sample_chapter.pdf

LEARNING OBJECTIVES
LO1 Identify factors in a company’s broad macro-environment that may have
strategic significance.
LO2 Recognize the factors that cause competition in an industry to be fierce,
more or less normal, or relatively weak.
LO3 Become adept at mapping the market positions of key groups of industry
rivals.
LO4 Learn how to determine whether an industry’s outlook presents a
company with sufficiently attractive opportunities for growth and
profitability.
Evaluating a
Company’s External
Environment
3
chapter
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38 Part 1 Section B: Core Concepts and Analytical Tools
In Chapter 2, we learned that the strategy formulation, strategy execution
process begins with an appraisal of the company’s present situation. The
company’s situation includes two facets: (1) the competitive conditions in the
industry in which the company operates—its external environment; and (2) its
resources and organizational capabilities—its internal environment.
Charting a company’s long-term direction, conceiving its customer value
proposition, setting objectives, or crafting a strategy without first gaining an
understanding of the company’s external and internal environments ham-
strings attempts to build competitive advantage and boost company perfor-
mance. Indeed, the first test of a winning strategy inquires, “How well does the
strategy fit the company’s situation?”
This chapter presents the concepts and analytical tools for zeroing in on
a single-business company’s external environment. Attention centers on the
competitive arena in which the company operates, the drivers of market
change, the market positions of rival companies, and the factors that deter-
mine competitive success. Chapter 4 explores the methods of evaluating a
company’s internal circumstances and competitiveness.
Evaluating the Strategically Relevant
Components of a Company’s
Macro-Environment
A company’s external environment includes the immediate industry and com-
petitive environment and broader macro-environmental factors such as general
economic conditions, societal values and cultural norms, political factors, the
legal and regulatory environment, ecological considerations, and technologi-
cal factors. These two levels of a company’s external environment—the broad
outer ring macro-environment and immediate inner ring industry and com-
petitive environment—are illustrated in Figure 3.1. Strictly speaking, a com-
pany’s macro-environment encompasses all of the
relevant factors making up the broad environmental
context in which a company operates; by relevant,
we mean the factors are important enough that
they should shape management’s decisions regard-
ing the company’s long-term direction, objectives,
strategy, and business model. The relevance of
macro-environmental factors can be evaluated
using PESTEL analysis, an acronym for the six
principal components of the macro-environment:
political factors, economic conditions in the firm’s
general environment, sociocultural forces, techno-
logical factors, environmental forces, and legal/
regulatory factors. Table 3.1 provides a description of each of the six PESTEL
components of the macro-environment.
The impact of outer ring macro-environmental factors on a company’s
choice of strategy can be big or small. But even if the factors of the macro-
environment change slowly or are likely to have a low impact on the company’s
LO1 Identify factors
in a company’s broad
macro-environment
that may have
strategic significance.
CORE CONCEPT
The macro-environment encompasses the broad
environmental context in which a company is situ-
ated and is comprised of six principal components:
political factors, economic conditions, sociocultural
forces, technological factors, environmental fac-
tors, and legal/regulatory conditions.
PESTEL analysis can be used to assess the stra-
tegic relevance of the six principal components of
the macro-environment: political, economic, social,
technological, environmental, and legal forces.
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Chapter 3 Evaluating a Company’s External Environment 39
Component Description
Political factors These factors include political policies and processes, including the extent to which a government
intervenes in the economy. They include such matters as tax policy, fiscal policy, tariffs, the political
climate, and the strength of institutions such as the federal banking system. Some political factors,
such as bailouts, are industry-specific. Others, such as energy policy, affect certain types of indus-
tries (energy producers and heavy users of energy) more than others.
Economic
conditions
Economic conditions include the general economic climate and specific factors such as interest
rates, exchange rates, the inflation rate, the unemployment rate, the rate of economic growth, trade
deficits or surpluses, savings rates, and per capita domestic product. Economic factors also include
conditions in the markets for stocks and bonds, which can affect consumer confidence and dis-
cretionary income. Some industries, such as construction, are particularly vulnerable to economic
downturns but are positively affected by factors such as low interest rates. Others, such as discount
retailing, may benefit when general economic conditions weaken, as consumers become more
price-conscious.
Sociocultural
forces
Sociocultural forces include the societal values, attitudes, cultural factors, and lifestyles that impact
businesses, as well as demographic factors such as the population size, growth rate, and age distribu-
tion. Sociocultural forces vary by locale and change over time. An example is the trend toward healthier
lifestyles, which can shift spending toward exercise equipment and health clubs and away from alcohol
and snack foods. Population demographics can have large implications for industries such as health care,
where costs and service needs vary with demographic factors such as age and income distribution.
Technological
factors
Technological factors include the pace of technological change and technical developments that have
the potential for wide-ranging effects on society, such as genetic engineering and nanotechnology.
They include institutions involved in creating knowledge and controlling the use of technology, such as
R&D consortia, university-sponsored technology incubators, patent and copyright laws, and govern-
ment control over the Internet. Technological change can encourage the birth of new industries, such
as those based on nanotechnology, and disrupt others, such as the recording industry.
TABLE 3.1
The Six Components of the Macro-Environment Included in a PESTEL Analysis
FIGURE 3.1 The Components of a Company’s External Environment
Industry and Competitive Environment
Company
Macro-Environment
Suppliers
Rival
Firms
New
Entrants
Buyers
Substitute
Products
Economic
conditions
Sociocultural
Forces
Political
Factors
Legal/Regulatory
Factors
Environmental
Forces
Technological
Factors
(continued)
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business situation, they still merit a watchful eye. Motor vehicle companies
must adapt their strategies to customer concerns about carbon emissions and
high gasoline prices. Changes in lifestyles, attitudes toward nutrition and fit-
ness, and leisure preferences have begun to have strategy-shaping effects on
companies competing in the processed food, restaurant, and fitness industries.
As company managers scan the external environment, they must be alert for
potentially important outer ring developments, assess their impact and influ-
ence, and adapt the company’s direction and strategy as needed.
However, the factors and forces in a company’s macro-environment that
have the biggest strategy-shaping impact typically pertain to the company’s
immediate inner ring industry and competitive environment—competitive
pressures, the actions of rival firms, buyer behavior, supplier-related consid-
erations, and so on. Consequently, this chapter concentrates on a company’s
industry and competitive environment.
Assessing the Company’s Industry
and Competitive Environment
Thinking strategically about a company’s industry and competitive environ-
ment entails using some well-validated concepts and analytical tools to get
clear answers to seven questions:
1. Do the dominant economic characteristics of the industry offer sellers
opportunities for growth and attractive profits?
2. What kinds of competitive forces are industry members facing, and how
strong is each force?
3. What forces are driving industry change, and what impact will these
changes have on competitive intensity and industry profitability?
4. What market positions do industry rivals occupy—who is strongly posi-
tioned and who is not?
5. What strategic moves are rivals likely to make next?
6. What are the key factors of competitive success?
7. Does the industry outlook offer good prospects for profitability?
Component Description
Environmental
forces
These include ecological and environmental forces such as weather, climate, climate change, and
associated factors like water shortages. These factors can directly impact industries such as insur-
ance, farming, energy production, and tourism. They may have an indirect but substantial effect on
other industries such as transportation and utilities.
Legal and
regulatory
factors
These factors include the regulations and laws with which companies must comply such as con-
sumer laws, labor laws, antitrust laws, and occupational health and safety regulation. Some factors,
such as banking deregulation, are industry-specific. Others, such as minimum wage legislation,
affect certain types of industries (low-wage, labor-intensive industries) more than others.
TABLE 3.1 (continued)
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Analysis-based answers to these questions are prerequisites for a strategy
offering good fit with the external situation. The remainder of this chapter is
devoted to describing the methods of obtaining solid answers to the seven
questions above.
Question 1: What Are the Industry’s Dominant
Economic Characteristics?
Analyzing a company’s industry and competitive environment begins with
identifying the industry’s dominant economic characteristics. While the gen-
eral economic conditions of the macro-environment identified through PESTEL
analysis may prove to be strategically relevant, it is the economic characteris-
tics of the industry that will have a greater bearing on the industry’s prospects
for growth and attractive profits. An industry’s dominant economic charac-
teristics include such factors as market size and growth rate, the geographic
boundaries of the market (which can extend from local to worldwide), market
demand-supply conditions, market segmentation, and the pace of technologi-
cal change. Table 3.2 summarizes analytical questions that define the indus-
try’s dominant economic features.
