Key Terms

3 Chapter Outline: 3-1 The Organization’s Industry

3-2 The Organization’s Macroenvironment

3-3 Managing Environmental Uncertainty

3-4 Environmental Scanning

3-5 Forecasting the Environment

3-6 Crisis Management

Summary Review Questions Endnotes

Managing the External Environment

boundary-spanning buffering crisis crisis management culture Delphi technique environmental scanning

gross domestic product (GDP) imitation industry life cycle judgmental forecasting macroenvironment multiple scenarios population ecology

self-reference criterion time series analysis uncertainty

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macroenvironment the general environment that affects all business firms in an industry, which includes political-legal, economic, social, and technological forces

industry a group of competitors that produces similar products or services

An organization cannot function effectively unless its managers understand the forces outside of the organization that influence its performance and survival. There are two components of the organization’s external environment: the industry—the collection of competitors that offer similar products or services—and the complex network of political-legal, economic, social, and technological forces known as the organization’s macroenvironment. This chapter addresses each of these components.

3-1 The Organization’s Industry Each business unit operates among a group of companies that produce competing products or services known as an industry. Although there are usually some differences among competitors, each industry has “rules of combat” governing such issues as product quality, pricing, and distribution. This is especially true in industries that contain a large number of firms offering standardized products and services. For example, most service stations in the United States generally offer regular unleaded, mid-grade, and premium unleaded gasoline at prices that do not differ substantially from those at nearby stations. If a rival attempts to sell different grades, it may experience difficulty securing reliable sources of supply and may also confuse consumers by deviating from the standard.

In a perfect world, each organization would operate in one clearly defined industry. In the real world, however, many organizations compete in multiple industries, and it may be difficult to clearly identify the industry boundaries. As such, the concept of primary and secondary industries may be useful in defining an industry. A primary industry may be conceptualized as a group of close competitors, whereas a secondary industry includes less direct competition. The distinction between primary and secondary industry may be based on objective criteria such as price, similarity of products, or location, but is ultimately a subjective call.

3-1a Porter’s Five Forces Model

Industry factors have been found to play a major role in the performance of many companies, with the exception of those that are its notable leaders or failures.1 As such, one needs to understand these factors at the outset before delving into the characteristics of a specific firm. Michael Porter proposed a systematic means of analyzing an industry’s potential profitability known as Porter’s “five forces” model. As aforementioned, this model is based on IO economics and suggests that industry structure is the primary determinant of firm performance. According to Porter, an industry’s overall profitability depends on five basic competitive forces, the relative weights of which vary by industry:

1. The intensity of rivalry among incumbent firms: Competition intensifies when a firm identifies the opportunity to improve its position or senses competitive pressure from other businesses in its industry, which can result

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in price wars, advertising battles, new product introductions or modifications, and even increased customer service or warranties.2

2. The threat of new competitors entering the industry: Unless the market is growing rapidly, new entrants intensify the fight for market share, lowering prices and, ultimately, industry profitability.

3. The threat of substitute products or services: Firms in one industry may be competing with firms in other industries that produce substitute products, offerings produced by firms in another industry that satisfy similar consumer needs but differ in specific characteristics.

4. The bargaining power of buyers: The buyers of an industry’s outputs can lower that industry’s profitability by bargaining for higher quality or more services and playing one firm against another.

5. The bargaining power of suppliers: Suppliers can extract the profitability out of an industry whose competitors may be unable to recover cost increases by raising prices.

Each of the five forces suggests that potential profits within an industry may be high, moderate, or low. Analyzing the five forces for an organization’s industry can help managers understand the potential for superior performance within that industry. It does not guarantee high or low performance, as there are usually substantial performance differences among organizations in the same industry. Porter’s five forces model, however, provides a useful framework for thinking about the effects an industry has on an organization.

