Frameworks to Analyze the Competitive Environment of Business Ventures
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Introduction:

Various frameworks exist to analyze the competitive environment of business ventures or projects and are useful in assessing their stated objectives and identifying the internal and external factors that are favorable and unfavorable to achieve those objectives.

  • SWOT analysis
  • Competitive force analysis
  • Resource-based view (RBV) analysis
  • STEEPLED macro-environmental factors analysis

These are important tools for assessing compatibility and attainability of the stated objective with the competitive reality. With the implementation of the right competitive strategies, a company can sustain its positive growth and high rates of return-- the two most important value drivers. A company can either position itself to deflect the effect of the competitive forces in the industry (defensive strategy)-- through investing in technology that will lower production costs or through increased advertising and creating a strong brand; or it will use its strengths to affect the competitive forces in the industry (offensive strategy). Both, the defensive and offensive competitive strategies can incorporate low cost and differentiation strategy.

SWOT analysis:

SWOT analysis is a strategic planning method used to evaluate the Strengths, Weaknesses/Limitations, Opportunities, and Threats involved in a project or in a business venture. It involves specifying the objective of the business venture or project and identifying the internal and external factors that are favorable and unfavorable to achieve that objective.

  • Strengths: characteristics of the business, or project team that give it an advantage over others
  • Weaknesses (or Limitations): are characteristics that place the team at a disadvantage relative to others
  • Opportunities: external chances to improve performance (e.g. make greater profits) in the environment
  • Threats: external elements in the environment that could cause trouble for the business or project

One way of utilizing SWOT is matching and converting. Matching is used to find competitive advantages by matching the strengths to opportunities. Converting is to apply conversion strategies to convert weaknesses or threats into strengths or opportunities. An example of conversion strategy is to find new markets. If the threats or weaknesses cannot be converted a company should try to minimize or avoid them.

http://en.wikipedia.org/wiki/SWOT_analysis

 

Competitive force analysis:

Competitive forces analysis is a market opportunities model generally considered more robust than a standard SWOT analysis. Originally numbering five, a couple more have been added as the behavior in the marketplace has changed since original theory. It evaluates:

  • Threat of new competition
  • Threat of substitute products or services
  • Bargaining power of customers (buyers)
  • Bargaining power of suppliers
  • Intensity of competitive rivalry
  • Success of strategic alliances
  • Aggressiveness of government entities/pressure groups

 

Threat of new competition

Profitable markets that yield high returns will attract new firms. This results in many new entrants, which eventually will decrease profitability for all firms in the industry. Unless the entry of new firms can be blocked by incumbents, the abnormal profit rate will tend towards zero (perfect competition).

  • The existence of barriers to entry (patentsrights, etc.) The most attractive segment is one in which entry barriers are high and exit barriers are low. Few new firms can enter and non-performing firms can exit easily.
  • Economies of product differences
  • Brand equity
  • Switching costs or sunk costs
  • Capital requirements
  • Access to distribution
  • Customer loyalty to established brands
  • Absolute cost
  • Industry profitability; the more profitable the industry the more attractive it will be to new competitors.

 

Threat of substitute products or services

The existence of products outside of the realm of the common product boundaries increases the propensity of customers to switch to alternatives. Note that this should not be confused with competitors' similar products but entirely different ones instead. For example, tap water might be considered a substitute for Coke, whereas Pepsi is a competitor's similar product. Increased marketing for drinking tap water might "shrink the pie" for both Coke and Pepsi, whereas increased Pepsi advertising would likely "grow the pie" (increase consumption of all soft drinks), albeit while giving Pepsi a larger slice at Coke's expense.

  • Buyer propensity to substitute
  • Relative price performance of substitute
  • Buyer switching costs
  • Perceived level of product differentiation
  • Number of substitute products available in the market
  • Ease of substitution. Information-based products are more prone to substitution, as online product can easily replace material product.
  • Substandard product
  • Quality depreciation
  • analyze the market

 

Bargaining power of customers (buyers)

The bargaining power of customers is also described as the market of outputs: the ability of customers to put the firm under pressure, which also affects the customer's sensitivity to price changes.

  • Buyer concentration to firm concentration ratio
  • Degree of dependency upon existing channels of distribution
  • Bargaining leverage, particularly in industries with high fixed costs
  • Buyer switching costs relative to firm switching costs
  • Buyer information availability
  • Availability of existing substitute products
  • Buyer price sensitivity
  • Differential advantage (uniqueness) of industry products
  • RFM Analysis (Recency, Frequency, Monetary value)

 

Bargaining power of suppliers

The bargaining power of suppliers is also described as the market of inputs. Suppliers of raw materials, components, labor, and services (such as expertise) to the firm can be a source of power over the firm, when there are few substitutes. Suppliers may refuse to work with the firm, or, e.g., charge excessively high prices for unique resources.

