External Analysis: A Layered Approach

The external environment is broad in scope. Strategic management draws a sharp distinction between the external and the internal environments. The internal environment, which you will learn more about in Chapter 4 of this textbook, encompasses an organization’s resources and capabilities. This chapter focuses solely on the external environment, those factors that are beyond the control of a firm but influence its decisions.

We prefer a layered approach for analyzing the external environment that includes a narrow perspective with the firm at the center and expands toward a broader view. This chapter provides frameworks for analysts to focus their attention on each layer one by one (Figure 3.1).

Analysts can glean valuable insights by examining each layer in isolation. Competitive awareness requires a systematic study of all the layers and leads to a comprehensive understanding of an organization’s external environment. Decision makers in the firm require this external environment awareness to formulate an informed strategy.

Competitors

Competitors are rivals that vie for ownership or control of something valuable, and rivalry for valuable market share is one of the primary settings for competition. Business rivals also compete to acquire valuable resources, such as exclusive business relationships, skilled employees, or intellectual property. These assets may have high strategic importance. However, this unit focuses on competition for customers, market share, and profit within an industry.

Rivalry drives competitors to innovate, improve efficiency, and deliver products with greater variety, quality, and overall value for customers. The Roman poet Ovid once wrote, “A horse never runs so fast as when it has other horses to catch up and outpace.”

A strategic move to take market share or otherwise create a competitive advantage is known as an action, and competitors’ reactions to those actions are responses. Rivals within a market must carefully identify competitors and monitor their actions and responses to inform and adapt their strategy.

Recognizing this importance, well-resourced companies maintain competitive intelligence (CI) programs to track competitors’ activities. CI programs proactively collect data from competitors’ websites and social media feeds, market research reports, field intel from internal sales teams, and even from personal connections and interactions. Responsible CI practitioners stay within the boundaries of ethics and law, though business rivals sometimes resort to unscrupulous methods of acquiring information on competitors. Access to information itself can be a source of competitive advantage (Calof et al., 2017).

There are two different types of CI, tactical and strategic. Tactical competitive intelligence is short term and seeks to provide input into issues such as capturing market share, improving operations, or increasing revenue (Cavallo et al., 2021). Strategic competitive intelligence focuses on longer term issues such as long-range planning and decision making for ecosystem positioning or sustainable advantage (Cavallo et al., 2021).

Gathered data are analyzed and communicated to key organizational decision makers, who use it to guide major decisions. The Society for Competitive Intelligence describes CI as “a discipline that enables organizations to reduce strategic risk and increase revenue opportunities by having a deep understanding of what has happened, what is happening, and what may happen in their operating environment.” (“What is competitive intelligence?” n.d.)

Identifying Competitors

While CI professionals use advanced techniques and draw from proprietary information sources, anyone can find useful information about competitors using simple methods and with little or no monetary cost. To begin, one must first identify and classify competitors.

Most businesses promote their products and services publicly. They build websites, engage audiences on social media, seek product reviews with influencers, advertise, attend trade events, and use public relations strategies to create awareness. In short, they want to be found. Anyone with access to a search engine or generative AI tools can likely identify and locate a firm’s competitors with carefully worded queries or prompts.

Libraries represent another accessible source of information. Local and university libraries subscribe to databases that include comprehensive and valuable information on companies, markets, industries, sectors, and general trends. For example, the Oregon State University Library offers this portal with a list of useful databases for company and industry research.

Diligent students and analysts can also gather information directly by talking to people with knowledge of the industry. Customers are a great information resource because they are generally aware of prominent competitors and can discuss competing offerings from a personal perspective.

Additionally, publicly traded companies in the United States regularly file and publish reports with the Securities and Exchange Commission (SEC), including quarterly 10-Q and annual 10-K reports, that provide detailed disclosures of business and financial results, material risks, and discussions from company managers about what is driving those results. These reports are accessible for free online via the SEC’s EDGAR database and other sources.

Classifying Competitors

Once competitors have been identified, they should be compared and classified. Two key factors should be considered when comparing competitors. The first is market commonality, which refers to the degree to which companies’ product and service offerings, customer segments, and geographic scope overlap. The second factor is resource similarity, which refers to the extent to which competitors possess similar types and comparable amounts of resources to create value for customers.

For example, Apple and Samsung in the mobile device industries have high market commonality because their products are effectively interchangeable and they both serve customers across the globe. They also have high resource similarity, in that both possess large research and development (R&D) budgets, established supply chains, global distribution networks, and strong brands. Competitors tend to experience more intense competition when they have high market commonality, resource similarity, or both.

