Entrepreneurship/Leadership/Innovation- MGT 2251Y

UNIT 10: ANALYSIS OF THE BUSINESS ENVIRONMENT OF SMES

Unit Structure

10.0 Overview
10.1 Learning Objectives
10.2 Introduction
10.3 Influences on Small Firm Formation and Survival
10.3.1 ‘Push’ and ‘Pull’ Factors in Business Start-up
10.3.2 Personal Attitudes
10.3.3 Industry Analysis – The Five Forces Model
10.3.3.1 Potential Competitors
10.3.3.2 Rivalry among Established Companies
10.3.3.3 Power of Buyers
10.3.3.4 Power of Suppliers
10.3.3.5 Threat of Substitute Products
10.3.3.6 Relative Power of Unions, Governments and Interest
Groups
10.4 Competitor Analysis
10.4.1 Competitor Identification
10.5 Analysis of the External Environment
10.5.1 The PEST Framework
10.5.1.1 Political, Governmental and Legal Forces
10.5.1.2 Economic Forces
10.5.1.3 Socio-cultural, Demographic and Environmental Forces
10.5.1.4 Technological Forces
10.6 Summary
10.7 References

1
 Entrepreneurship/Leadership/Innovation- MGT 2251Y

10.0 OVERVIEW

In this Unit, the various elements constituting the internal environment of the business are
analysed with a view to uncover its strengths and weaknesses. The components of the
competitive environment are identified and assessed using competitor analysis. The
Porter's Five Forces framework is presented as a tool for measuring industry
attractiveness while the PEST framework uncovers opportunities and threats in the
external environment.

10.1 LEARNING OBJECTIVES

By the end of this Unit, you should be able to do the following:

1. Explain the influences on small firms birth and survival.
2. Analyse the Porter's Five Forces Model as a tool for measuring industry
attractiveness.
3. Identify competitor strengths and weaknesses via competitor analysis.
4. Identify strengths and weaknesses of the business following internal analysis.
5. Analyse the external environment of industry using the PEST framework to
identify opportunities and threats.

10.2 INTRODUCTION

Small businesses form a turbulent part of the national economy because of the dynamic
movements in and out of the SME sector as many new businesses are formed and are
closed each year. The fittest survive and it is good for the economy to have resilient
businesses remaining.

A number of factors in business environment, (some related to the enterprise, some to the
external environment) affect the births and deaths of small firms, some factors being
outside the direct control of firms. Internal factors, however, can be largely controlled by
entrepreneurs through their personal attributes, technical skills, competencies and

2
 Entrepreneurship/Leadership/Innovation- MGT 2251Y

behaviours. These factors decide first whether the new firm can start up and later on, its
chances of survival.

Going into business is influenced by either ‘pull’ factors such as a desire for
independence and autonomy and ‘push’ factors such as lack (or loss) of employment.
Cromie, 1991 reports that “research into the management problems faced by young small
firms revealed that they experience problems, particularly in the areas of marketing,
accounting and finance and the management of people”.

10.3 INFLUENCES ON SMALL FIRM FORMATION AND

SURVIVAL
Internal influences External influences
Owner-manager motives Macro environment
Personal attributes Political
Technical skills Economic
Management competencies Social
especially in: Technological
Marketing
Finance Micro environment
Management of people Local economy
Entrepreneurial management Market sector
behaviours, including: Competitors
Opportunity discovery and Customers
exploitation
Resource acquisition and
coordination
Entrepreneurial networking
Entrepreneurial decision-making

Likelihood of small business

formation and survival

(Source: Stokes & Wilson, 2006)

3
 Entrepreneurship/Leadership/Innovation- MGT 2251Y

Internal influences stem from the inner motivations, personal attributes, skills, competencies
and attitudes of the entrepreneur. Once the business is set up, how the firm grows will
depend on the entrepreneur’s ability to match his/her strengths and weaknesses with the
business environment’s opportunities and threats.

10.3.1 ‘Push’ and ‘Pull’ Factors in Business Start-up

Starting a business is hard work without guaranteed results. This may be the reason why
many people have ideas but do not go on materialising them. Whether they do so or not may
also be influenced by the ‘push’ or ‘pull’ factors. ‘Push’ factors are those that force people in
self-employment. This can result from redundancy, unemployment or simply retirement.
Push factors, being somewhat ‘involuntary’ rarely give rise to thriving businesses.

