BUSS1000 Future of Business - External Analysis

4.1 INDUSTRY AS AN EXTERNAL FACTOR

Return on Invested Capital (ROIC)
Return on Invested Capital (ROIC) measures the percentage return of profitability earned by a
company using the capital invested by equity and debt providers.

Frequently used to determine the efficiency at which capital is allocated, the consistent
generation of a positive ROIC is perceived positively as a necessary attribute of a quality
business.

Net Operating Profit After Taxes( NOPAT )

Return on Invested Capital ( ROIC )=
Average Invested Capital

There are two routes to think about invested capital, but either approach is ultimately identical to
the other due to double-entry accounting.
1. The dollar amount of net assets a company needs to run its business.
2. The dollar amount of funding provided by creditors and shareholders to finance the
purchase of the company’s assets.

4.2 PESTLE FRAMEWORK

BUSS1000 Future of Business - External Analysis

PESTLE was formulated in the 1960s by social scientist Francis Joseph Aguilar. Aguilar
scanned the business environment as a social phenomenon.

There are six key drivers of change. You can use these drivers to analyse and predict possible
scenarios in the future. As a manager, your job is to identify scenarios and plan for them. You
need to allow for shocks to a business that may occur regularly, as well as for the totally
unexpected.

A PESTLE analysis allows you to analyse problems at a macro level, and is much broader than
an industry, sector, or segment analysis. It is an analysis for the long-term, that looks as far back
and as far forward as possible. PESTLE analysis covers everything outside of your
organization, which is often bound within a context.

The PESTLE framework helps identify “key drivers of change” by considering the important
macro-environment, which can be used to construct “scenarios” of possible futures, which have
strategic implications.

PESTLE Analysis Diagram

Political
 Stability
 Rent seeking
 Activism

Economic
 Interest rates
 Inflation
 Cost of key inputs
 Disposable income
 Unemployment

Social
 Social Structure Heading
- Consumer preferences
- Cultural shifts
- Value changes
 Demographic Structure
- Population growth
- Age distribution
- Ethnic mix
- Gender mix

Technological
 Communication
 Information
 Physical
 Transport infrastructure

Legal
 Consumer laws
 Competition laws
BUSS1000 Future of Business - External Analysis

Environmental
 Resources
 Weather
 Seasonality

4.3 PORTER’S FIVE FORCES FRAMEWORK

Risk of threat of new
entrants

Bargaining Bargaining
Competitive
power of power of
Rivalry
suppliers buyers

Threat of substitute
products

Competitive Rivalry
There are many reasons for intense rivalry among competitors. There may be multiple
competitors of the same size, or the industry growth is slow. For example, if there is a lack of
differentiation, if everybody is producing the same thing, then the customer may switch to the
competition.
For example, often mineral water producers do not have a differentiator, so we’re only ready to
pay the undifferentiated price and their profit goes down. In that case, mineral water producers
must invest a lot of money to get economies of scale.
Buyers
The buyer’s Willingness to Pay (WTP) is obviously very important. Think about a time when
you have been a buyer and had bargaining power. Was it because there was a smaller number of
buyers than products?
Take the example of Coles and Woolies. Think about the farmers. Farmers have little bargaining
power with Coles and Woolies because these supermarkets dominate the market for everyday
shopping for vegetables, fruit and groceries. Again, the customer has bargaining power. The
organisation (supermarket) is in the middle and they are more vulnerable, as switching costs are
low, and their product is undifferentiated.

Suppliers
Organisations also need to consider the Supply Opportunity Cost (SoC), the price and the cost.
Supplier bargaining power can be high.
BUSS1000 Future of Business - External Analysis

For example, a very high percentage of personal computers currently run on the Windows
platform. As a result, Microsoft has a lot of bargaining power as the dominant supplier. Can you
negotiate with Microsoft if most companies depend on their operating system? This causes a lot
of competition in the hardware business, a lot of offloading, joint ventures and mergers.
Suppliers who become very customised providers may become closely attached to an
organisation. If the supplier is providing something niche or specific, then they have more
bargaining power. From a manufacturer’s perspective, a common strategy is to ask for a
standardised input.
For example, Starbucks use a quality checklist to source coffee, rather than a specific coffee
producer or type, so they are not dependant on suppliers.

Potential entrants (Risk of Threat of new entrants)

If there is a threat of more organisations joining the same industry, that may influence the way
profit or value is redistributed within the industry. Organisations can create entry barriers to
minimise the threat of a new entrant. For example, most airlines have a frequent flyer program.
Why? Because that creates a high switching cost.
For example, if you work for many years in an international corporate job and you have a
frequent flyer card, you may accumulate thousands of air miles. How difficult would it be to
switch airlines? Other barriers to potential entrants include high capital costs to set up, unequal
access to distribution, slow industry growth and restrictive government policy. Of course,
existing or incumbent companies have a natural advantage.

Substitutes
Can be difficult to predict. Organisations need to be aware of technological developments in
particular. Substitution sometimes takes place in a completely different industry.
For example, with the threat of coronavirus, people may prefer to drive rather than take a flight.
The automobile and aviation sector are completely different industries, but under these
circumstances, they suddenly become substitutions for each other. The easiest way to understand
substitution is to consider it from the consumer perspective. If you are the consumer of the
service, you may look for a close substitute. You will also consider performance versus price
ratio, which is again the marginal-cost argument. If a small change in the price causes a large
performance change, that has an impact on your buying decision.