Three primary categories exist for classifying (i.e., categorizing) competitors. Direct competitors are firms with similar products or services that target the same customer segments. In the airline industry, for example, the four major airlines in the United States—American, Delta, Southwest, and United—provide seats on flights to business and leisure travelers. They fly the same fixed routes between airports and utilize similar resources such as aircraft, fuel supply chains, sales partners, maintenance processes, and baggage handling systems. Due to their high market commonality and resource similarity, airlines must compete based on factors such as price, amenities, and minor points of differentiation to separate themselves from rivals.

A second category, indirect competitors, are those that serve the same target customer segments and customer needs but with different kinds of products or services. Indirect competitors generally have low resource similarity but high market commonality. For example, the Domino’s and Panda Express restaurant chains both offer consistent, affordable meals to consumers across the United States. However, Domino’s specializes in pizza and fast delivery, whereas Panda Express provides American Chinese cuisine primarily for take-out or eating onsite. While their menus, cooking methods, and formats are distinctly different, the chains compete indirectly for the overlapping customer segments. Executives of both companies undoubtedly monitor and take note when the other chain opens or closes locations, adds or removes menu items, adjusts prices, launches promotional campaigns, and announces financial results.

Notably, it is often very difficult to draw distinct lines between “direct” and “indirect” competition and partly depends on how we define their market. Despite their differences, one could argue Domino’s and Panda Express both operate in the same “quick-service restaurants,” and thus compete directly. Strategic analysts should recognize that classifications are debatable and context dependent. Ultimately, it is most important to understand the degree and nature of competition between rivals.

A third category of strategically important rivals, future competitors, include companies that are not competitors today but that have high potential to become competitors soon. Companies are likely to enter new industries when they possess the resources and strong strategic incentives to do so. For example, after the technology company Apple established a successful core business in mobile devices and personal computers, they sought related industries to expand into. Leveraging its market reach and brand strength, Apple launched Apple TV+ in 2019, in direct competition with Netflix and other streaming services. Apple also announced deals with Major League Baseball and Major League Soccer in 2022 to add live sports to the platform. These actions put Apple into competition with established sports broadcasters such as NBC Sports, ESPN, and Fox. These examples illustrate why forward-thinking executives should try to anticipate which competitors might enter the market and how those new entrants may affect the landscape.

Toolkit: Positioning Map

The goal of competitive analysis is to develop a comprehensive understanding of the competitive landscape, creating a framework for comparing competitors within the market or industry space. A positioning map (also known as a “perceptual map”) is an excellent tool for mapping and visualizing the landscape.

A positioning map is an XY chart that identifies key competitors in a two-dimensional space. When creating the map, dimensions should be identified that represent factors of critical strategic importance. Professor of Strategy Richard D’Aveni advises creating maps that show competitors’ positions in terms of price and a measure of “primary benefit,” such as perceived quality, number of features, level of service, or other measure of high importance to customers (D’Aveni, 2007).

The example in Figure 3.5 shows a positioning map built from data generated in the Micromatic business simulation. Each competitor in the marketplace has an identified position based on the price (Y-axis) and perceived quality (X-axis) of their offering.

Direct competitors offer similar goods and services. However, “similar” does not imply “identical.” Even small variances in price and primary benefits may be meaningful to customers. A positioning map is a tool for charting and visualizing a comparison of direct competitors in those key dimensions. Analysts can glean numerous and important insights from this type of chart.

From a glance, one can see which companies have superior or inferior products relative to each other (in the primary benefit dimension) and which companies have bargain or premium prices. These are key dimensions that help define a firm’s market position, which is a comprehensive description of its relative standing in the industry.

Another useful element of a well-constructed positioning map is the expected value line (the dashed line in Figure 3.5). That is a trendline that illustrates the relationship between price and primary benefit.

Rivals tend to cluster around an upward-sloping expected value line (i.e., one showing a positive relationship between price and product attributes). Companies that offer superior products typically must charge higher prices because they incur increased costs related to development and production, and they can charge higher prices because customers are willing to pay more for superior products. Conversely, companies with bargain prices must typically offer products with lesser benefits that are cheaper to produce. Some companies deliberately position themselves in the middle or attempt to differentiate based on benefit dimensions other than a primary one such as price.

The expected value line provides rich information. The slope of the line indicates how much, incrementally, customers value increased benefits. The tightness of the correlation indicates how important the primary benefit is to customers. A weak correlation suggests other factors have high importance.

