Management 4390 Exercise: Applying the Content of Chapter 3 to your Company 1. Which of the five competitive forces is creating the strongest competitive pressures for your digital camera company? 2. What are the factors affecting the intensity of rivalry in the industry in which your company is competing? Use Figure 3.4 and the accompanying discussion to help you in pinpointing the specific factors most affecting competitive intensity. Would you characterize the rivalry for better market position, increased sales, and market share among the companies in your industry as fierce, very strong, strong, moderate, or relatively weak? Why? 3. Are there any driving forces in the industry in which your company is competing? What impact will these driving forces have? Will they cause competition to be more or less intense? Will they act to boost or squeeze profit margins? List at least two actions your company should consider taking in order to combat any negative impacts of the driving forces. 4. Based on the strategic group maps for each of the four geographic regions shown in the most recent issue of the Competitive Intelligence Reports, which digital camera companies do you believe are in the most attractive positions? Which companies are the most weakly positioned? Which camera companies do you believe are likely to try to move to a different position on the strategic group map for this geographic region? What specific actions do these assessments indicate that your company should consider taking? Most attractively positioned companies: North America Latin America Asia-Pacific Europe-Africa Least attractively positioned companies: North America Latin America Asia-Pacific Europe-Africa Companies most likely to try to move to a different position: North America Latin America Asia-Pacific Europe-Africa Actions we may want to consider taking based on the above assessments: 5. What do you see as the key factors for being a successful competitor in your industry? List at least three. Chapter 3 Evaluating a Company's External Environment 32 Strategy: Core Concepts and Analytical Approaches Arthur A. Thompson, The University of Alabama 4th Edition, 2016-2017 An e-book published by McGraw-Hill Education, Burr Ridge, IL CHAPTER 3 Evaluating a Company's External Environment Analysis is the critical starting point of strategic thinking. Kenichi Ohmae, consultant and author Things are always differentthe art is figuring out which differences matter. Laszlo Birinyi, investments manager In essence, the job of a strategist is to understand and cope with competition. Michael E. Porter, Harvard Business School professor M anagers are not prepared to act wisely in steering a company in a different direction or altering its strategy until they have a deep understanding of the pertinent factors surrounding the company's situation. Two facets of a company's situation are especially pertinent: (1) the industry and competitive environment in which the company operates and the forces acting to reshape this environment, and (2) the company's own market position and competitivenessits resources and capabilities, its strengths and weaknesses vis--vis rivals, and its windows of opportunity. Insightful diagnosis of a company's external and internal environment is a prerequisite for managers to succeed in crafting a strategy that is an excellent fit with the company's situation, is capable of building a competitive advantage, and has good prospects for boosting company performancethe three criteria of a winning strategy. As depicted in Figure 3.1, the task of crafting a strategy begins with appraisals of the company's external and internal environments (as a basis for deciding upon a long-term direction and developing a strategic vision), moves toward an evaluation of the most promising alternative strategies and business models, and culminates in choosing a specific strategy. This chapter presents the concepts and analytical tools for zeroing in on those aspects of a single-business company's external environment that should be considered in making strategic choices. Attention centers on broad aspects of the company's \"macro-environment,\" the specific market arena in which the company operates, the drivers of market change, the market positions and likely actions of rival companies, and the factors that determine competitive success. In Chapter 4, we explore the methods of evaluating a company's internal circumstances and competitiveness. 32 Copyright 2016 by Arthur A. Thompson. All rights reserved. Not for distribution. Chapter 3 Evaluating a Company's External Environment Figure 3.1 From Thinking Strategically about the Company's Situation to Choosing a Strategy Thinking strategically about a company's external environment Thinking strategically about a company's internal environment Form a strategic vision of where the company needs to head Identify promising strategic options for the company Select the best strategy and business model for the company The Strategically Relevant Factors Influencing a Company's External Environment Every company operates in a broad macro-environment shaped by influences relating to national and/or global economic conditions; political, legal, and regulatory factors; technological factors; sociocultural factors (societal values, lifestyles, and shifting population demographics); considerations relating to the natural environment; and, closer to home, the industry and competitive arena in which the company operates (see Figure 3.2). Strictly speaking, a company's macro-environment includes all factors and influences outside the company's boundaries that are important enough to have a bearing on the decisions the company ultimately makes about its direction, objectives, strategy, and business model. The impact of influences in the outer ring of the macroenvironment can range from big to small and occur slowly or rapidly, with or without warningdifferent companies and industries are typically affected in different ways and to different degrees. For example, the strategic opportunities of cigarette producers to grow their business are influenced by antismoking ordinances, the decisions of governments to impose higher cigarette taxes, the cultural stigma attached to smoking, and newly-emerging e-cigarette technology. The homebuilding industry is affected by such macro-influences as shifting economic conditions; trends in household incomes and buying power; rules and regulations that make it easier/harder for homebuyers to obtain mortgages; changes in mortgage interest rates; shifting preferences of families for renting versus owning a home; shifting demand for homes of various sizes, styles, and price ranges; and shifting tastes and preferences for particular kinds of home features. Food processing companies must adapt to changing consumer attitudes toward processed foods laden with chemical ingredients, growing interest in natural and organic foods, and heightened public concerns about nutrition, healthy-eating, and obesity/diabetes risks. Fine dining and other types of restaurants have to adapt to growing consumer preferences for healthy, less-calorific menu choices that include vegetarian and gluten-free selections, organic and pasture-fed meats, and organic and/or locally grown fruits and vegetables. But even if the factors in the outer ring of the macroenvironment change slowly or seem likely to have a low impact on a company's business situation, company managers are obligated to remain alert to potentially important outer-ring developments, assess their impact and influence, and adapt the company's direction and strategy as needed. Table 3.1 discusses the factors in the outer ring of the macro-environment in more detail and explains why they are strategically relevant considerations worthy of ongoing management attention. Copyright 2016 by Arthur A. Thompson. All rights reserved. Not for distribution. 