There are other valid perspectives on organizations and industries besides Porter’s view. As Porter suggests, organizations functioning in a given industry generally possess a number of similarities that are not typically shared by those in other industries. Fast-food restaurants, for example, tend to be labor-intensive and cost-conscious, with established systems to provide fast, efficient service to customers. However, new organizations may “buck the trend” from to time by taking different approached designed to respond to changes in the environment more

Figure 3.1 Porter’s Five Forces Model

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population ecology a perspective on organizations that emphasizes the diversity among organizations that perform similar functions and utilize common resources

industry life cycle the stages (introduction, growth, shakeout, maturity, and decline) through which industries are believed to pass

effectively. Whereas Porter’s five forces model emphasizes similarities among organizations within an industry, the population ecology perspective emphasizes organizational diversity and adaptation.3 According to this view, organizations can be better understood by examining when and how they are formed, why new organizations might vary from existing ones, and ultimately why some survive when others fail. Some insight into this view can be obtained by considering the life cycle through which an industry passes.

3-1b Industry Life Cycle

Like organizations, industries develop and evolve over time. Not only might the group of competitors within an organization’s industry change constantly, but the nature and structure of the industry can also change as it matures and its markets become better defined. An industry’s developmental stage influences the nature of competition and potential profitability among competitors.4 In theory, each industry passes through five distinct phases of an industry life cycle.

A young industry that is beginning to form is considered to be in the introduction stage. Demand for the industry’s outputs is low because product and/or service awareness is still developing. Most purchasers are first-time buyers, and tend to be affluent, risk tolerant, and innovative. Technology is a key concern in this stage because businesses often seek ways to improve production and distribution efficiencies as they learn more about their markets. Organizations emerging in this stage often attempt to capitalize on first-mover advantages, similar to the prospector strategy discussed in a previous chapter.

Normally, after key technological issues are addressed and customer demand begins to rise, the industry enters the growth stage. Growth continues during this stage but tends to slow as the market demand approaches saturation. Fewer first-time buyers remain, and most purchases tend to be “upgrades” or replacements. Some of the industry’s weaker competitors may not survive. Those that do establish distinctive competencies that can help distinguish them from their competitors.

Shakeout occurs when industry growth is no longer rapid enough to support the increasing number of competitors in the industry. As a result, an organization’s growth is contingent on its resources and competitive positioning instead of a high growth rate within the industry. Marginal competitors are forced out, and a small number of industry leaders may emerge.

Maturity is reached when the market demand for the industry’s outputs is completely saturated. Virtually all purchases are upgrades or replacements, and industry growth may be low, nonexistent, or even negative. Industry standards for

Figure 3-2

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quality and service have been established, and customer expectations tend to be more consistent than in previous stages. The U.S. automobile industry is a classic example of a mature industry. Firms in mature industries often seek new uses for their products or services or pursue new markets, often through global expansion. Because the field has become crowded and customers have become more sophisticated, many successful organizations begin to emphasize efficiencies in order to offer greater value.

The decline stage occurs when demand for an industry’s products and services decreases and often begins when consumers begin to turn to more convenient, safer, or higher quality offerings from organizations in substitute industries. Some firms may divest their business units in this stage, whereas others may seek to “reinvent themselves” and pursue a new wave of growth associated with a similar product or service.

The life cycle model is a useful tool for evaluating an industry’s development and the types of organizations that may be most likely to succeed. The key problem with the model, however, is that identifying an industry’s precise position is often difficult, and not all industries follow these exact stages or at predictable intervals.5 For example, the U.S. railroad industry did not reach maturity for many decades and extended over a hundred years before entering decline, whereas the personal computer industry began to show signs of maturity after only seven years.

3-2 The Organization’s Macroenvironment The second component within an organization’s external environment is the macroenvironment and consists of political-legal, economic, social, and technological forces. Ultimately, the effects of these forces create opportunities and threats for an organization. In general, forces in the macroenvironment affect all competitors within a given industry, although the nature of the effects can differ among firms. For example, a sharp economic decline may threaten the livelihood of a luxury automobile manufacturer, while at the same time creating an opportunity for a carmaker with substantially lower costs.

Most organizations have little, if any influence over the macroenvironment. On occasion, a large, dominant firm such as Wal-Mart may be able to exert some degree of influence over one or more aspects of the macroenvironment. For example, the giant retailer’s political action committee contributed about $1 million to candidates and parties in the United States in both 2003 and 2004, presumably in an effort to influence regulation that might affect the organization.6 However, most organizations must seek to join with others in

trade and other associations in an attempt to exert some degree of influence on a particular factor in the macroenvironment.

