SWOT

DO N OT C OP Y OR P OS T SWOT Analysis I: Looking Outside for Threats and Opportunities Excerpted from Strategy: Create and Implement the Best Strategy for Your Business Harvard Business School Press Boston, Massachusetts ISBN-10: 1-4221-0552-0 ISBN-13: 978-1-4221-0552-8 5528BC copying or posting is an infringement of copyright. permissions@hbsp.harvard.edu or 617.783.7860 DO N OT C OP Y OR P OS T Copyright 2006 Harvard Business School Publishing Corporation All rights reserved Printed in the United States of America This chapter was originally published as chapter 1 of Strategy, copyright 2005 Harvard Business School Publishing Corporation. No part of this publication may be reproduced, stored in or introduced into a retrieval system, or transmitted, in any form, or by any means (electronic, mechanical, photocopying, recording, or otherwise), without the prior permission of the publisher. Requests for permission should be directed to permissions@hbsp.harvard.edu, or mailed to Permissions, Harvard Business School Publishing, 60 Harvard Way, Boston, Massachusetts 02163. You can purchase Harvard Business School Press books at booksellers worldwide. You can order Harvard Business School Press books and book chapters online at www.HBSPress.org, or by calling 888-500-1016 or, outside the U.S. and Canada, 617-783-7410. copying or posting is an infringement of copyright. permissions@hbsp.harvard.edu or 617.783.7860 DO N OT C OP Y OR P OS T SWOT Analysis I Key Topics Covered in This Chapter • Identifying threats and opportunities in the external environment • The world of workstyle and lifestyle trends that can affect your business • Assessing customers • Changes in the competitive arena • Porter’s five forces framework Looking Outside for Threats and Opportunities 1 copying or posting is an infringement of copyright. permissions@hbsp.harvard.edu or 617.783.7860 DO N OT C OP Y OR P OS T St rate g y b e g i n s w i th goals, which naturally fol-low from an entity’s mission. But for practical purposesgoals cannot stand in isolation. They are informed by an iterative sensing of the external environment and the organization’s internal capabilities. As much as some may think that everything de- volves from goals, the fact is that practical people form goals based on what is feasible, given the environment in which they must oper- ate their own resources and capabilities. For example, 3M Corpora- tion has committed itself to annual numerical goals: 10 percent earning growth or better, 27 percent return on employed capital, and so forth. Those specific goals didn’t come out of a hat; they are a product of the insights of 3M executives and directors who under- stand the markets they serve and the capabilities of the company. They looked outside and inside to determine those goals. As shown in figure 1-1, the strategic choices available to the en- terprise likewise emerge from the process of looking outside and in- side. Among strategic planners, this analysis goes by the acronym SWOT: Strengths, Weaknesses, Opportunities, and Threats. • Strengths are capabilities that enable your company or unit to perform well—capabilities that need to be leveraged. • Weaknesses are characteristics that prohibit your company or unit from performing well and need to be addressed. • Opportunities are trends, forces, events, and ideas that your company or unit can capitalize on. copying or posting is an infringement of copyright. permissions@hbsp.harvard.edu or 617.783.7860 DO N OT C OP Y OR P OS T • Threats are possible events or forces outside of your control that your company or unit needs to plan for or decide how to mitigate. Considering both external and internal factors is essential be- cause they clarify the world in which the business or the unit oper- ates, enabling it to better envision its desired future. This chapter explains the first of these challenges: external analysis. We’ll take up internal analysis later. External Analysis “The essence of formulating competitive strategy,” writes scholar Michael Porter, “is relating a company to its environment.”1 Every company’s environment is populated with customers, competitors, suppliers, and, in most cases, regulators. And all have an impact on its profit potential. There are both current and potential customers, each with requirements for product/service quality, features, and SWOT Analysis I 3 External Analysis • Customers • Pricing constraints • Competitors • Distribution issues • Technology • Macroeconomy • Regulation • Workstyle trends • Major uncertainties • Suppliers • Potential partners Threats and Opportunities Strengths and Weaknesses Internal Analysis • Current performance • Brand power • Cost structure • Product portfolio • R&D pipeline • Technical mastery • Employee skills • Company culture Specific Goals Strategy Formulation FIGURE 1-1 External and Internal Analysis copying or posting is an infringement