Objectives
External Environment
What is the external environment?
Chapter 2
3-1
External Environment

“All the relevant factors and influences outside
of the company’s boundaries”

Relevant means important enough to have a
bearing on the decisions of the company as it
makes about its directions

Some factors have low impact and others have
high impact
General Environment

Demographic segment – Most Crucial

Aging of the population
– Positive effect on healthcare
– Negative effects on funeral home industry
– Preference for cheaper funerals – cremations ($2000) vs.
burials ($7000)
– “Killing” margins in industry
– Need for company to be proactive
– Ex: Ski resorts and baby boomers
– Extreme luxury in cruises etc.

Key components of general environment

Porter’s five forces model

Organization of external environment:
Opportunities and threats

Techniques
– External factor analysis summary
Example

Motorola – founded in 1930s as a maker of car
radios
– By 1980s, it had become key supplier of cellular
phones
– 1994 – “the company that everyone loves to love”
– Malcolm Baldridge Award winner and Six Sigma
pioneer
– In 1996, Motorola released its StarTac – beautiful,
sleek and…ANALOG!
– Despite ample indications for preference for digital
technology, Motorola ignored the technology
– Nokia – more sensitive to market trends
Demographics: Other Changes

Graying of baby boomers
– National Association of Home Builders estimate that
people in age group 55-74 will buy 281,000 homes in
2010 – up from 189,000 in 1995
– Construction companies scrambling to satisfy niche
– In 2025, 20% of population will be over 65
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The Gray Entrepreneur

For the past 10 years, adults aged 55 to 64
have been most likely to start businesses

People are living longer
– More likely to pursue business dreams rather than
work in their gardens!

Often, they don’t need to work

But developed network of people where starting
a business is not too difficult
Advertising to 18-34 year olds

Rise in online spending – 23% up in 2005

Number of other smaller events aimed at the
age group
– Ex: Online games
– Car shows etc.
Demographics: Obese - Implications

Rav4 – 3 inches wider than previous models

Select Comfort makes a mattress that’s 30% bigger than
the king!

Clothing retailers are also no longer shying away from
plus sizes

Bigger consumers tend to be more brand loyal and less
price sensitive

Dove’s natural shape ad
– Dove’s sales jumped 12%
The “unreachables:” 18-34 years old

Most important demographics in advertising –
but also most elusive

TV is only a fifth of what this segment spends
time with various media
– Other media include internet, blogs, movies etc.

Top spenders on cars, internet stereo and
sneakers

Spends about $13.5b on internet purchases

How do you reach this segment?
Big Opportunity: The Obese

Tim Barry – launched a seat-belt extender for
airplanes – very successful

Government stats – 60m Americans now
qualify as obese (20% of population)
– Up from 23m in 1980

Creation of $49b weight -loss industry
Environmental Scanning

Need to track key environmental trends, events
and activities
– Motel 6 executive – track number of rooms in budget
segment, difference between average daily room rate
and CPI
– Pier 1 exports executive – Net disposable income,
consumer confidence index, housing starts
– Johnson and Johnson medical products executive - %
of GDP on healthcare etc.
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Porters’s Five Forces Model Rivalry Among Competing Sellers

• Step 1: Identify the specific competitive pressures
Usually the strongest of the five forces
associated with each of the five forces

Key factor in determining strength of rivalry
• Step 2: Evaluate the strength of each competitive
force -- fierce, strong, moderate to normal, or weak? – How aggressively are rivals using various weapons
of competition to improve their market positions and
• Step 3: Determine whether the collective strength of
performance?
the five competitive forces is conducive
to earning attractive profits

What Are the Typical Weapons for

Competing?
Examples

Vigorous price competition

More or different
performance features

Better product performance

Higher quality

Stronger brand image and
appeal

Wider selection of models
and styles

Bigger/better dealer network

Low interest rate financing

Higher levels of advertising

Stronger product innovation
capabilities

Better customer service

Stronger capabilities to
provide buyers with custom-
made products

Fast food industry – extremely competitive

Health care industry – less competitive

Need to understand subtleties of industry

Competition may not always be on the basis of
price

Also need to consider other factors such as
design, style,functionality etc
– Ex: Shoe industry – Nike, Adidas, Reebok, and Puma

Competitive Force of Potential Entry Common Barriers to Entry

Seriousness of threat depends on
Sizable economies of scale

– Size of pool of entry candidates and available resources
Cost and resource disadvantages independent of size
– Barriers to entry
Brand preferences and customer loyalty
– Reaction of existing firms
Capital requirements and/or other specialized resource

Evaluating threat of entry involves assessing requirements

– How formidable entry barriers are for each type of potential
Access to distribution channels
entrant and
Regulatory policies
– Attractiveness of growth and profit prospects
Tariffs and international trade restrictions

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Examples: JotSpot – Hosted Wiki Excite vs. Jot Spot – Decades Later

Wikis – server software letting users edit
Excite
Jotspot

homepages
Labor and Overhead:
Labor and Overahead:
$1.5m $15K – global market –

Becoming increasingly adopted by small and India, Romania and
medium companies as replacement for email Russia
threads
Hardware: $1m
Hardware: $15K –
servers were $60K for

