Chapter Two

The business environment

The business environment

The business environment can be grouped into two:

External Environment
Remote/Macro/ General
Immediate/Micro/Task
Internal environment
 Outcomes From External & Internal Environmental
Analyses

By Studying the External By Studying the

Environment, firms identify: Internal Environment,
firms identify:
•What they might
choose to do? • What they can do?

Examine unique
Examine resources, capabilities &
opportunities & competencies –
threats
sustainable
competitive advantage
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 The external environment

 Tools of analysis of the external environment:

◦ PEST/E analysis
 is done for sake of accommodating relevant elements in the
strategic development processes of organizations.
◦ Five forces competitive analysis
 Forces that impact competition within the confines of an industry.

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External Analysis –steps
 Step 1: Environmental scanning – gather
relevant information. It allows managers
to stay up to date and reduce uncertainty
 Step 2:Interpret environmental factors –
determine whether the factors are
opportunities or threats. Identify the most
important opportunities and threats
 Step 3: Take actions to capitalize
opportunities and minimize threats
External Analysis ...
OPPORTUNITIES:
 An opportunity is a major favorable situation in
a firm’s environment.
 Identification of

◦ a previously overlooked market segment

◦ changes in competitive or regulatory
circumstances
◦ technological changes, and
◦ improved buyer or supplier relationships
1‐5
External analysis cont’d...
THREATS:
 A threat is a major unfavorable situation in a firm’s
environment. Threats are key ingredients to the firm’s
current or desired position.
 Identification of
◦ the entrance of new competitors
◦ slow market growth
◦ increased bargaining power of key buyers or
suppliers,
◦ technological changes, and new or revised regulations
could represent threats to a firm’s success.

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Why external analysis?
 External analysis allows firms to:
◦ Discover threats and opportunities
◦ Make informed decisions as best as possible
◦ Better understand the nature of competition in
an industry
◦ See if above normal profits are likely in an
industry
Key External Forces
External forces can be divided into five
broad categories:
1. Macroeconomic forces
2. Social, cultural, demographic, and natural
environmental forces
3. Political, governmental, and legal forces
4. Technological forces
5. Competitive forces
Relationships Between Key External
Forces and an Organization
1. Economic Forces
Some key economic variables:
 Availability of credit
 Level of disposable income
 Interest rates
 Inflation rates
 Unemployment trends
 Consumption patterns
 Import/Export factors
 Demand shifts
 Price fluctuations
 Fiscal policies
Economic forces

 Economic decline leads to:

◦ A reduction in customer expenditure
◦ Increases competitive pressures
◦ Frequently causes price wars in mature
industries
 The level of interest rates can determine the
demand for a company's product
◦ It is important when customers are routinely
borrow many to finance their purchases
Economic forces
 Price inflation
◦ can destabilize the economy, producing
slower economic growth, higher interest
rates and volatile currency.
◦ Inflation keeps increasing, investment
planning becomes hazardous
◦ So high inflation is a threat to companies
2. Social, Cultural, and
Demographic Forces
Some key socio-cultural variables:
 Ethical standards
 Size of population
 Life expectancies
 Income disparity
 Consumer activism
 Geographic shifts in population
 Education
 Quality and Quantity of Life people
 Long Term Vs. Short Term Orientations
3. Political, Governmental, and
Legal Forces
Political factors define the legal and
regulatory parameters of organizations’
operation.
Some key Political (Gov’al & legal) variables
 Tax laws
 Trade liberalization
 Environmental protection laws
 Import/Export regulations
 Size of Government budget
 Local, state & national elections
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Political, Governmental, and
Legal Forces
 Political actions aimed at protecting:
◦ employees, customers, the general
public and the environment
◦ organizations via property right
laws, government subsidies, and
product research grants

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Political, Governmental, and
Legal Forces
Political action can bring about substantial
impact on three governmental functions
that influence the external environment of
firms:
 Supplier function: government decision
regarding the accessibility of private
businesses to government-owned natural
resources and products will profoundly
affect the viability of the strategies of the
firms.
1‐
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Political, Governmental, and
Legal Forces
 Customer function: government demand for
products and services can create, sustain,
enhance, or eliminate many market
opportunities.

