Evaluating a Firm’s External Environment

1. Evaluating a Firm’sExternal Environment Learning Objectives Understand the importance of environmental analysis, dimensions of the external environment, what determines profitability in an industry, the Structure – Conduct – Performance model, and opportunities based on type of industry structure

2. The General Environment Facing Firms Examples ?

3. The Structure – Conduct – Performance Model • Origin: 1930s, to spot anti-competitive conditions • Can be used to assess potential for above-normal profits in an industry • Porter’s Five-Forces model developed from this tradition

4. The Structure – Conduct – Performance Model Number of competing firms, homogeneity of products, cost of entry and exit Industry Structure Price taking, cost cutting, product differentiation, tacit collusion, exploit market power FirmConduct Firm: above, normal, belowSociety: social welfare implications Performance

5. Type of Industry = Perfect Competition Large number of firms, homogeneous products,low cost of entry and exit Industry Structure Price taking FirmConduct Firm: normalSocial welfare: maximized Performance Industry Examples ?

6. Type of Industry = Monopolistic Competition Large number of firms,heterogeneous products,low cost of entry and exit Industry Structure Cost leadership,Product differentiation FirmConduct Firm: above normalSocial welfare: less than perfect competition Performance Industry Examples ?

7. Type of Industry = Oligopoly Small number of firms,costly entry and exit Industry Structure FirmConduct Many options, including collusion Firm: above normalSocial welfare: less than monopolistic competition Performance Industry Examples ?

8. Type of Industry = Monopoly Only one competing firm,costly entry Industry Structure FirmConduct Uses market power to set prices Firm: above normalSocial welfare: less than oligopoly Performance Industry Examples ?

9. Five Forces Model of Environmental Threats What’s the profit potential of the industry ?

10. Five Forces ModelThreat of Entry • Economies of scale • Product differentiation • Cost advantages independent of size (Technology, know-how, access to raw materials, geographic locations, learning curve) • Government policy • Access to distribution channels * • Capital requirements * • Switching costs * * Some disagreement among scholars

11. Five Forces Model Threat of Rivalry • Many competitors • Similar in size • Slow rate of industry growth • Product lacks differentiation • Capacity added in large increments • High level of fixed costs • Exit barriers are high • Reputation or past history

12. Five Forces Model Threat of Substitute Products • Products that appear to be different but satisfy the same need • Customer switching costs are low • Substitutes often come from outside the industry • good examples butter vs. margarine calculators vs. slide rules tape b/u vs. CD burner • bad examples Coke vs. Pepsi Honda vs. Toyota

13. Porter’s Five Forces Model Threat of Suppliers • Supplier has few competitors • Supplier offers a unique product • Substitutes not readily available • Supplier can integrate forward • Firm or industry purchases represent small share of supplier’s total sales

14. Five Forces Model Threat of Buyers • Small number of buyers • Purchase products that are standard or undifferentiated • Industry products represent a large share of buyer’s total cost • Unimportant to final quality of product • Product does not save the buyer money • Buyer may integrate backward

15. Fragmented Emerging Mature Declining International Network Hypercompetitive Empty-core Identified by M. Porter Added by J. Barney Types of Industry Structure What is the structure of your firm’s industry ?

16. Industry structure Fragmented Emerging Mature Declining Opportunities Consolidation First-mover Product refinement, service, process innovation Leadership, niche, harvest, disinvestment Industry Structure andEnvironmental Opportunities Examples of industry structure ?

17. Opportunities in Fragmented Industries Definition: …many small or medium-sized firms with no dominant technology or market share… Industry examples: retailing, service, restaurant Strategic opportunities: new economies of scale or governance mechanisms through consolidation Practical examples: SCI funeral homes, KOA campgrounds,La Quinta motels What causes industries to be fragmented ?

18. Opportunities in Emerging Industries Definition: …industry formed by changes in technology, demand, customer needs … Industry examples: microprocessor, PC, medical imaging, biotechnology Strategic opportunities: first-mover advantages from technological leadership, preemption of strategically valuable assets, customer-switching costs Practical examples: Xerox, Wal-Mart, Microsoft When can a firm expect first-mover advantages ?

19. Opportunities in Mature Industries Definition: …slowing growth rate, experienced customers, limited growth in production capacity and new products, increase in international competition… Industry examples: auto manufacturing, fast food, gaming (US) Strategic opportunities: refining current products, emphasis on service, process innovation Practical examples: Ford, GM, McDonalds, Starbucks Strategies of firms in mature industries that fit these strategic opportunities ?

20. Process and Product Innovationand Industry Structure

21. Opportunities in Declining Industries Definition: …absolute decline in unit sales… Industry examples: AM/FM broadcast radio, electronic vacuum tubes, hand-held calculators Strategic opportunities: market leadership, niche strategy, harvest, divestment Practical examples: GTE Sylvania, GE How can market leader foster opportunities in a declining industry ?

22. Opportunities in International Industries Definition: …sales volume and growth comes from two or more independent countries… Industry examples: many; most businesses assume international competition will be the norm in the 21st century Strategic opportunities: Multinational – independent operations Global – seek to optimize (centralize) business functions Transnational – hybrid of multinational and global What are the pros and cons of these strategic opportunities ? How are your firms addressing international opportunities ?

23. Opportunities in Network Industries Definition: …industry where value of product or service depends on number of total items sold…”increasing returns industry”… Industry examples: telephone, fax, VCRs Strategic opportunities: first-mover, winner take all Practical examples: VHS vs. Beta, HDDVD vs. Blue Ray Does the “best” technology win ? Other examples of network industries ?

24. Opportunities in Hypercompetitive Industries Definition: …industry competition is unstable, unpredictable and/or constantly evolving… Industry examples: biotechnology, music download, Internet TV Strategic opportunities: flexibility, proactive disruption Attributes of successful proactive disruption: satisfy current stakeholders, anticipate customer needs, act quickly with surprise, change the bases of competition, invest in multiple efforts or a sequence of activities Examples of firms following proactive disruption ?

25. Opportunities in Empty-core Industries Definition: …bases of competition may be stable, but industry conditions make it difficult to earn profit…buyers are shopping and sellers are selling, but transactions may not take place… Industry examples: industries with high fixed costs, low variable costs – airlines: “fixed costs with wings” Strategic opportunities: collusion, government regulation, product differentiation, better demand prediction. How have airlines addressed these industry forces ? What can we expect from deregulation of the electric utility industry?