Getting a handle on an industry’s distinguishing economic features not
only provides a broad overview of the attractiveness of the industry, but also
Economic Characteristic Questions to Answer
Market size and growth rate • How big is the industry and how fast is it
growing?
• What does the industry’s position in the life cycle
(early development, rapid growth and takeoff,
early maturity and slowing growth, saturation and
stagnation, decline) reveal about the industry’s
growth prospects?
Scope of competitive rivalry • Is the geographic area over which most compa-
nies compete local, regional, national, multina-
tional, or global?
Demand-supply conditions • Is a surplus of capacity pushing prices and profit
margins down?
• Is the industry overcrowded with too many
competitors?
Market segmentation • Is the industry characterized by various product
characteristics or customer wants, needs, or
preferences that divide the market into distinct
segments?
Pace of technological change • What role does advancing technology play in this
industry?
• Do most industry members have or need strong
technological capabilities? Why?
TABLE 3.2
What to Consider in Identifying an Industry’s Dominant Economic Features
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promotes understanding of the kinds of strategic moves that industry mem-
bers are likely to employ. For example, industries that are characterized by
rapid technological change may require substantial investments in R&D and
the development of strong product innovation capabilities—continuous prod-
uct innovation is primarily a survival strategy in such industries as video
games, computers, and pharmaceuticals.
Question 2: How Strong Are the Industry’s
Competitive Forces?
After gaining an understanding of the industry’s general economic charac-
teristics, industry and competitive analysis should focus on the competitive
dynamics of the industry. The nature and subtleties of competitive forces
are never the same from one industry to another and must be wholly under-
stood to accurately assess the company’s current situation. Far and away the
most powerful and widely used tool for assessing the strength of the indus-
try’s competitive forces is the five-forces model of competition.1
This model, as
depicted in Figure 3.2, holds that competitive forces affecting industry attrac-
tiveness go beyond rivalry among competing sellers and include pressures
stemming from four coexisting sources. The five competitive forces affecting
industry attractiveness are listed below.
1. Competitive pressures stemming from buyer bargaining power.
2. Competitive pressures coming from companies in other industries to win
buyers over to substitute products.
3. Competitive pressures stemming from supplier bargaining power.
4. Competitive pressures associated with the threat of new entrants into the
market.
5. Competitive pressures associated with rivalry among competing sellers to
attract customers. This is usually the strongest of the five competitive
forces.
The Competitive Force of Buyer Bargaining Power
Whether seller-buyer relationships represent a minor or significant competi-
tive force depends on (1) whether some or many buyers have sufficient bar-
gaining leverage to obtain price concessions and other favorable terms, and
(2) the extent to which buyers are price sensitive. Buyers with strong bargain-
ing power can limit industry profitability by demanding price concessions,
better payment terms, or additional features and services that increase indus-
try members’ costs. Buyer price sensitivity limits the profit potential of indus-
try members by restricting the ability of sellers to raise prices without losing
volume or unit sales.
The leverage that buyers have in negotiating favorable terms of the sale can
range from weak to strong. Individual consumers, for example, rarely have
much bargaining power in negotiating price concessions or other favorable
terms with sellers. The primary exceptions involve situations in which price
LO2 Recognize the
factors that cause
competition in an
industry to be fierce,
more or less normal,
or relatively weak.
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haggling is customary, such as the purchase of new and used motor vehicles,
homes, and other big-ticket items such as jewelry and pleasure boats. For most
consumer goods and services, individual buyers have no bargaining lever-
age—their option is to pay the seller’s posted price, delay their purchase until
prices and terms improve, or take their business elsewhere.
In contrast, large retail chains such as Walmart, Best Buy, Staples, and
Home Depot typically have considerable negotiating leverage in purchas-
ing products from manufacturers because retailers usually stock just two or
three competing brands of a product and rarely carry all competing brands.
In addition, the strong bargaining power of major supermarket chains such as
Kroger, Safeway, and Albertsons allows them to demand promotional allow-
ances and lump-sum payments (called slotting fees) from food products man-
ufacturers in return for stocking certain brands or putting them in the best
shelf locations. Motor vehicle manufacturers have strong bargaining power in
negotiating to buy original equipment tires from Goodyear, Michelin, Bridge-
stone/Firestone, Continental, and Pirelli not only because they buy in large
Rivalry among
Competing
Sellers
Competitive pressures
created by the jockeying
of rival sellers for
better market position
and competitive
advantage
Buyers
Competitive
pressures
stemming
from
seller-
buyer
collaboration
and
bargaining
Competitive
pressures
stemming
from
supplier-
seller
collaboration
and
bargaining
Competitive pressures coming from
the threat of entry of new rivals
Suppliers of Raw
Materials, Parts,
Components,
or Other
Resource Inputs
Competitive pressures coming from
the market attempts of outsiders to
win buyers over to their products
Firms in Other
Industries Offering
Substitute Products
Potential New
Entrants
FIGURE 3.2 The Five-Forces Model of Competition
Sources: Based on Michael E. Porter, “How Competitive Forces Shape Strategy,” Harvard Business Review 57, no. 2 (March–April 1979), pp. 137–45;
and Michael E. Porter, “The Five Competitive Forces That Shape Strategy,” Harvard Business Review 86, no. 1 (January 2008), pp. 80–86.
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quantities, but also because tire makers have judged original equipment tires
to be important contributors to brand awareness and brand loyalty.
Even if buyers do not purchase in large quantities or offer a seller important
market exposure or prestige, they gain a degree of bargaining leverage in the
following circumstances:
• If buyers’ costs of switching to competing brands or substitutes are relatively
low. Buyers who can readily switch between several sellers have more
negotiating leverage than buyers who have high switching costs. When
the products of rival sellers are virtually identical, it is relatively easy for
buyers to switch from seller to seller at little or no cost. For example, the
screws, rivets, steel, and capacitors used in the production of large home
appliances such as washers and dryers are all commodity-like and avail-
able from many sellers. The potential for buyers to easily switch from one
seller to another encourages sellers to make concessions to win or retain a
buyer’s business.
• If the number of buyers is small or if a customer is particularly important to a
seller. The smaller the number of buyers, the less easy it is for sellers to find
alternative buyers when a customer is lost to a competitor. The prospect of
losing a customer who is not easily replaced often makes a seller more will-
ing to grant concessions of one kind or another. Because of the relatively
small number of digital camera brands, the sellers of lenses and other com-
ponents used in the manufacture of digital cameras are in a weak bargain-
ing position in their negotiations with buyers of their components.
• If buyer demand is weak. Weak or declining demand creates a “buyers’
market”; conversely, strong or rapidly growing demand creates a “sellers’
market” and shifts bargaining power to sellers.
• If buyers are well informed about sellers’ products, prices, and costs. The more
information buyers have, the better bargaining position they are in. The
mushrooming availability of product information on the Internet is giv-
ing added bargaining power to individuals. It has become common for
automobile shoppers to arrive at dealerships armed with invoice prices,
dealer holdback information, a summary of incentives, and manufactur-
ers’ financing terms.
• If buyers pose a credible threat of integrating backward into the business of sell-
ers. Companies such as Anheuser-Busch, Coors, and Heinz have inte-
grated backward into metal can manufacturing to gain bargaining power
in obtaining the balance of their can requirements from otherwise power-
ful metal can manufacturers.
Figure 3.3 summarizes factors causing buyer bargaining power to be strong
or weak.
Not all buyers of an industry’s product have equal degrees of bargaining power with
sellers, and some may be less sensitive than others to price, quality, or service
differences. For example, apparel manufacturers confront significant bargain-
ing power when selling to big retailers such as Macy’s, T. J. Maxx, or Target,
but they can command much better prices selling to small owner-managed
apparel boutiques.
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The Competitive Force of Substitute Products
Companies in one industry are vulnerable to competitive pressure from the
actions of companies in another industry whenever buyers view the products
of the two industries as good substitutes. For instance, the producers of sugar
experience competitive pressures from the sales and marketing efforts of the
makers of Equal, Splenda, and Sweet’N Low. Newspapers are struggling to
maintain their relevance to subscribers who can watch the news on numerous
television channels or go to the Internet for updates, blogs, and articles. Sim-
ilarly, the producers of eyeglasses and contact lenses face competitive pres-
sures from doctors who do corrective laser surgery.
Just how strong the competitive pressures are from the sellers of substitute
products depends on three factors:
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.
