By
Strategic planning is
a very logical approach to running a business. It is a methodology that
translates a company’s vision into its mission, goals and operational tactics.
The planning process culminates in a financial plan to determine if profit
expectations will be met.
A fundamental step in
the process is a review of external and internal factors impacting the
business. This is called a situational
analysis.
When done properly,
this step helps companies uncover those few but absolutely fundamental things a
company must do correctly in order to be successful in its market segment. (In
strategic planning, these are called the Critical Success Factors, or CSFs.)
Many companies shortcut the situational analysis by using a process
called SWOT (short for defining a
company's Strengths, Weaknesses, Opportunities and Threats).
This is a less time-consuming but also less analytical process, often performed
as part of a management retreat. As
you can see, Strengths and Weaknesses are internally focused, and Opportunities
and Threats are externally focused.
But external factors are continually changing. As competitors react to
changes in the marketplace, your company’s tactics may suddenly be invalid. That’s why analyzing external factors, on an ongoing basis, is
imperative.
External factors
relate to industry and competition.
The industry is the arena where the competitive battle takes place.
Analyzing this arena means looking at the threat of new entrants and at
barriers (usually cost-related) to entering and exiting the market. It also
encompasses economic and governmental factors that could significant impact the
industry
Analyzing the competition means looking at who the competitors are,
their relative positions in the market, and their operating characteristics.
Analyzing competition is not as easy as just identifying companies that make
products similar to yours.
In any market, the type of competition can vary and includes brand
competitors, form competitors, generic competitors and desire competitors. For
example, if you manufacture boats, your brand
competitors would be Bayliner and Boston Whaler; form competitors to your boating product
would be sailing and canoeing; generic
competitors to your recreation product would be tennis and baseball; and desire competitors for your total
spending would be housing, clothing and education.
Michael Porter of the
Porter's original five
forces — which we call the "Five Forces of Business" — can provide a
solid basis for your External Analysis. I’ve used Porter's concept in my
strategic planning work with companies because it so clearly focuses on the
issues that should be examined. The competitive forces determine the
profitability of an industry.
Porter's Five Forces,
with brief examples, are as follows:
1) Barriers to entry and exit — Typical barriers are high
capital costs, government and legal barriers, economies of scale already in the
industry, and fears of retaliation.
2) Bargaining power of the buyer — This is composed of two major areas:
·
The
buyer’s sensitivity to prices impacted by: the importance of the item they are
buying from you in proportion to their total cost; the intensity of competition
in the industry; and the importance of your product to their overall quality.
·
The
buyer’s relative bargaining power impacted by: the size and concentration of
buyers relative to suppliers; how much the buyer knows about suppliers’
products, prices and costs; buyer’s costs associated with switching suppliers;
and the buyer’s ability to vertically integrate.
3) Bargaining power of the suppliers — Exactly the same determinants as
listed in “Bargaining power of the buyer,” but the roles are reversed.
4) Competition from substitutes — If there are few substitutes for
the product, then consumers are insensitive to price. For example, with
products like gasoline or cigarettes, consumers will buy among competitive
brands. But in the short term, they will not substitute different forms
of products, e.g. diesel fuel for gasoline, cigars for cigarettes.
If
substitutes are available, then two major factors will determine whether the
buyer will make substitutions when price becomes an issue:
·
Buyer's
inclinations to make substitutions
among products or services that satisfy a buyer’s need (frozen food instead of
fresh foods). The key issue is to understand the willingness of buyers to shift their purchases
among similar products based purely on changes in relative prices. For example,
motorists continue to prefer their cars even though mass transit systems
provide significant reductions in commuting costs.
·
Performance characteristics of substitutes
relative to price. For example,
if buyers can travel by
train or plane from
5) Industry rivalry and
competition — In most industries, the major factor
determining profitability is competition among firms within the industry. Of the Five Forces, most companies pay the
most attention to this one.
Four major areas help define the level of competition:
·
Level of concentration — If there is a small group of leading
companies in the industry, price competition is generally restrained by pricing
parallelism or “collusion” (Duracel and Eveready in
the battery industry, Coke and Pepsi in the soda industry). The more
competitors, the more difficult it becomes to “coordinate” prices.
·
Diversity of competitors — The more similar
the competitors are in background, origin, common strategies and cost
structures, the more stable the market will be. The more diverse the
competitors are (for example, oil producing companies within OPEC), the more
difficult it will be to maintain pricing in the industry.
·
Product differentiation — The more similar
the products are within an industry the more likely competitors will use price
cuts to expand business … take commodities such as crude oil, telephone and
wheat for example. Highly differentiated
products are generally inelastic to price … take perfume, restaurants, and
management consulting services for example.
·
Excess capacity and costs — Competitors will
be more aggressive in pricing when they have a high ratio of fixed cost to
variable costs. When there is a combination of high fixed costs and unused
capacity, firms tend to offer price cuts to spread their fixed costs over a greater
sales volume. This practice is more prevalent in companies who have a
Production Driving Force — companies such as airlines, paper mills and
hotels. (See article for a more complete
definition of Driving Forces)
None of the Five
Forces is particularly complicated or difficult to understand. Focusing on each
of them individually and collecting the appropriate information will take time,
but it will allow you to more clearly understand the strategies needed to be
successful.
An external analysis
is not just a one-time occurrence; I can’t stress that enough. Gathering
information on the Five Forces should be a never-ending process. It is
important that you know not only what your competitive marketplace looks like
today, but also what it is going to look like tomorrow.