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Paper P3: Business Analysis

ACCA Paper P3: BUSINESS ANALYSIS Study Textbook
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Copyright statement For the ladies only Why study from a computer screen? Memorising: Tips and techniques Writing or saying things over and over again …. Vocalising Initial letters and making phrases The use of mnemonics The use of jingles Word association Visualising Link/story technique Do I need to memorise all your mnemonics? Disguise your use of mnemonics in the exam Charts Colour codes Electronic links within the database Our results speak for themselves …

ACCA Paper P3 Business Analysis Study Text

Syllabus
The structure of the syllabus Learning hours Guide to exam structure Guide to examination assessment Aim Main capabilities Relational diagram of main capabilities Rationale Detailed syllabus Approach to examining the syllabus

Study Guide
A B C D E F G H I Strategic position Strategic choices Strategic action Business process change Information technology Quality issues Project management Financial analysis People

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Contents (with screen references)

Tutorial 1: Strategic position: Environmental aspects Tutorial 2: Strategic position: Internal resources and stakeholders Tutorial 3: Strategic choices: The influence of corporate strategy on the organisation Tutorial 4: Strategic choices: Alternative ways of achieving competitive strategy Tutorial 5: Strategic choices: Alternative directions and methods of development Tutorial 6: Strategic action Tutorial 7: Business process change Tutorial 8: Information technology Tutorial 9: Quality issues Tutorial 10: Project management Tutorial 11: Financial analysis Tutorial 12: People Route map of F1 revision

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“Where shall I begin, please your majesty?” he asked. “Begin at the beginning,” the king said gravely, “and go on till you come to the end: then stop.” Lewis Carroll Through the Looking-Glass

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Tutorial 1 Strategic position: Environmental aspects

ACCA Paper P3 Business Analysis
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In this tutorial

              .  

Fundamental nature and vocabulary of strategy and strategic decisions. How strategy may be formulated at different levels (corporate, business level, operational) of an organisation. Johnson, Scholes and Whittingham’s model for defining elements of management. How strategic management is affected by different organisational contexts. A comparison of three strategic lens for viewing and understanding strategy. The scope of business analysis and its relationship to strategy and strategic management in the context of the relational diagram of this syllabus. The macro-environment of an organisation using PESTEL. Key drivers of change likely to affect the structure of a sector or market. Porter’s Diamond. Preparing scenarios that reflect different assumptions about the future environment of an organisation. Significance of industry, sector and convergence. Sources of competition in an industry or sector using Porter’s five forces framework. Contribution of the lifecycle model and the cycle of competition to understanding competitor behaviour. The influence of strategic groups and market segmentation. Establishing critical success factors for products and services. The role of the value chain in creating and sustaining competitive advantage. Different approaches to benchmarking an organisation’s performance.

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The need for, and purpose of, strategic and business analysis
1. The fundamental nature and vocabulary of strategy and strategic decisions (a) What is strategy? The work "strategy" originates from a Greek word meaning the art of planning and conducting a war, something akin to "generalship". From there the word has been stretched to cover the business field - the art of preparing and conducting a business plan. There are two distinct stages to strategy, namely - the planning or development stage, and - the stage when the plan is carried out - the execution stage. The former is no good without the latter, and vice versa. Roughly speaking, strategic planning is for the generals and other 'top brass', whereas execution is for 'foot soldiers' and more lowly employees (b) Strategy versus tactics The terms strategy and tactics are often confused: strategy is the overall plan, which may involve complex patterns of individual tactics, while tactics are the actual means used to achieve the strategy. If, for example, the overall goal is to build the customer base, one strategy might be to take customers from a competitor. The tactics involved might describe specific actions to be taken such as a price strike, advertising and promotion campaign, distribution network build and so on, and the specific techniques and methods involved in accomplishing such objectives. The differences might be remembered as: Strategy is what to do ...... Tactics is how to do Strategy is end ...... Tactics is means (c) Strategic development Once a policy decision has determined the long-term objectives for the company as a whole, it becomes the task of senior managers to decide the best way in which to achieve these over the following few years. Unless a policy decision has been made which severely limits the field of study for the strategists, their task will be complex, for the time-span they will be considering may be long enough to allow the complete reorientation of the entire organisation ('transformation strategy') and its resources. They will need to consider the desirability of certain product-market ploys the need for introducing new product lines the location of production sites changes required in the organisational structure of the company

and many other complex and far-reaching factors.
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The range of choice facing strategists is always wide and the elements of uncertainty associated with data upon which they must rely is also large. (d) Tactics (again) Once the strategy is approved, each part of the plan becomes the responsibility of an executive (or team of executives) who may then take a series of tactical decisions in order to implement or, within the limits of his/her authority, modify the strategy. Real-world example 'The Vietnam War was lost on the ground in Vietnam, not in Washington.' Source: Unknown End of Real-world example 2. How strategy is formulated at different levels (corporate, business level, operational) of an organisation The need for strategy to guide policy and set direction is self-evident, particularly where the situation is complex, the choices many and the information scarce and ambiguous. But what of the strategyformulating process, which so obviously differs from company to company and situation to situation. It is, perhaps, useful to distinguish different approaches to strategic thinking; indeed to suggest a stagetheoretical view as firms grow and mature, and evolve in their strategic processes. For study convenience let us first follow this evolution through three stages: - the 'entrepreneurial' stage - the 'departmentalisation' stage - the 'business-orientated planning' stage (a) The entrepreneurial stage At the entrepreneurial stage of enterprise one person dominates strategic thinking. His or her image is seen throughout the business which often bears his/her name. Usually he/she is the ownermanager. At most a handful of people are involved in longer-term thinking. Real-world example: Sakiya Any account of Honda's successes must grasp at the outset the unusual character of its founder, Soichiro Honda was an inventive genius with a large ego and mercurial temperament, given to bouts of 'philandering' (to use his expression). In the formative stages of his company, Honda is variously reported to have tossed a geisha out of a second-storey window, climbed inside a septic tank to retrieve a visiting supplier's false teeth (and subsequently placed the teeth in his own mouth), appeared inebriated and in costume before a formal presentation to Honda's bankers requesting finance vital to the firm's survival (the loan was denied), hit a worker on the head with a wrench, and stripped naked before his engineers to assemble a motorcycle engine. Honda spent most of his time at the factory and the research laboratory, teaching plant employees and engineers about technology. (Source: Sakiya, T,. 'Honda Motor: The Men, The Management, The Machines', Kodansha International, 1982.) End of Real-world example
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Real-world example: Ries and Trout 'Entrepreneurs are down at the front. Their ideas and concepts tend to spring from their own personal experiences. They have the power to make decisions since they don't have to seek the approval of others.‘ Source: Ries, A., Trout, J., 'Bottom-up marketing', (Plume 1990) End of Real-world example

