Students
Chapter 4
Chapter Outlines
Analyzing the Environment
One of the most important aspects of a business strategy is analyzing the environment in which the business operates. Each business environment is unique, and so a unique strategy is required for each. This chapter explains the necessary steps to a proper environmental analysis.
Defining the Business and the Environment
Business-Domain
Definition and Performance
Jatinder S. Sidhu's publication in the SAM Advanced Management Journal explains
how defining a business can be a key factor in performance
Competitive
and Performance Implications of Business Definitions
Noel Houthoofd's SAM Advanced Management Journal article
outlines the advantages of business definition
Corporate
Mission Statements
Texas A & M strategic management professor
Victoria Buenger relates Derek Abell's three dimensions of business definition
to the mission statements of businesses
When defining the environment of a business, one must think of it as a living organism with certain items necessary for survival, but these items can only be obtained from the environment in which it lives. A business must discern what inputs it takes from its environment in order to survive. An important factor in any business environment is the demand for its output. With no demand for its product, a business cannot survive.
Defining the business is just as important as defining the environment. Since no two businesses are the same, they all have different inputs necessary for their environments. Abell defines businesses along three different dimensions: customer groups, customer functions, or dominant technologies. After defining itself, a business must define both its customers, and their substitute options for the business' products and services. This determines the competitive environment.
Analyzing the Competitive Environment
The
Competitive Business Environment of the 21st Century
A synopsis of Dr.
Roger Selbert's keynote address concerning surviving in today's competitive
environment
Analyzing the competitive environment is the most important and immediate factor in the overall analysis of a business' environment. The competitive environment determines a business' bargaining power. The competitive environment also determines the customers elasticity, which relates to their options concerning buying or walking away from a product.
The Five-Forces Model
Porter's Five-Forces
Model
An extensive explanation of Porter's Five-Forces model on
Quickmba.com
How
Competitive Forces Shape Strategy
Michael Porter's article from the Harvard Business review relates competitive forces to
strategy
The Five Competitive Forces that Shape Strategy
Harvard Business video
interview with Michael Porter explaining his Five-forces model
A powerful tool in understanding bargaining power is the Five-forces model developed by Porter. It determines competitiveness and profit potential based on the interaction of five forces: the bargaining power of sellers, the bargaining power of buyers, the availability of substitute products, the threat of new entrants, and the rivalry among existing competitors.
The bargaining power of the seller can be based on a number of different factors. They may have a high quality product; perhaps their product is very rare, or maybe their product is simply very important and of high necessity. In all these cases, buyers are more likely to choose the seller's product, thus giving the seller bargaining power. A monopoly is the greatest example of this. This is when a customer either has no other option, or simply feels as if they have no other option than the seller's product.
The bargaining power of the buyer is essentially the same principle of bargaining power of the seller but in reverse. If a product is unimportant, or highly available, then the buyer has the power to choose between different businesses, or to simply walk away.
Availability of substitutes deals with the different options a customer has when looking for a particular product. However, no two customers see different products in quite the same way. One customer may see a Toyota car as a substitute for a Ford, but another customer would say there is no comparison between the two. A business must anticipate the desires of its customers to identify its substitutes.
Threat of new entrants is the threat of competition entering the environment. New competition represents bargaining power for the buyer. Some businesses will use contrived deterrents; this is the process of devaluing your own product simply to make it less attractive to potential new entrants. Some businesses rely on real deterrents such as patents.
Rivalry among competitors is the last force in the analysis. This determines how much actual rivalry exists between existing competitors. Some markets are less competitive than others. Mature markets are more competitive than emerging ones, and markets with low demand are more competitive than markets with high demand.
Used together, the Five-forces model can help a business identify an environment with little competition or elasticity that can be easily defended from new entrants.
