The use of copyrighted materials in all formats, including the creation, online delivery, and use of digital copies of copyrighted materials, must be in compliance with U.S. Copyright Law (http://www.copyright.gov/title17/). Materials may not be reproduced in any form without permission from the publisher, except as permitted under U.S. copyright law. Copyrighted works are provided under Fair Use Guidelines only to serve personal study, scholarship, research, or teaching needs. CONCEPTS Strategic Management COMPETITIVENESS & GLOBALIZATION Michael A. Hitt Texas A&M University R. Duane Ireland Texas A&M University Robert E. Hoskisson Rice University CENGAGE Learning* Australia • Brazil • Japan • Korea • Mexico • Singapore • Spain • United Kingdom • United States 2 The External Environment: Opportunities, Threats, Industry Competition, and Competitor Analysis Studying this chapter should provide you with the strategic management knowledge needed to: 1 Explain the importance of analyzing and understanding the firm's external environment. 2 Define and describe the general environment and the industry environment. 3 Discuss the four parts of the external environmental analysis process. 4 Name and describe the general environment's seven segments. 5 Identify the five competitive forces and explain how they determine an industry's profitability potential. 6 Define strategic groups and describe their influence on firms. 7 Describe what firms need to know about their competitors and different methods (including ethical standards) used to collect intelligence about them. THE COCA-COLA CO. AND PEPSICO: RIVALS COMPETING IN A CHALLENGING ENVIRONMENT Recognized throughout the revenue but 35 percent of its operat­ to the production of 5 million orange ing profits. In contrast, Coca-Cola is the trees for a period of 20 years. PepsiCo's Co are both successful com­ world's largest producer of soft drink recent competitive actions include panies. At least historically, concentrates and syrups and is also the paying $4.2 billion for Russian yogurt these firms are best known world's largest producer of juice and giant Wimm-Bill-Dann Foods. This is world, Coca-Cola and Pepsi­ for their soft drinks or sodas. Interestingly, some believe that the United States "has been defined by juice-related products; however, it does PepsiCo's largest-ever foreign acquisi­ not have a snack business unit. tion and is seen as a path to reach Changing conditions in the external consumers in neighboring countries soda in the same way France defined environment are affecting these firms' its empire on wine, Germany on beer, competitive choices. Overall declining Kyrgyzstan for the purpose of success­ and Britain on tea." sales in the soda category in the United fully distributing its Frito-Lay products. Even though they differ in the total States in particular but in other parts such as Ukraine, Turkmenistan, and In addition, these firms continue set of products they offer, the rivalry of the world as well are one reason for competing aggressively against each between these companies remains this. Soda sales appear to be declin­ other in sodas. Each firm has devel­ intense, particularly in terms of both ing partly as a result of changes in oped fountain machines that allow carbonated and noncarbonated bever­ societies' attitudes toward the "value" customers to create a variety of flavor ages. These competitions play out in associated with consuming soda prod­ combinations, such as strawberry many nations and regions of the world. ucts, particularly full-calorie versions of Mountain Dew (a Pepsi-Cola product). them. In response, Coca-Cola is finding To better attract younger consumers, Of the two companies, PepsiCo is more diversified in that, through its ways to generate more returns through PepsiCo completed an endorsement Frito-Lay business unit, it is a leader in its juice products. To ensure access deal with pop star Beyoncé. And both the global snack industry. The impor­ to the supply of oranges it needs, the firms are competing against each other tance of this unit to PepsiCo is shown firm recently established long-term to gain market share in noncarbonated by the fact that it recently accounted leases with two large Florida grow­ beverage products such as waters, for 21 percent of the firm's sales ers. This deal gives Coca-Cola access juices, and sports drinks. 37 Part 1: Strategic Management Inputs 38 Suggested links between obesity and some of these firms' products is another condition in the external environment that is affecting these firms, causing them to compete against each other to find ways to most effectively respond to this threat. Coca-Cola has announced that it is committed to contributing to individuals' health on a global basis. Supporting physical activities programs in every country where the firm competes is one action it is taking to demonstrate this commitment. In addition to committing to sell healthier products through its Quaker Oats, Gatorade, and Tropicana divisions, PepsiCo has established the "Global Nutrition Group" for the purpose of developing breakthrough products that will satisfy customers' needs for enjoyable but healthy products. Sources: 2013, Coca-Cola Co, Standard & Poor's Stock Report, www.standardandpoors.com. May 17; 2013, PepsiCo Inc., Standard & Poor's Stock Report, www.standardandpoors.com. May 17; A. Cardenal, 2013, The battle of the soda giants: Coke vs. Pepsi, www.beta.fool.com, April 10; C. Passy, 2013, Why soda is the great American beverage, Wall Street Journal, www.wsj.com, March 12; D. Stanford, 2013, Cola-Cola expands calorie labels and emphasizes no-cals, Bloomberg Business­ week, www.businessweek.com, May 9; D. Stanford, 2013, PepsiCo's East European snack attack, Bloomberg Businessweek, www.businessweek.com, February 28; K. Stock, 2013, Coke's sweet $2 billion orange juice deal, Bloomberg Businessweek, www.businessweek.com, May 8. As described in the Opening Case and suggested by research, the external environment (which includes the industry in which a firm competes as well as those against whom it competes) affects the competition actions and responses firms take to outperform competitors and earn above-average returns.1 For example, Coca-Cola and PepsiCo are trying to effectively address the allegation that some and perhaps many of their products contribute to obesity. The socio­ cultural segment of the general environment (discussed in this chapter) is the source of this allegation and the threat it represents to the two firms. The Opening Case also describes some of the ways these two firms compete against each other in markets throughout the world. As noted in Chapter 1, the characteristics of today’s external environment differ from historical conditions. For example, technological changes and the continuing growth of infor­ mation gathering and processing capabilities increase the need for firms to develop effective competitive actions and responses on a timely basis.2 (We fully discuss competitive actions and responses in Chapter 5.) Additionally, the rapid sociological changes occurring in many countries affect labor practices and the nature of products that increasingly diverse consumers demand. Governmental policies and laws also affect where and how firms choose to compete.3 And, changes to a number of nations’ financial regulatory systems that have been enacted since 2010 are expected to increase the complexity of organizations’ financial transactions.4 Firms understand the external environment by acquiring information about competi­ tors, customers, and other stakeholders to build their own base of knowledge and capa­ bilities.5 On the basis of the new information, firms take actions, such as building new capabilities and core competencies, in hopes of buffering themselves from any negative environmental effects and to pursue opportunities as the basis for better serving their stake­ holders’ needs.6 In summary, a firm’s competitive actions and responses are influenced by the conditions in the three parts (the general, industry, and competitor) of its external environment (see Figure 2.1) and its understanding of those conditions. Next, we fully describe each part of the firm’s external environment. 2-1 The General, Industry, and Competitor Environments The general environment is composed of dimensions in the broader society that influence an industry and the firms within it. The general environment is composed of dimensions in the broader society that influence an industry and the firms within it.7 We group these dimensions into seven environmental segments: demographic, economic, political/legal, sociocultural, technological, global, and physical. Examples of elements analyzed in each of these segments are shown in Fable 2.1. 39 Economic Demographic Physical Industry Environment Threat of New Entrants Power of Suppliers Power of Buyers Product Substitutes Intensity of Rivalry Sociocultural Competitor Environment Political/Legal Global Technological Firms cannot directly control the general environment’s segments. Accordingly, what a company seeks to do is recognize trends in each segment of the general environment and then predict each trend’s effect on it. For example, some believe that over the next 10 to 20 years, millions of people living in emerging market countries will join the middle class. 01 course no firm, including large multinationals, is able to control where growth in poten­ tial customers may take place in the next decade or two. Nonetheless, firms must study this anticipated trend as a foundation for predicting its effects on their ability to identify strate­ gies to use that will allow them to remain successful as market conditions change.* The industry environment is the set of factors that directly influences a firm and its competitive actions and responses:9 the threat of new entrants, the power of suppliers, the power of buyers, the threat of product substitutes, and the intensity of rivalry among com­ peting firms. In total, the interactions among these five factors determine an industry’s profitability potential; in turn, the industry’s profitability potential influences the choices each firm makes about its competitive actions and responses. The challenge for a firm is to locate a position within an industry where it can favorably influence the five factors or where it can successfully defend itself against their influence. The greater a firm’s capacity to favorably influence its industry environment, the greater the likelihood it will earn aboveaverage returns. How companies gather and interpret information about their competitors is called competitor analysis. Understanding the firm’s competitor environment complements the insights provided by studying the general and industry environments.10 This means, for example, that Coca-Cola and PepsiCo want to learn as much about each other as they can while each company simultaneously seeks to understand its general and industry environments. industry environment is the set The of factors that directly influences a firm and its competitive actions and responses: the threat of new entrants, the power of suppliers, the power of buyers, the threat of product substitutes, and the intensity of rivalry among competing firms. How companies gather and interpret information about their competitors is called competitor analysis Part 1: Strategic Management Inputs 40 Table 2.1 The General Environment: Segments and Elements i | Demographic segment • Population size • Age structure • Geographic distribution • Ethnic mix • Income distribution Economic segment • • • • • Personal savings rate • Business savings rates • Gross domestic product Political/Legal segment • Antitrust laws • Taxation laws • Deregulation philosophies • Labor training laws • Educational philosophies and policies Sociocultural segment • Women in the workforce • Workforce diversity • Attitudes about the quality of work life • Shifts in work and career preferences • Shifts in preferences regarding product and service characteristics Technological segment • Product innovations • Applications of knowledge • Focus of private and governmentsupported R&D expenditures • New communication technologies Global segment • Important political events • Critical global markets • Newly industrialized countries • Different cultural and institutional attributes Physical environment segment • • • • • Availability of water as a resource • Producing environmentally friendly products • Reacting to natural or man-made disasters 1 Inflation rates Interest rates Trade deficits or surpluses Budget deficits or surpluses Energy consumption Practices used to develop energy sources Renewable energy efforts Minimizing a firm's environmental footprint £■ Cengage Learning An analysis of the general environment focuses on environmental trends and their implications, an analysis of the industry environment focuses on the factors and conditions influencing an industry’s profitability potential, and an analysis of competitors is focused on predicting competitors’ actions, responses, and intentions. In combination, the results of these three analyses influence the firm’s vision, mission, its choice of strategies, and the competitive actions and responses it will take to implement those strategies. Although we discuss each analysis separately, performance improves when the firm effectively integrates the insights provided by analyses of the general environment, the industry environment, and the competitor environment. 