Notes

The analysis of the external business environment is indispensable for strategic decision making so as to ensure that the decisions it takes today prepare the company for the future. The external environment decides whether the strategies of firms are successful. The environment changes continuously, but many firms are unable to see the changes that are coming (and sometimes those that are already happening). What should a company look at to make sense of the current - or future - business environment, threats and opportunities aren't easy to pinpoint.

The strategy field has developed several concepts and frameworks to structure the analysis of external environment into manageable pieces, and help strategist ask the right questions:

Analysis of the Macro Environment

Broad developments in the external context beyond the boundaries of a given industry. It impacts on all industries. But the impact is different in each specific industry. PricewaterhouseCoopers (PwC) identified five "megatrends" affecting many industries: Demographic and Social Change, Shift in Global Economic Power, Rapid Urbanisation, Climate Change and Resource Scarcity, Technological Breakthroughs. In strategy, the PESTEL framework is often used to capture macro-environmental factors in a structured way: Political, Economic, Socio-cultural, Technological, Environmental, Legal. To apply the PESTEL framework should be aware that looking too closely at the industry isn't correct because even it's boundaries are affected by changes. Although the framework does not necessarily imply a geographical focus, many of its dimensions vary at the level of the country or region. For scanning and assessing the opportunities and risks of entry and operation in foreign markets, country level analysis is particularly appropriate. It occurs to define a time perspective that is appropriate for the industry and to understand whether the trends are real or not. (e.g. Luxottica is favoured by the macro trend of increasing and ageing amount of people).

Analysis of the Industry Environment

Factors specific to the industry, resulting in statements about the industry overall. Industry is a natural unit of external analysis in strategy. While the definition of industry boundaries is a subjective choice, depending on the purpose of the analysis, three questions are commonly used to draw clear industry boundaries: "What is the offer?"; "For whom?"; "Where?".

Generally, it is good practice to use the narrowest market definition that fits the analyst's purpose, since this provides more specific and actionable insights. In practice, the choice of boundaries is often constrained by data availability.

Most strategic analysts pay close attention to statistics on the size and growth trends of the industry and forecasts of future growth. Market size and growth indicate an industry's ability to create value. The drivers of industry growth are: demographic factors, costumer preferences, growth of the economy, reduction of costs, regulations, complementary goods, international demand.

While an industry's growth can generally be explained by the fundamental supply and demand drivers, a recurrent evolutionary pattern with distinct phases is observed across many industries. The industry life cycle distinguish between four phases:

• Introduction, may result from one firm's innovation, then imitators enter the industry. The growth initially is very slow, customers do not know or trust the product. High product prices, because of small volume and immaturity of product technologies. Existent distribution channels may not accept the product, building new one may be necessary. Technical know-how and components are in rare supply. The main challenge in a new industry is to demonstrate superior value creation relative to other industries (substitutes), at least for some customers niches with unmet needs.
• Growth, the product improves and comes to be accepted by the large public, first-time demand expands rapidly. Prices begin to fall, thanks to economies of scale and growing standardization of the product. Diffusion of technical know-how lowers costs but also reduces entry-barriers; many new competitors enter the industry. Rapid market growth means low competitive pressure, since any firm can expand its turnover without cutting prices. Massive new productive capacity is built.
• Maturity, The market is gradually saturated. Demand driven by replacements not first-time adoption. Shrinking technical opportunities for product innovation. Slow market growth ignites competition for market share, which drives down prices. Firms strive to reduce costs and to build brand loyalty. Competitors with high costs or weak brands exit the industry (sometimes they are acquired by other firms), leading to industry consolidation. There are also firms able to catch opportunities in the maturity phase, like IKEA, Swatch, Nespresso, Ryanair and Airbnb.
• Decline, it's characterized by negative growth due to changes in technology, social preferences, demographics and so on. Increased rivalry, since firms try to compensate negative growth with larger market shares. Excess capacity in the industry and price competition. The appearance of a substitute product can kill the industry (typing machines), but sometimes the market shrinks to a smaller size and then goes on (vinyl records). Profitability of the industry highly dependent on exit barriers that determine the level of excess capacity (obstacles to leave the industry or selling the equipments).

The industry life cycle is an empirical regularity, not a deterministic destiny. This model allows predictive model for the evolution of WTP and customers' demand; it connects competitive dynamics to demand dynamics; it emphasizes the possibility of decline; it's less important for industries that are structurally mature or that are structurally far from saturation of the market; big changes in technologies or business modal can change how revenue is obtained, modyfing the cycle.

