Conduct-Performance Model
- Industry Life Cycle
- 5 Forces Model
- External Factor Evaluation (EFE) Matrix
- Competitive Profile Matrix (CPM)
 The Industrial Organization
(I/O) View
 The Industrial Organization (I/O)
approaches to competitive advantage and
advocates that external (industry) factors
are more important than internal factors in
a firm for achieving competitive
advantage.
 focuses on markets, industries, and the
position, or possible positions, of
organizations within the industries.
Industrial Organization (I/O) Model

 External environment is primary determinant of organizational

strategy rather than internal decisions of managers
 Environment presents threats & opportunities
 All competing organizations control or have equal access to
resources
 Resources are highly mobile between firms
 Organizational success is achieved by
• Offering goods & services at lower costs than competitors
• Differentiating products to bring premium prices
 The Industrial Organization
(I/O) View
 Firm performance
is based more on
industry properties
 External Environment (Phases)
A firm’s External Environment is broken down into three parts:

 General environment
 Focused on the future MACRO
 Industry environment
 Focused on factors and conditions influencing
a firm’s profitability within an industry
 Competitor environment
 Focused on predicting the dynamics of
competitors’ actions, responses and intentions MICRO
The General Environment:
Segments and Elements
 Industry Environment

 The set of factors directly influencing a

firm and its competitive actions and
competitive responses
– Regulator
– New entrants
– Suppliers
– Buyers
– New products
– Competitors
 Competitor Analysis

 Gathering and interpreting information

about all of the companies that the firm
competes against.
 Understanding the firm’s competitor
environment complements the insights
provided by studying the general and
industry environments.
Frameworks and Models of
Assessment
- PESTLE Framework
- Structures-Conduct-Performance Model
- Industry Life Cycle
- 5 Forces Model
- External Factor Evaluation (EFE) Matrix
- Competitive Profile Matrix (CPM)
1 PESTLE Framework
Government pressures
Subsidies and incentives Growth rates
Differences in countries, states, and Interest rates
regions Employment levels
Currency exchange

Court system
Legislation
Hiring laws

Norms, culture, values

Demographics
Lifestyle change

Global warming
Sustainability Innovation
Pollution Diffusion
Research & development
 Best examples

 Vedanta
 Posco
 Tata in Bengal
2 Industry Structures-Conduct-
Performance Model
 Structure-Conduct-Performance Process

Industry Structure Firm Conduct Performance

• Number of buyers • Pricing • Econ profits
and sellers • Advertising • Accounting
• Degree of product • R&D profits (ratios)
differentiation • Investment in
• Barriers to entry plant and • NPV/DCF
• Cost structures equipment
• Vertical integration • MVA/EVA
• Alliances • Tobin’s Q

• Market Value Added (MVA) is the difference between the current market value of a firm and
the capital contributed by investors.
• Economic Value Added or EVA, is an estimate of a firm's economic profit – being the value
created in excess of the required return of the company's investors (being shareholders and
debt holders).
• The firm's market value added, or MVA, is the discounted sum (present value) of all future
expected economic value added: MVA = Present Value of a series of EVA values.

Tobin's Q = Total Market Value of Firm / Total Asset Value of Firm

3 The Traditional Model of
INDUSTRY LIFE CYCLE

Fermentation Shakeout Maturity Decline

Sales volume

Time
 The Industry Life Cycle as an S curve

Performance
Maturity

Discontinuity
Takeoff

Ferment

Time
 How Typical is the Life Cycle Pattern?

Technology-intensive industries (e.g. pharmaceuticals, semiconductors,

computers) may retain features of emerging industries.

Other industries (especially those providing basic necessities, e.g. food

processing, construction, apparel) reach maturity, but not decline.

Industries may experience life cycle regeneration.