And, when companies are positioned far above or below the expected value line, those exceptions present interesting cases that warrant further attention. One possible explanation is the company has deliberately positioned its products to exceed or fall short of expected value (price/benefit), to increase or decrease market share, respectively. This action may be a temporary one or the start of a long-term disruption in the industry. Another possibility is that the company has inadvertently positioned itself outside of industry norms for price/benefit. Yet another possibility is that other dimensions of benefit, separate from the primary one selected for analysis, are important to examine.

Examining further, we can learn from the clustering pattern on a positioning map. A strategic group is a subset of industry competitors that pursue strategies similar to others within the group and are distinct from those outside the group, as shown in Figure 3.6. Strategic groups are visible as distinct clusters on a positioning map and usually experience high rivalry within the group. The chart below illustrates strategic groups for the restaurant industry, with popular chains listed in terms of breadth of menu and perceived quality. The companies within each group have similar operating modes and relative price positions.

While looking for distinct clusters, strategic analysts also make note of empty spaces on the positioning chart, especially along the expected value line. Empty spaces are suggestive of potential opportunities to assume a position with few “close” competitors and, presumably, reduced rivalry.

In summary, the positioning map is a workhorse tool for strategic analyses. The map may be used for quick evaluation and illustration of market positions, or as a tool to prompt deep and thorough investigations of the competitive landscape.

Theory: The Five Forces Model for Industry Analysis

After reviewing specific competitors and strategic groups, we focus our strategic lens on another layer of the external environment: the industry. An industry is a collection of companies that offer similar goods or services and compete directly with each other for market share. In the United States, industries are formally classified using the North American Industry Classification System (NAICS), which organizes businesses into hierarchical levels from broad sectors to narrow industry groups. More broadly, the Global Industry Classification Standard (GICS) provides a common framework used by financial analysts and business strategists (MSCI, n.d.).

In 1979, Michael Porter provided a framework for industry analysis. Porter famously observed that, contrary to prevailing theories about economic efficiency, some industries had proven more profitable than others over long periods. At the time, industries such as tire and steel manufacturers had produced low long-run returns on invested capital, while other industries, such as oilfield services, cosmetics, and soft drinks, provided higher long-run returns.

Porter argued these divergent outcomes are attributable to a set of structural forces that affect the intensity of competition within the industry. These forces came to be known as Porter’s Five Forces Model of Competition and are one of the most popular tools in strategic analysis, as shown in Figure 3.7 (Porter, 1979).

Porter identified five categories of structural force that contribute to increased competitive intensity. When the aggregate strength of these forces is high, competition is very intense, and firms within an industry experience lower long-run returns because they have limited pricing power and must work harder to provide distinctive value. Conversely, when the forces are limited, industry participants experience milder competition and enjoy higher average long-run returns. Industries with less intense competitive forces are said to have higher industry attractiveness because they present more favorable conditions for firms to succeed (Porter, 1980, pp. 3–4).

Applying the Five Forces Model

As with other frameworks described in this textbook, the Five Forces Model (Figure 3.8) is highly extensible. The model is useful to students and early career professionals as well as corporate executives, financial analysts, government policymakers, and others. Its application applies to any for-profit, nonprofit, government, and non-governmental.

Someone new to an industry, such as a recent college graduate starting their first post-college job, could utilize the model as a simple checklist to develop a richer, more comprehensive understanding of their firm’s environment. Each of the Five Forces represents a prompt for research. By studying each force in turn, one can identify critical factors that drive competitive success or failure in the industry.

A more sophisticated analyst could use the model to diagnose and explain why some industries are more attractive than others in the present day. Publicly available financial statements and secondary databases can tell us how profitable industries are in aggregate, but those information sources do not explain why some industries do better than others. The Five Forces Model enables us to develop explanations.

For example, a project exploring the attractiveness of the market for recruiting military personnel in the state of Oregon might identify an unexpected group of rivals comprising any organization competing for the same demographic of recruits like Oregon Army National Guard, U.S. Army, Army Reserves, Navy, Coast Guard, Air Force, Marines, firefighters, highway patrol, and city police or sheriffs. This abundance of options for recruits (who are essentially the supply for the industry) means the incentives to join are typically high even though the economic buyer of these services is often very narrow (government or public) and the likelihood of new entry is low.

The model also helps to explain variances from industry average rates of return. While structural forces drive, firms with unique capabilities to defend against competitive forces may experience higher than average rates of return. In 2024, the race to develop the GPU (graphic processing units) and CPU (central processing units) at the core of artificial intelligence put NVIDIA and AMD in a unique position to compete to supply a new and rapidly expanding industry. Meanwhile other tech giants like Broadcom, Taiwan Semiconductor, Alphabet, META, Apple, Qualcomm, Microsoft, Intel, and Texas Instruments race to catch up to get their own slice of what they believe will be a larger industry than any other for integrated circuits. All of this before any of the rivals are actually earning a profit from AI technology.