33 Chapter 3 Evaluating a Company's External Environment However, the factors and forces in a company's external environment having the biggest strategy-shaping impact typically pertain to the company's industry and competitive environmentthese include industry growth, competitive pressures, anticipated actions of rivals, forces driving industry change, the key factors for future competitive success, and the industry's outlook for profitability (as depicted in the inner ring of Figure 3.2). Consequently, the bulk of our attention in this chapter will be concentrated on the factors shaping a company's industry and competitive environment. Figure 3.2 The Components of a Company's Macro-environment Table 3.1 The Five Outer-Ring Components of a Company's Macro-Environment Component General economic conditions Description Concerns the general economic climate and such specifics as the rate of economic growth, trends in per capita income and discretionary income, the inflation rate, the unemployment rate, interest rates and the availability of credit, consumer confidence, exchange rates, trade deficits or surpluses, and conditions in the stock market, bond market, and the real estate market. Some industries, such as construction, are particularly vulnerable to economic downturns but are positively affected by factors such as low interest rates and favorable mortgage lending terms. Some industries and companies, such as discount retailing, benefit when general economic conditions weaken, as consumers become more price conscious. Copyright 2016 by Arthur A. Thompson. All rights reserved. Not for distribution. 34 Chapter 3 Evaluating a Company's External Environment Political, legal, and regulatory influences Pertinent political, legal, and regulatory factors include whether government officials are friendly or openly hostile to businesses; whether the political climate is conducive to raising/lowering taxes or keeping tax rates stable; and whether government spending is under control or out of control. The extent to which politicians are inclined to intervene in the economy and impose a host of burdensome laws and regulations and/or grant subsidies to companies/industries deemed worthy of special government support, are industry specific. Likewise, companies in coal-mining, meat-packing, and steel-making where many jobs are hazardous or carry high risk of injury are much more impacted by occupational safety regulations than are companies in retailing or software programming. Minimum wage legislation largely impacts low-wage industries that employ substantial numbers of relatively unskilled workers. Technological influences The most important technological factors concern the pace of technological change and socalled breakthrough technical innovations that have the potential for wide-ranging effects on society, such as genetic engineering, nanotechnology, and solar energy technology. Technological changes can spawn the birth of altogether new industries (Internet retailing, drones, smart phones, connected wearable devices), disrupt others (cloud computing, mobile payments, 3-D printing, big data solutions), and render others obsolete (film cameras, music CDs). Sociocultural forces concern the nature and range of values, attitudes, beliefs, cultural influences, and lifestyles that impact demand for particular goods and services, as well as demographic factors such as population size, growth rate, and age distribution. An example of sociocultural influences is the trend toward healthier lifestyles, which can shift spending toward exercise equipment and health clubs and away from snack foods. The demographic effect of people living longer lives is having a huge impact on the health care, recreation, travel, hospitality, and entertainment industries. Sociocultural influences (values, lifestyles, and shifting population demographics) Considerations relating to the natural environment The relevance of environmental considerations stems from the fact that some industries contribute more significantly than others to air and/or water pollution or to the depletion of irreplaceable natural resources, or to inefficient energy/resource usage, or are closely associated with other types of environmentally damaging activities (unsustainable agricultural practices, the creation of waste products that are not recyclable or biodegradable). Growing numbers of companies worldwide, in response to stricter environmental regulations and also to mounting public concerns about the environment, are implementing actions to be more environmentally and ecologically responsible. Assessing a Company's Industry and Competitive Environment To gain deep understanding of a company's industry and competitive environment, managers do not need to gather all the information they can find and spend lots of time digesting it. Rather, the task can be focused on using some well-defined concepts and analytical tools to get clear answers to six questions: 1. What competitive forces do industry members face, and how strong are they? 2. What forces are driving changes in the industry, and what impact will these changes have on competitive intensity and industry profitability? 3. What market positions do industry rivals occupywho is strongly positioned and who is not? 4. What strategic moves are rivals likely to make next? 5. What are the key factors for future competitive success? 6. Is the industry outlook conducive to good profitability? Analysis-based answers to these questions provide managers with the understanding needed to craft a strategy that fits the company's external situation. The remainder of this chapter is devoted to describing the methods of obtaining solid answers to these six questions and explaining how the nature of a company's industry and competitive environment has some bearing on company managers' strategic choices. Copyright 2016 by Arthur A. Thompson. All rights reserved. Not for distribution. 35 Chapter 3 Evaluating a Company's External Environment Question 1: What Competitive Forces do Industry Members Face and How Strong are They? The character, mix, and subtleties of the competitive forces operating in a company's industry are never the same from one industry to another. The most powerful and widely used tool for systematically diagnosing the principal competitive pressures in a market and assessing the strength and importance of each is the five forces model of competition.1 This model, depicted in Figure 3.3, holds that the state of competition in an industry is a composite of five competitive forces: 1. The market maneuvering and jockeying for buyer patronage among rival sellers in the industry. 2. The threat of new entrants into the market. 3. The attempts of companies in other industries to win buyers over to their own substitute products. 4. The exercise of supplier bargaining power. 5. The exercise of buyer (or customer) bargaining power. Using the five forces model to determine the nature and strength of competitive pressures in a given industry involves building the picture of competition in three steps: n Step 1: Identify the specific competitive pressures associated with each of the five forces. n Step 2: Evaluate how strong the pressures comprising each of the five forces are (fierce, strong, moderate to normal, or weak). n Step 3: Determine whether the collective strength of the five competitive forces is conducive to earning attractive profits. Competitive Pressures Created by the Rivalry among Competing Sellers The strongest of the five competitive forces is nearly always the market maneuvering for buyer patronage that goes on among rival sellers of a product or service. In effect, a market is a competitive battlefield where the contest among competitors is ongoing and dynamic. Each competing company endeavors to deploy whatever means CORE CONCEPT in its business arsenal it believes will attract and retain Competitive maneuvering among industry rivals buyers, strengthen its market position, and yield good is ever changing, as competing sellers initiate profits. The challenge is to craft a competitive strategy that, round after round of offensive and defensive at the very least, allows a company to hold its own against moves, emphasizing first one mix of competitive rivals and that, ideally, produces a competitive edge over weapons and then another in efforts to improve many, if not all, rivals. But when one industry competitor their market positions and profitability. deploys a strategy or makes a new strategic move that produces good results, its rivals typically respond with offensive or defensive countermoves of their own. This pattern of action and reaction, move and countermove, adjust and readjust produces a continually evolving competitive landscape where the market battle ebbs and flows, sometimes takes unpredictable twists and turns, and produces winners and losers. But the winnersthe current market leadershave no guarantees of continued leadership; their market success is no more durable than the power of their latest strategies to fend off the latest strategies of ambitious challengers. In every industry, the ongoing jockeying of rivals leads to some companies gaining or losing momentum in the marketplace based on the success or failure of their latest strategic maneuvers.2 Copyright 2016 by Arthur A. Thompson. All rights reserved. Not for distribution. 