ANALYSIS OF THE EXTERNAL ENVIRONMENT: OPPORTUNITIES AND THREATS LEARNING
OBJECTIVES Studying this chapter should provide you with the knowledge to: Explain the
importance of correctly identifying and choosing a firm's industries and markets. Identify and
measure the five major forces that shape average firm profitability within industries to evaluate the
overall attractiveness of an industry. Discuss how understanding the five forces that shape industry
competition is useful as a starting point for developing strategy. Identify the factors in the general
environment that affect firm and industry profitability. 02 Nokia and the Smartphone Industry Nokia, a
long-time leader in the telecommunications equipment and mobile phone industry, got its start in that
industry in 1981 when it acquired a 51 percent stake in a Finnish telecommunication firm. Since that
time, Nokia has sold more mobile phones than any other company. The firm has been the world
leader in market share since the mid-1980s. By 2008, Nokia's worldwide market share had reached
40 percent, more than double the approximately 18 percent market share of Samsung, its nearest
rival. The Nokia brand was a top seller everywhere, including the United States, China, Latin
America, and Africa. Not only was Nokia the leader in handset manufacturing, offering value to its
customers by manufacturing a full line of phones from the lowest end of the price range to the most
expensive, the company also manufactured some of its own cell-phone components, such as
cameras and accessories. In addition, Nokia designed and manufactured network infrastructure
equipment, launched a gaming device (N-Gage) that tapped into the entertainment and media
markets, and owned Symbian, the leading operating system for the new generation of multifunctional
3G phones. In all, Nokia had nine divisions producing products for a variety of industries, each with
separate profit and loss accountability.1 As late as 2003, Nokia appeared to have a competitive
advantage in cell phones in the same way that Microsoft had an advantage in PC operating system
software and Intel in microprocessors. NOKIA FAILED, HOWEVER, TO LOOK MORE BROADLY
AT WHAT THE CELL PHONE MARKET WAS BECOMING AND WHO MIGHT BECOME ITS NEW
COMPETITORS IN THAT EMERGING MARKET. IT WASN'T PREPARED TO COMPETE WITH
THEM AND COULDN'T SUSTAIN ITS COMPETITIVE ADVANTAGE. By 2010, however, Nokia had
taken a nose dive. Although it still held a reasonable 32 percent of the worldwide market share of
cell phones, the company commanded only 2 percent of the emerging smartphone market in North
American. Nokia's profits had plunged 68 percent, from nearly €8 million in 2007 to only €3.3 million
in 2009. Moreover, the firm's stock also tumbled, falling 86 percent from a high of $39.57 a share in
October 2007 to $7.15 a share in April 2014. What happened? To a large extent, Nokia was caught
off guard by fundamental changes in the mobile phone industry from 2003 to the present. Before the
introduction of 3G (third generation) smart phones, the cell phone manufacturing industry had power
over its suppliers, the makers of chips, and other parts for cell phones. Software wasn't a big part of
the picture and most handset makers programmed their own software. The firm that could make the
most attractive phone with the best hardware features at the lowest cost outperformed others in the
industry. For years, Nokia had offered unique value to its customers by having the latest and best
hardware. With the advent of 3G smart phones, however, software became the central differentiator.
Today, most people buy a phone based on its operating system and the applications the operating
system can run. Nokia did see the change coming and poured Research and Development (R&D)
dollars into its own Symbian operating system, focusing on building the resources and capabilities
necessary to compete in software. In 2003, 80 percent of all 3G phones—the first ones able to surf
the Internet—were sold by companies that had licensed Nokia's Symbian operating system. In
contrast, Microsoft, Nokia's major competitor at the time, had great difficulty with the early launch of
Windows Mobile operating system for 3G smart phones. Several of Microsoft's partners abandoned
Windows Mobile for Nokia's Symbian system.2 Nokia failed, however, to look more broadly at what
the cell phone market was becoming and who might become its new competitors in that emerging
market. It wasn't prepared to compete with them and couldn't sustain its competitive advantage. With
the introduction of Apple's iPhone and Google's Android operating system, Nokia's share of
operating systems plummeted so far that the company eventually teamed up with its old rival,
Microsoft, to offer Windows Mobile 7 on Nokia phones.3 But this did little to stop the onslaught from
Apple and Samsung, who sold phones using Google's Android system. In the first quarter of 2011,
Nokia sold 108.5 million handsets for a total of $9.4 billion. Apple, in contrast, sold only 18.6 million
iPhones but made $11.9 billion.4 Nokia had clearly lost the market for high-end phones to Apple and
other phones running the Android operating system. In addition, Nokia's low-end handsets were
under pressure from new Asian manufacturers. Indeed, thousands of new low-cost Shanzhai
manufacturers, small Chinese firms focused on creating knockoff products, now make phones with
names such as “Nckia.” The Shanzhai manufacturers flooded the markets in China, India, the Middle
East, and Africa, threatening to erode Nokia's market share in the remaining markets where Nokia
was still dominant.5 Indeed, Nokia's position in cell phones became so stark that in 2013 it sold its
entire cell phone business, the cornerstone of its previous success, to Microsoft. Not only did Nokia
have to sell, but it did so at a shockingly low price of only 5.5 billion euros, off from the highest
market capitalization of 110 billion euros during its glory days.6 As described in Chapter 1, strategy
involves crafting a plan to create competitive advantage—and superior profitability—in particular
markets. This plan, however, is shaped by the landscape in which the firm competes. A firm's
external environment provides both opportunities—ways of taking advantage of conditions in the
environment to become more profitable—and threats—conditions in the competitive environment
that endanger the profitability of the firm.7 Successful firms have a deep understanding of their
environment and constantly scan the horizon to see opportunities and threats as they emerge.8 One
of the key threats a strategist must understand and cope with is competition. Often, however,
managers define competition too narrowly, as if it occurred only among today's direct competitors.
Nokia was so focused on Microsoft as its key competitor in the 3G operating system industry, and
Motorola and Ericsson as its cell phone competitors, that it failed to effectively prepare for Apple's
entry into the industry. Competition for profits goes beyond established industry competitors to
include four other forces that shape industry attractiveness and profitability: customers, suppliers,
potential entrants, and substitute products. Together, all five forces define an industry's structure and
shape the competitive interactions—and profitability—of companies within that industry. Even though
industries might appear to differ significantly, the principles that determine the underlying drivers of
profitability are often the same. The global cell phone industry, for instance, appears to have nothing
in common with the highly profitable soft drink industry or the low-cost airline industry (i.e.,
Southwest and JetBlue). But to understand industry competition and profitability in these and other
industries we must analyze the same five forces. This chapter will help you to recognize the major
threats and opportunities that make up the competitive landscape, both the industry forces and
general macroeconomic forces that drive industry attractiveness—and profitability. DETERMINING
THE RIGHT LANDSCAPE: DEFINING A FIRM'S INDUSTRY The first strategic decision that most
firms must make is to select the industry, and markets, in which it will compete. The Strategy in
Practice feature discusses the U.S. government's classification of industries. A firm's industry also
determines which customers and which competitors will be part of the firm's landscape. The
landscape is typically defined by: (1) the industry (or industries) in which a firm competes, and (2)
the product and geographic markets within that industry that the firm targets. For example, Nokia
competes primarily in the cellular telephone manufacturing and operating system industries. Within
the cellular telephone manufacturing industry, Nokia targets multiple product markets by selling a
range of handsets, from high-end smart phones to inexpensive basic phones. The company also
targets multiple geographic markets, focusing mainly on Europe and developing economies in the
Middle East and Africa. STRATEGY IN PRACTICE HOW THE U.S. GOVERNMENT DEFINES
INDUSTRIES One tool that helps to define industries is the NAICS (North American Industry
Classification System), a series of codes generated by the U.S. government.9 These codes
(formerly referred to as SIC codes, for Standard Industrial Classification) vary from two to seven
digits, becoming more narrow with increasing numbers of digits. Table 2.1 provides the NAICS
codes for the cell phone handset manufacturing and mobile operating system industries. In Nokia's
early years, it competed primarily in category 334220, cell phones. As cell phones became more
sophisticated, Nokia also began to compete in category 511210, operating systems. [TABLE 2.1]
NAICS Codes for Nokia HANDSET HARDWARE BUSINESS HANDSET SOFTWARE BUSINESS
Code Classification Code Classification 33 Manufacturing 51 Information 334 Computer and
Electronic Product Manufacturing 511 Publishing Industries 3342 Communication Equipment
Manufacturers 5112 Software Publishers 33422 Wireless Communication Equipment Manufacturers
51121 Software Publishers 334220 Cellular Telephone Manufacturers 511210 Operating Systems
Software Publishers NAICS codes can be useful not just for helping to define an industry but also for
determining who the primary competitors are, although in fast-changing industries, the NAICS can
sometimes lag behind changing technologies or changing customer demands. As we've seen, Nokia
failed to seriously update its definition of its industry to include all the companies competing under its
new classification code. The choice of industries is important because not all industries are created
equal. The profits of an average firm in some industries are substantially higher than profits of an
average firm in other industries. Figure 2.1 shows the return on equity for a variety of industries over
a ten-year period. As you can see, the industry in which a firm competes has a direct bearing on the
profits earned by that firm. [Figure 2.1] Varying Attractiveness of U.S. Industries 2000–2010 Source:
Troy's Almanac Be careful about assuming that it is obvious which industry a company competes in.
For example, it seems obvious that Barnes & Noble competes in the book retailing industry and
Microsoft competes in the computer software industry. However, it may be less obvious that those
aren't their only industries. In addition to operating systems, Microsoft also makes the X-Box gaming
system, so it competes in the gaming console industry as well as the PC operating system industry.