When substitutes are cheaper than an industry’s product, industry mem-
bers come under heavy competitive pressure to reduce their prices and
find ways to absorb the price cuts with cost reductions.
2. Whether buyers view the substitutes as comparable or better in terms of quality,
performance, and other relevant attributes. Customers are prone to compare per-
formance and other attributes as well as price. For example, consumers have
found digital cameras to be a superior substitute to film cameras because of
the superior ease of use, the ability to download images to a home computer,
and the ability to delete bad shots without paying for film developing.
FIGURE 3.3 Factors Affecting the Strength of Buyer Bargaining Power
Rivalry
among
Competing
Sellers
Buyers
How strong are competitive pressures stemming from
buyer bargaining power and seller-buyer collaboration?
Buyer bargaining power is stronger when:
• Buyer switching costs to competing brands or substitute products
are low.
• Buyers are large and can demand concessions when purchasing
large quantities.
• Large volume purchases by buyers are important to sellers.
• Buyer demand is weak or declining.
• There are only a few buyers—so that each one’s business is
important to sellers.
• Identity of buyer adds prestige to the seller’s list of customers.
• Quantity and quality of information available to buyers improves.
• Buyers have the ability to postpone purchases until later if they
do not like the prices offered by sellers.
• Some buyers are a threat to integrate backward into the business
of sellers.
Buyer bargaining power is weaker when:
• Buyers purchase the item infrequently or in small quantities.
• Buyer switching costs to competing brands or substitutes are high.
• There is a surge in buyer demand that creates a “sellers’ market.”
• A seller’s brand reputation is important to the buyer.
• A particular seller’s product delivers quality or performance that is
not matched by other brands.
Suppliers
Substitutes
New Entrants
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3. Whether the costs that buyers incur in switching to the substitutes are high
or low. High switching costs deter switching to substitutes while low
switching costs make it easier for the sellers of attractive substitutes to
lure buyers to their products. Typical switching costs include the inconve-
nience of switching to a substitute, the costs of additional equipment, the
psychological costs of severing old supplier relationships, and employee
retraining costs.
Figure 3.4 summarizes the conditions that determine whether the competi-
tive pressures from substitute products are strong, moderate, or weak. As a
rule, the lower the price of substitutes, the higher their quality and perfor-
mance, and the lower the user’s switching costs, the more intense the competi-
tive pressures posed by substitute products.
Firms in Other Industries Offering Substitute Products
How strong are competitive pressures coming from substitute
products from outside the industry?
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.
• End users have low costs in switching to substitutes.
• End users grow 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 performance they deliver.
• End users 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
drawing customers away
from the industry in question).
• Producers of substitutes are
moving to add new capacity.
• Profits of the producers of
substitutes are on the rise.
Rivalry
among
Competing
Sellers
Suppliers
New Entrants
Buyers
FIGURE 3.4 Factors Affecting Competition from Substitute Products
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The Competitive Force of Supplier Bargaining Power
Whether the suppliers of industry members represent a weak or strong compet-
itive force depends on the degree to which suppliers have sufficient bargaining
power to influence the terms and conditions of supply in their favor. Suppli-
ers with strong bargaining power can erode industry profitability by charging
industry members higher prices, passing costs on to them, and limiting their
opportunities to find better deals. For instance, Microsoft and Intel, both of
which supply PC makers with essential components, have been known to use
their dominant market status not only to charge PC makers premium prices
but also to leverage PC makers in other ways. The bargaining power possessed
by Microsoft and Intel when negotiating with customers is so great that both
companies have faced antitrust charges on numerous occasions. Before a legal
agreement ending the practice, Microsoft pressured PC makers to load only
Microsoft products on the PCs they shipped. Intel has also defended against
antitrust charges resulting from its bargaining strength, but continues to give
PC makers that use the biggest percentages of Intel chips in their PC models top
priority in filling orders for newly introduced Intel chips. Being on Intel’s list
of preferred customers helps a PC maker get an early allocation of Intel’s latest
chips and thus allows a PC maker to get new models to market ahead of rivals.
The factors that determine whether any of the industry suppliers are in a
position to exert substantial bargaining power or leverage are fairly clear-cut:
• If the item being supplied is a commodity that is readily available from many sup-
pliers. Suppliers have little or no bargaining power or leverage whenever
industry members have the ability to source from any of several alterna-
tive and eager suppliers.
• The ability of industry members to switch their purchases from one supplier to
another or to switch to attractive substitutes. High switching costs increase
supplier bargaining power, whereas low switching costs and the ready
availability of good substitute inputs weaken supplier bargaining power.
• If certain inputs are in short supply. Suppliers of items in short supply have
some degree of pricing power.
• If certain suppliers provide a differentiated input that enhances the performance,
quality, or image of the industry’s product. The greater the ability of a par-
ticular input to enhance a product’s performance, quality, or image, the
more bargaining leverage its suppliers are likely to possess.
• Whether certain suppliers provide equipment or services that deliver cost savings
to industry members in conducting their operations. Suppliers who provide
cost-saving equipment or services are likely to possess some degree of
bargaining leverage.
• The fraction of the costs of the industry’s product accounted for by the cost of a
particular input. The bigger the cost of a specific part or component, the
more opportunity for competition in the marketplace to be affected by the
actions of suppliers to raise or lower their prices.
• If industry members are major customers of suppliers. As a rule, suppliers have
less bargaining leverage when their sales to members of this one industry
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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.
• Whether it makes good economic sense for industry members to vertically inte-
grate backward. The make-or-buy decision generally boils down to whether
suppliers are able to supply a particular component at a lower cost than
industry members could achieve if they were to integrate backward.
Figure 3.5 summarizes the conditions that tend to make supplier bargain-
ing power strong or weak.
The Competitive Force of Potential New Entrants
Several factors determine whether the threat of new companies entering the
marketplace presents a significant competitive pressure. One 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 poten-
tial entry. This is especially true when some of the likely entry candidates have
ample resources to support entry into a new line of business. Frequently, the
strongest competitive pressures associated with potential entry come not from
outsiders but from current industry participants looking for growth opportuni-
ties. Existing industry members are often strong candidates to enter market segments or
geographic areas where they currently do not have a market presence.
A second factor concerns whether the likely entry candidates face high or
low entry barriers. High barriers reduce the competitive threat of potential
FIGURE 3.5 Factors Affecting the Strength of Supplier Bargaining Power
Rivalry
among
Competing
Sellers
Suppliers of Resource Inputs
How strong are the competitive pressures
stemming from supplier bargaining power and
seller-supplier collaboration?
Supplier bargaining power is stronger when:
• Industry members incur high costs in switching their
purchases to alternative suppliers.
• Needed inputs are in short supply (which gives suppliers
more leverage in setting prices).
• A supplier has a differentiated input that enhances the
quality, performance, or image of sellers’ products or is a
valuable or critical part of sellers’ production processes.
• There are only a few suppliers of a particular input.
Supplier bargaining power is weaker when:
• The item being supplied is a “commodity” that is readily
available from many suppliers at the going market price.
• Seller switching costs to alternative suppliers are low.
• Good substitute inputs exist or new ones emerge.
• There is a surge in the availability of supplies (thus greatly
weakening supplier pricing power).
• Industry members account for a big fraction of suppliers’
total sales and continued high-volume purchases are
important to the well-being of suppliers.
• Industry members are a threat to integrate backward into
the business of suppliers and to self-manufacture their own
requirements.
New Entrants
Buyers
Substitutes
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entry, while low barriers make entry more likely, especially if the industry is
growing and offers attractive profit opportunities. The most widely encoun-
tered barriers that entry candidates must hurdle include:2
• The presence of sizable economies of scale in production or other areas of opera-
tion. When incumbent companies enjoy cost advantages associated
with large-scale operations, outsiders must either enter on a large scale
(a costly and perhaps risky move) or accept a cost disadvantage and
consequently lower profitability.
• Cost and resource disadvantages not related to scale of operation. Aside from enjoy-
ing economies of scale, industry incumbents can have cost advantages that
stem from the possession of proprietary technology, partnerships with the
best and cheapest suppliers, low fixed costs (because they have older facilities
that have been mostly depreciated), and experience/learning curve effects.
The microprocessor industry is an excellent example of how learning/experi-
ence curves put new entrants at a substantial cost disadvantage. Manufactur-
ing unit costs for microprocessors tend to decline about 20 percent each time
cumulative production volume doubles. With a 20 percent experience curve
effect, if the first 1 million chips cost $100 each, once production volume
reaches 2 million the unit cost would fall to $80 (80 percent of $100), and by
a production volume of 4 million the unit cost would be $64 (80 percent of
$80).3
The bigger the learning or experience curve effect, the bigger the cost
advantage of the company with the largest cumulative production volume.