2-2 External Environmental Analysis Most firms face external environments that are turbulent, complex, and global—conditions that make interpreting those environments difficult." To cope with often ambiguous and An opportunity is a condition in the general environment that, if exploited effectively, helps a company reach strategic competitiveness. incomplete environmental data and to increase understanding of the general environment, firms complete an external environmental analysis. This analysis has four parts: scanning, monitoring, forecasting, and assessing (see Table 2.2). Identifying opportunities and threats is an important objective of studying the general environment. An opportunity is a condition in the general environment that, if exploited effectively, helps a company reach strategic competitiveness. Most companies—and cer­ tainly large ones—continuously encounter multiple opportunities as well as threats. Chapter 2: The External Environment: Opportunities, Threats, Industry Competition, and Competitor Analysis 41 Table 2.2 Parts of the External Environment Analysis Scanning • Identifying early signals of environmental changes and trends Monitoring • Detecting meaning through ongoing observations of environmental changes and trends Forecasting • Developing projections of anticipated outcomes based on monitored changes and trends Assessing • Determining the timing and importance of environmental changes and trends for firms' strategies and their management ©Cengage Learning In terms of possible opportunities, we can note that a combination of cultural, political, and economic factors is resulting in rapid retail growth in Africa and the Middle Hast as well as in Latin America. Accordingly Walmart, the worlds largest retailer, and the next three larg­ est global giants (France’s Carrefour, U.K.-based Tesco, and Germany’s Metro) are planning to expand in these regions. “Walmart is expanding its horizon to Chile, India and South Africa; Carrefour will open stores in Bulgaria, India and Iran. Tesco is also opening stores in India, and Metro will open in Egypt and Kazakhstan.”12 Similarly, Google intends to partner with local telecommunications Firms and equipment providers to help build and operate wireless networks in emerging markets such as sub-Saharan Africa and Southeast Asia. Pursuing these opportunities is part of Google’s goal of connecting a billion or more new users to the Internet.13 A threat is a condition in the general environment that may hinder a company’s efforts to achieve strategic competitiveness.14 Finnish-based Nokia Corp. is dealing with threats including one regarding its intellectual property rights. In roughly mid-2013, the company filed two additional complaints against competitor HTC Corp. alleging that the Taiwanese smartphone manufacturer had infringed on nine of Nokia’s patents.15 This threat obviously deals with the political/legal segment. From the technological segment, Nokia is facing a potential threat from a new device called Jolla. Created by former Nokia executives and developers who founded their own firm in Helsinki in 2011, its manufacturer believes that the Jolla operating system is “a truly independent and open alternative in mobile.”16 While its competitive success is yet to be determined, this product does appear to represent a tech­ nological threat tor Nokia and others smartphone manufacturers as well. Firms use multiple sources to analyze the general environment through scanning, moni­ toring, forecasting, and assessing. Examples of these sources include a wide variety of printed materials (such as trade publications, newspapers, business publications, and the results of academic research and public polls), trade shows and suppliers, customers, and employees of public-sector organizations. Of course, the information available from Internet sources is of increasing importance to a firm’s efforts to study the general environment. 2-2a Scanning Scanning entails the study of all segments in the general environment. Although challeng­ ing, scanning is critically important to firms’ efforts to understand trends in the general environment and predict their implications. This is particularly the case for companies competing in highly volatile environments.17 Through scanning, firms identify early signals of potential changes in the general environment and detect changes that are already under way.1” Scanning activities must be aligned with the organizational context; a scanning system designed for a volatile environ­ ment is inappropriate for a firm in a stable environment.19 Scanning often reveals ambigu­ ous, incomplete, or unconnected data and information that require careful analysis. Many firms use special software to help them identify events that are taking place in the environment and that are announced in public sources. For example, news event detection A threat is a condition in the general environment that may hinder a company's efforts to achieve strategic competitiveness. Part 1: Strategic Management Inputs 42 uses information-based systems to categorize text and reduce the trade-off between an important missed event and false alarm rates. Increasingly, these systems are used to study social media outlets as sources of information.20 Broadly speaking, the Internet provides a wealth of opportunities for scanning. Amazon, com, for example, records information about individuals visiting its Web site, particularly if a purchase is made. Amazon then welcomes these customers by name when they visit the Web site again. The firm sends messages to customers about specials and new products similar to those they purchased in previous visits. A number of other companies, such as Netflix, also collect demographic data about their customers in an attempt to identify their unique preferences (demographics is one of the segments in the general environment). 2-2b Monitoring When monitoring, analysts observe environmental changes to see if an important trend is emerging from among those spotted through scanning.21 Critical to successful monitoring is the firms ability to detect meaning in environmental events and trends. For example, those monitoring retirement trends in the United States learned in 2013 that 57 percent of U.S. workers surveyed reported that excluding the value of their home, they have only $25,000 or less in savings and investments set aside for their retirement. This particular survey also discovered “that 28% of Americans have no confidence they will have enough money to retire comfortably—the highest level in the (surveys) 23-year history.”22 Historically, U.S. workers saved larger percentages of their earned income as a foundation for retirement. Firms seeking to serve retirees’ financial needs will continue monitoring this change in workers’ savings and investment patterns to see if a trend is developing. Once convinced that saving less for retirement is indeed a trend, these firms will seek to understand its competi­ tive implications. Effective monitoring requires the firm to identify important stakeholders and under­ stand its reputation among these stakeholders as the foundation for serving their unique needs.23 (Stakeholders’ unique needs are described in Chapter 1.) Scanning and monitoring are particularly important when a firm competes in an industry with high technologi­ cal uncertainty.24 Scanning and monitoring can provide the firm with information; these activities also serve as a means of importing knowledge about markets and about how to suc­ cessfully commercialize the new technologies the firm has developed.25 A variety of microprocessors are displayed at the Mobile World Congress in Barcelona, Spain. The global showcase for the mobile technology industry draws 1,500 exhibitors to discuss the future of wireless communication. 2-2c Forecasting Scanning and monitoring are concerned with events and trends in the general environment at a point in time. When forecasting, analysts develop feasible projections of what might happen, and how quickly, as a result of the events and trends detected through scanning and monitoring.26 For example, analysts might forecast the time that will be required for a new technology to reach the marketplace, the length of time before differjs ent corporate training procedures are required to Í f deal with anticipated changes in the composition of the workforce, or how much time will elapse f before changes in governmental taxation policies s affect consumers’ purchasing patterns. Chapter 2: The External Environment: Opportunities. Threats, Industry Competition, and Competitor Analysis 43 Forecasting events and outcomes accurately is challenging. Forecasting demand for new technological products is difficult because technology trends are continually driving product life cycles shorter. This is particularly difficult for a firm such as Intel, whose products go into many customers’ technological products, which are consistently updated. Increasing the dif­ ficulty, each new wafer fabrication or silicon chip technology production plant in which Intel invests becomes significantly more expensive for each generation of chip products. In this instance, having access to tools that allow better forecasting of electronic product demand is of value to Intel as the firm studies conditions in its external environment.27 2-2d Assessing When assessing, the objective is to determine the timing and significance of the effects of environmental changes and trends that have been identified.28 Through scanning, moni­ toring, and forecasting, analysts are able to understand the general environment. Going a step further, the intent of assessment is to specify the implications of that understanding. Without assessment, the firm is left with data that may be interesting but of unknown com­ petitive relevance. Even if formal assessment is inadequate, the appropriate interpretation of that information is important. Accurately assessing the trends expected to take place in the segments of a firm’s general environment is important. However, accurately interpreting the meaning of those trends is even more important. In slightly different words, although gathering and organizing infor­ mation is important, appropriately interpreting the intelligence the collected information provides to determine if an identified trend in the general environment is an opportunity or threat is critical.29 2-3 Segments of the General Environment The general environment is composed of segments that are external to the firm (see Table 2.1). Although the degree of impact varies, these environmental segments affect all industries and the firms competing in them. The challenge to each firm is to scan, monitor, forecast, and assess the elements in each segment to predict their effects on it. Effective scanning, monitoring, forecasting, and assessing are vital to the firm’s efforts to recognize and evaluate opportunities and threats. 