  • Supplier switching costs relative to firm switching costs
  • Degree of differentiation of inputs
  • Impact of inputs on cost or differentiation
  • Presence of substitute inputs
  • Strength of distribution channel
  • Supplier concentration to firm concentration ratio
  • Employee solidarity (e.g. labor unions)
  • Supplier competition - ability to forward vertically integrate and cut out the BUYER

Ex.: If you are making biscuits and there is only one person who sells flour, you have no alternative but to buy it from him.

 

Intensity of competitive rivalry

For most industries, the intensity of competitive rivalry is the major determinant of the competitiveness of the industry.

 

Success of strategic alliances

An extension to Porter: Using game theory, the concept of complementors was added, helping to explain the reasoning behind strategic alliances. Complementors are businesses that directly sell a product (or products) or service (or services) that complement the product or service of another company by adding value to mutual customers; for example, Intel and Microsoft (Pentium processors and Windows), or Microsoft and McAfee (Microsoft Windows & McAfee anti-virus).

 

Aggressiveness of government entities/pressure groups

An extension to Porter: Government (national and regional) as well as Pressure Groups as notional external forces. These can be positive or negative, and usually come in the form of regulation, legislation, subsidies, grants, lawsuits, warnings, and simple rhetoric or protests.

http://hbr.org/2008/01/the-five-competitive-forces-that-shape-strategy/ar/1
http://en.wikipedia.org/wiki/Porter_five_forces_analysis
http://en.wikipedia.org/wiki/Six_Forces_Model

 

 

Resource-based view (RBV) analysis:

The resource-based view (RBV) as a basis for a competitive advantage of a firm lies primarily in the application of the bundle of valuable resources at the firm's disposal. To transform a short-run competitive advantage into a sustained competitive advantage requires that these resources are heterogeneous in nature and not perfectly mobile. Effectively, this translates into valuable resources that are neither perfectly imitable nor substitutable without great effort. If these conditions hold, the firm’s bundle of resources can assist the firm sustaining above average returns. The VRIO and VRIN model also constitutes a part of RBV.

The key points of the theory are:

  1. Identify the firm’s potential key resources.
  2. Evaluate whether these resources fulfill the following criteria (referred to as VRIN):
    1. Valuable – A resource must enable a firm to employ a value-creating strategy, by either outperforming its competitors or reduce its own weaknesses. Relevant in this perspective is that the transaction costs associated with the investment in the resource cannot be higher than the discounted future rents that flow out of the value-creating strategy.
    2. Rare – To be of value, a resource must be rare by definition. In a perfectly competitive strategic factor market for a resource, the price of the resource will be a reflection of the expected discounted future above-average returns.
    3. In-imitable – If a valuable resource is controlled by only one firm it could be a source of a competitive advantage. This advantage could be sustainable if competitors are not able to duplicate this strategic asset perfectly. The term isolating mechanism was introduced by Rumelt (1984, p567) to explain why firms might not be able to imitate a resource to the degree that they are able to compete with the firm having the valuable resource. An important underlying factor of inimitability is causal ambiguity, which occurs if the source from which a firm’s competitive advantage stems is unknown. If the resource in question is knowledge-based or socially complex, causal ambiguity is more likely to occur as these types of resources are more likely to be idiosyncratic to the firm in which it resides. Conner and Prahalad go so far as to say knowledge-based resources are “…the essence of the resource-based perspective”.
    4. Non-substitutable – Even if a resource is rare, potentially value-creating and imperfectly imitable, an equally important aspect is lack of substitutability. If competitors are able to counter the firm’s value-creating strategy with a substitute, prices are driven down to the point that the price equals the discounted future rents, resulting in zero economic profits.
  3. Care for and protect resources that possess these evaluations, because doing so can improve organizational performance.

The VRIO framework:

  • The Question of Value: "Is the firm able to exploit an opportunity or neutralize an external threat with the resource/capability?"
  • The Question of Rarity: "Is control of the resource/capability in the hands of a relative few?"
  • The Question of Imitability: "Is it difficult to imitate, and will there be significant cost disadvantage to a firm trying to obtain, develop, or duplicate the resource/capability?"
  • The Question of Organization: "Is the firm organized, ready, and able to exploit the resource/capability?"