36 Chapter 3 Evaluating a Company's External Environment Figure 3.3 The Five Forces Model of Competition: A Key Analytical Tool Firms in Other Industries Offering Substitute Products Competitive pressures coming from the market attempts of outsiders to win buyers over to their products Suppliers of Raw Materials, Parts, Components, or Other Resources Inputs Rivalry among Competing Sellers Competitive pressures stemming from supplier bargaining power Competitive pressures created by the maneuvers of rival sellers to win increased sales and market share and build/strengthen competitive advantage Competitive pressures stemming from buyer bargaining power Buyers Competitive pressures coming from the threat of entry of new rivals Potential New Entrants Source: Adapted from Michael E. Porter, \"How Competitive Forces Shape Strategy,\" Harvard Business Review 57, no. 2 (March-April 1979), pp. 137-145, and Michael E. Porter, \"The Five Competitive Forces that Shape Strategy,\" Harvard Business Review 86, no. 1 (January 2008), pp. 80-86. Figure 3.4 shows the competitive weapons that firms often employ in battling rivals and indicates the factors that influence the intensity of their rivalry. A brief discussion of the factors that influence the tempo of rivalry among industry competitors is in order:3 n Rivalry intensifies when competing sellers are active in launching fresh actions to boost their market standing and business performance. One indicator of active rivalry is lively price competition, a condition that puts pressure on industry members to drive costs out of the business and threatens the survival of high-cost companies. Another indicator of active rivalry is rapid introduction of next-generation productswhen one or more rivals frequently introduce new or improved products, competitors that lack good product innovation capabilities feel considerable competitive heat to get their own new and improved products into the marketplace quickly. Other indicators of active rivalry among industry members include: n\tWhether industry members are racing to differentiate their products from rivals by offering better performance features, higher quality, improved customer service, or a wider product selection. n\tHow frequently rivals resort to such marketing tactics as special sales promotions, heavy advertising, rebates, or low-interest-rate financing to drum up additional sales. Copyright 2016 by Arthur A. Thompson. All rights reserved. Not for distribution. 37 Chapter 3 Evaluating a Company's External Environment n\tHow actively industry members are pursuing efforts to build stronger dealer networks or expand their presence in foreign markets or otherwise expand their distribution capabilities. n\tHow hard companies are striving to gain a market edge over rivals by developing valuable expertise and capabilities that rivals are hard-pressed to match. Normally, competitive maneuvering among rival sellers is active because every competitor has a strong incentive to initiate fresh actions that hold promise for boosting its profitability and market standing. n Rivalry is usually weaker when buyer demand is growing rapidly, and stronger when buyer demand is growing slowly or even falling. Rapidly expanding buyer demand produces enough new business for all industry members to grow without resorting to aggressive efforts to steal sales from rivals. But in markets where growth is only 1 to 2 percent or certainly when buyer demand is shrinking, companies anxious (or perhaps desperate) to gain more business are likely to engage in aggressive price discounting, sales promotions, or other tactics to boost their sales volumes and revenues at the expense of rivals, sometimes precipitating by adversely affected industry members and igniting a fierce battle among most all industry members for customers and market share. n Rivalry increases as it becomes less costly for buyers to switch brands. The less costly it is for buyers to switch their purchases from the seller of one brand to the seller of another brand, the easier it is for sellers to steal customers away from rivals. But the higher the costs buyers incur to switch brands, the less prone they are to brand switching. Even if consumers view one or more rival brands as more attractive, they may not be inclined to switch because of the added time and inconvenience that may be involved or the psychological costs of abandoning a familiar brand. Distributors and retailers may not switch to the brands of rival manufacturers because they are hesitant to sever longstanding supplier relationships, incur any technical support costs or retraining expenses in making the switchover, go to the trouble of testing the quality and reliability of the rival brand, or devote resources to marketing the new brand (especially if the brand is lesser known). Consequently, unless buyers are dissatisfied with the brand they are presently purchasing, high switching costs weaken the rivalry among competing sellers. n Rivalry increases as the products of rival sellers become less differentiated and weakens as the products of industry rivals become more strongly differentiated. When the offerings of rivals are identical or weakly differentiated (because the brands of different sellers have comparable attributes), buyers have less reason to be brand loyalwhen one brand is mostly like another, buyers can shop the market for the best deal and switch brands at will. On the other hand, strongly differentiated product offerings among rivals breed high brand loyaltybecause many buyers are attached to the attributes of their preferred brand as opposed to the attributes of rival brands. Strong brand attachments make it tougher for sellers to draw customers away from rivals. Unless meaningful numbers of buyers are open to considering whatever new or different product attributes rivals are offering, the high degrees of brand loyalty that accompany strong product differentiation work against fierce rivalry among competing sellers. The degree of product differentiation also affects switching costs. When rivals' offerings are identical or weakly differentiated, it is usually easy and inexpensive for buyers to switch their purchases from one rival to another. Strongly differentiated products raise the probability that buyers will find it costly, inconvenient, or annoying to switch to brands with different and potentially less satisfying features. n Rivalry is more intense when industry members have too much inventory or significant amounts of idle production capacity, especially if the industry's product entails high storage costs or high fixed costs. Competitive pressures among rival sellers build quickly whenever a market is oversupplied (because many rivals have excessive inventories and/or industry-wide production capacity significantly exceeds market demand for the product). Efforts on the part of sellers to rid themselves of unwanted inventories or find ways to use idle production capacity creates a \"buyer's market\" that not only prompts rival sellers to pursue various volume-boosting sales tactics (for example, price discounts, extra advertising, rebates, and favorable credit terms) but also empowers buyers to insist on a lower price and other favorable purchase terms or else take their business elsewhereall of which intensifies rivalry. And if fixed costs account for a large fraction of total cost, industry members with significant amounts of Copyright 2016 by Arthur A. Thompson. All rights reserved. Not for distribution. 