Strategy is seldom explicit in the entrepreneurial firm. (In other words it is not recorded or documented.) Entrepreneurs carry ideas in their head. They know the business environment and is in direct touch with it. The entrepreneur visits customers, contracts with suppliers, negotiates with the bankers and knows the competitors. There is no need for involved management information systems or complicated calculations; the manager is his/her own information system. Consequently the situation has to be seen in relatively simple terms. As long as the entrepreneur can cope with the complexity and handle the forces in his/her competitive setting, this can be a very successful basis for strategy formulation. (After all look at the success of Honda!) Typically strategy emerges from a pattern of behaviour, without deliberate or intended strategy, based on the short-term. (Some writers refer to this process of planning as representing '.) Because of the close involvement of the owner-manager the strategy usually produces a rational outcome. The underlying perception of the business is as a series of ad hoc deals, a succession of contracts or ventures, rather than a dominant strategy to create a market. Consequently such firms are often dependent on a handful of customers for whom they provide a customised service, such as manufacture to order. There is seldom a research and development function, a marketing function, management accountants or expenditure on product or market development. There is an element of intuition and hunch, a reliance on good fortune, which is less apparent in larger firms who rely, at least overtly, on more analysis and qualitative planning. These characteristics are, obviously, highly generalised in this brief discussion. They are well substantiated in a wealth of serious research undertaken by Henry Mintzberg, and others. Real-world example: Mintzberg 'Planning, plans, and planners are likely to meet considerable resistance in the entrepreneurial form of organisation..... Serious planning may get in the leader's way, impeding free movement ...... .' Source: Mintzberg, H., 'The rise and fall of strategic planning', (Prentice-Hall, 1994) End of Real-world example Such firms may be under pressure to change as enterprises grow, become more complex in their products and services, more diverse in their procurement and production processes, more geographically spread in their markets and large in their organisational scope.
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Real-world example: Mintzberg 'Of course, as the entrepreneurial organisation grows, settles down, and begins to take on the machine form [a 'Mintzberg term that we will discuss later], the visionary strategy of the leader may be pinned down through strategic programming, and so the influence of the planners may have to increase accordingly.' Source: Mintzberg, H., 'The rise and fall of strategic planning', (Prentice-Hall, 1994) End of Real-world example (b) Department strategy As enterprises grow and increase in complexity, formalisation and professionalism tend to occur. Many responsibilities are delegated in departments, usually 'functional' departments. Budgetary planning and control methods are introduced to help cope with the complexity, and departmental responsibilities are located in cost and responsibility centres. Managers are involved and held accountable. The main effect of such a management process is, however, that decision making (and thus planning) is, to a degree, decentralised into possibly three hierarchies: (1) the senior level [directors], (2) the departmental (or functional) level [executives], and (3) the operating management level [junior managers/supervisors]. Strategy, it could be said, has become multilayered. System and order have been imposed, very necessarily, on the entrepreneurial excesses. But the focus of attention has shifted into the business from its environment, although the main problem is that the time horizon of budgetary control methods, typically a year, may be inappropriate for strategic decision making on new investments, markets, technologies and products. Because of the nature of the planning process, strategy here tends to produce an incremental (as opposed to 'rational‘) outcome. To meet this criticism some firms attempt to roll forward their annual plans for three or even five years. Still seeking forecasts of volumes and levels of activity in the years ahead, still attempting to predict revenues, costs, profits and cash flows. (This is the essence of the term, 'long-term planning'!) Unfortunately, in rapidly changing technological, market and economic conditions, such long term plans (or strategy?) become less and less reliable and hence less useful as a basis for strategic decisions. Also because they are based on the accountancy model of business (with the use of decision making techniques such as DCF, etc.), they lack a sense of customer expectation and competitor potential. However, by the nature of what long-term planning represents, strategy is intended (or deliberate) It is at this stage, it has to be said, when one hears complaints of the company being 'driven by planners, analysts and accountants'. (c) Business-orientated planning As firms grow they find themselves operating in numerous different businesses. A business can be defined, according to Abell, in terms of three dimensions: customer groups, customer needs, and technology. Companies identify their separate businesses in order to manage them strategically. The approach adopted is to look ahead, with a time horizon appropriate to the particular business (for example, quite short in the fashion industry, quite long in forestry) to identify possible future scenarios, for each separate business.
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The market-orientated (or positioning) approach to planning forces decisions on whether the business should be: - developing its existing products and services to its existing customers; - extending through market development to provide existing products to new customers; - extending with new products to existing customers; or/and - growing in a diversification mode with essentially new products in a new market place. Thus emerges the strategic business unit (SBU), a term often used in relation to business strategy. SBU means a unit within the overall corporate entity for which there is an external market for its goods and services and which is distinct from that of another SBU. For the sake of clarity it is useful to consider business strategy at the level of the distinct market. Real-world example: Strategic business units The concept of the Strategic Business Unit (SBU) was devised by General Electric (GE) of America. In the 1960s GE found that despite substantial growth in sales, its profits were not increasing proportionately. GE's top management came to realise that one of the major causes of the inadequate profits was the complexity and number of its product-markets and the lack of balance between them. Accordingly, therefore, in 1971, it restructured its 170 or so departments into just fifty Strategic Business Units. Other large companies were later to imitate GE by applying the concept. Real-world example: Strategic business units Campbell Soup Company established eight SBUs: soups, beverages, pet foods, frozen foods, fresh produce, main meals, grocery, and food service. End of Real-world examples