The consecutive chain of supplier-buyer relationships in an industry is the industry value chain. The chain is the sequence of firms or other organizations that are involved in producing and delivering a product or service. The sequence begins with basic supplier of raw material and extends all the way to the final costumer. The result is an end to end picture of how products and services are built up, from initial inputs to the end costumer.

For example, the value chain of the diamond industry comprises the four stages of rough diamond exploration and sales, cutting and polishing, jewellery manufacturing, and retail sales.

In strategy analysis terms, each of the four stages in the diamond chain represents an industry in its own right.

An industry is a set of firms (or business units) that sell similar products to the same costumer, while a market is a set of costumers defined by a given product, distribution channel, geographical area, or, purchasing behaviour (segments).

Firms in an industry usually serve multiple markets.

In the industry, rivals are those firms who compete in the same industry. Substitutes are those who compete from outside of the industry (airplanes vs trains). We can define a difference from the two on the nature of the product or the technology involved, but also on how revenues are collected.

Although the costumers are similar, substitutes have cost structures and entry barriers that are different than those of the industry rivals.

It may be difficult to establish the industry's boundaries due to:

• Different costumer segments (Ferrari - Peugeot)
• Different distribution channels (Esselunga - Deliveroo)
• Different geographical areas (Alitalia -- Emirates).

The criterion can sometimes be choosing the narrowest industry that is coherent with hypotheses about competition (what happens to the demand of B when A reduces prices?)

The Five Forces Model is the most prominent framework for industry analysis is that of Michael Porter, who advocated structural analysis of competitive pressures to understand an industry's profitability.

Porter proposed five forces that jointly determine an industry's activeness in terms of profitability:

• The intensity of rivalry among industry incumbents. The rivalry is strengthened if there are many firms, equal in size and capability, the market growth is slow, there are high fixed costs, there is a lack of differentiation opportunities and high exit barriers.
• The threat of new entry, barriers to entry are structural factors that prevent or make the entry expensive, such that economies of scale, other cost disadvantages for the new entrant that arise when the incumbents have privileged access to crucial resources; product differentiation, capital requirements, switching costs, distribution channels, government policy and expected retaliation (response by existing competitors to entry).
• The threat of substitutes products, the competitive threat of substitutes is stronger when they are: attractively priced, readily available, high quality and perform well, customer switching costs are low. In general, any increase in quality or decrease in price of a substitute will put pressure on the industry to reduce prices to avoid losing customers (thus reducing profitability).
• The bargaining power of suppliers to the industry (upstream). Suppliers have bargaining power when the item is crucial to buyers, it is costly for buyers to switch suppliers (Airbus - Boeing), threat to integrate forward into buyer's industry or there are only a few large suppliers.
• The bargaining power of distribution channels and buyers (downstream). Buyers have bargaining power when they are large, they threat to integrate backward into the seller's industry, buyers can switch to another product without high costs.

An ideal situation for an industry is low rivalry, high entry barriers, little threat from substitutes and little bargaining power both of suppliers and buyers. The industry concentration depends on how market shares are distributed among competitors, CR4 Index: is the sum of the market shares of the four biggest firms. The higher the index, the higher the concentration.

The "Sixth force" are complementors. Goods and services that make the industry's products more valuable. Complementors can create additional demand for the industry but they can also compete with the industry in appropriating value (the more expensive the complementor, the lower the value appropriated by the industry). Porter says that he never wanted to add complementors to the framework because they already impact the bargaining power of costumers.

• Analysis of Customers and Competitors, critical information about costumer segments and specific competitors' abilities and strategies in the industry.

Customers of an industry vary in terms of many distinct characteristics. Groups of customers who share given characteristics that influence their purchase behaviour are called segments. Segmentation of market allows firms to:

• Choose which segments to target
• Design specific offerings for different segments
• Adapt marketing strategies to specific segments.

Typical criteria for segmentation are Geographics, Demographics, Psychographics and Behavioural. Firms need to know objective data about the Competitors, such as market share, growth rates, product offerings, target segments, or channels of distribution. Firms also need to understand the competitive approach of their rivals, based on:

• Their future goals (growth rather than focus on a niche)
• Their current strategies (positioning, vertical integration, domains of activity)
• Their assumptions on the industry (trends they believe are important)
• Their resources and capabilities (technology, human resources, routines and financial resources).