38 Chapter 3 Evaluating a Company's External Environment idle production capacity experience mounting competitive pressure to cut prices and/or institute other volume-boosting competitive tacticsso as to spread the burdensome total fixed costs over more a bigger unit sales volume and lower overall cost per unit sold. Figure 3.4 The \"Weapons\" That Can Be Used to Battle Rivals and the Factors Affecting the Strength of Rivalry Typical \"Weapons\" for Battling Rivals and Attracting Buyers Reducing price; granting discounts to win the business of particular buyers Introducing more or different features Innovating to improve product performance and quality Running ads to inform buyers of new or special features and/or to strengthen brand awareness and brand image Having periodic sales promotions, holding clearance sales, advertising items on sale Improving selection of models/styles Building a bigger/better dealer network Offering low interest rate financing Offering coupons Improving customer service Allowing buyers to customize what they purchase Improving warranties Providing quicker or cheaper delivery Developing competitively valuable capabilities rivals don't have Rivalry is generally stronger when: Rivalry among Competing Sellers How strong are the competitive pressures stemming from the maneuvers of rivals to win higher sales and market shares and build/strengthen competitive advantages? Competing sellers are active in making fresh moves to improve their market standing and business performance. Buyer demand is growing slowly. Buyers incur low costs in switching to rival brands. The products of rival sellers are essentially identical or else weakly differentiated, resulting in little or no buyer brand loyalty. Sellers have idle capacity and/or excess inventory. The industry's product is costly to hold in inventory, perishable, or seasonal. The number of rivals increases and/or rivals are of roughly equal size and competitive capability. One or more rivals are dissatisfied with their business performance and are making aggressive moves to attract more customers. Outsiders have recently acquired weak competitors and are spending heavily to turn them into major contenders. Rivals have diverse industry outlooks, objectives, or strategies and/or have production facilities in countries where production costs are materially different. Rivalry is generally weaker when: Industry members infrequently launch aggressive actions to take sales and market share away from rivals. Buyer demand is growing rapidly. Buyer costs to switch to rival brands are high. The products of rival sellers are strongly differentiated and the loyalty of buyers to their preferred brand is high. There are so many rivals that any one company's actions have little direct impact on the businesses of rivals. Sellers have small inventories and/or little idle capacity. Rivals have low fixed costs and low inventory storage costs. A few large sellers have the majority of sales and dominant market shares. Rivals have similar costs and similar industry outlooksthere are no industry mavericks to disrupt the status quo. Copyright 2016 by Arthur A. Thompson. All rights reserved. Not for distribution. 39 Chapter 3 Evaluating a Company's External Environment n Rivalry tends to be more intense when a product is costly to hold in inventory, perishable, or seasonal. This is because industry rivals have potent incentives to employ volume-boosting tactics to avoid high inventory storage costs, to rid themselves of perishable items before they spoil, and to clear out seasonal items before the end of the selling season. n Rivalry usually becomes more intense as competitors become more equal in size and capability, and as the number of competitors increases. When rivals are of comparable size and competitive strength, they can usually compete on a fairly equal footingan evenly matched contest tends to be fiercer than where one or more industry members have commanding market shares and substantially greater resources and capabilities than their much smaller rivals. A bigger number of competitors typically strengthens rivalry because the presence of more sellers raises the likelihood that fresh, creative strategic initiatives will be launched rather frequently, thereby prompting countermoves by rivals and precipitating a livelier market contest than might otherwise occur. However, as the number of competitors in the marketplace becomes progressively largerso that big sales and market share gains flowing from successful strategic moves by any one company ripple out to have little discernible impact on the businesses of its many rivals head-to-head rivalry becomes weaker. Why? Because in an industry with a large number of rivals (say, more than 20 or 30), each rival soon learns it is much affected by the actions of a single rival to boost its sales and improve its market positionthe absence of an imperative to respond to the moves of each rival weakens the intensity of head-to-head battles for market share. Furthermore, rivalry tends to grow weaker as the number of industry members declines from 5 to 4 to 3 to just 2. This is because in a market with few rivals, each competitor soon learns that an offensive to grow its sales and market share will be viewed by rivals as a hostile move to steal their customers. Actions that have an immediate adverse impact on rivals' sales and profits will almost certainly provoke vigorous retaliation, potentially triggering a ferocious and costly competitive battle. Companies that have only a few strong rivals thus come to understand the merits of restrained efforts to wrest sales and market share from competitors as opposed to undertaking hard-hitting offensives that escalate into a price war or that force industry members to sharply increase their expenditures for advertising, sales promotions, and other inducements to secure and retain customers. Deep price discounting and a marketing arms race nearly always erode the profits of every industry participant. n Rivalry increases when one or more competitors become dissatisfied with their sales volumes and launch offensives to steal business away from rivals. Firms in financial trouble or desperate for more customers often employ sales-boosting turnaround strategies that intensify rivalry. Aggressive rivals seeking to be a market leader or simply gain a bigger market share frequently initiate strategic offensives that turn competitive pressures up a notch. On occasion, rivalry intensifies because one or two industry members achieve game-changing technological breakthroughs and/or develop innovative new products that prove wildly popular, enabling them to capture significantly bigger sales volumes and market shares. In such cases, industry members that unexpectedly begin to lose many customers must scramble quickly to stay in the game; they either have to launch effective counterstrategies or become also-rans. n Rivalry increases when strong companies outside the industry acquire weak firms in the industry and launch aggressive, well-funded moves to transform their newly acquired competitors into major market contenders. A concerted effort to turn a weak rival into a market leader nearly always entails launching well-financed strategic initiatives to dramatically improve the competitor's product offering, excite buyer interest, and win a much bigger market shareactions that, if successful, put added pressure on rivals to counter with fresh strategic moves of their own. n Rivalry often becomes more intenseas well as more volatile and unpredictablewhen competitors have diverse views about where the industry is headed and/or have sharply differing long-term directions, objectives, strategies, and resource capabilities and/or have production facilities in different countries with different production costs. In industries where future market conditions are murky or fast changing, differing views of rivals about where the industry is headed and the resulting differences in how best to attract and retain customers typically sparks a spirited competitive battle for sales and market share. In globally competitive markets, attempts by cross-border rivals to gain stronger footholds in each other's domestic markets typically boost the intensity of rivalry, especially when the aggressors have Copyright 2016 by Arthur A. Thompson. All rights reserved. Not for distribution. 