KMBN 301

Strategic Management
Unit-2
ENVIRONMENTAL SCANNING

Environmental scanning is a process used by organizations to monitor their external and internal
environments. Every organization has an internal and external environment. In order for the
organization to be successful, it is important that it scans its environment regularly to assess
its developments and understand factors that can contribute to its success.

Components of a Business Environment

The internal environment offers strengths and weaknesses to business while the external
environment brings opportunities and threats. The four influencing environmental factors known
as SWOT Analysis are:

1. Strength – an inherent capacity of an organization which helps it gain a strategic

advantage over its competitors.

2. Weakness – an inherent constraint or limitation which creates a strategic disadvantage

for a business.

3. Opportunity – a favorable condition in the organization’s environment enabling it to

strengthen its position.
 4. Threat – an unfavorable condition in the organization’s environment causing damage to
the organization.

The following is the need and importance of environmental scanning:

1. Identification of strength:

Strength of the business firm means capacity of the firm to gain advantage over its competitors.
Analysis of internal business environment helps to identify strength of the firm. After identifying
the strength, the firm must try to consolidate or maximize its strength by further improvement in
its existing plans, policies and resources.

2. Identification of weakness:

Weakness of the firm means limitations of the firm. Monitoring internal environment helps to
identify not only the strength but also the weakness of the firm. A firm may be strong in certain
areas but may be weak in some other areas. For further growth and expansion, the weakness
should be identified so as to correct them as soon as possible.

3. Identification of opportunities:

Environmental analyses helps to identify the opportunities in the market. The firm should make
every possible effort to grab the opportunities as and when they come.

4. Identification of threat:

Business is subject to threat from competitors and various factors. Environmental analyses help
them to identify threat from the external environment. Early identification of threat is always
beneficial as it helps to diffuse off some threat.

5. Optimum use of resources:

Proper environmental assessment helps to make optimum utilisation of scare human, natural and
capital resources. Systematic analyses of business environment helps the firm to reduce wastage
and make optimum use of available resources, without understanding the internal and external
environment resources cannot be used in an effective manner.

6. Survival and growth:

Systematic analyses of business environment help the firm to maximise their strength, minimise
the weakness, grab the opportunities and diffuse threats. This enables the firm to survive and
grow in the competitive business world.

7. To plan long-term business strategy:

A business organisation has short term and long-term objectives. Proper analyses of
environmental factors help the business firm to frame plans and policies that could help in easy
accomplishment of those organisational objectives. Without undertaking environmental
scanning, the firm cannot develop a strategy for business success.

8. Environmental scanning aids decision-making:

Decision-making is a process of selecting the best alternative from among various available
alternatives. An environmental analysis is an extremely important tool in understanding and
decision making in all situation of the business. Success of the firm depends upon the precise
decision making ability. Study of environmental analyses enables the firm to select the best
option for the success and growth of the firm.

EXTERNAL ENVIRONMENT ANALYSIS

External environment analysis is a primary study and analysis of macro-environmental forces,

industry analysis and competitor analysis in purview of an organization’s growth. Macro-
environmental forces are dimensions in the broader society which influence the firms within it. It
focuses on the future probability of events. Industry environment includes set of contingencies
which have a direct influence on the firm’s action and response.

Tools used for external environment analysis:-

PESTLE ANALYSIS

PESTLE analysis (formerly known as PEST analysis) is A framework or tool used to analyse
and monitor the macro-environmental factors that may have a profound impact on an
organisation’s performance.

Political Factors:

These factors are all about how and to what degree a government intervenes in the economy or a
certain industry. This can include government policy, political stability or instability, corruption,
foreign trade policy, tax policy, labour law, environmental law and trade restrictions.
Furthermore, the government may have a profound impact on a nation’s education system,
infrastructure and health regulations. These are all factors that need to be taken into account
when assessing the attractiveness of a potential market.

Economic Factors:

Economic factors are determinants of a certain economy’s performance. Factors include

economic growth, exchange rates, inflation rates, interest rates, disposable income of consumers
and unemployment rates. These factors may have a direct or indirect long term impact on a
company, since it affects the purchasing power of consumers and could possibly change
demand/supply models in the economy.

Social Factors:

This dimension of the general environment represents the demographic characteristics, norms,
customs and values of the population within which the organization operates. This inlcudes
population trends such as the population growth rate, age distribution, income distribution, career
attitudes, safety emphasis, health consciousness, lifestyle attitudes and cultural barriers. These
factors are especially important for marketers when targeting certain customers.

