Week 3: External Analysis – Identifying
Opportunities & Threats
Understanding the external environment is a fundamental part of business strategy.
Companies must analyze competition, industry trends, and external forces to identify
opportunities (chances for growth) and threats (challenges to overcome).
This chapter focuses on how companies analyze their external environment, using Porter’s
Five Forces Model, Industry Life Cycle, and macroenvironmental factors to shape strategy.
1. Strategy Formulation: Understanding Competition
Strategy formulation begins with analyzing the competitive environment in an
industry.
The goal is to identify key opportunities and threats and use them to develop
competitive strategies.
Companies that understand their industry well can position themselves to outperform
competitors.
Why Does Industry Matter?
A company’s success depends on the industry it operates in.
Even a great company in a bad industry (one with high competition or declining
demand) can struggle.
Understanding industry structure and trends helps businesses make better strategic
decisions.
2. Defining an Industry
What is an Industry?
An industry is a group of companies that offer similar products or services that act as close
substitutes for each other.
📌 Example:
The smartphone industry includes Apple, Samsung, and Xiaomi, as they all sell similar
products (smartphones).
Industry vs. Sector
Industry = A specific business field (e.g., smartphone industry).
Sector = A broader category that includes related industries.
📌 Example:
Technology sector includes:
o Hardware industry (computers, smartphones)
o Software industry (apps, operating systems)
o Cloud computing industry (Google Cloud, AWS)
Market Segments: Different Customer Groups
Companies do not sell to everyone in the same way—they divide customers into market
segments based on their needs, income, or lifestyle.
📌 Examples:
1. Fashion Industry:
o Men’s wear vs. Women’s wear
o Luxury buyers vs. Budget buyers
2. Outdoor Clothing (North Face):
o Cold-weather gear (for extreme climates)
o Hiking & adventure wear (for outdoor sports)
📌 Key Insight:
Market segmentation helps businesses target customers effectively. Different segments have
different purchasing power, preferences, and demands.
3. Porter's Five Forces Model
Michael Porter’s Five Forces Model is used to analyze industry competition. These forces
determine profitability and help businesses shape their strategies.
1. Risk of Entry (Threat of New Competitors)
New companies entering an industry increase competition and reduce profitability for existing
businesses.
📌 Example:
Tesla dominates electric cars because:
Strong brand loyalty
Advanced battery technology
High investment costs for new competitors
Factors that reduce the risk of entry: ✔ Brand loyalty – Customers prefer established brands
(e.g., Apple users rarely switch).
✔ Cost advantages – Large companies have economies of scale (produce at lower costs).
✔ Government regulations – Laws prevent new competitors from entering.
✔ High switching costs – Customers find it costly to change brands (e.g., Adobe subscription
software).
2. Rivalry Among Existing Competitors
High competition in an industry forces companies to lower prices, reducing overall profits.
📌 Example:
The airline industry has high rivalry because:
High fixed costs (airplanes, maintenance)
Customers are price-sensitive
Companies can’t easily exit (they have invested billions in planes)
Factors affecting rivalry:
1. Industry Structure:
o Oligopoly → Few big firms dominate (e.g., FedEx, UPS, DHL in delivery
services).
o Monopoly → One company dominates (e.g., Google Search).
o Fragmented Industry → Many small businesses compete (e.g., restaurants,
gyms).
2. Market Demand:
o High demand = Less rivalry (everyone makes money).
o Low demand = Intense rivalry (companies fight for fewer customers).
3. Exit Barriers:
o If companies can’t leave an industry easily, they stay & compete harder.
3. Bargaining Power of Buyers (Customers)
Buyers (customers) control prices by demanding better deals and higher quality.
📌 Example:
Walmart has strong buying power because it buys in bulk and forces suppliers to lower
prices.
Buyers have power when:
✔ Many sellers exist (customers can choose between brands).
✔ They buy in large volumes (big buyers can demand discounts).
✔ Switching costs are low (customers can change brands easily).
4. Bargaining Power of Suppliers
Suppliers control raw materials & labor costs. If they have power, they can increase prices,
making it harder for companies to profit.
📌 Example:
Intel dominates the computer processor market, giving it power over PC
manufacturers.
Suppliers have power when:
✔ Few supplier options exist.
✔ High switching costs (companies can’t change suppliers easily).
✔ Product is essential (no substitutes).
5. Threat of Substitute Products
Substitutes are alternative products that meet the same customer need.
📌 Examples:
Uber vs. Taxis – Uber replaced taxis.
Tea vs. Coffee – If coffee prices rise, people switch to tea.
6. Complementary Products
Complementors are products that increase the value of another product.
📌 Examples:
Printers & Ink – More printers sold = more ink needed.
Video game consoles & Games – PlayStation sales drive game sales.
4. Industry Life Cycle (Stages of Industry Evolution)
Industries grow & decline over time:
1. Embryonic Stage – New industry, few customers, high costs (e.g., Hydrogen-powered
cars).
2. Growth Stage – More sales, lower costs, rising competition (e.g., Electric cars).
3. Shakeout Stage – Weak companies fail, strong ones survive (e.g., Smartphone industry).
4. Mature Stage – Market stabilizes, only established brands remain (e.g., Traditional cars).
5. Declining Stage – Demand drops, companies exit (e.g., DVD rentals).
5. Punctuated Equilibrium (Industry Disruptions)
Industries do not evolve smoothly—a major change can disrupt everything.
📌 Example:
iPhone disrupted the mobile phone market, eliminating Nokia & Blackberry.
6. Macroenvironment Factors Affecting Industries
Industries are influenced by external factors:
✔ Economic Factors (Inflation, Interest rates).
✔ Technological Changes (New innovations).
✔ Demographics & Social Trends (Aging population, values).
✔ Political & Legal Regulations (Government policies).
📌 Example:
Electric cars are rising because of government subsidies & climate concerns.
Final Takeaways
✔ Understanding competition helps businesses grow.
✔ Industries evolve—companies must adapt.
✔ External forces shape competition.
✔ Strategic planning = Long-term success.