Color AI Digital
B&W Portable
Sales

HDTV

1900 50 90 07 1930 50 70 90 07 15
MOTORCYCLES TV’s

Life cycle model can help us to anticipate industry evolution—but dangerous to

assume any common, pre-determined pattern of industry development
 Evolution of Industry Structure over the Life Cycle

INTRODUCTION GROWTH MATURITY DECLINE

DEMAND Affluent buyers Increasing Mass market Knowledgeable,
penetration replacement customers, resi-
demand dual segments

TECHNOLOGY Rapid product Product and Incremental Well-diffused

innovation process innovation innovation technology

PRODUCTS Wide variety, Standardization Commoditiz- Continued

rapid design change ation commoditization

MANUFACT- Short-runs, skill Capacity shortage, Deskilling Overcapacity

URING intensive mass-production

TRADE -----Production shifts from advanced to developing countries-----

COMPETITION Technology- Entry & exit Shakeout & Price wars,

consolidation exit

KSFs Product innovation Process techno- Cost efficiency Overhead red-

logy. Design for uction, ration-
alization, low
cost sourcing
 An Alternate Industry Life Cycle

Emergence Convergence Coexistence Dominance

Sales volume

Established
Industry

Emerging Industry

Time
 The Spectrum of Industry Structures

Perfect
Oligopoly Duopoly Monopoly
Competition

Concentration Many firms A few firms Two firms One firm

Entry and Exit No/Low barriers Significant barriers High barriers

Barriers

Product Homogeneous
Differentiation Potential for product differentiation
Product

Perfect
Information Imperfect availability of information
Information flow
- Industrial Organization I / O overview
- PESTLE Framework
- Structures-Conduct-Performance Model
- Industry Life Cycle
- 5 Forces Model
- External Factor Evaluation (EFE) Matrix
- Competitive Profile Matrix (CPM)
4 The Five-Forces Model of
Competition
POTENTIAL
ENTRANTS

3a. Threat of new

entrants

INDUSTRY
COMPETITORS
2a. Bargaining
of suppliers
power
2b. Bargaining
of buyers
power

SUPPLIERS BUYERS

1. Rivalry among
existing firms

3b. Threat of substitute, new

products or services

SUBSTITUTES

Competitive Strategy, Porter, M.E., McMillan, 1980

Using the Five-forces Model of Competition

 STEP 1: For each of the five forces, identify

the different parties involved, along with the
specific factors that bring about competitive
pressures.

 STEP 2: Evaluate how strong the pressures

stemming from each of the five forces are
(strong, moderate, or weak).

 STEP 3: Determine whether the five forces,

overall, are supportive of high industry
profitability.
 Three stages in Porters
external analysis
1. Analyze industry structure
• How concentrated is it?
• What are the dynamics

2. Analyze the industry's appropriability

• Are there powerful buyers?
• Are there powerful suppliers?

3. Analyze its long term viability

• Will more firms enter?
• Will substitute products or services be found?
1 Industry competitors: Concentration
Bargaining power Bargaining power
of suppliers of buyers
Industry
Suppliers Buyers
competitors

• How many firms (i.e. competitors) are there in our

industry?
• Firm concentration ratio (4 companies is the rule)
– Sum of revenues of four largest firms divided by total industry
revenues
– Sum of market shares of four largest firms
 Industry Rivalry
Bargaining power Bargaining power
of suppliers of buyers
Industry
Suppliers Buyers
competitors

• Rivalry refers to the extent to which firms compete on the

basis of price alone

– Competing by out spending on advertising is not considered highly

rivalrous

– Competing by out spending on innovation is not considered highly

rivalrous

– Competing by cutting prices is considered highly rivalrous

 Industry Competitors: Summary

Bargaining power Bargaining power

of suppliers Industry of buyers
Suppliers Buyers
competitors

• Is it a concentrated industry?
• 4 firm concentration ratio (what % of total industry output is
accounted for by the 4 largest firms)
• concentrated if > 70%
• fragmented if < 30%
– If fragmented…
• STOP HERE AND PROCEED INTERNAL ANALYSIS
– Otherwise
• Is there non-price competition?
– e.g. around brand, through product innovation
• Are there large economies of scale ?
• Are there high barriers to exit?
• Is the product a commodity?
• Do companies segment the market and differentiate
their products from each another?
 Porter’s Five forces model
POTENTIAL
ENTRANTS