Lastly, the model helps to predict how current events and trends will impact an industry’s attractiveness in the future. For example, for many decades the copper industry was a quiet, staid industry that acted more like a commodity than a competitive market with the average lithium-ion battery pack falling in price by 89% between 2010 and 2021. In 2021, a ton of lithium carbonate, a critical component of electric vehicle (EV) batteries, cost $6,500. But with the exploding demand for EVs and the slow ramping up of additional capacity (five years on average), by November 2022, the metal had increased nearly five times in price to $80,000 per ton (Mining.com, 2022). When something changes that affects the strength of any of the Five Forces, we expect a change to average industry profitability, all else equal.

An industry is more likely to be labeled as attractive when more of the following conditions exist: Low threat of substitute products; high barriers to enter the industry; rivalry among existing competitors is low or when existing industry rivals have high bargaining power with their suppliers. It is unattractive when the opposites are true or mostly true. In short, Porter’s Five Forces Model is a powerful analytical tool that may be used to quickly scan, comprehensively evaluate, or predict changes within an industry (Porter, 1979).

The model is universal in its applicability but does not yield precise, quantified data about the industry. Instead, it produces a framework for understanding the relative strength or weakness of each of the Five Forces and helps the analyst ultimately determine the attractiveness of the industry relative to profit potential. The model is useful for describing an industry, but attractiveness boils down to how likely is it for competitors in the industry to earn a profit.

Threat of New Entrants

New competitors that emerge within an established industry are known as new entrants. The threat of new entrants describes the potential for new competitors to emerge. New entrants bring new capacity to the industry and compete for market share with existing industry participants. These factors increase the intensity of competition and reduce profitability within an industry.

Potential new entrants include new startup companies and well-established firms, including foreign firms. Young startups tend to be cash-poor but nimble and innovative, and able to take market share by focusing on underserved niche segments. Well-established companies, by contrast, tend to be highly capable, with established product lines, production systems, brands, networks, and other key resources. Established companies are particularly likely to enter a new industry if they operate in a related industry.

Barriers to entry reduce the threat of new entrants. Such barriers to entry are structural factors that increase the cost and difficulty of entering the market (Geroski, 1999). For example, the New York City Taxi and Limousine Commission require all taxi drivers to carry a permit, known as a taxi medallion, to operate within the city. A limited number of medallions are issued, restricting the number of operators in the market at any given time. New entrants are required to purchase medallions from existing operators to legally enter the market; this is a particularly rigid example of a barrier to entry.

The threat of new entrants depends on factors including those identified in Table 3.1.

Table 3.1 Conditions that Reduce the Threat of New Entry by Increasing Barriers to Entry (Porter, 1980, pp. 3–4)

Factor	Description
Economies of scale	These factors deter entry by forcing new entrants to have a large scale or accept a significant cost disadvantage. Scale economies could appear in production, research, marketing, and service or other similar functions such as distribution, salesforce productivity, and working capital requirements, among others.
Differentiation	Brand identification creates a barrier by forcing new entrants to spend heavily to attract customers who are already loyal to incumbent rivals. Increased spending for advertising, customer service, and developing unique features can increase the cost of delivering a product or service that is competitive with existing firms.
Capital requirements	The need for large financial investment in order to compete can be a significant barrier, especially if the capital is unrecoverable upfront for advertising or research and development costs. Physical facilities may be necessary as well as finished goods inventory, credit for customer financing, and the learning curve for competing in an unfamiliar market.
Cost advantages independent of scale	Entrenched companies may have already accrued cost advantages that cannot be overcome despite the size of potential new entrants. These include proprietary technology, patents, sources of raw materials, favorable locations, and historic government subsidies.
Distribution channels	New entrants must secure distribution for product or service. The more limited the wholesale or retail channels are, and the more existing competitors have these channels tied up, the tougher it will be for new firms to access existing distribution capacity. New entrants often must create their own distribution channels to compete with existing ones.
Government policy	Regulated industries like trucking, liquor retailing, and freight forwarding operate with special government licensing requirements, restrictions for access to raw materials, air and water pollution standards, and safety requirements.
Expectation of retaliation	The ferocity of industry rivalry and competitive retaliation may also create hesitation for new entrants to an industry. Incumbents may have deep pockets in terms of excess cash, unused borrowing power, production capacity, and influence over distribution channels, or may be able to absorb price cuts that make the industry unattractive to newcomers.
Network effects	The phenomenon where a product or service becomes more valuable as more people use it, creating a self-reinforcing cycle that attracts additional users and strengthens the provider’s market position. For example, the more people use Venmo for payments, the more attractive it becomes for merchants to accept it, which in turn encourages even more users to join.