Technological Factors:

These factors pertain to innovations in technology that may affect the operations of the industry
and the market favorably or unfavorably. This refers to technology incentives, the level of
innovation, automation, research and development (R&D) activity, technological change and the
amount of technological awareness that a market possesses.

Environmental Factors:

Environmental factors have come to the forefront only relatively recently. They have become
important due to the increasing scarcity of raw materials, pollution targets and carbon footprint
targets set by governments. These factors include ecological and environmental aspects such as
weather, climate, environmental offsets and climate change which may especially affect
industries such as tourism, farming, agriculture and insurance.

Legal Factors:

Although these factors may have some overlap with the political factors, they include more
specific laws such as discrimination laws, antitrust laws, employment laws, consumer protection
laws, copyright and patent laws, and health and safety laws. It is clear that companies need to
know what is and what is not legal in order to trade successfully and ethically.
 Industrial Organization
Industrial organization is a field that builds on the theory of the firm by examining the structure
of (and, therefore, the boundaries between) firms and markets. Industrial organization adds real-
world complications to the perfectly competitive model, complications such as transaction
costs, limited information, and barriers to entry of new firms that may be associated
with imperfect competition. It analyzes determinants of firm and market organization and
behavior on a continuum between competition and monopoly, including from government
actions.

There are different approaches to the subject. One approach is descriptive in providing an
overview of industrial organization, such as measures of competition and the size-
concentration of firms in an industry. A second approach uses microeconomic models to explain
internal firm organization and market strategy, which includes internal research and development
along with issues of internal reorganization and renewal. A third aspect is oriented to public
policy related to economic regulation, antitrust law, and, more generally, the economic
governance of law in defining property rights, enforcing contracts, and providing
organizational infrastructure.

SCP Model
The Structure-Conduct-Performance model is used to trace the causes of industry performance. It
is based on a model of Cause and Effect: Industry financial Performance is caused by the
competitive Conduct of players in the industry; this Conduct is is turn caused by the
industry Structure.
 SCP Model

When is it useful?

SCP Model has just explanatory power in an industry that is not changing. It is most powerful
when used DYNAMICALLY to predict how an industry’s profitability will change in response
to an external shock.

For example, when electricity was deregulated in the UK, we can predict a nosedive in
profitability. Deregulation impacts industry Structure by reducing barriers to entry and
increasing number of competitors increased as the monolithic state-run Central Electricity
Electricity Board was privatised into small Regional Electricity Companies (RECs). With
economies of scale important, this change in structure drove aggressive pricing Conduct to
capture share in each others regions. This drove down profit Performance. However, over time
the natural economics re-emerged, M&A activity drove many RECs to merge again, leading to a
more concentrated industry Structure, less aggressive competitive Conduct and better
profit Performance.
External Shocks often play out like this – a dramatic change in the industry leads to a landgrab, a
bloodbath, a consolidation stage then a return to profitable stability.

This model can be used to justify consolidation in the industry. If Structure drives Performance,
one way to improve performance is to create a more attractive industry Structure.

This analysis is similar to the Porters 5 forces analysis.

The usefulness of this model is diminished when industry boundaries are blurred and primary
threats are coming from outside the industry.

An Example?

How do you do the analysis?

Highlight in Structure

• Industry concentration (Herfindal index) – from monopoly to perfect competition

• Market share pattern – is there a dominant leader?

• What is the Minimum Efficient Scale?

• Is it vertically integrated? Why?

• Ownership of major companies (if they are listed/family/state-owned)

Highlight in Conduct

• Where do they compete? Prices? Service? Advertising investment? War for Talent?
Product innovation?

• Is the conduct stable, or is it erratic, linked to the industry cycle?

• Do player try to differentiate, or follow “me-too” strategy?

• Do competitors try to grow the pie (“good competitors”), or fight to enlarge their share
(“bad competitors”)?

Highlight in Performance

• Long term Total Shareholder Returns (TSR)?

• Return on Capital Employed? (ROCE)

• Economic Profit
 PORTER'S FIVE FORCES MODEL
Five forces model was created by M. Porter in 1979 to understand how five key competitive
forces are affecting an industry.

Porter's Five Forces is a framework for analyzing a company's competitive environment. The
number and power of a company's competitive rivals, potential new market entrants, suppliers,
customers, and substitute products influence a company's profitability.

The five forces identified are:

Threat of new entrants. This force determines how easy (or not) it is to enter a particular
industry. If an industry is profitable and there are few barriers to enter, rivalry soon intensifies.