40 Chapter 3 Evaluating a Company's External Environment lower costs or products with more attractive features. Furthermore, a diverse group of sellers often contains one or more mavericks willing to try novel, high-risk, or rule-breaking market approaches, thus generating a livelier competitive environment that can produce surprising twists and turns. The above factors, taken as whole, determine how strong this competitive force is. Rivalry can be characterized as cutthroat or brutal when competitors engage in protracted price wars or habitually undertake other aggressive strategic moves that prove mutually destructive to profitability and inflict losses on most industry members. Rivalry can be considered fierce to strong when the battle for market share is so vigorous that industry profitability is unattractively low. Rivalry is moderate or normal when the maneuvering among industry members, while lively and healthy, still allows most industry members to earn acceptable profits. Rivalry is weak when most companies in the industry are relatively well satisfied with their sales growth and market shares, rarely undertake offensives to steal customers away from one another, andbecause of weak competitive forcesearn consistently good profits and returns on investment. Competitive Pressures Associated with the Threat of New Entrants New entrants into an industry threaten the positions of current industry participants since they will compete fiercely for sales and market share, add to the number of industry rivals, and add to the industry's supply capabilities. But even a moderate to strong threat of new entry puts added competitive pressure on current industry members and thus functions as an important competitive force. This is because credible threat of entry typically prompts some/many industry members to initiate defensive strategies (like exercising caution in raising prices and maybe even trimming prices, boosting advertising, announcing intentions to accelerate new product introductions, and so on) to deter new entry and signal their intent to make it harder for new entrants to be competitively successful. Just how serious the threat of entry is into a particular market depends on (1) whether entry barriers are high or low, (2) the expected reaction of existing industry members to the entry of newcomers, and (3) the size of the pool of likely entry candidates and the degree to which they have the resources to become formidable competitors (see Figure 3.5). Figure 3.5 Factors Affecting the Threat of Entry Entry threats are stronger when: Rivalry among Competing Sellers How strong are the competitive pressures associated with the entry threat from new rivals? Entry barriers are low or can be readily hurdled by entry candidates with adequate resources. Potential entrants do not expect that industry members are likely or able to strongly contest the entry of newcomers. The pool of entry candidates is large and some have adequate resources to overcome entry barriers and combat defensive actions of existing industry members. Existing industry members are looking to expand their market reach by entering product segments or geographic areas where they currently do not have a presence. Buyer demand is growing rapidly. Newcomers can expect to earn attractive profits. Entry threats are weaker when: Potential New Entrants Entry barriers are high. Entry candidates expect that industry members will strongly contest the efforts of newcomers to gain a market foothold. The pool of entry candidates is small. Buyer demand is growing slowly or is stagnant. The industry's outlook is risky or uncertain or offers limited profit opportunities for newcomers. Industry conditions often cause existing competitors to struggle to earn a decent profit. Copyright 2016 by Arthur A. Thompson. All rights reserved. Not for distribution. 41 Chapter 3 Evaluating a Company's External Environment Whether Entry Barriers Are High or Low. The strength of the threat of entry is governed to a large degree by whether potential new entrants face high or low entry barriers. High barriers reduce the threat of potential entry, whereas low barriers enable easier entry. The most widely encountered barriers that entry candidates must hurdle include:4 n The cost advantages enjoyed by industry incumbents. Existing industry members frequently have costs that are hard for a newcomer to replicate. The cost advantages of industry incumbents can stem from (1) scale economies in production, distribution, or other activities, (2) the learning-based cost savings that accrue from experience in performing certain activities such as manufacturing or new product development or inventory management, (3) cost-savings accruing from patents or proprietary technology, (4) partnerships with the best and cheapest suppliers of raw materials and components, (5) favorable locations, and (6) low fixed costs (because they have older facilities that have been mostly depreciated). The bigger the cost advantages of industry incumbents, the more risky it becomes for outsiders to attempt entry (since they will have to accept thinner profit margins or even losses until the cost disadvantages can be overcome). n Strong brand preferences and high degrees of customer loyalty. The stronger the attachments of buyers to established brands, the harder it is for a newcomer to break into the marketplace. In such cases, a new entrant must have the financial resources to spend enough on advertising and sales promotion to overcome customer loyalties and build its own clientele. Establishing brand recognition and building customer loyalty can be a slow and costly process. In addition, if it is difficult or costly for a customer to switch to a new brand, a new entrant must persuade buyers that its brand is worth the switching costs. To overcome switching-cost barriers, new entrants may have to offer buyers a discounted price or an extra margin of quality or service. All this can mean lower expected profit margins for new entrants, which increases the risk to startup companies dependent on sizable early profits to support their new investments. n High capital requirements. The larger the total dollar investment needed to enter the market successfully, the more limited the pool of potential entrants. The most obvious capital requirements for new entrants relate to manufacturing facilities and equipment, introductory advertising and sales promotion campaigns, working capital to finance inventories and customer credit, and sufficient cash to cover startup costs. n The difficulties of building a network of distributors or retailers and securing adequate space on retailers' shelves. A potential entrant can face numerous distribution channel challenges. Wholesale distributors may be reluctant to take on a product that lacks buyer recognition. Retail dealers must be recruited and convinced to give a new brand ample display space and an adequate trial period. When existing sellers have strong well-functioning distributor-dealer networks, a newcomer has an uphill struggle in squeezing its way into existing distribution channels. Potential entrants sometimes have to \"buy\" their way into wholesale or retail channels by cutting their prices to provide dealers and distributors with higher markups and profit margins, or by giving them big advertising and promotional allowances. As a consequence, a potential entrant's own profits may be squeezed unless and until its product