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Strategic Management and Business Policy

Unit 7

Unit 7
Structure

External Environmental Factors

7.1 Introduction 7.2 Caselet Objectives 7.3 Environmental Factors 7.4 Scanning of Environment 7.5 Environment Forecasting 7.6 Environmental Opportunity and Threat Analysis 7.7 SWOT Analysis 7.8 Case Study 7.9 Summary 7.10 Glossary 7.11 Terminal Questions 7.12 Answers 7.13 References

7.1 Introduction
Companies have internal competences or capabilities that enable them to face, among others, the external environment for formulating and implementing corporate strategies. The external environment does not refer only to the macroeconomic environment or broad macro-parameters like socio-economic factors, government policy and legislations; it also includes technology, competitors, intermediaries and suppliers; in short, all those factors or forces which together constitute the market environment within which a company operates. Analysis of the external environment consists of identification of opportunities and threats, and exploiting opportunities and meeting threats based on organizational strengths and weaknesses. Companies that do this effectively on a regular basis become successful. Companies that ignore the environment or do not analyse or scan the environment properly, could face disastrous results. We have many examples of companies that ignored the changing environment and perished as a result. Hindustan Motors and Premier Automobiles lost their pre-eminent market position to Maruti Udyogs Maruti 800. Mahindra and Mahindra was shaken by Marutis Gypsy petrol jeeps. Television giants like Nelco, Weston, Crown, Bush, etc., lost to companies and brands like Onida
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and Videocon and new brands like LG and Samsung. Titan watches shook the giant HMT. The Surf and Nirma story is well known.

7.2 Caselet
The Nirma success story of how an Indian entrepreneur took on the big MNCs and rewrote the rules of business: It was in 1969 that Dr. Karsanbhai Patel started Nirma and went on to create a whole new segment in the Indian domestic detergent market.During that time, the domestic detergent market only had the premium segment and there were very few companies, mainly the MNCs. Karsanbhai Patel used to make detergent powder in the backyard of his house in Ahmedabad and then carry out door-to-door selling of his handmade product. He gave a money back guarantee with every pack that was sold. Karsanbhai Patel managed to offer his detergent powder for `3 per kg when the cheapest detergent at that time was `13 per kg and so he was able to successfully target the middle and lower middle income segment. Sabki Pasand Nirma Karsanbhai Patel had good knowledge of chemicals and he came up with Nirma detergent which was a result of innovative combination of the important ingredients. Indigenous method was used, and also the detergent was more environment friendly. Consumers now had a quality detergent powder, having an affordable price tag.
Source: http://toostep.com/insight/success-story-of-nirma

Objectives
After studying this unit, you should be able to: Analyse the major factors of environment that impact a business Explain the techniques of environmental scanning Discuss environment forecasting Distinguish between environmental threat and opportunity (ETOP) analysis and SWOT analysis Conduct organizational SWOT analysis using different approaches

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7.3 Environmental Factors


All these and many other such cases point to an important facet of business sensitivity of strategy to the external environment. The major environmental factors a business strategist should reckon with are: Political factors Economic factors Sociological factors Government policies/controls Technology Competition Intermediaries Suppliers Competition analysis would be undertaken in detail in Unit 11. Competition is not just an element or factor of the environment. It has more direct and vital implications for an organizations business and strategy. This is the reason why competition or competitors would be analysed separately in a more comprehensive way. We shall, however, make references here about competition as a factor of environment. All other major environmental factors mentioned above are discussed below.

7.3.1 Political Factors


Political factors or political conditions can have significant impact on industry, business and the corporates. Political stability improves business environment and encourages economic and business activities. Political instability produces the opposite effects. Political factors do not refer to only national political conditions or relations, but also to international relations. Improved political relations between the US and China in the mid-70s resulted in trade agreement between the two countries. The trade agreement provided opportunities to US electronics manufacturers to commence operations in China. There are many instances where deteriorating political relations between countries (India and Pakistan), have affected business conditions. Rubock (1971) has developed an analytical framework for identifying and assessing political risks which may affect business conditions. Sources of political risks can be many. Major risk factors identified by Rubock are: electoral majority

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of the party in power; internal dissensions within the ruling party; strengths of the parliamentary opposition parties; conflicting political ideologies; insurgencies in border areas, international power alignments and alliances, etc. Given below are two contrasting Indian examples of the impact of political environment on business. The progressive political philosophy of Chandrababu Naidu during his tenure as the chief minister of Andhra Pradesh led to the creation of Cyberabad. IT companies have found Hyderabad, nicknamed by the media as Cyberabad, to be the most hospitable location for development of IT, mostly because of highly supportive political climate. Chandrababu had taken keen personal interest in IT; and, had encouraged and ensured use of IT in governance by simplifying rules and procedures, offering concessions and building good supportive infrastructure. The Ayodhya-Babri Masjid episode became a political issue and provoked violence in different parts of the country, and caused serious law and order problems during December,1992 and January 1993. Apart from the apprehensions of political instability, the events disrupted transport, slowed down industrial production and growth of exports, and, also reduced government revenue.1

7.3.2 Economic Factors


Economic environment is an amalgam; it comprises all aspects or areas of economic activitynational income (GDP or GNP), the manufacturing sector, the services sector, capital or financial sector, investment, savings, etc. All these areas or sectors together influence the structure and trends of the economy and determine the economic environment. The major economic factors, which influence any market system, are: (a) GDP or GNP (b) Income distribution or income levels (c) Business cycles or different phases of the cycle like boom, recession, depression and recovery (d) Price levels of goods and services, i.e., whether the trend is inflationary or deflationary (e) Rate of interest on market borrowing Each of these and other such macroeconomic factors can be an opportunity or a threat to a company depending on how it reacts to or exploits
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the factor. For example, inflationary trends can generally pose a serious threat to a companys competitiveness in terms of input costs and selling prices. But a smart company with a definite strategy may use this as an opportunity or challenge to analyse all its cost drivers (activities which affect the cost structure) to minimize cost and increase competitiveness. Porter (1980) has identified a number of cost drivers: Economies of scale Pattern of capacity utilization Linkages with suppliers and channels Coordination among different activities Interrelationships with other business units within a company Timing of an activity Management of institutional factors like government regulations, tax holidays/rebates, tariffs, etc.

