Chap - 3 The Macro Envioronment

chapter 3
The macro environment

Contents
Introduction
Examination context
Topic List
1
The business environment
Environmental dynamics
PESTEL analysis
The international business context
Limits to globalisation of business
Summary and Self-test

Answers to Self-test
Answers to Interactive questions
The Institute of Chartered Accountants in England and Wales, March 2009
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Business strategy
Introduction
Learning objectives
Explain how a business collects and distributes environmental information in order to manage
its strategy
Analyse for a given situation the external factors which may impact on a business's
performance and identify significant issues in the following areas:
Sustainable development
Global macroeconomic forces
International trade and financial systems
Government policies
Cultural environment
Tick off
Identify the risks attached to operating a global business
Specific syllabus references for this chapter are: 1b, 3g.
Practical significance
The wealth of many European countries, and of the businesses within them, can be attributed to their early
industrialisation and imperialism commencing in the 17th century. The USA caught up and overtook Europe
during the early 20th century. From the mid 20th century those gains have been gradually superseded by the
development of emerging economies in Asia and Latin America. These have brought new markets and new
challenges which must be addressed by businesses from the developed economies if they are to survive.
Stop and think

You are early in your career as a professional accountant. Where in the world should you be working in
order to make the best of the opportunities over the next 40 years? Which industries around you are likely
to thrive and which to die?
Exactly the same questions are facing business strategists, albeit on a grander scale.
Working context
Many of your clients will be global businesses, or at least have some form of buying and selling relationship
with overseas firms. Your firm may be required to:
Assist in transnational audits alongside professional colleagues from outside of your home country
Assess the extra risks the client runs as a consequence of operating internationally
Advise on taking-on international contracts
Syllabus links
Environmental analysis was covered in your Business and Finance paper under section 6 of the syllabus.
However its coverage was at the level of core knowledge. In the Business Strategy examination you will be
required to apply it.
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THE MACRO ENVIRONMENT
Examination context
Exam requirements
The scenarios in the majority of exam questions will require you to absorb and understand information
about the external environment in which an organisation operates. You will also need to assess the
implications of the environment and changes in the environment for the strategic positioning and strategic
decisions of an organisation. To do this you will need to apply your knowledge of the tools and ideas
covered in this chapter.
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Business strategy
1 The business environment

Section overview
1.1
Strategy is concerned with matching the organisation to the threats and opportunities in its
environment.
The process of gathering and disseminating the necessary knowledge about a firm's external
environment is a specific example of knowledge management.
Importance of management understanding business environment

The environment contains those factors 'surrounding the organisation'. Therefore it includes more than the
'ecological' environment. In your answers you must ensure you discuss environmental factors such as
competitors and legislation as well as factors such as environmental pollution and recycling.
To be viable (e.g. able to sustain itself through time) the organisation must achieve an appropriate 'fit' with
this environment. This includes:
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Results that meet the expectations of its owners (shareholders, government, members etc)
Products and services that meet its clients' expectations at least as well as rivals'
Ability to remain within the legal and ethical codes of the societies it works in
Attractive as a place to work for its staff
Satisfying the needs of other powerful or influential stakeholders
EXTERNAL
ANALYSIS
INTERNAL
ANALYSIS
CORPORATE
APPRAISAL
MISSION AND
OBJECTIVES
REVIEW AND
CONTROL
STRATEGIC
ANALYSIS
GAP
STRATEGIC
CHOICE
STRATEGIC
CHOICE
STRATEGY
IMPLEMENTATION
STRATEGY
IMPLEMENTATION
Rational planning approach: Environmental appraisal is a one-off assessment which establishes the
forces acting on the business at present and forecasts how these may develop during the years of the plan.
Strategic management approach: The need for environmental scanning. This is a continuous
awareness by management of environmental issues enabling them to be routinely considered in decision
making.
Interactive question 1 Considering the business environment

[Difficulty level: Intermediate]
For a professional accountancy practice, answer the following questions.
(a)
What are the main external factors, in your view?
(b) How do these main environmental/external factors affect the strategies of the practice?
(c)
In your view, how do managers perceive the environment of the organisation?
(d) How do you think managers incorporate environmental/external issues into decision-making?
See Answer at the end of this chapter.
1.2
Gathering and disseminating environmental information

An effective system:
Gathers environmental information
Validates and corroborates the information
Disseminates the information so that people who need it can find it.
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Business strategy
1.2.1
Sources of environmental information

Internal sources include:
Employees: Some will be following developments affecting the firm or their field of work, or have
past experiences and networks of contacts that can provide insights.
Internal records system: This will reveal comments of sales teams at meetings, revenue and cost
trends at different locations, customer requests or complaints etc.
Formal information resources: Many firms may employ information resources specialists to create
current awareness reports e.g. large accountancy firms have technical departments that monitor
changes to regulations and the outcomes of adjudications, test cases and appeals.
External sources include:
1.2.2
Trade media: The magazines and journals specific to the industry or to particular business functions
Published accounts of rivals, suppliers and clients
Government statistical reports
On-line resources: Subscriptions to business information vendors, current awareness services

(emails from vendors who monitor the media for articles containing keywords specified by
management)
Market reports: Published research from investment analysts, market researchers, trade
departments of governments etc.
Validating environmental information

Methods:
Appointing an Information Officer with skills of 'librarianship'. to act as a central point of contact
for obtaining, sifting and relaying information
Appointing a database administrator for information stored and disseminated electronically, e.g. via an
intranet, to check on the validity of postings.
Issues to consider in validating environmental information include:
1.2.3
Integrity of the source: internet gossip and market rumours lack integrity on their own
Forecasting and predictive record in the past
Degree of substantiation: is there more than one report or instance of this from independent sources?
Age of the information: how up to date is it?
Motivation of provider: does the provider have something to gain from convincing the firm of this
information?
Disseminating environmental information

Tacit knowledge refers to 'information the organisation does not know it has' i.e. it is known to very few
people and not easily available to the organisation as a whole. Explicit knowledge is information that has
been disseminated more widely.
Dissemination can be assisted by:
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A well designed intranet with clear files and a search facility
Periodic briefing reports with a digest of the most significant information
Periodic seminars to brief management
Annual management development sessions at an internal or external business school to introduce and
discuss new environmental issues
2 Environmental dynamics
Section overview
2.1
The ability of the business to plan, and its requirement for environmental information, will be
influenced by how predictable its environment is.
In Business Strategy the factors affecting this are given very precise meanings.
Complexity, predictability and turbulence

The intensity of environmental issues varies from sector to sector and company to company.
Definition
Turbulence: How changeable the environment is and how easy it is to predict.
Lynch (Corporate Strategy) presents turbulence as

Changeability Predictability
Changeability
Is the environment likely to change? There are two aspects to changeability.
Complexity: The variety of influences and conditions. These include regulatory, social and political
factors, technological change and internationalisation.
Novelty: The degree to which the environment presents new situations to be dealt with.
Predictability
Is it possible to forecast trends in the environment or at least make sensible predictions of discontinuous
change? Again there are two aspects:
Rate of change: In relation to the firm's ability to respond (slow to fast) to this (in other words,
does the environment change at a slower pace than the organisation's ability to respond to it?)
'Visibility of the future': Is there reliable information to make forecasts for decision making?
The degree of turbulence will affect the amount of resources devoted to environmental assessment. For
example, investment banks employ substantial research departments and each day begins with dissemination
of relevant environmental information to traders and managers. Airlines also have research departments
which 'red flag' issues on a regular basis and also provide reports and forecasts as inputs into their strategic
planning process.
2.2
Scenario planning
Definition
Scenario planning: The development of pictures of potential futures for the purposes of managerial
learning and the development of strategic responses.
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Business strategy
2.2.1
Introduction
Scenario planning is useful where a long-term view of strategy is needed and where there are a few key
factors influencing the success of the strategy, e.g. in the oil industry there may be a need to form a view of
the business environment up to 25 years ahead, and issues such as crude oil availability, price and economic
conditions are critical. For example, Shell was the only major oil company to have prepared its management
for dealing with the shock of the 1970s oil crisis through scenario planning and was able to respond faster
than its competitors. Precision is not possible, but it is important to develop a view of the future against
which to evaluate and evolve strategies.
Scenario building attempts to create possible future situations using the key factors. The aim is to produce a
limited number of scenarios so that strategies can be examined against them in terms of 'what if ...?' and
'what is the effect of ...?' (basically a form of sensitivity analysis).
A car manufacturer could assess the impact of a 'Green Scenario' or a 'High Value Sterling Scenario' on its
business. Financial models of the firm are often used in conjunction with this approach to assess impact on
profit. Although these provide a useful approach, it is important not to become too committed to one
scenario; after all, they are only forecasts which might not in the event be valid.
2.2.2
Steps
Identify key forces, using techniques such as PEST analysis (see later)
Understand the historic trend in respect of the key forces
Build future scenarios, e.g. optimistic, pessimistic and most likely.
The scenarios generated are then 'plots' to be played out making managers consider future possibilities and
encouraging them to think about strategy more flexibly.
Interactive question 2: Oil industry scenarios
Oil producers use scenario planning extensively.