3a. Threat of new

entrants

INDUSTRY
COMPETITORS
2a. Bargaining
of suppliers
power
2b. Bargaining
of buyers
power

SUPPLIERS BUYERS

1. Rivalry among
existing firms

3b. Threat of substitute new

products or services

SUBSTITUTES

Competitive Strategy, Porter, M.E., McMillan, 1980

2 Bargaining power
Bargaining power Bargaining power
of suppliers Industry of buyers
Suppliers Buyers
competitors

• Suppliers (2a) • Buyers (2b)

– Are we buying from a monopoly – Are we selling to a monophony,
(or from a highly concentrated (or into a highly concentrated
industry)? (bad) market)? (bad)
– Does their product represent an – Does our product represent a
insignificant portion of our significant portion of the buyers
product costs? (?) product costs? (bad)
– Do we take a small – Do they take a significant
(insignificant) proportion of their proportion of our output (bad)
output (bad) – Can they backward integrate
– Can they forward integrate into into our business? (bad)
our business? (bad) – Can they easily switch suppliers
– Is it difficult for them to switch (bad)
suppliers (good)
 Porter’s Five forces model
POTENTIAL
ENTRANTS

3a. Threat of new

entrants

INDUSTRY
COMPETITORS
2a. Bargaining
of suppliers
power
2b. Bargaining
of buyers
power

SUPPLIERS BUYERS

1. Rivalry among
existing firms

3b. Threat of substitute new

products or services

SUBSTITUTES

Competitive Strategy, Porter, M.E., McMillan, 1980

3 Threat of new entry or substitution
• substitutes create a
price ceiling because
consumers switch to the
• Are there barriers to entry? (3a) substitute if prices rise
– Economies of scale (good?)
– Significant sunk costs (e.g. brand) to act as a deterrent
– Does regulation restrict entry? (good)

• How likely is it that a substitute product for the needs

the industry currently meets will be found? (3b)

• If no likely substitutes and entry barriers are high,

above normal returns may persist over time.
 Barriers to Entry
 Government regulatory policies • economies of scale—firm that can’t
 Tariffs produce the minimum efficient scale
will be at a disadvantage
 Lack of access to raw materials
 Possession of patents
• product differentiation—
 Undesirable locations
entrants are forced to overcome
 Counterattack by entrenched firms customer loyalties to existing
 Potential saturation of the market products

• cost advantages independent of

scale—incumbents may have
learning advantages, etc.
Is the Collective Strength of the Five Competitive Forces
Conducive to Good Profitability?

 Answers to three questions are needed:

• Is the state of competition in the industry
stronger than normal?
• Can industry firms expect to earn decent profits
given prevailing competitive forces?
• Are some of the competitive forces sufficiently
powerful to undermine industry profitability?

Even one powerful competitive force may be enough

to make the industry unattractive in terms of its
profit potential.
Porter 5 Forces Model – Summary
• Grew out of industrial organization economics.
– Concern with monopoly and oligopoly markets.
– Focus was industry concentration.
• Deals with the firm’s external environment.
– Specifically its industry and the up- and down-stream
industries.
• Buyers are those that pay the focal firm for its
services, not end users or consumers.
• Sellers are those that sell goods and services to the
focal firm, not the firm itself.
• Large investments in ‘irrecoverable’ assets are a
barrier to entry, requiring large amounts of capital per
se is not.
Porter’s Five Forces Model
Threat of Buyers
• powerful buyers can ‘squeeze’ (lower profits)
the focal firm by demanding lower prices and/or
higher levels of quality and service

Industry conditions that facilitate buyer power:

• small number of buyers for focal firm’s output

• lack of a differentiated product

• the product is significant to the buyer

Complementors and the Value Net

 How the value net differs from the five forces

 Focuses on the interactions of industry participants
with a particular (focal) company
 Defines the category of competitors to include the
focal firm’s direct competitors, industry rivals, the
sellers of substitute products, and potential entrants
 Introduces a new category of industry participant—
complementors—producers of products that
enhance the value of the focal firm’s products when
they are used together
The Value Net
Identifying the Forces Driving Industry Change

• Changes in the long-term industry growth rate

• Increasing globalization
• Emerging new Internet capabilities and applications
• Shifts in buyer demographics
• Technological change and manufacturing process innovation
• Product and marketing innovation
• Entry or exit of major firms
• Diffusion of technical know-how across firms and countries
• Changes in cost and efficiency
• Reductions in uncertainty and business risk
• Regulatory influences and government policy changes
• Changing societal concerns, attitudes, and lifestyles
- Industrial Organization I / O overview
- PESTLE Framework
- Structures-Conduct-Performance Model
- Industry Life Cycle
- 5 Forces Model
- External Factor Evaluation (EFE) Matrix
- Competitive Profile Matrix (CPM)
5 Industry Analysis: The External
Factor Evaluation (EFE) Matrix
 Economic  Political
 Social  Governmental
 Cultural  Technological
 Demographic  Competitive
 Environmental  Legal
 EFE Matrix Steps

1. List key external factors

2. Weight from 0 to 1
3. Rate effectiveness of current strategies
4. Multiply weight * rating
5. Sum weighted scores
EFE Matrix for a Local Cinema
Complex
- Industrial Organization I / O overview
- PESTLE Framework
- Structures-Conduct-Performance Model
- Industry Life Cycle
- 5 Forces Model
- External Factor Evaluation (EFE) Matrix
- Competitive Profile Matrix (CPM)
6 Industry Analysis: Competitive
Profile Matrix (CPM)

 Identifies firm’s major competitors and

their strengths & weaknesses in relation
to a sample firm’s strategic positions
 Critical success factors include internal
and external issues
An Example Competitive
Profile Matrix
 Strategic Group Analysis

 Strategic group
 Consists of those industry members with
similar competitive approaches and positions
in the market
• Having comparable product-line breadth
• Emphasizing the same distribution channels
• Depending on identical technological approaches
• Offering the same product attributes to buyers
• Offering similar services and technical assistance
Using Strategic Group Maps to Assess the
Market Positions of Key Competitors

 Constructing a strategic group map

 Identify the competitive characteristics that delineate strategic
approaches used in the industry.
 Plot the firms on a two-variable map using pairs of competitive
characteristics.
 Assign firms occupying about the same map location to the
same strategic group.
 Draw circles around each strategic group, making the circles
proportional to the size of the group’s share of total industry
sales revenues.
 Typical Variables Used in
Creating Group Maps

• Price and quality range (high, medium, low)

• Geographic coverage (local, regional, national, global)
• Product-line breadth (wide, narrow)
• Degree of service offered (no frills, limited, full)
• Distribution channels (retail, wholesale, Internet,
multiple)
• Degree of vertical integration (none, partial, full)
• Degree of diversification into other industries (none,
some, considerable)
Guidelines for Creating Group Maps

1. Variables selected as map axes should not be highly correlated.

2. Variables should reflect important (sizable) differences among rival
approaches.
3. Variables may be quantitative, continuous, discrete, or defined in
terms of distinct classes and combinations.
4. Drawing group circles proportional to the combined sales of firms in
each group will reflect the relative sizes of each strategic group.
5. Drawing maps using different pairs of variables will show the
different competitive positioning relationships present in the
industry’s structure.
Comparative Market Positions of Selected Companies in the
Casual Dining Industry: A Strategic Group Map Example

 Footnote: Circles are drawn roughly proportional to the sizes of the chains, based on revenues.
Strategic Groups by Quality and
Price – AIRBORN