Threat of Substitution

Substitutes are goods or services from outside of the existing industry that replace an existing product by providing similar value to the same customers at a lower price. For example, beverage manufacturers may choose between packaging their goods in glass bottles, aluminum cans, or other types of containers. Glass bottle manufacturers not only compete with each other, but also with aluminum can manufacturers because their customers (beverage manufacturers) have a choice.

The threat of substitution describes how readily an industry’s products could be replaced by alternative goods or services. A higher threat of substitution limits the profit potential of an industry because customers can purchase from providers in a different industry if the alternative provides an attractive mix of price and performance.

Emerging substitutes often present profound threats to industries. The emergence of fax machines in the 1970s, which inexpensively sent documents electronically via telephone lines, significantly reduced demand for overnight document delivery services. However, fax machine sales in the United States peaked in 1998 and declined by more than 90% over the next 10 years as electronic mail became widely available and ubiquitous (Statista, 2009).

However, while often profound, the threat of substitution has limits. Beverage manufacturers must modify production processes, shipping containers, and distribution logistics if they switch packaging materials. They must also get wholesalers, retailers, and consumers to accept the new package. Customers must carefully evaluate the cost and complexity of a change before accepting a substitute input and will only make a change if the cost-benefit ratio appears favorable.

Table 3.2 Factors that Increase the Threat of Substitution

Factor	Description
Availability of substitutes	Quantity and quality of available substitutes drive the threat.
Attractive price-to-performance trade-off	Customers are inclined to switch if a substitute offers an attractive mix of performance and price.
Low switching costs	Switching costs may reduce the threat of substitutes, but the threat is enhanced if switching costs are low.
Absence of regulatory or legal barriers	Regulatory or legal barriers may prevent switching as well, though the absence of major barriers leaves the industry vulnerable.

In summary, the threat of substitution is increased when buyers have multiple options, when those options are attractively priced, when the alternative has comparable or better performance features, when buyers have low switching costs, and when end users grow more comfortable using the alternative.

Supplier Bargaining Power

Suppliers are companies that provide products and services to an industry. Determining the bargaining power of suppliers in a five-forces analysis, you must first identify the upstream industries that supply key inputs for the industry that is the focus of the analysis. For example, an analysis of ice cream producers, such as Ben & Jerry’s in Burlington, Vermont, would begin with identification of key inputs of production. Milk, cream, sugar, and other ingredients to create unique flavors are all essential. The company’s production process also requires storage tanks, blending tanks, pumps, pasteurizers, homogenizers, flavor vats, freezers, pint fillers, bundlers, and other specialized equipment (“How we make,” n.d.).

Ben & Jerry’s count dairy farmer co-ops, sugar distributors, equipment manufacturers, and maintenance service providers among its suppliers. All operating businesses require inputs of goods and services from suppliers to succeed.

From an economic perspective, buyers and sellers enter into transactions when they mutually benefit from the exchange. These business relationships may be amiable. However, buyers and sellers are implicitly in competition because both seek to maximize the value they receive. Buyers prefer lower prices, higher quality, greater service, richer features, ample product availability, favorable payment terms, and other benefits that are costly for sellers to provide. Sellers, in contrast, prefer to charge higher prices while keeping costs low. The parties negotiate, directly one-on-one or implicitly through the collective action of entire industries, to determine the terms of exchange.

The bargaining power of suppliers describes the ability of firms in supplier industries to obtain terms favorable to the seller. High supplier bargaining power reduces the general attractiveness of an industry. The following table lists factors that enhance the bargaining power of suppliers:

Table 3.3 Factors that Increase the Bargaining Power of Suppliers

Factor	Description
High concentration within the supplying industry	When the supplier industry is dominated by a few large companies, buyers have fewer options.
Supplier differentiation and non-substitutability	Suppliers with unique inputs that are difficult to replicate or replace with substitutes have high negotiating leverage.
High reliance of buyers on suppliers’ inputs	When the supplier provides crucial inputs to the industry, the buyers have limited bargaining power.
Low reliance of suppliers on buyer purchases	Buyers become “price takers” if they (or their industry) represent a small fraction of the suppliers’ total market.
Cost of switching suppliers	Buyers become dependent on specific suppliers if the costs of switching suppliers are high.
Threat of forward integration	Forward integration is when a supplier enters the industry of its buyers (i.e., produces the needed product or service themselves). Sellers gain leverage from the ability to threaten forward integration.