2-3a The Demographic Segment The demographic segment is concerned with a population’s size, age structure, geographic distribution, ethnic mix, and income distribution.30 Demographic segments are commonly analyzed on a global basis because of their potential effects across countries’ borders and because many firms compete in global markets. Population Size The world’s population doubled (from 3 billion to 6 billion) between 1959 and 1999. Current projections suggest that population growth will continue in the twenty-first century, but at a slower pace. The U.S. Census Bureau projects that the world’s population will be 9 billion by 2042 and roughly 9.25 billion by 2050.31 In 2012, China was the world’s largest country by popu­ lation with over 1.3 billion people. By 2050, however, India is expected to be the most populous The demographic nation in the world (approximately 1.69 billion). China (1.3 billion), the United States (439 mil­ segment is concerned lion), Indonesia (313 million), and Pakistan (276 million) are expected to be the next four most with a population's size, age structure, geographic populous countries in 2050.32 Firms seeking to find growing markets in which to sell their goodsdistribution, ethnic mix, and and services want to recognize the market potential that may exist for them in these five nations.income distribution. Part 1 Strategic Management Inputs While observing the population of nations and regions ofthe world, firms also want to study changes occurring within different populations to assess their strategic implications. For exam­ ple, in 2011, 23 percent of Japans citizens were 65 or older, while the United States and China will not reach this level until 2036.33 Aging populations are a significant problem for countries because of the need for workers and the burden of supporting retirement programs. In Japan and some other countries, employees are urged to work longer to overcome these problems. Age Structure The most noteworthy aspect of this element of the demographic segment is that the world’s population is rapidly aging. For example, predictions are that, “By 2050, over one-fifth of the U.S. population will be 65 or older up from the current figure (in 2012) of one-seventh. The number of centenarians worldwide will double by 2023 and double again by 2035. Projections suggest life expectancy will surpass 100 in some industrialized countries by the second half of this century—roughly triple the lifespan that prevailed worldwide through­ out most of human history.”31 In China, the 65 and over population is expected to reach roughly 330 million by 2050, which will be close to one-fourth of the nation’s total popula­ tion.3" In the 1950s, Japan’s population was one of the youngest in the world. However, 45 is now the median age in Japan, with the projection that it will be 55 by 2040. With a fertility rate that is below replacement value, another prediction is that by 2040, there will be almost as many Japanese people 100 years old or older as there are newborns.36 These predictions lead to different possibilities. In Japan, an expectation that the work­ ing age population will shrink from 81 million in 2012 to about 57 million in 2040 seems to threaten companies’ ability to operate. On the other hand, is there an opportunity for Japanese firms to find ways to increase the productivity of their workers and/or to establish additional operations in other nations? From an opportunity perspective, delayed retire­ ments of baby boomers (those born between 1947 and 1965) that are expected in the United States (and perhaps other countries as well) create the possibility of helping companies “avoid or defer the baby-boomer brain drain that has been looming for so long” In this sense, “organizations now have a fresh opportunity to address the talent gap created by a shortage of critical skills in the marketplace as well as the experience gap created by multiple waves of downsizing over the past decade.”37 Having those delaying their retirement use their knowledge to help younger employees quickly gain valuable skills is another opportu­ nity that the age structure element suggests firms should consider. Geographic Distribution How a population is distributed within countries and regions is subject to change over time. For example, the last few decades have seen the U.S. population shifting from states in the Northeast and Great Lakes region to states in the west (California), south (Florida), and southwest (Texas). These changes can be seen as moving from the “Frost Belt” to the “Sun Belt.” Outcomes from these shifts include the facts that the gross domestic product (GDP) of California in 2011 was just under $2 trillion, an amount that makes California the ninthlargest economy in the world. In this same year, at a value of $1.3 trillion, Texas’ GDP was second to that of California.38 Recent shifts show that New Jersey had the highest ratio of people moving out compared to the number of people moving into the state in 2012. Illinois, New York, Michigan, Maine, Connecticut, and Wisconsin are additional states for which a large net migration occurred in 2012. In a shift in the pattern witnessed for the first decade-plus of the twenty-first century, Washington, D.C., was the most popular destination for relocation in 2012 with Oregon being the second most popular. Washington, D.C., seemed to be popular because of its somewhat recession-proof economic opportunities that are generated by a maturing high-tech sector and federal government jobs. In particular, the city of Portland appears to Chapter 2: The External Environment; Opportunities, Threats, Industry Competition, and Competitor Analysis capture the allure of Oregon in terms of its mix of economic growth, cutting edge urban planning, and scenic landscapes.'9 Firms want to carefully study the patterns of population distributions in countries and regions to identify opportunities and threats. Thus in the United States, current patterns suggest the possibility of opportunities in Washington, D.C., as well as in states on the West Coast including Oregon and those in the South and Southwest. In contrast, firms compet­ ing in the Northeast and Great Lakes areas may concentrate on identifying threats to their ability to operate profitably in those areas. Of course, geographic distribution patterns differ throughout the world. For example, in China, the majority of the population still lives in rural areas; however, todays growth patterns are toward urban communities such as Shanghai and Beijing.40 Shifts that occurred between 2011 and 2012 in Europe show net (but small) population gains for countries such as France, Germany, and the United Kingdom while Greece experienced a net (again, small) population decline. Overall, the geographic distribution patterns at least for this year in Europe were quite stable.41 This tact too has relevance for firms studying this segment of their general environment. Ethnic Mix The ethnic mix of countries’ populations continues to change, creating opportunities and threats for many companies as a result. For example, Hispanics are now the largest ethnic minority in the United States.4-’ In fact, the U.S. Hispanic market is the third largest “Latin American” economy behind Brazil and Mexico. Spanish is now the dominant language in parts of U.S. states such as Texas, California, Florida, and New Mexico. Given these facts, some firms might want to assess the degree to which their goods or services could be adapted to serve the unique needs of Hispanic consumers. Additional evidence is of interest to firms when examining this segment. For example, African countries are the most ethnically diverse in the world, with Uganda having the highest ethnic diversity rating with Liberia second. In contrast, Japan and the Koreas are the least diver­ sified from the perspective of a mix of ethnicities in their populations. European countries are ethnically homogeneous while the Americas are often diverse. “From the United States through Central America down to Brazil, the ‘new world’ countries, maybe in part because of their his­ tories of relatively open immigration (and, in some cases, intermingling between natives and new arrivals) tend to be pretty diverse.”4' Income Distribution Understanding how income is distributed within and across populations informs firms of different groups’ purchasing power and dis­ cretionary income. Of particular interest to firms are the average incomes of households and individuals. For instance, the increase in dual-career couples has had a notable effect on average incomes. Although real income has been declining in general in some nations, the household income of dual-career couples has increased, especially in the United States. These figures yield strategically relevant information for firms. For instance, research indicates that whether an employee is part of a dual-career couple can strongly influence the willingness of the employee to accept an international assignment. However, because of recent global Patterns of population distribution present both opportunities and threats to companies. 45 Part 1: Strategic Management Inputs 46 economic conditions, many companies were still pursuing international assignments but changing them to avoid some of the additional costs of funding expatriates abroad.4 ’ The growth of the economy in China has draw'n many firms, not only for the low-cost production, but also because of the large potential demand for products, given its large population base. However, in recent times, the amount of China’s gross domestic prod­ uct that makes up domestic consumption is the lowest of any major economy at less than one-third. In comparison, India’s domestic consumption of consumer goods accounts for twro-thirds of its economy, or tw'ice China’s level. As such, many western multinationals are considering entering India as a consumption market as its middle class grow’S extensively. Although India as a nation has poor infrastructure, its consumers are in a better position to spend. Furthermore, the urban-rural income difference has been declining in India more rapidly than in China. Because of situations such as this, paying attention to the differences between markets based on income distribution can be very important.4" 2-3b The Economic Segment The economic environment refers to the nature and direction of the economy in w'hich a firm competes or may compete.46 In general, firms seek to compete in relatively stable economies with strong growth potential. Because nations are interconnected as a result of the global economy, firms must scan, monitor, forecast, and assess the health of their host nation as well as the health of the economies outside it. For firms studying the economic environment today for purposes of being able to predict trends that may occur in this segment of the general environment and their effects on them, the picture remains unclear and challenging. There are at least two reasons for this. First, the global recession of 2008 and 2009 created numerous problems for companies throughout the world, including those of reduced consumer demand, increases in firms’ inventory levels, development of additional governmental regulations, and a tightening of access to financial resources. The second reason to consider is that the global recovery from the 2008 and 2009 recession remains persistently slow and relatively weak compared to previous recoveries. Some argue that enhanced economic uncertainty (which refers to an environment in which relatively little and perhaps nothing at all is known about the future state of an economy) is a major cause of the “less-than-robust-recovery” that was experienced at least through mid-2013. Of likely concern to firms studying the economic segment today is the fact that historically, high degrees of economic uncertainty coincide with periods of lower growth. And again, according to some research, “it is clear that (economic) uncertainty has increased in recent times.”47 This increase suggests the possibility of slower growth in the foreseeable future. When facing economic uncertainty, firms want to be certain to study the economic environment in multiple regions and countries throughout the world. Although economic The economic environment refers to the nature and direction of the economy in which a firm competes or may compete. The poiitical/legal segment is the arena in which organizations and interest groups compete for attention, resources, and a voice in overseeing the body of laws and regulations guiding interactions among nations as well as between firms and various local governmental agencies. growth remains relatively weak and economic uncertainty has been strong in Europe and the United States in recent times, this was not the case in other settings. In 2013, for example, growth was projected to increase by 8.2 percent in China, by 4 percent in Brazil, and by 3.5 percent in Mexico. From a regional perspective, 2013 projections were for growth of 5.8 percent in Southeast Asia and 5.7 percent in sub-Saharan Africa, estimates that highlight the anticipation of the continuing development of emerging economies.48 Ideally, firms will be able to pursue growth opportunities in regions and nations where they exist while avoid­ ing the threats of slow growth periods in other settings. 