A growth firm is more likely to result from a ‘pull’, voluntary factor because of the positive
motivation. ‘Pull’ factors include the need for achievement and recognition, need for
independence and pursuance of wealth or otherwise the wish to materialise on motivation.

Despite these ‘push’ or ‘pull’ triggers, to-be entrepreneurs may face a number of barriers
which may curb their enthusiasm, for example, the need for a regular income and lack of
capital. Many of these barriers can be overcome by the entrepreneur through his/her personal
strengths.

10.3.2 Personal Attitudes

The smaller the business, the more qualities the entrepreneur will need to run the operations.
These include hard work ethics, the energy to run the business day and night, foregoing rest
and holidays etc. For such dedication to the venture, the owner/manager will be committed
enough to make the above mentioned sacrifices.
Entrepreneurial people also show resilience, that is, the ability to bounce back persistently
and a strong tolerance for risk and uncertainty.

4
 Entrepreneurship/Leadership/Innovation- MGT 2251Y

Cooper (1981) proposed a framework for classification of start-up influences:

1. The antecedent influences on entrepreneurs: their background, family, age, education,
job experience and so on.
2. The incubator organisation in which they have previously been working: its location,
market sector, skills required and so forth.
3. The environmental factors external to the individual: the economy, role models,
availability of finance, staff and other support and so on.

Elements of the external environment will be dealt with in a subsequent section.

Activity 1

How far do you think the University Placement programmes at UoM (SWEP, WBL,
Practicum and so on) serve the above purpose?
Is a module on Entrepreneurship and SME Management across all Programmes (in all
faculties) warranted?

10.3.3 Industry Analysis

An industry is a group of firms that produce a similar product or service. Industry analysis is
an analysis of important stakeholder groups such as customers and suppliers.

Michael Porter contends that the intensity of competition within an industry is determined
by a number of basic competitive forces, namely, rivalry among existing firms, power of
buyers, power of suppliers, threat from substitute products, potential entrants and relative
power of other stakeholders such as Unions, Governments and Special Interest Groups
(for example, consumer associations).

5
 Entrepreneurship/Leadership/Innovation- MGT 2251Y

Risk of entry by
potential
competitors

Bargaining
power of
suppliers Bargaining
Rivalry Among power of buyers
Established
Competitors
Relative Power
of Unions,
Governments
and Interest
Groups
Threat of
substitute products

Figure 1: Porter’s Five Forces Model

(Source: Wheelen & Hunger, 2008).

Activity 2

Identify a set of substitute products/services.

According to Porter, the stronger any of the forces mentioned above, the more limited is
the ability of the company to reap greater profit or market share.

From the same model, it follows that managers need to closely follow changes in the
given competitive forces and if possible to alter any of them to their advantage. The Five
Forces will now be discussed in detail.

6
 Entrepreneurship/Leadership/Innovation- MGT 2251Y

10.3.3.1 Potential Competitors

These are companies which are not currently competing in the industry, but have the
potential to do so. Managers have to assess if the risk of a competitive move by one firm
can be expected to have a noticeable effect on other firms and thus cause any retaliation.

Small firms can tackle the problem by erecting:

• Brand loyalty: buyers’ preference for the products of established companies.
Competitors will find it a difficult and/or too costly task to break down well-
anchored consumer preferences.
• Absolute Cost Advantages, for example, Cost Advantages can arise from superior
production techniques e.g. control on costs of intrants such as materials, labour,
equipment, funds and so on. Some companies may produce their own raw
materials.
• Economies of Scale, that is, Cost advantages associated with company size and
mass production of a standard output. In this situation, these companies benefit
from bulk discount in purchase of intrants, they can spread their fixed costs over a
longer volume, they may also benefit from economies of scale in advertising.

This last strategy as well as erecting barriers to entry (for example, R & D costs)
applies to large firms in general, small firms being unable to access the same
advantage.

10.3.3.2 Rivalry among Established Companies

If rivalry in the industry is strong, this can give rise to intense competition, which can
result in price wars. Mail order companies such as Dell and Gateway increased the level
of competitive activity so much that the PC industry dominated by Apple, IBM and
Compaq had to reduce prices drastically.

7
 Entrepreneurship/Leadership/Innovation- MGT 2251Y

The extent of rivalry in an industry depends on three factors:

(1) Industry structure.
(2) Demand conditions.
(3) Exit barriers in the industry.