7.3.3 Sociological Factors


Sociological factors include demographic factors or population profiles, value system in society and lifestyles of individuals. Demographic factors or population profiles reflect age and sex composition of the population, occupational patterns, literacy levels, etc. Demographic parameters are a very intimate component of the market environment because they directly affect consumer behaviour. For example, today there is a lot of focus on the youth and many products and brands are promoted for the young generation. Apart from Pepsi (which has been specially positioned on the age factor), mobikes Hero Honda, TVS Suzuki and Kawasaki Bajajall are focusing on this segment. Readymade garment companies are invading the childrens sector. Many FMCG brands are targeted at women of particular age groups. Occupational patterns and literacy levels are also influencing consumption patterns of males and females. Besides demographic factors, changes in the value system and lifestyles greatly affect purchasing patterns. Strong family bonding and love for family have been a big influencing factor in the Indian market. The Vicks Vaporub theme (the child with cough and cold and the mothers concern for him) is a very good example of exploiting core Indian values for marketing communications.

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The international exposure of Indian consumers is increasing and changing lifestyles are getting reflected in preferences for international brands of readymade garments (Peter England Pizza Hut, Baskin Robbins, etc). These are important environmental developments for the strategists in the FMCG and services sector.

7.3.4 Government Policies and Controls


Government policies have a more direct impact on business decision and marketing strategies than macroeconomic indicators like GDP or GNP. Government regulations and controls have even more immediate impact than government policies. Policies and controls can be of three types as shown in Figure 7.1.
Government Policy

Monetary policy

Fiscal policy

Physical policy controls)

Bank rates

Credit controls

Taxes

Subsidies

Investment and production

Prices and distribution

Figure 7.1 Government Policies and Controls

At any point of time, the corporate tax structure, various lending rates of banks and financial institutions, monetary controls like the bank rate, price controls, etc., offer a particular economic or business climate. An extension of the regulatory controls is to be found in economic or business legislation. Two good examples of this are the Foreign Exchange Regulation Act (FERA) and Monopolies and Restrictive Trade Practices (MRTP) Act. Given these policies and controls, the corporate management has to match these through appropriate strategies for cost control and effectiveness, pricing strategy, marketing efficiency, etc.

7.3.5 Technology
Technology, as an environmental factor, influences strategic planning and management in a number of ways. Technological changes lead to the shortening of product life cycles and create new sets of consumer expectations. Electronic products are a good example. This sector is experiencing the most rapid changes today. One can
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clearly see the technological revolution in the colour TV market. Sometimes, advance signals on technological developments are available through research and development and industry/trade journals and magazines. Companies in the pharmaceutical industry, for example, are continuously aware of developments in new formulations and drugs in the world through medical journals and periodicals. Developments in information technology are greatly affecting the competitive position of companies. In a different way, technological developments affect a companys raw material, packaging, operations, products and services. For example, developments in the plastics and packaging industry have brought in new packaging in the form of tetrapacks, pet bottles, cellophane, etc. This has made the packing more attractive, carrying of the product more convenient and has definitely reduced the cost of packaging and the product. Similarly, containerized movement of cargo, deep freezers and trawlers have influenced the operations of the companies. Technological development also provides an opportunity to companies to develop new products. On the other hand, companies which ignore these developments face a crisis and eventually may even face extinction. The Indian automobile industry gives a good illustration. With the introduction of Maruti 800 which caught the imagination of consumers, Hindustan Motors (Ambassador) and Premier Automobiles (Padmini) had to improve their vehicle performances in terms of fuel efficiency, driving comfort, aesthetic appeal, etc. But what they did was to bring in peripheral changes only and those were not enough. The result: Padmini is extinct today with Ambassador following suit (some extension of life has been given to Ambassador by the government and the public sector).

7.3.6 Intermediaries
The primary role of intermediaries is to link the producers to the end-user market in those cases where the latter are unable or unwilling to manage the delivery or the distribution process. Intermediaries play a really big role in consumer goods2, particularly in FMCGs. FMCG majors such as Kelloggs, Heinz and Unilever (Hindustan Unilever in India) and many other companies utilize the services of large supermarket chains to distribute their products to households. The selection of appropriate intermediaries is a matter of marketing choice and strategy. A company has to take into account a number of factors while
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selecting an intermediary or a channel. First, a company should take into account the purchase behaviour or pattern within the end-user market. For example, consumers may be prepared to travel up to 50 or 100 km to buy a specific brand of furniture but may be unwilling to exhibit the same behaviour while purchasing a packet (or box) of detergent. So, the location of the intermediary is important. Second is the willingness of the intermediaries to carry their goods. The problem currently faced by many FMCG companies in the US and Europe is that the supermarket chains want to expand sales of their own-label products and brands and, therefore, reduce the number and volume of equivalent branded items of other companies in their stores. Another problem may be the supermarket chains preference or commitment to promote some other companys brands. The third factor is the capability of an intermediary to provide appropriate support services to the market. There are many discount retailers who are not willing to offer installation or repair services on the electrical goods they sell, and this almost boils down to negative marketing. It is important for companies to identify shifts in consumer behaviour and emerging trends in customer-buying patterns and the intermediaries willingness to service the changing end-user market. An example of consumer behaviour shift and changing expectations is the field of personal computers (PC). In the PC market in the US, many large customer organizations now expect distributors to go beyond just selling boxes and give advice on selection, installation and post-sales operations of sophisticated computer systems. A number of distributors, known as value added resellers (VARs) are now available who specialize in supplying certain types of systems and/or serving particular market segments. In the late 1980s, IBMs policy of dealing directly with the industrial customers might have resulted in their being rather slow in building strong relationships with leading VARs. Many feel that because of such a decision, sales were adversely affected particularly in those sectors which preferred to purchase their systems through VARs instead of dealing directly with computer manufacturers.