of copyright. permissions@hbsp.harvard.edu or 617.783.7860 DO N OT C OP Y OR P OS T utility. Are any of these requirements unserved? There is also a set of current competitors and still others who might enter the arena. Technology is part of the competitive environment, and that technology is always changing. Is there something developing in the world of technology that could alter your competitive environment, perhaps making the products of today’s industry leaders obsolete? Substitutes represent another threat factor in the external envi- ronment. For example, in the early 1980s, newly developed word- processing software for personal computers represented a substitute for the typewriter. The substitution rate was so rapid that typewrit- ers were largely displaced within ten years. The current popularity of cell phones with digital imaging capabilities likewise has created a substitute for cameras and film. What are the potential substitutes for your products? Do any of your products have substitute potential in other markets? An analysis of the external factors listed in the left-hand box of figure 1-1 helps the strategist to uncover and understand threats and opportunities, which, in turn, helps to reveal a company’s strategic options. (This list is by no means exhaustive, and the reader is en- couraged to think of other factors that pertain to his or her industry.) Because detailed coverage of each of these is beyond the scope of this Essentials book, we will address just a handful here. We will also discuss Michael Porter’s “five forces” approach to analyzing compe- tition in an industry, a conceptualization that has proven its value to business people for more than twenty-five years. (Note: For a more complete discussion of external analysis, see texts listed in the “For Further Reading” section at the back of this book. In particular, refer to Michael Porter, Competitive Strategy; David Aaker, Developing Business Strategies; and Jay Barney, Gaining and Sustaining Competitive Advantage.) Workstyle and Lifestyle Trends No matter what industry you’re in, workstyle and lifestyle trends are likely to affect your future. Consider this one: According to IDC, a private research firm, the number of U.S. employees working on the 4 Strategy copying or posting is an infringement of copyright. permissions@hbsp.harvard.edu or 617.783.7860 DO N OT C OP Y OR P OS T road increased to 40 percent in 2004 and may rise to 66 percent by the end of 2006. Depending on your business, that raw statistic should provoke a number of questions: • How will these millions of people travel? • Where and what will they eat? • Where will they spend the night, and what special accommo- dations would make evenings on the road more tolerable? • How will they keep in touch with their families, offices, and clients while traveling? • What can be done to reduce the cost of so much travel? • How can wasted travel time be turned into productive time? These are the kinds of questions for which executives in travel, restaurant, hospitality, and mobile computing and telecommunica- tions industries should seek answers. Those answers will reveal threats for some and opportunities for others. For example, IDC’s projection of increasing business travel is good news for airlines and hotels that cater to this segment of travelers. But it is also good news for companies that provide effective travel substitutes, such as Web- and videoconferencing products and services, and the success of these latter substitutes is a direct threat to those same airlines and ho- tels. Why spend piles of money and eat up productive time flying people to meetings when they could meet online or from videocon- ferencing facilities near home? The growth in business travel is just one of many workstyle and lifestyle changes that are happening right under our noses. Each rep- resents some combination of threat and opportunity to companies in a range of industries. Consider these: • More and more people are working from home offices. These people rely heavily on telecommunications, PCs, and Internet connectivity. Their office-bound managers are not sure how to supervise them. How will these facts affect your business or provide opportunities for new business? SWOT Analysis I 5 copying or posting is an infringement of copyright. permissions@hbsp.harvard.edu or 617.783.7860 DO N OT C OP Y OR P OS T • The Internet has made shopping, research, arranging travel, and money management faster and more convenient. Will this kill your current business or open new opportunities to serve customers profitably? • U.S. officials have declared obesity a national health epidemic, and EU citizens are also getting more portly. What does this declaration portend for food companies, restaurant chains, health clinics, and weight-control specialists? • The price of new and older homes has exploded along the east and west coasts of