Week 4:

Evaluating External Environment

MEC602 Strategic Engineering Management and Business Practices

Learning objectives
• To recognise the role of industry and its structure for an
engineering/technology organisation to be successful
• To understand the theoretical foundations of the market-based
view in strategy planning
• To analyse the state of competition within an industry
• To identify strategic opportunities in different industry
structures

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A case study: Elon Musk’s decision to join
the automotive industry

Image from neowin.net, edited with companies’ logos added

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Profitability by industry in the U.S.
(2018)

Data provided by Aswath Damodaran, illustrated by Philip Campbell

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Discussion
• Why did Elon Musk still decide to enter the
automotive industry?
• Is it possible to succeed in a generally unattractive
industry?

YOUR VIEW

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Key questions in evaluating the
external environment
• How does the general environment impact an
organisation’s strategy?
• What is the role of the industry and its structure for an
organisation’s performance?
• How can we unpack industries and identify the most
attractive strategic positions to occupy therein?
• How do we identify what it takes to outcompete others in
the industry?

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Understanding the general environment
(PESTEL-ie analysis)
Political Economical
+
Social-
Legal
Cultural

+
Environmental Technological

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Political factors
• Taxation policy
• Privatisation/deregulation policies
• Public expenditure controls
• EU directives and post-Brexit agreements
• Government stability

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Economical factors
• Interest and inflation rates
• Consumer confidence
• The business cycle
• Economic growth prospects
• Unemployment rates
• Disposable incomes
• Labour costs

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Social-cultural factors
• Demographics (population and household
numbers)
• Values in society
• Changing lifestyles (e.g. family composition,
attitude to work and leisure)
• Changes in consumer tastes and preferences
• Levels of education

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Technological factors
• New discoveries
• Alternative means of providing services
• Research and development leading to new product
potential
• New production technology
• Communication technology
• Rate of technology transfer

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Environmental factors
• Climate change
• Water resources
• Energy supplies
• Material resources (metal, wood, minerals etc.)

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Legal factors
• Employment law
• Environmental legislation
• Health and safety regulations
• Company and business law

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International factors
• Important for multi-national organisations
• Difference in culture and practices

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Ethical factors
• Corporate social responsibility
• Fair trade
• Affiliations

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Understanding the industry structure

• Many firms • Many firms but • A small number • One firm

• Homogenous none dominant of firms • Control of
product • Differentiated • Differentiated supply or price
• Perfect products products
knowledge • Lack of price
competition

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Structure-Conduct-Performance (SCP)
model
Industry Organisation Organisation
Structure Conduct Performance
Assumptions Implications
• Profit maximisation as the • Identification and assessment of sources
main strategic objective of profit as the main objective of industry
• Industries differ in their analysis
profit potential • Selection of industry and position therein
• Industry structure as the most important strategic choice
determines the profit • Industry analysis seeks to examine:
potential  Industry attractiveness (profit potential)
 Key success factors (profit drivers)
• External view

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Market-based view: the purpose
Understanding industry structures
• Understand competitive forces that shape industry profitability
1 • Understand how trends in general environment shape industry
structures
General
Assessing future industry profit potential knowledge to
• Forecasting future profitability due to structure changes maximise
2 • Shape competitive forces by means of adequate
organisation
strategies
profit potential
Positioning the organisation
• Identify the industry with high long term profit
3 potential
• Identify the most favourable position

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Market-based view: the process
Process Industry Actor Structural Dynamic Action
phase Definition Identification Analysis Analysis Scoping

Key
What products Who are the What are the How have the What aspects of
questions
or services are buyers and underlying competitive the industry
part of this suppliers? drivers of each forces evolved structure can be
industry? competitive in recently? influenced by
Who are the force? competitors?
Which ones are competitors? How is each
part of another Which forces force likely to Which ones by
distinct What are are strong, and evolve? new entrants?
industry? possible which weak?
substitutes? How will it be And which ones
Why is the affected by by the focal
Who might be level of emerging organisation
new entrants? profitability as trends? (us)?
it is?
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Market-based view: the application
“Industry as a group of firms whose products have so many of the
same attributes that they compete for the same buyers”

Are providers able to switch

production between types of
products/services and across
countries?
Demand side
substitutability Supply side
substitutability
Are buyers willing to substitute
between types of products/services
and across countries?
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Examining the case of Tesla
Which industry do you think Tesla is in?