Requirements
(a)
Identify the factors that make scenario planning popular with oil industries.
(b) Suggest some alternative scenarios that an oil producer might consider in its strategic planning.
3 PESTEL analysis
Section overview
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In your Business and Finance paper, you will have encountered PESTEL factors in your studies of the
environment of business.
This section looks in each PESTEL factor in more detail and identifies how each may impact on the
strategy of the organisation.
Later sections extend analysis to the global business environment.
3.1
PESTEL analysis and underlying assumptions

PESTEL is a handy checklist environmental factors.
Political
Economic
Social/cultural
Technological
Ecological/environmental
Legal
Worked example: Software in India

The rapid emergence of the software industry in Bangalore in India has been made possible by a
combination of technology (cheap and reliable telecommunications), economics (low labour costs in India
compared to industrialised nations) and political/social factors (the high level of education and the
widespread use of English).
Economic factors
Globalisation
Business cycles
Interest rates
Inflation
Unemployment
Exchange rates
Environmental factors
Sustainability issues, eg energy,
natural resources
Pollution, etc
Green issues, etc
Technology
Government and EU
investment and R&D policy
New discoveries: products and
methods of production
Speed of technology transfer
Levels of R&D spending by
competitors
Developments in other
industries that could transfer
across
PEST ANALYSIS
Social/demographic factors
Income distribution
Social mobility
Levels of education/health
Size of population
Location
Age distribution
Lifestyle changes
Consumerism
Attitudes to work and leisure
Green issues, etc
Economic factors
Globalisation
Business cycles
Interest rates
Inflation
Unemployment
Exchange rates
Environmental factors
Sustainability issues, eg energy,
natural resources
Pollution, etc
Green issues, etc
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Business strategy
3.2
Political factors
Political factors relate to the distribution of power locally, nationally and internationally.
Political risk is the possibility that political factors will have an impact on the business's environment or prospects.
The impact could be positive or negative, the issue is the uncertainty created.
Types of risk include the following.
Ownership risk: A company or its assets might be expropriated (or nationalised) by the state,
normally with compensation. Confiscation is, effectively, expropriation without compensation.
Operating risk: Indigenisation/domestication. The firm may be required to take local partners.
There may be a guaranteed minimum shareholding for local investors.
Transfer risk may affect the company's ability to transfer funds or repatriate profits.
Political risk: The government of the host country may change taxes or seek a stake in the business
to increase its power or to satisfy local public opinion.
Worked example: Oil companies in Russia

Drilling for oil and gas has never been for the faint hearted and as most of the easily recoverable fields are
now rapidly being run down, energy giants are being forced to confront bigger and bigger risks in an effort
to replenish their reserves.
Once again, though, Russia has demonstrated that the political risks involved in ensuring that an oil giant has
a viable future can be every bit as challenging as the physical hurdles.
By subjecting Shell to an almost paralysing blizzard of ecological complaints on the giant Sakhalin project,
Moscow has succeeded in securing control for its own Gazprom.
However, Shell and its Japanese partners simply cannot make Sakhalin work without Russian cooperation,
so ceding 50% of the project to Gazprom is regarded as an acceptable price.
Walking away was not an option. Shell has already invested billions of dollars in this 'elephant' project and
even if it were ready to take such a large financial hit, the long-term need to find new sources of oil and gas
means compromise is a necessity.
Following Shell's experience, BP is expected to face similar pressures on its joint venture with the Russian
company TNK. Gazprom has its eyes on TNK's 50% and would like to secure majority control by taking
part of BP's share too.
While the challenges are great, they are nothing new. Muddling through with hostile political regimes is dayto-day stuff for oil giants.
As BP's chief executive, Lord Browne, remarked when discussing the difficulties of doing business in Russia,
if not there then the alternative was violent, war-ravaged Africa. Looked at from this perspective, Russia
appears eminently hospitable.
Extract from article in UK Daily Mail 17 December 2006
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Sources of political risk

Source
The country
This covers government stability, international relations, the ideology of the

government in power, the need for contacts, favouritism for local suppliers,
political violence, governments' ability to change the law and operating conditions,
governments' need to appease powerful stakeholders.
The product
Consumer/basic products. High-tech components may have national security or

armaments implications. Oil extraction in some countries places the oil companies
near regions of ethnic or political conflict.
The company
Size, connections, reputation, influence on the environment.
Managing political risk

Companies, especially transnational corporations, might take measures to reduce political risk. These include:
3.3
Detailed risks assessments prior to investing in the country
Seeking protection from legal agreements with the host country or from bi-lateral trade agreements
between nations
Partnering with a local business to increase acceptance of the project and to lobby for political support
Raising finance for projects from host country to put local pressure on politicians to help safeguard
investment
Operate under the auspices of international bodies e.g. World Health Organisation, UNICEF etc.
Share project with other firms to spread the risks between them
Avoid total reliance on one country e.g. oil companies extract oil from many countries to offset risks
of interrupted supplies or spiralling costs
Lobbying for political support from home government for projects and to resolve issues
Support for political groups in host country that are favourable to the project
Economic factors
A typical economic factor that should be considered in strategic decision-making is the economic structure
of a country. Countries typically progress from reliance on primary industries (e.g. agriculture, minerals,
forestry) through manufacturing to tertiary services (e.g. financial and commercial sectors).
Lesser developed countries
Reliant on a small number of products (e.g. crops or minerals) as the

main export earner. Infrastructure is poor.
Implications:
Wealth and foreign exchange rate depend on yield of product and
world price of product.
Political actions aimed at securing control over incomes from
product either domestically (e.g. insurgent liberation forces) or
externally (e.g. develop cartels, invasion etc).
Newly industrialising
countries
Rapid industrialisation and manufacturing base grows

Implications:
Infrastructure struggles to keep pace (e.g. power shortages, lack of
housing, lack of roads, ports etc).
Large shifts in population towards areas of industry and away from
villages.
Advanced industrial country
There is a wide industrial base and a well developed service sector.
These affect overall wealth, financial stability and patterns of demand.
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Business strategy
Business cycle
Growth
rate %
Recovery
Boom
Recession
Long-term trend
+
0
-
Time
Depression
The long-term trend of industrialised economies is one of positive growth. The different phases of the cycle
have the following characteristics:
Recovery phase
Increased business confidence and investment causes growth to increase. Unemployment declines and
consumer confidence/spending rises.
Boom phase
Growth exceeds the long-term trend. Demand is too great, leading to rising prices of goods, balance
of trade deficits (as exports fall, imports rise), labour shortages and wage/factory price increases.
Recession phase
Demand falls, leading to increased unemployment and falling investment and business/consumer
confidence. Recession is often first seen in building and capital goods sectors.
Depression phase
Weak consumer and business spending/confidence. Unemployment in excess of normal levels with
falling (or even negative) inflation and wage cuts.
In setting strategy an organisation needs to consider where the economy is currently and where it is
heading.
3.4
Long-term exchange rates' behaviour affect the relative competitiveness of imported and domestically
produced products and exports. A falling domestic exchange rate makes firm's exports more
competitive and imported inputs more expensive. This may be determined by the value of key exports
such as oil, minerals, crops, manufactured goods etc.
Interest rates (long-term and short-term) affect cost of finance and also levels of demand in the
economy.
The economic infrastructure, for example access to payments systems, consumer and trade credit,
access to venture and other capital, the quality of the stock exchanges.
Social/cultural factors
These factors affect strategy in several ways:
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They affect the market for products, e.g. religious proscriptions on food, financial services
They affect promotional strategies, e.g. language of adverts, considerations of imagery and decency
They affect methods of conducting business in countries, e.g. conventions of negotiation, giving
and receiving of gifts, ensuring 'face' for contacts (i.e. maintaining self-respect and status)
They affect methods of managing staff, e.g. language differences, attitudes to managerial authority
They affect expectations of business conduct, e.g. extent of engagement with CSR, time horizon of
investment, engagement in political matters.
Social factors include
Make-up of population: e.g. growth rate, proportion of old and young people
Family structure and size; the importance (or lack of it) of the extended family and relationships
with non family members; the extended family provides contacts and work.
The role of women in the labour force and in society as a whole (expectations vary from society to
society). In different cultures, gender stereotypes are more sharply drawn than in the industrialised
west.
Extent of social mobility: the degree of social stratification and difference within each society and
whether people can move between them, the changes in size, wealth and/or status of different groups
within the population and the geographical distribution of the population between regions and urban,
suburban and rural areas.
Cultural factors are identified in the diagram below.
Worked example: EuroDisney