7.3.7 Suppliers
Suppliers to a company can be raw material suppliers, energy suppliers, suppliers of labour and capital; and the suppliers can affect the competitive position and business capabilities and therefore, the corporate strategy of a company. According to Porter, the relationship between suppliers and a company represents a power equation between them. The equation is based on, or
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governed by, the market environment, industry conditions and the extent to which one is dependent on the other. The buyer company has better bargaining power under the following conditions: The buyer is a monopolist (single seller) or a monopsonist (single buyer) and buys large volumes relative to sellers sales. The buyer can easily switch vendors it has a choice of alternative sources of supplies. The suppliers product is not very important to buyers finished products/ services. The supplier has stronger bargaining power in the following situations: The supplier is a monopolistic or an oligopolistic firm. The suppliers product is a significant input to the buyers finished product. The buyer is not an important customer of the supplier. The suppliers products are well differentiated and it has built up significant switching costs. A company should evaluate the two sets of strengths or bargaining powers and ascertain where it stands in the power equation with a particular supplier and then decide on the choice of the supplier depending on the cost effectiveness, indispensability, etc. This is the general or classical prescription. But, the trend is changing. Now the slogan is: collaborate with the suppliers. Companies are taking equity in supplier companies; some are even taking part in the management of the vendor companies. The Japanese are leading the way. But, even in such cases, the initial choice of the supplier may depend on the relative power equation.

Self-Assessment Questions
1. The national income (GDP or GNP), the manufacturing sector, the services sector, capital or financial sector, investment, savings, etc., constitute the ________environment. 2. Occupational patterns and literacy levels are also influencing _______ patterns of males and females. 3. Technological changes lead to the shortening of product _______ and create new sets of consumer expectations.
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4. In which condition does the buyers company have better bargaining power (a) When the buyer is a monopolist (single seller) (b) The buyer can easily switch vendors (c) The suppliers product is not very important to buyers finished products/services. (d) All the above

7.4 Scanning of Environment


In any business or product category, a companys task of finding market opportunities is generally constrained by lack of sufficient information about the environmentgovernment policies and controls, the customers, the competitors, channel members, etc. Therefore, understanding the environment and properly analysing or scanning it are vital for the formulation of any strategy and, more so, for the success of it. Scanning is a continuous process because it involves analysing changes and sometimes even forecasting the impact of developments in the environment. Some call it external audit.3 Various environmental factors or influences are generally expressed in one or more of four forms events, trends, issues and expectations. Events are specific occurrences which take place from time to time like elections, formation of government, bilateral trade talks or negotiations, etc. Trends are prevailing tendencies, courses of action or events taking place over time like movements in national income, inflationary tendencies, growth in industrial production, etc. Issues are current concerns about events and/or trends like high/low growth of national income, high rate of inflation, low rate of savings, stagnant industrial production, etc. Expectations are hopes or demands of different interest groups like the government expects companies to be constantly aware of their tax obligations and social responsibilities. So, while planning environmental scanning, organizations should analyse each important environmental factor in terms of events, trends, issues and expectations (as applicable). The task involved in scanning the environment is to assess the possible impact of various environmental factors in an interaction matrix or an impact linkage matrix. Such a matrix is shown in Figure 7.2.

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Strategy Factor

Env. Factor

Government Policy

Rate of Interest

Controls

Technology

Customer Choices and Preferences Competition

Liberal credit for important customers Price cut/Discount Increasing dealer network Focus on customer satisfaction Intensifying advertising New product launch

High Impact Linkage

Impact Linkage Normal

Weak or Minimal Impact Linkage

Figure 7.2 Environmental Impact Linkage Matrix

The matrix in Figure 7.2 has been constructed for six major environmental factors and six business strategy factors. The matrix can be extended to more number of factors (by using a computerized model) to make it more comprehensive. Such matrix should be developed by the strategic planning group. Establishing the impact linkages correctly is difficult and involves objective assessment of various factors and working of linkage values as far as possible. Judgemental factor of the planning team, however, cannot be completely ruled out. But, once constructed, the matrix builds the right linkages between the environment and corporate strategies or action plans. On the basis of this, the possible outcome of a particular strategy can be more easily anticipated or worked out.

