The External Environment

Chapter 4

McGraw-Hill/Irwin Copyright © 2009 by the McGraw-Hill Companies, Inc. All rights reserved.

Learning Objectives1. Three tiers of environmental factors that affect firm

performance2. Five factors in the remote environment3. Examples of the economic, social, political,

technological, and ecological influences on a business4. The five forces model of industry analysis and give

examples5. The influences of entry barriers, supplier power, buyer

power, substitute availability, and competitive rivalry on a business

6. The five factors in the operating environment7. The influences of competitors, creditors, customers,

labor, and direct suppliers on a business

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The Firm’s External Environment

Comprised of following Components: Remote environment Industry environment Operating environment

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Firm’s External Environment

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Societal EnvironmentImportant Variables

EconomicEconomicGDP trendsGDP trends

Interest ratesInterest ratesMoney supplyMoney supplyInflation ratesInflation rates

Unemployment levelsUnemployment levelsWage/price controlsWage/price controls

Devaluation/Devaluation/revaluationrevaluation

Energy availability Energy availability and costand cost

Disposable and Disposable and discretionary discretionary

incomeincome

TechnologicalTechnologicalTotal government Total government spending for R&Dspending for R&DTotal industry Total industry

spending for R&Dspending for R&DFocus of Focus of

technological technological effortsefforts

Patent protectionPatent protectionNew productsNew products

New developments in New developments in technology transfer technology transfer

from lab to from lab to marketplacemarketplaceProductivity Productivity improvements improvements

through automationthrough automation

Political-LegalPolitical-LegalAntitrust regulationsAntitrust regulations

Environmental Environmental protection lawsprotection laws

Tax lawsTax lawsSpecial incentivesSpecial incentives

Foreign trade Foreign trade regulationsregulations

Attitudes toward Attitudes toward foreign companiesforeign companies

Laws on hiring and Laws on hiring and promotionpromotion

Stability of Stability of governmentgovernment

SocioculturalSocioculturalLifestyle changesLifestyle changes

Career expectationsCareer expectationsConsumer activismConsumer activism

Rate of family Rate of family formationformation

Growth rate of Growth rate of population population

Age distribution of Age distribution of populationpopulation

Regional shifts in Regional shifts in populationpopulation

Life expectanciesLife expectanciesBirth ratesBirth rates

Remote Environment

Economic Factors Social Factors Political Factors Technological Factors Ecological Factors

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Economic Factors1. Prime interest rates2. Inflation rates3. Trends in the growth of the

gross national product 4. Unemployment rates5. Globalization of the economy

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Social FactorsPresent in the external environment:

Beliefs & Values Attitudes & Opinions Lifestyles

Developed from: Cultural conditioning Ecological conditioning Demographic makeup Religion Education Ethnic conditioning.

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Political Factors

Political constraints on firms:• Fair-trade Decisions• Antitrust Laws• Tax Programs• Minimum Wage Legislation• Pollution and Pricing Policies

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Technological Factors Technological forecasting helps protect and

improve the profitability of firms in growing industries.

It alerts strategic managers to impending challenges and promising opportunities.

The key to beneficial forecasting of technological advancement lies in accurately predicting future technological capabilities and their probable impacts.

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Ecological Factors Ecology refers to the relationships among

human beings and other living things and the air, soil, and water that supports them.

Threats to our life-supporting ecology caused principally by human activities in an industrial society are commonly referred to as pollution

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International Environment

Monitoring the international environment involves assessing each non-domestic market on the same factors that are used in a domestic assessment.

While the importance of factors will differ, the same set of considerations can be used for each country.

Economic, political, legal, and social factors are used to assess international environments.

One complication to this process is that the interplay among international markets must be considered.

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Industry Environment Harvard professor Michael E. Porter propelled the

concept of industry environment into the foreground of strategic thought and business planning.

The cornerstone of Porter’s work first appeared in the Harvard Business Review, in which he explains the five forces that shape competition in an industry.

Porter’s well-defined analytic framework helps strategic managers to link remote factors to their effects on a firm’s operating environment.

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Competitive Forces Shape Strategy

The essence of strategy formulation is coping with competition.

Intense competition in an industry is neither coincidence nor bad luck.

Competition in an industry is rooted in its underlying economics, and competitive forces exist that go well beyond the established combatants in a particular industry.

The corporate strategists’ goal is to find a position in the industry where his or her company can best defend itself against these forces or can influence them in its favor.

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Forces Driving Industry Competition

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Contending Forces Threat of New Entrants Threat of New Entrants

Threat of Entry Economies of Scale Product Differentiation Capital Requirements Cost Disadvantages Independent of Size Access to Distribution Channels Government Policy

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Powerful SuppliersSupplier is powerful when:

Supplier industry is dominated by a few companies but sells to many

Its product is unique and/or has high switching costs

Substitutes are not readily available Suppliers are able to integrate forward and

compete directly with present customers Purchasing industry buys only a small portion

of the supplier’s goods.

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Powerful BuyersBuyer is powerful when:

Buyer purchases large proportion of seller’s products

Buyer has the potential to integrate backward Alternative suppliers are plentiful Changing suppliers costs very little Purchased product represents a high percentage of a

buyer’s costs Buyer earns low profits Purchased product is unimportant to the final

quality or price of a buyer’s products

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Substitute ProductsSubstitute Products:

Those products that appear to be different but can satisfy the same need as another product. To the extent that switching costs are low, substitutes can have a strong effect on an industry

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Jockeying for PositionIntense rivalry related to:

Number of competitors Rate of Industry Growth Produce or Service Characteristics Amount of Fixed Costs Capacity Height of Exit Barriers Diversity of Rivals

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Industry Analysis & Competitive Analysis

An industry is a collection of firms that offer similar products or services.

Structural attributes are the enduring characteristics that give an industry its distinctive character.

Concentration refers to the extent to which industry sales are dominated by only a few firms.

Barriers to entry are the obstacles that a firm must overcome to enter an industry.

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Competitive Analysis1. How do other firms define the scope of their

market?2. How similar are the benefits the customers

derive from the products and services that other firms offer? The more similar the benefits of products or services, the higher the level of substitutability between them.

3. How committed are other firms to the industry?

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Operating EnvironmentAlso called competitive or task environment Includes competitor positions and customer

profiling based on the following factors: Geographic Demographic Psychographic Buyer Behavior

Also includes suppliers & creditors and HRM

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HR: Nature of the Labor Market

Access to personnel is affected by 4 factors: Firm’s reputation as an employer Local employment rates Availability of people with the needed

skills Its relationship with labor unions.

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Emphasis on Environmental Factors Differing external elements affect different strategies at

different times and with varying strengths Only certainty is that the effect of the remote and operating

environments will be uncertain until a strategy is implemented

Many managers, particularly in less powerful firms, minimize long-term planning

Instead, they allow managers to adapt to new pressures from the environment

Absence of strong resources and psychological commitment to a proactive strategy effectively bars a firm from assuming a leadership role in its environment

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