• Strong brand preferences and high degrees of customer loyalty. The stronger
the attachment of buyers to established brands, the harder it is for a new-
comer to break into the marketplace.
• 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 start-up costs.
• The difficulties of building a network of distributors-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. Retailers have to be
recruited and convinced to give a new brand ample display space and an
adequate trial period. 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.
• Restrictive regulatory policies. Government agencies can limit or even bar
entry by requiring licenses and permits. Regulated industries such as
cable TV, telecommunications, electric and gas utilities, and radio and
television broadcasting entail government-controlled entry.
• Tariffs and international trade restrictions. National governments commonly use
tariffs and trade restrictions (antidumping rules, local content requirements,
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local ownership requirements, quotas, etc.) to raise entry barriers for foreign
firms and protect domestic producers from outside competition.
• The ability and willingness of industry incumbents to launch vigorous initiatives
to block a newcomer’s successful entry. Even if a potential entrant has or can
acquire the needed competencies and resources to attempt entry, it must
still worry about the reaction of existing firms.4
Sometimes, there’s little
that incumbents can do to throw obstacles in an entrant’s path. But there
are times when incumbents use price cuts, increase advertising, introduce
product improvements, and launch legal attacks to prevent the entrant
from building a clientele. Cable TV companies have vigorously fought the
entry of satellite TV into the industry by seeking government intervention
to delay satellite providers in offering local stations, offering satellite cus-
tomers discounts to switch back to cable, and charging satellite customers
high monthly rates for cable Internet access.
Figure 3.6 summarizes conditions making the threat of entry strong or weak.
Rivalry
among
Competing
Sellers
Potential New Entrants
How strong are the competitive pressures associated with the entry threat from new rivals?
Substitutes
Buyers
Suppliers
Entry threats are weaker when:
• The pool of entry candidates is small.
• Entry barriers are high.
• Existing competitors are struggling to earn good
profits.
• The industry’s outlook is risky or uncertain.
• Buyer demand is growing slowly or is stagnant.
• Industry members will strongly contest the efforts of
new entrants to gain a market foothold.
Entry threats are stronger when:
• The pool of entry candidates is large and some have
resources that would make them formidable market
contenders.
• Entry barriers are low or can be readily hurdled by
the likely entry candidates.
• 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.
• Newcomers can expect to earn attractive profits.
• Buyer demand is growing rapidly.
• Industry members are unable (or unwilling) to
strongly contest the entry of newcomers.
FIGURE 3.6 Factors Affecting the Threat of Entry
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The Competitive Force of Rivalry among Competing
Sellers
The strongest of the five competitive forces is nearly always the rivalry among
competing sellers of a product or service. In effect, a market is a competitive battle-
field where there’s no end to the campaign for buyer patronage. Rival sellers
are prone to employ whatever weapons they have in their business arsenal to
improve their market positions, strengthen their market position with buyers,
and earn good profits. The strategy formulation challenge is to craft a competi-
tive strategy that, at the very least, allows a company to hold its own against
rivals and that, ideally, produces a competitive edge over rivals. But competitive
contests are ongoing and dynamic. When one firm makes a strategic move that
produces good results, its rivals typically respond with offensive or defensive
countermoves of their own. This pattern of action and reaction produces a
continually evolving competitive landscape where the market battle ebbs and
flows and produces winners and losers. But the current market leaders have no
guarantees of continued leadership. In every industry, the ongoing jockeying of
rivals leads to one or more companies gaining or losing momentum in the mar-
ketplace according to whether their latest strategic maneuvers succeed or fail.5
Figure 3.7 shows a sampling of competitive weapons that firms can deploy
in battling rivals and indicates the factors that influence the intensity of their
rivalry. Some factors that influence the tempo of rivalry among industry com-
petitors include:
• Rivalry intensifies when competing sellers regularly launch fresh actions to boost
their market standing and business performance. Normally, competitive jock-
eying among rival sellers is fairly intense. Indicators of strong competitive
rivalry include lively price competition, the rapid introduction of next-
generation products, and moves to differentiate products by offering bet-
ter performance features, higher quality, improved customer service, or a
wider product selection. Other common tactics used to temporarily boost
sales include special sales promotions, heavy advertising, rebates, or low-
interest-rate financing.
• Rivalry is stronger in industries where competitors are equal in size and capabil-
ity. Competitive rivalry in the quick-service restaurant industry is partic-
ularly strong where there are numerous relatively equal-sized hamburger,
deli sandwich, chicken, and taco chains. For the most part, McDonald’s,
Burger King, Taco Bell, KFC, Arby’s, and other national fast-food chains
have comparable capabilities and are required to compete aggressively to
hold their own in the industry.
• Rivalry is usually stronger in slow-growing markets and weaker in fast-growing
markets. Rapidly expanding buyer demand produces enough new busi-
ness for all industry members to grow. But in markets where growth is
sluggish or where buyer demand drops off unexpectedly, it is not uncom-
mon for competitive rivalry to intensify significantly as rivals battle for
market share and volume gains.
• Rivalry is usually weaker in industries comprised of vast numbers of small
rivals; likewise, it is often weak when there are fewer than five competitors.
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Head-to-head rivalry tends to be weak once an industry becomes popu-
lated with so many rivals that the strategic moves of any one competitor
have little discernible impact on the success of rivals. Rivalry also tends to
be weak if an industry consists of just two to four sellers. In a market with
few rivals, each competitor soon learns that aggressive moves to grow its
sales and market share can have an immediate adverse impact on rivals’
businesses, almost certainly provoking vigorous retaliation. However,
some caution must be exercised in concluding that rivalry is weak just
because there are only a few competitors. The fierceness of the current
battle between Google and Microsoft and the decades-long war between
Coca-Cola and Pepsi are prime examples.
• Rivalry increases when buyer demand falls off and sellers find themselves with
excess capacity and/or inventory. Excess supply conditions create a “buyers’
market,” putting added competitive pressure on industry rivals to scram-
ble for profitable sales levels (often by price discounting).
FIGURE 3.7 Factors Affecting the Strength of Competitive Rivalry
Rivalry among Competing Sellers
How strong is seller-related competition?
Rivalry is generally stronger when:
• Competing sellers are active in making fresh moves to improve their
market standing and business performance.
• Buyer demand is growing slowly.
• Buyer demand falls off and sellers find themselves with excess capacity
and/or inventory.
• The number of rivals increases and rivals are of roughly equal size and
competitive capability.
• The products of rival sellers are commodities or else weakly differentiated.
• Buyer costs to switch brands are low.
• Outsiders have recently acquired weak competitors and are trying to turn
them into major contenders.
Rivalry is generally weaker when:
• Industry members aren’t aggressive in drawing sales and market share
away from rivals.
• Buyer demand is growing rapidly.
• The products of rival sellers are strongly differentiated and customer
loyalty is high.
• Buyer costs to switch brands are high.
• There are fewer than 5 sellers or else so many rivals that any one
company’s actions have little direct impact on rivals’ business.
Buyers
Suppliers
Substitutes
New Entrants
Typical “Weapons” for
Battling Rivals and
Attracting Buyers
• Lower prices
• More or different features
• Better product performance
• Higher quality
• Stronger brand image
• Wider selection of models
• Bigger/better dealer network
• Low-interest-rate financing
• Higher levels of advertising
• Better customer service
• Product customization
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• Rivalry increases as it becomes less costly for buyers to switch brands. The less
expensive 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 cus-
tomers away from rivals.
• Rivalry increases as the products of rival sellers become more standardized and
diminishes as the products of industry rivals become more differentiated. When
the offerings of rivals are identical or weakly differentiated, buyers have
less reason to be brand loyal—a condition that makes it easier for rivals to
persuade buyers to switch to their offering. On the other hand, strongly
differentiated product offerings among rivals breed high brand loyalty on
the part of buyers.
• Rivalry is more intense when industry conditions tempt competitors to use price
cuts or other competitive weapons to boost unit volume. When a product is
perishable, seasonal, or costly to hold in inventory, competitive pressures
build quickly any time one or more firms decide to cut prices and dump
supplies on the market. Likewise, whenever fixed costs account for a
large fraction of total cost, so that unit costs tend to be lowest at or near
full capacity, firms come under significant pressure to cut prices or other-
wise try to boost sales whenever they are operating below full capacity.