7.4.1 Sources of Information for Environmental Scanning


The first step in scanning the environment is to identify proper sources of information to be used for scanning. Because environmental factors are too diverse, even for scanning the relevant or operating environment, an organization has to tap the right sources of information. Sources of information can be primary or secondary; internal or external; formal or informal; written or verbal. Even market gossip can be a good source of information or signal for possible changes in the environment. Various sources of information for environmental scanning

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can be classified into some major types or categories. These are mentioned below in terms of primary and secondary sources and internal and external sources. Secondary or Published Sources 1. Internal: Annual reports, corporate strategic plans, company files and documents. 2. External: Different types of publications like books, journals, magazines, newspapers, government publications, industry association reports and newsletters, annual reports of competitors, etc. Primary Sources 1. Internal: MIS, special databases, managers/employees 2. External: Stakeholders like customers, competitors, marketing intermediaries or channel members, suppliers; and also industry trade associations, government agencies, etc. Mass media like radio, television and the Internet Special studies conducted (for the company) by consultants, market research agencies, educational institutions, etc. Surveillance or intelligence by ex-employees of the company, employees or ex-employees of competitors, industrial espionage agencies, etc. Activity 1 Choose a company an automobile, cell phone or FMCG producer and conduct an environmental scanning on its behalf. You will need to express various environmental factors in terms of events, trends, issues and expectations in an interaction matrix.

Self-Assessment Questions
5. ________is a continuous process that involves analysing changes and sometimes even forecasting the impact of developments in the environment. 6. Scanning is also called______by some people.

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7. Prevailing tendencies, courses of action or events taking place over time like movements in national income, inflationary tendencies, growth in industrial production, etc., are known as _______. 8. The first step in scanning the environment is to identify proper sources of ________to be used for scanning.

7.5 Environment Forecasting


To understand the emerging or evolving environment better, some have suggested environmental forecasting. Any forecasting is a hazardous job; and, so is environmental forecasting. But, forecasting is a better approximation than not knowing anything about the future. That is the reason why forecasting has become inseparable from economic and business analysis. In environmental forecasting, planners have to start by answering a basic question: how far ahead should they look, that is, the time horizon for forecasting. An approach which has been found quite useful is determining the time horizon is Gap Analysis. Gap analysis should logically be the starting point for environmental forecasting. The gap analysis projects over time, the gap between the desired change in strategic parameters like sales, profitability, market share, etc., and actual change with continuation of present strategy, that is, not responding to changes in the environment. Gap analysis is shown in Figure 7.3.

Strategic Parameter: sales, profit, capacity

A1 Gap A2

3 Time

Figure 7.3 Gap Analysis for Strategic Forecasting

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In Figure 7.3, A1 shows the desired change in strategic parameter, say, growth in sales (as per company objective or target). A2 shows projected growth in sales with continuation of present strategy. (A1 A2) is the gap in achievement of the target, and the gap starts emerging after the second year. This gap has been created because of a new product or brand (like Nirma was introduced and a gap was created in sales of Surf), product/brand or market expansion by a competitor, slump in the market, etc. In the case of Hindustan Unilever, they not only did not foresee the entry of Nirma, they had even ignored it for sometime. That is why the battle was so long for Surf to regain its position. Correct and timely forecasting of the environment and introduction of necessary changes in the strategy can help to eliminate or reduce the gap. Based on gap analysis, an appropriate technique can be chosen for environmental forecasting. Different authors have suggested different methods or techniques. Detailed description and analysis of different techniques can be found in the works of these authors. Two such works or names of authors should be mentioned here. Lebell and Krasner (1977) have described nine techniques which range from highly mathematical or statistical techniques to structured and unstructured opinion methods. Fahey, King and Narayanan (1988) have mentioned 10 techniques, mostly quantitative, in their survey of environmental scanning and forecasting. These include scenario writing, simulation and game theory.

7.5.1 Scenario Building


Forecasting has its limitations. All forecasting is based on certain assumptions and some database, both of which can be incorrect or imperfect. Therefore, achieving exactness in forecasting is hardly possible. Forecasters also realize this. That is why, instead of exact forecasting, many have suggested alternative scenario development which is quite common in forecasting exercises. A scenario is a detailed and probable view of how the business environment of an organization may develop in the future based on the analysis of key environmental influences and factors of change about which there is a high degree of uncertainty.4 Planners and strategists should develop alternative scenarios and, should try to indicate the most probable scenario. Or, else, decision makers may have to decide the right alternative. Scenario building has to be a systematic process and it should be completed in stages. Four major steps should be followed:

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1. Identify the key environmental factors or forces which should form the basis for scenario building. For example, three such factors for scenario building for competitive environment may be market growth rate, competitive situation in the industry and likely move or behavior of the market leader. Number of factors would be, in most situations, more than three, but, this would depend on the environmental situation to be projected. 2. Formulate or write down the key assumptions for scenario building assumptions about the future pattern of environmental forces which have been identified. In the above example, a relevant assumption can be that there would be no dramatic change in the structure of the industry. It is advisable to keep the assumptions low because complexity in scenario building generally increases as the number of assumptions increases. 3. Understand the historical trend in environmental factors or forces which have been used in assumptions. Also consider their impact on present market conditions and likely future impact. This analysis is done to establish a logic for the assumptions and, also to make inferences based on the assumptions. 4. Build scenarios which are internally consistent. Build alternative scenarios; may be, an optimistic future, a pessimistic future and a mainline or mean future. Experts feel that two to four scenarios are generally appropriate. Some have suggested a more elaborate, step-by-step, process for scenario development. One such sequential process is given in Figure 7.4.5 Shells long-term scenario building for the oil industry (favourable and unfavourable) is given in Box 7.1.

Figure 7.4 Sequential Scenario Development Process

Self-Assessment Questions
9. The logical starting point for environmental forecasting should be _______. 10. Achieving exactness in forecasting is always possible. (True/False)
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11. A ______is a detailed and probable view of how the business environment of an organization may develop in the future. 12. Planners and strategists should develop _______scenarios and, should try to indicate the most probable scenario.