YOUR VIEW

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Classification of Tesla in SIC
• “Today, Tesla builds not only all-
electric vehicles but also infinitely
scalable clean energy generation
and storage products.”
• UK’s Standard Industrial
Classification of economic
activities (SIC):
 Cluster 29xxx describes the industry
of motor vehicle manufacturing
 Cluster 45xxx describes the industry
of sales and maintenance of motor
vehicles
Source: Tesla (2020), gov.uk (2020) and Companies House (2020)
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Porter’s five forces model
Threat of New
Entrants

Bargaining Bargaining
Industrial
Power of Power of
Rivalry
Suppliers Buyers

Threat of
Substitutes

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Industrial rivalry: factors and analysis
• Concentration (+)

Determinant
Threat of New
Entrants • Diversity of Competitors (-)
• Product or service differentiation (-)
• Excess capacity levels (+)
Bargaining Bargaining • Cost conditions (+ if high fixed)
Industrial
Power of Power of • Barriers to exit (+)
Rivalry
Suppliers Buyers

• Around 10 dominant global vehicle

Threat of
Automotive manufacturing groups
Substitutes • High overlap of product portfolios
• Excess production capacity
• Slow market growth
High rivalry among competitors • High exit barriers

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Threat of new entrants: factors and
analysis
• Capital/knowledge requirements (-)

Determinant
Threat of New • Economies of scale (-)
Entrants
• Cost (or learning) advantages (-)
• Branding advantages (-)
• Access to distribution channels (+)
Bargaining Bargaining
Industrial • Governmental and legal barriers (-)
Power of Power of
Suppliers
Rivalry
Buyers
• Retaliation of incumbents (-)

• High investment in manufacturing

Threat of
Automotive • High product development costs
Substitutes • Economies of scale in product
development and manufacturing
• Significant learning effects
• Regulated approval process
Threat of New Entrants low • Strong patent protection

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Threat of substitutes: factors and
analysis

Determinant
Threat of New • Availability of close substitutes (+)
Entrants
• User loyalty and switching costs (-)
• Substitute power/aggressiveness (+)
• Substitute relative performance (+)
Bargaining Bargaining
Industrial • Substitute relative price (+)
Power of Power of
Rivalry
Suppliers Buyers

• Increasing availability of alternatives

Threat of
Automotive types of transportation (e.g.)public
Substitutes transport, car sharing, e-bike
• Low switching costs
• Growing environmental awareness
Threat of Substitutes present but • Substitutes do not offer all the
moderate benefits of owning a car

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Bargaining power of suppliers: factors
and analysis
• Supplier concentration (+)

Determinant
Threat of New • Associations and labour unions (+)
Entrants
• Availability of substitute suppliers (-)
• Switching cost for organisation (+)
• Potential for backward integration (-)
Bargaining Bargaining
Industrial • Supplier forward integration (+)
Power of Power of
Suppliers
Rivalry
Buyers
• Value contribution of supplier (+)

• Large number of suppliers

Threat of
Automotive • Supply of entire modules
Substitutes • High switching costs due to initial
investment in part design
• Low threat of supplier forward
Moderate but increasing integration
Bargaining Power of Suppliers • High value contribution (>80%)

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Bargaining power of buyers: factors
and analysis
• Buyer concentration (+)
Threat of New • Availability of substitute products (+)

Determinant
Entrants • Buyer price sensitivity (+)
• Buyer switching cost (-)
• Buyer backward integration (+)
Bargaining Bargaining • Potential for forward integration (-)
Industrial
Power of Power of • Product/service differentiation (-)
Rivalry
Suppliers Buyers • Value contribution of organisation (-)
• Large number of buyers (individuals,
Threat of
Automotive fleet managers, rental firms)
Substitutes • Increasing availability of substitutes
• Low switching costs
• High price sensitivity in most
Moderate but increasing segments
Bargaining Power of Buyers • No threat of backward integration

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Adding an additional force
Is there any other force that would also have impact
on competition within an industry?

