Video Transcript: External Analysis Overview

Announcer: This strategy learning content is brought to you by the Marriott  School of Business and the Center for Teaching and Learning at Brigham Young University. The primary purpose of this video is to give you a high level overview of external analysis and help you to first understand the purpose of external  analysis and the types of insights we hope to gain. Second, gain exposure to a  few key tools for external analysis. And third, show you how these key tools  work together to help you generate strategic insight. Every company operates in an external environment. You may or may not have any control or influence over that external environment, but in all cases, the external environment presents  both threats and opportunities for you to consider in your decision making. If you are a fish, and we wanted to know whether or not you can be the biggest fish in  the pond, we might start by examining the pond itself. There may be other fish in the pond, so we want to understand something about the nature of competition  between and among fish in the pond. Do they generally cooperate with each  other, or do they fight viciously with each other for limited resources? We may  want to understand something about the critical supplies. Is there sufficient  oxygen in the water? Is there a sufficient food source to sustain growth? But we  also want to understand future trends that might affect the pond. Is there a local  climate shift that may change the availability of resources in the pond, or is there a drought that may eliminate the pond altogether? These all seem like very  important questions for our fish to explore, but note that none of them are about  the fish itself. These are all questions about the external environment of the fish. The tools of external analysis, likewise, give us insights about the external  environment of the company, not the company itself. For all of our external  analysis tools, we are examining entities and situations that are outside of the  company to complete an external analysis for a particular company, we first  need to identify and clearly define the competitive environment in which the  company competes. If we manufacture automobiles, then we need to identify  the competitive environment we want to analyze. Are we analyzing the global  auto industry, or just the US auto industry, or just the EU auto industry. Are we  analyzing the economy car segment, or the mid size car segment, or the luxury  car segment, or maybe we're analyzing the competitive environment for luxury  cars only in the EU geography. It is important for us to create some conceptual  boundaries around our competitive environment so that we can perform a  consistent and meaningful external analysis, conceptually, we can now draw a  circle that represents our competitive environment, competitor companies, or  companies that do what we do and may compete with us for customers go  inside of the circle. These are companies that do the same jobs for customers  that we do, and that generally do these jobs in similar ways. Every other  company or organization goes outside of the circle. Let's set them aside for now  and come back to them later. We have a few strategy tools to deal with  competition within the circle. We can look specifically at competitive dynamics. 

Do these companies compete aggressively on price for otherwise similar  products, or do they compete through differentiated products? Are these  companies cooperating with each other to keep profits high, or are they  aggressively competing with each other in ways that drive down profits for  everyone? Thus, the first analysis we perform leverages our tools of competitive  interaction and competitive dynamics within a certain competitive environment.  Now, again, note that we are not analyzing a single company. We're looking at  how these various companies inside the circle compete with each other.  Generally. After we have a solid understanding of the nature of competitive  interactions or the extent of rivalry inside the circle, we can bring our attention  back to the entities outside of the circle. This is where the tools of industry  analysis can be particularly useful. Industry Analysis requires us to first analyze  the nature of competition within the competitive environment, and this maps to  the tools of competitor interactions I mentioned a moment ago. But the other  factors we analyze in an industry analysis help us to categorize the other entities that are closely related to our circle and evaluate the extent to which they  threaten profits within our competitive environment. Some of these organizations are potential entrants, meaning that they are not currently competing inside of  the circle, but they could move into the circle and try to compete directly in the  competitive environment, the easier it is for new companies to enter your circle,  the more difficult it will be for existing companies to capture profits within the  circle. Some of these organizations or individuals are buyers, meaning that they  purchase products and services from the companies within our circle. Buyers  want lower prices and better products. So they will try to bargain for both. When  buyers have a lot of power, they can shift profits from the companies inside our  circle to their own pocketbooks. Some of these organizations are suppliers,  meaning that they provide the products and services to the companies within  our circle. Suppliers want higher prices and want to provide low cost products.  So like buyers, they try to shift profits from the companies inside the circle into  their own pocketbooks. Some of these organizations provide substitute products or services, meaning that they satisfy the jobs customers are hiring companies  in your circle to do, but they're doing it in a different way. So for example, a  substitute for purchasing a bottled water is to take a drink from a drinking  fountain. The easier it is for your buyers to find appropriate substitutes, the  harder it will be for existing companies to capture profits within the circle. Some  of these organizations provide complementary products or services, meaning  that they provide products or services that when purchased, increase demand  for the products and services inside your circle. For example, if our circle  represents Android smartphones, then Android apps are compliments. The more attractive and useful the available Android apps, the more attractive Android  phones will be for consumers, the more there are attractive compliments, the  easier it will be for the companies in your circle to capture profits. Thus asking 