7.6 Environmental Opportunity and Threat Analysis


The objective of environmental analysis or scanning or even scenario building is to identify opportunities and threats in the environment and formulate strategies accordingly. This can be done more directly through environmental appraisal, that is, assessing the environment for clearly identifying major opportunities and threats. There are many methods for environmental appraisal. One such method, suggested by Glueck (1984), is preparation of an environmental threat and opportunity profile (ETOP) of an organization. Preparation of ETOP involves dividing the total environment into different factors or sectors, and, analysing the impact of each sector on the organization. A more detailed ETOP requires dividing each environmental sector further into subsectors and, then, assessing the impact of each subsector on the organization. A summary ETOP, however, may only show the major factors. An example of ETOP is given in Table 7.1 This example is for a sports cyclemanufacturing company operating both in the domestic market and export market. The example relates to a hypothetical company but, is realistically based on the current Indian business environment.6 An actual ETOP of BHEL is given Table 7.2. Preparation of ETOP enables planners and strategists to identify specific sectors or subsectors which have clear impact on the organization either as an opportunity or a threat. ETOP can also help to analyse the nature and intensity of impact of different sectors or subsectorsfavourable or unfavourable. Based on ETOP, an organization can formulate appropriate strategies to exploit the opportunities and counter the threats from the environment. Conclusion : Sports cycle manufacturing is a recommended business because the environment provides many opportunities; there is only one threat (international).

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Table 7.1 Environmental Threat and Opportunity Profile (ETOP) for a Sports Cycle Manufacturer
Environmental Sector Market Nature of impact Sector position/development Industry growth rate for bicycles 7 to 8 per cent per annum; growth rate for sports cycles 30 per cent; largely unsaturated demand Technological upgradation in the industry in progress; import of machinery simple Mostly ancillaries and associated companies supply parts and components; imported raw materials easily available Growing affluence among urban consumers; export potential promising Bicycle industry a thrust area for exports No significant factor Customer preference for sports cycles; durable and easy to ride Emerging threats from cheap imports from China

Technological Supplier

Economic Regulatory Political Socio-cultural International

indicates favourable impact or opportunity ; indicates unfavourable impact or threat; indicates neutral impact.

Table 7.2 Environmental Threat and Opportunity Profile (ETOP) for BHEL
BHEL : ETOP
Environmental sector Socio-economic Impact (+) Opportunity/() Threat (+) Continued emphasis on infrastructural development which inc ludes power supply for indus try, trans port and domes tic consumption. () Severe resource constraints. (+) High growth envisaged in industrial production and technology upgradation. () Sources of technology will become scarce due to forma-tion of technology cartels. (+) Liberalization of technology import policy. () Customers will become more discerning in their requirements due to an increasing role of power plant consultants. () Public sector will find it increasingly difficult to retain specialists and highly qualified personnel.

Technological Supplier Government Competition

Source: Bharat Heavy Electricals Ltd (BHEL)

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Box 7.1: Long-term Scenario Building by Shell for the Oil Industry
Every two or three years, the Central Planning Group of Shell prepares scenarios about the future of the oil industry on behalf of the Shell Group. The process generates two scenarios. The objective of scenario generation is to sensitize decision makers in the group to receive signals for possible changes in the global environment. The logic is that a more timely and appropriate business response can take place instead of changes coming as a surprise. For formulating strategies for 25 years between 1995 and 2020, the Shell Group has developed two global scenarios projecting the future of the oil industry in two different ways. These two scenarios can be termed as favourable or optimistic and unfavourable or pessimistic. Favourable or Optimistic In this scenario, economic and political liberalization increases wealth creation in the countries which adopt them. However, big upheavals are also experienced as long-standing barriers are dismantled, and economically weak countries assert themselves claiming a larger role in world economic activity and growth. High economic growth of 56 per cent is sustained in these developing countries. But, there is slow erosion of wealth of the developed world which produces its own problems. Big companies find themselves increasingly challenged as cheaper capital and fewer international barriersboth tariff and non-tarifflead to an environment of relentless competition and innovation. This creates a high level of oil and energy demand, and substantial new resource development and improvement in efficiency are required to propel this growth. Growth should be high enough so that demand does not outstrip supply, and there are no inflationary trends. Stagflationary tendencies should also be curbed. Unfavourable or Pessimistic In this scenario, liberalization is resisted because people fear that they might lose what they need mostjobs, power, autonomy, cultural identity. This creates a world of regional, economic and cultural conflict in which international business cannot operate efficiently. Markets are difficult for outsiders to enter as reforms are structured to help insiders. Oil prices are depressed because of instability and, also, uncertainty; oil prices also suddenly shoot up as trouble flares up in the Middle East. There is increasing divergence between rich and poor economies as many developing countries
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become marginalized mostly because of lack of foreign investment. In the developed world, due to convergence of or conspiracy by green and other political interests, energy is regarded as something bad and polluting. The unfavourable investment climate which this produces is reinforced by high disparities around the world. Widespread poverty and environmental problems are experienced in poorer countries. The richer countries face problems of shrinking labour force and ageing population. These become their major concerns.
Source : Adapted from G Johnson, and K Scholes, Exploring Corporate Strategy, 3rd ed., 4th ed and 6th ed. (Prentice Hall of India and Pearson Education, 1995, 1999 and 2005), 8687, 105 and 109.

Self-Assessment Questions
13. The objective of environmental analysis or scanning or even scenario building is to identify ______ and ________in the environment and formulate strategies accordingly. 14. The preparation of an environmental threat and opportunity profile (ETOP) of an organization was suggested by_________.