Barnes & Noble sells an e-reader, the Nook that combines electronic books with computer hardware.
Amazon.com, Barnes & Nobles' main book retailing competitor, not only sells books and the Kindle
e-Reader, but also sells web services competing with Microsoft and a wide range of products online
as a discount retailer competing with Walmart. Firms must choose which markets to compete in, with
many large firms choosing to compete in several at the same time. If managers do not properly
define and understand their industry, they may be vulnerable to unseen competitors. For example,
Nokia defined itself primarily as a mobile handset manufacturer. As a result, managers failed to see
computer hardware companies like Apple and web search companies like Google becoming
potential competitors—or potential partners. Their focus on preventing Microsoft from creating a
dominant position in the mobile operating system industry caused them to overlook Apple, a
company that has consistently been the leader in innovative, user-friendly operating systems for a
variety of platforms.10 Truly understanding an industry often begins by taking a customer-oriented
view. Rather than identifying the industry based on the product or service they produce (such as cell
phone handsets), firms should think carefully about the job that products do for customers. What
need does a product fill? Understanding customer needs can be very helpful in defining the
boundaries of an industry. If two firms have products that do the same job for customers—they meet
similar customer needs—then those two firms can be considered part of the same industry. For
instance, companies that meet the need for communication by manufacturing mobile handsets, as
opposed to mobile ham radios (long-range walkie talkies), compete in the same industry.11 In the
case of cell phones, changing customer needs broadened the boundaries of the industry, from
primarily hardware manufacturing to include mobile operating systems and applications that allowed
phones to do far more jobs for customers than just place a phone call. This led to new competitors
for Nokia, including Apple and Google. FIVE FORCES THAT SHAPE AVERAGE PROFITABILITY
WITHIN INDUSTRIES Michael Porter, a well-known strategy professor at Harvard, identified five
forces that shape the profit-making potential of the average firm in an industry. As shown in Figure
2.2, those five forces are: (1) rivalry, (2) buyer power, (3) supplier power, (4) threat of new entrants,
and (5) threat of substitute products. The strength of each of these five forces (known as Porter's
Five Forces12) varies widely from industry to industry. For instance, in the semiconductor industry,
the threat of substitutes is almost nonexistent, while in the carbonated soft drink industry it is a
significant threat. A careful analysis of the five forces is a powerful way for firms to discover the
threats and opportunities in their environments. We provide a tool at the end of this chapter to help
you conduct a careful analysis of an industry's five forces. rivalry Competition among firms within an
industry. Typically this involves firms putting pressure on each other and limiting each other's profit
potential by attempting to steal profits and/or market share. substitute A product that is
fundamentally different yet serves the same function or purpose as another product. threats
Conditions in the competitive environment that endanger the profitability of a firm. opportunities
Ways of taking advantage of conditions in the environment to become more profitable. [Figure 2.2]
Analyzing Major Threats: The Five Forces Industry Analysis Tool Source: Adapted from Michael E.
Porter, “How Competitive Forces Shape Strategy,” Harvard Business Review 86, 1 (January 2008),
pp. 80–86. There are three basic steps involved in using the five forces analysis tool: Step 1: Identify
the specific factors relevant to each of the five major forces. We describe the factors that contribute
to each of the five forces in the next five sections of this chapter. Step 2: Analyze the strength of
each force. To what extent is it shaping the industry's attractiveness? The appendix at the end of the
book lists several sources where you might find the data you need to analyze each of the five forces.
Step 3: Estimate the overall strength of the combined five forces to determine the general
attractiveness of the industry, the profit potential for an average firm in the industry. attractiveness of
an industry The degree to which an average firm in the industry can earn good profits. Instructions
for steps 2 and 3 are at the end of the chapter. Step 1, the factors relevant to each of the five forces,
is discussed next. Rivalry: Competition among Established Companies Competition in an industry is
sometimes referred to as war, with each company deploying as many weapons in its arsenal as
possible to gain greater profits. Because there are typically a limited number of buyers, each firm's
profits often come at the expense of other firms in the industry. Each move by a firm provokes
countermoves among competitors, resulting in a constantly shifting competitive landscape populated
by winners and losers. (Chapter 11 explores how successful firms manage that shifting landscape by
planning for the countermoves of their rivals.) Firms' moves and countermoves can take many forms,
including sales and promotions, better quality or service, a wider variety of products, or lower prices.
Not surprisingly, these types of moves increase rivalry—the intensity with which companies compete
with each other for customers—which tends to squeeze the profit margins of most firms in an
industry. Rivalry among firms in an industry—for either rational or irrational reasons—is such an
important driver of profitability that it is shown at the center of Figure 2.2. The following seven factors
are critical to understanding the intensity of rivalry in an industry: The number and size of
competitors Standardization of products Costs to buyers of switching to another product Growth in
demand for products Levels of unused production capacity High fixed costs and highly perishable
products The difficulty for firms of leaving the industry The Number and Relative Size of
Competitors. The more competitors in an industry, the more likely that one or more of them will take
action to gain profits at the expense of others. Economists call an industry with a lot of competitors a
fragmented industry. In a fragmented industry, it is difficult to keep track of the pricing and
competitive moves of multiple players. The large number of firms responding to one another tends to
create intense rivalry. The same is true of the relative sizes of competitors. If firms are approximately
the same size, they tend to be able to respond, or retaliate, strongly to moves by rival firms.
Industries that are concentrated, as opposed to fragmented, have far fewer competitors and tend to
be dominated by a few large firms. In these industries, rivalry is typically much less intense. Smaller
competitors do not have the capability to respond to actions taken by large firms, and the few large
competitors are more aware of each other and less likely to risk actions that may result in price wars.
Relatively Standardized Products. Differentiated products, ones that boast different features or better
quality, tend to engender loyalty in customers because they meet customer needs in unique ways.
When products are standardized, or commodity-like, buyers are less loyal to a particular brand and it
is easier to convince them to switch brands. A rider may be fiercely loyal to his or her HarleyDavidson motorcycle, for example, but willing to buy several different brands of gas for the Harley.
Firms that sell standardized products—manufactured products or materials that are interchangeable
regardless of who makes them like bolts and nuts, rubber, plastics or commodities such as coal,
crude oil, salt, or sugar—often have to compete by offering sales, rebates, or lowering prices. Price
wars increase rivalry and decrease profits. Low Switching Costs for Buyers. Switching costs include
any cost to the customer for changing brands. Switching costs for buyers are related to the degree of
product standardization. For a computer user, changing operating system or word processing
software would entail considerable switching costs because the user would need to: (1) convert files
to the new software, and (2) learn how to use the new software. Switching from an iPod to another
MP3 player might require music lovers to move all of their music files from iTunes to a different
music software. In contrast, most of us can change our brand of gum or candy bar without any
switching costs. The lower the switching costs, the easier it is for competitors to poach customers,
thereby increasing industry rivalry. switching costs Barriers that help keep buyers using the same
supplier by imposing extra costs for switching suppliers. Switching costs are a fundamental part of
not just rivalry but also the other four forces: Buyer power. If customers, or buyers, can easily switch
firms, then buyers have increased power. Supplier power. If firms can't switch suppliers easily, then
suppliers have increased power. New entrants. If buyers can easily switch to new companies
attempting to enter the industry, there is a greater threat of new entrants. Substitutes. If buyers can
switch to substitute products without much difficulty, firms face an increased threat from those
substitutes. Slow Growth in Demand for Products or Services. When demand is increasing rapidly,
most firms can grow without taking existing customers from competitors. When growth slows,
however, firms can become desperate. They may try to increase their sales volume by attracting
customers from their competitors through sales promotions, price discounts, or other tactics.13 Of
course, competitors then respond with their own sales promotions and price cuts, thereby increasing
industry rivalry. Consider the flat-screen television industry. When large, flat-panel displays were first
introduced, prices were high. They remained that way for years while industry growth exploded. As
flat-panel manufacturers anticipated slower growth, from 18 percent in 2010 to 4 percent in the first
half of 2011, they dropped prices by more than 25 percent in the last quarter of 2010 in a bid to gain
what market share they could from their competitors.14 High Levels of Unused Production Capacity.
Unused production capacity is expensive. Firms typically try to produce at or near their full
production capacity so that they can spread the fixed cost of factories, machinery, and other means
of production across more units. In fact, they may try to produce more product than the market
demands, in order to use their capacity completely. However, when more is produced than is
demanded in the market, firms often have to drop their price or risk having unsold product. This has
frequently been the case in the automobile industry. During an economic downturn, automakers offer
price cuts, rebates, and special sales incentives to buyers so that they don't have significant unused
production capacity. High Fixed Costs, Highly Perishable Products, High Storage Costs. Industries
that produce or serve products in these three categories sometimes find themselves with a supply of
products that they have to sell quickly or take large losses on. For example, airlines operate with
high fixed costs. Most of the cost of a flight is in the airplane, the fuel, and the pilot and flight
attendants. It is not in the cost of serving an additional passenger. The marginal cost of adding an
additional passenger is truly only peanuts (and a drink). If it appears that a scheduled flight is going
to have few passengers, an airline may be tempted to discount steeply in order to fill as many seats
as possible. The variable cost of an additional passenger is very little, so selling a seat for less would
not cost the airline money, but leaving it empty would mean the airline has fewer passengers over
whom to spread its fixed costs. Firms that sell highly perishable products, such as fruits or
vegetables, face similar problems. As food nears the date when produce will spoil, grocery chains
often steeply discount it rather than lose the sale completely. Products with high storage costs
exhibit the same characteristics. If firms have an oversupply and are forced to store the product, they
may discount the price to avoid storage costs. In all three cases, steep discounting leads to
increased rivalry as competitors are forced to respond with discounts of their own, or be left with
losses while others recoup their production costs. High Exit Barriers. In some industries, companies
don't exit even when they aren't making a lot of money. Most often, they stay because they have
made investments in specialized equipment that can't be used in any other industry. For example,
steel blast furnaces are very expensive and cannot be used in any industry other than steelmaking.
