Strategic Management

SMN580S
 STRATEGY
AFI FRAMEWORK
External Analysis: Industry Structure, Competitive Forces, and
Strategic Groups
A firm’s external environment consists of all the factors that can affect its potential to gain and sustain a competitive
advantage.
By analyzing the factors in the external environment, strategic leaders can mitigate threats and leverage
opportunities.
For example, external factors in the firm’s general environment are ones that managers have little direct influence
over, such as macroeconomic factors (e.g., interest or currency exchange rates).

Pestel Model Framework

The PESTEL model groups the factors in the firm’s general environment into six segments:
■ Political
■ Economic
■ Sociocultural
■ Technological
■ Ecological
■ Legal
External Analysis: Industry
Structure, Competitive
Forces, and Strategic Groups
•The PESTEL model provides a
relatively straightforward way to scan,
monitor, and evaluate the important
external factors and trends that might
impact upon a firm.

•With more open markets and

international trade in recent decades,
the PESTEL factors have become more
global.

•Such factors create both opportunities

and threats
External Analysis: Industry Structure, Competitive Forces, and
Strategic Groups
Political factors result from the processes and actions of government bodies that can influence the decisions and
behavior of firms.
Although political factors are located in the firm’s general environment, where firms traditionally wield little
influence, companies nevertheless increasingly work to shape and influence this realm.
Political and legal factors are closely related, as political pressure often results in changes in legislation and
regulation;

Economic factors in a firm’s external environment are largely macroeconomic.

Managers need to consider how the following five macroeconomic factors can affect firm strategy:
■ Growth rates.
■ Levels of employment.
■ Interest rates.
■ Price stability (inflation and deflation).
■ Currency exchange rates
External Analysis: Industry Structure, Competitive Forces, and
Strategic Groups
Sociocultural factors capture a society’s cultures, norms, and values.
Because sociocultural factors not only are constantly in flux but also differ across groups, strategic leaders need to
closely monitor such trends and consider the implications for firm strategy.
Demographic trends are also important sociocultural factors.
These trends capture population characteristics related to age, gender, family size, ethnicity, sexual orientation,
religion, and socioeconomic class.
Like other sociocultural factors, demographic trends present opportunities but can also pose threats.

Technological factors capture the application of knowledge to create new processes and products.
Major innovations in process technology include lean manufacturing, Six Sigma quality, and biotechnology.
technological progress is relentless and seems to be picking up speed.
Technological environment bring both opportunities and threats for companies (AI)

Ecological factors involve broad environmental issues such as the natural environment, global warming, and
sustainable economic growth.
Organizations and the natural environment coexist in an interdependent relationship.
Managing these relationships in a responsible and sustainable way directly influences the continued existence of
human socithe organizations we create.
Managers can no longer separate the natural and the business worlds; they are inextricably linked.
Ecological factors can also provide business opportunities.
External Analysis: Industry Structure, Competitive Forces, and
Strategic Groups
Legal factors include the official outcomes of political processes as manifested in laws, mandates, regulations,
and court decisions—all of which can have a direct bearing on a firm’s profit potential.
As noted earlier, legal factors often coexist with or result from political will.
Governments especially can directly affect firm performance by exerting both political pressure and legal
sanctions, including court rulings and industry regulations
External Analysis: Industry Structure, Competitive Forces, and
Strategic Groups
 Industry Structure and Firm Strategy: The Five Forces Model
Firm performance is determined primarily by two factors: industry and firm effects. Industry effects describe the
underlying economic structure of the industry.
They attribute firm performance to the industry in which the firm competes

Firm effects attribute firm performance to the actions strategic leaders take.

Michael Porter developed the highly influential five forces model to help managers understand the profit
potential of different industries and how they can position their respective firms to gain and sustain competitive
advantage.

The five forces model allows strategic leaders to analyze all players using a wider industry lens, which in turn
enables a deeper understanding of an industry’s profit potential.