Threat of new entrants is high when:

• Low amount of capital is required to enter a market;

• Existing companies can do little to retaliate;

• Existing firms do not possess patents, trademarks or do not have established brand
reputation;

• There is no government regulation;

• Customer switching costs are low (it doesn’t cost a lot of money for a firm to switch to
other industries);
 • There is low customer loyalty;

• Products are nearly identical;

• Economies of scale can be easily achieved.

Bargaining power of suppliers. Strong bargaining power allows suppliers to sell higher priced
raw materials to their buyers. This directly affects the buying firms’ profits because it has to pay
more for materials.

Suppliers have strong bargaining power when:

• There are few suppliers but many buyers;

• Suppliers are large and threaten to forward integrate

• Few substitute raw materials exist;

• Suppliers hold scarce resources;

• Cost of switching raw materials is especially high.

Bargaining power of buyers Buyers have the power to demand lower price or higher product
quality from industry producers when their bargaining power is strong. Lower price means lower
revenues for the producer, while higher quality products usually raise production costs. Both
scenarios result in lower profits for producers.

Buyers exert strong bargaining power when:

• Buying in large quantities or control many access points to the final customer;

• Only few buyers exist;

• Switching costs to other supplier are low;

• They threaten to backward integrate

• There are many substitutes;

• Buyers are price sensitive.

Threat of substitutes. This force is especially threatening when buyers can easily find substitute
products with attractive prices or better quality and when buyers can switch from one product or
service to another with little cost. For example, to switch from coffee to tea doesn’t cost
anything, unlike switching from car to bicycle.
Rivalry among existing competitors. This force is the major determinant on how competitive
and profitable an industry is. In competitive industry, firms have to compete aggressively for a
market share, which results in low profits.

Rivalry among competitors is intense when:

• There are many competitors;

• Exit barriers are high;

• Industry of growth is slow or negative;

• Products are not differentiated and can be easily substituted;

• Competitors are of equal size;

• Low customer loyalty.

THE RESOURCE-BASED VIEW (RBV)

RBV is an approach to achieving competitive advantage that emerged in 1980s and 1990s, after
the major works published by Wernerfelt, B. (“The Resource-Based View of the Firm”),
Prahalad and Hamel (“The Core Competence of The Corporation”), Barney, J. (“Firm resources
and sustained competitive advantage”) and others.

The supporters of this view argue that organizations should look inside the company to find the
sources of competitive advantage instead of looking at competitive environment for it.

The resource-based view (RBV) is a model that sees resources as key to superior firm
performance. If a resource exhibits VRIO attributes, the resource enables the firm to gain and
sustain competitive advantage.
 In RBV model, resources are given the major role in helping companies to achieve higher
organizational performance. There are two types of resources: tangible and intangible.

Tangible assets are physical things. Land, buildings, machinery, equipment and capital – all
these assets are tangible. Physical resources can easily be bought in the market so they confer
little advantage to the companies in the long run because rivals can soon acquire the identical
assets.

Intangible assets are everything else that has no physical presence but can still be owned by the
company. Brand reputation, trademarks, intellectual property are all intangible assets. Unlike
physical resources, brand reputation is built over a long time and is something that other
companies cannot buy from the market. Intangible resources usually stay within a company and
are the main source of sustainable competitive advantage.

The two critical assumptions of RBV are that resources must also be heterogeneous and
immobile.

Heterogeneous

The first assumption is that skills, capabilities and other resources that organizations possess
differ from one company to another. If organizations would have the same amount and mix of
resources, they could not employ different strategies to outcompete each other.Therefore, RBV
assumes that companies achieve competitive advantage by using their different bundles of
resources.

The competition between Apple Inc. and Samsung Electronics is a good example of how two
companies that operate in the same industry and thus, are exposed to the same external forces,
can achieve different organizational performance due to the difference in resources.

Immobile

The second assumption of RBV is that resources are not mobile and do not move from company
to company, at least in short-run. Due to this immobility, companies cannot replicate rivals’
resources and implement the same strategies. Intangible resources, such as brand equity,
processes, knowledge or intellectual property are usually immobile.

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VRIO resources

In order for companies to transform these resources into sustainable competitive advantage,
resources must have four attributes that can be summarized into the VRIO framework.The
resources must be valuable, rare, imperfectly imitable and organised.
 VRIO FRAMEWORK

It is the tool used to analyze firm’s internal resources and capabilities to find out if they can be a
source of sustained competitive advantage.