If the firm exits the steel industry, its blast furnaces lose most of their value. Another barrier to exit is
labor or government agreements that make it difficult to close a plant. Emotional ties to employees
or a business can also lead to less than rational decisions by top management to stay in business.
Buyer Power: Bargaining Power and Price Sensitivity When buyers have sufficient power, they can
demand either lower prices or better products from their suppliers, thereby hurting average
profitability of firms in the supplier industry. The two primary situations in which buyers have high
power are when buyers hold a stronger bargaining position than sellers and when buyers are pricesensitive. The strength of a buyer's bargaining power or price sensitivity can be affected by a
number of factors. When firms understand what causes buyers to have power over their industry,
they have a better chance of countering that power. supplier A firm that provides products that are
inputs to another firm's production process. Buyer Bargaining Power. Four key factors influence the
degree to which buyers have bargaining power over their suppliers. We already discussed two of
these factors—buyers' switching costs and demand—because they are also factors in rivalry among
firms. The two remaining factors are the concentration and size of buyers and the threat that buyers
can backward integrate: Number, or concentration, and size of buyers. Buyer concentration reflects
the law of supply and demand. If there are few buyers but many sellers, then the sellers must
compete more strongly for buyer business. Sellers in this situation are likely to give concessions to
make the sale. Likewise, the larger the buyers, compared to sellers, the more likely sellers are to
increase the level of competition in order to gain buyers' business. For example, farmers, as
suppliers to the frozen-food industry, are not very concentrated. The three largest farmers account
for only about 1 percent of all food produced and sold. Frozen food makers, however, are
concentrated. The top four (Nestlé, Schwan, ConAgra, and HJ Heinz) accounted for nearly half (48.6
percent) of total market share in their industry in 2010.15 This means that frozen-food
manufacturers, as buyers, have a great deal of power over farmers. A farmer who needs the
business of the big four frozen-food makers in order to sell this year's crop may be willing to accept a
lower price in order to secure their business. Credible threat of backward integration. In some cases,
a buyer can exert pressure over suppliers by threatening them with backward integration, meaning
they will make the product themselves. For example, one way Walmart keeps prices low for
consumers is by threatening to expand its Sam's Choice store brand products into additional
categories if manufacturers of other branded products don't meet Walmart's pricing demands.
backward integration A firm purchases one or more of its suppliers in order to make a product itself
rather than buying it from another firm. Buyer Price Sensitivity. In general, when buyers are more
price-sensitive, they are more likely to exert pressure on suppliers to keep prices low. Buyers exert
pressure not just through price negotiation but also through more comparison-shopping and a
greater willingness to switch suppliers. Buyer price sensitivity tends to increase in the following
situations: Buyers are struggling financially. When companies are struggling financially, they are
more likely to be price-conscious and to look for ways to get less expensive sources of supply. If
many of an industry's buyers are in the same situation, there is a cap on what suppliers can charge.
Product is significant proportion of buyer's costs. Buyers tend to care more about getting a good
price when the product they are buying creates a large part of the costs of their own production (or
their budget, if the buyers are the end consumers). If the product is only a small part of their cost
structure, buyers are less likely to bother negotiating or comparison-shopping. For instance, end
consumers are less likely to do extensive comparison-shopping for a gallon of milk than they are for
a home or car. Likewise, auto manufacturers are less likely to pressure suppliers of electrical wiring
for price cuts than suppliers of steel or engine components. Buyers purchase in large volumes.
When buyers purchase in large volumes, they typically expect to get breaks in price. In essence, the
buyer is taking a risk by being willing to buy large amounts at once rather than smaller amounts over
time. Product doesn't affect buyers' performance very much. If a product is very important to the
quality of the buyers' end product, then buyers tend not to be very price conscious. For instance,
when Nokia had the most innovative handsets on the market, many cellular phone carriers, like
Verizon and T-Mobile, were willing to pay whatever Nokia charged in order to be able offer Nokia
phones to their customers. However, if suppliers' products don't affect buyers' quality or performance
very much, then buyers are much more likely to be price conscious. For instance, the plastic casing
on tablet or laptop computers doesn't enhance the performance of the computers very much; it
doesn't drive sales to the end consumer. As a consequence, PC manufacturers are likely to shop
around for price discounts on plastic casings in ways that they might not for the microprocessors that
run the computers. Product doesn't save buyers money. If a product saves buyers money, they tend
not to be very price conscious when purchasing it. These types of products can be anything from
machinery in manufacturing industries that replaces highly skilled, costly labor to inexpensive,
overseas labor that replaces more expensive labor or machinery in countries such as the United
States. If a product does not save buyers money, however, buyers are as likely to be price
conscious as they are with other types of products they buy. Supplier Bargaining Power The factors
that increase the bargaining power of suppliers are very similar to those that increase the bargaining
power of buyers. In this case, however, the firms are not customers, but suppliers, those from whom
your industry purchases inputs. When supplier industries have strong bargaining power, they can
charge higher prices, which tend to decrease average profitability in an industry. As firms understand
the factors that give suppliers power, they may be able to make decisions that decrease that power.
Number, or Concentration, and Size of Suppliers. As with buyer concentration, supplier
concentration follows the law of supply and demand. If there are few sellers, but lots of buyers in an
industry, then the buyers have to compete to get the products that they want, often paying higher
prices to get sufficient supply. Likewise, the larger the number of sellers compared to the buyers, the
less likely buyers are to pay the price that sellers are demanding. For instance, ARM, a designer of
semiconductor chips for smart phones, controls more than 95 percent of the market for its
product,16 resulting in a highly concentrated supplier industry dominated by one large firm. As a
consequence, Nokia, or any other smart phone handset manufacturer that wants a sufficient supply
of chips, and wants the high-quality chips that won ARM its market share in the first place, has to
buy from chip manufacturers who license from ARM. ARM has sufficient power that it can, to a large
degree, set the price for its product. Suppliers who charge more often squeeze the profits of buyers,
who may not be able to pass additional costs through to their customers. In fact, ARM's rise to power
in the mobile semiconductor chip industry is a major contributor to Nokia's current difficulties. Nokia
cannot charge enough for its low-cost handsets to make a good profit after paying for expensive
ARM chips. Credible Threat of Forward Integration. In some cases, a supplier can exert pressure
over its buyers by threatening them with forward integration, doing what its buyers do, if the buyers
don't offer price concessions. A good example of this is Google and its decision to forward integrate
in the smart phone handset industry by manufacturing its own phones.17 Google also licenses its
Android operating system to other handset makers, such as HTC and Samsung. Google's ability to
forward integrate gives Google power over those handset makers. When there is a credible threat of
forward integration, buyers are often willing to take a cut in profit by paying higher prices, rather than
risk losing the supply altogether and creating a new rival (if the supplier hasn't already forward
integrated). forward integration A firm goes into the business of its former buyers, rather than
continuing to sell to them. Threat of New Entrants As previously shown in Figure 2.1, not all
industries are created equal. Industries in which the average firm is making good profits can often be
targets, enticing firms from outside those industries to enter. Likewise, quickly growing industries are
often attractive, which increases the incentive for outside firms to enter those industries. One of the
important tasks for strategists is to identify firms that might enter their industries. New entrants pose
a double hazard. First, they typically are anxious to gain market share.18 Unless the industry is
growing quickly, that market share must come at the expense of existing firms. Second, new
entrants bring new production capacity, which tends to drive prices down unless demand is growing
faster than the increase in supply. New entrants mean greater rivalry, so existing firms often try to
discourage new entrants by building barriers to entry. The higher the barriers to entry, the more
difficult it is for potential entrants to get a foothold in the industry, and the more likely that they are to
quit or choose to not enter in the first place. Likewise, incumbent firms, those already in the industry,
often signal new entrants that they are likely to retaliate by slashing prices, increasing advertising, or
other competitive moves that help the established firms hold on to their market share. If the threats
of retaliation are perceived as credible, potential entrants might decide to stay away. barriers to entry
The way organizations make it more difficult for potential entrants to get a foothold in the industry. It
is essential for firms to understand the barriers to entry that already exist in their industry and to
consider ways of increasing them. Existing firms may also want to build new barriers. Firms that are
considering going into an industry can use an analysis of the barriers to entry in the target industry to
help them determine how likely they are to succeed. Economies of Scale, Experience, or Learning.
These types of economies occur when the cost per unit of production (the cost for producing each
individual product or service) decreases as a firm produces more. Typically, these economies come
from mass manufacturing methods, discounts through purchasing in high volumes, employees
becoming quicker and better at production, and being able to spread the fixed costs of production
machinery, R&D, advertising, and marketing across more units.19 Chapter 4 will explore these three
types of cost advantages in greater detail. In essence, lower costs allow the firm either to lower its
price, perhaps in retaliation for a new firm entering the market, or to maintain its price while earning
more profits than competitors. When economies of scale, experience, or learning exist in an industry,
new firms will be at a cost disadvantage. New firms are not likely to have as much market share as
existing firms, so they will not produce as much and can't achieve the same economies as existing
firms. Some firms may not be able to lower their prices sufficiently to match incumbent firms' prices.
