Chapter 2: The External Environment

Chapter 2
The External Environment: Opportunities,
Threats, Industry Competition, and Competitor Analysis

ANSWERS TO REVIEW QUESTIONS

1. Why is it important for a firm to study and understand the external environment?

The external environment influences the firms strategic options as well as the decisions
made in light of them. The firms understanding of the external environment is especially
useful when it is matched with knowledge about its internal environment. Matching the
conditions of the two environments is the foundation the firm needs to form its vision,
mission, and to take strategic actions in the pursuit of strategic competitiveness and above-
average returns. The importance of understanding the external environment is further
underscored by the fact that the environmental conditions facing firms in the global economy
of the 21st century differ from those firms faced previously. For example, technological
changes and the explosion in information gathering and processing capabilities demand more
timely and effective competitive actions and responses. The rapid sociological changes
occurring in many countries affect labor practices and the nature of products demanded by
increasingly diverse consumers. Governmental policies and laws affect where and how firms
choose to compete. Competitive advantage goes to those firms who know their external
environment and plan their strategies so they are relevant to these conditions.

2. What are the differences between the general environment and the industry
environment? Why are these differences important?

The general environment represents those elements in the broader society that can influence
all (or most) industries and the firms that compete in those industries; it represents elements
or segments that firms cannot directly control. The general environment is composed of the
following segments: demographic, economic, political/legal, sociocultural, technological, and
global.

The industry environment is the constellation of factors that directly influences a firm and its
competitive actions and responses. Firms are influenced by these factors and should attempt
to establish a position in the industry that enables the firm to favorably influence the factors
or to successfully defend against the factors influence. These factors are: threat of new
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 Chapter 2: The External Environment

entrants, bargaining power of suppliers, bargaining power of buyers, threat from substitute
products, and intensity of rivalry among competitors.

3. What is the external environmental analysis process (four parts)? What does the firm
want to learn when using this process?
The environmental analysis process represents an organized attempt by the firm to better
understand turbulent, complex, and global environments. This is achieved by scanning
(studying all segments of the general environment to identify existing or potential changes),
monitoring (observing the pattern of changes over time in an attempt to detect meaning or
identify trends), forecasting (developing feasible projections of what might happen, and how
quickly, as a result of changes and trends identified from scanning and monitoring activities)
and assessing (determining the timing and significance of environmental changes and trends
on the strategic management of the firm). Stated differently, this analysis should examine and
process external data on a continuous basis.

An important objective of the environmental analysis process is to identify potential threats

4. What are the seven segments of the general environment? Explain the differences
among them.

The demographic segment is concerned with characteristics of the population or society that
makes up the general environment. Characteristics of interest are size, age, structure,
geographic distribution, ethnic mix, and income distribution.

The economic segment refers to the nature and direction of the economy in which a firm
competes or may compete in the future. Important characteristics include inflation and
interest rates, trade deficits (or surpluses), budget deficits (or surpluses), individual and
business savings and investment rates, and gross domestic product.

The political/legal segment is the arena in which organizations and interest groups compete
for attention, resources, and a voice in overseeing the body of laws and regulations guiding
interactions between nations. In other words, this segment is concerned with how firms and
other organizations attempt to influence government and how governmental entities in turn
influence them.

The sociocultural segment is concerned with the social attitudes and cultural values of
different societies.

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 Chapter 2: The External Environment

The technological segment is made up of the institutions and activities involved with creating
new knowledge and translating that knowledge into new outputs, products, processes, or
materials.

The global segment includes relevant new global markets and existing ones that are
changing, important international political events, and critical cultural and institutional
characteristics of relevant global markets. This segment recognizes that firms now compete
in a competitive landscape where both competitors and customers are global, due in part to
the rapid diffusion of both information and technology. Competitors will no longer be
domestic; they can originate from industrialized, newly industrialized, or emerging countries.
Customer demands and expectations have changed; they are based on an ever-increasing
awareness of global products and services.

The physical environment segment refers to potential and actual changes in the physical
environment and business practices that are intended to positively respond to and deal with
those changes. Ecological, social, and economic systems interact to influence what happens
in this segment. Global warming, energy consumption, and sustainability are all examples of
issues related to the physical environment.

