Chapter two: External environment

2.1 External (Macro) environment.

 External environmental factors are events that take place outside

of the organization and are harder to predict and control.

 External environmental factors can be more dangerous for an

organization given the fact they are unpredictable, hard to prepare
for.

 Environmental scanning is the monitoring, evaluation, and

dissemination of information from the external and internal
environments to key people within the corporation
 External environment---
2.1.1 PESTEL analysis (Identifying External EnvironmentalVariables)

 PESTEL analysis refers to the examination of political

environment, Economic environment, socio-cultural environment,
technological environment, Ecological (natural) environment and
legal environment).
 PESTEL analysis in general refers to the examination of the natural
and societal environment.
 The analysis of natural environment is the monitoring of physical
resources, wildlife, and climate that are an inherent part of
existence on Earth.
 The analysis of societal environment refers to the examination of
political, economical, socio-cultural, technological and legal
environment.
External environment---
A) Scanning the natural environment

 The natural environment includes physical resources, wildlife,

and climate that are an inherent part of existence on Earth.

 These includes physical resources such as underground mineral,

forest, arable land; solar energy, fresh air etc.

 These factors form an ecological system of interrelated life.

 Management must scan the natural environment for possible

strategic factors
External environment---
B) Scanning the Societal Environment. STEP analysis
 This refers to the monitoring of sociocultural, technological,
economical and political-legal environment
 The number of possible strategic factors in the societal
environment is very high.

i) The sociocultural environment includes growth rate of

population, age distribution of population, life expectancies, birth
rates, pension plans, health care, level of education, lifestyle changes,
rate of family formation, changing household composition etc.
External environment---
ii) The technological environment
 Technological factors to be considered are:
• Source of technology like company, external and foreign sources,
cost of technology acquisition, collaboration and transfer of
technology.
• The technological environment includes internet availability, total
government spending for R&D, total industry spending for R&D,
telecommunication infrastructure etc.
iii) The economic environment: this includes GDP trends, per
capita income, interest rates, money supply, inflation rates,
unemployment levels, energy availability and cost, energy
alternatives, currency markets, global financial system etc.
 Trends in the economic part of the societal environment can have
an obvious impact on business activity.
 External environment---

iv) The political-legal environment: this includes

environmental protection laws, tax and labor lows, political stability
of government, government bureaucracy and regulations , political
ideology, laws on hiring and promotion, outsourcing regulation,
import–export regulations, special incentives etc.
External environment--
Identifying External Strategic Factors

 The origin of competitive advantage lies in the ability to

identify and respond to environmental change well in
advance of competition.

 One way of doing this is through developing issue priority

matrix.

 The issue priority matrix is used to identify and analyse

developments in the external environment
External environment---
 This can be done as follows:
1) Identify a number of likely trends emerging in the natural,
societal, and task environments.
 These are strategic environmental issues—those important
trends that determine what the industry or the world will
look like in the near future
2) Assess the probability of these trends actually occurring,
from low to medium to high.
Attempt to ascertain the likely impact (from low to high) of
each of these trends on the corporation being examined
External environment---
 A corporation’s external strategic factors are the key
environmental trends that are judged to have both:
 a medium to high probability of occurrence and
 a medium to high probability of impact on the corporation.

 Those environmental trends judged to be a corporation’s strategic

factors are then categorized as opportunities and threats and are
included in strategy formulation.
External environment---
External environment---
2.2) Industry (Micro) Environment

 The industry environment is also called task or immediate

environment
 It refers to those elements or groups that directly affect the
corporation and, in turn, are affected by it.
 It is typically the industry within which the firm operates.

 These are local communities, suppliers, competitors, customers,

creditors, employees/labor unions and trade associations.

Scanning the task environment (industry analysis)

 A corporation’s scanning of the environment includes analyses of
all the relevant elements in the task environment.
External environment---
 Porter’s Five-Forces Model of competitive analysis is a widely used
approach for developing strategies in many industries:

1. Threats of new entrant

2. Rivalry among competing firms

3. Threats of substitute products

4. Bargaining power of suppliers

5. Bargaining power of consumers

External environment---
a) Threats of new entrants

 New entrants to an industry typically coming up with new

capacity, a desire to gain market share, and substantial resources.
They are, therefore, threats to an established corporation.

 The threat of entry depends on the presence of entry barriers and

the reaction that can be expected from existing competitors.

 An entry barrier is an obstruction that makes it difficult for a

company to enter an industry.
External environment---
 Some of the possible barriers to entry are:
 Economies of scale
 Product differentiation( through promotion, quality improvement,
etc.)
 Capital requirements
 Access to distribution channels
 Government policy
 Switching cost
 Expected retaliation
External environment---
b) Rivalry among existing firms
 A competitive move by one firm can be expected to have a
noticeable effect on its competitors and
 thus may cause retaliation such as lowering prices, enhancing quality,
adding features, providing services, extending warranties, and increasing
advertising.
 According to Porter, intense rivalry is related to the presence of
several factors, including:
1. small number, Similar size, and Similar capability of firms
competing
2. Falling demand for the industry’s products
3. Falling product/service prices in the industry
4. When barriers to entering the market are low
5. When fixed costs are high among firms competing –air line
6. When rivals have excess capacity
7. When barriers to leaving the market are high
External environment---
c) Threat of Substitute Products or Services
 A substitute product is a product that appears to be different but
can satisfy the same need as another product.