Quick Note:

Competitive advantage occurs when an organization acquires or develops an attribute or combination of attributes that allows it to outperform its competitors. These attributes can include access to natural resources, such as high grade ores or inexpensive power, access to highly trained and skilled personnel human resources, or new technologies such as robotics and information technology either to be included as a part of the product, or to assist in making it.

http://en.wikipedia.org/wiki/Resource-based_view
http://en.wikipedia.org/wiki/VRIO

 

STEEPLED Macro-Environmental Factors:

STEEPLED analysis, (a derivative of PEST), describes a framework of macro-environmental factors used in the environmental scanning component of strategic management. It is a part of the external analysis when conducting a strategic analysis or doing market research, and gives an overview of the different macro-environmental factors that the company has to take into consideration. It is a useful strategic tool for understanding market growth or decline, business position, potential and direction for operations.

 

Composition:

  • Social factors include the cultural aspects and include health consciousness, population growth rate, age distribution, career attitudes and emphasis on safety. Trends in social factors affect the demand for a company's products and how that company operates. For example, an aging population may imply a smaller and less-willing workforce (thus increasing the cost of labor). Furthermore, companies may change various management strategies to adapt to these social trends (such as recruiting older workers).
  • Technological factors include technological aspects such as R&D activity, automation, technology incentives and the rate of technological change. They can determine barriers to entry, minimum efficient production level and influence outsourcing decisions. Furthermore, technological shifts can affect costs, quality, and lead to innovation.
  • Economic factors include economic growth, interest rates, exchange rates and the inflation rate. These factors have major impacts on how businesses operate and make decisions. For example, interest rates affect a firm's cost of capital and therefore to what extent a business grows and expands. Exchange rates affect the costs of exporting goods and the supply and price of imported goods in an economy
  • Environmental factors include ecological and environmental aspects such as weather, climate, and climate change, which may especially affect industries such as tourism, farming, and insurance. Furthermore, growing awareness of the potential impacts of climate change is affecting how companies operate and the products they offer, both creating new markets and diminishing or destroying existing ones.
  • Political factors are how and to what degree a government intervenes in the economy. Specifically, political factors include areas such as tax policy, labour law, environmental law, trade restrictions, tariffs, and political stability. Political factors may also include goods and services which the government wants to provide or be provided (merit goods) and those that the government does not want to be provided (demerit goods or merit bads). Furthermore, governments have great influence on the health, education, and infrastructure of a nation
  • Legal factors include discrimination law, consumer law, antitrust law, employment law, and health and safety law. These factors can affect how a company operates, its costs, and the demand for its products.
  • Ethical factors
  • Demographic factors

http://en.wikipedia.org/wiki/PEST_analysis

 

In Conclusion:

These frameworks are useful when making a qualitative evaluation of the firm’s strategic position and competitive environment-- especially when used in conjunction with one another. When evaluating a company for the first time, it is often helpful to at least breeze through these items as a starting point or as a checklist, if for nothing else, to fully understand what you do and don’t know about your company and its industry, and to identify those areas that could be considered critical opportunities or deal breakers.

 

A word of caution:

A good investment thesis identifies both opportunities and threats. Some of those threats identified shall bear to pass and invalidate the investment thesis. We enter these investments with eyes wide open-- it is the nature of the risk-taking business. It is unacceptable, however, for any threat that could have been identified through this process (but wasn’t) to negatively impact your investment thesis. Any loss, due to the lack of analytical rigor, is a severe failure and unforgivable.

 

Steps to take in a strategic evaluation:

In my opinion, the steps for a solid qualitative strategic evaluation are as follows:

  1. The analyst should always perform some sort of cursory SWOT analysis when evaluating an opportunity, even if it’s just mentally.
  2. If the idea has merit and warrants further attention, then the analyst should assess the key resources using the Resource-Based View (RBV) analysis in conjunction with a stripped-down Competitive Force Analysis to gauge both the competitive advantage and market opportunity.
  3. If the idea still has merit and warrants further attention, the Competitive Force Analysis should be fully evaluated to determine the competitive intensity and profitability of the market, and the STEEPLED analysis sketched out to assess macroenvironmental factors.
  4. If the idea still has merit and warrants further attention, determine the relative importance of the STEEPLED analysis factors based on opportunity’s industry and the goods it produces, and to the extent that the factors haven’t been covered elsewhere, complete the analysis.

Caveat:

Like all general frameworks, use this analysis such that it fits the specifics about the particular situation you are evaluating. You may not find all aspects relevant.

 

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