the United States, putting home ownership out of reach for a growing number of people, and there is no relief in sight. What does this mean for new homebuilders, for building materials suppliers, and mortgage finance companies? Is there an opportunity here for a new approach to building and financing affordable housing? • The populations of Europe and Japan are aging, and women of childbearing age in these countries are having fewer children. This will have huge implications for medical care systems, housing for the elderly, and labor markets. Strains on social services and pen- sion systems are inevitable. Transitions like this contain threats for some companies and tremendous opportunities for others. These are just a few of the many developments that are altering our world. Each is forcing companies to reformulate their strategies. So keep abreast of reports from think tanks, from IDC, Forrester Re- search, government agencies, and other investigative organizations. Scan many papers and periodicals. Conduct your own research into trends that may affect your business and form the basis of a new strat- egy. Pay particular attention to any area in which significant change is under way. Be broad-ranging in your scanning; the changes that af- fect you the most may be brewing outside your industry. Customers A business, as Peter Drucker once wrote, has no higher requirement than that to create customers. In the absence of customers, the many 6 Strategy copying or posting is an infringement of copyright. permissions@hbsp.harvard.edu or 617.783.7860 DO N OT C OP Y OR P OS T things that businesses do—product development, manufacturing, shipping, and so forth—are utterly pointless. Thus, analysis of exter- nal factors generally begins with a study of customers: • Who are they? • How sensitive are they to price? • How can they be reached? • How are they currently using a particular product or service? • Which of their needs are poorly served—or unserved? • What level of loyalty do they have to current vendors? • Do they seek an arm’s-length transaction or a long-term relationship? Since potential questions about customers are so numerous, it’s useful to segment customers into groups that have common features. Market segmentation comes directly from the marketer’s toolkit; it is a technique for dividing a large heterogeneous market of customers into smaller segments with homogeneous features. Those homoge- neous features many be defined in any number of ways. Here are some examples: • Age—senior citizens, teenagers, college students • Gender—women, foreign-born men • Geographic location—suburban families north and west of London • Type of users—heavy users of voice messaging, lead users • Income—households with total incomes between ∈30,000 and ∈50,000 • Behavior—people who shop regularly via the Internet Analysis of customer segments has many uses for strategists. Seg- mentation makes it easier to identify the needs (met and unmet), price sensitivity, accessibility, and loyalty of identifiable customers. The study of key segments may, for example, reveal that some customers SWOT Analysis I 7 copying or posting is an infringement of copyright. permissions@hbsp.harvard.edu or 617.783.7860 DO N OT C OP Y OR P OS T are much more profitable to serve than others. For instance, during the early days of the cell-phone era, research by one firm uncovered several distinct customers segments: • Infrequent users. These were people (mostly women) who subscribed at the minimum level and mostly for personal safety reasons. This segment bought the lowest-price service and was unprofitable to serve. Turnover in the segment was extremely high as these customers switched service providers in response to special, low-priced deals offered periodically by rivals. • Occasional users. These were customers who made only a few calls each week. The cell-phone company broke even on this group. • Business professionals. These people used their cell phones regularly and subscribed to the premium services. They were also loyal and relatively insensitive to prices. Most of the com- pany’s profits came from this segment. These findings had an impact on the telecom company’s future strategy. Take a few minutes to think about the customers in your indus- try—both the ones you have and the ones you’d like to recruit. How much does your company really know about these people and their needs? Has it segmented them into homogeneous groups that reveal key facts for strategists? Are any important and potentially profitable segments unserved by you or your competitors? Price Sensitivity and Elasticity of Demand Among the external factors that strategists should understand is the price sensitivity of customers. Whether they intend to offer cus- tomers a new disk drive, a low-carbohydrate family of snack foods, or a new drug therapy, they must have an informed awareness of the relationship between