Session 3

The external environment 2: Industry

and competitive analysis
Layers of the operating
environment

Macro-
environment
Industry / Sector

Competitors /
Markets

Organisation
Industry and competitive analysis

• Industry/Sector:
– ‘A group of firms producing products and services that are
essentially the same’ (Johnson et al., 2014: 41)
– ‘A group of firms whose products have so many of the same
attributes that they compete for the same buyers’ (Thompson and
Strickland, 2001: 77)
– E.g. airline, automotive, education, energy

• Often made up of several specific markets…

• Market: ‘a group of customers for specific products or services
that are essentially the same, e.g. a particular geographical
market (Johnson et al., 2014: 41)
– E.g. North American market for jet fuel, European market for heavy
marine fuel, African market for diesel oil…(a particular segment of
the market)
 Thompson and Strickland (2001)

Industry & competitive analysis - Developing insightful answers to

7 questions:
1. PESTLE (Macro environmental analysis)
2. What are the industry’s dominant economic features?
3. What is competition like and how strong are each of the
competitive forces?
4. What is causing the industry’s competitive structure and
business environment to change?
5. Which companies are in the strongest/weakest positions?
6. What strategic moves are rivals likely to make next?
7. What are the key factors for competitive success?
8. Is the industry attractive and what are the prospects for above-
average profitability?
1. Dominant economic features

Industries differ in their economic characteristics, competitive situations

and future profit prospects
– Differences between fast food retailing and oil extraction?
– Economic character varies according to:
• market size and growth rate
• pace of technological change
• geographic boundaries of the market
• number and size of buyers and sellers
• whether sellers products are virtually identical or highly
differentiated
• extent to which costs are affected by economies of scale
• types of distribution channels used to access buyers
 Why are these strategically important?

Market size Small markets don’t tend to attract big/new competitors; large markets
are interesting to companies seeking to acquire competitors with
established positions

Market growth rate Fast growth breeds new entry; growth slowdowns spawn increased
rivalry and shake-out of weak competitors

Capacity Surpluses push prices and profit margins down; shortages pull them up
surpluses/shortages

Industry profitability High profit industries attract new entrants; depressed conditions
encourage exit
Entry/exit barriers High barriers protect positions and profits of existing firms; low barriers
make existing forms vulnerable

Capital requirements Big requirements are a barrier to entry and exit

Adapted from Thompson and Strickland (2001: 80)

2. What is competition like?

Threat of New
Entrants

Power of Rivalry among Power of

Suppliers competing sellers Buyers

Threat of
Substitute
Products

Source: Porter (1979)

 Rivalry among competing sellers

• Usually the strongest force

• Competitive markets are economic battlefields

• Commodity: price is determined as a function of the

market as a whole – spot and derivative markets

• Intensifies as:
– Number of competitors increases
– Competitors become more equal in size and capability
– Demand for product growing slowly
– Industry conditions tempt competitors to use price cuts
– Customers costs to switch brands are low
– Some competitors are dissatisfied with their position & try to bolster their standing
– Strong firms acquire weak firms in the industry & launch aggressive moves
 Threat of new entrants

• New entrants – new capacity, new resources, want a

share!
• Existing players can create barriers to entry as a form of
retaliation, or a deterrent to entry
• Key barriers:
– Economies of scale (higher risk for potential entrants)
– Cost disadvantages independent of size (partnerships, patents, proprietary
technology, favourable locations)
– Learning and experience curve effects (lower unit costs due to more
accumulated know-how)
– Inability to match specialized know-how (personnel, patents, technology)
– Brand preferences and customer loyalty (establishing this can be slow and
costly)
– Capital requirements
– Access to distribution channels
– Regulatory policy
– Tariffs and international trade restrictions
• If costs of getting out of the market are high, existing
players will fight to remain, if low, they may exit when
confronted with a new entrant
Threat of substitute products

• Firms in one industry can be in close competition

with firms in another:
– Eyeglasses and contact lens’ and laser surgery
– Electric power and natural gas
– Oil and ??