2-3c The Political/Legal Segment The political/legal segment is the arena in which organizations and interest groups com­ pete for attention, resources, and a voice in overseeing the body of laws and regulations guiding interactions among nations as well as between firms and various local governmen­ tal agencies.49 Essentially, this segment is concerned with how organizations try to influence Chapter 2: The External Environment: Opportunities, Threats, Industry Competition, and Competitor Analysis 47 governments and how they try to understand the influences (current and projected) of those governments on their competitive actions and responses. Commonly, firms develop a politi­ cal strategy to specify how they will study the political/legal segment as well as approaches they might take (such as lobbying efforts) in order to successfully deal with opportunities and threats that surface within this segment at different points in time.50 Regulations formed in response to new national, regional, state, and/or local laws that are legislated often influence a firms competitive actions and responses. For example, the state of Nevada in the United States recently legalized the business of online poker/ gambling. New Jersey and Delaware quickly took the same action. In response to Nevada’s regulatory change, firms such as MGM Resorts International were trying to decide the degree to which these decisions represented a viable opportunity. According to a MGM official, the immediate concern with respect to Nevada is that “the state may be too small to provide a lucrative online market on a standalone basis.”51 At a regional level, changes in the laws regarding the appropriate regulation of European banks are still being actively debated.52 For interactive, technology-based firms such as Facebook, Google, and Amazon, among others, “the effort in Europe to adopt the world’s strongest data protection law has drawn the attention of dozens of lobbyists from U.S. tech­ nology and advertising companies.”53 Highly restrictive laws about consumer privacy could threaten how these firms conduct business in the European Union. Finally, in a comprehen­ sive sense, recent transformations from state-owned to private firms occurring in multiple nations have substantial implications for the competitive landscapes in a number of coun­ tries and across multiple industries.54 2-3d The Sociocultural Segment The sociocultural segment is concerned with a society’s attitudes and cultural values. Because attitudes and values form the cornerstone of a society, they often drive demo­ graphic, economic, political/legal, and technological conditions and changes. Individual societies’ attitudes and cultural orientations are anything other than stable, meaning that firms must carefully scan, monitor, forecast, and assess them to recognize and study associated opportunities and threats. Another way of thinking about this is to note that companies do not exist in an isolated state. Because of this, even successful firms must have an awareness of changes taking place in the societies and their associated cultures in which they are competing. Indeed, societal and culture changes challenge firms to find ways to “adapt to stay ahead of their competitors and stay relevant in the minds of their consumers.”55 Attitudes about and approaches to health care are issues being considered in nations and regions throughout the world. For Europe, the European Commission has developed a health care strategy for all of Europe that is oriented to preventing diseases while tackling lifestyle factors influencing health such as nutrition, working conditions, and physical activity. This Commission argues that promoting attitudes to take care of one’s health is especially impor­ tant in the context of an aging Furope as shown by the projection that the proportion of people over 65 living in Europe will increase from 17 percent in 2010 to almost 30 percent by 2060.56 In the United States, costs remain at the forefront of discussions about health care. Recent surveys show that consumers are dissatisfied with the cost of health care and do not understand why these costs continue to increase. Simultaneously though, most patients (as many as 80 percent of women and 85 percent of men) fail to compare the costs of doctors and recommended procedures.v At issue for business firms is that attitudes and values about health care can affect them; accordingly, they must carefully examine trends regard­ ing health care in order to anticipate the effects on their operations. As the U.S. labor force has increased, it has become more diverse, as significantly more women and minorities from a variety of cultures enter the workplace. In 1993, the total U.S. workforce was slightly less than 130 million; in 2005, it was slightly greater than 148 million. It is predicted to grow to more than 192 million by 2050. The sociocultural segment is concerned with a society's attitudes and cultural values. Part 1: Strategic Management Inputs 48 However, the rate of growth in the U.S. labor force has declined over the past two decades largely as a result of slower growth of the nation’s population and because of a downward trend in the labor force participation rate. More specifi­ cally, data show that “after nearly five decades of steady growth, the overall participation rate— defined as the proportion of the civilian noninstitutional population in the labor force—peaked at an annual average of 67.1 percent for each year from 1997 to 2000... By September 2012, the rate had dropped to 63.6 percent”58 and is expected to fall to 58.5 percent by 2050. Other changes in the U.S. labor force between 2010 and 2050 are Greater workforce diversity has become the norm in many indus­ expected. During this time period, the Asian labor force is projected to more than double in tries. These changes have forced many companies to challenge the size while the growth in the white labor force is notion of traditional organizational roles for men and women. predicted to be much slower compared to other racial groups. In contrast, people of Hispanic ori­ gin are expected to account for roughly 80 per­ cent of the total growth in the labor force. Finally, “it is projected that the higher growth rate of the female labor force relative to that of men will end by 2020 and the growth rates for men and women will be similar for the 2020-2050 period.”59 Greater diversity in the workforce creates challenges and opportunities, including com­ bining the best of both men’s and women’s traditional leadership styles. Although diversity in the workforce has the potential to improve performance, research indicates that diversity initiatives must be successfully managed in order to reap these organizational benefits. Human resource practitioners are trained to successfully manage diversity issues to enhance positive outcomes.60 In an overall sense though, learning how to effectively manage a firm’s workforce is increasingly important in that “many companies recognize today, more than ever, their people have become their most critical competitive asset.”61 Although the lifestyle and workforce changes referenced previously reflect the atti­ tudes and values of the U.S. population, each country is unique with respect to these sociocultural indicators. National cultural values affect behavior in organizations and thus also influence organizational outcomes such as differences in CEO compensation.62 Likewise, the national culture influences to a large extent the internationalization strategy that firms pursue relative to one’s home country.63 Knowledge sharing is important for dispersing new knowledge in organizations and increasing the speed in implementing innovations. Personal relationships are especially important in China as guanxi (personal relationships or good connections) has become a way of doing business within the coun­ try and for individuals to advance their careers in what is becoming a more open market society. Understanding the importance of guanxi is critical for foreign firms doing busi­ ness in China.64 2-3e The Technological Segment technological segment includes the The institutions and activities involved in creating new knowledge and translating that knowledge into new outputs, products, processes, and materials. Pervasive and diversified in scope, technological changes affect many parts of societies. These effects occur primarily through new products, processes, and materials. The technological segment includes the institutions and activities involved in creating new knowledge and translating that knowledge into new outputs, products, processes, and materials. Given the rapid pace of technological change and risk of disruption, it is vital for firms to thoroughly study the technological segment.65 The importance of these efforts is suggested Chapter 2: The External Environment: Opportunities, Threats, Industry Competition, and Competitor Analysis 49 by the finding that early adopters of new technology often achieve higher market shares and earn higher returns. Thus, both large and small firms should continuously scan the general environment to identify potential substitutes for technologies that are in current use, as well as to identify newly emerging technologies from which their firm could derive competitive advantage.66 As a significant technological development, the Internet offers firms a remarkable capa­ bility in terms of their efforts to scan, monitor, forecast, and assess conditions in their general environment. Companies continue to study the Internet’s capabilities to anticipate how it may allow them to create more value for customers in the future and to anticipate future trends. Additionally, the Internet generates a significant number of opportunities and threats for firms across the world. Predictions about Internet usage in the years to come are one reason for this. By 2016, the estimate is that there will be 3 billion Internet users glob­ ally. This is almost one-half of the world’s population. Moreover, “the Internet economy will reach $4.2 trillion in the G-20 economies. If it were a national economy, the Internet economy would rank in the world’s top five, behind only the U.S., China, Japan, and India, and ahead of Germany.”67 Overall, firms can expect that the future is a time period in which the Internet “will have more users (especially in developing markets), more mobile users, more users using various devices throughout the day, and many more people engaged in an increasingly participatory medium.”68 In spite of the Internet’s far-reaching effects and the opportunities and threats associated with its potential, wireless communication technology is becoming a significant technologi­ cal opportunity for companies to pursue. Handheld devices and other wireless communica­ tions equipment are used to access a variety of network-based services. The use of handheld computers with wireless network connectivity, Web-enabled mobile phone handsets, and other emerging platforms (e.g., consumer Internet-access devices such as the iPhone, iPad, and Kindle) has increased substantially and may soon become the dominant form of com­ munication and commerce. In fact, with each new version of these products, additional functionalities and software applications are generating multiple opportunities—and poten­ tial threats—for companies of all types. 