Other new entrants may match incumbent prices, but earn smaller profit margins than the
incumbents. The higher the economies of scale, the greater the barrier to entry and the easier it is
for the larger incumbent to pose a credible threat of retaliation. If conditions change so that cost
savings from these economies become smaller, the barrier diminishes. For example, from the late
1980s until the early 2000s, the cell phone handset manufacturing industry possessed high
economies of scale. Nokia produced millions of handsets per year during this time and had the
lowest costs of its competitors. Consequently, the number of firms in the industry was relatively
stable during this period. However, the invention of flexible manufacturing processes, coupled with
the rise of low-cost, highly-skilled labor in China in the mid-2000s, lowered the cost savings that
could be achieved from high levels of production and allowed thousands of new Shanzhai
manufacturers to successfully enter the industry. Other Cost Advantages Not Related to Scale.
Incumbent firms might have cost advantages relative to new entrants for a variety of reasons
besides economies of scale. These include the following: Patents or proprietary technology such as
those that exist in the pharmaceutical industry Better locations (a deterrent to firms wishing to enter
markets where Starbucks is dominant, for example) Economies of scope—less expensive costs per
unit created by bundling different types of products. For example, Procter & Gamble has low-cost
marketing and distribution costs, compared to firms that manufacture only one type of product,
because P&G ships dozens of different types of products to the same retailers. (See Chapter 4 for a
more detailed explanation of economies of scope.) Preferential access to critical resources, such as
raw materials or access to distribution networks. For example, Chinese makers of lithium ion
batteries have government-protected access to sources of rare earth elements, raw materials that
are necessary for battery production. In many industries, new entrants face high barriers in the cost
of building a dealer network or recruiting retailers to sell their products. With a limited number of
potential dealers and retailers, new entrants often find themselves having to cut prices, and profit
margins as well, to secure access to distribution. As with economies of scale, it is important for firms
to track whether barriers are rising or falling. An expiring patent or the advent of an innovative
distribution channel, such as the Internet, has the potential to radically change the strength of
barriers related to cost advantages. Capital Requirements. It costs money to enter a new industry.
Not only do potential entrants often need capital to build a factory or store, but they may also have to
invest in R&D to generate viable products, build inventory, undertake sufficient advertising and
marketing to take market share from incumbent firms, and have sufficient cash on hand to cover
customer credit. Anything that increases the start-up costs will reduce the pool of possible entrants.
For instance, the computer semiconductor chip industry, dominated by Intel, makes a very complex
product. New entrants would need to spend years of R&D before they had a viable product and
could make their first sale. The high capital requirements needed for long periods of R&D limit the
number of entrants to those with enough financial or other resources to enter. However, firms that
already have made R&D investments in similar products, such as semiconductor chips for mobile
phones, could lower the capital costs associated with entering the computer semiconductor industry.
It is likely no coincidence that ARM, the maker of mobile semiconductor chips, is one of only a few
successful entrants into Intel's industry in the last 30 or more years. Network Effects. In some
industries, network effects increase the switching costs for customers, making it more difficult for
new entrants to steal business from incumbent firms. When network effects are in operation, the
greater the number of people using products from a given firm, the greater the demand grows for
that firm's product. For example, the more people who use a particular social networking site, the
more customers want to continue to use the site, and the more new customers are likely to try it. A
new entrant wanting to compete with Facebook is at a distinct disadvantage, because most of their
potential customers' “friends” are likely to be on Facebook, making it less likely that they will be
willing to switch to a new social media site. network effects Growth in demand for a firm's product
that results from a growth in the number of existing customers. Government Policy Restrictions.
Finally, government policies may make it more difficult to enter a market or even restrict a market
completely to new entrants. For instance, governments often raise the costs of entry by requiring
bonding, licenses, insurance, or environmental studies before a firm can enter an industry. New
entrants will have to use capital that might have been used for R&D, production, or advertising to
meet those requirements. When competing across international borders, additional regulations, such
as trade restrictions and local content requirements, may be applied to try to limit foreign
competition. In some industries, such as hairstyling, the requirements might be fairly minimal, but in
others, such as oil refining, they can become so onerous that most new firms cannot overcome the
barrier. Threat of Substitute Products A substitute is a product that is fundamentally different yet
serves the same basic function or purpose as another product. One of the primary problems for the
strategist in assessing substitutes is determining what is a substitute and what isn't. It involves
determining the boundaries of an industry, as we addressed earlier in the chapter, and then
scanning other industries to find products that might serve the same basic functions. For instance, email is a substitute for telephone messages, faxed documents, or documents delivered via the post
office. All four are ways of delivering messages. Similarly, fruit juice is a substitute for any number of
other drink products, including coffee, wine, and soda. Generally, something can be considered a
substitute if it serves the same function, such as quenching thirst, but does so with a different set of
characteristics. If the product has the same basic characteristics and is made using the same
general set of inputs, it would be considered part of rivalry, rather than a substitute. For instance,
competitor brands serving the same basic need, such as Apples iPhone and Samsung smart phones
running Google's Android operating system, are rivals, not substitutes. In general, substitutes put
downward pressure on the price that firms in an industry can charge. For instance, streaming video
across the Internet is a substitute for watching movies in the theater. Even if you had the only movie
theater in an area, you could not charge whatever price you wanted to. As your price rose, more
customers would switch to streaming video. If the price difference is enough, customers will stream
even though the quality is lower and they have to wait weeks or months before the movie leaves the
theater and is available online. For some industries, such as newspapers, the low price of the
substitute—in this case, free news on the Internet—can be disastrous, creating such a low cap on
the prices they can charge that many firms go out of business. The factors that determine the
intensity of a threat of substitutes include the awareness and availability of substitutes and their price
and performance compared to an industry's products. Awareness and Availability. Sometimes
customers aren't readily aware that substitutes exist. The threat increases when substitute products
are well known. This is particularly true if there are strong brands among the substitute products.
Likewise, if the substitute product is just as easy for customers to obtain as another industry's
products are, it is more of a threat. If the substitute is difficult to find or acquire, the threat is
diminished. Price and Performance. A significant part of the customer decision to switch to
substitutes will concern the price and performance trade-offs. As we discussed earlier in the chapter,
customers are more likely to switch to a substitute if the costs of switching are low. The price of the
substitute, itself, also factors into customers' decisions. If substitutes are cheaper than products from
another industry, the threat is higher. Likewise, if the performance of substitutes is similar or better,
the threat is higher. The closer the substitute is in performance, the less flexible a seller can be with
price. For instance, many newspapers have seen steep declines in circulation as Internet news has
gained in quality. The Wall Street Journal, however, has not declined in circulation over the same
time period because online substitutes for serious business news have not increased in quality
nearly as fast as for other types of news. OVERALL INDUSTRY ATTRACTIVENESS Understanding
the five forces that shape industry competition is useful as a starting point for developing strategy.
Indeed, managers often define competition too narrowly, as if it occurred only among direct
competitors. Yet competition for profits goes beyond direct rivals to include buyers, suppliers,
potential entrants, and substitute products. The extended rivalry that results from all five forces
defines an industry's structure and shapes the nature of competitive interaction within an industry.
Every company should know what the average profitability of its industry is and how that has been
changing over time. The five forces help explain why industry profitability is what it is—and why it
might be changing. Attractive (profitable) industries are those where firms have created power over
buyers and suppliers, created barriers to entry to reduce the threat of new entrants, and minimized
the threat of substitutes while keeping rivalry to a minimum. Even inefficient, relatively poorly run
companies can earn superior profits under such conditions. At the other extreme, are unattractive
industries. Firms in these industries are consistently pressured by buyers and suppliers alike. They
face high rivalry, easy entrance for new competitors, and many well-positioned substitute products.
Under these conditions, only the most efficient, well-run companies are able to turn a profit. Each of
the five forces can be analyzed to determine the degree to which, and how, it contributes to industry
attractiveness. We provide a strategy tool at the end of this chapter for analyzing each force. After
doing an analysis of each force, these can be combined to develop a detailed picture of what is
driving the overall profitability—the attractiveness—of the industry. Few industries will rate high
(attractive) or low (unattractive) on all forces. A significant threat from just one or two of the five
forces is often sufficient to destroy the attractiveness of an industry. For example, many firms in the
auto industry have struggled to be profitable over the last decade. This industry, however, has
relatively low buyer and supplier power, no real threat of substitutes, and a moderate threat of new
entrants. Rivalry, however, has been fierce, with constant excess production capacity and price
discounting. Sometimes, it only takes one of the five forces to be unattractive to make an industry
struggle. When many of the five forces are unattractive, firms face great challenges maintaining
profitability. However, understanding each force and how it is influencing profitability helps managers
know where to focus in dealing with those challenges. Moreover, a company strategist who
understands that competition extends well beyond existing rivals will perceive wider competitive
threats and be better prepared to address them. At the same time, thinking comprehensively about
an industry's structure can uncover opportunities to improve performance on each of the five forces,
thereby becoming the basis for distinct strategies that yield superior performance. One thing to keep
in mind is that the five forces are subject to change. Each of the five forces can be altered by actions
taken by firms within or without the industry. For instance, Google built the Android operating
system, even though it gives it away for free, to increase the number of suppliers for its search
engine, thus decreasing the supplier power that Apple might have had had it been able to dominate
the smartphone industry. A good strategist always has her eye on actions and trends that might
change any of the five forces in her industry. Not all of those trends come from actions taken by
firms close to the industry. Some come from the general environment. These are discussed in the
next section. HOW THE GENERAL ENVIRONMENT SHAPES FIRM AND INDUSTRY
PROFITABILITY To determine the landscape that a firm competes in, it isn't enough to only
understand the five forces that directly affect an industry. The general environment also needs to be
understood. The general environment can affect firms in a variety of ways,20 including affecting the
shape of each of the five industry forces. A simple way to think about the general environment is to
break it down into eight categories. Strategic managers in the best companies are focused on each
of these categories, looking for trends that might lead to new opportunities or threats. This is
illustrated in Figure 2.3: Complementary products or services Technological change General
economic conditions Population demographics Ecological/natural environment Global competitive
forces Political, legal, and regulatory forces Social/cultural forces [Figure 2.3] Trends in
Opportunities and Threats in the General Environment Developments in each of the eight categories
shown in the outer ring have the potential to shape and change the general landscape for any
specific industry. Each category can affect an industry's dynamics, which are shown by the area
within the center circle, altering any or all of the five forces. You should always keep in mind that an
industry's five forces are not static. The five forces are subject to change and may change, even
radically, if elements of the general environment change. When you are examining the general
environment, it is important, then, to not just get a picture of what things look like today but to
analyze trends, the direction each category is headed toward tomorrow. Remember, as well, that
this analysis is industry specific. You want to know how each of the eight categories is going to affect
the industry you are studying. The relative importance of each of the general environmental factors
differs from industry to industry. In the fast-food industry, social forces, such as a shift toward
healthier eating, are likely to alter the threat of substitutes, but technological change doesn't play as
a large a role. In the motorcycle manufacturing industry, demographics play a key role, as many
industrialized nations experience an upward trend in the average age of the population, but changes
in societal perceptions of motorcycles don't appear to be shifting quickly, resulting in fewer people
riding motorcycles because they are perceived to be transportation for the young. Managers need to
develop a deep sense of which environmental factors are strategically relevant to their own
industries.21 Managers need to understand not only which factors have the largest impact on their
industry right now, but also which factors are likely to change in the future, so that they can adapt
their firms' strategies to changing conditions. Complementary Products or Services Complementary
products or services are those that can be used in tandem with those in another industry. For
example, video gaming hardware and software, or smartphone operating systems and apps, are
complementary sets of products. When two complements are used together, they are worth more
than when they are used apart. Complementary pairs or groups (also called ecosystems) of products
can be found in many places, not just in the technology sector.22 Gas stations and roads are
complements to automobiles, and piping is a complementary product to natural gas. Trends in
complementary industries have the potential to radically alter—for better or worse—the landscape in
which firms compete. complementary products or services Products or services that can be used in
tandem with those from another industry. Take the rise of application software (apps), for instance.