The characteristics of this form of multilayered management structure, is that planning and decision making may take place at four distinct levels: (i) Corporate strategy (senior management involved in corporate management, setting corporate objectives, and agreeing the investment balance between the different business units [portfolio management]). Business strategy (SBU and divisional management concerned with product-market positioning, capital programmes, and so on). Functional strategy (functional [departmental] management involved with functional strategies and functional budgets, etc.) Operating management (junior management concerned with day to day operations, meeting sales targets, cost reduction goals, and so on).

(ii)

(iii)

(iv)

Figure 1.1 (on the next screen) summarises the different levels of strategy.

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Paper P3: Business Analysis       Business portfolio management Liaison with Stock Exchange/shareholders Corporate treasury management Maximising corporate core competence Coordinating work within different SBUs Managing the effectiveness of SBU management  ‘Fronting’ the company – public relations, etc.

Figure 1.1: Different levels of strategy
      Competitive strategy Market penetration strategy Product development strategy Market development strategy Achieving agreed targets Management of human and other resources  Management of the unit’s investments  Liaison with the corporate board
Corporate strategy (Corporate management

Business strategy (SBU management)
    Budgets Planning programmes Project planning Resource planning

Departmental tactics and plans (Executive management)
 Action plans

Operational (day-to-day) plans (Junior managers)

3.

The Johnson, Scholes and Whittington model for defining elements of strategic management Most writers would agree that there is no unique formula for the development of strategy. However, in accordance with the views of Johnson, Scholes and Whittington, and numerous other writers, it is still possible to identify three key elements of almost all different forms of strategic management. As Figure 1.2 (below) shows, the three elements are: - strategic position analysis - strategic choices - strategy into action (in other words, the implementation of the strategy)

Strategic position analysis

Strategic choices

Strategy into action (Strategy implementation)

Figure 1.2:The elements of strategic management

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(a) Strategic position analysis Strategic analysis is concerned with understanding the strategic position of the organisation, i.e. - the current strategic position, and - the predicted future strategic position A strategic position audit takes account of both external environmental factors and internal resources. The aim of strategic position analysis is to form a view of the key influences on the present and future prosperity of the enterprise and therefore on the choice of strategy. Real-world example: Drucker 'The basic business analysis starts with an examination of the business as it is now, the business as it has been bequeathed to us by the decisions, actions and results of the past. We need to see the hard skeleton, the basic stuff that is the economic structure. We need to see the relationship, and inter- relationship of resources and results, of efforts and achievements, of revenues and costs'. (Source: Drucker, P., 'Managing for Results', Pan, 1973.) End of Real-world example Tutorial comment 1. "Before you know where you are going, first you must know who you are and where you've come from." (A statement from the Jewish faith) 2. "All the business of war, and indeed all the business of life, is to endeavour to find out what you don't know by what you do; that's what I called 'guessing what was on the other side of the hill". (Lord Wellington) End of tutorial comment Definition: Position audit 'Part of the planning process which examines the current state of the entity in respect of: (a) resources of tangible and intangible assets and finance; (b) products, brands and markets; (c) operating systems such as production and distribution; (d) internal organisation; (e) current results; (f) returns to stockholders.' (Source: 'Management Accounting, Official Terminology of the CIMA‘, CIMA) End of Definition (b) Strategic choices The aspect of strategic choice can be conceived of as having three parts: - generation of strategic options - evaluation of the strategic options - selection of an appropriate strategy.
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(c) Strategy into action (implementation) Implementation of strategy can be thought of as having several parts: 4. resource planning organisational structure development systems development managing change

How strategic management is affected by different organisational contexts We have already seen how strategy and strategic development processes often evolve as organisations change. Figure 1.3 helps by summarising the organisational contexts which may be involved. Strategic processes (Contingent on types of enterprise)
 Centralised planning.  Power culture.  ‘Small company’ organisation and finance.  Informal systems.  Entrepreneurial thrust of owners.  Mix of centralised/decentralised planning and decision making.  Role/task culture.  More formality within systems.  Entrepreneurship reserved for Board.

Figure 1.3: The organisational contexts of strategic development

Small (or embryonic) enterprise

 Strategy emerges from learning.  Strategy often emerges due to short-run pressures/events.  Strategy has a short-run focus.  Strategic aims are cash related.

Mediumsized enterprise

 Centralised (corporate) strategy.  Decentralised (divisional) business strategy.  Formal systems.  Entrepreneurship decentralised in business units.

Large to very large enterprise

 Use of formal planning system.  More focus on long-term aims.  Use of sophisticated planning techniques.  Strategy is mainly ‘deliberate’ – but there may also be emergent strategy.  Strategic aims are earnings-based.

 Entrepreneurship decentralised in territorial business planning and/or execution units.