2-3f The Global Segment The global segment includes relevant new global markets, existing markets that are chang­ ing, important international political events, and critical cultural and institutional charac­ teristics of global markets.69 For example, firms competing in the automobile industry must study the global segment. The fact that consumers in multiple nations are willing to buy cars and trucks “from whatever area of the world”70 supports this position. When studying the global segment, firms (including automobile manufacturers) should recognize that globalization of business markets may create opportunities to enter new markets as well as threats that new competitors from other economies may also enter their market. In terms of an opportunity for automobile manufacturers, the possibility for these firms to sell their products outside of their home market would seem attractive. But what markets might firms choose to enter? Currently, Brazil, Russia, India, China, and to a lesser extent Indonesia and Malaysia are nations in which automobile and truck sales are expected to increase. In contract, sales are expected to decline, at least in the near term, in Europe and Japan. These expectations suggest the most and least attractive markets for automobile manufacturers desiring to sell outside their domestic market. At the same time, from the perspective of a threat, Japan, Germany, Korea, Spain, France, and the United States are nations in which there appears to be excess production capacity in the automobile manu­ facturing industry. In turn, overcapacity signals the possibility that companies based in markets where this is the case will simultaneously attempt to increase their exports as well The global segment includes relevant new global markets, existing markets that are changing, important international political events, and critical cultural and institutional characteristics of global markets. Part 1: Strategic Management Inputs 50 as sales in their domestic market.71 Thus, global automobile manufacturers should carefully examine the global segment in order to precisely identify all opportunities and threats. In light of threats associated with participating in international markets, some firms choose to take a more cautious approach to globalization. These firms participate in what some refer to as globalfocusing. Globalfocusing often is used by firms with moderate levels of international operations who increase their internationalization by focusing on global niche markets.: This approach allows firms to build on and use their core competencies while limiting their risks within the niche market. Another way in which firms limit their risks in international markets is to focus their operations and sales in one region of the world.3 Success with these efforts finds a firm building relationships in and knowledge of its markets. As the firm builds these strengths, rivals find it more difficult to enter its markets and compete successfully. Firms competing in global markets should recognize each market’s sociocultural and institutional attributes. For example, Korean ideology emphasizes communitarianism, a characteristic of many Asian countries. Alternatively, the ideology in China calls for an emphasis on guanxi—personal connections—while in japan, the focus is on wa, or group harmony and social cohesion.74 The institutional context of China suggests a major empha­ sis on centralized planning by the government. The Chinese government provides incen­ tives to firms to develop alliances with foreign firms having sophisticated technology in hopes of building knowledge and introducing new technologies to the Chinese markets over time.75 As such, it is important to analyze the strategic intent of foreign firms when pursuing alliances and joint ventures abroad, especially where the local partners are receiving tech­ nology which may in the long run reduce the foreign firms’ advantages.76 Increasingly, the informal economy as it exits throughout the world is another aspect of the global segment requiring analysis. Growing in size, this economy has implications for firms’ competitive actions and responses in that increasingly firms competing in the formal economy (defined in the Strategic Focus) will find that they are competing against informal economy companies as well. We provide additional insights about the informal economy in the Strategic Focus. Learn more about Spain's Informal Economy. www.cengagebrain.com 2-3g The Physical Environment Segment The physical environment segment refers to potential and actual changes in the physical envi­ ronment and business practices that are intended to positively respond to and deal with those changes.77 Concerned with trends oriented to sustaining the world’s physical environment, firms recognize that ecological, social, and economic systems interactively influence what happens in this particular segment and that they are part of an interconnected global society.78 Companies across the globe are concerned about the physical environment and many record the actions they are taking in reports with names such as “Sustainability” and “Corporate Social Responsibility.” Moreover and in a comprehensive sense, an increasing number of companies are interested in sustainable development, which is “the development that meets the needs of the present without compromising the ability of future generations to meet their own needs.” 4 There are many parts or attributes of the physical environment that firms consider as The physical environment segment refers to potential and actual changes in the physical environment and business practices that are intended to positively respond to and deal with those changes. they try to identify trends in the physical environment segment.80 For example, McDonald’s seeks to become a sustainable influence on the global food industry. Receiving certification from the Marine Stewardship Council (MCS) for its U.S. supply signals that the company is sourcing fish from “suppliers that follow strict MSC standards for ecosystem impact, man­ agement, and health of fish stock.”81 As the world’s largest retailer, Walmart’s environmental footprint is huge, meaning that trends in the physical environment can significantly affect this firm and how it chooses to operate. Perhaps in light of trends occurring in the physi­ cal environment, Walmart has announced that its goal is to produce zero waste and to use 100 percent renewable energy to power its operations.82 Chapter 2: The External Environment: Opportunities, Threats. Industry Competition, and Competitor Analysis Strategic Focus 51 GLOBALIZATION The Informal Economy: What It Is and Why It Is Important The informal economy refers to commercial activities that occur in 2009. In terms of the number of people working in an informal at least partly outside a governing body's observation, taxation, economy, we can consider the suggestion that "India's informal and regulation. In slightly different words, sociologists Manuel economy.. .(includes) hundreds of millions of shopkeepers, farm­ Castells and Alejandro Portes suggest that the "informal economy ers, construction workers, taxi drivers, street vendors, rag pickers, is characterized by one central feature: it is unregulated by the tailors, repairmen, middlemen, black marketers and more." institutions of society in a legal and social environment in which including an inability of a nation's economic environment to cre­ omy are typically thought of as businesses that are unregistered ate a significant number of jobs relative to available workers. This but that are producing and selling legal products. In contrast to has been a particularly acute problem during the recent global the informal economy, the formal economy is comprised of com­ recession. In the words of a person living in Spain: "Without the mercial activities that a governing body taxes and monitors for underground (informal) economy, we would be in a situation of society's benefit and whose outputs are included in a country's probably violent social unrest." Governments' inability to facilitate gross domestic product. growth efforts in their nation's economic environment is another For some, working in the informal economy is a choice, issue. In this regard, another Spanish citizen suggests that "What such as is the case when individuals decide to supplement the the government should focus on is reforming the formal econ­ income they are earning through employment in the formal omy to make it more efficient and competitive." economy with a second job in the informal economy. However, for most people working in the informal economy is a necessity In a general sense, the informal economy yields threats and opportunities for formal economy firms. One threat is that infor­ rather than a choice—a reality that contributes to the informal mal businesses may have a cost advantage when competing economy’s size and significance. Although generalizing about against formal economy firms in that they do not pay taxes or the guality of informal employment is difficult, evidence suggests incur the costs of regulations. But the informal economy surfaces that it typically means poor employment conditions and greater opportunities as well. For example, formal economy firms can try poverty for workers. to understand the needs of customers that informal economy Estimates of the informal economy's size across countries and regions vary. In developing countries, the informal economy firms are satisfying and then find ways to better meet their needs. Another valuable opportunity is to attract some accounts for as much as three-quarters of all nonagricultural of the informal economy's talented human capital to accept posi­ employment, and perhaps as much as 90 percent in some tions of employment in formal economy firms. countries in South Asia and sub-Saharan Africa. But the infor­ mal economy is also prominent in developed countries such as © Vividfour / Shutterstock.com There are various causes of the informal economy's growth, similar activities are regulated." Firms located in the informal econ­ Finland, Germany, and France (where this economy is estimated to account for 18.3 percent, 16.3 percent, and 15.3 percent, Sources: A. Picchi, 2013, A shadow economy may be keeping the US afloat, MSN Money, www.msn.com, May 3; 2013, Meeting on informal economy statistics: Country experience, international recommendations, and application, United Nations Economic Commission for Africa, www.uneca.org, April; 2013, About the informal economy, Women in informal employment: Globalizing and organizing, www.wiego.org, respectively, of these nations'total economic activity). In the May; G. Bruton, R. D. Ireland, & D. J. Ketchen, Jr., 2012, Toward a research agenda on the United States, recent estimates are that the informal economy is informal economy, Academy of Management Perspectives, 26(3): 1-11; R. D. Ireland, 2012, 2012 program theme: The informal economy, Academy of Management, www.meeting. aomonline.org, March; R. Minder, 2012, In Spain, jobless find a refuge off the books, New York Times, www.nytimes.com, May 18. now generating as much as $2 trillion in economic activity on an annual basis. This is double the size of the U.S. informal economy As our discussion of the general environment shows, identifying anticipated changes and trends among segments and their elements is a key objective of analyzing this envi­ ronment. With a focus on the future, the analysis of the general environment allows firms to identify opportunities and threats. It is necessary to have a top management team with the experience, knowledge, and sensitivity required to effectively analyze a firm’s general environment.83 Also critical to a firm’s choices of strategies and their associated competitive Part 1 Strategic Management Inputs 52 actions and responses is an understanding of its industry environment and its competitors; next, we discuss the analyses firms complete to gain such an understanding. 2-4 Industry Environment Analysis An industry is a group of firms producing products that are close substitutes. In the course of competition, these firms influence one another. Typically, companies use a rich mix of dif­ ferent competitive strategies to pursue above-average returns when competing in a particu­ lar industry. An industry’s structural characteristics influence a firm’s choice of strategies.