• Rivalry increases when one or more competitors become dissatisfied with their
market position. Firms that are losing ground or are in financial trouble
often pursue aggressive (or perhaps desperate) turnaround strategies that
can involve price discounts, greater advertising, or merger with other
rivals. Such strategies can turn competitive pressures up a notch.
• Rivalry increases when strong companies outside the industry acquire weak firms
in the industry and launch aggressive, well-funded moves to build market share.
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 share—actions that, if successful, put added pres-
sure on rivals to counter with fresh strategic moves of their own.
Rivalry can be characterized as cutthroat or brutal when competitors engage
in protracted price wars or habitually employ other aggressive tactics that
are mutually destructive to profitability. Rivalry can be considered fierce to
strong when the battle for market share is so vigorous that the profit margins
of most industry members are squeezed to bare-bones levels. Rivalry can be
characterized as 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 share and rarely
undertake offensives to steal customers away from one another.
The Collective Strengths of the Five Competitive Forces
and Industry Profitability
Scrutinizing each of the five competitive forces one by one provides a power-
ful diagnosis of what competition is like in a given market. Once the strategist
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has gained an understanding of the competitive pressures associated with
each of the five forces, the next step is to evaluate the collective strength of
the five forces and determine if companies in this industry should reasonably
expect to earn decent profits.
As a rule, the stronger the collective impact of the five competitive forces, the
lower the combined profitability of industry participants. The most extreme case
of a “competitively unattractive” industry is when
all five forces are producing strong competitive
pressures: Rivalry among sellers is vigorous, low
entry barriers allow new rivals to gain a market
foothold, competition from substitutes is intense,
and both suppliers and customers are able to exercise considerable bargaining
leverage. Fierce to strong competitive pressures coming from all five direc-
tions nearly always drive industry profitability to unacceptably low levels,
frequently producing losses for many industry members and forcing some out
of business. But an industry can be competitively unattractive without all five
competitive forces being strong. Fierce competitive pressures from just one of
the five forces, such as brutal price competition among rival sellers, may suf-
fice to destroy the conditions for good profitability.
In contrast, when the collective impact of the five competitive forces is mod-
erate to weak, an industry is competitively attractive in the sense that indus-
try members can reasonably expect to earn good profits and a nice return on
investment. The ideal competitive environment for earning superior profits is
one in which both suppliers and customers are in weak bargaining positions,
there are no good substitutes, high barriers block further entry, and rivalry
among present sellers generates only moderate competitive pressures. Weak
competition is the best of all possible worlds for companies with mediocre
strategies and second-rate implementation because even they can expect a
decent profit.
Question 3: What Are the Industry’s
Driving Forces of Change and What Impact
Will They Have?
The intensity of competitive forces and the level of industry attractiveness are
almost always fluid and subject to change. It is essential for strategy makers to
understand the current competitive dynamics of the industry, but it is equally
important for strategy makers to consider how the industry is changing and
the effect of industry changes that are under way. Any strategies devised by
management will play out in a dynamic industry environment, so it’s impera-
tive that such plans consider what the industry environment might look like
during the near term.
The Concept of Industry Driving Forces
Industry and competitive conditions change because forces are enticing or
pressuring certain industry participants (competitors, customers, suppliers) to
The stronger the forces of competition, the harder
it becomes for industry members to earn attractive
profits.
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alter their actions in important ways. The most
powerful of the change agents are called driv-
ing forces because they have the biggest influ-
ences in reshaping the industry landscape and
altering competitive conditions. Some driving
forces originate in the outer ring of the company’s macro-environment (see
Figure 3.1), but most originate in the company’s more immediate industry and
competitive environment.
Driving forces analysis has three steps: (1) identifying what the driving forces
are, (2) assessing whether the drivers of change are, individually or collectively,
acting to make the industry more or less attractive, and (3) determining what
strategy changes are needed to prepare for the impact of the driving forces.
Identifying an Industry’s Driving Forces
Many developments can affect an industry powerfully enough to qualify as
driving forces, but most drivers of industry and competitive change fall into
one of the following categories:
• Changes in an industry’s long-term growth rate. Shifts in industry growth
have the potential to affect the balance between industry supply and
buyer demand, entry and exit, and the character and strength of compe-
tition. An upsurge in buyer demand triggers a race among established
firms and newcomers to capture the new sales opportunities. A slowdown
in the growth of demand nearly always brings an increase in rivalry and
increased efforts by some firms to maintain their high rates of growth by
taking sales and market share away from rivals.
• Increasing globalization. Competition begins to shift from primarily a
regional or national focus to an international or global focus when indus-
try members begin seeking customers in foreign markets or when produc-
tion activities begin to migrate to countries where costs are lowest. The
forces of globalization are sometimes such a strong driver that companies
find it highly advantageous, if not necessary, to spread their operating
reach into more and more country markets. Globalization is very much
a driver of industry change in such industries as credit cards, mobile
phones, digital cameras, motor vehicles, steel, petroleum, personal com-
puters, and video games.
• Changes in who buys the product and how they use it. Shifts in buyer demo-
graphics and the ways products are used can alter competition by affect-
ing how customers perceive value, how customers make purchasing
decisions, and where customers purchase the product. The burgeoning
popularity of streaming video has affected broadband providers, wireless
phone carriers, and television broadcasters and created opportunities for
such new entertainment businesses as Hulu and Netflix.
• Product innovation. An ongoing stream of product innovations tends to
alter the pattern of competition in an industry by attracting more first-
time buyers, rejuvenating industry growth, and/or creating wider or nar-
rower product differentiation among rival sellers. Product innovation has
CORE CONCEPT
Driving forces are the major underlying causes of
change in industry and competitive conditions.
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been a key driving force in such industries as computers, digital cameras,
televisions, video games, and prescription drugs.
• Technological change and manufacturing process innovation. Advances in
technology can dramatically alter an industry’s landscape, making it
possible to produce new and better products at lower cost and opening
new industry frontiers. For instance, Voice over Internet Protocol technol-
ogy (VoIP) has spawned low-cost, Internet-based phone networks that
have begun competing with traditional telephone companies worldwide
(whose higher-cost technology depends on hard-wire connections via
overhead and underground telephone lines).
• Marketing innovation. When firms are successful in introducing new ways
to market their products, they can spark a burst of buyer interest, widen
industry demand, increase product differentiation, and lower unit costs—
any or all of which can alter the competitive positions of rival firms and
force strategy revisions.
• Entry or exit of major firms. The entry of one or more foreign companies
into a geographic market once dominated by domestic firms nearly always
shakes up competitive conditions. Likewise, when an established domestic
firm from another industry attempts entry either by acquisition or by launch-
ing its own start-up venture, it usually pushes competition in new directions.
• Diffusion of technical know-how across more companies and more countries.
As knowledge about how to perform a particular activity or execute a
particular manufacturing technology spreads, the competitive advantage
held by firms originally possessing this know-how erodes. Knowledge
diffusion can occur through scientific journals, trade publications, on-site
plant tours, word of mouth among suppliers and customers, employee
migration, and Internet sources.
• Changes in cost and efficiency. Widening or shrinking differences in the
costs among key competitors tend to dramatically alter the state of com-
petition. Declining costs to produce PCs have enabled price cuts and
spurred PC sales (especially lower-priced models) by making them more
affordable to lower-income households worldwide.
• Growing buyer preferences for differentiated products instead of a commodity
product (or for a more standardized product instead of strongly differentiated
products). When a shift from standardized to differentiated products
occurs, rivals must adopt strategies to outdifferentiate one another. How-
ever, buyers sometimes decide that a standardized, budget-priced prod-
uct suits their requirements as well as a premium-priced product with lots
of snappy features and personalized services.
• Regulatory influences and government policy changes. Government
regulatory actions can often force significant changes in industry prac-
tices and strategic approaches. New rules and regulations pertaining to
government-sponsored health insurance programs are driving changes in
the health care industry. In international markets, host governments can
drive competitive changes by opening their domestic markets to foreign
participation or closing them.
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• Changing societal concerns, attitudes, and lifestyles. Emerging social issues and
changing attitudes and lifestyles can be powerful instigators of industry
change. Consumer concerns about the use of chemical additives and the
nutritional content of food products have forced food producers to revamp
food-processing techniques, redirect R&D efforts into the use of healthier
ingredients, and compete in developing nutritious, good-tasting products.
