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External Analysis
Opportunities and Threats . Analyzing the dynamics of the industry in which an organization competes to help identify:
Opportunities . Conditions in the environment that a company can take advantage of to become more profitable .
Threats . Conditions in the environment that endanger the integrity and profitability of the company’s business .
Environment as :
· A source of information . Correct and timely information is obtained by analyzing external environment .
· A source of resources . Controlling environmental resources means knowing about the environment and attempting to change or influence it .
What is an external analysis?
1. External analysis builds upon the notion that organization’s are open systems. Often success is determined by the environment around the organization and not the intelligence inside the organization
2. Organizations need to pay attention to Opportunities and Threats :
a. Opportunities are positive external environmental trends that improve the organization’s performance
b. Threats are negative external environmental trends that hinder the organization's performance
Remote Environment : Economic , Demographic , Sociocultural , Political-Legal , Technological .
1. Economic Factors :
- Interest rates
- Monetary / currency exchange rates
- Inflation rates
- Consumer income, spending, and debt levels
- Unemployment levels
- Workforce productivity
2. Demographic Factors : Gender , Age , Income levels , Ethnic makeup , Education , Family composition , Geographic location, Birth rates .
3. Socio-Cultural Factors :
- Country’s culture
- Social Values : Traditions , Values , Attitudes / behaviors , Beliefs , Tastes , Patterns of behavior .
4. Political Legal Factors :
- Federal, state, and local : Laws , Regulations , Judicial decisions , Political forces
- Examples of legal changes ( US ) :
• Occupational Safety and Health Act of 1970
• Americans with Disabilities Act of 1990
• Family and Medical Leave Act of 1993
• North American Free Trade Agreement of 1993
5. Technical Factors : Communications, Computing, Transportation, Robotics, Biotechnology, Medicine and medical, Telecommunications, Consumer electronics
Porter’s Five Forces Model
The task facing managers is to recognize how changes in the five forces give rise to new opportunities and threats and to formulate appropriate strategic responses . It is possible for a company ( through its choice of strategy ) to alter / change the strength of one or more of the five forces to its advantage .
Industry Environment :
- potential Competitors (Entry Barriers) .
- Rivalry Among Established companies (Competitive Rivalry) .
- The Bargaining of Buyers (Buyer Power) .
- The Bargaining Power of Suppliers (Supplier Power) .
- The threat of Substitute Products (Substitute Availability) .
1. potential Competitors .
Potential competitors are companies that are not currently competing in an industry, but have the capability to do so if they chose . The more difficult it becomes for established companies to hold their share of the market and to generate profits . A high risk of entry by potential competitors represents a threat to the profitability of established companies .
If The risk of new entry is low, incumbent companies can take advantage of this opportunity to rise price and earn greater returns . The strength of competitive force of potential rivals / competitors is largely a function of the height of barriers to entry .
Barriers to entry : are the factors that make it costly for companies to enter an industry . The greater the costs that potential competitors must bear to enter an industry, the greater are the barriers to entry .
High barriers to entry keep potential competitors out of an industry, even when industry returns are high . The four main sources of barriers to new entry as following : ( Joe Bain )
a. Brand loyalty .
b. Absolute cost advantages .
c. Economies of scale .
d. Governmental regulation .
2. Rivalry Among Established companies .
The second of Porter’s five competitive forces is the extent of rivalry among established companies within an industry . If this rivalry is strong, significant price competition, including price wars, may result . If this rivalry is weak, companies have an opportunity to raise prices and earn greater profits.
Intense rivalry among established companies constitutes a strong threat to profitability . The extent of rivalry among established companies within an industry is largely a function of three factors :
1. The industry’s competitive structure .
2. Demand conditions .
3. The height of exit barriers in the industry .
exit barriers : Exit Barriers are economic, strategic, and emotional / effective factors that keep companies in an industry even when returns are low . If exit barriers are high, companies can become locked into an unprofitable industry in which overall demand is static or declining .
3. The Bargaining of Buyers .
A company’s buyers may be the customers who ultimately consume its products ( its end users ) . They may also be the companies that distribute its products to end users, such as retailers and wholesalers. Buyers can be viewed as a competitive threat when they are in position to demand lower prices from the company, or when they demand better service ( which can increase operating cost . On the other hand, when buyers are weak, a company can raise its prices and earn greater profits .