In the 1990s, Microsoft created tools for software designers. By doing so, Microsoft lowered the
barriers to entry in the application software industry, a complementary industry to operating systems.
Apple made it even easier to enter the app industry by releasing segments of its operating system
code, creating even more new entrants and sparking the rise of single-purpose, inexpensive apps for
mobile computing devices. Now, customers at Apple's app store can choose from hundreds of
thousands of apps for their iPhones. The number of new entrants in the app industry is actually
increasing the barriers to entry in the smartphone operating system industry. It would be difficult for a
new mobile operating system to come on the scene and compete with Apple or Android. Even
powerful Microsoft has experienced challenges entering the mobile operating system business.23
For many industries, changes in complementary products are one of the most important trends to
keep an eye on. Some consider them significant enough that they even refer to them as a sixth force
among the five industry forces.24 Technological Change Technological change within an industry
has the potential to radically reshape a firm's landscape, and sometimes society with it.
Technological changes can include new products, such as smart phones; new processes, such as
hydraulic fracturing (fracking), which has dramatically increased the output of the natural gas
industry; or new materials, such as lithium batteries, which make electric automobiles possible. In
many industries, the pace of technological change has accelerated over the last couple of
decades.25 Managers find it increasingly important to consistently scan the environment to locate
potential new technologies that might affect their industries.26 Early adopters are often able to gain
greater market share and earn higher profit margins than those who are late to adopt, suggesting the
importance of incorporating new technologies early. Not only can technology change the nature of
rivalry in an industry by giving some firms an upper hand in gaining market share, but it can
sometimes lower barriers to entry. For instance, flexible manufacturing processes have allowed
Shanzhai handset makers to nearly match Nokia's cost of manufacturing cell phones. Even in lowtechnology industries such as steel, new technology can sometimes pave the way for new entrants.
In the 1970s, a new technology for smelting steel called the electric arc oven allowed new firms,
such as Nucor, to enter the industry with only one-tenth the capital investment that would have been
needed to start a traditional steel firm. Perhaps the technological change that has affected the threat
of new entrants in the greatest number of industries in the last 20 years is the Internet. Some have
suggested that the next giant wave of technology change, one we are in the middle of experiencing
is wireless communication, like smart phones, which allow individuals to connect from and to
anywhere and anyone at any time.27 General Economic Conditions Changing macroeconomic
forces can also have a large impact on industries. The state of an economy can affect a region or
nation and, subsequently, the ability of the average firm in an industry to be profitable. Analyzing the
economic environment typically involves measuring the economic growth rate, interest rates,
currency exchange rates, and the rate of inflation or deflation. The appendix provides a list of
sources where you can find information on these economic indicators. Economic Growth. How
quickly, or slowly, an economy is growing has a direct impact on most firms' bottom line. Economic
expansion tends to improve customer balance sheets, lower price sensitivity, and increase the
growth rate in an industry, as customers purchase more, easing rivalry. For example, a number of
African nations, such as Nigeria and Kenya, have experienced solid levels of economic growth in the
last few years.28 As a consequence, a growing percentage of the population has sufficient
disposable income to afford products like automobiles and cell phones. Companies providing
products like these in Africa have experienced a boom in customer demand.29 The reverse is also
true. When an economy slows down, industry growth rates slow, customers are more price sensitive,
and suppliers are also likely to be struggling and pursuing ways of increasing profits—at the expense
of firms in your industry, if they have the power to do so. Interest Rates. Interest rates mostly can
affect rivalry by increasing or decreasing the demand for an industry's products. This is true for
expensive items like housing, cars, and even education, which often requires customers to take out
loans to purchase. For example, the housing boom experienced in the United States and Europe in
the early 2000s was fueled by low-interest-rate loans, sometimes below 4 percent, when the
average mortgage interest rate in the previous decade had been above 6 percent. When interest
rates are low, industry growth rates increase and rivalry decreases. When interest rates are high, the
opposite can occur. In addition, interest rates affect the cost of capital. When interest rates are low,
many firms can afford to invest in new assets. As interest rates increase, new investments become
more difficult. As a result, firms sometimes engage in price wars as a strategy for gaining market
share when rates are high, rather than investing in R&D and new product development. Currency
Exchange Rates. Currency exchange rates reflect the value of one country's currency in relation to
the currency from another country. Exchange rates can have a large impact on the prices that
customers pay for products from firms in other countries, directly affecting profitability for those firms.
For instance, from mid-2010 to mid-2011, the Swiss franc appreciated 65 percent against the U.S.
dollar, making Swiss products 65 percent more costly in the United States, even though the cost of
production hadn't changed at all. Nestlé, a Swiss firm, was particularly hard hit. It either had to
decrease its profit margin to cover the extra cost or increase its prices substantially, risking fewer
customers buying its products. Inflation. A significant, consistent rise in prices, known as inflation,
can create many problems for firms. Inflation, or the opposite, deflation, means that the value of the
dollar doesn't stay constant. Today, a product may cost $1. If inflation is at 2 percent a year, then
next year that product will cost $1.02. Inflation or deflation, if they are high enough, can make it hard
for firms to plan investments. Inflation tends to decrease overall economic growth, increasing rivalry
and possibly buyer and supplier power and the threat of substitutes. When firms can't predict what
price they will be able to get for a particular product, investments in new product development
become riskier. When inflation is high, many industries experience increases in price competition,
rather than development, as a means of gaining market share. Demographic Forces Demographic
forces involve changes in the basic characteristics of a population, including changes in the overall
number of people, the average age, the number of each gender or ethnicity, or the income
distribution of the population.30 Because demographic changes involve basic shifts in the product
and geographic markets that firm's target, demographic changes are always accompanied by
opportunities and threats. Even though demographics often change slowly, they fundamentally
reshape the landscape, so good strategic managers have a firm understanding of demographic
trends. The appendix contains a list of readily available sources for demographic information. Some
sources, such as the World Bank, contain hundreds of demographic indicators. Over the last 50
years, the size the world's population has more than doubled, from around 3 billion to more than 7
billion people. Projections suggest that the Earth's population could reach 9 billion by 2040.31 Each
new individual is a potential new consumer, suggesting that growth rates of many industries will
increase over time. However, increases in consumption resulting from population growth also mean
that supplies of raw materials (such as the rare-earth metals terbium and europium currently used in
flat-panel displays32) are likely to decrease. Furthermore, the world population isn't spread evenly
over all nations. The enormous populations of China and India account, to a large degree, for the
number of firms that have set up operations in those countries. The average age of the population
within a nation can also have a tremendous effect on some industries. In Japan, for instance, more
than 20 percent of the population is over age 65. In the United States, this won't occur until around
2040.33 The robotics industry has already felt this shift. Japanese companies like Honda have
invested tens of millions of dollars in robots for home use, including walk-assist robots that help
elderly people with weakened muscles remain ambulatory when they would otherwise need to use a
wheelchair.34 Ecological/Natural Environment The natural environment can also be a source of
change for many industries. In some cases, this involves changes to the physical environment such
as increasing shortages of key inputs like rare earth metals or fluctuations in the amount and cost of
energy (i.e., oil and gas). More often, though, current trends in the natural environment involve
changes in the public's perception of how business affects the environment. From global warming to
clean air and water, the public in many countries—including developing economies like China—are
demanding that firms be more proactive in protecting the environment. Many firms have responded
by implementing green initiatives. Although some of these may be for public relations purposes only
many firms have established serious goals. For instance, Procter & Gamble has goals to use 30
percent renewable energy to power its plants by 2020. By 2014, 7.5 percent of its energy needs
were already met by renewable energy. They have also promised to reduce their energy
consumption, water usage, greenhouse gas emissions and waste by 20 percent by 2020. They have
already reduced them by 8 percent by 2014.35 If consumers truly care about the environment, then
actions like these increase rivalry as competitors are forced to respond in kind. Global Forces Global
forces also play a large role in shaping many industries. Over the last 50 years, as communications
and transportation technologies have undergone a revolution, trade barriers among nations have
fallen dramatically. Many countries, from South Korea and Taiwan, to China and India, to Brazil and
South Africa, have enjoyed remarkable economic growth and a rising standard of living. These
changes have caused firms from many countries to expand operations and begin producing and
selling across national borders. We will examine global forces and strategies for capitalizing on them
in greater detail in Chapter 9. Political, Legal, and Regulatory Forces Political, legal, and regulatory
forces are those that arise from the use of government. When new laws are passed, they may alter
the shape of an industry and influence the strategic actions that firms might take.36 For example, the
federal Affordable Health Care Act, enacted in 2009, mandates that health insurers cover everyone,
including those with preexisting conditions. This may change the cost structure of the industry,
potentially resulting in consolidation and less rivalry, as inefficient firms either go out of business or
