Evaluating a Firm's External Environment - Illinois State University

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M02_BARN4586_03_SE_C02.qxd 7/1/09 7:34 AM Page 59 Chapter 2: Evaluating a Firm’s External Environment 59 advantages may find divestment a superior option to harvest, because they have few competitive advantages they can exploit through harvesting. In the 1980s, GE used this rapid divestment approach to virtually abandon the consumer electronics business. Total demand in this business was more or less stable during the 1980s, but competition (mainly from Asian manufacturers) increased substantially. Rather than remain in this business, GE sold most of its consumer electronics operations and used the capital to enter into the medical imaging industry, where this firm has found an environment more conducive to superior performance. 58 In the defense business, divestment is the stated strategy of General Dynamics, at least in some of its business segments. General Dynamics’ managers recognized early on that the changing defense industry could not support all the incumbent firms. When General Dynamics concluded that it could not remain a leader in some of its businesses, it decided to divest those and concentrate on a few remaining businesses. Since 1991, General Dynamics has sold businesses worth over $2.83 billion, including its missile systems business, its Cessna aircraft division, and its tactical aircraft division (maker of the very successful F-16 aircraft and partner in the development of the next generation of fighter aircraft, the F-22). These divestitures have left General Dynamics in just three businesses: armored tanks, nuclear submarines, and space launch vehicles. During this time, the market price of General Dynamics stock has returned almost $4.5 billion to its investors, has seen its stock go from $25 per share to a high of $110 per share, and has provided a total return to stockholders of 555 percent. 59 Of course, not all divestments are caused by industry decline. Sometimes firms divest certain operations to focus their efforts on remaining operations, sometimes they divest to raise capital, and sometimes they divest to simplify operations. These types of divestments reflect a firm’s diversification strategy and are explored in detail in Chapter 11. Summary The strategic management process requires that a firm engage in an analysis of threats and opportunities in its competitive environment before a strategic choice can be made. This analysis begins with an understanding of the firm’s general environment. This general environment has six components: technological change, demographic trends, cultural trends, economic climate, legal and political conditions, and specific international events. Although some of these components of the general environment can affect a firm directly, more frequently they affect a firm through their impact on its local environment. The S-C-P model is a theoretical framework that enables the analysis of a firm’s local environment and that links the structure of the industry within which a firm operates, its strategic alternatives, and firm performance. In this model, structure is defined as industry structure and includes those attributes of a firm’s industry that constrain a firm’s strategic alternatives and performance. Conduct is defined as a firm’s strategies. Performance refers either to the performance of a firm in an industry or the performance of the entire economy—although the former definition of performance is more important for most strategic management purposes. The S-C-P model can be used to develop tools for analyzing threats in a firm’s competitive environment. The most influential of these tools is called the “five forces framework.” The five forces are: the threat of entry, the threat of rivalry, the threat of substitutes,
M02_BARN4586_03_SE_C02.qxd 7/1/09 7:34 AM Page 60 60 Part 1: The Tools of Strategic Analysis the threat of suppliers, and the threat of buyers. The threat of entry depends on the existence and “height” of barriers to entry. Common barriers to entry include economies of scale, product differentiation, cost advantages independent of scale, and government regulation. The threat of rivalry depends on the number and competitiveness of firms in an industry. The threat of rivalry is high in an industry when there are large numbers of competing firms, competing firms are roughly the same size and have the same influence, growth in an industry is slow, there is no product differentiation, and productive capacity is added in large increments. The threat of substitutes depends on how close substitute products and services are—in performance and cost—to products and services in an industry. Whereas rivals all meet the same customer needs in approximately the same way, substitutes meet the same customer needs, but do so in very different ways. The threat of suppliers in an industry depends on the number and distinctiveness of the products suppliers provide to an industry. The threat of suppliers increases when a supplier’s industry is dominated by a few firms, when suppliers sell unique or highly differentiated products, when suppliers are not threatened by substitutes, when suppliers threaten forward vertical integration, and when firms are not important customers for suppliers. Finally, the threat of buyers depends on the number and size of an industry’s customers. The threat of buyers is greater when the number of buyers is small, products sold to buyers are undifferentiated and standard, products sold to buyers are a significant percentage of a buyer’s final costs, buyers are not earning significant profits, and buyers threaten backward vertical integration. Taken together, the level of these threats in an industry can be used to determine the expected average performance of firms in an industry. One force in a firm’s environment not included within the five forces framework is complementors. Where competitors (including rivals, new entrants, and substitutes) compete with a firm to divide profits in a market, complementors increase the total size of the market. If you are a CEO of a firm, you know that another firm is a complementor when the value of your products to your customers is higher in combination with this other firm’s products than when customers use your products alone. Where firms have strong incentives to reduce the entry of competitors, they can sometimes have strong incentives to increase the entry of complementors. The S-C-P model can also be used to develop tools for analyzing strategic opportunities in an industry. This is done by identifying generic industry structures and the strategic opportunities available in these different kinds of industries. Four common industry structures are fragmented industries, emerging industries, mature industries, and declining industries. The primary opportunity in fragmented industries is consolidation. In emerging industries, the most important opportunity is first-mover advantages from technological leadership, preemption of strategically valuable assets, or creation of customer-switching costs. In mature industries, the primary opportunities are product refinement, service, and process innovation. In declining industries, opportunities include market leadership, niche, harvest, and divestment.
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