EuroDisney (Disneyland theme park and resort hotels) opened outside Paris, France, in April 1992. The
American company, celebrating the success of theme parks in Los Angeles (California), and Orlando
(Florida), and Tokyo (Japan 1983) thought that Western Europe was the next step. (Curwen, 1995).
Europeans, especially Britons, liked Disney's American parks, the sunshine, the amenities near the parks,
and the reasonable accommodation costs. However, Paris was chosen as the European location because it
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Business strategy
was at the centre of Europe's wealthiest region, and the French government offered inducements. Despite
opposition from French intellectuals, the project went ahead. Disney owned 49 percent of the shares.
The project plans assumed there would be a large number of visitors who would want to stay in the vicinity
of the park.
The park opened on 12 April 1992. However, queues formed for rides that did not work and 'many of the
employees appeared to be struggling with the need to conform to Walt Disney's code of acceptable
behaviour'. (Curwen, 1995)
Curwen (1995) identified a number of difficulties, which we have listed below. Some were bad luck and
some were of Disney's own making.
In 1992, when the park opened, mainland Europe was entering a recession.
The value of the French franc rose, increasing the costs to Italian and British holidaymakers. (The UK
left the exchange rate mechanism in 1992, and Italy was temporarily suspended).
The weather EuroDisney should have considered this factor. Paris is in northern Europe.
Why should holidaymakers go to a rain-drenched version of a Disney theme park when they could
experience the 'real thing' in sunny Florida (or California)?
A trip to EuroDisney would rarely provide more than a couple of days' outing: hence attendance
figures were optimistic.
Hotel occupancy rates were low (in part because of the excellent transport facilities to Paris).
Admission charges were seen as too high, and visitors 'broke the rules' by smuggling in their own food
and drink. Price resistance was a key issue.
Labour turnover was very high. French employees did not behave like Americans.
Cultural issues
Alcohol, as in the US theme parks, was banned. This impacted on the traditional French Sunday Lunch
which is relaxed, conversational and where wine is served. Thus the full service restaurants saw
reduced trade.
The management team were American, there were no European representatives.
At one point the French media called it a 'Cultural Chernobyl'.
The first year was catastrophic. The Disney corporation reconsidered its plans for further expansion of the
site. However, the French government, the bankers and Disney itself had good reasons for business to
continue, and were able to persuade a wealthy Saudi investor to contribute.
Recovery
After this disastrous start, the company began to turn around, and it reported a profit in 1995. As well as
financial support from a Saudi investor, and Disney's agreement to forego royalties the company began to
change. Pierre Bourguignon, the CEO, also attempted to institute cultural and structural change, and to
change the marketing.
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The chain of command with reduced employees were empowered to take decisions. There were 220
small groups with total profit responsibility.
All managers have to work on the front line once a week.
Admission prices were cut by 20 percent and cost of staying in the cheaper hotels was cut.
The catering was improved, with lower prices, more fast food, drinks and so on.
Cultural issues
Reflecting greater sensitivity to national factors, EuroDisney targeted its marketing and promotional
offers more closely to those factors.
The 'low-price' marketing strategy did not conform with the USA's strategy of offering a 'premium' quality
product, but the strategy brought in more people. However, attracting people to the more expensive
hotels has been difficult.
By 1996 EuroDisney, by then renamed Disneyland Resort Paris, had become France's most-visited tourist
attraction. Management embarked on an ambitious expansion scheme opening Walt Disney Studios in 2002.
Hong Kong
In 2005 Disney opened its fifth, and smallest, Disney park on reclaimed land in Hong Kong. Disney owns
43% and the Hong Kong government 57%. Initial cultural adaptation problems included:
Significant overcrowding at Chinese New Year as a an unanticipated wave of visitors arrived from
mainland China
Protests from global environmental groups at the inclusion of shark's fin soup on the wedding menus
at Disneyland HK
Criticisms from guests of wait times and overcrowding which had been endured more quietly at other
Disney resorts
Guests not respecting no-smoking and alcohol-free regulations.
In May 2007 it was reported that declining attendances at Disneyland HK and revenues below targets were
jeopardising Disney's ability to raise finance to continue the planned investments in the resort. Management
was contemplating significant promotional activity to turn it around.
3.5
Technology
Technological differences and change operate at three levels:
1.
Apparatus, technique and organisation: How technology is used in the business, e.g. the use of
ICT within the firm .
2.
Invention and innovation: These affect the products being offered, e.g. the impact of higher power
handsets on the development from mobile phone handsets to Personal Digital Assistants.
3.
Metatechnology: A technology that can have a variety of applications, e.g. lasers are a technology
that have found uses in industry (welding), surgery (corrective eye surgery, key hole surgery),
recorded music and software (CD, CD-ROM and DVD), and visual displays and light shows.
The strategic significance of the technological environment includes:
Technological base, and therefore customer and staff familiarity with it, varies across countries.
Operations will have to take this into account.
Technological change challenges existing industry structure and competitive advantages and so
strategies to harness or evade it are necessary.
Technological change can render existing products obsolete. Therefore continuous R&D and learning
is necessary to remain competitive.
Technological change creates uncertainty which may influence the approach to strategy formulation
that is adopted.
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Business strategy
Worked example: Pulp and paper

Reports of the death of paper were rampant in the 1990s. However the paperless office never materialised
nor yet have e-books. Even so the vast paper-and-pulp multinationals have been hard hit by the electronic
age, especially in America. Mills are closing to buoy prices. Newsprint has been worst hit as circulation and
classified advertising at newspapers fall and the Wall Street Journal and other papers grow skinnier.
'The only grade of paper immune to technological substitution is tissue' such as bathroom or facial tissue
says investments analysts D.A. Davidson.
Restructuring in the paper industry is proceeding at a furious pace and have included:
Mergers between producers to eliminate slack capacity
Closure of capacity
Selling off of lumber farms and associated businesses (e.g. plywood, cartons, home furniture)
Development of businesses in non-affected areas such as corrugated cardboard used in packaging and
export industries.
As they thrash around for new direction, the pulp-and-paper giants of America and Europe must also deal
with the forces of globalisation. Brazil, with fast-growing eucalyptus trees, is the cheapest place to make
paper and China has recently gone from being a net importer to being a net exporter of newsprint.
At the same time, emerging economies also represent new markets that are not as hooked on email as the
developed world. However BlackBerrys and Dells will not keep a low profile in Brazil for ever.
Source: Economist March 2007
3.6
Ecological environment factors