• Attractiveness of substitutes:
– Whether attractively priced substitutes are available:
places a price ceiling
– Whether buyers view substitutes as satisfactory in
terms of quality, performance, relevant attributes:
buyers compare quality, performance, ease of use,
price…
– Whether buyers can switch easily: switching costs for
buyers: price premiums, additional equipment, time and
cost in testing quality & reliability, psychological costs,
employee retraining
 Bargaining power of buyers

• Whether buyers have sufficient bargaining power to

influence the terms & conditions of sale in their favour
– Buyers costs of switching brands are low
– Number of buyers are small or a buyer particularly important to a
seller
– Buyers are well-informed about sellers products, prices & costs
– Buyers pose a credible threat of integrating backward in the
supply chain
– Buyers have discretion in whether or when they purchase
– Not all buyers have equal degrees of bargaining power!

• The extent & competitive importance of seller-buyer

strategic partnerships
– Business-business relationships: mutual interest to collaborate
closely e.g. Joint Ventures
 Bargaining power of suppliers

• Whether suppliers have sufficient bargaining power to

influence the terms & conditions of sale in their favour
– No bargaining power or leverage when the items are
commodities available on the open market
– Suppliers have market power only when supplies are tight
– Weak bargaining position when substitutes are available,
when the buyer is a major customer
– Higher bargaining power when supplier is a major supplier
(e.g. Intel), when item accounts for large % of costs, when
item is crucial to production, when it is difficult to switch to
alternative supplier, when suppliers can produce more
cheaply than industry members can make it themselves
(e.g. American Airlines producing jumbo jets??)

• The extent & competitive importance of seller-supplier

strategic partnerships e.g. JV’s, managing supply chain
relationships
 Positioning the firm

• Depends on the interaction of the 5 forces

• Shield the firm from the competitive forces
• Requires internal company analysis to
supplement an assessment of market forces
• Strategies can be defensive or offensive
• Growth in the future comes from strategies
which protect the company from attack by
direct competitors
 Five forces analysis

Key issues:
• Defining the industry (markets, segments, geographical markets)
• Converging industries (previously separate begin to overlap/merge)
• Complementary organizations (enhances your business attractiveness to
customers or suppliers; cooperation instead of competition)

Implications:
• Which industries to enter / leave
• What influences can be exerted? (e.g. building barriers)
• Forces have different impact Industry
on different organizations (e.g. large v
small)

Common pitfalls in conducting the analysis - avoid the following:

Defining the industry too broadly or too narrowly.
Making lists instead of engaging in rigorous analysis.
Paying equal attention to all of the forces rather than digging deeply into the
most important ones.
Confusing effect with cause.
Using static analysis that ignores industry trends.
Confusing cyclical or transient changes with true structural changes (e.g.
converging industries)

From: Porter, M. 2008. The Five Competitive Forces that Shape Strategy. Harvard Business Review, pp. 78-93.
5 Forces – output chart

Industry analysis Competitive Rivalry

2015 vs 2016 LOW

Entry threat Substitute Threat

LOW LOW

HIGH

LOW LOW
Supplier power Buyer power

15
 In groups
using the Ryanair
case study,
conduct a five
forces analysis

The industry:
European
(budget) airlines
Q3. What is causing the competitive structure &
business environment to change?

• Economic features and competitive forces say a lot about

fundamental character…
• ….but little about the ways the environment might be changing

• Applicable tools include:

– Analysis of industry structure
– Industry lifecycle
– PESTEL, Environmental Scanning
– Driving forces
 The Spectrum of Industry
Structure

Perfect
Oligopoly Duopoly Monopoly
Competition

Concentration Many firms A few firms Two firms One firm

Entry and Exit No barriers Significant barriers High barriers

Barriers

Product Homogeneous
Differentiation Potential for product differentiation
Product