Taylor Swift Productions, named after the eponymous singer and managed by her parents, created a film called Taylor Swift: The Eras Tour in 2023, based on the record-breaking concert tour of the same name. The company intended to show the film in theaters and as is traditional, sought a distribution partnership with a major studio to license, market, and deliver the film to theater operators.

However, Swift’s parents were not satisfied with the terms that distributors were offering and directly contacted the CEO of AMC Entertainment Holdings, the largest theater operator in the United States. Together they arranged a deal whereby the production company would work directly with theaters, bypassing the traditional distribution companies altogether (Shaw-Williams, 2023). By bypassing the traditional distribution channels in Hollywood, the production company created a classic forward integration, leveraging its power as a supplier of entertainment and moving from production directly to end consumer distribution via AMC Theaters (Eggertsen, 2023).

Buyer Bargaining Power

In an industry analysis, economic buyers are the parties who purchase products or services from the industry in question. Buyers may be consumers or may be companies that incorporate the industry’s output as their input. For example, Ben & Jerry’s Homemade sells ice cream directly to consumers via franchise-owned “scoop shops” and distributes it via supermarkets, grocery stores, and convenience stores (Figure 3.13).

Companies and industries must negotiate with the buyers downstream just as they do with their suppliers upstream. The bargaining power of buyers describes the ability of buyers to demand lower prices or more value from the exchange with industry sellers.

Table 3.4 Factors that Increase the Bargaining Power of Buyers

Factor	Description
High concentration within the buying industry	When the buying industry is dominated by a few large companies (i.e., “highly concentrated”), they exert more market power in negotiations.
Low switching costs	Depending on specific circumstances, switching suppliers may be costly and disruptive. However, if switching is simple and inexpensive, buyers can demand better terms from competing suppliers.
Price transparency and information access	Buyers who are informed about competing suppliers’ prices, features, terms, and cost structures have enhanced negotiating power.
Threat of backward integration	Backward integration is when a buyer enters the industry of its suppliers (i.e., produces the needed product or service themselves). Buyers gain leverage from the ability to threaten backward integration.

Intensity of Rivalry

The first force to understand is rivalry. Recall that an industry, by definition, consists of firms that offer similar packages of goods and services. Rivalry refers to the competitive behaviors of firms within the industry. When rivals offer similar products, and customers are free to compare and choose from among them, the intensity of rivalry is high and the profit potential for all industry participants is suppressed (Figure 3.14).

For example, the restaurant chain Popeye’s began offering a fried chicken sandwich in 2019, putting the company in direct competition with Chick-fil-A and Wendy’s. The rivalry is exemplified by dueling social media posts from the companies. The “feud” went viral and led to a brief sales boom for Popeye’s. However, noticing the opportunity, more than 20 other fast-food chains created and heavily promoted new competing products featuring breaded chicken on a bun with pickles. The entire event came to be known as “the chicken sandwich wars” (Cobe, 2021).

Rival competitors jockey for position in the marketplace with a variety of moves, including price modulation, promotions, product improvements, and new product launches. These efforts are costly and result in lower profitability when all companies are competing in low-sum or zero-sum markets.

However, structural factors within an industry determine the intensity of rivalry. The intensity of rivalry is increased under the conditions described in Table 3.5.

Table 3.5 Causes of Increased Intensity of Rivalry in an Industry

Factor	Description
Competitors are numerous and equally balanced	Intense rivalries are common in industries with many companies. With multiple competitors, it is common for a few firms to believe that they can act without eliciting a response. However, evidence suggests that other firms generally are aware of competitors’ actions, often choosing to respond to them.
Slow industry growth	When a market is growing, firms try to use resources effectively to serve an expanding customer base. Growing markets reduce the pressure to take customers from competitors. However, rivalry in non-growth or slow-growth markets becomes more intense as firms battle to increase their market shares by attracting their competitors’ customers.
High industry fixed costs	When fixed costs account for a large part of total costs, companies try to maximize the use of their productive capacity. Doing so allows the firm to spread costs across a larger volume of output. However, when many firms attempt to maximize their productive capacity, excess capacity is created on an industry-wide basis. To then reduce inventories, individual companies typically cut the price of their product and offer rebates and other special discounts to customers. These practices, however, often intensify competition.
Industry products lack differentiation	When buyers find a differentiated product that satisfies their needs, they frequently purchase the product faithfully over time. Industries with many companies that have successfully differentiated their products have less rivalry, resulting in lower competition for individual firms (Deephouse, 1999). However, when buyers view products as commodities (as products with few differentiated features or capabilities), rivalry intensifies. In these instances, buyers’ purchasing decisions are based primarily on price and, to a lesser degree, service.
High strategic stakes	Competitive rivalry is likely to be high when it is important for several of the competitors to perform well in the market. High strategic stakes can also exist in terms of geographic locations. For example, Japanese automobile manufacturers are committed to a significant presence in the U.S. marketplace. A key reason for this is that the United States is the world’s single largest market for auto manufacturers’ products. Because of the stakes involved in this country for Japanese and U.S. manufacturers, rivalry among firms in the U.S. and global automobile industry is highly intense (Chung & Kalnins, 2001).
High exit barriers	Sometimes companies continue competing in an industry even though the returns on their invested capital are low or negative. Firms making this choice likely face high exit barriers, which include economic, strategic, and emotional factors, causing companies to remain in an industry when the profitability of doing so is questionable.