Climate change
The 2007 report of the Intergovernmental Panel on Climate Change (IPCC) has forecast that global average
temperatures by the end of the 21st century will have risen between 1.4C and 6.4C above the average for
1990.
Global warming is forecast to cause polar ice caps to melt, leading to a chain of events including rises in sea
levels and climate change.
The IPCC regards the actual level of average temperature at the end of the century to be dependent upon:
Actions taken by governments to reduce emission of carbon dioxide and ozone depleting gases into
the atmosphere.
The availability and use of technologies to reflect the sun's rays back into space such as vast reflectors
in low earth orbit or reflective particles scattered into low earth orbit.
The actual feedback mechanism in the ecosystem which may accelerate global warming as ice sheets
cease to reflect sunlight, forests disappear and plants under stress become carbon dioxide producing
rather than carbon dioxide absorbing.
Various socio-political consequences have been forecast.
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Much greater cross-national cooperation to combat this common threat.
Re-mergence of state-funded nuclear energy as a solution following its international abandonment after
the Chernobyl explosion in 1986 and the consequent escalating costs of safety.
Political conflicts are breaking out between developed countries and emerging economies over carbon
emissions.
Inter-racial conflict and rise of fascism as populations migrate towards higher or more temperate
climates and are rejected by indigenous people.
Land grab wars between USA, China and European states over Siberia and Alaska.
Increasing blame heaped on industrialised nations by impoverished states leading to calls for aid or
other countries using and to gain political influence.
Breakdown in civil order as population squabbles over diminishing food and water supplies.
Main government policies are:
Reduce carbon emissions through targets set in cross governmental accords such as Kyoto
agreements.
Penalisation of carbon creating industries through taxes levied on emissions or on fossil fuels used.
Investment in non-carbon creating technologies such as nuclear energy, wind and wave power and
electric or hybrid cars.
Making foreign aid dependent on acceptance of environmental policies by recipient countries.
Other ecological issues
Energy gap as fossil fuels diminish at a time when India and China are growing rapidly and demand
more energy.
Waste recycling issues as developed countries recognise the forecast use of landfill and also realise
that much landfill is hazardous waste (e.g. NiCad batteries, electronic circuitry, oil and solvents in car
engines).
Bio-diversity issues as growing of cash crops and destruction of forests for grazing or building land also
destroys species of plant, insects and animals.
Introduction of genetically modified organisms into the food chain leading to loss of species and
potentially hazardous future effects.
Implications for business strategy
3.7
Need to accept 'polluter pays' costs taxes on emissions and requirements that firms buy certificates
from refuse firms confirming recovery or destruction of materials the firm introduces into the supply
chain
Increased emphasis on businesses acceptance of CSR and of principles of sustainable development;
Potential for economic gain from cleaning-up operations and selling surplus 'permits to pollute' to
firms that have not cleaned up
Potential competitive advantage from development of products that ecologically conscious buyers will
favour
Need to monitor ecology-related geo-political and legislative developments closely
Legal factors
Legal factors relate to the role of law in society and its role in business relationships. This can be assessed in
terms of:
Systemic factors: How effective is the legal system at enforcing contracts? To what extent are legal
decisions likely to be interfered with by politicians i.e. are the courts independent of government?
How easy is it to get hold of legal advice? How speedy are the courts? To what extent is regulation
delegated? Are rights of private property genuinely enforceable?
Cultural factors: To what extent are business relationships conducted formally or informally? The
USA is regarded as a litigious society; in Japan (partly because the small size of the legal profession),
business is widely believed to be based more on long-term relationships.
Context and regulatory factors: cover civil and criminal law, laws relating to consumer protection
and advertising, employment and so forth. Furthermore, to what extent is competition promoted,
regulated and enforced? Intellectual property rights are examples of specific issues which need to be
considered.
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Business strategy
Interactive question 3: Newspaper industry
[Difficulty level: Exam standard]
On 12 June 1993 The London-based newspaper The Sun dropped its cover price from 25p to 20p, claiming
that this would help its readers in the recession. The Daily Mirror responded quickly, cutting its price for a
single day to 10p, in an attempt to maintain circulation at the expense of lost revenue.
The resulting increased circulation of The Sun was no surprise for the tabloid market. However, how would
the circulation of the quality papers be affected by a similar strategy?
It has always been felt that broadsheets are price insensitive and therefore that a similar strategy adopted by
a broadsheet publication would be of no benefit: branding was too strong. However, Peter Stothard, editor
of The Times, had begun to disagree, feeling that readers did have brand loyalty but were also very much
interested in value for money. A drop in price, he felt, could enhance a publication's value for money and
therefore on 6 September 1993 the price of The Times dropped from 45p to 30p.
Media analysts were unconvinced, maintaining that any resulting increased circulation would not offset the
decreased revenue, hence losses are the obvious result: CU200,000 for The Times and CU700,000 for The
Sun per week (estimated). Analysts struggled to work out the rationale behind increased circulation bids.
One justification was that it was needed to combat the overall decline in the newspaper market a 20% fall
over the previous thirty years according to leading accountants. The worst affected by this decline had been
the tabloids.
Another argument was that it was done in order to affect Mirror Group Newspapers adversely during the
sale of 55% of its shares in September.
Whatever the reason, the worry was that the price of The Sun would rise again and when it did the success
or failure of the strategy would be shown by how many of the new readers (300,000) were retained. As the
tabloid market is price sensitive, the signs were not good.
The outlook for The Times was slightly different: city analysts felt that a cut in price was necessary as the
paper was on a downward spiral, having lost its previous image. The price cut, they felt, was there to stay: it
was envisaged that more money would flow in from advertisers due to increased circulation.
Advertising was a major concern for newspapers in the recession: a typical tabloid received 20% of its
revenues from circulation, with the rest coming from advertising. Broadsheets, on the other hand, had a
50:50 split.
The total split on advertising spend had changed dramatically in the previous decade.
Newspapers
Television
Radio
1981
66%
20%
14%
1993
51%
36%
13%
The initial reaction to this was to increase newspaper prices but obviously this had limited effect, hence the
cuts by News International. Rupert Murdoch, it was felt, could sustain initial losses from profits elsewhere:
his competitors would not be able to do so.
In 1993 The Daily Telegraph remained number one in the UK broadsheet market, its revenue declining by
only 1% compared with the previous year. This was achieved by a series of promotions including discounted
holidays, as well as by its readers showing remarkable loyalty and an unwillingness to move.
The circulation of The Guardian had fallen by 5.6% and its market position had been affected as The Times
overtook it in the race for second position. However, the paper still remained popular.
The Independent, however, had been hardest hit. It was felt that the strategy of The Times could potentially
squeeze it out of the market. If this were to be the result The Times was sure to benefit. The situation
appeared to be mirroring the experience of the London Daily News a few years previously when it was
driven out of business by the Evening News. Indeed, The Times would benefit both from increased circulation
and increased advertising revenue if The Independent were to be terminated.
However, The Independent was struggling before The Times cut its price. Its circulation had declined
significantly since 1988 (20%) and it had been perceived as being 'weak' due to the lack of colour
photographs. Although this was corrected it meant that the price of The Independent had to be increased to
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compensate. This 5p rise was unfortunate, since it was implemented a matter of weeks after the reduction
by The Times.
The Independent panicked and contacted the Office of Fair Trading, claiming that the price cut by The Times
amounted to predatory pricing and that this was not allowed. This complaint was not upheld: it would have
to be proved that the cut was aimed solely at The Independent and this would have been difficult to establish.
Furthermore, The Independent was not one of the financially strongest companies, having made a loss
approaching CU500,000 in the previous year. A takeover appeared to be a logical next step as
The Independent did have a small niche in the market. However, whoever bought it would have to overcome
the recent batterings which had left it with an image problem.
If newspapers had been allowed to expand into TV, then the competitive picture would have changed
completely.
Requirement
Discuss the environmental factors that affected the newspaper industry, using the following headings.
(a)
Political and Economic
(b) Social
(c)
Technological
(d) Ecological
(e)
Legal
4 The international business context

Section overview
4.1
Few if any businesses are unaffected by global influences from competition, new markets or, at the
very least, cheaper sources of supply.
The view that certain nations have built-in advantages from low costs or harder-working staff has
given way to a more sophisticated view that home factors may configure to give advantages to a
handful of specific industries.
This is illustrated using the Porter Diamond model.
The importance of the global business environment

The rapid industrialisation from the 18th century was a consequence of early involvement of merchants and
businesses in trade. In the 21st century improved transportation and communications and cross-border
business ownership have created, for most industries, a global business environment.
Global competition affects firms in several ways:
It provides the opportunities of new markets to exploit
It presents the threat of new sources of competition in the home economy from foreign firms
It offers an opportunity of relocating parts of business activity (or supply chain) to countries able to
perform them better or more cheaply
It may drive cross border acquisitions and alliances
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Business strategy
This leads management to make significant strategic investment decisions that rely on assessments of the
stability and trends of the global business environment:
Development of products for international markets
Advancing credit to clients in international markets or investing in businesses and assets in host
countries
Reliance of international sources for supplies of crucial inputs
Worked examples: Vehicle manufacture and call centres

Case study (1) Global vehicle manufacturing
The history of vehicle manufacturing is an example of internationalisation and, to an degree, globalisation.
According to Dicken, world output of motor vehicles in 1960 was c 13m units. In 2006 it had risen to 67m.
Fuelling this quantitative increase was vehicle production in Asia, Latin America and, in recent years,
countries such as China and Thailand. According to the Economist (in 2005), global capacity stood at 80
million units but actual production was 60 million, yet capacity utilisation needs to be 80% for most plants
to generate any decent profits.
Today the global automobile industry is characterised by extended global supply chains and cross national
alliances between manufacturers. The Economist (January 2007) cites the example of vehicle development
in General Motors:
'At the 2006 [North American International Auto Show] only one question seemed to matter; how soon
would the giant American car manufacturer go bust? At this year's show [2007] the subject of choice was
the firm's nascent turnaround. The revival of the Saturn division cast light on some of the changes. Saturn
[US] has consolidated its vehicle development efforts with those of GM's European arm, Opel and more
broadly the car maker's previously autonomous regional operations are now working together coherently.
North America is developing the big pick-up trucks that dominate the market and Europe will handle
mainstream passenger cars. The car unit of South Korea's Daewoo, now a GM subsidiary, will work on
entry level models and Holden, and Australian subsidiary, will develop big saloons. If GM can make this
approach work it will achieve economies of scale that only Toyota can match.'
Case study (2) Call centres and 'offshoring'
Call centres are being used increasingly by organisations seeking to centralise their customer service
functions. Increasingly call centres are located overseas.
Some firms that locate call centres in India, for reasons of the lower cost of graduate labour, give their staff
elocution lessons in the appropriate regional accents, and update their staff on sporting events and soap
opera plot lines for the sake of small talk. An example is GE Capital, whose US, UK and Australian arms
have set up call centres in India. In some cases, more sophisticated functions are sent offshore.
4.2
The global corporation

Definition
Globalisation: The production and distribution of products and services of a homogenous type and quality
on a worldwide basis.
Levitt (The Globalisation of Markets 1983) described the development of a 'global village' in which
consumers around the world would have the same needs and attitudes and use the same products. A global
corporation would be one that operated as if the entire world was one entity, to be sold the same things
everywhere.
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Levitt's focus was on the marketing aspects of globalisation. The global business corporation will also be
characterised by
Extended supply chains: Instead of making the product at home and exporting it, or setting up a
factory in the host country to make it, the global corporation may factor out production so that
different parts of the product (or service) originate in different countries. Womack et al (The Machine
That Changed The World) suggest that the globalisation of the automobile industry led the way for this
model.
Global human resource management: This involves pan-national recruitment and development of
human resources.
Interactive question 4: A global corporation?
[Difficulty level: Easy]
Some would say that such purely global organisations are rare. Industry structures change and foreign
markets are culturally diverse. Even within the USA, there is an enormous variety of cultural differences.
Can you think of a global corporation that fulfils the requirements of the definition given above?
4.3
Ohmae's five Cs: factors encouraging development of global

business
Ohmae (The Borderless World) has identified a number of reasons which might encourage a firm to act
globally arranged into a 'five C's' framework. (recall in Chapter 1 the discussion of three of these C's under
Ohmae's prescriptions for strategic thinking. By adding an extra two C's Ohmae extends his analysis into
global business).
The customer
Are consumer tastes across the world converging upon similar product
characteristics?
The company itself
Selling in a number of markets enables fixed costs to be spread over a larger

sales volume.
Competition
The presence of global competitors, who are enjoying the benefits of global
commitment, could encourage a previously local or regional operator to
expand its activities.
Currency volatility
Setting up assembly overseas is a way of reducing the exchange rate risks

inherent in exporting and may also help to get around government imposed
trade barriers.
Country
Locating business activities overseas may provide cheaper access to labour,

materials and finance, along with the goodwill of host governments.
The continuing political acceptance of free-trade by international economies is essential to the success of
these strategic investments.
4.4
Porter: The Competitive Advantage of Nations