gains enough consumer acceptance that distributors and retailers are anxious to carry it. n Restrictive or costly regulatory policies. Government agencies can limit or even bar entry by requiring licenses and permits. Regulated industries like cable TV, telecommunications, electric and gas utilities, radio and television broadcasting, liquor retailing, and railroads entail government-controlled entry. In international markets, host governments commonly limit foreign entry and must approve all foreign investment applications. Government-mandated safety regulations and environmental pollution standards are entry barriers because they raise entry costs. Recently-enacted banking regulations in many countries have made entry particularly difficult for small new bank startupscomplying with all the new regulations along with the various rigors of competing against existing banks requires very deep pockets. n Tariffs and international trade restrictions. National governments commonly use tariffs and various kinds of burdensome trade restrictions to raise entry barriers for foreign firms and protect domestic producers from outside competition. Copyright 2016 by Arthur A. Thompson. All rights reserved. Not for distribution. 42 Chapter 3 Evaluating a Company's External Environment Whether an industry's entry barriers ought to be considered high or low depends on the resources and competencies possessed by potential entrants. Small startup enterprises may find the prevailing entry barriers insurmountable. However, current industry participants looking to expand their market reach by entering new segments or geographic areas where they currently have no market presence normally have the resources to overcome the existing entry barriers without much difficulty. Likewise, outsiders with sizable financial resources, proven competitive capabilities, and a respected brand name may be able to hurdle an industry's entry barriers rather easily. For example, when Honda opted to enter the U.S. lawnmower market in competition against Toro, Snapper, Craftsman, John Deere, and others, it was easily able to hurdle entry barriers that would have been formidable to other newcomers because it had longstanding expertise in gasoline engines, and its well-known reputation for quality and durability in automobiles gave it instant credibility with homeowners. Honda had to spend relatively little on advertising to attract buyers and gain a market foothold. Distributors and dealers were quite willing to handle the Honda lawnmower line, and Honda had ample capital to build a U.S. assembly plant. Similarly, Samsung's brand reputation in televisions, DVD players, and other electronics products gave it strong credibility in entering the market for smart phonesSamsung's Galaxy smartphones are now a formidable rival of Apple's iPhone. However, it is important to understand that the barriers to entering an industry can become stronger or weaker over time. Changing industry circumstances can cause one or more entry barriers to become easier to hurdle (maybe even disappear) or harder to hurdle, thus raising or lowering the threat of entry. For example, in the pharmaceutical industry the expiration of a key patent on a widely prescribed drug greatly lowers an important entry barrier and virtually guarantees that one or more drug makers will enter with generic offerings of their own. When companies win new patents on their technological discoveries or develop proprietary low-cost production techniques, entry barriers rise significantly. Regulatory changes can raise entry barriers when new regulations impose significant cost and compliance burdens on industry members and lower entry barriers when rules and regulations become more relaxed. The Expected Reaction of Industry Members in Defending against New Entry A second factor affecting the threat of entry relates to the ability and willingness of industry incumbents to launch strong defensive maneuvers to maintain their positions and make it harder for a newcomer to compete successfully and profitably. Entry candidates may have second thoughts about attempting entry if they conclude that existing firms will mount well-funded campaigns to hamper (or even defeat) a newcomer's strategy to gain a market foothold big enough to compete successfully; such campaigns can include reducing prices, offering special price discounts to the very customers a newcomer is seeking to attract, stepping up advertising expenditures, running frequent sales promotions, adding attractive new product features (to match or beat the newcomer's product offering), increasing spending on R&D to speed the introduction of new and improved products, or providing additional services to customers. Strong expectations on the part of new entrants that some or many important industry incumbents will strongly contest a newcomer's entry raise a new entrant's costs and risks, perhaps by enough to dissuade some/many entry candidates from going forward. Microsoft can be counted on to fiercely defend the position that Windows enjoys in computer operating systems and that Microsoft Office has in office productivity software. The world's leading motor vehicle producers (General Motors, Ford, BMW, Volkswagen, Toyota, Daimler Benz, and others) are mounting strong defensive actions to contest the strategic intent and strategic actions of newcomer Tesla Motors to sell 500,000 battery-powered Tesla vehicles by 2021. However, there are occasions when industry incumbents have nothing in their competitive arsenal that is formidable enough to either discourage entry or put obstacles in a newcomer's path that will defeat its strategic efforts to become a viable competitor. In the restaurant industry, for example, existing restaurants in a given geographic market have a limited and largely ineffective menu of actions they can take to discourage a new restaurant from opening or to block it from attracting enough patrons to be profitable. A fierce competitor like Nike has not prevented newcomer Under Armour from rapidly growing its sales and market share in sport apparel. Amazon.com, despite its competitively formidable size, attractively low prices, wide selection, fast delivery, and well-regarded reputation, lacks the ability to prevent other online retailers whose merchandise lineups are comparable to items found on Amazon's website from building a profitable customer baserather, the number of online retailers is growing and the sales of all kinds of online retailers are exploding. Copyright 2016 by Arthur A. Thompson. All rights reserved. Not for distribution. 43 Chapter 3 Evaluating a Company's External Environment 44 Furthermore, there are occasions when industry incumbents can be expected to not initiate any actions specifically aimed at contesting a newcomer's entry. In large industries, entry by small startup enterprises normally poses no immediate or direct competitive threat to industry incumbents and their entry is not likely to provoke defensive actions. For instance, a new online retailer with sales prospects of maybe $5-$10 million annually can reasonably expect to escape competitive retaliation from Amazon.com. The less that a newcomer's entry will adversely impact the sales and profitability of industry incumbents, the more reasonable it is for potential entrants to expect industry incumbents to ignore the entry of newcomers (in the sense of not making new competitive moves to combat the newcomer's efforts to attract customers and become profitable). The Pool of Likely Entry Candidates and Their Resource Capabilities. A third factor relates to the size of the pool of likely entry candidates and the resources at their command. As a rule, the bigger the pool of entry candidates, the stronger the threat of potential entry. This is especially true when some entry candidates have ample resources to hurdle existing entry barriers and may also have the potential to become formidable contenders for market leadership. However, in many industries the strongest entry threat frequently comes not from companies outside the industry but from existing industry members seeking to