*4 Compared with the general environment, the industry environment (measured primar­ ily in the form of its characteristics) has a more direct effect on the competitive actions and responses a firm takes to succeed.85 To study an industry, the firm examines five forces that affect the ability of all firms to operate profitably within a given industry. Shown in Figure 2.2, the five forces are: the threats posed by new entrants, the power of suppliers, the power of buyers, product substitutes, and the intensity of rivalry among competitors. The five forces of competition model depicted in Figure 2.2 expands the scope of a firm’s competitive analysis. Historically, when studying the competitive environment, firms concentrated on companies with which they directly competed. However, firms must search more broadly to recognize current and potential competitors by identifying potential cus­ tomers as well as the firms serving them. For example, the communications industry is now broadly defined as encompassing media companies, telecoms, entertainment companies, and companies producing devices such as smartphones.86 In such an environment, firms must study many other industries to identify companies with capabilities (especially technology-based capabilities) that might be the foundation for producing a good or a service that can compete against what they are producing. When studying the industry environment, firms must also recognize that suppliers can become a firm’s competitors (by integrating forward) as can buyers (by integrating Figure 2.2 The Five Forces of Competition Model Threat of new entrants Rivalry among competing firms Threat of substitute products An industry is a group of firms producing products that are close substitutes. Bargaining power of suppliers Bargaining power of buyers Chapter 2: The External Environment Opportunities, Threats, Industry Competition, and Competitor Analysis backward). For example, several firms have integrated forward in the pharmaceutical indus­ try by acquiring distributors or wholesalers. In addition, firms choosing to enter a new market and those producing products that are adequate substitutes for existing products can become a company’s competitors. Next, we examine the five forces the firm analyzes to understand the profitability potential within an industry (or a segment of an industry) in which it competes or may choose to compete. 2-4a Threat of New Entrants Identifying new entrants is important because they can threaten the market share of existing competitors.*7 One reason new entrants pose such a threat is that they bring additional pro­ duction capacity. Unless the demand for a good or service is increasing, additional capacity holds consumers’ costs down, resulting in less revenue and lower returns for competing firms. Often, new entrants have a keen interest in gaining a large market share. As a result, new competitors may force existing firms to be more efficient and to learn how to compete in new dimensions (e.g., using an Internet-based distribution channel). The likelihood that firms will enter an industry is a function of two factors: barriers to entry and the retaliation expected from current industry participants. Entry barriers make it difficult for new firms to enter an industry and often place them at a competitive disadvantage even when they are able to enter. As such, high entry barriers tend to increase the returns for existing firms in the industry and may allow some firms to dominate the industry.88 Thus, firms competing successfully in an industry want to maintain high entry barriers in order to discourage potential competitors from deciding to enter the industry. Barriers to Entry Firms competing in an industry (and especially those earning above-average returns) try to develop entry barriers to thwart potential competitors. In general, more is known about entry barriers (with respect to how they are developed as well as paths firms can pursue to overcome them) in industrialized countries such as those in North America and Western Europe. In contrast, relatively little is known about barriers to entry in the rapidly emerging markets such as those in China. However, recent research suggests that Chinese executives perceive that advertising effects are the most significant of seven barriers to China while capital requirements are viewed as the least important.89 There are different kinds of barriers to entering a market that firms study when exam­ ining an industry environment. Companies competing within a particular industry study these barriers to determine the degree to which their competitive position reduces the like­ lihood of new competitors being able to enter the industry for the purpose of competing against them. Firms considering entering an industry study entry barriers to determine the likelihood of being able to identify an attractive competitive position within the industry being analyzed. Next, we discuss several significant entry barriers that may discourage com­ petitors from entering a market and that may facilitate a firm’s ability to remain competitive in a market in which it currently competes. Economies of Scale Economics of scale are derived from incremental efficiency improvements through experience as a firm grows larger. Therefore, the cost of producing each unit declines as the quantity of a product produced during a given period increases. A new entrant is unlikely to quickly generate the level of demand for its product that in turn would allow it to develop economies of scale. Economies of scale can be developed in most business functions, such as marketing, manufacturing, research and development, and purchasing.1'" Firms sometimes form stra­ tegic alliances or joint ventures to gain scale economies. This is the case for Mitsubishi Heavy Industries Ltd. and Hitachi Ltd., as these companies “merged their operations for fossil-fuel-based power systems into a joint venture aimed at gaining scale to compete against global rivals.”91 Part 1 Strategic Management Inputs Becoming more flexible in terms of being able to meet shifts in customer demand is another benefit for an industry incumbent and another possible entry barrier for the firm thinking of entering an industry. For example, a firm may choose to reduce its price with the intention of capturing a larger share of the market. Alternatively, it may keep its price constant to increase profits. In so doing, it likely will increase its free cash flow, which is very helpful during financially challenging times. Some competitive conditions reduce the ability of economies of scale to create an entry barrier. Many companies now customize their products for large numbers of small cus­ tomer groups. In these cases, customized products are not manufactured in the volumes necessary to achieve economies of scale. Customization is made possible by several factors including flexible manufacturing systems (this point is discussed further in Chapter 4). In fact, the new manufacturing technology facilitated by advanced information systems has allowed the development of mass customization in an increasing number ot industries. Although it is not appropriate for all products and implementing it can be challenging, mass customization has become increasingly common in manufacturing products.92 Online ordering has enhanced customers’ ability to buy customized products. Companies manu­ facturing customized products learn how to respond quickly to customers’ needs in lieu of developing scale economies. Product Differentiation Over time, customers may come to believe that a firm’s prod­ uct is unique. This belief can result from the firm’s service to the customer, effective adver­ tising campaigns, or being the first to market a good or service. Greater levels of perceived product uniqueness create customers who consistently purchase a firm’s products. To com­ bat the perception of uniqueness, new entrants frequently offer products at lower prices. This decision, however, may result in lower profits or even losses. As noted in the Opening Case, Coca-Cola Company and PepsiCo have established strong brands in the markets in which they compete, and these companies compete against each other in countries throughout the world. Because each of these competitors has allocated a significant amount of resources over many decades to build its brands, cus­ tomer loyalty is strong for each firm. When considering entry into the soft drink market, a potential entrant would be well advised to pause to determine actions it would take for the purpose of trying to overcome the brand image and consumer loyalty each of these giants possess. Capital Requirements Competing in a new industry requires a firm to have resources to invest. In addition to physical facilities, capital is needed for inventories, marketing activi­ ties, and other critical business functions. Even when a new industry is attractive, the capital required for successful market entry may not be available to pursue the market opportunity.9’ For example, defense industries are difficult to enter because of the substantial resource investments required to be competitive. In addition, because of the high knowledge require­ ments of the defense industry, a firm might acquire an existing company as a means of enter­ ing this industry, but it must have access to the capital necessary to do this. Switching Costs Switching costs are the one-time costs customers incur when they buy from a different supplier. The costs of buying new ancillary equipment and of retraining employees, and even the psychic costs of ending a relationship, may be incurred in switch­ ing to a new supplier. In some cases, switching costs are low, such as when the consumer switches to a different brand of soft drink. Switching costs can vary as a function of time as shown by the fact that in terms of credit hours toward graduation, the cost to a student to transfer from one university to another as a freshman is much lower than it is when the student is entering the senior year. Occasionally, a decision made by manufacturers to produce a new, innovative product creates high switching costs for customers. Customer loyalty programs, such as airlines’ fre­ quent flyer miles, are intended to increase the customer’s switching costs. If switching costs Chapter 2: The External Environment Opportunities, Threats, Industry Competition, and Competitor Analysis are high, a new entrant must offer either a sub­ stantially lower price or a much better product to attract buyers. Usually, the more established the relationships between parties, the greater the switching costs. Access to Distribution Channels Over time, industry participants commonly learn how to effectively distribute their products. Once a relationship with its distributors has been built a firm will nurture it, thus creating switching costs for the distributors. Access to distribution channels can be a strong entry barrier for new entrants, particularly in consumer nondurable goods industries (e.g., in grocery stores where shelf space is limited) and in international mar­ kets. New entrants have to persuade distributors to carry their products, either in addition to or in place of those currently distributed. Price breaks and cooperative advertising allowances may be used for this purpose; however, those practices reduce the new entrant’s profit potential. Interestingly, access to distribution is less of a bar­ rier for products that can be sold on the Internet. Cost Disadvantages Independent of Scale Sometimes, established competitors have cost advantages that new entrants cannot duplicate. Proprietary product technology, favor­ able access to raw materials, desirable locations, and government subsidies are examples. Successful competition requires new entrants to reduce the strategic relevance of these fac­ tors. For example, delivering purchases directly to the buyer can counter the advantage of a desirable location; new food establishments in an undesirable location often follow this practice. Zara is owned by Inditex, the largest fashion clothing retailer in the world.9,1 From the