When firms compete against each other in multiple markets in different geographical regions, multi-market competition can increase familiarity between competitors and provide opportunities for competitive signaling and retaliation. The theory of multi-market competition suggests that the market overlap can create “mutual forbearance,” which can lessen the intensity of rivalry. Such forbearance can make competitors less likely to compete as when United Airlines decided to avoid certain markets that were dominated by Southwest because profitability was deemed to be marginal.

Competitiveness is ultimately defined by the ability of a firm to create a product or service with durability and sustainability in the market. A competitive industry environment describes the dynamic external structure in which a business operates. The level of competition depends on how many sellers are in the market currently; the higher the number of competing businesses, the more competitive the market will be.

The General Macroenvironment

The last and outermost layer of the external environment is the broadest in scope. The general environment, also called the general macroenvironment, includes major events and trends in society at regional, national, or global scales that affect multiple industries. Firms have limited if any ability to directly affect the general environment.

A framework called PESTEL helps us to learn about and structure our understanding of the general environment (Figure 3.15). “PESTEL” is an acronym (pronounced pestəl) that identifies six aspects of the general environment and provides a checklist for research: Political, Economic, Social, Technological, Ecological, and Legal. Analysts can treat each segment as a prompt for further study toward the development of a complete picture.

Paradoxically, this farthest layer of the external environment is the least likely to impact any one firm. However, when it does, the impact can be enormous—even destroying an industry or specific firms within an industry (Figure 3.16). On December 1, 2023, the U.S. Environmental Protection Agency (EPA) introduced restrictions around the use of PFAS in products used for human consumption. PFAS is a micro-coating that prevents gas from permeating plastic bottles. The EPA found that it can cause harm to humans in large volumes. Most plastic containers that we use contain this substance to prevent the bottle from collapsing. The barrier packaging business of Inhance Technologies was effectively killed by this action (Jones, 2024).

Forces in the general environment have the potential to profoundly impact a company’s long-term success, although most firms have little if any control of their general environment, unless they have significant resources, such as disruptive technology or clout, to effect change at the general environmental scale. Firms must otherwise resign themselves to merely observe and anticipate events and trends in the general environment.

Table 3.6 The Six PESTEL Elements Defined. This table is adapted from Table 3.1 PESTEL Framework  by Reed Kennedy, Strategic Management (2020), which is licensed under CC BY-NC-SA 4.0. Modifications by John Morris and Sanjai Tripathi are licensed under CC BY-NC-SA 4.0.

Element	Description
Political	Political campaigns around immigration policies, changes in trade restrictions and tariffs, subsidies, and the stability of governments
Economic	Interest rates, inflation rates, gross domestic product, unemployment rates, levels of disposable income, and the general growth or decline of the economy
Social	Trends in demographics such as population size, age, and ethnic mix, as well as cultural trends such as attitudes toward obesity and consumer activism
Technological	Changes in the rate of new product development, increases in automation, and advancements in service industry delivery
Ecological	Natural disasters, global warming, pollution, and weather patterns
Legal	Laws involving issues such as employment, health and safety, discrimination, and antitrust—generally enforced in the courts by attorneys

As a note, many students are confused by the difference between political and legal factors in the PESTEL model. While these two elements certainly overlap in many areas, a convenient way to distinguish the two is that political factors happen before a law is passed and legal ones are in effect after the law is passed. Political factors are generally about relationships between people and groups of people. Legal factors are generally codified into specific laws with specific enforcement stipulations.

Toolkit: PESTEL Questions

See Table 3.7 for examples of the questions you might ask for each component when analyzing an industry using the PESTEL model.