expand by entering market segments or geographic areas where they currently do not have a market presence. Companies already well established in certain product categories or geographic areas usually possess the resources, competencies, and competitive capabilities to hurdle the barriers of entering a different market segment or new geographic area. Industry Attractiveness Factors The fourth and final factor shaping whether the threat of entry is strong or weak is how attractive the growth and profit prospects are for new entrants. Rapidly growing market demand and high potential profits act as magnets, growing the pool of entry candidates and motivating potential entrants to commit the resources needed to hurdle entry barriers.5 When the growth opportunities and profit prospects of new CORE CONCEPT entrants are sufficiently attractive, entry barriers are unlikely The threat of entry is stronger when entry barriers to be an effective entry deterrent. At most, they limit the are low, when incumbent firms are unable or pool of candidate entrants to enterprises with the requisite unwilling to vigorously contest a newcomer's resources and competencies to compete head-to-head with entry, when there's a sizable pool of entry incumbent firms. In contrast, when an industry's growth candidates, and when the industry's outlook is prospects are minimal or if its outlook is risky/uncertain or highly attractive to outsiders. if industry members often struggle to earn a decent profit (because the industry is plagued by intense competition or other profit-limiting conditions), the pool of potential entrants shrinksthere is seldom any good business reason for a company to enter an industry or a market segment if its prospects for good long-term profitability are poor. Therefore, a very revealing indicator of whether potential entry is a strong or weak competitive force in the marketplace is to inquire if the industry's growth and profit prospects are strongly attractive to potential entry candidates. When the answer is no, potential entry is a weak competitive force. When the answer is yes and there are entry candidates with sufficient (maybe even competitively powerful) expertise and resources to contend with entry barriers and retaliatory moves by industry incumbents, then the high probability of new entry qualifies as a strong competitive force. Competitive Pressures from the Sellers of Substitute Products Companies in one industry come under competitive pressure from the actions of companies in a closely adjoining industry whenever buyers view the products of the two industries as good substitutes. For instance, the producers of eyeglasses and contact lens face competitive pressures from the doctors who do corrective laser surgery. The producers of wine face competitive pressures from the makers of beer and hard liquors (bourbon, vodka, tequila, rum, etc.). The producers of sugar experience competitive pressures from the producers of sugar substitutes (high-fructose corn syrup, agave syrup, and artificial sweeteners). Internet providers of news-related information have put brutal competitive pressure on the publishers of newspapers. As depicted in Figure 3.6, three factors determine whether the competitive pressures from substitute products are strong, moderate, or weak: Copyright 2016 by Arthur A. Thompson. All rights reserved. Not for distribution. Chapter 3 Evaluating a Company's External Environment 1. Whether substitutes are readily available and attractively priced. The presence of readily available and attractively priced substitutes creates competitive pressure by placing a ceiling on the prices industry members can charge without giving customers an incentive to switch to substitutes and risking sales erosion.6 This price ceiling, at the same time, puts a lid on the profits that industry members can earn unless they find ways to cut costs. 2. Whether buyers view the substitutes as comparable or better in terms of quality, performance, and other relevant attributes. The availability of substitutes inevitably invites buyers to compare performance, features, ease of use, and other attributes besides price. The users of paper cartons constantly weigh the performance trade-offs with plastic containers and metal cans. Movie enthusiasts are increasingly weighing whether to go to movie theaters to watch newly released movies or wait till they can watch the same movies streamed to their home TV by Netflix, Amazon Prime, cable providers, and other on demand sources. Competition from the providers of good-performing substitutes unleashes competitive pressures on industry participants to incorporate new features and attributes that make their product offerings more competitive. 3. Whether the costs that buyers incur in switching to the substitutes are low or high. Low switching costs make it easier for the sellers of attractive substitutes to lure buyers to their offering; high switching costs deter buyers from purchasing substitute products.7 As a rule, the lower the price of readily available substitutes, the higher their quality and performance, and the lower the user's switching costs, the more intense the competitive pressures posed by the sellers of substitute products. Other market indicators of the competitive strength of substitute products include (1) whether the sales of substitutes are growing faster than the sales of the industry being analyzed (a sign that the sellers of substitutes may be drawing customers away from the industry in question); (2) whether the producers of substitutes are investing in added capacity and market coverage; and (3) whether the producers of substitutes have rising profits. Figure 3.6 Factors Affecting Competition from Substitute Products Competitive pressures from substitutes are stronger when: Good substitutes are readily available or new ones are emerging. Substitutes are attractively priced. Substitutes have comparable or better performance features. Buyers have low costs in switching to substitutes. Buyers are growing more comfortable with using substitutes. Competitive pressures from substitutes are weaker when: Good substitutes are not readily available or don't exist. Substitutes are higher priced relative to the value they deliver to buyers. Substitutes lack comparable or better performance features. Buyers have high costs in switching to substitutes. Signs that Competition from Substitutes Is Strong Sales of substitutes are growing faster than sales of the industry being analyzed (an indication that the sellers of substitutes are stealing the industry's customers away). Producers of substitutes are investing in new capacity and expanding their market coverage. Profits of the producers of substitutes are rising. Firms in Other Industries Offering Substitute Products How strong are competitive pressures coming from the attempts of companies outside the industry to win buyers over to their products? Rivalry Among Competing Sellers Copyright 2016 by Arthur A. Thompson. All rights reserved. Not for distribution. 