• Industry Structure

The industry can range from a pure monopoly to a fully fragmented one.

Firstly, a monopolistic situation is where only one dominant firm exists without
competitors.

Secondly, apart from this extreme, there can be a situation where a few companies
dominate the industry, whereby an oligopoly.

Thirdly, a fragmented industry consists of a large group of companies without any

dominant one serving the market. Barriers of entry are low and whenever demand
increases, new entrants flood the industry creating a Boom and Bust cycle. A fragmented
industry therefore constitutes a threat because of ease of entry and the risk of price wars.

In consolidated industry structures (oligopoly), although threat from new entrants is low,
any competitive action taken by one company is going to affect the market share of the
other ones. “This happens often in the retail clothing industry when a number of retailers
open outlets in the same location – thus taking sales away from each other”. (Wheeler &
Hunger, 2008).

There is competitive interdependence whereby if one reduces prices, the market share
position is going to shift. Therefore companies tend either to follow the leader or else to
agree tacitly on prices (Explicit price agreement is illegal).

8
 Entrepreneurship/Leadership/Innovation- MGT 2251Y

• Demand Conditions

Demand grows when the market increases in size.

Therefore companies can grow without taking market share from competitors. However,
when demand declines, companies grow by taking market share from competitors.

• Exit Barriers

Exit barriers keep a company from leaving an industry. Some companies persist to remain
in the industry when returns are declining. This can be due to a number of factors e.g.
emotional attachments, economic or strategic reasons.
Exit Barriers include:
- High investment in Equipment e.g. in the brewing industry.
- High costs of closing down e.g. severance payment.
- Emotional reasons e.g. family businesses.
- Strategic relationships between business units in the same firm e.g. provide inputs
to a profitable sub unit.
- Lack of diversification, i.e. dependence on a unique product.

10.3.3.3 Power of Buyers

Buyers have bargaining power when they can threaten to shift to another supplier, for
example, by asking for lower prices, better quality and customer care (higher operating
costs). There are a number of situations which can give rise to buyer power, for instance,
- Few institutional (large) buyers and a large number of providers. “Small
entrepreneur” poultry industries in Mauritius sell to a few poultry
processing plants.
- Buyers buy in large quantities and demand bulk discounts, for example, hypermarkets
buying soft drinks.
- Supply industries have developed dependence on buyers.

9
 Entrepreneurship/Leadership/Innovation- MGT 2251Y

- Buyers can threaten to produce their own intrants (vertical integration), for example,
the soft drinks industry starts producing sugar.

10.3.3.4 Power of Suppliers

Powerful Suppliers can unilaterally decide to increase and impose their prices and quality
(low) on the company.

Porter proposes the following situations where suppliers are powerful:

- When the product supplied is of vital importance for the company and cannot be
substituted for.
- When the company’s industry is not an important customer for the supplier.
- When the company depends on the supplier for a customised product/intrant.
- When suppliers can easily resort to vertical integration and become competitors, that
is, suppliers of raw materials enter the manufacturing industry.

10.3.3.5 Threat of Substitute Products

The beverages industry is a good example where consumers can frequently and easily
shift from one product to a close substitute in case one is unavailable or becomes more
expensive.

Depending on price of coffee (unstable) people shift from coffee to tea which is more
stable in price. Nowadays, people tend to shift from soft drinks due to health concerns.
The existence of close substitutes presents a threat, limiting the price a company can
charge and hence its profitability.

10
 Entrepreneurship/Leadership/Innovation- MGT 2251Y

10.3.3.6 Relative Power of Unions, Governments and Interest

Groups

Depending on membership, size and subsequent bargaining power, Unions can have
influence on firms’ freedom to take corporate decisions. Fostering good employment
relations in a tripartite fashion with Government can promote healthy industrial relations, an
intangible asset for companies. Special interest groups can similarly influence the industry,
for example, Consumer association and Green movements. One proactive strategy to be
adopted by firms is to take such interest groups’ views on board when making corporate
decisions.

The issues discussed earlier are expected to provide valuable insights as to the strengths and
weaknesses of the organisation (or of the entrepreneur). Strengths arise from the resources
and competencies possessed by the firm.

“Management performs internal analysis and diagnosis to identify clearly the current
strengths and weaknesses of the firm. Management also examines the most probable
future strengths and weaknesses”. (Jauch & Glueck, 1998).