are acquired by more viable firms. In the United States following the Great Recession of 2008–2009,
the Federal Reserve required banks to keep larger amounts of cash on hand to cover potential
mortgage-related losses. One consequence of this regulation was less lending to small businesses,
erecting entry barriers in many industries and changing the nature of rivalry in industries with many
small firms. Because political processes, laws, and regulations have the potential to shape and
constrain industries, managers should analyze and understand the impact of new laws and
regulations and decide how to respond. The Affordable Health Care Act, for example, requires firms
with over 50 employees to provide health insurance for their workers, or face fines. Because the law
also provides for health insurance exchanges through which uninsured people can buy their own
insurance, many firms are considering dropping employee health insurance as a benefit. Their
managers have determined that the fines their companies face would be cheaper than the current
premiums for health insurance. Of course, laws often provide opportunities, as well as threats. For
instance, laws in many countries and states in the United States that require electricity providers to
obtain a percentage of their electricity from renewable sources have resulted in a boom in demand
for wind turbines and solar panels. Because of the potentially far-ranging effect of laws and
regulations, many firms and industries strategically lobby government in an attempt to influence the
lawmakers to enact legislations favorable to those industries. Social/Cultural Forces Social forces
refer to society's cultural values and norms, or attitudes. Values and attitudes are so fundamental
that they often affect the other six general environmental forces, shaping the overall landscape in
which firms compete. For instance, changing cultural norms about health have resulted in laws
against sodas being sold in schools and lawsuits against fast-food retailers such as McDonald's for
marketing “unhealthy” food to children. Like the other environmental forces, however, social forces
can create opportunities if a firm happens to be among the first to act on changes in values and
attitudes. For instance, Facebook helped to change social norms about connecting to friends and
family. It reaped enormous profits for being among the first to capitalize on the change in social
networking. Social forces are different, sometimes radically so, in different countries. Firms that
compete in a global industry must understand differences among consumers in each country they
serve. For example, the collectivist orientation of many people in China results in a general belief
that the well-being of the group is more important than that of the individual and a related norm of
open information sharing.37 This open-sharing norm allows a greater acceptance of product
knockoffs and software pirating than many people are comfortable with in countries that tend to have
individualist orientations, such as the United States. SUMMARY One of the primary decisions that
firms need to make is which industry, or environment, they are going to compete in. Defining a firm's
industry correctly is important because it helps managers to identify their competition. One tool for
helping to define an industry is the NAICS codes produced by the U.S. government. Not all
industries are equally attractive. Five major forces determine the attractiveness of an industry,
defined as the profitability of the average firm in the industry. These forces are: rivalry, buyer power,
supplier power, threat of new entrants, and threat of substitute products. Good managers develop a
deep understanding of the effect of each of the five forces on industry attractiveness. Such an
understanding allows them to take strategic action to influence the five forces in a positive way for
their firm and industry. Misunderstanding the nature of the five forces can lead to decisions that
destroy industry profitability. Eight general environmental factors can affect the profit potential of a
firm: complementary products or services; technological change; general economic conditions;
demographic forces; the ecological/natural environment; global forces; political, legal, and regulatory
forces; and social/cultural forces. Changes in any of these eight factors can create additional
opportunities and threats and often shape the five industry-specific forces. KEY TERMS
attractiveness of the industry backward integration barriers to entry complementary products or
services forward integration network effects opportunities rivalry substitutes suppliers switching costs
threat REVIEW QUESTIONS Why is it important for a firm to accurately determine what industry it is
in? How should a firm decide what industry it is in? What are the five major industry forces? How do
they shape average profitability in an industry? What factors determine the intensity of rivalry?
Explain why increased buyer concentration would increase buyer power. Explain what it means for
suppliers to have a credible threat of forward integration. What factors determine the intensity of the
threat of new entrants? What are substitutes? What are the eight general environmental factors that
affect industry profitability? How does each of the eight general environmental factors influence
industry profitability? How do the eight general environmental factors affect the five industry forces?
What are the elements of a complete external analysis? APPLICATION EXERCISES Exercise 1:
Practice evaluating the industry five forces using the strategy tools presented in this chapter. Read
the case, Coca-Cola, Pepsi, and the Shifting Landscape of the Carbonated Soft Drink Industry. Use
the strategy tool presented in this chapter, along with data from the case, to evaluate: The intensity
of rivalry within the cola manufacturing industry (where Coca-Cola and Pepsi are prominent firms). Is
rivalry high, medium or low? The intensity of supplier power within the cola bottling industry (where
Coca-Cola and Pepsi are prominent suppliers). Is supplier power high, medium, or low? Where
sufficient data aren't available, use qualitative evidence to evaluate the strength of a particular factor.
Fill in the explanation/data line of the strategy tool with page numbers and a summary of your logic.
Which industry is likely to be more attractive: cola manufacturing or bottling? Why? Exercise 2:
Analyze the effects of the general environment on an industry of your choice. Identify an industry you
would like to learn more about. Ideally, you should be able to gather sufficient information on this
industry to thoroughly analyze the impact of the general environment on industry profitability.
Although information is available for a wide variety of industries, this exercise will be easier if you
choose an industry that has been written about consistently in the business press. In order to
manage the volume of data required for a thorough analysis, your instructor might want you to focus
solely on the home country of the largest firms in the industry (unless most firms earn a majority of
their profits from abroad). Use data from a variety of sources, including those listed in the appendix,
in your analysis. Try to identify the major effects of each of the eight factors (complementary
products; technological change; general economic conditions; demographic forces;
ecological/natural environment forces; global forces; political, legal, and regulatory forces; and
social/cultural forces) on industry profitability. Identify and predict any short-term to medium-term
changes in any of the eight factors that might alter average profitability in the industry. Address how
those changes will affect industry profitability in the future. As part of the analysis, consider how the
general environmental factors may affect each of the five industry forces (rivalry, buyer power,
supplier power, threat of new entrants, and threat of substitutes). Strategy Tool Evaluating Industry
Attractiveness Using Porter's Five Forces Model Understanding the five forces and their effect on the
landscape that a firm competes in is a cornerstone of successful strategic analysis. Figures 2.4
through 2.9 are general analytical tools used by a number of Fortune 500 firms to evaluate the
intensity of the five forces in an industry.38 These tools essentially help to quantify the ideas that we
have already discussed in this chapter. In practice, top management often implicitly understands the
dynamics of the five forces and might not personally use the tools presented here to map out the
strength of each force and its overall effect on industry profitability. However, a number of Fortune
500 firms use these tools in their strategic planning departments to provide rigor to the strategic
analyses and recommendations they present to top management. Although the tools might appear
complicated, they distill the concepts from this chapter, allowing a relatively simple, yet
comprehensive and detailed analysis of the five forces. [Figure 2.4] StrategyTool - Evaluating the
Intensity of Rivalry (mark an × in the appropriate box for each factor) [Figure 2.5] StrategyTool Evaluating the Intensity of Buyer Power (mark an × in the appropriate box for each factor) [Figure
2.6] StrategyTool - Evaluating the Intensity of Supplier Power (mark an × in the appropriate box for
each factor) [Figure 2.7] StrategyTool - Evaluating the Intensity Threat of New Entrants (mark an × in
the appropriate box for each factor) [Figure 2.8] StrategyTool - Evaluating the Intensity of the Threat
of Substitutes (mark an × in the appropriate box of each factor) [Figure 2.9] StrategyTool Evaluating the Overall Attractiveness of an Industry (highlight the appropriate box for each factor)
You can look for the data to complete these analysis tools in the sources listed in the appendix at the
end of the book. Many of the indicators in these analysis tools are objective numbers that you can
obtain from various data sources. Others are more subjective; they require a logical argument for the
level—low, medium, or high—that you choose. Even for more subjective indicators, however, data
from various sources can take the guesswork out of doing a five-forces analysis. For each item, put
an X in the box that most accurately reflects the data. For some boxes this is a range of data, for
instance, 60 to 70 percent combined market share in the rivalry tool. If the correct number is
anywhere within the range, put an X in the appropriate box. Cite your data source and/or explain
your placement underneath each item. Your answer for some rows of boxes will be an average of
more than one item. For instance, in the rivalry tool, the degree of industry standardization is the
average of the four items below it. Each column is assigned a number, 1 through 6. To take the
average, you add the value for each column (which, for each item, is determined by the set of
numbers that most accurately reflects the data you have gathered) and divide by the number of
items. For instance, to know where to place the X for degree of industry standardization in the rivalry
tool, you will add the values from the four items below it, determined by which column they are
located in, and divide by 4. To get the value for the overall intensity of each force you will add the
values from the boxes with Xs in them and divide by the total possible for those rows. For rivalry, this
means that you add the column values for each of the six rows of boxes, and then divide by 30.