YOUR VIEW

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Complements: factors and analysis

Threat of New
Entrants • Customer focus on system (+)

Determinant
• Complement value contribution (+)
• Complement differentiation (+)
Bargaining Bargaining • Complement concentration (+)
Industrial
Power of
Rivalry
Power of • Complement substitutability (-)
Suppliers Buyers • Complement integration (-)

• Complements historically no
Threat of
Automotive bottleneck
Substitutes • Growing importance for alternative
fuels (LPG, electric, hydrogen)
• Charging network critical for uptake
Historically low but increasing, of electric cars
particularly for electric cars • Car companies build own network

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Avoiding pitfalls in competition
analysis
Using static analysis that
Defining the ignores industry trends
industry too broadly
or too narrowly
Confusing cyclical
changes with structural
Making lists instead changes
Pitfalls
of engaging in
rigorous analysis to avoid

Using insights only to

assess industry
Paying equal attention to all attractiveness and not to
forces rather than focusing on guide strategic choices
the most important factors

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Competition analysis for strategic planning
Strategy
• How is the organisation competing? Predictions
Objectives and Values
• What strategy
• What are competitor’s current goals?
• Is actual performance meeting these goals?
changes will the
• How are its goals likely to change competitor initiate?
Assumptions and Representation • How will the
• What assumptions does the competitor
hold about the industry and itself? competitor respond
Resources and Capabilities to our strategic
• What are the competitors’ key strengths initiatives?
and weaknesses?

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Exploiting industry structure
• At any point in time, the structure of most
industries fits into one of the four generic
categories
• Each industry structure presents opportunities that
may be exploited
• Organisations can choose to exploit an industry
structure, continue business as usual, or exit the
industry

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Fragmented industry structure

Industry Characteristics
• Large number of small firms Opportunity Consolidation
• No dominant firms • Buy competitors
• No dominant technology • Build market power
• Commodity-type products • Exploit economies of scale
• Low barriers to entry
• Few, if any, economies of scale

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Emerging industry structure
Industry Characteristics
• New industry based on
breakthrough technology or Opportunity Consolidation
product
• First mover advantages
• No product standard has been
• Technology
reached
• Locking-up assets
• No dominant firm has emerged
• Creating switching costs
• New customers come from
nonconsumption not from
competitors

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Mature industry structure

Industry Characteristics
• Slowing growth in demand Opportunity Consolidation
• Technology standard exists • Refine current products
• Increasing international • Improve service
competition
• Process innovation
• Industry-wide profits declining
• Industry exit is beginning

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Declining industry structure

Industry Characteristics
• Industry sales have sustained
Opportunity Consolidation
pattern of decline • Market leadership
• Some well-established firms • Niche
have exited • Harvest
• Organisations have stopped • Divest
investing in maintenance

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Summary
Economical

Political Rivalry Social-Cultural

Suppliers New Entrants

Focal
Organisation
Buyers Substitutes

Complement
Legal Technological
Environmental

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Reference and Further Reading
• Barney and Hesterly (Chapter 2)
• Other reference and useful reading:
 Harvard Business Review, (2008). The Five Competitive Forces That Shape
Strategy: An Interview with Michael E. Porter [online]. YouTube. [Viewed
24 October 2020]. Available from: https://youtu.be/mYF2_FBCvXw
 Stringham, E.P., Miller, J.P., and Clark, J.R., (2015). Overcoming Barriers to
Entry in an Established Industry. California Management Review. 57(4).
Available on-line from:
http://search.ebscohost.com.sheffield.idm.oclc.org/login.aspx?direct=tru
e&db=buh&AN=109928656&site=ehost-live

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