Competitiveness and the Lifecycle Model
Empty
Cores in Airlines Markets
Kenneth Button of George Mason University's
School of Public Policy gives the airline industry as an example of an empty
core market
After determining how the five forces relate to a business, it is necessary to study the business' timeline, or lifecycle. Since the battle for competitive advantage is never ending, it is critical to look at the long term picture for a business. As the environment changes, so does supply and demand, and in turn so does production and profit. A business must see these changes coming and try to predict them before they happen. These changes have a profound effect on competition, as a high-demand market is less competitive, but a low-demand market is more competitive. It is in these low-demand stages that the stronger firms survive and the weaker firms fail. These can eventually become empty core markets, where there is no interest in new entry, little opportunity for profit, and the firms that have, to that point, survived are largely locked in.
Ongoing Evolution in the Environment
The changes a business goes through are like an evolutionary cycle: startup, growth, sustainment, decline, to new idea to grow from again. This cycle, over a long enough timeline, will repeat itself. This idea is known and is illustrated in the theories of punctuated equilibrium and creative destruction. New ideas always enter the market which either force firms to fold or change, but when these new ideas become old then the cycle repeats.
Concluding Thoughts and Caveats
D'Aveni on Hypercompetition
A video of D'Aveni explaining Hypercompetition
- These tools are not to be used as a formula or an exact science. As each environment and business is unique, they all require unique strategies. These tools are rather a framework to be generally followed.
- Hypercompetition is a term coined by Richard D'Aveni to explain the accelerated way in which these evolutionary cycles are happening in the modern business world. It reflects the constant change the business world has always faced.
- Industry definition is a critical aspect of environmental analysis. However, it is important to define an industry through the eyes of the consumer, as industry likeness is in the eye of the beholder.
- Never neglect the locus of competition. It is easy to get caught up in grand scale strategy, and in doing so forget the importance of the individual customer. Businesses should never neglect the simple factors that are the backbones of their industry.
Key Terms
Branding
Represents one of the primary mechanisms by which firms differentiate their products and services.
Contrived deterrence
Describes those investments made by incumbent firms that discourage new entrants from opting to compete. Incumbents' investments in excess capacity, altering cost structures, product differentiation, and vertical integration can all increase barriers to entry, and may also have an effect on smaller existing competitors.
Creative destruction
A term coined in 1942 by economist Joseph Schumpeter, describes the process whereby the economic structure of industries is revolutionized from within — old structures become replaced by new ones. For management, the concept suggests that only those firms that can respond to dynamic capital markets and relax their conventional notions of control and decision making can maintain superior, long-term returns.
Economies of scale
Describes a measure of economic growth wherein the average per unit costs associated with the production, marketing, or distribution of a product/service decreases as the number of units increases.
Economies of scope
Occurs when the average total cost of production decreases as the number of different goods/services produced increases.
Elasticity
A measure of the rate of response of quantity demanded resulting from a change in price, with all other factors held constant. For products with high elasticity, a price increase will result in a decrease in revenue, since the revenue lost from decreasing quantity demanded outweighs revenue gains from the price increase.
Empty core
Markets exist when there is no sustainable, equilibrium, market-clearing price. That condition exists where capacity exceeds the quantity demanded at the price equal to minimum average cost.
Monopoly
Describes a market condition whereby only one firm produces (or provides an overwhelming majority of) a certain good. In such conditions, the demand curve for the firm is identical to the market demand curve. Monopoly firms will produce a quantity at the level where marginal costs equal marginal revenue. The ability to do this and the degree to which a seller has the ability to set the market price for a certain good is referred to as monopoly power.
Niche market
A focused, tangible segment of the general market that receives no or limited service from existing mainstream providers. Such narrow market segments, which tend to be either undetected or omitted by potential competitors, can be attractive targets for focused differentiators.
Punctuated equilibrium
A view describing organizations and industries as evolving through relatively long periods of stable and incremental change punctuated by relatively short periods of radical and fundamental change. These changes disrupt the established patterns of activity and provide the basis for new equilibrium periods.
Switching costs
The costs incurred when customers change from one supplier or market to another. These costs are a key factor in determining the bargaining power of suppliers/buyers. When switching costs are high/low, bargaining power of suppliers is high/low, and bargaining power of buyers is low/high.