Multinational enterprise

ACCOUNTING SYSTEMS (Strategic management accounting systems (SMAS) and Management accounting information systems (MAIS) adapt to meet the need of the situation (‘contingency theory’.)) Copyright: Tony Surridge Online Limited, 2010

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The 'Relational diagram of main capabilities‘ (of the Syllabus) demonstrates how the various parts of the syllabus for Paper P3, Business Analysis are interrelated. It suggests that there are three organisational layers: (a) the top layer the middle layer the bottom layer The top layer The 'top layer' of the relational diagram reflects the vocabulary of Johnson, Scholes and Whittington. The syllabus begins with an assessment of the strategic position of an organisation, before moving on to consider the strategic choices available to it. Finally, strategic action concerns the implementation of strategic choices through appropriate organisational actions. (b) The middle layer The 'middle layer' is an expansion of the implementation of strategy. Understanding the strategic position of an organisation, and considering the strategic choices open to it, are of little value unless the preferred strategies can be turned into organisational action. Johnson, Scholes and Whittington acknowledge that 'such action takes form in the day-to-day procedures and relationships that exist in organisations'. Furthermore, strategies may emerge from these day-to-day activities, and the inclusion of this 'middle layer' (and indeed the 'bottom layer') should give students of this subject more opportunity to reflect on strategy as an emergent, rather than a designed activity. The focus of the 'middle layer' is on process redesign and automation, the e-business application of information technology, and the role of quality - both as a threshold value and a differentiator. It is perceived that these three elements are also interconnected. For example, many process redesign initiatives use information technology to achieve improvements in product or service quality. All three elements require effective project management. Finally, strategic position, choices and implementation are all subject to financial benchmarks. Financial analysis explicitly recognises this, reminding exam candidates of the importance of focusing on the key ratios and measures that may be used to assess the position of an organisation, the viability of a selected strategy, and the monitoring and measuring of its success. This builds on capabilities defined in Paper F7, Financial Reporting and Paper F9, Financial Management. (c) The bottom layer The 'bottom layer' of the relational diagram recognises that successful strategic planning and implementation requires the effective recruitment, training, motivation, and organisation of people. Tutorial comment The text in the last section, referring to 'The relational diagram of this syllabus' was reproduced from the article "Examiner's approach to Paper P3" by the examiner, Steve Skidmore (26 January, 2008). End of tutorial comment
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5.

Three different strategic lenses Strategic lenses are a concept of strategic management. They are three angles or visions from which strategy can be viewed and implemented on a corporate level. They are: - strategy as design - strategy as experience - strategy as ideas (a) Strategy as design This is a logical analytical process which views strategic development as a process of logical determinism. Through careful evaluation of the firm's industry, environment and available resources, the optimum strategy and clear direction can be determined. The strategic process thus follows an analysis - selection - implementation sequence. Fundamental to this view is that the responsibility of strategy development is top-management driven and that they are capable of choosing the optimal strategy for the business. (b) Strategy as experience Many proponents of the view of strategy as design, such as Mintzberg, would argue that the design lens is often inaccurate as top executives are too distant from daily developments of the enterprise. According to Mintzberg, strategic development should be adaptive, and divides into intended, realised and emergent strategies. In this model, strategic development is the continuous adaptation of past strategies based on experience. This view of strategy is greatly influenced by taken-for-granted assumptions (culture) and involves high levels of bargaining and negotiation. Management pay close attention over time to what does work and what doesn't work. They incorporate these "lessons learned" into their overall plan of action. The world is too complex to allow strategies to be developed all at once. Hence a strategy must emerge from experience in small steps, as an organisation adapts or "learns". (c) Strategy as ideas This lens spawned from the fact that innovation is taken for granted under the design view. The imposition of new strategy on employees under the design view leads to conformity which can often stifle innovation. In industries with short business cycles and fast technological advances, innovation is an essential ingredient for competitive advantage. The Ideas lens attempts to provide an approach to utilise the innovation of the firm. It places a strong emphasis on the importance of variety and diversity for innovation. It actively seeks out emergent strategy from within and around the organisation. As opposed to creating strategy, senior management instead create the conditions to foster and encourage innovative thinking and creative development.

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Real-world example: Ohmae 'But they [Japanese companies] have an intuitive grasp of the basic elements of strategy. They have an idiosyncratic mode of thinking in which company, customers, and competition merge in dynamic interaction out of which a comprehensive set of objectives and plans for action eventually crystallizes.' (Source: Ohmae, K., 'The Mind of the Strategist', Penguin)

Real-world example: Peters 'What is a good strategic plan? There is none. But there is a good strategic planning process. A good strategic planning process (1) gets everyone involved, (2) is not constrained by overall corporate "assumptions" (e.g. about the general economics picture), (3) is perpetually fresh, forcing the asking of new questions, (4) is not left to the planners, and (5) requires lots of noodling time and vigorous debate.' (Source: Peters, T., 'Thriving On Chaos', Pan)

Real-world example: Ford’s Taurus/Sable programme In the successful Taurus/Sable programme, Ford purchased cars from around the world. They assessed over 400 features, from major performance parameters to the ease with which petrol caps could be removed. The objective was to become Best in Class (BIC) on most of these features; with a creative mix of copying and marginal improvement, Ford feels it reached BIC status on 80 percent of the 400. (Source: Peters, T., 'Thriving On Chaos', Pan) End of Real-world examples 6. The scope of business analysis and its relationship to strategy and strategic management Business analysis helps an organisation to improve how it conducts its strategy, functions and activities in order to better support customers, provide more efficient use of resources, and reduce overall costs. As the scope of business analysis is very wide, there has been a tendency for business analysts to specialise in one of the three sets of activities which constitute the scope of business analysis: - strategist - architect - systems analyst (a) Strategist Organisations need on strategic matters is on a more or less continuous basis in modern business environments. Business analyst, in the strategic area, are well-versed in analysing the strategic profile of the organisation and its environment, advising senior management on suitable policies, and the effect of policy decisions. (b) Architect Organisations need to introduce change to solve business problems which have been identified by the strategic analysis, just referred to. Business analysts contribute by analysing objectives, processes and resources, and suggesting ways by which business process re-design (BPR), or business process improvements (BPI) could be made. Particular skills of this type of analyst are
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"soft skills", such as the knowledge of the business, requirements engineering, stakeholder analysis, and some "hard skills", such as business process modeling. Although the role requires an awareness of technology and its uses, it is not an IT-focused role. Three elements are essential to this aspects of the business analysis effort: the redesign of core business processes; the application of enabling technologies to support the new core processes; and the management of organisational change. This aspects of business analysis is also called 'business process improvement (BPI), or business process re-engineering (BPR). (c) Systems analyst There is a need to align IT Development with the systems actually running in the business. A long-standing problem in business is how to get the best return from IT investments, which are generally very expensive and of critical, often strategic, importance. IT departments, aware of the problem, often create a business analyst role to better understand, and define the requirements for their IT systems.

