CHAPTER 3

EVALUATING ENVIRONMENTAL THREATS

3.1 THE STRUCTURE-CONDUCT-PERFORMANCE MODEL

The theoretical framework that developed out this effort became
known as the structure-conduct-performance model (SCP). The term
structure in this model refers to industry structure, measured by such factors
as the number of competitors in an industry, the heterogeneity of products,
and the cost entry and exit. Conduct refers to specific firm actions in an
industry, including price taking, product differentiation, tacit collusion, and
exploitation of market power. Performance in the SCP model has two
meanings: the performance of individual firms and the performance of the
economy as a whole. The SCP is summarized in figure 3.1

Industries are perfectly competitive when there are large numbers of

competing firms; products being sold are homogeneous with respect to cost
and product attributes, and entry and exit are very low cost. A firm is a price
taker when it responds to changes in industry supply or demand by adjusting
prices rather than attempting to influence the level of supply or demand.
Price taking firm can expect to gain only competitive parity.

3.2 THE FIVE FORCEA MODEL OF ENVIRONMENTAL THREATS

The most widely known model of environmental threats in the field of
strategies management was developed by Professor Michael Porter of the
Harvard Business School. In this model, known as the five forces frame work,
Porter suggests that five specific attributes of industry structure can threaten
the ability of a firm to either maintain or create competitive advantages.

The Threat of Entry

Barriers to entry are attributes of an industrys structure that increase
the cost of entry. The five barriers :

Economics of scale as a barrier to entry

Product differentiation as a barrier to entry
Cost advantages independent of scale as a barrier to entry
Contrived deterrence as a barrier to entry
Government policy as a barrier to entry

The Threat of Rivalry

New entrants are an important threat to the ability of firms to maintain
or improve their level of performance, but they are not the only threat in a
firms environment. A second environmental threat in the five forces frame
work is rivalry.

Attributes of an industry that increase the threat of rivalry :

Large number of competing firms

Competing firms that are the same size and have the same influence
Slow industry growth
Lack of product differentiation
Productive capacity added in large increments

The Threat of Substitutes

A third environmental threat in the five forces frame work is
substitutes. The products or services provided by a firms rivals meet
approximately the same customer need in the same ways as the product or
services provided by the firm itself. Substitutes meet approximately the
same customer needs but do so in different ways.
The Threat of Powerful Suppliers
Suppliers provide a wide variety of raw materials, labor, and critical
assets to firms. Suppliers can threaten the performance of firms in an
industry by increasing the prices of their supplies or by reducing the quality
of those supplies. Any profits that were being earned in an industry can be
transferred to suppliers in this way.
The Threat of Powerful Buyers
Buyers purchase a firms products or services. Whereas sellers actions
may increase a firms costs, buyers actions may decrease a firms revenues.

3.3 APPLYING THE FIVE FORCES MODEL

In an important sense, the five forces model describes processes that
tend to move an industry toward the economic condition of perfect
competition. In general, industries are perfectly competitive when there are
high levels of threat from new entry, rivalry, substitutes, suppliers, and
buyers. Firms in this kind of industry generally enjoy only competitive parity.
Any profits that might exist in this type of industry are quickly competed
away by potential entrants, rivals reducing their prices, substitutes becoming
more attractive, suppliers raising their prices or lowering their quality, and
buyers demanding lower prices or higher quality.

Analyzing the Pharmaceutical Industry

The pharmaceutical industry consists of organizations that develop, patent,
and distribute drugs. Some of the major players in this industry include
Merck, Eli Lily, Johnson & Johnson, and Bristol-Myers Squibb.
Analyzing the Consumer Electronics Industry
The consumer electronics industry consists of the firms that develop,
manufacture, and distribute electronics for the home and consumer. Major
players in this industry include Sony, Matsushita (known by its brand name,
Panasonic), and Philips.

3.4 ANOTHER INDUSTRY FORCE: COMPLEMENTORS

Recently, professors Adam Brandenburger and Barry Nalebuff
suggested that another force needs to be added to Porters five forces frame
work. These authors distinguish between competitors and what they call a
firms complementors. Another firm is a competitor if your customers value
your product less when they have this other firms product than when they
have your product alone. Rivals, new entrants, and substitutes can all be
seen as specific examples of competitors. On the other hand, another firm is
a complementor if your customers value your product more when they have
this other firms product than when they have your product alone.

3.5 OTHER IMPLICATIONS OF THREATS ANALYSIS

In addition to using the five forces frame work to evaluate the overall
attractiveness of an industry, it can be also be used in two other ways. First,
it can e used to identify specific opportunities in an industry. In particular,
every significant threat in an industry can also be understood as an
opportunity. Firms that are able to neutralize a threat in an industry, or turn
threat into an opportunity, are often able to gain significant competitive
advantages

3.6 THREATS IN AN INTERNATIONAL CONTEXT

One of the most important benefits of the five forces frame work is that
it forces strategic managers to broaden their definition of competition.
Traditionally, a firms competitors have been defined as those firms whose
products or service meet approximately the same customer needs as
particular firms products or services. In five forces language, these
competitors are a firms rivals. However, in an important sense, any
individual, group, or organization that seeks to reduce a firms economic
performance can be thought of a competitor. The five forces frame work
gives us a tool for describing the forms these other sources of competition
can take. Thus new and potential entrants, substitutes, suppliers, buyers,
and rivals can all be a firms competitors and can all reduce an industrys
attractiveness.

3.7 SUMMARY
The structure-conduct-performance frame work was originally designed
to evaluate the competitiveness of industries to assist government
regulators. This frame work suggests that a firms conduct and performance
are determined largely by industries structure. Thus, sources of abovenormal economic performance must be sought in the structural
characteristics of industries. Michael Porter developed the most influential
model of environment threats. His five forces (threats) in an industry are :
1.
2.
3.
4.

The
The
The
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5. The

threat
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threat
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threat

of
of
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rivals
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