According to Porter, buyers are most powerful in following circumstances :
a. When the supply industry is composed of many small companies and the buyers are few in number and large. These circumstances allow the buyers to dominate supply companies .
b. When the buyers purchase in large quantities. In such circumstances, buyers can use their purchasing power as leverage to bargain for price reductions .
c. When the supply industry depend on the buyers for large percentage of its total orders .
d. When the buyers can switch orders between supply companies at low cost, thereby playing off companies against each other to force down prices .
e. When it is economically feasible for the buyers to purchase the input from several companies at once .
f. When the buyers can use the threat to supply their own needs through vertical integration as a device for forcing down prices .
4. The Bargaining Power of Suppliers .
Suppliers can be viewed as a threat when they are able to force up the price that a company must pay for its inputs or reduce the quality of the inputs they supply, thereby depressing the company’s profitability . If suppliers are weak, this gives a company the opportunity to force down prices and demand higher input quality . As with buyers, the ability of suppliers to make demands on a company depends on their power relative to that of the company .
According to Porter, suppliers are most powerful :
- When the product that sell has few substitutes and is important to the company .
- When the company’s industry is not an important customer of theirs . In such instances, the suppliers health dose not depend on the company’s industry, or improve quality .
- When their respective products are differentiated to such an extent that it is costly for a company to switch from one supplier to another . In such cases, the company depends on its suppliers and cannot play them off against each other .
- When, to raise prices, they can use the threat of vertically integrating forward into the industry and competing directly with the company .
- When buying companies cannot use the threat of vertically integrating backward and supplying their own needs as a means to reduce input prices .
5. The threat of substitute products .
Substitute products are those of industries that serve consumer’s needs in a way that is similar to those being served by the industry being analyzed . For example, companies in the coffee industry compete indirectly with those in the tea and soft drink industries. All three industries serve consumers’ needs for drinks . The prices that companies in the coffee industry can charge are limited be the existence of substitutes such as tea and soft drinks . If the prices of coffee rises too much relative to that of tea or soft drinks, coffee drinkers will switch from coffee to those substitutes .
The existence of close substitutes presents a strong competitive threat, limiting the price a company can charge and thus its profitability . However, if a company’s products have few close substitutes ( that is, if substitutes are weak competitive force ) then, other things being equal, the company has the opportunity to raise prices earn additional profits.
Industry / potential Competitors
Opportunity : Few competitors , Industry sales growing , Low fixed or inventory storage costs , Significant differentiation , Minimal exit barriers .
Threat : Numerous competitors , Industry sales slowing , High fixed or inventory storage costs , No differentiation , High exit barriers .
Potential Entrants
Opportunity: Significant economies of scale, Strong product differentiation , Significant switching costs , Controlled access to distribution channels .
Threat : No or low economies of scale, Weak product differentiation ,
Minimal switching cost , Open access to distribution channels .
Bargaining power of buyers
Opportunity : Buyer purchases small volumes , Purchases highly differentiated and unique , Buyer’s profits are strong, Buyer can’t manufacture products , Buyer’s have limited information .
Threats : Buyer purchases large volumes , Purchases standard or undifferentiated , Buyer’s profits are weak , Buyer can manufacture product , Buyer has full information.
Bargaining Power of Supplier
Opportunity : Supplying industry is fragmented , Supplier’s products have substitutes , Supplier’s products aren’t differentiated , Minimal switching costs in supplier’s products .
Threats : Supplying industry has a few companies , Supplier products do not have substitutes , Supplier’s products are differentiated , Significant switching costs .
Substitute Products
Opportunities : There are no good substitutes .
Threat : There are few good substitutes , There are several not-so-good substitutes .
How do you do an external analysis?
1. Find data :
a. Informal : Customer comments , Reading trade journals and general news media , Talking with suppliers' sales representatives .
b. Formal : External Information System (EIS) , Market and customer surveys .
2. Evaluate whether data is good or bad
3. Anticipate changes and plan accordingly
4. Provide information for planning, decision making & strategy formulation
5. Acquire and control needed resources
6. Make a difference with higher performance
7. Cautions :
- Rapid environmental changes are difficult to keep up with
- Amount of time that analysis can consume
- Forecasts and trend analyses are not actual fact
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