Round your answer to the nearest whole number, and place an X in the appropriate box in the
“Overall Intensity of Rivalry” row. REFERENCES 1. Nokia SEC FORM 20-F, 2002, p. 27; Andy
Reinhart, “Nokia's Next Act.” 2. “Special Report: The Fight for Digital Dominance—Nokia vs.
Microsoft,” Economist (November 23, 2002). 3. S. Faris, “Is Windows Nokia's Lifeline?” Time (April
11, 2011). 4. “Nokia Market Share Falls but Microsoft Deal Confirmed,” BBC News (April 21, 2011).
5. B. Chiang, “China's ‘Bandit’ Cell Phones—The High-Tech Golden Egg with ‘Taiwan Inside,’”
Commonwealth Magazine (December 3, 2008). 6. T. Kuittenen, “Nokia Sells Handset Business to
Microsoft at a Shockingly Low Price,” Forbes (September 2, 2013). 7. D. A. Bosse, R. A. Philips, and
J. S. Harrison, “Stakeholders, Reciprocity, and Firm Performance,” Strategic Management Journal,
30 (2009): 447–456. 8. P. Chattopadhyay, W. H. Glick, and G. P. Huber, “Organizational Actions in
Response to Threats and Opportunities,” Academy of Management Journal, 44 (2001): 937–955. 9.
These can be found at http://www.census.gov/eos/www/naics/index.html. 10. B. Hunt and P.
Abrahams, “Microsoft's Battle with Symbian,” Financial Times (Feb. 25, 2003). 11. F. M. Scherer and
D. Ross, Industrial Market Structure and Economic Performance (Boston: Houghton Mifflin, 1990).
12. M. E. Porter, “The Five Competitive Forces that Shape Strategy,” Harvard Business Review 86
(1) (2008): 78–93. 13. S. Nadkarni and V. K. Narayanan, “Strategic Schemas, Strategic Flexibility,
and Firm Performance: The Moderating Role of Industry Clockspeed,” Strategic Management
Journal 28 (2007): 243–270. 14. R. Tidwell, “2011 Flat Panel TV Growth Rate Projected to Fall
Sharply,” News Junky Journal (May 2, 2011). 15. “Frozen Food Production in the U.S.” IBISWorld.
Accessed September 2011. 16. A. Gonsalves, “ARM Introduces 2.5 GHz Cortex A-15 Processor,”
InformationWeek (September 10, 2010). 17. A. Efrati and S. E. Ante, “Google's $12.5 Billion
Gamble,” The Wall Street Journal (August 16, 2011), pp. A1 and A4. 18. K. E. Kushida and J.
Zysman, “The Services Transformation and Network Policy: The New Logic of Value Creation,”
Review of Policy Research 26 (2009):173–194. 19. R. Makadok, “Interfirm Differences in Scale
Economies and the Evolution of Market Shares,” Strategic Management Journal 20 (1999): 935–
952. 20. L. Fahey, Competitors (New York: John Wiley and Sons, 1999). 21. J. A. Lamberg, H.
Tikkanen, T. Nokelainen, and H. Suur-Inkeroinen, “Competitive Dynamics, Strategic Consistency,
and Organizational Survival,” Strategic Management Journal 30 (2009): 45–60. 22. A. M.
Brandenburger and B. J. Nalebuff, Co-opetition (New York: Currency Doubleday, 1996). 23. T. Virki
and S. Mukherjee, “Windows Phone Struggles to Break Catch-22 as App Makers Hold Off,” Reuters
(March 26, 2012). 24. A. S. Grove, Only the Paranoid Survive (New York: Doubleday, 1996). 25. R.
K. Sinha and C. H. Noble, “The Adoption of Radical Manufacturing Technologies and Firm Survival,”
Strategic Management Journal 29 (2008): 943–962. 26. D. Lavie, “Capability Reconfiguration: An
Analysis of Incumbent Responses to Technological Change,” Academy of Management Review 31
(2006): 153–174. 27. S. A. Brown, “Household Technology Adoption, Use, and Impacts: Past,
Present, and Future,” Information Systems Frontiers 10 (2008): 397–402. 28. The World Bank.
http://data.worldbank.org/indicator/NY.GDP.MKTP.CD 29. “Nigeria Gives Huawei a Place to Prove
Itself,” The Wall Street Journal (September 12, 2011), p. B2. 30. E. K. Foerdermayer and A.
Diamantopoulos, “Market Segmentation in Practice: Review of Empirical Studies, Methodological
Assessments, and Agenda for Future Research,” Journal of Strategic Marketing 16 (2008): 223–265.
31. U.S. Census Bureau, 2011, International database,
http://www.census.gov/pic/www/idb/worldpopgraph.html. 32. D. Powell, “Sparing the Rare Earths:
Potential Shortages of Useful Metals Inspire Scientists to Seek Alternatives for Magnet
Technologies,” Science News (August 27, 2011), p. 20. 33. S. Moffett, “Fast-Aging Japan Keeps Its
Elders on the Job Longer,” The Wall Street Journal (June 15, 2005), pp. A1 and A8. 34.
http://corporate.honda.com/innovation/walk-assist/. 35. Procter and Gamble, Sustainability Report
(2013),
http://www.pg.com/en_US/downloads/sustainability/reports/PG_2013_Sustainability_Summary.pdf.
36. C. Oliver and I. Holzinger, “The Effectiveness of Strategic Political Management: A Dynamic
Capabilities Framework,” Academy of Management Review 33 (2008): 496–520. 37. S. Michailova
and K. Hutchings, “National Cultural Influences on Knowledge Sharing: A Comparison of China and
Russia,” Journal of Management Studies 43 (2006): 384–405. 38. Roger McCarty is credited with
the early versions of these tools. The five forces tools presented here are generalized forms of
specific tools used in a number of Fortune 500 firms. While the tools presented here are a good
starting point, in actual practice they may need to be altered to fit the circumstances of a particular
industry. For instance, in the operating systems industry, network effects play a bigger role than the
capital cost of plant and equipment.
LEARNING OBJECTIVES Studying this chapter should provide you with the knowledge to: Define
business strategy, including the importance of competitive advantage, the four choices that are
critical to strategy formulation, and the strategic management process. Summarize the information
that the company's mission and thorough external and internal analysis provide to guide strategy.
Discuss how strategies are formulated and implemented in order to achieve objectives. Explain who
is responsible for, and who benefits from, good business strategy. 01 Strategy at Apple In 2000,
Apple computer held a loyal customer base but was limping along as a relatively minor player in the
personal computer market. Launched by Steve Jobs and Steve Wozniak, Apple was one of the
pioneers in the industry. Unlike other PC makers that relied on Microsoft's operating system and
application software, Apple wrote its own operating system software and much of its application
software, which was known as being easy to use. In fact, Apple was the first to introduce software on
a low cost personal computer with drop-down menus and a graphical user interface that allowed
customers to easily complete a task—like drag a file to the trash to delete it. However, Apple's
investment in unique software led to high-priced computers and created files that were originally
incompatible with those of Microsoft's Windows operating system and Office software suite. As a
result, Apple rarely achieved more than about a 5 percent share of the computer market.1
CUSTOMERS NOW COULD EASILY AND LEGALLY ACCESS SONGS SIMPLY BY
CONNECTING THEIR iPODS TO THEIR COMPUTERS AND LETTING THE SOFTWARE DO TO
THE REST. EVEN A TECHNOLOGY-CHALLENGED GRANDPARENT COULD DO IT. That all
changed in 2001, however, when Apple entered an entirely new market with the launch of an MP3
portable music player called the iPod. Apple's MP3 player was not the first on the market. A
company called Rio had offered an MP3 player for a couple of years before iPod's entry into the
market. But iPod quickly took market share from the Rio, for three primary reasons: iPod had a mini
hard drive that allowed it to hold 500 songs, as opposed to the roughly 15 songs the Rio could hold
using flash memory. iPod was the first to introduce a “fly wheel” navigation button—the round button
that was easy to use and allowed users to quickly scroll through menus and songs. iPod was backed
with Apple's name and an innovative design.2 These advantages helped iPod quickly move to
industry leadership, despite the fact that an iPod cost 15 to 25 percent more than a Rio.3 At the time
the iPod was launched, it was difficult for most consumers to legally access digital downloads of
songs. Initially, the iPod was only snapped up by a relatively small group of users, mostly teenagers
and college students, who were illegally downloading songs through Napster and other free
downloading sites. Apple recognized that in order to grow the market for iPods, it needed to help
consumers legally access songs to play on their iPods. As a result, Apple developed software called
iTunes, allowing customers to legally download songs. One main reason iTunes was able to provide
legal downloads before its competitors was because Steve Jobs, as CEO of both Apple and Pixar
(the animation movie production company), understood that music companies, like movie
companies, were concerned about people pirating their products. So Apple worked with the music
companies to sell songs that had been digitized using software that prevented customers from
copying the songs to more than a few computers. iTunes was designed to be easy to use with the
iPod. Customers now could easily and legally access songs simply by connecting their iPods to their
computers and letting the software do to the rest. Even a technology-challenged grandparent could
do it.4 But Apple wasn't done with its music player strategy. Apple's experience in the computer
business was that other companies could make similar products, often at lower prices. Indeed, while
Apple and IBM were the pioneers of the personal computer industry and dominated it during the
early years, lower-priced competitors like Dell, Hewlett-Packard, Lenovo, and ASUS, eventually
came to dominate the market. Apple realized it needed to prevent easy imitation of its music offering.