45 Chapter 3 Evaluating a Company's External Environment Competitive Pressures Stemming from Supplier Bargaining Power Whether the suppliers of industry members represent a strong, moderate, or weak competitive force depends on how much bargaining power suppliers have to influence the terms and conditions of supply in their favor. Powerful or influential suppliers can be a source of competitive pressure because of their ability to charge industry members higher prices and/or make it difficult or costly for industry members to switch to other suppliers. A number of circumstances determine the nature and strength of supplier bargaining power:8 n Whether certain needed inputs are in short supply. Suppliers of items in short supply have some degree of pricing power, whereas a surge in the available supply of particular items greatly weakens supplier pricing power and bargaining leverage. n Whether certain suppliers provide a differentiated input that enhances the performance or quality of the industry's product. The more valuable a particular input is in terms of enhancing the performance or quality of industry members' products, the more bargaining leverage and pricing power such suppliers have. n Whether certain suppliers provide equipment or services that deliver valuable cost-saving efficiencies to industry members in operating their production processes. Suppliers who provide cost-saving equipment or other valuable or necessary production-related services are likely to possess bargaining leverage and be in a position both to resist requests for concessions from industry members and to charge higher prices than they might otherwise be able to provide. Industry members that do not source from such suppliers may find themselves at a cost disadvantage and thus under competitive pressure to buy the cost-saving equipment or services of these suppliers (on terms that are favorable to the suppliers). n Whether the item being supplied is a standard item or commodity that is readily available from a host of suppliers at the going market price. The suppliers of commodities (like copper or steel reinforcing rods or shipping cartons) are in a weak position to demand a premium price or insist on other favorable terms because industry members can readily obtain essentially the same item at the same price from any of several other suppliers eager to win their business, perhaps dividing their purchases among two or more suppliers to promote lively competition for orders. The suppliers of commodity items have market power only when supplies become so tight that industry members agree to pay more to have their orders filled and delivered on time. n Whether it is difficult or costly for industry members to switch their purchases from one supplier to another or to switch to attractive substitute inputs. High switching costs convey strong bargaining power to suppliers, whereas low switching costs and ready availability of good substitute inputs weaken the bargaining power of suppliers. Soft drink bottlers, for example, can counter the bargaining power of aluminum can suppliers by shifting or threatening to shift to greater use of plastic containers and introducing more attractive plastic container designs. n Whether industry members are major customers of suppliers. As a rule, suppliers have less bargaining leverage when their sales to members of this one industry constitute a big percentage of their total sales. In such cases, the well-being of suppliers is closely tied to the well-being of their major customers. Suppliers have a big incentive to protect and enhance the competitiveness of their major customers via reasonable prices, exceptional quality, and ongoing advances in the technology of the items supplied. n Whether suppliers provide an item that accounts for a sizable fraction of the costs of the industry's product. The bigger the cost of a particular part or component, the harder it is for suppliers to boost their prices because such higher prices result in big increases in unit costs and total costs for the industry memberscost increases that may adversely affect their competitiveness and long-term well-being. In such cases, suppliers must be cautious about charging prices that damage the business performance of their customers, and they can expect industry members to bargain hard in resisting suppliers' price increases. On the other hand, when suppliers' product or service accounts for a small or tiny fraction of industry members' unit costs and total costs, suppliers have added power over the price and other terms of supply; this is especially true when industry members are not major customers of these suppliers and their purchases generate only small revenues. Copyright 2016 by Arthur A. Thompson. All rights reserved. Not for distribution. 46 Chapter 3 Evaluating a Company's External Environment n Whether only a few suppliers are regarded as the best or preferred sources of a particular item. Highly regarded suppliers with strong demand for the items they supply generally have sufficient bargaining power to deny industry members' requests for lower prices or other concessions, and they may also have the clout to charge higher prices when they make innovative improvements in the items they supply. Nonetheless, the bargaining power of preferred suppliers can erode substantially if their profits are suffering and they need to boost sales. Moreover, the larger the number of acceptable that industry members have to purchase from, the weaker the bargaining power of any one supplier, even if they enjoy preferred status. n Whether it makes good economic sense for industry members to integrate backward and self-manufacture items they have been buying from suppliers. The make-or-buy issue generally boils down to whether suppliers who specialize in the production of a particular part or component and make them in volume for many different customers have the expertise and scale economies to supply as good or better components at a lower cost than industry members could achieve via self-manufacture. Frequently, it is difficult for industry members to self-manufacture parts and components more economically than they can obtain them from suppliers who specialize in making such items. For instance, most producers of outdoor power equipment (such as lawn mowers, rotary tillers, and leaf blowers) find it cheaper to source the small engines they need from outside manufacturers who specialize in small engine manufacture rather than make their own engines because the quantity of engines they need is too small to justify the investment in production facilities, master the production process, and capture scale economies. Specialists in small engine manufacture, by supplying many kinds of engines to the whole power equipment industry, can obtain a big enough sales volume to fully realize scale economies, become proficient in all the manufacturing techniques, and keep costs low. As a rule, suppliers are safe from the threat of selfmanufacture by their customers until the volume of parts a customer needs becomes large enough for the customer to justify backward integration into self-manufacture of the component. Figure 3.7 summarizes the conditions that tend to make supplier bargaining power strong or weak. Figure 3.7 Factors Affecting the Bargaining Power of Suppliers Suppliers of Raw Materials, Parts, Components, or Other Resource Inputs How strong are the competitive pressures stemming from supplier bargaining power? Rivalry among Competing Sellers Supplier bargaining power is stronger when: Supplier bargaining power is weaker when: A needed input is in short supply. Certain suppliers either have a differentiated input that enhances the quality or performance of sellers' products or provide equipment/services that deliver valuable cost-saving efficiencies. Industry members incur high costs in switching to alternative suppliers. There are no good substitutes for certain products/services being supplied. Suppliers are not dependent on industry members for a large portion of their revenues. Suppliers provide an item that accounts for a small fraction of the costs of the industry's product. There are only a few \"preferred\" suppliers of a particular input. Some suppliers are a threat to integrate forward into the business of industry members and perhaps become a powerful rival. There are ample supplies of a needed input. The item being supplied is a \"commodity\" obtainable from many different suppliers at the going market price. Industry members incur low costs in switching to alternative suppliers. Good substitutes exist for the products/services of suppliers. Industry members are major customers and continuing to secure their business is important to suppliers' well-being. Suppliers provide an item that accounts for a sizable fraction of the costs of the industry's product. Industry members can purchase what they need from any of many different \"good to acceptable\" suppliers. Industry members are a threat to integrate backward into the business of suppliers and to self-manufacture their own requirements. Copyright 2016 by Arthur A. Thompson. All rights reserved. Not for distribution. 47 Chapter 3 Evaluating a Company's External Enviro