While many forces of change may be at work in a given industry, no more
than three or four are likely to be true driving forces powerful enough to qualify
as the major determinants of why and how the industry is changing. Thus, com-
pany strategists must resist the temptation to label every change they see as a
driving force. Table 3.3 lists the most common driving forces.
Assessing the Impact of the Industry Driving Forces
The second step in driving forces analysis is to determine whether the prevailing
driving forces are acting to make the industry environment more or less attractive.
Getting a handle on the collective impact of the driving forces usually requires
looking at the likely effects of each force separately,
because the driving forces may not all be pushing
change in the same direction. For example, two
driving forces may be acting to spur demand for
the industry’s product while one driving force may
be working to curtail demand. Whether the net
effect on industry demand is up or down hinges on
which driving forces are the more powerful.
Determining Strategy Changes Needed to Prepare
for the Impact of Driving Forces
The third step of driving forces analysis—where the real payoff for strat-
egy making comes—is for managers to draw some conclusions about what
An important part of driving forces analysis is
to determine whether the individual or collective
impact of the driving forces will be to increase or
decrease market demand, make competition more
or less intense, and lead to higher or lower industry
profitability.
1. Changes in the long-term industry growth rate.
2. Increasing globalization.
3. Emerging new Internet capabilities and applications.
4. Changes in who buys the product and how they use it.
5. Product innovation.
6. Technological change and manufacturing process innovation.
7. Marketing innovation.
8. Entry or exit of major firms.
9. Diffusion of technical know-how across more companies and more countries.
10. Changes in cost and efficiency.
11. Growing buyer preferences for differentiated products instead of a standardized commodity
product (or for a more standardized product instead of strongly differentiated products).
12. Regulatory influences and government policy changes.
13. Changing societal concerns, attitudes, and lifestyles.
TABLE 3.3
Common Driving Forces
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strategy adjustments will be needed to deal with
the impact of the driving forces. Without under-
standing the forces driving industry change and
the impacts these forces will have on the indus-
try environment over the next one to three years,
managers are ill prepared to craft a strategy tightly
matched to emerging conditions. Similarly, if managers are uncertain about
the implications of one or more driving forces, or if their views are off-base,
it will be difficult for them to craft a strategy that is responsive to the conse-
quences of driving forces. So driving forces analysis is not something to take
lightly; it has practical value and is basic to the task of thinking strategically
about where the industry is headed and how to prepare for the changes ahead.
Question 4: How Are Industry Rivals
Positioned?
The nature of competitive strategy inherently positions companies compet-
ing in an industry into strategic groups with diverse price/quality ranges,
different distribution channels, varying product
features, and different geographic coverages. The
best technique for revealing the market positions
of industry competitors is strategic group map-
ping. This analytical tool is useful for comparing
the market positions of industry competitors or for
grouping industry combatants into like positions.
Using Strategic Group Maps to Assess the Positioning
of Key Competitors
A strategic group consists of those industry members with similar competi-
tive approaches and positions in the market. Companies in the same strategic
group can resemble one another in any of several ways—they may have com-
parable product-line breadth, sell in the same price/quality range, emphasize
the same distribution channels, use essentially
the same product attributes to appeal to similar
types of buyers, depend on identical technologi-
cal approaches, or offer buyers similar services
and technical assistance.6
An industry with a
commodity-like product may contain only one
strategic group whereby all sellers pursue essentially identical strategies and
have comparable market positions. But even with commodity products, there
is likely some attempt at differentiation occurring in the form of varying deliv-
ery times, financing terms, or levels of customer service. Most industries offer
a host of competitive approaches that allow companies to find unique indus-
try positioning and avoid fierce competition in a crowded strategic group.
Evaluating strategy options entails examining what strategic groups exist,
identifying which companies exist within each group, and determining if a
LO3 Become
adept at mapping the
market positions of
key groups of industry
rivals.
CORE CONCEPT
Strategic group mapping is a technique for
displaying the different market or competitive posi-
tions that rival firms occupy in the industry.
The real payoff of driving forces analysis is to help
managers understand what strategy changes are
needed to prepare for the impacts of the driving
forces.
CORE CONCEPT
A strategic group is a cluster of industry rivals
that have similar competitive approaches and mar-
ket positions.
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competitive “white space” exists where industry competitors are able to create
and capture altogether new demand.
The procedure for constructing a strategic group map is straightforward:
• Identify the competitive characteristics that delineate strategic approaches
used in the industry. Typical variables used in creating strategic group
maps are the price/quality range (high, medium, low), geographic cover-
age (local, regional, national, global), degree of vertical integration (none,
partial, full), product-line breadth (wide, narrow), choice of distribution
channels (retail, wholesale, Internet, multiple channels), and degree of
service offered (no-frills, limited, full).
• Plot firms on a two-variable map based upon their strategic approaches.
• Assign firms occupying the same map location to a common strategic
group.
• Draw circles around each strategic group, making the circles proportional
to the size of the group’s share of total industry sales revenues.
This produces a two-dimensional diagram like the one for the retail chain
store industry in Concepts & Connections 3.1.
Several guidelines need to be observed in creating strategic group maps.
First, the two variables selected as axes for the map should not be highly corre-
lated; if they are, the circles on the map will fall along a diagonal and strategy
makers will learn nothing more about the relative positions of competitors
than they would by considering just one of the variables. For instance, if
companies with broad product lines use multiple distribution channels while
companies with narrow lines use a single distribution channel, then looking
at product line-breadth reveals just as much about industry positioning as
looking at the two competitive variables. Second, the variables chosen as axes
for the map should reflect key approaches to offering value to customers and
expose big differences in how rivals position themselves in the marketplace.
Third, the variables used as axes don’t have to be either quantitative or con-
tinuous; rather, they can be discrete variables or defined in terms of distinct
classes and combinations. Fourth, drawing the sizes of the circles on the map
proportional to the combined sales of the firms in each strategic group allows
the map to reflect the relative sizes of each strategic group. Fifth, if more than
two good competitive variables can be used as axes for the map, multiple
maps can be drawn to give different exposures to the competitive positioning
in the industry. Because there is not necessarily one best map for portraying
how competing firms are positioned in the market, it is advisable to experi-
ment with different pairs of competitive variables.
The Value of Strategic Group Maps
Strategic group maps are revealing in several respects. The most important has
to do with identifying which rivals are similarly positioned and are thus close
rivals and which are distant rivals. Generally, the closer strategic groups are to
each other on the map, the stronger the cross-group competitive rivalry tends to be.
Although firms in the same strategic group are the closest rivals, the next closest
rivals are in the immediately adjacent groups.7
Often, firms in strategic groups
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that are far apart on the map hardly compete. For
instance, Walmart’s clientele, merchandise selec-
tion, and pricing points are much too different to
justify calling them close competitors of Neiman
Marcus or Saks Fifth Avenue in retailing. For the
same reason, Timex is not a meaningful competi-
tive rival of Rolex, and Kia is not a close competitor of Porsche or Lexus.
The second thing to be gleaned from strategic group mapping is that not all
positions on the map are equally attractive. Two reasons account for why some
positions can be more attractive than others:
High
Low
T.J.
Maxx
Gap,
Banana
Republic
Macy’s,
Nordstrom,
Dillard’s
Neiman
Marcus,
Saks Fifth
Avenue
Polo
Ralph
Lauren
Sears
Kohl’s
Target
Walmart,
Kmart
Many localities
Few localities
Geographic Coverage
Price/Quality
Gucci, Chanel, Fendi
CONCEPTS & CONNECTIONS 3.1
COMPARATIVE MARKET POSITIONS OF SELECTED RETAIL CHAINS: A STRATEGIC GROUP
MAP APPLICATION
Note: Circles are drawn roughly proportional to the total revenues of the retail chains included in each strategic group.
Some strategic groups are more favorably posi-
tioned than others because they confront weaker
competitive forces and/or because they are more
favorably impacted by industry driving forces.
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1. Industry driving forces may favor some strategic groups and hurt others. Driv-
ing forces in an industry may be acting to grow the demand for the
products of firms in some strategic groups and shrink the demand for
the products of firms in other strategic groups—as is the case in the news
industry where Internet news services and cable news networks are
gaining ground at the expense of newspapers and network television. The
industry driving forces of emerging Internet capabilities and applications,
changes in who buys the product and how they use it, and changing soci-
etal concerns, attitudes, and lifestyles are making it increasingly difficult
for traditional media to increase audiences and attract new advertisers.