 Competitive function: the government can

operate as an almost unbeatable competitor in
the market place.
 Thus, knowing of government’s strategies
can help a firm avoid unfavorable
confrontation with the government as a
competitor. 1‐
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4. Technological Forces
Organizations must strive to understand the
existing scientific or technological advances:
 avoid obsolescence and promote innovation
- Technological advancements can:
◦ Create new markets
◦ Result in a proliferation of new and improved
products
◦ Change the relative competitive cost positions
in an industry
◦ Replace existing products and services
Technological Forces.. Example
For instance, the Internet has changed the very
nature of opportunities and threats by:
◦ altering the life cycles of products
◦ increasing the speed of distribution
◦ creating new products and services
◦ erasing limitations of traditional geographic
markets
◦ changing the historical trade-off between
standardization and flexibility.
 Technological Forces

 In general the Internet is:

◦ Altering scale Economies

◦ Changing entry barriers, and

◦ Redefining the relationship between industries

and various suppliers, creditors, customers, and
competitors
 The SWOT Matrix

 A firm should not necessarily pursue the more lucrative opportunities.

Rather, it may have a better chance at developing a competitive advantage
by identifying a fit between the firm's strengths and upcoming
opportunities.

 In some cases, the firm can overcome a weakness in order to prepare itself
to pursue a compelling opportunity.

 To develop strategies that take into account the SWOT profile, a matrix of
these factors can be constructed.
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The SWOT Matrix cont’d …
 S-O strategies pursue opportunities that are a
good fit to the company's strengths.
 W-O strategies overcome weaknesses to pursue
opportunities.
 S-T strategies identify ways that the firm can use
its strengths to reduce its vulnerability to external
threats.
 W-T strategies establish a defensive plan to
prevent the firm's weaknesses from making it
highly susceptible to external threats.
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5. Competitive Forces
 An important part of an external audit is
identifying rival firms and determining
their strengths, weaknesses, capabilities,
opportunities, threats, objectives, and
strategies
 These process can be executed through a
proper analysis of the
operating/immediate environment.
 The Immediate Environment

- In this environment firms can

execute
1. Industrial Analysis- Porter’s five
force model
2. Competitors analysis

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Analysis of the Industry
 An industry is a group of firms
producing products that are close
substitutes
 Firms that influence one another
 Includes a rich mix of competitive forces

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 Analysis of the industry cont’d.
 Analysis of the industry environment:
◦ focuses on the factors & conditions
influencing the firm’s profitability in the
industry.
◦ Compared to the general environment, the
industry environment has a more direct
effect on the firm’s strategic
competitiveness & capability of earning
above-average returns
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 Industry Analysis …
Industry analysis refers to the analysis
of:
◦ Industry trends as a whole
◦ Competition within the industry
◦ Technologies employed
◦ What it takes to succeed – the key success factors
◦ Comparing the firm, its products, its systems, its
technology etc., with other firms in the industry.

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Nature and Degree Of Competition

The nature and degree of competition in an

industry hinge on five forces:
1. The threat of new entrants
2. The bargaining power of suppliers
3. The bargaining power of buyers
4. The threat from substitute products
5. Rivalry (competition) among existing
firms
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The Five-Forces Model of
Competition

3‐
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 Nature cont’d …
How Competitive Forces Shape Strategy?
◦ The essence of strategy formulation is coping with
competition. Competition exists in the fight for market
share.
◦ Therefore, competition in an industry is rooted in its
underlying economics, and competitive forces.
◦ In light of this, customers, suppliers, potential entrants,
and substitute products are all competitors that may be
more or less prominent or active depending on the
industry type.
◦ Thus, the collective strength of these forces determines
the ultimate profit potential of an industry.

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 Nature cont’d …
 The weaker the forces collectively the greater the
opportunity for superior performance in the industry
would be.

 Thus, to cope with them, the strategist must explore

below the surface and analyze the sources of
competition. For example:
◦ What makes the industry vulnerable to entry?
◦ What determines the bargaining power of
suppliers?

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 Nature cont’d …
 Knowledge of these underlying sources of
competitive pressure provides the groundwork for a
strategic plan of action to:
◦ Highlight the critical strengths and weaknesses of
the company
◦ Animate the positioning of the company in its
industry
◦ Clarify the areas where strategic changes may
yield the greatest payoff
◦ Highlight the industry trends as either
opportunities or threats
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 Threat of Entry
There are seven major sources of barriers
to entry:
1. Economies of scale
2. Product differentiation
3. Capital requirements
4. Cost disadvantages
5. Access to distribution channels
6. Government policy
7. Expected retaliations 33
 Threat of Entry cont’d …
Economies of scale:
 Deter entry by forcing the aspirant either to
come in on large scale or accept a cost
disadvantage.