Excite co-founder Joe Kras created Jot Spot Excite – now only $1000

Marketing: $8K – “pay-

Marketing: $250K per-click” advertising

Software – opensource

Software: $250K freely available

How to Tell Whether Substitute Products

Force of Substitute Products Are a Strong Force

Substitutes matter when customers are
Whether substitutes are readily available and
attracted to the products of firms in other attractively priced
industries

Whether buyers view substitutes as being

Eyeglasses and contact lens vs. laser surgery comparable or better

Sugar vs. artificial sweeteners
How much it costs end users to switch to

Newspapers vs. TV vs. Internet substitutes

Example: Splenda Splenda

Johnson and Johnson has done the impossible: Take an
unknown brand to #1 in 5 years

How? Attacking sugar directly, not other artificial
sweeteners

Timeline:
– 1976 – sucralose discovered by Tate & Lyle – accidental
discovery
– Researcher misunderstood ‘taste’ for ‘test’
– Discovered that product is 600 times sweeter than sugar –
yet is not absorbed as a carbohydrate

To build Buzz, product was first rolled out to
diabetics

On to grocery stores and restaurants

Partnered with many major companies – now in
McDonald’s, Starbucks, Coke etc

Consumers are demanding Splenda

Has dipped into sugar sales and also exceeds
sales for Equal and Sweet’N’Low combined!

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Competitive Pressures From Suppliers

Whether supplier-seller relationships represent
a weak or strong competitive force depends on
– Whether suppliers can exercise sufficient bargaining
leverage to influence terms of supply in their favor
– Nature and extent of supplier-seller
collaboration in the industry
Bargaining Power of Buyers

Whether seller-buyer relationships represent a
weak or strong competitive force depends on
– Whether buyers have sufficient bargaining
leverage to influence terms of sale in their favor
– Extent and competitive importance of
seller-buyer strategic partnerships
in the industry
Strategic Implications of the Five
Competitive Forces

Competitive environment is unattractive from
the standpoint of earning good profits when
– Rivalry is vigorous
– Entry barriers are low and entry is likely
– Competition from substitutes is strong
– Suppliers and customers have considerable
bargaining power
When Is the Bargaining Power of Suppliers
Stronger?

There are only a few suppliers of a specific
input
– PC Industry: Microsoft and Intel

They provide unique and differentiated products
– For Coca-Cola bottler, there is only one supplier of
Coke Syrup

Customer is not important
– Ex: Boeing and Airbus are less likely to lower price for
smaller airlines
When Is the Bargaining Power of Buyers
Stronger?

Small number of buyers
– Ex: Few auto companies dealing with 1000s of
automobile component suppliers

Buyers purchase standard, commodity products
– Fast food industry

Possibility of backward integration
– Ex: Qualcomm used to have 90% market share of
code division multiple access chips for phones
– Samsung and Nokia began making their own CDMA
– Department stores carrying their own brand names
Strategic Implications of the Five
Competitive Forces

Competitive environment is ideal from a profit-
making standpoint when
– Rivalry is moderate
– Entry barriers are high and no firm is likely to enter
– Good substitutes do not exist
– Suppliers and customers are in a weak bargaining
position

Example: Pharmaceuticals industry
5
Caveats with Porter’s Five Forces

Static

Assumes a zero sum game – strategic alliance
can actually be helpful
SWOT: Threats – External Problems

Emergence of cheaper/better technologies

Introduction of better products by rivals

Entry of lower-cost foreign competitors

Onerous regulations

Rise in interest rates

Potential of a hostile takeover

Unfavorable demographic shifts

Adverse shifts in foreign exchange rates

Political upheaval in a country
External Factor Analysis Summary

To summarize information from industry
analysis etc.

Provides quantitative information about
external situation

Shows which areas of the external environment
the company should pay attention to
Example: Health Foods industry

People now obsess about obesity and food
safety

Growth of 17% in retail sales of natural foods

Will be even more powerful in the future

Smaller companies such as Hain Celestial are
the leading companies

However, large food companies such as Kraft
and General Mills are also eyeing the segment
Opportunities

Opportunities most relevant to a company are
those offering
– Good match with its financial and
organizational resource capabilities
– Best prospects for profitable
long-term growth
– Potential for competitive advantage

Popular examples
– New markets – e.g., international
– New product use
– Etc.
Steps

Step 1 - Identify critical opportunities and
threats (5 of each) OR Strengths and
Weaknesses
– Ex: Opportunities for beer industry - new markets,
new technology etc.
– Ex: Threat - Competition, sociocultural norms vs.
drinking

Step 2 - Assign weights (must be equal to one)
6
Steps Conclusion

Step 3 - Rate opportunities and threats OR SW
External environment provides key insights into
based on company’s response to each factor [5 conditions facing any firm
- outstanding, 4 - above average, 3 - average, 2
Need to properly assess conditions and
- below average, 1- poor) determine strategies that work best

Step 4 - Multiply weights by ratings and add

Step 5 - Add all weights x ratings

If total is above 3, company is dealing with its
external environment well