The tool was originally developed by Barney, J. B. (1991) in his work ‘Firm Resources and
Sustained Competitive Advantage’, where the author identified four attributes that firm’s
resources must possess in order to become a source of sustained competitive
advantage. According to him, the resources must be valuable, rare, imperfectly imitable and non-
substitutable.
Valuable
The first question of the framework asks if a resource adds value by enabling a firm to exploit
opportunities or defend against threats. If the answer is yes, then a resource is considered
valuable. Resources are also valuable if they help organizations to increase the perceived
customer value. This is done by increasing differentiation or/and decreasing the price of the
product. The resources that cannot meet this condition, lead to competitive disadvantage.

Rare
Resources that can only be acquired by one or very few companies are considered rare. Rare and
valuable resources grant temporary competitive advantage. On the other hand, the situation when
more than few companies have the same resource or uses the capability in the similar way, leads
to competitive parity. This is because firms can use identical resources to implement the same
strategies and no organization can achieve superior performance.

Costly to Imitate
A resource is costly to imitate if other organizations that doesn’t have it can’t imitate, buy or
substitute it at a reasonable price. Imitation can occur in two ways: by directly imitating
(duplicating) the resource or providing the comparable product/service (substituting).

A firm that has valuable, rare and costly to imitate resources can (but not necessarily will)
achieve sustained competitive advantage. Barney has identified three reasons why resources can
be hard to imitate:

• Historical conditions. Resources that were developed due to historical events or over a
long period usually are costly to imitate.

• Causal ambiguity. Companies can’t identify the particular resources that are the cause of
competitive advantage.

• Social Complexity. The resources and capabilities that are based on company’s culture or
interpersonal relationships.

Organized to Capture Value

The resources itself do not confer any advantage for a company if it’s not organized to capture
the value from them. A firm must organize its management systems, processes, policies,
organizational structure and culture to be able to fully realize the potential of its valuable, rare
and costly to imitate resources and capabilities. Only then the companies can achieve sustained
competitive advantage.
 VALUE CHAIN ANALYSIS
The value chain also known as Porter’s Value Chain Analysis is a business management concept
that was developed by Michael Porter. In his book Competitive Advantage (1985), Michael
Porter explains Value Chain Analysis; that a value chain is a collection of activities that are
performed by a company to create value for its customers. Value Creation creates added value
which leads to competitive advantage. Ultimately, added value also creates a higher profitability
for an organization.

Value chain analysis is a process of dividing various activities of the business in primary and
support activities and analyzing them, keeping in mind, their contribution towards value creation
to the final product. And to do so, inputs consumed by the activity and outputs generated are
studied, so as to decrease costs and increase differentiation.

Value chain analysis is used as a tool for identifying activities, within and around the firm and
relating these activities to an assessment of competitive strength.

Classification of Value Chain Analysis

Value Chain Analysis is grouped into primary or line activities, and support activities discussed
as under:

1. Primary Activities: The functions which are directly concerned with the conversion of
input into output and distribution activities are called primary activities. It includes:
 o Inbound Logistics: It includes a range of activities like receiving, storing,
distributing, etc. which make available goods and services for operational
processes. Some of those activities are material handling, transportation, stock
control, etc.

o Operations: The activity of transforming input raw material to final product

ready for sale, is termed as operation. Machining, assembling, packaging are the
activities covered under operations.

o Outbound Logistics: As the name suggests, the activities that help in collecting,
storage and delivering the product to the customer is outbound logistics.

o Marketing and Sales: All the activities like advertising, promotion, sales,
marketing research, public relations, etc. performed to make the customer aware
of the product or service and create demand for it, comes under marketing.

o Service: Service means service provided to the customer so as to improve or

maintain the value of the product. It includes financing service, after-sales service
and so on.

2. Support Activities: Those activities which assist primary activities in accomplishment,

are support activities. These are:

o Procurement: This activity serves the organization, by supplying all the

necessary inputs like material, machinery or other consumable items, that required
by the organization for performing primary activities.

o Technology Development: At present, technology development requires heavy

investment, which takes years for research and development. However, its
benefits can be enjoyed for several years and by a multitude of users in the
organization.

o Human Resource Management: It is the most common plus important activity

which excel all primary activities of the organization. It encompasses overseeing
the selection, retention, promotion, transfer, appraisal and dismissal of staff.

o Infrastructure: This is the management system, which provides, its services to

the whole organization and includes planning, finance, information management,
quality control, legal, government affairs, etc.