careful questions about these various entities helps us understand the extent to  which other organizations immediately outside of our competitive environment  may affect the overall profitability and the nature of competitive interactions  inside of our circle. Consider, for example, how an increase in attractive  substitutes might affect the nature of competition within our competitive  environment. If customers all of a sudden have more attractive substitutes, then  our buyers may be less interested in the products and services within our circle  overall. Thus our entire pool of customers shrinks and the companies within our  circle start fighting more aggressively for their share of a shrinking marketplace.  Typically, this leads to price wars and lower overall profits for the companies  inside the circle. We can do similar analyzes for how changes in the other forces will affect the nature of competition within our circle. Now, before we move on. It  is important to point out that the tools we've described so far are really best used to take snapshots of your external environment. When we engage these  analyzes, we are essentially asking, how easy or hard is it for competitors inside the circle to capture profits in today's external environment? This is important  because, of course, external environments change, and this snapshot might  look very different in a year or in five years. Thus we need some additional tools  to help us think about how these snapshots may shift and change. The PEST  analysis gives us tools to do exactly this. Pest stands for political, economic,  social and technological factors. Let's draw another larger circle that contains all  the organizations in our external environment. This circle is what we capture  inside the lens of a traditional industry analysis. But political, economic, social  and/or technical trends may change what our snapshot looks like over time from a political perspective, imagine what would happen if a regulation change made  it illegal for some of the companies in our competitive environment to sell  products or services, all of a sudden, the other companies inside the circle  would have a much better chance at being profitable because rivalry would  decrease rapidly. From an economic perspective, imagine what would happen if  an economic crash made it so that a large percentage of the buyers could no  longer afford to buy these products and services. The companies would have to  fight aggressively for fewer buyers, and would likely sacrifice profits. The  remaining buyers likely have much more power to bargain for better prices  and/or better products from a social perspective, imagine what would happen if  societal preferences shifted such that most consumers felt that the companies in our competitive environment were doing something morally inappropriate, such  as negatively impacting the natural environment. As social preferences shift, our pool of potential customers likely shrinks given these social preferences again,  this likely leads to higher rivalry and higher buyer power for the remaining  customers. From a technological perspective, imagine what would happen if a  new technology made substitute products more attractive. Again, the new  snapshot would look far less appealing. Of course, not all trends are concerning,

as society has shifted towards a stronger preference for green energy.  Numerous competitive environments that focus on renewable energy have  increased wind energy capacity. For example, more than tripled in the eight  years, from 2008 to 2016 social shifts towards green energy led to improved  performance opportunities for companies in the. Wind Energy competitive  environment. Thus, the key value of the PEST model in our external analysis is  to help us think through the various political, economic, social and technological  trends and try to map them carefully to our industry analysis. How will these  trends change the nature of competition and the ease of capturing profits for the  companies within our competitive environment. At this point, we have a  reasonably complete picture of our external environment, and again, we've  analyzed the environment and not the company. These tools don't really allow  us to say anything about the company itself, just the environment in which it is  embedded, but if we do this analysis, well, then we know everything we need to  know about our external environment today, and we know how our external  environment is likely to change in the near future, given the PEST trends. We  can then couple our external analysis with an internal analysis to generate a  powerful set of strategic insights. In other words, now that we know something  about the pond, we can start to ask questions about the fish.