Management developing strategy in a global environment needs to understand the competitive advantages
they have over firms from other countries.
Porter (The Competitive Advantage of Nations) seeks to 'isolate the national attributes that foster competitive
advantage in an industry'.
Porter identifies determinants of national competitive advantage which are outlined in the following
diagram. Porter refers to this as the Diamond.
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Business strategy
Role of factor conditions
Basic factors
Advanced factors
Human resources skills, (price, motivation,

industrial relations)
Basic factors include:

natural resources,
climate, semi-skilled and
unskilled labour. Basic
factors are inherited, or
at best their creation
involves little
investment.
Advanced factors
include modern digital
communications, highly
educated personnel,
research laboratories
and so forth. They are
necessary to achieve
high order competitive
advantages such as
differentiated products
and proprietary
production technology.
Physical resources (land, minerals, climate, location

relative to other nations)
Knowledge (scientific and technical know-how,
educational institutions)
Capital (i.e. amounts available for investment, how
it is deployed?)
Infrastructure (transport, communications,
housing)
Role of demand conditions
Comment
The home market determines how firms perceive,

interpret and respond to buyer needs. This
information puts pressure on firms to innovate and
provides a launch pad for global ambitions.
There are few cultural impediments to

communication in the home market.
The segmentation of the home market shapes a
firm's priorities: companies will generally be
successful globally in segments which are
similar to the home market.
Sophisticated and demanding buyers set
standards.
Anticipatory buyer needs: if consumer needs
are expressed in the home market earlier than
in the world market, the firm benefits from
experience.
The rate of growth: slow growing home
markets do not encourage the adoption of
state of the art technology.
Early saturation of the home market will
encourage a firm to export.
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Role of related and supporting industries
Comment
Competitive success in one industry is often linked

to success in related industries. Domestic suppliers
are preferable to foreign suppliers, as 'proximity of
managerial and technical personnel, along with
cultural similarity, tends to facilitate free and open
information flow' at an early stage.
This facilitates the generation of clusters. These

are concentrations of many companies in the same
industry in one area, together with industries to
support them. For example, London in the UK is a
global financial services centre, with a
concentration of banks, legal services, accounting
services and a depth of specialist expertise. Silicon
Valley is a further example.
Role of strategy, structure

and rivalry
Comment
Structure
National cultural factors create certain tendencies to orientate

business people to certain industries. German firms have a strong
presence in industries with a high technical content.
Strategy
Industries in different countries have different time horizons, funding

needs and so forth.
National capital markets set different goals for performance. In

some countries, banks are the main source of capital, not equity
shareholders.
When an industry faces difficult times, it can either innovate
within the industry, to sustain competitive position or shift
resources from one industry to another (e.g. diversification).
Domestic rivalry
With little domestic rivalry, firms are happy to rely on the home
market.
Tough domestic rivals teach a firm about competitive success.
Each rival can try a different strategic approach.
Two other variables, chance events and the role of government, also play their part in determining the
competitive environment.
4.4.1
Interactions between the determinants

The factors in the 'Diamond' are interrelated. Competitive advantage in an industry rarely rests on a single
determinant.
4.4.2
Related industries affect demand conditions for an industry. For example 'piggy-back' exporting is
when an exporting company also exports some of the products of related industries.
Domestic rivalry can encourage the creation of more specialised supplier industries.
Clusters
Related business and industries are geographically clustered. A cluster is a linking of industries through
relationships which are either vertical (buyer-supplier) or horizontal (common customers, technology,
skills). Clusters are supposedly a key factor in the competitive advantage of nations.
Within a country, the industry may be clustered in a particular area.
The Indian software industry is based in Bangalore.
The UK investment banking industry is largely based in London.
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Business strategy
Interactive question 5: Why do banks cluster?
[Difficulty level: Easy]
It is easy to see why mining companies should congregate in a cluster around coal seams, or shipping
services would congregate around ports, but why should banks and software companies be clustered in the
same way, given plentiful IT and broad bandwidth communications?
4.4.3
Using Porter's Diamond to develop business strategies

Porter claims that firms gain competitive advantage from either of two sources.
Lower costs of supply to customers which result in higher profitability (cost leadership).
Differentiated service or reputation resulting in higher prices and sales revenues (differentiation).
This is covered in more detail in Chapter 6.

Porter advises management to consider the diamond factors in their home country and to compare them
with the diamond factors available to rivals from other countries.
He offers the following prescription.
If the home diamond factors give a comparative cost advantage over those of foreign rivals then
management should adopt strategies based on overall cost leadership. This may explain the strategies
of South Korean car manufacturers like Hyundai/Kia, Daewoo and SsangYong (the latter two being
respectively offshoots of General Motors and Daimler Chrysler).
If the home diamond factors give a differentiation advantage over foreign rivals management should
adopt strategies based on differentiation. This may explain why car manufacturers Mercedes, BMW
and Audi tend to develop and initially produce their limousines in Germany but build vans and utility
cars in Spain, South Africa and Brazil.
If the diamond does not confer advantage over rivals then management must focus on sub-sections of
the industry which large players may have overlooked or not be able to exploit commercially. This
may explain the large number of private banks in Switzerland or the boutique sports car makers in
Italy (Ferrari, Lamborghini, Maserati etc).
Interactive question 6: Chinese car industry
At the Beijing Auto Show (in November 2006) China's car makers felt confident enough to show off not
just their newest low-cost runabouts, but also luxury and sports models, 'concept cars' showing future
possible designs and even a few hybrid and electric vehicles. Local car makers in the world's third largest
and fastest-growing car market would appear to have come of age.
Until recently many Chinese car makers built thinly-disguised copies of vehicles made by Volkswagen, GM
and Toyota. In the past few years things have changed. In preparation for a push overseas local firms such as
Chery, Great Wall and Geely have proved they can develop their own vehicles too. Buying designs from
international specialists and installing fancy robotic production lines means more than 100 new models will
be introduced in China this year. Their car makers have captured 27% of the market in China and will
export 75,000 vehicles to over 100 countries this year. Foreign car makers are worried by the Chinese
firms' ultra low prices. The latest Shanghai Maple, for example, with leather seats, anti-lock brakes, air
conditioning and a 2 year warranty costs a mere $6,500. Foreign firms grumble that they cannot even buy
the steel needed to make the car for that price.
How much of this miracle is the result of good business sense rather than special treatment granted to
local firms is not entirely clear. A lot of early technology was borrowed. The government also offered
support to fledgling firms via direct investments and guaranteed loans. Universities provided technical help,
especially in the development of expensive engines. The authorities even considered a law that would
mandate a 50% share for local firms by 2010. Future legislation is likely to force foreign firms to do more
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research and development in conjunction with Chinese partners to ensure continued access to cutting-edge
engineering skills.
In a market where buyers are unashamedly experimental, brands have little value so far, except in the
luxury segment. For most buyers cost is more important. With average retail process falling by $1,250 a
year producers are racing to cut costs, not improve quality. The number of faults per 100 cars made rose
from 246 in 2005 to 338 in 2006. Reliability is likely to deteriorate further.
Chinese cars exported today mostly go to Africa, south-east Asia and the Middle East where expectations
are lower and price matters more.
Requirements
(a)
Identify, using Porter's Diamond, the sources and nature of any competitive advantage enjoyed by
Chinese car manufacturers.
(b) Recommend a strategy for Chinese car makers based on this analysis.
5 Limits to globalisation of business

Section overview
5.1
Despite the forecasts there are many impediments to the development of global businesses such as
protectionism. These are reviewed here.
Pursuing a global strategy is a source of risk to a business, either because the forecast opportunity
doesn't come about or because host governments change their policies towards 'foreign' investment
and render it no-longer valuable.
Political risks in international business