time of its launching, Spanish clothing company Zara relied on classy, well-tailored, and relatively inexpensive items that were produced and sold by adhering to ethical practices to successfully enter the highly competitive global clothing market and overcome that market’s entry barriers.9" Government Policy Through their decisions about issues such as the granting of licenses and permits, governments can also control entry into an industry. Liquor retail­ ing, radio and TV broadcasting, banking, and trucking are examples of industries in which government decisions and actions affect entry possibilities. Also, governments often restrict entry into some industries because of the need to provide quality service or the desire to protect jobs. Alternatively, deregulating industries such as the airline and utilities industries in the United States, generally results in additional firms choosing to enter and compete within an industry.96 Governmental decisions and policies regarding antitrust issues also affect entry barriers. For example, in the United States, the Antitrust Division of the Justice Department or the Federal Trade Commission will sometimes disallow a proposed merger because officials conclude that approving it would create a firm that is too dominant in an industry and would thus create unfair competition.97 Such a negative ruling would obviously be an entry barrier for an acquiring firm. Expected Retaliation Companies seeking to enter an industry also anticipate the reactions of firms in the indus­ try. An expectation of swift and vigorous competitive responses reduces the likelihood of entry. Vigorous retaliation can be expected when the existing firm has a major stake in the 55 Part 1: Strategic Management Inputs 56 industry (e.g., it has fixed assets with few, if any, alternative uses), when it has substantial resources, and when industry growth is slow or constrained. For example, any firm attempt­ ing to enter the airline industry can expect significant retaliation troin existing competitors due to overcapacity. Locating market niches not being served by incumbents allows the new entrant to avoid entry barriers. Small entrepreneurial firms are generally best suited tor identifying and serv­ ing neglected market segments. When Honda first entered the U.S. motorcycle market, it concentrated on small-engine motorcycles, a market that firms such as Harley-Davidson ignored. By targeting this neglected niche, Honda initially avoided a significant amount ot head-to-head competition with well-established competitors. After consolidating its posi­ tion, Honda used its strength to attack rivals by introducing larger motorcycles and compet­ ing in the broader market. 2-4b Bargaining Power of Suppliers Increasing prices and reducing the quality of their products are potential means suppliers use to exert power over firms competing within an industry. If a firm is unable to recover cost increases by its suppliers through its own pricing structure, its profitability is reduced by its suppliers’ actions. A supplier group is powerful when It is dominated by a few large companies and is more concentrated than the industry to which it sells. Satisfactory substitute products are not available to industry firms. Industry firms are not a significant customer for the supplier group. Suppliers’ goods are critical to buyers’ marketplace success. The effectiveness of suppliers’ products has created high switching costs for industry firms. It poses a credible threat to integrate forward into the buyers’ industry. Credibility is enhanced when suppliers have substantial resources and provide a highly differentiated product. The airline industry is one in which suppliers’ bargaining power is changing. Though the number of suppliers is low, the demand for major aircraft is also relatively low. Boeing and Airbus aggressively compete for orders of major aircraft, creating more power for buy­ ers in the process. When a large airline signals that it might place a “significant” order for wide-body airliners that either Airbus or Boeing might produce, both companies are likely to battle for the business and include a financing arrangement, highlighting the buyer’s power in the potential transaction. 2-4c Bargaining Power of Buyers Firms seek to maximize the return on their invested capital. Alternatively, buyers (custom­ ers of an industry or a firm) want to buy products at the lowest possible price—the point at which the industry earns the lowest acceptable rate of return on its invested capital. To reduce their costs, buyers bargain for higher quality, greater levels of service, and lower prices.1'8 These outcomes are achieved by encouraging competitive battles among the indus­ try’s firms. Customers (buyer groups) are powerful when They purchase a large portion of an industry’s total output. The sales of the product being purchased account for a significant portion of the seller’s annual revenues. They could switch to another product at little, if any, cost. The industry’s products are undifferentiated or standardized, and the buyers pose a credible threat if they were to integrate backward into the sellers’ industry. Chapter 2 The External Environment: Opportunities, Threats, Industry Competition, and Competitor Analysis 57 Consumers armed with greater amounts of information about the manufacturers costs and the power of the Internet as a shopping and distribution alternative have increased bargain­ ing power in many industries. 2-4d Threat of Substitute Products Substitute products are goods or services from outside a given industry that perform simi­ lar or the same functions as a product that the industry produces. For example, as a sugar substitute, NutraSweet (and other sugar substitutes) places an upper limit on sugar manu­ facturers’ prices—NutraSweet and sugar perform the same function, though with different characteristics. Other product substitutes include e-mail and fax machines instead of over­ night deliveries, plastic containers rather than glass jars, and tea instead of coffee. Newspaper firms have experienced significant circulation declines over the past decade or more. The declines are a result of the ready availability of substitute outlets for news including Internet sources, cable television news channels, and e-mail and cell phone alerts. Likewise, satellite TV and cable and telecommunication companies provide substitute ser­ vices for basic media services such as television, Internet, and phone. Tablets such as the iPad are reducing the number of PCs sold as suggested by the fact that worldwide shipments of PCs declined 14 percent during the first quarter of 2013 compared to the same quarter a year earlier. At the same time, “tablets like Apple’s iPad flew off the shelves.”99 In general, product substitutes present a strong threat to a firm when customers face few if any switching costs and when the substitute product’s price is lower or its quality and performance capabilities are equal to or greater than those of the competing product. Differentiating a product along dimensions that are valuable to customers (such as quality, service after the sale, and location) reduces a substitute’s attractiveness. 2-4e Intensity of Rivalry among Competitors Because an industry’s firms are mutually dependent, actions taken by one company usu­ ally invite responses. In many industries, firms actively compete against one another. Competitive rivalry intensifies when a firm is challenged by a competitors actions or when a company recognizes an opportunity to improve its market position. Firms within industries are rarely homogeneous; they differ in resources and capabili­ ties and seek to differentiate themselves from competitors. Typically, firms seek to differen­ tiate their products from competitors’ offerings in ways that customers value and in which the firms have a competitive advantage. Common dimensions on which rivalry is based include price, service after the sale, and innovation. Next, we discuss the most prominent factors that experience shows affect the intensity of rivalries among firms. Numerous or Equally Balanced Competitors Intense rivalries are common in industries with many companies. With multiple com­ petitors, it is common for a few firms to believe they can act without eliciting a response. However, evidence suggests that other firms generally are aware of competitors’ actions, often choosing to respond to them. At the other extreme, industries with only a few firms of equivalent size and power also tend to have strong rivalries. The large and often similar-sized resource bases of these firms permit vigorous actions and responses. The competitive battles between Airbus and Boeing exemplify intense rivalry between rela­ tively equal competitors, especially as airlines place bids for the new wide-body planes they are producing. As discussed in the Opening Case, Coca-Cola Company and PepsiCo have a strong rivalry in an array of liquid drinks as consumers demand great taste and real health benefits.100 J i Learn more about Substitute Products. www.cengagebrain.com Part 1 Strategic Management Inputs Slow Industry Growth When a market is growing, firms try to effectively use resources to serve an expanding cus­ tomer base. Markets increasing in size reduce the pressure to take customers from competi­ tors. However, rivalry in no-growth or slow-growth markets becomes more intense as firms battle to increase their market shares by attracting competitors’ customers. Certainly, this has been the case in the fast-food industry as McDonalds, Wendy’s, and Burger King use their resources, capabilities, and core competencies to try to win each other’s customers.101 The instability in the market that results from these competitive engagements may reduce the profitability for all firms engaging in such battles. High Fixed Costs or High Storage Costs When fixed costs account for a large part of total costs, companies try to maximize the use of their productive capacity. Doing so allows the firm to spread costs across a larger volume of output. However, when many firms attempt to maximize their productive capacity, excess capacity is created on an industry-wide basis. To then reduce inventories, individual compa­ nies typically cut the price of their product and offer rebates and other special discounts to customers. However, doing this often intensifies competition. The pattern of excess capacity at the industry level followed by intense rivalry at the firm level is frequently observed in industries with high storage costs. Perishable products, for example, lose their value rapidly with the passage of time. As their inventories grow, producers of perishable goods often use pricing strategies to sell products quickly. Lack of Differentiation or Low Switching Costs When buyers find a differentiated product that satisfies their needs, they frequently pur­ chase the product loyally over time. Industries with many companies that have successfully differentiated their products have less rivalry, resulting in lower competition for individual firms. Firms that develop and sustain a differentiated product that cannot be easily imitated by competitors often earn higher returns. However, when buyers view products as com­ modities (i.e., as products with few differentiated features or capabilities), rivalry intensi­ fies. In these instances, buyers’ purchasing decisions are based primarily on price and, to a lesser degree, service. Personal computers are a commodity product and the cost to switch from a computer manufactured by one firm to another is low. Thus, the rivalry among Dell, Hewlett-Packard, Lenovo, and other computer manufacturers is strong as these companies consistently seek to find ways to differentiate their offerings. High Strategic Stakes Competitive rivalry is likely to be high when it is important for several of the competitors to perform well in the market. Competing in diverse businesses (such as semiconductors, petrochemicals, fashion, medicine, and skyscraper and plant construction, among others), Samsung has now become a formidable foe for Apple in the global smartphone market. Samsung has committed a significant amount of resources to develop innovative products as the foundation for its efforts to try to outperform