Some factors may be placed neatly into one of these interrelated categories, whereas others may straddle two or more classes. For example, automobile safety has political-legal (e.g., legislation requiring that safety standards be met), social (e.g., consumer demands for safe vehicles), and technological (e.g., innovations that may improve safety) dimensions. For clarity concerns, however, each category of macroenvironmental forces is discussed separately.

Figure 3-3

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gross domestic product the value of a nation’s annual total production of goods and services

3-2a Political-Legal Forces

Political-legal forces include such factors as the outcomes of elections, legislation, and judicial court decisions, as well as the decisions rendered by various commissions and agencies at every level of government. Military conflicts are also included in this arena and can also influence how a number of industries operate, especially those with tight global ties. In 2003, for example, during the beginning of the war in Iraq, many American firms modified their promotional strategies, fearing that their television advertisements might be considered insensitive if aired alongside breaking coverage of the war. At the same time, others began to plan for meeting the anticipated future needs in Iraq for such products as cell phones, refrigerators, and automobiles. In late 2003, American firms began to compete vigorously for lucrative reconstruction contracts, while others prepared for increased business activity there in the coming years.7

Industries are often affected by legislation and other political events specific to their line of business. For example, the Highway Traffic Safety Administration in the United States constantly tests cars and trucks sold in the U.S. and works with carmakers to improve safety performance.8 Following the sharp declines in air travel in the United States in 2001, airlines on the verge of bankruptcy campaigned for and received $15 billion in government support in 2002 and an additional $2.9 billion in 2003.9 All societies have laws and regulations that restrict or control business operations. Relatively speaking, free market oriented nations such as the United States have fewer restrictions, but the level of regulation can be extensive in some areas. Many socialist nations have rigid guidelines for hiring and firing employees or establishing operations, and some require that a portion of what is produced in that country be exported to earn foreign exchange. These regulations are specific to each nation and create opportunities or pose threats to firms interested in operating across national boundaries.

3-2b Economic Forces

Every organization is affected by changes in the local, national, and/or global economies. The first economic consideration is that of the gross domestic product (GDP), the value of a nation’s annual total production of goods and services. GDP growth among nations is often interrelated, but all nations do not experience the same rate of growth. For example, while GDP levels in the West were stagnant during the late 1990s and early 2000s, China’s GDP grew at a staggering pace.10

Consistent GDP growth generally produces a healthy economy fueled by increases in consumer spending, whereas a decline signals lower consumer spending and decreased demand for goods and services. When GDP declines for two consecutive quarters, a nation’s economy is generally considered to be in a recession. A recession is not detrimental for all organizations. For example, college and university enrollments often increase as undergraduate and graduate students

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seek to gain an advantage in a tight job market.11 Unfortunately, it is difficult to forecast a recession in advance, and many recessions are identified only after they have occurred.

High inflation negatively affects most, but not all businesses. High rates raise many of the costs of doing business, and continued inflation can constrict the expansion plans of businesses and trigger governmental action, such as is the case when the U.S. Federal Reserve Board raises its discount rate during inflationary periods to slow economic growth. However, oil companies may benefit during inflationary times if the prices of oil and gas rise faster than the costs of exploration, refinement, and transportation. Sharp increases in the price of heating oil sparked a resurgence in the market for coal stoves in the winter of 2000–2001.12

Interest rates affect the demand for many products and services, especially “high ticket” items whose costs are financed over an extended period of time, such as homes, automobiles, and appliances. At the consumer level, low short-term interest rates benefit retailers such as Wal-Mart and J.C. Penney because they also tend to lower rates on credit cards, thereby encouraging consumer spending. At the organizational level, high interest rates can hinder expansion efforts.

Organizations that transact a significant amount of business with entities outside of its borders are especially vulnerable to changes in rates of exchange between the home and other currencies. When the value of the dollar increases relative to other currencies, for example, American organizations are at a competitive disadvantage internationally, as the prices of American-made goods rise in foreign markets. In addition, American manufacturers tend to locate more of their plants abroad and make purchases from foreign sources. During this time, American consumers are more likely to purchase products produced abroad, which are less expensive than goods produced at home.