7.7 SWOT7 Analysis


ETOP and EFEM focus only on the opportunities and threats from the environment. But, to exploit an opportunity or to consider a threat, a company should have required strengths or competence. A company also needs to know its weaknesses in terms of competence, because weaknesses may affect its capability to take advantage of an opportunity or negotiate a threat. So, simultaneously with environmental analysis or appraisal, organizations also need to assess their internal strengths and weaknesses. This is done through SWOT analysis. Companies have been using SWOT analysis for long, whether for general business strategy or for marketing strategy. In SWOT, S and W relate to internal competence factors, and O and T pertain to external environment factors: S Strengths Internal competence factor W Weaknesses

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O Opportunities T Threats

External environmental factors

A strength is a resource, skill, capability or any other advantage relative to competitors and in relation to markets. A weakness is a limitation or deficiency in resource, skills and capabilities or any other disadvantage relative to competitors which impedes performance of an organization. SWOT analysis can be a useful tool to analyse the extent to which strategy of an organization and its more specific strengths and weaknesses are capable of dealing with the changes in the business environment. And, this would decide whether a particular factor in the environment is an opportunity or threat to the organization with reference to the particular strategy. For systematic SWOT analysis, major strengths and weaknesses of the organization for the strategy should be worked out. Then, the important factors in the environment relevant to this strategy should be identified. Finally, the strengths and weaknesses should be matched with the environmental factors through matching analysis or a matrix. Some potential or likely strengths, weaknesses, opportunities and threats are shown in Table 7.3, and a hypothetical SWOT analysis for an international retail chain is presented in Table 7.4.
Table 7.3 Potential/ Likely Strengths, Weaknesses, Opportunities and Threats
Potential Strengths Abundant financial resources Well-known brand name # 1 ranking in the industry Economies of scale Proprietary technology Patented processes Lower costs (raw materials or processes) Respected, company/product/brand image Superior management talent Better marketing skills Superior product quality Alliances with other firms Good distribution skills Committed employees Potential Opportunities Rapid market growth Rival firms are complacent Changing customer needs/tastes Opening of foreign markets Mishap of a rival firm New uses for product discovered Economic boom Government deregulation New technology Demographic shifts Other firms seek alliances High brand switching Sales decline for a substitute product New distribution methods

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Potential Weaknesses Lack of strategic direction Limited financial resources Weak spending on R&D Very narrow product line Limited distribution Higher costs (raw materials or processes) Out-of-date products or technology Internal operating problems Internal political problems Weak market image Poor marketing skills Alliances with weak firms Limited management skills Undertrained employees
:

Potential Threats Entry of foreign competitors Introduction of new substitute products Product life cycle in decline Changing customer needs/tastes Rival firms adopt new strategies Increased government regulation Economic downturn New technology Demographic shifts Foreign trade barriers Poor performance of ally firm

Source: OC Ferrell, M D Hartline, and G H Lucas Jr, Marketing Strategy , 2nd ed. (Thomson South Western,Vikas Publishing House), 2003, p. 57.

Table 7.4 SWOT Analysis for an International Retail Chain Seeking Entry into the Indian Market
KEY ENVIRONMENTAL FACTORS Strength/Weaknesses New Technology Customer Choices Competition Market & Preferences Growth International Exposure

Major Strengths Capacity to innovate O Market research Global base/international brands O Major Weakness New in India/Developing countries Existing brand suited for US/European markets High cost products T O (Opportunity) 2 T (Threats) 1 OT 1 indicates neither opportunity nor threat

O O O

O O O

O O O

O O O

T T T 3 3 0

T T T 3 3 0

O O T 5 1 4

O O O 6 0 6

In SWOT analysis in Table 7.4, opportunities far outweigh threats (O T = 11)shown in the last row. On this basis, it can be said that the environment is project or strategy friendly and the project is recommended. If threats are more than opportunities, the environment is to be considered hostile unless some threats can be converted into opportunities by working on the weaknesses.

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If opportunities are equal to threats, the matter should be put to vote of the senior/top management for decision. The matrix in Table 7.4 can also be presented in a more clear quantitative form by assigning numbers in places of O and T. Numbers would indicate relating significance of opportunities and threats . Opportunities will have positive signs; threats will have negative signs. On this basis, the matrix and the outcome of SWOT analysis can be reformulated as shown in Table 7.5.
Table 7.5 SWOT Analysis for an International Retail Chain Seeking Entry into the Indian Market
KEY ENVIRONMENTAL FACTORS Strength/Weaknesses Major Strengths Capacity to innovate Market research Global base/International brands Major Weaknesses New in India/Developing countries Existing brand suited for the US/European markets High cost products O (Opportunity) T (Threats) OT New Technology 3 2 Customer Choice Competition & Preferences 2 3 2 2 2 2 Market International Growth Exposure 2 2 1 2 2 3