Environmental issues affecting the strategic position of an organisation
(i) The uncontrollables We shall now consider some of the most basic forces that affect the structure, conduct, and performance of organisations' strategic planning systems. These forces make up the business environment. They have a great impact on the company, while the reverse is seldom true. They are the 'uncontrollables', to which organisations adapt through setting the 'controllable' factors, their strategies.

Real-world example: Competing in a world of rapidly changing technologies can be likened to playing a video game. The target constantly moves, and new opponents zoom in from various sectors. Focusing solely on one target sometimes means losing the game to an unexpected foe that has been overlooked in the fray. To play the game well, a new set of skills is required: heightened reflexes plus the ability to anticipate challenges and to make fast, rational challenges. (Source: Foster, R., '‘Business Week”)

Real-world example: Baby-food producers The baby-food producers in Europe, companies such as Gerber, and Cow & Gate, failed to anticipate the full impact that the declining birth rates and changing positive attitude of women to breast-feeding babies would have on their market. The European market for baby-foods fell by about 5% in real terms over the five year period 1976-1980. Exports to the developing countries had also grown very slowly. By failing to spot and act on these trends the industry was plunged into disorder. End of Real-world examples

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(ii) Are usually external factors The business environment, then, is the set of elements that affect the organisation, but are not controlled by it. Though clearly relevant to the organisation, they are regarded as falling outside its boundary (in other words, factors which are external to the organisation). Obviously, there are some factors within the organisation over which management have little control and some writers refer to these as forming part of the internal environment. (iii) The influence of the environment on strategy development Environmental factors play an important role in the value creation opportunities of a strategy. They usually exert four influences on the way a strategy is formulated as shown in Figure 1.4 (below):

1

Customers

The environment contains customers and other interest or ‘pressure groups’.

2

Competitors

The environment includes competitors who represent potential direct threat. The environment is the source of organisational resources because human resources come from outside the organisation, as do supplies and funds generally. The environment offers opportunities and present threats.

3

Organisational resources

4

Macro ‘Opportunities and Threats’

Figure 1.4: Environmental influences on a strategy

The practical implications are that each organisation faces a particular environmental outlook that is contingent upon its industry, products-markets, stage of life-cycle, size, use of technology and the convulsion and complexity of its business environment. Examples of how the extent of change and complexity of a business environment can affect the strategic development process are shown in Figure 1.5 and instances of different types of businesses operating in the different environmental vectors outlined in Figure 1.5 are shown in Figure 1.6. (iv) Micro- and macro- environments and the business domain An organisation's environment can be split into (a) micro-environment and (b) macro-environment depending on the domain it stakes out for itself. This is shown in Figure 1.7.

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Simple environment is where few environmental factors change

This environment changes slowly and has little force

Dynamic means change that may force the organisation to also change

EXTENT OF CHANGE IN THE ENVIRONMENT STABLE ENVIRONMENT • Emphasis on tactical/ operational aspects • Planning is relatively simple • Change is usually incremental • Historic perspective is important • Economy and efficiency is more important than doing new things • Inside-outside (resource-based) strategic focus • Central (single-level) strategy DYNAMIC ENVIRONMENT • Central (single-level) strategy • Investment focused on riskassessment and riskassessment and riskmanagement management • Usually strategy is incremental butbut might be transformational might be transformational

COMPLEXITY OF THE ENVIRONMENT

SIMPLE ENVIRONMENT

A complex environment is where many environmental factors (segments) might change

Figure 1.5: Extent of change and complexity of business environments

COMPLEX ENVIRONMENT

• Central (single-level) strategy with with decentralised (divisional) decentralised (divisional) execution. Possible following execution. Mintzberg’s ‘Missionary’ Possible following Mintzberg’s structure ‘Missionary’ structure

• Strategic development is a continuous need • Sophisticated planning techniques are used • Transformational strategy may be required • Current intelligence and future projections are important • Creativity/innovation and new product-market initiatives are vital • Outside-inside (market-based) strategic focus • Divisional (multi-level) businessunit strategy formulation

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EXTENT OF CHANGE IN THE ENVIRONMENT STABLE ENVIRONMENT
• Stable with minor fluctuations A local government school will adopt a set of procedures for educating children, only having to adjust its operations to respond to changing regulations and guidelines or to adjust its scale to accommodate the changing numbers in the school. • Gradually changing in a predictable way With the predictable changes in the values of women the Girl Guide Movement gradually shifted its programmes toward developing the ‘new woman’ rather than the ‘future wife and mother’. • Stable but with a complex environment A railway company often operates in an environment characterised by seasonal fluctuations within a fairly stable mechanistic structure. The PESTEL factors are numerous. • Rapidly changing in an unpredictable fashion The UK National Heath Service (NHS) in recent years has endured a succession of shocks and surprises – private medicare, fast-changing medical technology, in-depth appraisal of its performance by the Audit Commission, new government policies and controls, rising costs and ‘consumerism’.