3-2c Social Forces

Social forces include such factors as societal values, trends, traditions, and religious practices and can substantially influence organizational performance. Social forces can vary widely among nations, especially as they are related to other factors. For example, smaller cars have been the vehicle of choice in European countries since the 1990s. In Europe, roads are more narrow, gasoline is more heavily taxed, and fuel economy is a greater concern. In the United States, roads are wider, gasoline is less expensive, and fuel consumption does not play as strong a role in the purchase decision. As a result, American consumers tend to demand relatively larger vehicles.13 Fashion in China also offers another example, where styles reflect a mix of Asian, American, and European tastes.14

Recessions can be devastating for firms in many industries, but they are difficult to predict.

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Social forces often reflect societal practices that have lasted for decades or even centuries. For example, the celebration of Christmas in the Western Hemisphere provides significant financial opportunities for card companies, toy retailers, confectioners, tree growers, and gift shops. Some retailers are happy just to break even during the year and generate their profits during the Christmas shopping season.

Societal trends also include demographic changes that can affect how organizations must function in order to succeed. Consider the United States as an example. The baby boom, which lasted from 1945 through the mid- 1960s, initially created opportunities for baby apparel and diaper manufacturers, private schools, and even candy and snack makers. Later, as this crop of baby boomers departed high school, universities grew at an astounding rate and organizations had large applicant pools from which to select their employees. More recently, these baby boomers have begun shopping at home more and are spending heavily on health-care needs, leisure activities, and vacations.15

Today, the average American is older, busier, better educated, more technologically astute, and less likely to be a member of the Caucasian race than in previous years. This trend has affected consumer demand in areas such as personal computers and educational services, and has prompted many organizations emphasizing the broad middle-age market to modify their strategic approaches to include either younger or older adults. For example, cosmetics maker Avon, confronted with a shrinking clientele, began to expand its appeal to the trendier 16- to 24-year-old market in 2002.16 J.C. Penney, and Sears even opened stand-alone locations to provide easier access to customers too busy to plan a day at the mall.17

In many respects, social forces—more than other forces in the macroenvironment—have the greatest effect on organizations that produce goods for or provide services directly to consumers. Consider the American automobile industry as an example. Sport utility vehicles (SUVs) were born in the 1990s and by the end of the decade had become the vehicle of choice for many suburban families. Auto manufacturers realized,

however, that SUV patrons were willing to give up some of the rugged features associated with the SUV in exchange for the additional space and softer ride associated with the previously most popular class of vehicles known as the minivan. Ford responded by introducing a redesigned Explorer with three rows of seats, additional safety gadgets, and a softer ride.18 By 2003, Ford, General Motors, and Nissan had begun to shift attention away from large SUVs to the vehicles they often termed “crossovers” or “active lifestyle wagons.”19

Interestingly, however, the popularity of the SUV in the United States has been attacked on the grounds of another social force, environmental responsibility. Environmentalists charge that SUVs are simply too large and fuel-inefficient, increasing the nation’s dependence on external sources of oil, a reliance that may compromise the nation’s ability to broker a lasting peace in the oil-rich Middle East. As a result, SUV manufacturers began to develop and produce more fuel-efficient hybrid (i.e., gasoline and electric) versions in the mid-2000s.

One of the difficulties associated with social trends, however, is that they are often difficult to identify. In some cases, two trends may even appear to be at odds with each other. For example, American consumers have been sending a mixed message of “the celery stick and the double chocolate peanut swirl” for the past decade, confusing restaurants and packaged food producers alike. Fast food restaurants responded by “supersizing” their meal combinations with extra fries and larger drinks, while at the same time expanding alternatives for

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items such as grilled chicken sandwiches and salads.20 In 2004, Coca-Cola and PepsiCo began to emphasize smaller cans and bottles,21 while McDonald’s introduced low-carb menu items.22

During this same time, fast-food consumers began eating less at Burger King, Pizza Hut, and Taco Bell, in favor of such outlets as Subway and Panera Bread, restaurants many consumers perceived to be more healthy. Although the traditional competitors responded with more salads and low-calorie, low-fat alternatives, their “heavy and fried” images have been difficult to overcome.23 As these U.S. fast-food icons continue to expand abroad, restaurant chains from other parts of the world, most notably Latin America, are expanding into the United States.24