5. How do the five forces of competition in an industry affect its profit potential?
Explain.

An industrys competitive intensity and profit potential can be determined by the relative
strengths of five competitive forces. This model of industry competition recognizes that
suppliers can influence industry profitability by raising prices or reducing the quality of
goods sold if industry participants are unable to recover cost increases through pricing
structures. Buyers can influence the profit potential of an industry if the buyer group is able
to successfully bargain for higher quality, greater levels of service, and lower prices.
Substitute products influence an industrys profit potential by placing an upper limit on prices
that can be charged. New entrants to an industry influence industry profitability because they
bring additional production capacity to the industry. Unless product demand is increasing,
additional capacity holds down (or reduces) buyers costs. This reduces profitability for all
firms in the industry. The intensity of rivalry among competitors reflects competitor actions
and responses as firms initiate moves to improve their competitive position or when they act
in retaliation for competitive pressures brought about by the strategic actions of rival firms.
Generally, the greater the intensity of competitive rivalry, the lower the overall profitability
of an industry.

6. What is a strategic group? Of what value is knowledge of the firms strategic group in
formulating that firms strategy?

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 Chapter 2: The External Environment

A strategic group is a group of firms within an industry that generally follow the same (or a
similar) strategy, competing along the same strategic dimensions (such as product quality,
pricing policy, distribution channels, or level of customer service).

The strategic group concept is valuable to a firms strategic decision makers because a firms
primary competitors are those within its strategic group (all group members are selling
similar products to a similar group of customers), the strengths of the five competitive forces
varies across strategic groups, and strategic groups that are similar (in terms of strategies
followed and competitive dimensions emphasized) increase the possibility of increased
competitive rivalry between the groups.

The notion of strategic groups can be useful for analyzing an industrys competitive structure.
Such analyses can be helpful in diagnosing competition, positioning, and the profitability of
firms within an industry. Strategic group analysis shows which companies are competing
similarly in terms of how they use similar strategic dimensions. At the same time, research
has found that strategic groups differ in performance, suggesting their importance. Strategic
group membership also remains relatively stable over time, making analysis easier and more
useful.

Strategic groups have several implications. First, because firms within a group offer similar
products to the same customers, the competitive rivalry among them can be intense. The
more intense the rivalry, the greater the threat to each firms profitability. Second, the
strengths of the five industry forces (the threats posed by new entrants, the power of
suppliers, the power of buyers, product substitutes, and the intensity of rivalry among
competitors) differ across strategic groups. Third, the closer the strategic groups are in terms
of their strategies, the greater is the likelihood of rivalry between the groups. In the end,
having a thorough understanding of primary competitors helps a firm formulate and
implement an appropriate strategy.

7. What is the importance of collecting and interpreting data and information about
competitors? What practices should a firm use to gather competitor intelligence and
why?

Competitor analysis can help the firm understand and better anticipate competitors future
objectives, current strategies, assumptions, and capabilities. The firm should gather
intelligence about its competitors as well as about public policies in countries across the
world, which can serve as an early warning of threats and opportunities emerging from the
global public policy environment that may affect the achievement of the companys strategy.
Through effective competitive and public policy intelligence, the firm gains the insights
needed to create a competitive advantage and to increase the quality of the strategic decisions
it makes when deciding how to compete against its rivals.
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 Chapter 2: The External Environment

Firms want to know how competitor intelligence is gathered to determine whether the
practices employed are legal and, further, to assess whether these methods are ethical, given
the firms culture and the image it desires as a corporate citizen. The line between legal and
ethical practices can be difficult to ascertain, especially when it comes to electronic
transmissions. Often it is difficult for a firm to know how to gather intelligence and how to
prevent competitors from gathering competitive intelligence that may threaten its own
competitive advantage.

Openly discussing intelligence-gathering techniques that the firm employs goes a long way
toward assuring that people understand the firms convictions about what is ethical and
acceptable for use and what is not ethical and is unacceptable for use when gathering
competitor intelligence. The firm can frame these practices in terms of respect for the
principles of common morality and the right of competitors not to reveal information about
their products, operations, and strategic intentions.

Despite its importance, evidence suggests that a relatively small percentage of firms use
formal processes to study competitors. Beyond this, some firms fail to analyze a competitors
future objectives when trying to understand its current strategy, assumptions, and capabilities,
but it is important to study the present and the future when examining competitors. Failure to
do so may lead to incomplete or distorted insights about competitors.

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