DYNAMIC ENVIRONMENT
• A soft-drink marketer may operate in a dynamic environment but one with few environmental uncertainties.

COMPLEXITY OF THE ENVIRONMENT

Figure 1.6: Examples of the extent of change and complexity of business environments

COMPLEX ENVIRONMENT

SIMPLE ENVIRONMENT

It is useless to tell a river to stop running; the best thing is to learn how to swim in the direction it is flowing. Anonymous

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Macro-environment
Those components of the environment that affect many businesses in the economy as a whole and may potentially affect a particular organisation but whose relevance is not specific as a particular time. They are broad forces (PESTEL) which we cover later. The effect of macro factors is usually less immediate than direct ones.

Domain
What an organisation stakes out for itself with respect to the range of products or services offered and markets served. An organisation’s domain determines those parts of the business environment that are ‘micro’ or ‘macro’.

MACROENVIRONMENT

MICROENVIRONMENT

Example: The UK ‘Sun’ newspaper has a different business domain than the (London) ‘Times’ newspaper.

Micro-environment That part of the business environment that is directly relevant to an industry or market and is therefore relevant for the organisation is achieving its goals. It usually contains:  customers  competitors  stakeholders but depending on the organisation’s domain can include other factors.

Figure 1.7: Divisions of the business environment

1.

The macro-environment of an organisation using PESTEL (a) PESTEL Analysis PESTEL Analysis is a framework that strategy consultants use to scan the external macroenvironment in which an organisation operates. PESTEL is an acronym for the factors shown in Figure 1.8 (on the next screen).

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P E S T E L

Political factors Economic factors Social factors Technological factors Ecological (natural, ‘green) factors Legal factors

Figure 1.8: PESTEL factors

In Table 1.1 (on the next page) we find examples of each of the PESTEL factors. Remember, macro-environmental factors can differ per continent, country or even region, so normally a PESTEL Analysis should be performed on a geographical basis. (b) Conducting a PESTEL Analysis Completing a PESTEL Analysis is relatively simple, and can be done by: - workshops - using brain-storming techniques - conditioned and directed research. (c) Using a PESTEL Analysis The usage of PESTEL analysis can vary depending on the industry, business, strategic development approach or market planning method. In general terms, PESTEL Analysis aids the following important stages of strategic development: 2. 'current position' auditing future position projection formulation of strategic proposals evaluation of strategic proposals

Key drivers of change likely to affect the structure of a sector or market We have seen that the business environment consists of those factors that can affect an organisation's operations, but which its management have little or no power to influence or control. An organisation can be thought of as an open system which is influenced by a complex political, economic, social, technological, ecological and legal structure of variables which can change, sometimes suddenly and without warning. For these reasons, the environmental dimension will usually drive business change and as such comprises a number of segments or sub-environments. The main drivers (or forces, or dynamics) of environmental change are listed below:

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Table 1.1: Examples of PESTEL factors In this table are examples of each of the PESTEL factors. Remember, macro-environmental factors can differ per continent, country or even region, so normally a PESTEL Analysis should be performed on a geographical basis.
Political International trade regulations and restrictions Tax policies Economic Interest rates & monetary policies Stages of the business cycle Economic growth Social Labour/social mobility Technological New inventions and development Government research spending Industry focus on technological effort Ecological Environmental regulations and protection Energy use Legal Contract enforcement law Customer protection law Employment law

Lifestyle changes Income distribution

Government organisation/ attitude

Political stability

Government spending

Demographics, population growth rates, age distribution Education

Life cycle and speed of technological obsolescence

Destabilising factors (war, etc.)

Taxation

Rate of technology transfer

Social attitude (including influence of ‘pressure groups’) Legislation/ regulation enforcing pollution (effluent) controls Legislation/ regulation controlling traffic movement and its cost

Trading block directives (such as European directives)

Competition regulation Safety regulation

Inflation rates Exchange rates

Fashion, hypes Work/career and leisure attitudes Entrepreneurial spirit Living conditions Health consciousness & welfare, feelings on safety

Energy costs (Changes in) information technology

Unemployment policy Consumer confidence

(Changes in) mobile technology (Changes in) Internet

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(i) customer drivers (the 'market' environment) (ii) competitive drivers; (iii) social and cultural drivers; (iv) national and international environmental drivers; (v) economic drivers; (vi) political drivers; (vii) ecological drivers; (viii) legal drivers; (ix) technological drivers; and (x) demographic drivers. Although each of the environmental segments (or different drivers) have been listed separately, they tend to overlap. However, breaking down the environment into segments is useful in order that an attempt can be enabled to evaluate the relative importance of each to the organisation. Micro-environmental (and to an lesser extent macro-environmental [PESTEL]) changes impact on strategy in different ways, as shown in Figures 1.9 (below), 1.10 (below), 1.11, 1.12 and 1.13.

environmental change strategic change The environment changes gradually and predictably Environmental change

Time

Strategic change is incremental (bit by bit). The hour hand on a clock moves so slowly that change cannot be seen but each 12 hours the hand traverses through a complete 360˚

Figure 1.9: A supermarket chain opening branch by branch as it uses self-growth to generate funds for its expansion.
There is a significant (possibly single) change in the environment

Environmental change

Depending on the extent of the change a transformational strategy may be required

Time

Figure 1.10: This was much the effect that the opening of the Channel Tunnel had on cross-sea ferries (Kent [UK] to Europe). However, the change was sign-posted!