The development of plans for international business will depend on the following factors:
1.
The stability of the government. Rapid changes or political unrest make it difficult to estimate reactions
to an importer or a foreign business.
2.
International relations. The government's attitude to the firm's home government or country may
affect trading relations.
3.
The ideology of the government and its role in the economy will affect the way in which the company
may be allowed to trade, and this might be embodied in legislation.
4.
Informal relations between government officials and businesses are important in some countries.
Cultivation of the right political contacts may be essential for decisions to be made in your favour.
Political risk is still relevant with regard to overseas investment, especially in large infrastructure projects
overseas. History contains dismal tales of investment projects that went wrong, and were expropriated
(nationalised) by the local government.
Suspicion of foreign ownership is still rife, especially when prices are raised.
Opposition politicians can appeal to nationalism by claiming the government sold out to foreigners.
Governments might want to re-negotiate a deal to get a better bargain, at a later date, thereby
affecting return on investment.
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Business strategy
In addition to expropriation, there are other dangers:
Restrictions on profit repatriation (for example, for currency reasons)

'Cronyism' and corruption leading to unfair favouring of some companies over others
Arbitrary changes in taxation
Pressure group activity
Worked example: China's failure to attract new investment

In eight months (of 2006) Intel committed more money to building production capacity in Vietnam than it
committed to China in whole previous 10 years. Flextronics, a manufacturer of computer printers for
Hewlett-Packard already has vast facilities in China but it chose Malaysia for its latest investment. Yue Yuen,
a Hong-Kong based shoemaker, has been ramping up output of trainers for Nike and Adidas and production
is increasing at the firm's factories in China and Vietnam, but output in Indonesia is growing the fastest.
These companies are not alone. In the calculus of costs, risks, customers and logistics that goes into building
global operations, an increasing number of firms are coming to the conclusion that China is not necessarily
the best place to make things.
Analysts give two big reasons for why China is not top of the list for new factories.
Rising costs: Most development has taken place on China's Eastern costal strip and now costs of land,
office space, utilities and labour are rising. Firms cannot find or retain managers versed in international
production techniques and this causes rampant poaching and wage inflation.
Diversification: Many firms are reluctant to put more eggs in the same basket. Many firms are adopting a
'China + 1 other country' strategy. Risks include increasing civil disturbances in China as the have-nots get
left behind by the haves; growing protectionist talk from the USA and EU which has already resulted in
'anti-dumping duties' being imposed by the EU in October 2006. Another risk is the lack of legal protection
for intellectual property in China which has led to designs being churned out by local factories under
different brand names. Capital intensive industries where cheap labour is not so valuable, such as chemicals,
prefer Singapore. The rising currency (6.5% rise 2005-2006 and projected to rise 5% during 2007) is also
another concern because it will make exports from China less competitive.
Source: Economist January 2007
5.2
Protectionism in international trade

Protectionism is the discouraging of imports by, for example, raising tariff barriers and imposing quotas in
order to favour local producers. It is rife in agriculture.
Worked example: Sugar

Agriculture receives subsidies and government support in two of the world's most important areas, the
USA and the EU, despite the fact that this sector employs decreasing numbers of people (unlike Africa and
India, where people live on the land).
Sugar is one of the most heavily protected. According to the World Bank, reform of sugar policy could
benefit global welfare by $4.7bn pa.
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The US maintains price controls and high prices costing US consumers $2bn per year. The sugar
industry, accounting for 61,000 jobs, is an intensive lobbyist. Florida, a sensitive state electorally, is a
big culprit. The sugar lobby successfully excluded sugar from a free trade deal the US was negotiating
with Australia and CAFTA (Central American Free Trade Agreement) Some have suggested that the
sugar-lobby was behind the US's reluctance to endorse the World Health Authority's advice to limit
sugar intake.
The EU has proposed reducing its subsidies to sugar companies by 39% for 2009, owing to a WTO
ruling that the EU's subsidy regime broke legal limits.
Agriculture is a serious issue: campaigners such as Oxfam argue that opening agricultural markets to
developing country producers could significantly alleviate global poverty. Sugar might find another use, as
fuel alcohol.
Protectionist measures include:

Tariffs or customs duties: A tax on imports where the importer is required to pay either a percentage
of the value of the imported good (an ad valorem duty), or per unit of the good imported (a specific duty).
Non-tariff barriers: Restrictions on the quantity of product allowed to be imported into a country. The
restrictions can be imposed by import licences (in which case the government gets additional revenue) or
simply by granting the right to import only to certain producers.
Minimum local content rules: A specified minimum local content of products should be made in the
country or region in which they are sold to qualify as being 'home made' and so avoid other restrictions on
imports. This leads manufacturers to set up factories in the country.
Minimum prices and anti-dumping action: To stop the sale of a product in an overseas market at a
price lower than charged in the domestic market, anti-dumping measures including establishing quotas,
minimum prices or extra excise duties are used
Embargoes: A total ban or zero quota.
Subsidies for domestic producers: Financial help and assistance from government departments that give
the domestic producer a cost advantage over foreign producers in export as well as domestic markets.
Exchange controls and exchange rate policy: Regulations designed to make it difficult for importers
to obtain the currency they need to buy foreign goods.
Unofficial non-tariff barriers: Administrative controls such as slow inspection procedures or changing
product standards which are hard for foreign suppliers to anticipate and respond to.
5.3
Trade blocks and triads

Trading blocks
Currently, a number of regional trading arrangements (or 'blocks') exist, as well as global trading
arrangements. These regional trading groups take three forms.
1.
Free trade areas members in these arrangements agree to lower barriers to trade amongst
themselves.
2.
Customs unions these agree a common policy on barriers to external countries. Tariffs, taxes and
duties are harmonised amongst members.
3.
Common markets in effect, the members become one trading area. There is free movement of all
factors of production. The European Union has economic union as an aim.
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Business strategy
Some major regional trade organisations are as follows.
Name
Acronym
Participating countries
North American Free Trade Agreement

www.nafta-sec-alena.org
NAFTA
US, Canada and Mexico.
European Free Trade Association
EFTA
Norway, Switzerland, Iceland,

Liechtenstein.
European Union
http://europa.eu.int
EU
Ireland, Britain, France, Germany, Italy,

Spain, Portugal, Finland, Sweden,
Denmark, Luxembourg, Belgium, the
Netherlands, Austria, Greece. In May
2004, Poland, Hungary, the Czech
Republic, Malta, Cyprus, Estonia, Latvia,
Lithuania, Slovakia and Slovenia.
Mercosur
www.mercosur.org
Brazil, Argentina, Paraguay and Uruguay

(Chile is an associate).
Southern African Development Community

www.sadc.int
SADC
Angola, Botswana, Lesotho, Malawi,

Mozambique, Mauritius, Namibia, South
Africa, Swaziland, Tanzania, Swaziland,
Zimbabwe.
West African Economic and Monetary Union

www.uemoa.int
UEMOA
Ivory Cost, Burkina Faso, Niger, Togo,

Senegal, Benin and Mali.
South Asian Association for Regional

Co-operation
www.saarc-sec.org
SAARC
India, Pakistan, Sri Lanka, Bangladesh, the

Maldives, Bhutan and Nepal.
Andean Community
www.comunidadandina.org
Association of Southeast Asian Nations
www.aseansec.org
Venezuela, Colombia, Ecuador, Peru and

Bolivia.
ASEAN
Indonesia, Malaysia, Philippines, Singapore

and Thailand.
Regional blocks such as those shown above only extend the benefits of free trade to their members. They
may distort, and certainly do not represent, truly global trading patterns. Triad theory describes the
international business environment as a limited number of 'superblocks'.
Worked example: Trading blocks