 According to Porter, “Substitutes limit the potential returns of an

industry by placing a ceiling on the prices firms in the industry can
profitably charge.”

 Examples of substitute products are: tea is a substitute for coffee;

e-mail is a substitute for the fax; bottled water is a substitute for a
cola.
 If the price of coffee goes up high enough, coffee drinkers will
slowly begin switching to tea. The price of tea thus puts a price
ceiling on the price of coffee.
External environment---
d) Bargaining power of the buyers
 Buyers affect an industry through their ability to force down
prices, bargain for higher quality or more services, and play
competitors against each other.

 A buyer or a group of buyers is powerful if some of the

following factors hold true:

1. A buyer purchases a large proportion of the seller’s product

or service
External environment---
2) A buyer has the potential to integrate backward by
producing the product itself
3. Alternative suppliers are plentiful because the product is
standard or undifferentiated
4. Changing suppliers costs very little
5. The purchased product represents a high percentage of a
buyer’s costs-purchase large amount
6. The purchased product is unimportant to the final quality
or price of a buyer’s products or services and thus can be
easily substituted without affecting the final product
adversely
External environment---
e) Bargaining power of the suppliers

 Suppliers can affect an industry through their ability to raise prices

or reduce the quality of purchased goods and services.

 A supplier or supplier group is powerful if some of the following

factors apply:

1. The supplier industry is dominated by a few companies, but it

sells to many
External environment---
2. Its product or service is unique and/or it has built up switching
costs

3. Substitutes are not readily available

4. Suppliers are able to integrate forward and compete directly with

their present customers

5. A purchasing industry buys only a small portion of the supplier

group’s goods and services and is thus unimportant to the supplier
External environment---
Strategic Groups
 is a set of business units or firms that “pursue similar strategies
with similar resources

 Categorizing firms in any one industry into a set of strategic

groups is very useful as a way of better understanding the
competitive environment.

 companies or business units belonging to a particular strategic

group within the same industry tend to be strong rivals AND
 tend to be more similar to each other than to competitors in
other strategic groups within the same industry
External environment---
Strategic Types Based on
 A strategic type is a category of firms based on a common
strategic orientation(group) and a combination of structure,
culture, and processes consistent with that strategy.

 According to Miles and Snow, competing firms within a single

industry can be categorized into one of four basic types on the
basis of their general strategic orientation

1. Defenders
 are companies with a limited product line that focus on improving
the efficiency of their existing operations.
 This cost orientation makes them unlikely to innovate in new areas.
External environment---
2. Prospectors
 are companies with fairly broad product lines that focus on
product innovation and market opportunities.
 They tend to emphasize creativity over efficiency
3. Analysers
 are corporations that operate in at least two different product-
market areas, one stable and one variable.
 In the stable areas, efficiency is emphasized.
 In the variable areas, innovation is emphasized
4. Reactors
 are corporations that lack a consistent strategy-structure-culture
relationship
2.3) Competitive analysis

 Competitive analysis is some times called competitive intelligence.

 is a formal program of gathering information on a company’s
competitors.
 Often called business intelligence
 According to a survey of competitive intelligence professionals,
the primary reasons for practicing competitive intelligence are
 to build industry awareness
 to support the strategic planning process
 to develop new products ,
 to create new marketing strategies and tactics
Competitive analysis---
 the competitive/business intelligence function can housed in its
own unit,

 it can be within marketing, strategic planning, information

services, business development (merger & acquisitions), product
development, or other units

 Information is obtained from a variety of sources—suppliers,

customers, industry publications, employees, industry experts, industry
conferences, current or former competitors’ employees, and the Internet
 External environment---
Synthesis of External Factors— EFAS/EFE Matrix
 EFAS (External Factors Analysis Summary) matrix helps
 to organize the external factors into the generally accepted categories
of opportunities and threats as well as

 to analyze how well a particular company’s management (rating) is

responding to these specific factors in light of the perceived
importance (weight) of these factors to the company.
 External environment---
Steps
 In Column 1 (External Factors), list the eight to ten most
important opportunities and threats facing the company.

 In Column 2 (Weight), assign a weight to each factor

from 1.0 (Most Important) to 0.0 (Not Important) based on
that factor’s probable impact on a particular company’s current
strategic position. The higher the weight, the more important is
this factor to the current and future success of the company.
 All weights must sum to 1.0 regardless of the number of
factors.
External environment---
 In Column 3 (Rating), assign a rating to each factor
from 5.0 (Outstanding) to 1.0 (Poor) based on that
particular company’s specific response to that particular
factor. Each rating is a judgment regarding how well the
company is currently dealing with each specific external
factor.
External environment---
 In Column 4 (Weighted Score), multiply the weight in Column 2
for each factor times its rating in Column 3 to obtain that factor’s
weighted score.

 In Column 5 (Comments), note why a particular factor was

selected and how its weight and rating were estimated.

 Finally, add the weighted scores for all the external factors in
Column 4 to determine the total weighted score for that
particular company.
External environment---
External environment---
 The total weighted score indicates how well a particular
company is responding to current and expected factors in its
external environment.
 The score can be used to compare that firm to other firms in the
industry.
 Check to ensure that the total weighted score truly reflects the
company’s current performance in terms of profitability and
market share.
 The total weighted score for an average firm in an
industry is always 3.0.
 Note that Maytag’s total weight was 3.15, meaning that the
corporation was slightly above average in the major home
appliance industry.