1 5 1 4

3 2 2 7 7 0

2 2 3 6 7 1

1 1 1 7 1 6

1 2 1 11 0 11

indicates neither opportunity nor threat

Pearce and Robinson (2002) have suggested an alternative form of SWOT analysis more directly in terms of strategy. Based on four different combinations of strengths and weaknesses and opportunities and threats, four strategic situations develop. These four strategic situations imply four different strategic actions: aggressive strategy, diversification strategy, defensive strategy and turnaround type strategy. These are shown in Figure 7.5. Cell 1 is the most favourable situation ; there are several environmental opportunities and the organization has substantial internal strengths to exploit opportunities. Such condition suggests aggressive growth strategies to take advantage of the favourable match between strengths and opportunities. IBMs intensive market development strategy in the PC market was driven by a favourable match between its strengths (reputation and resources) and ample opportunity for market growth. In Cell 2, an organization with key strengths faces an unfavourable environment.
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In such situation, strategists should use current strength to create opportunities in other products/ markets, that is, to go for diversification. An organization in Cell 3 has plenty of market opportunities, but, is constrained by major internal weaknesses. Businesses in this cell are like question marks in the BCG Matrix. The focus of strategy here should be to remove internal weaknesses to capitalize on existing opportunities, that is, to follow some kind of a turnaround strategy. Cell 4 is the least favourable situation with the environment posing major threats and the organization suffering from major weaknesses. The most immediate strategy in this situation is to defend or sustain current position. Organizations in this cell should also work on internal weaknesses or competences to be able to negotiate environmental threats as Chrysler Corporation did in the 1980s when analysis revealed that the company was in Cell 4.
Numerous environmental opportunities

Critical internal weaknesses

Cell 3: Supports a turnaroundoriented strategy Cell 4: Supports a defensive strategy

Cell 1: Supports an aggressive strategy Cell 2: Supports a diversification strategy

Substanial internal strengths

Major environmental threats

Figure 7.5 SWOT Analysis and Recommended Strategies Source: I A Pearce II, and R B Robinson Jr, Strategic Management, 3rd ed. (Irwin Series in Management, Reprint India, 2002), 274.

All the four strategies mentioned above, i.e., aggressive or offensive strategy, defensive strategy, turnaround strategy and diversification strategy would be discussed in details in the later units.

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SWOT analysis, as presented in Tables 7.4 and 7.5 and also Figure 7.5 involves subjectivity. Judgement of the strategic planning group or SWOT analysis team plays a very important role. Therefore, no SWOT analysis should be taken as exact. This should be understood as a good approximation to matching a companys strengths and weaknesses with key environmental factors as opportunities or threats. This should be always done with respect to a particular business (e.g., entry of an international retail chain in India as shown above). Such analysis, however, is an essential starting point for a more detailed and rigorous exercise on strategic investment decisions in terms of costs and returns and organizational objectives and priorities. As mentioned, SWOT analysis gives the initial signalspositive or negativefor launching of a project or product, market entry, etc. Even if initial SWOT analysis is not favourable, i.e., threats outweigh opportunities, this does not mean that the project has to be abandoned. This, in fact, provides basis for re-examination of the strengths and weaknesses and the possibility of converting some weaknesses into strengths by investing more resources and improving skills and capabilities. This would make possible conversion of some of the threats into opportunities so that matching improves (Figure 7.6) and the project can still be considered on the basis of investment levels and costs and returns analysis.

Figure 7.6 SWOT Analysis: a Continuing Process Source: F R David, Strategic Management: Concepts and Cases (2003), 111.

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Activity 2 Choose a company or organization that you are familiar with and conduct a SWOT analysis for it. Analyse the results.

Self-Assessment Questions
15. A _______is a resource, skill, capability or any other advantage relative to competitors and in relation to markets. 16. A _________is a limitation or deficiency in resource, skills and capabilities or any other disadvantage relative to competitors which impedes performance of an organization.

7.8 Case Study


General Motors: Slow Response to Environmental Demand In the 1970s, General Motors (GM) was the largest automobile manufacturer in the world, with a market share of more than 50 per cent. In 2005, GMs market share was just about 25 per cent and it was still declining. GM remained (in 2005) the largest automobile manufacturer in the world, but, Toyota (No. 2) was fast catching up because of its competitiveness in terms of quality and differentiated products. According to one automobile analyst: GM has found itself stuck in second gear for a quarter of a century. Another analyst observed: The bedrock principle upon which GM was builtoffering a car to feed every market segmenthas degraded into a series of contrived brands, most with little identity and bland, overlapping product lines. GMs problems are too many. Managerial ego or lethargy (which often leads to inaction or inefficiency) is one of the more important ones. The company failed to quickly adapt to earlier demand for compact cars and more recent trend towards hybrid vehicles. It has negotiated badly with unions incurring massive costs and creating future liabilities. Due to such commitments and costs, the company has made compromises in car design and engineering. The result has been automobiles with outdated designs unable to compete with more modern and attractive models from competitors like Toyota and others.*

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GM has also become quite bureaucratic in its management approach implying slow systems and proceduresoften non-responsive to situations. GMs senior executives have shown a tendency for poor strategic decisions and inability to capitalize on opportunities in the market. Here is an example. GM was an early mover into China. It invested more than $1 billion in China since 1998. But, because of intense competition, it suffered a 35 per cent decline in sales during 2005 in Shanghai, the largest automarket in China. In contrast, Hyundai and a local company, Chery, increased their sales substantially during this period. This means that those competitors have outweighed GM in designing and manufacturing cars which Chinese buyers want.** Because of organizational inertia for response to changing environmental conditions, GM has landed itself into the present serious situation. An important development took place for GM in 2009. Billionaire investor Kirk Kerkorian increased his stake in GM to approximately 9 per cent. To ensure adequate return on his investment, Kerkorian might urge GMs Board of Directors to sell off non-core assets, cut costs or restructure the bloated auto business faster than current management appears inclined to do. But, can GM do it? And, if so, how soon? We must remember that we are in the auto generation of 2010. Speed and adaptability are vital for survival and success. * M A Hitt et al., Management of Strategy, Indian Edition (Cengage Learning, 2007), 139. **M A Hitt et al., (2007), 139.