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Environmental change

The company has ‘drifted’ from its business environment A transformational strategy (developed possibly b y a new board of directors) may be required to realign the company with its environment Time

Figure 1.11: An example of ‘strategic drift’

Environmental change

The change in the environment is erratic, random and thus unpredictable. Strategy will need to be     short-term flexible versatile adaptable

Time

although set within longterm goals (the ‘tunnel affect’). The ‘tunnel effect’ Daylight at the end of the tunnel is the ‘goal’

The width of the tunnel allows for short-term manoeuvrability although tunnel walls will determine overall direction towards the goal

Figure 1.12: The electronics industry generally, mobile telephony particularly

The environment becomes complex and diverse with increased short-run change Environmental change May call for change to multilevel strategic planning (e.g. the setting up of a strategicbusiness-unit structure)

Time

Figure 1.13: Environmental complexity caused by diversification
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The objectives of a micro-environmental appraisal and PESTEL Analysis are to bring together all the strands of data concerning the firm's present position, extrapolated position, strategic drift and gaps, to profile its competitive, market and industry 'fit' positions and to provide important (if not vital) information for strategists about the extent of change required and the direction the firm should be heading for. By highlighting the firm's opportunities and threats and the profiles produced would provide its management with ideas as to how best to formulate future strategy.

3.

Porter's Diamond and the influence of national competitiveness on the strategic position (a) Porter's 'The Competitive Advantage of Nations Business is more global than it's ever been. With every passing year, competition between different organisations in different countries is likely to become even more intense. This creates a strong need for ever-increasing efficiency, innovation, and intelligent deployment of limited resources, if organisations are to be competitive in this global market. In his book, The Competitive Advantage of Nations, Michael Porter introduced his model for analysing the areas of strength and weakness that can give a country, or industry within a country, a competitive advantage or disadvantage. This model is known as "Porter's Diamond" and includes four key elements: "factor" conditions demand conditions firm (or organisation) strategy, structure and rivalry related and supporting industries.

Factor conditions Related and supporting industries Firm strategy, structure and rivalry Figure 1.14: Porter’s 4-factor ‘Diamond model’ In addition, Porter argues that the four key elements all influence each other, and these dynamics are shown in Figure 1.14 (above) . Porter also suggests that they are all effected by Chance and by Government Policies, and the inclusion of these two additional variables into the model is shown in Figure 1.15, although Figure 1.14 (above) is the one used by most text-books when discussing the Diamond model.

Demand conditions

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Chance

Factor conditions

Related and supporting industries Firm strategy, structure and rivalry Figure 1.15: Porter’s 6-factor ‘Diamond model’

Demand conditions

Government policies

(b) Factor conditions "Factor" is an economist's term for the things that contribute to the production of goods and services. Traditionally these were people, raw materials, "land" and capital (although this idea has shifted to include a measure for knowledge and technology). "Factor conditions" relate to the availability or non-availability of these things in a particular country, and this allows nations to: use factor strengths to differentiate use factor disadvantage to drive innovation.

This involves making best use of widely available production factors to differentiate one country from competing countries. This might involve developing university research programs to build skills in micro-electronics. Real-world example: using factor strength to differentiate India as a country has a large graduate workforce whose pay expectations are lower than those of graduates in Western countries. This has allowed India to become a leader in offshore call centre and business process supply. End of real-world example When factor conditions are in short supply ('selective factor disadvantage' [SFD]) countries need to innovate to overcome this, and this innovation can build competitive advantage. Abundance of factors may actually undermine competitive advantage and generate waste. Scarcity often breeds an innovative mindset. Since resource depletion seems to be a general trend, it pays to be the first mover in figuring out how to generate more output with fewer resource factors.

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Real-world examples: Using disadvantage to drive innovation Switzerland… experienced labour shortage… abandoned labour-intensive watches… concentrated on innovative and/or high-end watches… Rolex, Swatch. Holland… cold, grey climate… innovation in glass-growing… innovation in energy conservation (taking advantage of abundant natural gas)… exports over $1bn (refrigerated) ready-to-bloom in shops, fresh-cut flowers. Japan… high-priced land… high cost of factory space… just-in-time (JIT) inventory. Sweden… short building season… high construction costs… pre-fabricated housing. End of real-world examples (c) Demand conditions This term refers to the level of demand for a product or service from the organisation's home country. If people in an organisation's own country are demanding a lot of a product or service, that can give it a strong advantage over global competitors. The more demanding the customers are in an economy, the greater the pressure facing companies to constantly improve their competitiveness via innovative products, through high quality, etc. The advantages gained from "demand conditions" can be exploited in three ways: - exporting - national advantage - anticipating trends (i) Exporting When the organisation's own country creates a large demand for a particular type of product or service, domestic companies get good at producing them. That country is then well placed to respond to developing demands abroad. Real-world example: Using advantage to build exports Japan… high-priced land… small houses/rooms… need for small household durables… miniaturisation became core competence of companies, such as SONY. End of real-world example

(ii)

National advantage When demand is high at home, there are likely to be more competitors in the organisation's local industry. Competition forces innovation, making the country as a whole effective in that industry.

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Real-world examples: Using national advantage England… interest of people in gardening… development of skills in seed production.... world-wide competitive advantage. England… interest in football (built up over years in 'working-class' areas)… development of football club management... Premium League branded products sold throughout the world. End of real-world examples (iii) Anticipating trends When consumers at home are discerning and keyed into trends in a particular product- or service-type, this forces domestic competitors to stay current and change quickly and flexibly as demand changes. This helps these companies succeed in international competition. (d) Firms strategy, structure and rivalry These are the factors that shape domestic competition. The typical size of companies, the way they are managed, and the way they compete are factors that help companies succeed or fail globally. Things affecting this include the following: Different companies suit different types of industry. Real-world example: Matching industries to conditions Italy… unusually high proportion of small family run firms… helps to keep Italy at the forefront of the fashion industry... the ability to react quickly to trends is critical to success in this industry... much harder to have the same level of flexibility in larger organisations. End of real-world example Industries will thrive best in a country if that country's investors find that the industry's way of operating meets their needs. Those investors looking for long-term, stable returns, may be nervous of industries based on clusters of highly innovative start-up organisations. Equally, investors wanting high returns will not find them easily in well-established industries.