Together with an understanding of the dynamics of the industry, the Five Forces Model gives
an insight on whether the firm should enter the industry and whether it can carve an
attractive position within the industry. For example, if several of the threats to industry
profitability are high, the firm may reconsider entering the industry or think more carefully
about the position it will be able to occupy in the industry.

10.4 COMPETITOR ANALYSIS

Many organisations neither seriously nor regularly consider their competitors. Even public
sector bodies which may not be competing for customers, do compete for scarce resources.
In a global economy, it is vital to systematically monitor the environment so that one is

11
 Entrepreneurship/Leadership/Innovation- MGT 2251Y

aware of competitors’ strengths and weaknesses and other changing opportunities and
threats.

It is seldom necessary to resort to industrial espionage or any other illegal methods to do

competitor analysis. There are many sources of cheap information for small firms:
• Attending conferences and trade shows where latest trends are displayed
• Reading trade journals and web sites
• Talking to customers and suppliers to capture valuable competitor information, for
example, advantages and disadvantages of competitor products
• Purchasing competitor’s products to assess their customer value or weaknesses
• Watching competitors’ web sites for information on any new products, and so on.

This is done by getting people at all levels to capture and interprete competitor data
especially at customer interface levels. Such type of sensitive activities can be built into job
descriptions and appraisal systems whereby frontline staff and supervisors are trained to ask
sensitive questions to customers, suppliers and, indirectly, competitors. Managers can be
trained to scan the media regularly, as part of their job. All the information and analysis can
then go on the intranet to make it available as a cost effective competitive intelligence
source.

10.4.1 Competitor Identification

Who your competitor is might appear to be a simple question to answer. This is more
difficult than one might think. For example, a company which sells flowers is not only in the
flower business because, since flowers are offered as gifts, the company is also in the gift
business. Identifying competitors using this perspective gives a very different outlook on
competitor analysis.

Competitors can be direct, indirect or future competitors.

• Direct competitors offer products similar or identical to the firm’s, therefore targeting
the same customers
• Indirect competitors offer close substitutes which target the same basic need that is

12
 Entrepreneurship/Leadership/Innovation- MGT 2251Y

met by the new firm’s product. According to the former CEO of Coca-Cola, the
average consumer buys only 2% of his/her daily fluid intake as Coke, the competitors
being water, coffee, tea and so on.
• Future competitors are neither direct, nor indirect competitors. They are yet to move
in as new competitors.

Conversely, competitor analysis can uncover avenues for collaboration, especially when it is
a question of survival. Cooperation among competitors is sometimes essential for survival of
the community of related businesses. Domestic firms, for example, can join forces with
competing firms for mutual benefit.

Activity 3

Explain the “Grandes Surfaces Reunies” model in the retail business in Mauritius.

10.5 ANALYSIS OF THE EXTERNAL ENVIRONMENT

The external analysis of the business environment includes an analysis of the Macro
environment, the PEST framework. Changes in the PEST framework can result in
Opportunities and/or Threats.

External forces can be broadly categorised as:

- Political, governmental and legal forces.
- Economic forces.
- Social, cultural and environmental forces.
- Technological forces.

In order to survive, organisations have to recognise and take advantage of external

opportunities. The process must involve managers and employees leading to commitment

13
 Entrepreneurship/Leadership/Innovation- MGT 2251Y

from the whole organisation.

To perform external scanning, companies first gather competitive intelligence as mentioned

earlier and information pertaining to socio-cultural, economic, politico-legal and
technological trends. The sources of such information include newspapers, magazines and
trade journals and on line sources.

10.5.1 The PEST Framework

10.5.1.1 Political, Governmental and Legal Forces
These can present both opportunities and threats. If firms depend heavily on government
contracts, political forecasts are going to be a major variable in external scanning. Issues such
as genetic engineering, animal testing, euthanasia and so on are quite controversial and
divide opinion. Such political issues have a profound influence on, for example,
pharmaceutical industry.

Political and legal influences are linked because in democratic countries, politicians in
power make laws in Parliament. One significant worldwide trend is Deregulation
(Airlines, telecommunications, Electricity/Water Distribution etc.). This has opened
numerous opportunities although the Entry Barriers are sometimes quite high.

Concerns about the Natural Environment have also prompted Parliaments to pass laws to
protect the environment, for example, on the Ozone layer, Seas and other Water Bodies
and recently Climate change.