Apple in selling this particular product. The fact that the end of the first quarter of 2013 found Samsung holding 33 percent of the global smartphone market compared to an 18 percent share for Apple seemed to suggest that the firm’s commitment was yielding desirable outcomes.102 However, this market is extremely important to Apple as well, suggesting that the smartphone rivalry between these two firms (along with others) will remain quite intense. High strategic stakes can also exist in terms of geographic locations. For example, a num­ ber of automobile manufacturers have committed or are committing to establishing manu­ facturing facilities in China, which has been the world’s largest car market since 2009.103 General Motors recently announced that it received permission from Chinese authorities Chapter 2: The External Environment: Opportunities, Threats, Industry Competition, and Competitor Analysis to build an 8 billion yuan ($1.3 billion) factory to manufacture its Cadillac brand. The Shanghai GM joint venture is to build this facility.104 Because of the high stakes involved in China for both General Motors and other firms producing luxury cars (including Audi, BMW, and Mercedes-Benz), rivalry among these firms in this market is quite intense. High Exit Barriers Sometimes companies continue competing in an industry even though the returns on their invested capital are low or negative. Firms making this choice likely face high exit barriers, which include economic, strategic, and emotional factors causing them to remain in an industry when the profitability of doing so is questionable. Exit barriers are especially high in the airline industry. Profitability in this industry has been very difficult to achieve since the start of the latest global financial crisis (beginning in roughly late 2007 or early 2008). However, profits in the airline industry were expected to increase by approximately 40 percent in 2013 compared to 2012. Industry consolidation and efficiency enhancements to how airline alliances integrate their activities helped reduce airline companies’ costs while improving economic conditions in a number of countries. This resulted in a greater demand for travel. These are positive signs, at least in the short run, for these firms given that they do indeed face very high barriers if they were to con­ template leaving the airline travel industry.105 Common exit barriers that firms face include the following: Specialized assets (assets with values linked to a particular business or location) Fixed costs of exit (such as labor agreements) Strategic interrelationships (relationships of mutual dependence, such as those between one business and other parts of a company’s operations, including shared facilities and access to financial markets) Emotional barriers (aversion to economically justified business decisions because of fear for one’s own career, loyalty to employees, and so forth) Government and social restrictions (often based on government concerns for job losses and regional economic effects; more common outside the United States). 2-5 Interpreting Industry Analyses Effective industry analyses are products of careful study and interpretation of data and information from multiple sources. A wealth of industry-specific data is available for firms to analyze for the purpose of better understanding an industry’s competitive realities. Because of globalization, international markets and rivalries must be included in the firm’s analyses. And, because of the development of global markets, a country’s borders no longer restrict industry structures. In fact, in general, entering international markets enhances the chances of success for new ventures as well as more established firms.106 Analysis of the five forces within a given industry allows the firm to determine the industry’s attractiveness in terms of the potential to earn average or above-average returns. In general, the stronger the competitive forces, the lower the potential for firms to generate profits by implementing their strategies. An unattractive industry has low entry barriers, suppliers and buyers with strong bargaining positions, strong competitive threats from product substitutes, and intense rivalry among competitors. These industry characteristics make it difficult for firms to achieve strategic competitiveness and earn above-average returns. Alternatively, an attractive industry has high entry barriers, suppliers and buy­ ers with little bargaining power, few competitive threats from product substitutes, and relatively moderate rivalry.107 Next, we explain strategic groups as an aspect of industry competition. 59 60 Part 1 Strategic Management Inputs 2-6 Strategic Groups A set of firms emphasizing similar strategic dimensions and using a similar strategy is called a strategic group.108 The competition between firms within a strategic group is greater than the competition between a member of a strategic group and companies outside that Find out more about Mercedes. www.cengagebrain.com strategic group. Therefore, intra-strategic group competition is more intense than is interstrategic group competition. In fact, more heterogeneity is evident in the performance of firms within strategic groups than across the groups. The performance leaders within groups are able to follow strategies similar to those of other firms in the group and yet main­ tain strategic distinctiveness as a foundation for earning above-average returns.I0,i The extent of technological leadership, product quality, pricing policies, distribution channels, and customer service are examples of strategic dimensions that firms in a strate­ gic group may treat similarly. Thus, membership in a particular strategic group defines the essential characteristics of the firm’s strategy.110 The notion of strategic groups can be useful for analyzing an industry’s competitive structure. Such analyses can be helpful in diagnosing competition, positioning, and the profitability of firms competing within an industry.1" High mobility barriers, high rivalry, and low resources among the firms within an industry limit the formation of strategic groups.112 However, after strategic groups are formed, their membership remains relatively stable over time.113 Using strategic groups to understand an industry’s competitive struc­ ture requires the firm to plot companies’ competitive actions and responses along strategic dimensions such as pricing decisions, product quality, distribution channels, and so forth. This type of analysis shows the firm how certain companies are competing similarly in terms of how they use similar strategic dimensions. Strategic groups have several implications. First, because firms within a group offer similar products to the same customers, the competitive rivalry among them can be intense. The more intense the rivalry, the greater the threat to each firms profitability. Second, the strengths of the five forces differ across strategic groups. Third, the closer the strategic groups are in terms of their strategies, the greater is the likelihood of rivalry between the groups. German-based car manufacturers Audi (a part of the Volkswagen group), Bayerische Motoren Werke AG (BMW), and Daimler-Benz (Mercedes-Benz) implement similar strate­ gies (based on the differentiation business-level strategy), emphasize similar strategic dimen­ sions, and compete aggressively against each other. These three firms constitute a strategic group (in the performance/luxury segment) as do Maruti-Suzuki, Tata Motors, and Skoda (these three firms form a passenger car strategic group with the distinctive feature that they sell their products primarily in their domestic markets and very little internationally). We describe the strategic group featuring the three German companies in the Strategic Focus. 2-7 Competitor Analysis The competitor environment is the final part of the external environment requiring study. Competitor analysis focuses on each company against which a firm competes directly. Coca-Cola Company and PepsiCo, Home Depot and Lowe’s, Carrefour SA and Tesco PLC, and Boeing and Airbus are examples of competitors who are keenly interested in under­ standing each others objectives, strategies, assumptions, and capabilities. Indeed, intense rivalry creates a strong need to understand competitors.114 In a competitor analysis, the firm seeks to understand the following: A set of firms emphasizing similar strategic dimensions and using a similar strategy is called a strategic group What drives the competitor, as shown by its future objectives What the competitor is doing and can do, as revealed by its current strategy Chapter 2 The External Environment Opportunities. Threats. Industry Competition, and Competitor Analysis Strategic Focus 61 GLOBALIZATION German Performance/Luxury Cars: If You Have Seen One, Have You Seen Them All? Audi, BMW, and Mercedes-Benz (Mercedes) have long com­ peted against each other in the performance/luxury segment of the automobile industry. Given that they implement similar strategies in many of the same markets throughout the world and emphasize similar dimensions to do so, these firms form a strategic group. This means that the rivalry within this group is more intense than is the rivalry between members of this group and companies offering products that are intended to functionally serve and satisfy a mass-market appeal among large customer groups. One could even argue that three substrategic groups exist for these firms in that each offers prod­ ucts in the large, mid-size, and small parts of the performance/ luxury segment. (Think of the Audi S8 versus the BMW 7 series versus the S Mercedes series as products through which these firms compete against each other in terms of large perfor­ mance/luxury cars.) The similarities among these firms as they compete are exten­ sive. For example, the Chinese and U.S. markets are critical to their The 2014 CLA 45 AMG Mercedes-Benz is presented at the New York International Auto Show in New York's Javits Center in March 2013. The new addition to Mercedes-Benz' product mix is aimed at customers typically targeted by mass market brands. success. With respect to China, an analyst recently noted that “BMW, Audi and Daimler's Mercedes-Benz units have benefited as States, and other countries as well. Because of this, the three of China's fast-growing wealthy population has flocked to high-end them recently joined a few other companies to develop a Web cars in recent years." In response to this growth in demand for site (www.clearlybetterdiesel.org) that touts diesel's benefits of their products, all three firms are investing billions of dollars to superior fuel economy and a reduced environmental impact. To expand production and their sales operations In China. better serve the needs of younger consumers, all three compa­ For the U.S. market, the firms are introducing new models that nies are're-thinking everything from dashboard entertainment are intended to significantly expand their sales. One way these systems to the relative importance of mileage over horsepower to competitors are doing this is to offer "lower priced models that fundamental marketing strategies." An initial outcome from these would draw younger, less affluent U.S. customers away from mass evaluation processes is a decision to include smartly presented, market brands such as Ford Motor Co., Honda Motor Co., and smartphone-driven multimedia systems in models being devel­ Toyota Motor Corp.” A lower-cost version of the A3 sedan is Audi's oped for the U.S. market. initial offering to reach this objective. BMW has developed a new As is often the case with strategic groups, the one among version of its top-selling 3 series sedan (the 320) that will have a Audi, BMW, and Mercedes has remained stable over the years. As base price roughly $4,000 below the currently least expensive car such, we can anticipate that the rivalry among them will remain in this series. Similarly, Mercedes intends to offer the CLA, which is intense as they rely on similar strategic dimensions to implement a 4-cyclinder car with a base price just below $30,000. Essentially, similar strategies. introducing these products is a strong attempt by the three firms to lower price as an entry barrier to...