So it created proprietary software called Fairplay that restricted the use of music downloaded from
iTunes to iPods only. That meant consumers couldn't buy a lower-priced MP3 player and use it with
iTunes because it was incompatible. If they wanted to use a different MP3 player, they would have to
download and pay for music a second time.5 To top it off, Apple did something that no other maker
of computers, music players, or any other electronic device company had done. It opened its own
stores to sell Apple products. This required that Apple learn how to operate retail stores. The Apple
Stores helped Apple create a direct link to its customers, making it easier for consumers to learn
about and try out Apple products—and get their products serviced. As a result of Apple's strategic
initiatives, it has built a very secure market position in music players, currently holding over 70
percent of that market.6 But the battle isn't over. Amazon has entered the industry, offering music
buyers unrestricted use of its songs. Moreover, competitors e-Music, Rhapsody.com, and Spotify are
offering music via subscription. Users can listen to any song they want for a monthly subscription
fee. And Pandora, a free online radio service, offers similar unlimited access to songs. The $17
billion music industry is so large that it will continue to attract new competitors who want to dethrone
Apple. How did Apple enter the music industry and within 10 years become the dominant seller of
both songs and music players? Why is Pandora, a start-up, succeeding in the music industry while
former giant Sony (maker of the Walkman and Discman) is struggling? For that matter, why is any
company successful? Understanding the series of actions taken by Apple to achieve a dominant
position in the online music business will go a long way toward understanding business strategy—a
company's plan to gain, and sustain, competitive advantage in its markets. In this chapter, we'll help
you get started by answering some basic questions. We begin with the most obvious: “What is a
business strategy?” WHAT IS BUSINESS STRATEGY? The word strategy comes from the Greek
word strategos, meaning, “the art of the general.” In other words, the origin of strategy comes from
the art of war, and, specifically, the role of a general in a war. In fact, there is a famous treatise titled
The Art of War that is said to have been authored by Sun Tzu, a legendary Chinese general. In the
art of war, the goal is to win—but that is not the strategy. Can you imagine the great general
Hannibal saying something like, “Our strategy is to beat Rome!” No, Hannibal's goal was to defeat
Rome. His strategy was to bring hidden strengths against the weaknesses of his enemy at the point
of attack—which he did when he crossed the Alps to attack in a way that his enemies did not believe
he could. He achieved an advantage through his strategy. In similar fashion, a company's business
strategy is defined as a company's plan to gain, and sustain competitive advantage in the
marketplace. This plan is based on the theory its leaders have about how to succeed in a particular
market. This theory involves predictions of which markets are attractive and how a company can
offer unique value to customers in those markets in a way that won't be easily imitated by
competitors. This theory then gets translated into a plan to gain competitive advantage. Apple's
theory of how to gain a competitive advantage in music download business was to create cool and
easy-to-use MP3 players that could easily—and legally—download digital songs from a computer
through the iTunes store. Apple sought to sustain its advantage by making it impossible for
competitor MP3 players to download songs from the iTunes store. The Apple Stores contributed to
Apple's advantage by providing a direct physical link to customers that competitors couldn't match. In
this particular instance, Apple's plan to gain, and sustain, competitive advantage worked. But there
have been other times, such as with the Apple Newton Message Pad (the first handheld computer
that Apple sold as a personal digital assistant) that Apple's theory about how to gain and sustain
competitive advantage did not work. Sometimes strategies are successful and sometimes they are
not. business strategy A plan to achieve competitive advantage that involves making four strategic
choices: (1) markets to compete in; (2) unique value the firm will offer in those markets; (3) the
resources and capabilities required to offer that unique value better than competitors; and (4) ways
to sustain the advantage by preventing imitation. competitive advantage When a firm generates
higher profits compared to its competitors. market The industry and geographic area that a company
competes in. unique value The reason a firm wins with customers or the value proposition it offers to
customers, such as a low cost advantage or differentiation advantage. Strategies are more likely to
be successful when the plan explicitly takes into account four factors: the attractiveness of a market
how to offer unique value relative to the competition what resources or capabilities are necessary to
deliver that unique value how to sustain a competitive advantage once it has been achieved. The
goal of the strategic plan is to create competitive advantage. First, let's examine the goal.
Competitive Advantage What exactly do we mean when we use the term competitive advantage?7
In the sports world, it is usually obvious when a team has a competitive advantage over another
team: The better team wins the game by having a higher score. The ability to consistently win is
based on attracting and developing better players and coaches, and by employing strategies to
exploit the weaknesses of opponents. In the business world, the scoring is measured by looking at
the profits (as a percentage of invested capital) generated by each firm. We describe the most
common ways of measuring profits in Strategy in Practice: Measuring American Home Products'
Competitive Advantage. STRATEGY IN PRACTICE MEASURING AMERICAN HOME PRODUCTS'
COMPETITIVE ADVANTAGE To see which firms in an industry are most successful, we typically
compare their return on assets (ROA), a calculation of operating profits divided by total assets, or
their return on equity (ROE), which is operating profits divided by total stockholders' equity. The
company that consistently generates the highest returns for its investors, in terms of ROA or ROE,
wins the game. For example, from 1971 to 2000, the pharmaceutical company American Home
Products averaged 19 percent ROA, compared to competitor American Cyanamid's 7 percent.
American Home Products' ROA was higher than American Cyanamid's every year for 30 years. This
is evidence that during this time period, American Home Products had a competitive advantage over
American Cyanamid.8 American Home Products' advantage over American Cyanamid frequently
has been attributed to its ability to develop more blockbuster drugs (through more effective research
and development) and to quickly get those drugs to market through a larger and more effective sales
force. Profitability of Different Firms in the Pharmaceutical Industry Source: Annual reports; 1973–
1992 Just as in sports, where an inferior team may outscore a superior team on a given day, it may
be possible for an inferior company to outscore a superior company in a particular quarter, or
perhaps even a year. Competitive advantage requires that a firm consistently outperform its rivals in
generating above-average profits. A firm has a competitive advantage when it can consistently
generate above-average profits through a strategy that competitors are unable to imitate or find too
costly to imitate. Above-average profits are profit returns in excess of what an investor expects from
other investments with a similar amount of risk. Risk is an investor's uncertainty about the profits or
losses that will result from a particular investment. For example, investors suffer a lot of uncertainty
(and, hence, risk) when they put their money into a start-up company that is trying to launch
products based on a new technology, such as a solar power company. There is much less risk in
investing in a stable firm with a long history of profitability, such as a utility company that supplies
power to customers who have few, if any, alternative sources of power.9 above-average profits
Returns in excess of what an investor expects from other investments with a similar amount of risk.
Many organizations work to achieve objectives other than profit. For example, universities, many
hospitals, government agencies, not-for-profit organizations, and social entrepreneurs play important
roles in making our economy work and our society a better place to live. These organizations do not
measure their success in terms of profit rates, but they still use many of the tools of strategic
management to help them succeed (see Chapter 14). For these organizations, success might be
measured using tangible outcomes such as the number of degrees granted, patient health and
satisfaction measures, people served, or some other measure of an improved society. The primary
source of a company's competitive advantage can come from several areas of its operations. For
example, the diamond company De Beers has an advantage that comes from paying lower costs for
its diamonds than other companies do, because De Beers owns its own diamond mines.
Competitive advantage can also come from different functional areas within the company.
Biotechnology pioneer Genentech's advantage comes primarily from research and development that
has produced several blockbuster drugs; Toyota's advantage in automobiles comes primarily from its
operations (known as the Toyota Production System); Procter & Gamble's advantage in household
products comes largely from its sales and marketing, and Nordstrom's advantage as a retailer
comes largely from its merchandising and service. The Strategic Management Process The
processes that firms use to develop a strategy can differ dramatically across firms. In some cases,
executives do not spend significant time on strategy formulation and strategies are often based only
on recent experience and limited information. However, we propose that a better approach to the
formulation of strategy is the strategic management process outlined in Figure 1.1. The strategic
management process for formulating and implementing strategy involves thorough external analysis
and internal analysis. Only after conducting an analysis of the company's external environment and
its internal resources and capabilities are a firm's executives and managers able to identify the most
attractive business opportunities and to formulate a strategy for achieving competitive advantage.
[Figure 1.1] The Strategic Management Process strategic management process The process by
which organizations formulate a plan and allocate resources to achieve competitive advantage that
involves making four strategic choices: (1) markets to compete in; (2) unique value the firm will offer
in those markets; (3) the resources and capabilities required to offer that unique value better than
competitors; and (4) ways to sustain the advantage by preventing imitation. external analysis
Examining the forces that influence industry attractiveness, including opportunities and threats that
exist in the environment. internal analysis The analysis of a firm's resources and capabilities to
assess how effectively the firm is able to deliver the unique value (value proposition) that it hopes to
provide to customers. The central task of the strategy formulation process is specifying the high-level
plan and set of actions the company will take in its quest to achieve competitive advantage. Once
the plan for creating competitive advantage is created, the final step is to develop a detailed plan to
effectively implement, or put into action, the firm's strategy through specific activities. The focus of
the strategic management process should be to make four key strategic choices, as shown in Figure
1.2 Which markets the company will pursue. A company's markets include both the industries in
which it competes and its geographic markets. What unique value to offer the customer in those
markets. This is the firm's value proposition, the reason the company wins with a set of
customers.10 What resources and capabilities are required? What does the company need to have
and know how to do so that it can deliver its unique value better than competitors, and exactly how
will the company deliver its unique value?11 How the company will capture value and sustain a
competitive advantage over time. Firms need to create barriers to imitation to keep other companies
from delivering the same value. [Figure 1.2] Four Key Strategic Choices in Strategic Management
Markets. One of the first decisions a company must make is which markets it will serve. Leaders
must choose the industries a company competes in and the product and service markets within
those industries. For example, before iPod, Apple only competed in the computer industry. Its
product markets included desktop and lapt...
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