Table 3.7 PESTEL Model Questions

Political	Economic
How stable is the political environment?	What are current and forecasted interest rates?
What are local taxation policies, and how do these affect your business?	What is the level of inflation, what is it forecast to be, and how does this affect the growth of your market?
Does the government have trade agreements such as European Union, North American Free Trade Agreement, Association of Southeast Asian Nations, or others?	What are local employment levels per capita and how are they changing?
What are the foreign trade regulations?	What are the long-term prospects for the economy, gross domestic product per capita, and so on?
What are the social welfare policies?	What are exchange rates between critical markets and how will they affect production and distribution of your goods?
Social	Technological
What are local lifestyle trends?	What is the level of research funding in government and industry, and are those levels changing?
What are the current demographics, and how are they changing?	What is the government and industry’s level of interest and focus on technology?
What is the level and distribution of education and income?	How mature is the technology?
What are the dominant local religions and what influence do they have on consumer attitudes and opinions?	What is the status of intellectual property issues in the local environment?
What is the level of consumerism and popular attitudes toward it?	Are potentially disruptive technologies in adjacent industries creeping in at the edges of the focal industry?
What pending legislation is there that affects corporate social policies (e.g., domestic partner benefits, maternity/paternity leave)?	How fast is technology changing? How is its pace impacting the industry?
What are the attitudes toward work and leisure?	What role does technology play in competitive advantage?
Ecological	Legal
What are local environmental issues?	What are the regulations regarding monopolies and private property?
Are there any ecological or environmental issues relevant to your industry that are pending?	Does intellectual property have legal protections?
How do the activities of international pressure groups affect your business (e.g., Greenpeace, Earth First, People for the Ethical Treatment of Animals)?	Are there relevant consumer laws?
Are there environmental protection laws? What are the regulations regarding waste disposal and energy consumption?	What is the status of employment, health and safety, and product safety laws?

Toolkit: Opportunities and Threats

The final tool we’ll review in this chapter is SWOT analysis. “SWOT” stands for strengths, weaknesses, opportunities, and threats. As a best practice, strategic managers in every type of organization (for-profit, nonprofit, and governmental) conduct a broad survey of the external environment, called an environmental scan, to identify key factors in the external environment, and then incorporate the results in a SWOT analysis before making major strategic decisions.

Each of the four factors is typically examined both anecdotally and using quantified information to assess the internal capabilities of a firm (strengths and weaknesses) and the external conditions within which the firm operates (opportunities and threats). It is typically used as a preliminary tool to provide qualitative information that can be used to focus quantitative investigation.

Chapter 4: Internal Resources will address the first half of the model, strengths and weaknesses. This chapter will address the external component of the model, opportunities and threats. Learn how to use the complete model in Chapter 9: Analysis and Reporting.

Opportunities, strictly defined, are factors in the external environment with the potential to impact the organization positively. Such factors may derive from any layer of the external environment. A firm may see opportunities, for example, in the financial struggles of a rival, the growth of an industry market, changing demand trends, or a breakthrough technology that opens new markets. An opportunity may be any external factor that could increase risk-adjusted returns. When Tesla introduced its Cybertruck in November 2019, they were seizing upon an opportunity that would leverage capabilities for electric vehicle manufacturing that would expand their market (Dooley, 2023).

Threats are external factors, from any layer of the external environment, with the potential to negatively impact the organization. Any change that, if it occurs, will reduce the profitability of a firm’s existing business model may be considered a threat. Potential threats include rivals that plan to launch new and competing products, new entrants into the industry, substitutes that disintermediate a firm, and anything else that increases risk to the firm’s existing business model. On March 11, 2011, a tsunami resulting from a major earthquake in Japan damaged the nuclear reactor in Fukushima. While the manufacturer of the facility anticipated such a threat to the facility—they had constructed the plant 33 ft (10 m) above sea level—the tsunami exceeded the design specifications by 10–15 ft. The waves topped a seawall and flooded the turbine and reactor buildings, causing a catastrophic loss of power, killing two plant workers, and displacing as many as 164,000 people. Cleanup continues to this day (“Fukushima,” 2024).

Interestingly, while opportunities and threats are opposite, some external events and trends represent both an opportunity and a threat to a firm. When it started in 1891, the Wrigley company sold soap and baking powder. But the baking powder product was not selling well, so William Wrigley, Jr. began offering a free packet of chewing gum with each box. Only two years after adopting the strategy to sell baking powder, Wrigley abandoned it to focus the company on selling chewing gum (Allonso, 2023). A shift in consumer preferences may open new opportunities while threatening its existing markets. Emerging technology could enable the firm to launch new products while its rivals do the same.

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