2. Competitive pressures may cause the profit potential of different strategic groups
to vary. The profit prospects of firms in different strategic groups can vary
from good to poor because of differing degrees of competitive rivalry
within strategic groups, differing degrees of exposure to competition from
substitute products outside the industry, and differing degrees of supplier
or customer bargaining power from group to group. For instance, the
competitive battle between Walmart and Target is more intense (with con-
sequently smaller profit margins) than the rivalry among Versace, Chanel,
Fendi, and other high-end fashion retailers.
Thus, part of strategic group analysis always entails drawing conclusions
about where on the map is the “best” place to be and why. Which companies
or strategic groups are in the best positions to prosper and which might be
expected to struggle? And equally important, how might firms in poorly posi-
tioned strategic groups reposition themselves to improve their prospects for
good financial performance?
Question 5: What Strategic Moves Are Rivals
Likely to Make Next?
As in sports, scouting the business opposition is an essential part of game plan
development. Competitive intelligence about rivals’ strategies, their latest
actions and announcements, their resources and organizational capabilities,
and the thinking and leadership styles of their executives is valuable for pre-
dicting the strategic moves competitors are likely to make next. Having good
information to predict the likely moves of key competitors allows a company
to prepare defensive countermoves and to exploit any openings that arise
from competitors’ missteps.
Considerations in trying to predict what strategic moves rivals are likely to
make next include the following:
• What executives are saying about where the industry is headed, the firm’s
situation, and their past actions and leadership styles.
• Identifying trends in the timing of product launches or new marketing
promotions.
• Determining which rivals badly need to increase unit sales and market share.
• Considering which rivals have a strong incentive, along with the
resources, to make major strategic changes.
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• Knowing which rivals are likely to enter new geographic markets.
• Deciding which rivals are strong candidates to expand their product
offerings and enter new product segments.
To succeed in predicting a competitor’s next moves, company strategists need
to have a good understanding of each rival’s situation, its pattern of behavior
and preferences in responding to prior strategic
attacks, what its best strategic options are, and how
rival management measures success. Doing the
necessary detective work can be tedious and time-
consuming, but scouting competitors well enough
to anticipate their next moves allows managers to
prepare effective countermoves and to take rivals’ probable actions into account
in crafting their own offensive strategies.9
Concepts & Connections 3.2 discusses
the ethical limits to gathering competitive intelligence.
Question 6: What Are the Industry
Key Success Factors?
An industry’s key success factors (KSFs) are those competitive factors that most
affect industry members’ ability to prosper in the marketplace. Key success
factors may include particular strategy elements,
product attributes, resources, competitive capabili-
ties, or intangible assets. KSFs by their very nature
are so important to future competitive success that
all firms in the industry must pay close attention to
them or risk an eventual exit from the industry.
In the ready-to-wear apparel industry, the KSFs
are appealing designs and color combinations, low-cost manufacturing, a
strong network of retailers or company-owned stores, distribution capabilities
that allow stores to keep the best-selling items in stock, and advertisements that
effectively convey the brand’s image. These attributes and capabilities apply
CONCEPTS & CONNECTIONS 3.2
BUSINESS ETHICS AND COMPETITIVE INTELLIGENCE
Those who gather competitive intelligence on rivals can
sometimes cross the fine line between honest inquiry and
unethical or even illegal behavior. For example, calling rivals
to get information about prices, the dates of new-product
introductions, or wage and salary levels is legal, but mis-
representing one’s company affiliation during such calls is
unethical. Pumping rivals’ representatives at trade shows
is ethical only if one wears a name tag with accurate com-
pany affiliation indicated. Avon Products at one point secured
information about its biggest rival, Mary Kay Cosmetics (MKC),
by having its personnel search through the garbage bins out-
side MKC’s headquarters.8
When MKC officials learned of the
action and sued, Avon claimed it did nothing illegal because
a 1988 Supreme Court ruling declared that trash left on public
property (in this case, a sidewalk) was anyone’s for the taking.
Avon even produced a videotape of its removal of the trash at
the MKC site. Avon won the lawsuit—but Avon’s action, while
legal, scarcely qualifies as ethical.
Studying competitors’ past behavior and prefer-
ences provides a valuable assist in anticipating
what moves rivals are likely to make next and out-
maneuvering them in the marketplace.
CORE CONCEPT
Key success factors are the strategy elements,
product attributes, competitive capabilities, or
intangible assets with the greatest impact on future
success in the marketplace.
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to all brands of apparel ranging from private-label brands sold by discounters
to premium-priced ready-to-wear brands sold by upscale department stores.
Table 3.4 lists the most common types of industry key success factors.
Technology-related KSFs • Expertise in a particular technology or in scientific research (important in
pharmaceuticals, Internet applications, mobile communications, and most
high-tech industries)
• Proven ability to improve production processes (important in industries
where advancing technology opens the way for higher manufacturing effi-
ciency and lower production costs)
Manufacturing-related KSFs • Ability to achieve scale economies and/or capture experience curve effects
(important to achieving low production costs)
• Quality control know-how (important in industries where customers insist on
product reliability)
• High utilization of fixed assets (important in capital-intensive/high-fixed-cost
industries)
• Access to attractive supplies of skilled labor
• High labor productivity (important for items with high labor content)
• Low-cost product design and engineering (reduces manufacturing costs)
• Ability to manufacture or assemble products that are customized to buyer
specifications
Distribution-related KSFs • A strong network of wholesale distributors/dealers
• Strong direct sales capabilities via the Internet and/or having company-
owned retail outlets
• Ability to secure favorable display space on retailer shelves
Marketing-related KSFs • Breadth of product line and product selection
• A well-known and well-respected brand name
• Fast, accurate technical assistance
• Courteous, personalized customer service
• Accurate filling of buyer orders (few back orders or mistakes)
• Customer guarantees and warranties (important in mail-order and online
retailing, big-ticket purchases, and new-product introductions)
• Clever advertising
Skills- and capability-related KSFs • A talented workforce (superior talent is important in professional services
such as accounting and investment banking)
• National or global distribution capabilities
• Product innovation capabilities (important in industries where rivals are rac-
ing to be first to market with new product attributes or performance features)
• Design expertise (important in fashion and apparel industries)
• Short delivery time capability
• Supply chain management capabilities
• Strong e-commerce capabilities—a user-friendly website and/or skills in
using Internet technology applications to streamline internal operations
Other types of KSFs • Overall low costs (not just in manufacturing) to be able to meet low-price
expectations of customers
• Convenient locations (important in many retailing businesses)
• Ability to provide fast, convenient, after-the-sale repairs and service
• A strong balance sheet and access to financial capital (important in newly
emerging industries with high degrees of business risk and in capital-
intensive industries)
• Patent protection
TABLE 3.4
Common Types of Industry Key Success Factors
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An industry’s key success factors can usually be deduced through identi-
fying the industry’s dominant characteristics, assessing the five competitive
forces, considering the impacts of the driving forces, comparing the market
positions of industry members, and forecasting the likely next moves of key
rivals. In addition, the answers to the following three questions help identify
an industry’s key success factors:
1. On what basis do buyers of the industry’s product choose between the
competing brands of sellers? That is, what product attributes are crucial?
2. Given the nature of the competitive forces prevailing in the marketplace,
what resources and competitive capabilities does a company need to have
to be competitively successful?
3. What shortcomings are almost certain to put a company at a significant
competitive disadvantage?
Only rarely are there more than five or six key factors for future competitive
success. Managers should therefore resist the temptation to label a factor that
has only minor importance a KSF. To compile a list of every factor that matters
even a little bit defeats the purpose of concentrating management attention on
the factors truly critical to long-term competitive success.
Question 7: Does the Industry Offer Good
Prospects for Attractive Profits?
The final step in evaluating the industry and competitive environment is boil-
ing down the results of the analyses performed in Questions 1–6 to determine
if the industry offers a company strong prospects for attractive profits.
The important factors on which to base such a conclusion include:
• The industry’s growth potential.
• Whether powerful competitive forces are squeezing industry profitability
to subpar levels and whether competition appears destined to grow stron-
ger or weaker.
• Whether industry profitability will be favorably or unfavorably affected
by the prevailing driving forces.
• The company’s competitive position in the industry vis-à-vis rivals. (Well-
entrenched leaders or strongly positioned contenders have a much better
chance of earning attractive margins than those fighting a steep uphill
battle.)
• How competently the company performs industry key success factors.
It is a mistake to think of a particular industry
as being equally attractive or unattractive to all
industry participants and all potential entrants.