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7.9 Summary
Let us recapitulate the important concepts discussed in this unit: The external environment consists of a large number of factors which influence a companys business. Major environmental factors are: political factors, economic factors, sociological factors, government policies/ controls, technology, competition intermediaries and suppliers. Organizations should be generally concerned with relevant environment and operating environment. The operating environment, also known as competitive environment consists of factors in the immediate competitive situation like customer profile, level of competition, the industry structure, technology, any specific regulations affecting the company or industry, etc. Since the environment is too diverse, scanning of environment (some call it external audit) is necessary to elicit information relevant to a particular organization. Environmental information occurs in one or more of four forms; events, trends, issues and expectations. To understand the emerging or evolving environment better, some have suggested environmental forecasting. For environment forecasting, Gap analysis is a good starting point. Forecasting is a hazardous exercise, and exactness in forecasting is hardly possible. That is why many have suggested alternative scenario building for the futuresay, optimistic, pessimistic and mean scenario. Shells long-term scenario building for the oil industry is a good example. For identifying opportunities and threats in the environment, organizations should undertake environmental appraisal, i.e., assessing the environment for clearly identifying major opportunities and threats. One method for environment appraisal, suggested by Glueck, is preparation of an environmental threat and opportunity profile (ETOP). Simultaneously with environmental analysis or appraisal (ETOP or EFEM), organizations also need to assess their internal strengths and weaknesses to exploit opportunities and negotiate threats. This is done through SWOT analysismatching organizational strengths and weaknesses with environmental opportunities and threats.

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7.10 Glossary
Forecasting: Estimate or prediction of future developments in business such as sales, expenditures, and profits. Gap analysis: Projections, over time, of the gap between the desired change in strategic parameters like sales, profitability, market share, etc., and actual change with continuation of present strategy, that is, not responding to changes in the environment. Scenario: A detailed and probable view of how the business environment of an organization may develop in the future based on the analysis of key environmental influences and factors of change about which there is a high degree of uncertainty. SWOT analysis: A tool used by organizations to match their internal strengths and weaknesses with factors of the environment.

7.11 Terminal Questions


1. Enumerate major environmental factors. Which of these, according to you, are more important and why? 2. What is scanning of environment? Mention the major sources of information for environmental scanning. 3. What is gap analysis ? Explain its relevance to environmental forecasting. 4. What is ETOP? Prepare an ETOP for a sports cycle manufacturing company. 5. What is SWOT analysis? Explain SWOT analysis in the form of a matrix. 6. Explain Pearce and Robinsons form of SWOT analysis. Use the relevant diagram for the analysis.

7.12 Answers Answers to Self-Assessment Questions


1. Economic 2. Consumption 3. life cycles
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4. (d) All the above 5. Scanning 6. external audit 7. Trends 8. Information 9. Gap analysis 10. False 11. Scenario 12. Alternative 13. Opportunities, threats 14. Glueck (1984) 15. Strength 16. Weakness

Answers to Terminal Questions


1. The external environment consists of a large number of factors which influence a companys business. Refer to Section 7.3 for further details. 2. Scanning of environment (some call it external audit) is necessary to elicit information relevant to a particular organization. Refer to Section 7.4 for further details. 3. Gap analysis refers to the projections, over time, of the gap between the desired change in strategic parameters like sales, profitability, etc., and actual change with continuation of present strategy. Refer to Section 7.5 for further details. 4. Environmental threat and opportunity profile (ETOP) is one of the many methods for environmental appraisal. It was suggested by Glueck (1984). Refer to Section 7.6 for further details. 5. SWOT analysis is a tool used by organizations to match their internal strengths and weaknesses with factors of the enviroment. Refer to Section 7.7 for further details. 6. Pearce and Robinson have suggested a form of SWOT analysis more directly in terms of strategy. Refer to Section 7.7 for further details.

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7.13 References
1. David, F R. 2003. Strategic Management: Concepts and Cases, 9th ed. New Jersey: Pearson Education. 2. Fahey, L, W R King, and V K Narayanan. 1983. Environmental Scanning and Forecasting in Strategic Planningthe State of the Art. In The Truth about Corporate Planning: International Research into the Practice of Planning, edited by D Hussey. Oxford: Pergamon Press. 3. Mandell, T S. 1983. Future Scenarios and Their Uses in Corporate Strategy. In The Strategic Management Handbook, edited by K J Abert. New York: McGraw Hill. 4. Pearce, II, J A, and R B Robinson Jr. 2004. Strategic Management. 7th ed. McGraw Hill/Irwin, Ch.6. 5. Porter, M.E. 1980.Competitive Strategy: Techniques for Analyzing Industry and Competition. New York: The Free Press. Endnotes
1

P K Ghosh, Strategic Planning and Management, 10 th ed. (New Delhi: Sultan Chand & Sons, 2003), 106. In many industrial markets and some consumer goods markets, intermediaries may be absent because companies decide to deal directly with the end users. Here, we are talking of personal selling or direct marketing. R David, Strategic Management: Concepts and Cases (Pearson Education, 2003), 80. G Johnson, and K Scholes, Exploring Corporate Strategy , 9 th ed. (2005), 107 T S Mandel, Future Scenarios and Their Uses in Corporate Strategy in The Strategic Management Handbook , ed. K J Albert (McGraw Hill, 1983), 10 11. A Kazmi, Business Policy and Strategic Management, 2 nd ed . (New Delhi: Tata McGraw Hill, 2002), 125. Some prefer to use C in place of W , C standing for Constraints because Weaknesses sounds discouraging or negative. So, instead of SWOT , it is called SCOT analysis.

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