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(e) Related and supporting industries This element relates to the competitiveness of other industries in the country. The presence of high-quality suppliers and other related industries leads to two main types of advantage: Highly competitive suppliers typically offer a cost advantage. When these competing suppliers operate in the same country, this translates to a cost advantage for all related industries. The reasons for this relate to the following: A large industry presence in a country/area will increase the supply of specific factors (e.g. specialised engineering support, skilled labour) since suppliers will tend to get higher returns and less risk of losing work/employment. http://www.tonysurridge.co.uk 29

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At the same time, upstream firms (i.e. those who supply intermediate inputs) will invest in the country/area for the same reasons. They will look to save on transport costs, tariffs, inter-firm communication costs, etc. Likewise, downstream firms (i.e. those who use the industry's product as an input) will invest in the country/area. This results in savings of the types mentioned for upstream firms. Finally, attracted by the synergies of upstream and downstream firms, producers in related industries (i.e. those who use similar inputs or who are purchased by the same set of customers) will also invest in the country/area. Firms locating near to their rivals often gain the advantage of quick technological transfer ("technology spillover"). The existence of such external scale effects often makes competitive advantage self-reinforcing. Real-world examples: Cost advantages through related and supporting industries Italy… high success of the shoe and leather industries… translated into other successes related to leather manufacturing and processing. Canada… late 1990s… Abitib and Stone Consolidated merged... despite language difficulties (Quebec speaks French)… despite higher taxes (Quebec)… despite political uncertainty (Quebec)… Why?... Montreal's status as "hub" of "Eastern Canada's forest industry… proximity to majority of its 26 mills... critical mass of paper expertise (more than any other city in North America)… proximity to university forest research centres, engineers, supplier. End of real-world examples

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Also, Highly competitive suppliers tend to be innovative. Related industries benefit from this innovation. Real-world examples: Related industries benefiting from innovation USA… Silicon Valley (San Jose, California)... chips, computers, software. USA… Hollywood. End of real-world examples

(f)

Government policy The role of government in the "Diamond" is to encourage companies to raise their performance, e.g. by enforcing strict product standards stimulate early demand for advanced products focus on specialised factor creation stimulate local rivalry by limiting direct co-operation and enforcing anti-trust regulations.

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Real-world example: Government support The Japanese facsimile industry (fax machines) illustrates the Diamond of national advantage. Japanese firms achieved dominance in this industry for the following reasons: Japanese factor conditions: Japan has a relatively high number of electrical engineers per capita. Japanese demand conditions: The Japanese market was very demanding because of the written language. Large number of related and supporting industries with good technology, for example, miniaturised components. Domestic rivalry in the Japanese fax machine industry pushed innovation and resulted in significant and rapid cost reductions. Government support - NTT (the state owned telecom company) changed its cumbersome approval requirements for each installation to a more general-type approval.

End of real-world example (g) Using the 'Diamond model' Most organisations have little opportunity to influence government's policy and the national economy at the level of the elements of Porter's Diamond. The model starts to be useful when an organisation's management wants to understand how the Diamond factors affect the organisation. By thinking about questions like this, management can understand whether the industry they're in (or thinking of diversifying into) has a long term future. Consultants/accountants can aid the process in the following ways: Identify factor conditions It is important to identify the factor conditions that apply to the industry and country the organisation operates in. If the industry is successful internationally, what factors give your country an advantage over other countries? Is the organisation taking full advantage of these factors? If the industry is struggling, why? How do people, raw materials, capital, land, education levels and technological expertise of the organisation's country/area compare with those countries that compete with the organisation? What action could be taken? Appraise demand conditions The characteristics of the demand conditions in the organisation's industry need to be identified. Are domestic buyers discerning and demanding in the organisation's market or industry? Are there aspects of demand that are specific to the organisation's country that wouldn't apply anywhere else and would give the organisation an international competitive advantage? How sophisticated are the industry's distribution methods? How do these compare with the situation in the countries that most successfully compete with the organisation? Consider organisation structure The national approach to organisation structure and the levels of competitive rivalry in the organisation's country needs to be analysed. Is this the best structure?

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Examine the related and supporting industries The related and supporting industries of the organisation's own industry needs examination. How much does the industry rely on imports, or benefit from high quality or low cost (or both) local supply? How much knowledge and expertise is there in local related industries that could benefit the organisation?

4.

Scenarios reflecting different assumptions about the future environment (a) What is a scenario? A scenario is an account or synopsis of a projected course of action, events or situations. In practice it does not attempt to forecast what might happen, but What the consequences would be if something did happen. Tutorial comment Of course there is a difference between these two predictions. Take yourself. First you could attempt to forecast the likelihood of passing the exam. Another exercise, similar, but different, would be to decide what the consequence would be if you failed the exam. End of tutorial comment

Scenario development is used in policy planning, organisational development and, generally when organisations wish to test strategies against uncertain future developments. Scenarios are widely used by organisations (either explicitly, or more commonly implicitly) to help understand different ways that future events could unfold, whose strategic implications can then be investigated. Scenario planning is a complex business process related to 'futures planning'. Real-world example: Government support A scenario model might be developed for a manufacturer using steel in its products to explore the question: 'What would happen if green environmental pressure groups and social concerns forced private cars off the road by the year 2020 and demand for steel in cars collapsed as a result. What impact would this have on the company?’ End of real-world example (b) Technique of scenario building Scenarios are concerned with peering into the future, not forecasting the future. The act of forecasting takes the current situation and extrapolates it forward. Scenarios take possible future situations (i.e. situations which could occur) with a different starting point - 'What would happen if?', not 'What will happen?’
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