Perfect
Information Imperfect availability of information
Information flow

Robert Grant 2010, Contemporary Strategy Analysis

 Brainstorm
• Examples of
– Perfect competition
– Oligopoly
– Duopoly
– Monopoly

Dr. Michelle O'Toole 19

 Profitability of US industries,
2000-2010

Industry Median ROE (%) Leading companies

Tobacco 33.5 Philip Morris, Altria, Reynolds American

Household and 27.8 Procter & Gamble, Kimberly-Clark,

personal products Colgate-Palmolive

Pharmaceuticals 20.5 Pfizer, Johnson & Johnson, Merck

Petroleum 17.6 ExxonMobil, Chevron, ConocoPhillips

Refining
Mining, Crude oil 16.3 Occidental Petroleum, Devon Energy
production

Pipelines 11.1 Plains All American, Enterprise Products,

ONEOK

Airlines -11.3 United Airlines, Delta

Source: Excerpt from Grant, 2013: 63

The industry life cycle

Source: Johnson et al. (2014: 52)

 Driving forces
• Stage in the lifecycle is important

• As are the specific factors causing fundamental industry

and competitive adjustments – link to PESTEL
– Technological substitution (air v. rail travel)
– Social changes (health consciousness v. cigarettes)

• The most dominant forces are called driving forces

Have the biggest influence
1. Identify
2. Assess impact
 Important!

• Driving forces IS NOT EQUAL TO ‘Key

strategic drivers’

• Undertake a strategic analysis of your chosen

organization and its environment. Using the
outcomes of your analysis, identify the key
strategic drivers for the organization (40% of
the assignment marks).

• Driving forces = what is causing the industry to

change
• Key strategic drivers = outcome of multiple
layers of analysis (internal and external)
Dr. Michelle O'Toole 23
 Brainstorm
• Most common driving forces?

• In other words, why are industries changing?

• Pick Sri Lanka’s key industries

– Garment manufacture
– Tourism

Dr. Michelle O'Toole 24

 Most common driving forces

• Internet & new e-commerce opportunities/threats

• Increasing globalization of the industry
• Changes in the long-term industry growth rate
• Changes in who buys the product and how they use it
• Product innovation
• Technological change
• Marketing innovation
• Entry or exit of major firms
• Diffusion of technical know-how across more companies and more countries
• Changes in cost and efficiency
• Buyer preferences for differentiated products/more standardized product
• Regulatory influences & government policy changes
• Changing societal concerns, attitudes, lifestyles
• Reductions in uncertainty and business risk

• Identify
• Assess impact

• 5 or 6 major determinants of why and how the industry is changing

Source: Thompson and Strickland (2001: 76) based on Porter (1980)

Driving Forces Analysis –
Auto Industry
Force

Customers want specialized after sale service • Are they valid?

• How do we know?
Buyers want better fuel economy • What is their strength?
• Which can/can’t be altered?
Better roads and highways allow for higher speeds • Which can be altered quickly?
Slowly?
Increased demands for passenger safety
• If altered, which would
produce rapid change? Slow
change?
New technologies allow more engine and fuel
options
• Can we get the resources and
capabilities needed to change
Demand increasing most in China and India them?

Outsourcing options are growing fast

Source: Bensoussan and Fleisher (2013: 72)

Driving forces: Auto Industry
 Q4. Which companies are in the
strongest/weakest positions?
• Strategic group: ‘organizations within an industry with similar
strategic characteristics, following similar strategies or competing
on similar bases’ (Johnson et al. 2014: 54)
– E.g. Aston Martin and Kia both sell cars
– Need to disaggregate the industry

• Identify strategic groups by their differing characteristics:

– Scope of activities: extent of product/service diversity,
geographical coverage, market segments, distribution
channels
– Resource commitment: branding, marketing effort, vertical
integration, quality, technological leadership, size

• Why strategically important?

– Understand the competition & focus on direct competitors
– Analyse strategic opportunities: Opportunities to develop
distinctive positions within broader industries (white space)
– Analyse mobility barriers (obstacles to movement from one
strategic group to another)
 Strategic groups
• Variables need to expose big
differences in how rivals position
themselves to compete

• Firms in the groups are the

closest rivals, the next closest
rivals are immediately adjacent
groups
• The closer strategic groups are,
the stronger competitive rivalry
among member firms
• Far apart groups hardly compete
at all
• What is likely to happen next?
• White space
• Moving position
• Do driving forces favour some
strategic groups and hurt
others?
Johnson G., et al. (2014) Exploring Strategy: Text and Cases 10th edn. (Pearson) p56
Developed from R. Chittoor and S. Ray, ‘Internationalisation paths of Indian pharmaceutical firms: a strategic group analysis’, Journal of International Management,
vol. 13 (2009), pp. 338–55.
Strategic groups: World petroleum industry
NOTE: NOT IN THE CORRECT ORDER!