These trading blocks differ in their degree of integration and effectiveness.
The EU is the only such block with an elected parliament and a common currency (for some of its
members). The USA has a common currency between its individual states.
The ASEAN Free Trade Area has a total population of over 500 million, and a maximum tariff of 5
percent (The Economist, 2 March 2002).
The EU has resisted the scrapping of agricultural subsidies. However, Mercosur is focusing on market
access. This renewed negotiations resulting from the failure of the WTO negotiations at Cancun, and
waning enthusiasm for a Free Trade Area of the Americas. Argentina, a member of Mercosur, is desperate
to expand exports in order to generate growth to overcome its current financial crisis. Mercosur appears
to accept that it is pointless trying to change the EU's Common Agricultural Policy.
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The Triad
Rather than a globalised world or a federalised world of trading blocks some commentators see economic
activity as principally occurring in three main economic blocks: the USA, the EU and Japan. These do the
biggest value of their trade with each other.
Triad theory rejects the idea that homogenous products can be developed and sold throughout the world.
Multinationals have to develop their products for the circumstances of each triad.
The Triad theory may be out of date. Japan was, in effect, in recession for 20 years from the mid 1980s
whilst emerging markets, particularly those of China and India, but also Brazil, are likely to be some of the
world's largest and fastest growing markets. They still have a long way to go before per capita incomes
reach the level of the Triad countries. They may form the fourth and fifth trading blocks, or perhaps the
triad will be superseded by their faster economic growth.
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Business strategy
Summary and Self-test
Summary
104
Self-test
Answer the following questions.
1
PDB Motors Ltd is a major UK car manufacturer with plants in the UK and Europe. It is seeking to
exploit both the buoyant North American and Brazilian markets for car sales.
Suggest two reasons why it would be a logical strategy for PDB Motors Ltd to build an assembly plant
in Mexico.
Social and technological factors always need to be assessed when analysing the environment within
which a business operates.
Give two examples of each of these factors which would be relevant to Busline Ltd, a UK operator of
coach tours to Scarborough and Whitby.
Suggest how each of your factors may impact future demand.
Dunvegan Ltd
Dunvegan Ltd is a forestry company operating in the UK, mainly in Scotland. In addition to forests at
various stages of maturity, the company also owns many hectares of undeveloped land.
So far Dunvegan Ltd's timber has consisted almost exclusively of spruce trees which produce
softwood used extensively in building work. Spruce sells for the equivalent of about CU200 per cubic
metre. However, genetic engineering has produced a remarkable new tree which has the growth
characteristics of spruce, but which produces hard wood with the appearance and qualities of
mahogany. This species, the Maho spruce, should grow quite happily in Scotland and produce
worthwhile crops after ten years, each Maho spruce tree producing about 2 cubic metres. Currently,
mahogany sells for the equivalent of CU900 per cubic metre.
The company which developed the Maho spruce has ensured that the trees are sterile and has also
successfully applied for world-wide patents on the genetic material. Seedlings are available only from
that company at a cost of CU200 each.
Dunvegan Ltd is considering whether to invest in Maho spruce. Land already owned by the company
would be used and the company's planting and drainage equipment would be assigned temporarily to
the project. Because the seedlings are so expensive, relatively light planting would be used at 1,500
seedlings per hectare. Annual maintenance and security would be CU1,000/hectare for each of the ten
years of the project. Dunvegan Ltd is considering planting 1,000 hectares with Maho spruce.
In the UK Dunvegan Ltd has three main competitors; mahogany is also imported from four countries
in the tropics where it is a valuable export. Some of the wood is from managed plantations, but some
is from natural forest. Recently the price of mahogany has been rising as supplies become short and
plantations have to be renewed. Dunvegan Ltd's accountant has read an article in a recent edition of
Lumber About, the monthly trade paper of the timber business, in which the economic effects of the
Maho spruce were discussed. If around 3,000-4,000 hectares were planted in the UK, then the price of
mahogany would be CU500 per cubic metre at the end of ten years. If around 2,000 hectares only
were planted, then the price would be CU800 per cubic metre.
Requirement
From the viewpoint of an independent consultant, write a memorandum to the directors of Dunvegan
Ltd on the proposed Maho spruce plantation.
Your memorandum should include an environmental analysis.
(20 marks)
Now, go back to the Learning Objectives in the Introduction. If you are satisfied that you have achieved
these objectives, please tick them off.
105
Business strategy
Answers to Self-test
1
Two reasons from the following:
This would allow PDB to take advantage of low labour costs in Mexico.
The location would be close to potential major markets, cutting transport costs and reducing
lead time.
The NAFTA will avoid sales to the USA and Canada being subject to import restrictions.
It delivers sales growth prospects to a company facing a saturated European market.
Social factors
Two examples form the following:
Increasing car ownership (lower demand)
Higher proportion of older people in society (higher demand)
Cheap overseas packages available (lower demand).
Technological factors
Two examples from the following:
Development of high speed trains (lower demand)
More comfortable coaches being developed (higher demand)
Greater internet accessibility, creating more awareness of other travel options (lower demand).
Memorandum
To
The Directors of Dunvegan Ltd
From
Independent Consultant
Date
Today
Subject Proposed Maho spruce plantation

The trading environment
The Maho spruce project is a ten-year project and it is important to try to predict how the trading
environment may change by the time the timber is ready to harvest. However, the time scale
obviously makes any predictions unreliable. The environment can first be analysed under the headings
Political, Economic, Social, Technological.
Political
Mahogany currently comes from four countries in the tropics. As it is a valuable export, these
countries can be expected to be willing to sell mahogany irrespective of local political changes.
In the UK, however, there is growing concern about the deforestation of the tropics and suspicion
about the source of many hardwoods. It is possible that the UK or EC will tighten import legislation.
Locally grown, renewable mahogany-substitute should be favoured in this ecologically-aware age.
Economic
Mahogany is principally used for building (window frames, etc) and furniture (veneers). Both of these
industries are very sensitive to the health of the economy. It is difficult to predict the economic health
of the country ten years hence and so the project will have considerable risk and uncertainty.
106
Social
If home-owning continues to grow, it is to be expected that demand for high quality materials will also
grow. As mentioned under the political paragraph, using tropical hardwoods could become socially
unacceptable and it would appear that the Maho spruce should provide a politically correct substitute.
However, some people may object to using genetically-engineered material.
Technological
Although Maho spruce has been patented, there is no reason why other manufacturers could not
develop similar products. That would drive down the cost of seedlings (a major cost of the
undertaking) and hence the price that would eventually have to be achieved to make the investment
pay.
Size of investment
The proposed investment is large, especially as there are many important factors which could change
over the project's life: the project is high risk even if not using innovative technology. Risk could be
reduced by planting over several years rather than 1,000 hectares at one time. In that way the
economics of the investment could be monitored and decisions taken about each slice of investment.
Naturally, this approach would delay the maturity of some of the crop. There is a risk that this would
reduce the final income (if mahogany prices were to fall) but prices could also rise (strong reaction
against natural mahogany, economic upturn). Delaying planting could also reduce the initial price of
seedlings as other bioengineering companies launch new products.
Summary
Insofar as environmental factors can be judged it would seem that Maho spruce should be a popular
product. The main risk arises from technological advances which could produce similar cheaper
timber.
However, the economics of the project are very dependent on the future price of Maho spruce
timber, its substitutes and the reactions of rivals.
My advice is as follows:
(i)
Attempt to get the suppliers of Maho spruce to regulate sales of the seedlings.
(ii)
Consider spreading out the investment instead of committing so much expenditure in the first
year.
107
Business strategy
Answers to Interactive questions
Answer to Interactive question 1

(a)
External factors would include:
Rival accounting firms seeking to take clients themselves

Other professional practices which may direct work toward us
Regulations such as tax laws, accounting standards and audit standards
The labour market for post-qualified and qualified accountants
The general state of the economy and its effect on business
(b) These factors create opportunities and threats. New regulations create a need for professional
advisers to provide guidance to clients. Competitors or a thriving labour market with higher pay
create threats (incidentally notice how you changed your perspective on the last point because you
would like to have the higher pay but you are calling it a threat for your firm). This illustrates how
flawed the distinction between 'internal' and 'external' is when we discuss environmental analysis.
(c)
This will depend on the managers psychological make-up. Some will see it as a tiresome bind that
makes them have to keep changing things and also which makes it hard to plan or feel certain. Others
will see it as invigorating.
A very interesting test of management is the extent to which they see themselves as powerless in the
faces of environmental changes or whether they believe they can shape and respond to them.
(d) Again, this varies. Some will avoid making decisions which could be affected by environmental
uncertainty, and will wait till it settles down (hence incrementalism). Some will simply ignore
environmental issues that cannot be proven. Perhaps a more balanced approach is to adopt strategies
that would still deliver benefit under a number of environmental developments or perhaps have
several courses of action running at the same time, with each one designed to take advantage of
different environments. In another context, energy companies invest in several different technologies
because they do not know how oil prices and environmental regulations will develop.

(a)
Oil producers adapted scenario planning techniques from their original military applications (notably in
planning for the aftermath of thermonuclear war) during the 1970s. This followed the oil price shock
when the Arab states then at the centre of OPEC massively increased the price of oil and caused
inflation and recession in industrialised Europe and North America. This decision was itself justified in
part as a response to the perceived support of oil consuming Western countries for support of the
occupation of Palestine and Egypt.
It was a response to the high turbulence (e.g. political shifts, vulnerability to economic factors etc.) and
dynamism (e.g. speed of change of political landscape) in the oil industry. Furthermore the very long
investment periods in the industry necessitated long-term strategic plans based on assumptions about
the future.
(b) Possible scenarios would incorporate a combination of:
108
War in the oil producing countries of the Middle East
Aggressive energy politics by countries such as Russia and Venezuela, holders of large reserves of
oil and gas
High energy demand from newly industrialising countries such as China and India
Increasing legislation in industrialised nations aimed at reducing use of carbon dioxide producing
fuels
Development of new energy sources such as clean coal, biomass fuel, wave and wind, and reemergence of nuclear power
Discovery of new oil or energy reserves

3
Environmental analysis
The factors in the surrounding environment obviously played a significant part in the state of the
newspaper industry at that time. They were largely external and as such outside the control of the
individual newspaper companies, resulting in a reactive approach by the companies to such factors.
(a)
Political and economic

