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 33 Chapter 2: Evaluating a Firm’s External Environment 33 general nature of the relationship between government and business. These laws and the relationship between business and government can vary significantly around the world. For example, in Japan, business and the government are generally seen as having a consistently close and cooperative relationship. Indeed, some have observed that one reason that the Japanese economy has been growing so slowly over the last decade has been the government’s reluctance to impose economic restructuring that would hurt the performance of some Japanese firms— especially the largest Japanese banks. In the United States, however, the quality of the relationship between business and the government tends to vary over time. In some administrations, rigorous antitrust regulation and tough environmental standards—both seen as inconsistent with the interests of business—dominate. In other administrations, antitrust regulation is less rigorous and the imposition of environmental standards is delayed, suggesting a more business-friendly perspective. A final attribute of a firm’s general environment is specific international events. These include events such as civil wars, political coups, terrorism, wars between countries, famines, and country or regional economic recessions. All of these specific events can have an enormous impact on the ability of a firm’s strategies to generate competitive advantage. Of course, one of the most important of these specific events to have occurred over the past several decades was the terrorist attacks on New York City and Washington, D.C., on September 11, 2001. Beyond the tragic loss of life, these attacks had important business implications as well. For example, it took over five years for airline demand to return to pre–September 11 levels. Insurance companies had to pay out billions of dollars in unanticipated claims as a result of the attacks. Defense contractors saw demand for their products soar as the United States and some of its allies began waging war in Afghanistan and then Iraq. A firm’s general environment defines the broad contextual background within which it operates. Understanding this general environment can help a firm identify some of the threats and opportunities it faces. However, this general environment often has an impact on a firm’s threats and opportunities through its impact on a firm’s more local environment. Thus, while analyzing a firm’s general environment is an important step in any application of the strategic management process, this general analysis must be accompanied by an analysis of a firm’s more local environment if the threats and opportunities facing a firm are to be fully understood. The next section discusses specific tools for analyzing a firm’s local environment and the theoretical perspectives from which these tools have been derived. The Structure-Conduct-Performance Model of Firm Performance In the 1930s, a group of economists began developing an approach for understanding the relationship among a firm’s environment, behavior, and performance. The original objective of this work was to describe conditions under which competition in an industry would not develop. Understanding when competition was not developing in an industry assisted government regulators in identifying industries where competition-enhancing regulations should be implemented. 11
M02_BARN4586_03_SE_C02.qxd 7/1/09 7:34 AM Page 34 34 Part 1: The Tools of Strategic Analysis One of the basic tenets of economic theory is that society is better off when industries are very competitive. Industries are very competitive when there are large numbers of firms operating in an industry, when the products and services that these firms sell are similar to each other, and when it is not very costly for firms to enter into or exit these industries. Indeed, as is described in more detail in the Strategy in Depth feature, these industries are said to be perfectly competitive. The reasons that society is better off when industries are perfectly competitive are well known. In such industries, firms must constantly strive to keep their costs low, their quality high, and, when appropriate, innovate if they are to even survive. Low costs, high quality, and appropriate innovation are generally consistent with the interests of a firm’s customers, and thus consistent with society’s overall welfare. Indeed, concern for social welfare, or the overall good of society, is the primary reason the S-C-P model was developed. This model was to be used to identify industries where perfect competition was not occurring, and thus where social welfare was not being maximized. With these industries identified, the government could then engage in activities to increase the Ethics and Strategy Is a Firm Gaining a Competitive Advantage Good for Society? competitiveness of these industries, thereby increasing social welfare. Strategic management scholars turned the S-C-P model upside down by using it to describe industries where firms could gain competitive advantages and attain above-average performance. However, some have asked that if strategic management is all about creating and exploiting competitive imperfections in industries, is strategic management also all about reducing the overall good of society for advantages to be gained by a few firms? It is not surprising that individuals who are more interested in improving society than improving the performance of a few firms question the moral legitimacy of the field of strategic management. However, there is another view about strategic management and social welfare. The S-C-P model assumes that any competitive advantages a firm has in an industry must hurt society. The alternative view is that at least some of the competitive advantages exist because a firm addresses customer needs more effectively than its competitors. From this perspective, competitive advantages are not bad for social welfare; they are actually good for social welfare. Of course, both perspectives can be true. For example, a firm such as Microsoft has engaged in activities that at least some courts have concluded are inconsistent with social welfare. However, Microsoft also sells applications software that is routinely ranked among the best in the industry, an action that is consistent with meeting customer needs in ways that maximize social welfare. Sources: J. B. Barney (1986). “Types of competition and the theory of strategy.” Academy of Management Review, 11, pp. 791–800; H. Demsetz (1973). “Industry structure, market rivalry, and public policy.” Journal of Law and Economics, 16, pp. 1–9; M. Porter (1981). “The contribution of industrial organization to strategic management.” Academy of Management Review, 6, pp. 609–620. The theoretical framework that developed out of this effort became known as the structure-conduct-performance (S-C-P) model; it is summarized in Figure 2.2. The term structure in this model refers to industry structure, measured by such factors as the number of competitors in an industry, the heterogeneity of products in an industry, the cost of entry and exit in an industry, and so forth. Conduct refers to the strategies that firms in an industry implement. Performance in the S-C-P model has two meanings: (1) the performance of individual firms and (2) the performance of the economy as a whole. Although both definitions of performance in the S-C-P model are important, as suggested in Chapter 1, the strategic management process is much more focused on the performance of individual firms than on the performance of the economy as a whole. That said, the
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