Managers need to anticipate regulations and take prompt action so as to convert threats
into opportunities.

Multinational firms heavily rely on political forecasts, especially if they depend on certain
countries for natural resources or simply for a market. Strategists therefore compete on
correctly forecasting and/or influencing public policy. Conversely, many companies have
changed or abandoned strategies because of governmental actions.

14
 Entrepreneurship/Leadership/Innovation- MGT 2251Y

• Examples of governmental actions are:

• Government regulation (or deregulation).
• Tax laws.
• Equal opportunity laws.
• Import-Export regulations.
• Political conditions in foreign countries.

10.5.1.2 Economic Forces

Economic factors (as shown in economic indicators) have a direct impact on the potential
attractiveness of business strategies. One example is interest rates. If interest rates rise, funds
needed for capital expenditure become more expensive, discretionary income declines and as
a result, demand for discretionary goods falls.

Similarly, trends in the value of foreign currency have significant effects on exports and
imports (and tourism).

In the USA, job loss during recession is considered as a blessing in disguise. Laid off
workers are encouraged to become entrepreneurs, whereby they take charge of themselves
and may even create jobs.

Examples of economic variables are given below:

Availability of credit Tax Rates
Inflation rates Shift to service/knowledge economy
Consumption patterns Worker productivity levels

Activity 4

Explain how each one of the above can present opportunities and/or threats.

15
 Entrepreneurship/Leadership/Innovation- MGT 2251Y

10.5.1.3 Socio-cultural, Demographic and Environmental Forces

It is estimated that “persons aged 65 and older in the U.S will rise from 12.7 per cent of the
population to 18.5 per cent between 1997 and 2025” David, 1999. Expected trends are that
consumers will become more and more educated and we will be faced with an ageing
population phenomenon. Furthermore, more attention will be given to the natural
environment and more women will enter the workplace and take top positions in
organisations.

The ageing American population has triggered opportunities in the residential building sector,
for example, in the form of apartment complexes with served meals. The elder population
will be the market for business initiatives like health care, financial services, travel, crime
prevention and leisure.

Examples of such variables are:

Life expectancy rates Per capita income
Buying habits Attitudes towards product quality
Ethical concerns Social responsibility
Pollution control
Ozone depletion
Endangered species

10.5.1.4 Technological Forces

Business operations are currently being revolutionised by innovations such as robotics,
Internet connectivity, fibre optics, satellite networks and so on. Enabling amongst others,
electronic funds transfer, space communications, telemedicine and so on.

Technological forces can dramatically affect the way products/services are designed,
manufactured, distributed and sold. They can ‘create’ new markets and change competitive
cost positions in an industry.

16
 Entrepreneurship/Leadership/Innovation- MGT 2251Y

Technology can therefore uncover opportunities and sometimes threats.

Activity 5

Give an appropriate example of how new technology can present a threat to

an established industry.

Companies must continuously operate a technology watch to keep pace with changes. Firms
which fail to manage technology can find themselves being ‘managed’ by technology in
future.

Technological change can be disruptive in the sense that an innovation can make a
product become obsolete overnight. Technology can greatly affect barriers of entry and
exit and can therefore reshape a whole industry. Technology can therefore be both an
opportunity and a threat.

Activity 6

Give an example of technological obsolescence which has reduced barriers of entry.

Activity 7

Research on the Harvard Business Review article of Theodore Levitt,

‘Marketing Myopia’ and comment on the lessons learnt.

17
 Entrepreneurship/Leadership/Innovation- MGT 2251Y

10.7 SUMMARY

Analysing the internal environment uncovers the strengths and weaknesses of the
organisation while external analysis shows the opportunities and threats. Competitor analysis,
using a number of low cost competitor intelligence methods were seen to be more
appropriate for SMEs. Competitor analysis may also uncover avenues of cooperation
between firms.

10.8 REFERENCES

1. Jauch & Glueck. (1998). Strategic Management.

2. Cooper, A. (1981). ‘Strategic Management: New Ventures and Small Business’, Long
Range Planning, 14(5).
3. Cromie, S. (1991). ‘The Problems experienced by young firms’, International Small
Business Journal 19(3).
4. Stokes, D. & Wilson, N. (2006). Small Business Management Entrepreneurship.
5. Wheelen, T. & Hunger, D. (2008). Strategic Management and Business Policy.

18