INTEGRATED

UPSTREAM

DOWNSTREAM

NATIONAL REGIONAL GLOBAL

Q5. What strategic moves are rivals
likely to make next?

• Gather competitive intelligence about competitors’

strategies, actions, strengths & weaknesses:
– What are they doing in the marketplace?
– What do management say about the company’s
plans?

• Consider:
– Competitive scope
– Strategic intent
– Market share objective
– Competitive situation
– Strategic posture
– Competitive strategy

• Output should be a profile of close

competitors
 6. What are the key success factors for
competitive success

• KSFs ‘are those things that most affect industry

members’ ability to prosper in the marketplace…they are
the prerequisites for industry success…the rules that
shape whether a company will be financially and
competitively successful’ (Thompson & Strickland, 2001:
106)
• Being distinctively better than rivals on one or more
• Use the KSFs as cornerstones for strategy
• To identify KSFs ask these questions:
1. On what basis do customers chose between competing
brands of sellers? What attributes are crucial?
2. What resources and competitive capabilities does a
seller need to have to be competitively successful?
3. What does it take for sellers to achieve a sustainable
competitive advantage?
 Key success factors:
Examples

• If I was in the soft drinks (e.g. coca cola,

pepsi) industry, what would I need to be
really good at in order to make money?

Dr. Michelle O'Toole 33

Common key success factors
Technology Scientific research expertise, technical capability to make innovative
improvements in production processes, product innovation capability, expertise
in a given technology, alliances with universities

Manufacturing Low-cost production efficiency, quality of manufacture, high utilization of fixed

assets, low-cost plant locations, access to labour, high labour productivity, low-
cost product design, ability to customize to buyer specifications

Distribution Strong network of wholesale distributors, ability to secure shelf space, company-
owned retail outlets, low distribution costs, accurate filling of customer orders,
short delivery times

Marketing 4 P’s –product, price, place, promotion, advertising, brand names, warranties,
attractive styling/packaging, understanding of consumer behaviour

Skills & capability Superior workforce talent, historical advantages, quality control know-how,
design expertise, e-commerce capabilities, adaptive corporate culture, time to
market, information systems, managerial expertise

Other Reputation with buyers, overall low cost, convenient location, access to capital,
patent protection…
7. Is the industry attractive & what are its
prospects for above-average profitability?
• Use the answers of the 6 questions to draw conclusions about
the relative attractiveness, short / medium / long term of the industry

• Growth potential
• Whether competition permits profitability
• Whether profitability will be favourably or unfavourably affected by driving forces
• The company’s competitive position in the industry and whether position is likely to
grow stronger or weaker
• The company’s potential to capitalize on the vulnerabilities of weaker rivals
• Whether the company can defend against or counteract the factors that make the
industry unattractive
• The degree of risk and uncertainty
• The severity of problems confronting the industry as a whole

1. Factors making the industry attractive

2. Factors making the industry unattractive
3. Special industry issues/problems
4. Profit outlook

Attractiveness is relative, not absolute

 Summary
1. PESTLE (Macro environmental analysis)
2. What are the industry’s dominant economic features?
• Industry value chain
3. What is competition like and how strong are each of the
competitive forces?
• Porters 5 forces
4. What is causing the industry’s competitive structure and
business environment to change?
• Industry life-cycle
• Driving forces
5. Which companies are in the strongest/weakest positions?
• Strategic group
6. What strategic moves are rivals likely to make next?
7. What are the key factors for competitive success?
8. Is the industry attractive and what are the prospects for
above-average profitability?
 Question of the session:

• If you were asked to conduct an

analysis of the external
environment, what tools and
theories would you use, and why?