The health and fitness trend that emerged in the 1990s facilitated the growth in a number of fitness equipment manufacturers and sports drink producers, while hurting organizations in less health-friendly industries such as tobacco and liquor. In 2002, Anheuser Busch launched Michelob Ultra, a low-carbohydrate beer, in an attempt to tap the health-conscious market,25 while PepsiCo announced it would attempt to increase its sales of healthy snacks, including baked and low-fat offerings, to 50 percent of its total snack food sales.26

In the early 2000s, concern about obesity in developed nations such as the United States and the United Kingdom became more prominent. Critics charge that sedentary lifestyles and unhealthy foods—such as those produced by many fast-food restaurants—have led to increases in diabetes, heart disease, and other medical problems associated with obesity. Some claim that food processors and fast-food restaurants such as McDonald’s have contributed to this phenomenon by encouraging individuals to consume larger quantities of unhealthy foods.27 Many consumers began to pursue low-carbohydrate diets to lose weight and improve overall health. As a result, many food producers and restaurants began catering to consumer interest in “low-carb” regiments as dieter concern shifted from fat content in foods to carbohydrate content. Unilever, for example, began promoting “low-carb” Skippy peanut butter, Wishbone dressing, and Ragu spaghetti sauce.28

Another prominent social trend in the early 2000s is related to technological advances associated with the Internet. During this time, many traditional retailers began to experience sales declines as more consumers shopped online. As a result, retailers began searching for new ways to attract prospective buyers to their stores, discovering that many consumers were less likely to frequent a traditional retailer unless it also provided some form of entertainment value. Bass Pro Shops, for example, increased its store traffic substantially by including such amenities as a large fish tank, live bats, and even a rock-climbing wall. Mall developers began to include “activity zones” in their facilities for such attractions as skating and fitness centers. This trend of mixing retailing with entertainment is expected to continue in the coming years.29

The tragic events of September 11, 2001 (“9-11”) also resulted in social changes that affect many organizations. Concerns over air travel safety have greatly influenced everything from flight routes to airline marketing strategies. After 9-11, Americans as a whole became more willing to accept inconveniences associated with their transactions if these inconveniences are associated with safety and security. Studies also suggest that investment and personal life strategies have become more conservative and reflective as a result of the tragedy.30 Even

Fast food restaurants have found it difficult to shed their “heavy and fried” images as the health and fitness trend enters its second decade.

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churches are taking notice, as the 25 percent increase in national attendance immediately following the events of September 11 had all but disappeared by the following year.31

General environmental concerns have also affected a number of organizations. These include the emphasis on socially responsible manufacturing and waste management practices, as well as concerns for saving private wetlands from business development.32 Interest in both consumer recycling and the production of recyclable products heightened in the 1990s and has continued to remain a key concern in the 2000s. Many analysts question consumer willingness to pay the higher prices typically associated with environmentally friendly products.33

3-2d Technological Forces

Technological forces include scientific improvements and innovations that affect organizations. The rate of technological change can vary considerably among organizations and can affect operations in various ways. Many organizations have capitalized on advances in technology such as computers, satellites, and fiber optics to lower costs and serve their customers more effectively.

Technological change can also decimate existing organizations and even entire industries. Historical examples of such change include the shifts from vacuum tubes to transistors, from steam locomotives to diesel and electric engines, from fountain pens to ballpoints, and from typewriters to computers.34

On the consumer side, estimates of global Internet access in 2003 range from 600 to 800 million individuals, the vast majority of whom reside in the United States, Canada, Europe, or Asia. Most Americans now shop online, while frequent online shoppers tend to be male, married, and college educated, between 18 and 40 years of age.35 Online retail spending for 2003 is estimated at $52 billion, with an average annual growth rate through 2007 estimated at 21 percent.36 Indeed, the widespread use of the Internet over the past decade is arguably the most pervasive technological force affecting business organizations since the dissemination of the personal computer.

The effects of the Internet are most profound in some industries, such as brokerage houses, where online companies have demonstrated huge gains in the market, or the travel industry, where the number of flights, hotels, and travel packages booked over the past decade has skyrocketed. The Internet has also spawned the advent of online banking, a much less costly means of managing …

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