Moreover, a five forces analysis provides the basis for how a firm should position itself to gain and sustain a
competitive advantage.
Industry Structure
and Firm Strategy:
The Five Forces
Model
 Industry Structure and Firm Strategy: The Five Forces Model
The threat of entry describes the risk that potential competitors will enter the industry.
There are, however, a number of important barriers to entry that raise the costs for potential competitors and
reduce the threat of entry.
Entry barriers, which are advantageous for incumbent firms, are obstacles that determine how easily a firm can
enter an industry.
Incumbent firms can benefit from several important sources of entry barriers:
• Economies of scale.
• Network effects.
• Customer switching costs.
• Capital requirements.
• Advantages independent of size.
• Government policy.
• Credible threat of retaliation.
 Industry Structure and Firm Strategy: The Five Forces Model
Power of Suppliers
The bargaining power of suppliers captures pressures that industry suppliers can exert on an industry’s profit
potential.
This force reduces a firm’s ability to obtain superior performance for two reasons:
Powerful suppliers can raise the cost of production by demanding higher prices for their inputs or by reducing the
quality of the input factor or service level delivered.
Powerful suppliers are a threat to firms because they reduce the industry’s profit potential by capturing part of the
economic value created.
To compete effectively, companies generally need a wide variety of inputs into the production process, including
raw materials and components, labor (via individuals or labor unions, when the industry faces collective
bargaining), and services.
The relative bargaining power of suppliers is high when
■ The supplier’s industry is more concentrated than the industry it sells to.
■ Suppliers do not depend heavily on the industry for a large portion of their revenues.
■ Incumbent firms face significant switching costs when changing suppliers.
■ Suppliers offer products that are differentiated.
■ There are no readily available substitutes for the products or services that the suppliers offer.
■ Suppliers can credibly threaten to forward-integrate into the industry
 Industry Structure and Firm Strategy: The Five Forces Model
Power of Buyers
The bargaining power of buyers is the flip side of the bargaining power of suppliers.
The power of buyers concerns the pressure an industry’s customers can put on the producers’ margins in the
industry by demanding a lower price or higher product quality.
When buyers successfully obtain price discounts, it reduces a firm’s top line (revenue).
When buyers demand higher quality and more service, it generally raises production costs.
Strong buyers can therefore reduce industry profit potential and a firm’s profitability.
Powerful buyers are a threat to the producing firms because they reduce the industry’s profit potential by
capturing part of the economic value created.

The power of buyers is high when

■ There are a few buyers and each buyer purchases large quantities relative to the size of a single seller.
■ The industry’s products are standardized or undifferentiated commodities.
■ Buyers face low or no switching costs.
■ Buyers can credibly threaten to backwardly integrate into the industry
 Industry Structure and Firm Strategy: The Five Forces Model
Threat of Substitute products and services
Substitutes meet the same basic customer needs as the industry’s product but in a different way.
The threat of substitutes is the idea that products or services available from outside the given industry will come
close to meeting the needs of current customers
A high threat of substitutes reduces industry profit potential by limiting the price the industry’s competitors can
charge for their products and services.
The threat of substitutes is high when:
■ The substitute offers an attractive price-performance trade-off.
■ The buyers cost of switching to the substitute is low
In addition to a lower price, substitutes may also become more attractive by offering a higher value proposition –
Example Airlines

Rivalry amongst existing competitors

Rivalry among existing competitors describes the intensity with which companies within the same industry jockey
for market share and profitability.
Rivalry among existing competitors describes the intensity with which companies within the same industry jockey
for market share and profitability.
The intensity of rivalry among existing competitors is determined largely by the following factors:
■ Competitive industry structure.
■ Industry growth.
■ Strategic commitments.
■ Exit barriers
 Industry Structure and Firm Strategy: The Five Forces Model
The competitive industry structure refers to elements and features common to all industries.
The structure of an industry is largely captured by

■ The number and size of its competitors.

■ The firm’s degree of pricing power.
■ The type of product or service (commodity or differentiated product).
■ The height of entry barriers.

The four main competitive industry structures are:

1. Perfect competition
2. Monopolistic competition
3. Oligopoly
4. Monopoly
Industry Structure
and Firm Strategy:
The Five Forces
Model
 Class exercise
Group Exercise 2 One industry with an impact on both undergraduate and MBA students is textbook publishing.
Traditional printed textbooks are being challenged on one hand by self-publishing firms offering very low prices
for specific instructor materials, and on the other hand by a need to offer digital resources that substitute for
printed materials. Large textbook publishers are increasingly investing in adaptive learning systems such as
WileyPLUS, Cengage MindTap, and McGraw-Hill Connect. Complicating factors for the publishers is the
changing business model of renting textbooks (printed and electronic). U.S. university book rental was about 25
percent of student purchasing volume in 2015.50 Use the five forces model (with complements) to think through
the various impacts such technology shifts may have on the textbook industry. Include in your response answers
to the following questions:

1. How should managers of a textbook publishing company respond to such changes?

2. Will the shifts in technology and business models be likely to raise or lower the textbook industry profits?
Explain