Conclusions have to be drawn from the perspec-
tive of a particular company. Industries attractive
to insiders may be unattractive to outsiders. Indus-
try environments unattractive to weak competitors
LO4 Learn how to
determine whether
an industry’s outlook
presents a company
with sufficiently
attractive opportunities
for growth and
profitability.
The degree to which an industry is attractive or
unattractive is not the same for all industry partici-
pants and potential new entrants. The attractive-
ness of an industry depends on the degree of fit
between a company’s competitive capabilities and
industry key success factors.
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may be attractive to strong competitors. A favorably positioned company may
survey a business environment and see a host of opportunities that weak com-
petitors cannot capture.
When a company decides an industry is fundamentally attractive, a strong
case can be made that it should invest aggressively to capture the opportu-
nities it sees. When a strong competitor concludes an industry is relatively
unattractive, it may elect to simply protect its present position, investing cau-
tiously if at all, and begin looking for opportunities in other industries. A com-
petitively weak company in an unattractive industry may see its best option as
finding a buyer, perhaps a rival, to acquire its business.
KEY POINTS
Thinking strategically about a company’s external situation involves probing for
answers to the following eight questions:
1. What are the strategically relevant factors in the macro-environment? Industries dif-
fer as to how they are affected by conditions in the broad macro-environment.
PESTEL analysis of the political, economic, sociocultural, technological, envi-
ronmental/ecological, and legal/regulatory factors provides a framework for
approaching this issue systematically.
2. What are the industry’s dominant economic features? Industries may also differ sig-
nificantly on such factors as market size and growth rate, the number and rela-
tive sizes of both buyers and sellers, the geographic scope of competitive rivalry,
the degree of product differentiation, the speed of product innovation, demand-
supply conditions, the extent of vertical integration, and the extent of scale econ-
omies and learning curve effects.
3. What kinds of competitive forces are industry members facing, and how strong is each
force? The strength of competition is a composite of five forces: (1) competitive
pressures stemming from buyer bargaining power and seller-buyer collaboration,
(2) competitive pressures associated with the sellers of substitutes, (3) competi-
tive pressures stemming from supplier bargaining power and supplier-seller col-
laboration, (4) competitive pressures associated with the threat of new entrants
into the market, and (5) competitive pressures stemming from the competitive
jockeying among industry rivals.
4. What forces are driving changes in the industry, and what impact will these changes have
on competitive intensity and industry profitability? Industry and competitive condi-
tions change because forces are in motion that create incentives or pressures for
change. The first phase is to identify the forces that are driving industry change.
The second phase of driving forces analysis is to determine whether the driving
forces, taken together, are acting to make the industry environment more or less
attractive.
5. What market positions do industry rivals occupy—who is strongly positioned and who
is not? Strategic group mapping is a valuable tool for understanding the similari-
ties and differences inherent in the market positions of rival companies. Rivals in
the same or nearby strategic groups are close competitors, whereas companies in
distant strategic groups usually pose little or no immediate threat. Some strategic
groups are more favorable than others. The profit potential of different strategic
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66
groups may not be the same because industry driving forces and competitive
forces likely have varying effects on the industry’s distinct strategic groups.
6. What strategic moves are rivals likely to make next? Scouting competitors well
enough to anticipate their actions can help a company prepare effective coun-
termoves (perhaps even beating a rival to the punch) and allows managers to
take rivals’ probable actions into account in designing their own company’s best
course of action.
7. What are the key factors for competitive success? An industry’s key success factors
(KSFs) are the particular product attributes, competitive capabilities, and intangi-
ble assets that spell the difference between being a strong competitor and a weak
competitor—and sometimes between profit and loss. KSFs by their very nature
are so important to competitive success that all firms in the industry must pay
close attention to them or risk being driven out of the industry.
8. Does the outlook for the industry present the company with sufficiently attractive pros-
pects for profitability? Conclusions regarding industry attractiveness are a major
driver of company strategy. When a company decides an industry is fundamen-
tally attractive and presents good opportunities, a strong case can be made that
it should invest aggressively to capture the opportunities it sees. When a strong
competitor concludes an industry is relatively unattractive and lacking in oppor-
tunity, it may elect to simply protect its present position, investing cautiously if at
all and looking for opportunities in other industries. A competitively weak com-
pany in an unattractive industry may see its best option as finding a buyer, per-
haps a rival, to acquire its business. On occasion, an industry that is unattractive
overall is still very attractive to a favorably situated company with the skills and
resources to take business away from weaker rivals.
ASSURANCE OF LEARNING EXERCISES
1. Prepare a brief analysis of the coffee industry using the information provided
on industry trade association websites. Based upon information provided on
the websites of these associations, draw a five-forces diagram for the coffee
industry and briefly discuss the nature and strength of each of the five competi-
tive forces.
2. Based on the strategic group map in Concepts & Connections 3.1, who are Nord-
strom’s closest competitors? Between which two strategic groups is competition
the strongest? Why do you think no retail chains are positioned in the upper-
right corner of the map? Which company/strategic group faces the weakest com-
petition from the members of other strategic groups?
3. The National Restaurant Association publishes an annual industry factbook that
can be found at www.restaurant.org. Based on information in the latest report,
does it appear that macro-environmental factors and the economic characteristics
of the industry will present industry participants with attractive opportunities
for growth and profitability? Explain.
LO3
LO1, LO4
LO2
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67
LO1, LO2, LO3,
LO4
EXERCISES FOR SIMULATION PARTICIPANTS
1. Which of the five competitive forces is creating the strongest competitive pres-
sures for your company?
2. What are the “weapons of competition” that rival companies in your industry
can use to gain sales and market share? See Figure 3.7 to help you identify the
various competitive factors.
3. What are the factors affecting the intensity of rivalry in the industry in which
your company is competing? Use Figure 3.7 and the accompanying discussion to
help you in pinpointing the specific factors most affecting competitive intensity.
Would you characterize the rivalry and jockeying 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?
4. Are there any driving forces in the industry in which your company is compet-
ing? 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 to combat any negative
impacts of the driving forces.
5. Draw a strategic group map showing the market positions of the companies in
your industry. Which companies do you believe are in the most attractive posi-
tion on the map? Which companies are the most weakly positioned? Which
companies do you believe are likely to try to move to a different position on the
strategic group map?
6. What do you see as the key factors for being a successful competitor in your
industry? List at least three.
7. Does your overall assessment of the industry suggest that industry rivals have
sufficiently attractive opportunities for growth and profitability? Explain.
ENDNOTES
1. Michael E. Porter, Competitive Strat-
egy: Techniques for Analyzing Indus-
tries and Competitors (New York: Free
Press, 1980), chap. 1; Michael E.
Porter, “The Five Competitive
Forces That Shape Strategy,” Har-
vard Business Review 86, no. 1 (Janu-
ary 2008).
2. J. S. Bain, Barriers to New Competition
(Cambridge, MA: Harvard Uni-
versity Press, 1956); F. M. Scherer,
Industrial Market Structure and Eco-
nomic Performance (Chicago: Rand
McNally & Co., 1971).
3. Pankaj Ghemawat, “Building
Strategy on the Experience Curve,”
Harvard Business Review 64, no. 2
(March–April 1985).
4. Michael E. Porter, “How Competi-
tive Forces Shape Strategy,” Harvard
Business Review 57, no. 2 (March–
April 1979).
5. Pamela J. Derfus, Patrick G. Maggitti,
Curtis M. Grimm, and Ken G. Smith,
“The Red Queen Effect: Competitive
Actions and Firm Performance,”
Academy of Management Journal 51,
no. 1 (February 2008).
6. Mary Ellen Gordon and George R.
Milne, “Selecting the Dimensions
That Define Strategic Groups: A
Novel Market-Driven Approach,”
Journal of Managerial Issues 11, no. 2
(Summer 1999).
7. Avi Fiegenbaum and Howard
Thomas, “Strategic Groups as
Reference Groups: Theory, Model-
ing and Empirical Examination of
Industry and Competitive Strategy,”
Strategic Management Journal 16
(1995); and S. Ade Olusoga, Michael
P. Mokwa, and Charles H. Noble,
“Strategic Groups, Mobility Barri-
ers, and Competitive Advantage,”
Journal of Business Research 33 (1995).
8. Larry Kahaner, Competitive Intelli-
gence (New York: Simon and Schus-
ter, 1996).
9. Kevin P. Coyne and John Horn,
“Predicting Your Competitor’s
Reaction,” Harvard Business Review
87, no. 4 (April 2009).
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