One the major factors that influenced the industry was the recession. The industry had and still
has two main sources of income revenue from individual sales coupled with revenue from
advertising.
The tabloid newspapers were heavily reliant on advertising revenue (representing 80% of their
income) whilst the broadsheets had a more even split. Both sources, however, suffered severely
in the recession as disposable income fell. Redundancies, pay freezes, and low inflation all resulted
in a decrease in the income of the individual. The individual therefore cut back on what he
perceived to be non-essential items, which may include his newspaper. Alternatively he will
search for a cheaper alternative the tabloid or the free issue ('freebie').
Probably the broadsheets were relatively more influenced by government policies such as
increased taxes, which were aimed directly at individuals, decreasing their disposable income and
hence decreasing demand for the more expensive newspaper. This obviously resulted in the price
drop for The Times. To some extent this price drop prevented broadsheet customers deserting
to cheaper tabloids, and also hit very hard the higher priced broadsheets, such as The
Independent.
The decrease in the individual's net disposable income would have had a knock-on effect on the
advertisers: if the target market had less disposable income than previously was the case,
companies would be less willing to advertise in newspapers, as it may not have been costefficient.
The overall effect was a sharp fall in revenues for newspaper companies. In order to overcome
this the newspapers attempted to increase volume by dropping sales price, hoping that the
increased volume would compensate for the overall decrease in revenues.
(b) Social
At that time, the newspaper market was split into two distinct sections the tabloids and the
broadsheets. Historically those individuals with lower incomes tended to buy the tabloids and
those with higher incomes tended to buy the broadsheets. Furthermore, the tabloids are
intended to be sold to a more 'lower class' market than the broadsheets.
How the recession would have affected this is arguable. Some held that the 'higher class' image
attached to the broadsheets would prevent a switch by such readers to the cheaper 'lower class'
tabloid. However, the tabloid editors believed that this was not the case: people are moneydriven and the broadsheet readers would be just as price-sensitive as those of the tabloids
hence a switch would be feasible.
General levels of literacy have declined and the public are less inclined to obtain their news from
newspapers but instead rely on news bursts in the middle of radio and television programming.
(c)
Technological
Changes in technology at that time had a considerable effect on the newspaper industry. Colour
photographs, although not too recent an innovation, were considered by then to be the norm for
national newspapers and therefore became a necessity if a newspaper was to compete at a
national level. This was borne out by the experience of The Independent which initially had no
109
Business strategy
colour pictures, resulting in an uncompetitive stance. The technology required to upgrade the
paper to colour printing was very expensive, necessitating an increase in the price of the paper at
a time when a price war was emerging.
Since then the emergence of on-line services such as news websites and 24 hour-news
programming on digital TV have increased the competition to newspapers. As we live in an age
where television is the focal point of many people's lives, the accessibility of news/sport and
television information has rendered it less important for people to have a newspaper on a daily
basis.
Newspaper companies have also encountered further costs due to increased technology in the
typesetting area which is now centrally controlled and downloaded to regional areas where the
printing is done. Once again, to compete on a national basis, this has involved major capital outlay
for most companies, which has to be recouped by increased circulation, increased selling prices
or increased efficiencies.
Given that newspapers are often bought to while away boredom on journeys to and from work
etc the development of compact multimedia devices such as MP3 music and video players will
reduce the casual purchase of newspapers.
(d) Ecological
Newspaper production and distribution has many ecological impacts. The raw material is timber
and the manufacture of paper involves large amounts of water and bleaches. Print ink was solvent
based originally. It is an industry that requires substantial logistics and so leaves a carbon
footprint.
Regulations affecting pollutants, the recycling of paper, and the carbon emissions from a business
would impact sharply on the costs of the newspaper industry.
(e)
Legal
During the recession, in order to boost sales, the tabloids in particular tended to search for
more 'popular' stories such as the Royal family and scandals about prominent people. This,
however, resulted in an increase in law suits, as a struggle emerged as to whether the private
lives of prominent individuals were indeed 'private'. The current ruling is that anything that is in
the public interest may be published. However, there remains a grey area as to what is in the
'public interest'.
This was then coupled with the manoeuvring by newspapers on the issue of publishing sensitive
photographs. Some published in order to obtain a short-term boost to their circulation whereas
others decided to publish their 'disgust at those seizing the opportunity' in the hope of a longerterm increase in circulation.
The legal issues surrounding the competitive nature of the industry also came to the fore,
particularly as to whether the price cuts were an attempt at predatory pricing in order to force a
competitor out of business.
Conclusion
The newspaper industry was in a particularly turbulent phase in the 1990s. This was mainly caused by
the recession and the effect this had on disposable incomes. Moreover, with technology everimproving since that time, television and radio have taken increasing shares of the media market away
from newspapers.

Levitt cited examples such as Coca-Cola in his article. More recently, examples such as Starbucks, Mercedes
Benz, Microsoft and Disney have been called global businesses.
In practice, these corporations offer subtly different products in different markets and their appeal is not
global. For example, Coca-Cola has suffered badly from an anti-American sentiment and Disney has not
been as successful in Europe as it had hoped.
110

The reasons cited for geographical clustering of Financial and IT businesses are:
Proximity to educational and research centres. For example, in USA the IT industry clusters around its
universities.
Networking and mutual exchanging of staff.

(a)
The scenario suggests the following sources of the Cost Leadership advantages enjoyed by the Chinese
car industry:
1.
Demand conditions: China is a very large market (third largest) and fast growing. This enables
firms to gain significant economies of scale and also to justify investment in the new models (100
next year) and production equipment. With the exception of the luxury segment the demand is
for low price cars and this has forced car makers to concentrate on reducing costs.
2.
Related industries: The only cited example is the assistance from universities in R&D. This
provides significant cost advantages compared with in-house development. The low price of the
Shanghai Maple suggests that steel and other components are being sourced cheaply too.
3.
Factor conditions: China clearly has a good technical education system. It is also known for
having abundant cheap labour and land available for building car plants. It has good sea links and
freight handling for the purposes of exporting.
4.
Firm strategy, structure and rivalry: The scenario mentions only three firms which, between
them, share 27% of the Chinese market. The Chinese government wishes this to increase to 50%.
This will give each significant economies of scale and an incentive to invest in product and
process improvement. That foreign-made cars are allowed into China gives a stimulus to product
development and the search for competitive advantage. It is noticeable that the predominant
mode of competition is price/cost and not quality. The industry seeks to build a me-too version
of a foreign car but at a lower price.
(b) The attempt by Chinese car manufacturers to go 'up-market' and develop unique designs and
distinctive brands for export is a mistake. It suggests a vanity that could sacrifice the industry's
competitive advantage.
The appropriate strategy for the industry is to remain a low cost player. It has huge internal markets
available to it that value its present offerings. Its low cost position may enable it to focus on export
markets such as other developing economies where low cost is also important. However its
advantages are location specific and it should access these markets by exporting rather than, say,
setting up factories outside China.
The poor quality of its products should be addressed. The number of faults is rising and by giving a
two-year warranty the firms are bearing the substantial costs of rectifying these. It may be cheaper to
stop the faults happening than it is to fix them and it would improve customer perception at home and
abroad.
111
Business strategy
112

Chap - 3 The Macro Envioronment

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Chap - 3 The Macro Envioronment

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chapter 3

The macro environment

The business environment

The international business context

Limits to globalisation of business

Summary and Self-test

The Institute of Chartered Accountants in England and Wales, March 2009

Global macroeconomic forces

International trade and financial systems

Identify the risks attached to operating a global business

Specific syllabus references for this chapter are: 1b, 3g.

Stop and think

The Institute of Chartered Accountants in England and Wales, March 2009

THE MACRO ENVIRONMENT

The Institute of Chartered Accountants in England and Wales, March 2009

1 The business environment

Importance of management understanding business environment

Attractive as a place to work for its staff

Satisfying the needs of other powerful or influential stakeholders

The Institute of Chartered Accountants in England and Wales, March 2009

THE MACRO ENVIRONMENT

Interactive question 1 Considering the business environment

What are the main external factors, in your view?

In your view, how do managers perceive the environment of the organisation?

Gathering and disseminating environmental information

Gathers environmental information

Validates and corroborates the information

The Institute of Chartered Accountants in England and Wales, March 2009

Sources of environmental information

External sources include:

Published accounts of rivals, suppliers and clients

Government statistical reports

On-line resources: Subscriptions to business information vendors, current awareness services

Validating environmental information

Issues to consider in validating environmental information include:

Forecasting and predictive record in the past

Age of the information: how up to date is it?

Disseminating environmental information

A well designed intranet with clear files and a search facility

Periodic briefing reports with a digest of the most significant information

Periodic seminars to brief management

The Institute of Chartered Accountants in England and Wales, March 2009

THE MACRO ENVIRONMENT

Complexity, predictability and turbulence

Lynch (Corporate Strategy) presents turbulence as

The Institute of Chartered Accountants in England and Wales, March 2009

Interactive question 2: Oil industry scenarios

[Difficulty level: Intermediate]

Oil producers use scenario planning extensively.

Later sections extend analysis to the global business environment.

The Institute of Chartered Accountants in England and Wales, March 2009

THE MACRO ENVIRONMENT

PESTEL analysis and underlying assumptions

Worked example: Software in India

The Institute of Chartered Accountants in England and Wales, March 2009

Worked example: Oil companies in Russia

The Institute of Chartered Accountants in England and Wales, March 2009

THE MACRO ENVIRONMENT

Sources of political risk

This covers government stability, international relations, the ideology of the

Consumer/basic products. High-tech components may have national security or

Size, connections, reputation, influence on the environment.

Managing political risk