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 35 Chapter 2: Evaluating a Firm’s External Environment 35 Industry structure Figure 2.2 The Structure- Conduct-Performance Model Number of competing firms Homogeneity of products Cost of entry and exit Firm conduct Strategies firms pursue to gain competitive advantage Performance Firm level: competitive disadvantage, parity, temporary or sustained competitive advantage Society: productive and allocative efficiency, level of employment, progress relationship between these two types of performance can sometimes be complex, as described in the Ethics and Strategy feature. The logic that links industry structure to conduct and performance is well known. Attributes of the industry structure within which a firm operates define the range of options and constraints facing a firm. In some industries, firms have very few options and face many constraints. In general, firms in these industries can only gain competitive parity. In this setting, industry structure completely determines both firm conduct and long-run firm performance. However, in other, less competitive industries, firms face fewer constraints and a greater range of conduct options. Some of these options may enable them to obtain competitive advantages. However, even when firms have more conduct options, industry structure still constrains the range of options. Moreover, as will be shown in more detail later in this chapter, industry structure also has an impact on how long firms can expect to maintain their competitive advantages in the face of increased competition. The Five Forces Model of Environmental Threats As a theoretical framework, the S-C-P model has proven to be very useful in informing both research and government policy. However, the model can sometimes be awkward to use to identify threats in a firm’s local environment. Fortunately, several scholars have developed models of environmental threats based on the S-C-P model that are highly applicable in identifying threats facing a particular firm. The most influential of these models was developed by Professor Michael Porter and is known as the “five forces framework.” 12 The five forces framework identifies the five most common threats faced by firms in their local competitive environments and the conditions under which these threats are more
M02_BARN4586_03_SE_C02.qxd 7/1/09 7:34 AM Page 36 36 Part 1: The Tools of Strategic Analysis Figure 2.3 Five Forces Model of Environmental Threats Source: Adapted with the permission of The Free Press, a division of Simon & Schuster Adult Publishing Group, from Competitive Strategy: Techniques for Analyzing Industries and Competitors by Michael E. Porter. Copyright © 1980, 1998 by The Free Press. All rights reserved. Threat of suppliers Threat of entry Level of threat in an industry Threat of rivalry Threat of substitutes Threat of buyers or less likely to be present. The relationship between the S-C-P model and the five forces framework is discussed in the Strategy in Depth feature. To a firm seeking competitive advantages, an environmental threat is any individual, group, or organization outside a firm that seeks to reduce the level of that firm’s performance. Threats increase a firm’s costs, decrease a firm’s revenues, or in other ways reduce a firm’s performance. In S-C-P terms, environmental threats are forces that tend to increase the competitiveness of an industry and force firm performance to competitive parity level. The five common environmental threats identified in the five forces framework are: (1) the threat of entry, (2) the threat of rivalry, (3) the threat of substitutes, (4) the threat of suppliers, and (5) the threat of buyers. The five forces framework is summarized in Figure 2.3. The Threat of Entry The first environmental threat identified in the five forces framework is the threat of new entry. New entrants are firms that have either recently started operating in an industry or that threaten to begin operations in an industry soon. For Amazon.com, Barnes & Noble.com and Borders.com are new entrants to the online book-ordering business. Amazon largely invented this way of selling books, and both Barnes & Noble and Borders later followed with their entry into this market, even though both these firms already operated in the traditional book sales industry. For ESPN in the television sports industry, the Fox Sports Regional Network is a new entrant. The Fox Sports Regional Network consists of several regional sports channels that broadcast both national and regional sporting events, sports news shows, and sports entertainment shows—including The Best Damn Sports Show Period. 13 According to the S-C-P model, new entrants are motivated to enter into an industry by the superior profits that some incumbent firms in that industry may be earning. Firms seeking these high profits enter the industry, thereby increasing the level of industry competition and reducing the performance of incumbent firms. With the absence of any barriers, entry will continue as long as any firms in the industry are earning competitive advantages, and entry will cease when all incumbent firms are earning competitive parity. The extent to which new entry acts as a threat to an incumbent firm’s performance depends on the cost of entry. If the cost of entry into an industry is
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