price and customer demand. A basic tenet of economics in a free market is that people will buy more of a good or service when the price goes down, and less 8 Strategy copying or posting is an infringement of copyright. permissions@hbsp.harvard.edu or 617.783.7860 DO N OT C OP Y OR P OS T as the price rises, all other factors remaining unchanged. This is both intuitively obvious and easily substantiated. Rational consumers are sensitive to price. Figure 1-2 shows the elasticity of demand for two products. The sharp slope in the demand curve (D) for Product A indicates a high sensitivity to a price increase; customers will make many fewer purchases as the price increases. Product B, in contrast, demonstrates much less sensitivity to a price increase; customers re- duce their purchase only slightly in the face of rising prices; as econ- omists would say, demand is relatively inelastic. Some goods and services demonstrate relatively low price sensi- tivity—at least in the short term. Consider automobile fuel. The 30 percent rise in U.S. gasoline prices in the fall of 2004, when crude oil skyrocketed to $54 per barrel, caused only a 2 to 3 percent drop in U.S. gasoline consumption. Why? People were so locked into vaca- tion plans and commuting routines that the increase caused little more than a ripple in demand. If that level of pricing (or rising prices) were to persist for a long time, however, consumption would drop substantially as people stopped buying gas-guzzling SUVs, opted to use public transportation, began carpooling to work, and so forth. As if to confirm this long-term effect, OPEC, the cartel of oil-producing countries, intimated that it wanted to see crude prices to return to the $22- to $25-per-barrel range. Though the spurt in prices was a huge SWOT Analysis I 9 Q ua nt ity Price D Product A Q ua nt ity Price D Product B FIGURE 1-2 Sensitivity to Price Changes copying or posting is an infringement of copyright. permissions@hbsp.harvard.edu or 617.783.7860 DO N OT C OP Y OR P OS T windfall for OPEC members, they knew that sustained high prices would induce their customers to find substitutes for petroleum and to invest seriously in alternative energy sources—hurting oil producers in the long run. Many products and services exhibit a much more immediate and dramatic response to price changes, usually because the product or service is nonessential or because it has many available substitutes. Beef is an example. Every time that the price of beef has increased sharply, demand has declined immediately and almost as dramati- cally. Shoppers look at the price and say, “I think we’ll have chicken for dinner tonight.” Economists use the term price elasticity of demand to quantify the impact of price changes on customer demands. If you’ve taken micro- economics, you are probably familiar with this concept. Price elas- ticity of demand is calculated as follows: Percentage increase in price/Percentage decrease in quantity = Price elasticity of demand Thus, if a company raised the price of a product price from $100 to $120, price would increase by 20 percent. If that increase caused the quantity sold to drop from 600 units to 550 units, the percentage decrease would be 8.3 percent. Following our formula, the price elasticity of demand would be 20/8.3 = 2.4 The higher the final number, the more sensitive customers are to price changes. Knowing how customers will respond to a price change can often be determined by means of focus groups, questionnaires, and direct experiments in local markets. For example, the producer of a breakfast cereal sold throughout the EU might raise its price in Brus- sels and observe the impact on unit sales. To complete this analysis, however, the strategist should calcu- late the anticipated impact of a price change on total revenue. People may be buying fewer items at a higher price. For the example just given, the company had been selling 600 units at $100 each, earning revenues of $60,000. Under its new scenario, it expects to sell 550 10 Strategy copying or posting is an infringement of copyright. permissions@hbsp.harvard.edu or 617.783.7860 DO N OT C OP Y OR P OS T units at $120, resulting in total revenue of $66,000. Further analysis would be needed to determine if that higher revenue figure trans- lated into higher or lower gross profits. Formal studies of price elasticity of demand are normally re- served for tactical moves. Nevertheless, understanding the relation- ship between price levels and customer buying behavior is an important piece of the larger puzzle that strategists must understand. How well do you understand customer price sensitivity in your markets? How does that understanding inform your strategic choices? The Competitive Arena As George Day, a professor at the Wharton School, has perceptively written, “One of the primary issues facing mangers in formulating competitive strategy is defining