 Scale of economies in production, research,

marketing, and service are probably the key
barriers to entry in the mainframe computer
industry, as Xerox and GE discovered.

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 Threat of Entry cont’d …
Product differentiation:
 Brand identification creates a barrier by
forcing entrants to spend heavily to overcome
customer loyalty.
 Product differentiation is perhaps the most
important barrier in soft drinks, cosmetics,
and investment banking.

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 Threat of Entry cont’d …
Capital requirements:
 The need to invest large financial resources
in order to compete, creates a barrier to entry.
 Capital is necessary not only for fixed
facilities but also for customer credit,
inventories, and absorbing start-up loses.
 The huge capital requirements in certain
fields, such as computer manufacturing and
mineral extraction, limit other entrants.

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 Threat of Entry cont’d …
Cost disadvantages independent of scale:
 Well-established companies may have cost
advantages not available to potential rivals, no
matter what their size and economies of scale.

 These advantages can stem from the effects of:

◦ the learning curve, and proprietary technology,
◦ access to the best raw material sources,
◦ assets purchased at pre-inflation prices,
◦ government subsidies, favorable location, and
◦ official rights (patents)
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 Threat of Entry cont’d …

Access to distribution channels:

 Affects new entrants since the new product
must displace others via price breaks,
promotions, and intense selling efforts.

 When there are limited wholesale or retail

channels and the existing competitors
occupied them, entry into the industry will
be tougher.

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 Threat of Entry cont’d …

Government policy:
 The government can limit or even foreclose entry
to industries with such controls as license
requirements and limits on access to raw materials.

 The government can play a major indirect role by

effecting entry barriers through controls such as air
and water pollution standards and safety
regulations.

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 Threat of Entry cont’d …
Expected Retaliation
 Existing firms might respond in
different ways when new comers enter
in to the market.

 Responses by existing competitors may

depend on a firm’s present stake in the
industry and available business options

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 Powerful Suppliers
 Suppliers can exert bargaining power
on participants in an industry by
◦ raising prices of inputs or
◦ reducing the quality of purchased
goods and services affecting the
profitability of the industry.

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 Powerful Suppliers cont’d …
Supplier power increases when:
◦ Suppliers are large and few in number
◦ Suitable substitute products are not available
◦ Individual buyers are not large customers of suppliers and
there are many buyers
◦ Suppliers’ goods are critical to buyers’ marketplace
success
◦ Suppliers’ products create high switching costs
◦ Suppliers pose a threat to integrate forward into buyers’
industry

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 Powerful Buyers
 Customers can force down prices, demand higher
quality or more service, and play competitors off
against each other – all at the expense of industry
profits.

 The product buyers’ purchase from the industry is

standard or undifferentiated.

◦ In this situation, the buyers are always sure that

they can find alternative suppliers, may play one
company against another.

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 Powerful Buyers cont’d …
Buyer power increases when:
 Buyers are large and few in number
 Buyers purchase a large portion of an industry’s total
output
 Buyers’ purchases are a significant portion of a
supplier’s annual revenues
 Buyers can switch to another product without incurring
high switching costs
 Buyers pose threat to integrate backward into the
sellers’ industry

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 Threat of Substitute Products
 The threat of substitute products
increases when:
◦ Buyers face few switching costs
◦ The substitute product’s price is lower
◦ Substitute product’s quality and
performance are equal to or greater than
the existing product

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 Rivalry Among Competing Firms
Industry rivalry increases when:
 There are numerous or equally balanced
competitors
 Industry growth slows or declines
 There are high fixed costs or high storage costs
 There is a lack of differentiation opportunities or
low switching costs
 When the strategic stakes are high
 When high exit barriers prevent competitors from
leaving the industry 46
 Interpreting Industry Analysis

High entry barriers

Suppliers & buyers Unattractive

have strong positions
industry
Strong threats from
substitute products

Intense rivalry
Low profit
among competitors potential

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Interpreting Industry Analysis cont’d …

Low entry barriers

Suppliers & buyers Attractive

have weak positions
industry
Few threats from
substitute products

Moderate rivalry High profit

among competitors
potential

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 Strategic Groups
Definition
 A group of firms in an industry following
the same or a similar strategy along the
same strategic dimensions.
 Internal competition between strategic
group firms is greater than between firms
outside that strategic group
 There is more heterogeneity in the
performance of firms within strategic
groups

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 Strategic Groups cont’d …
 Strategic dimensions
◦ Extent of technological leadership
◦ Product quality
◦ Pricing policies
◦ Distribution channels
◦ Customer service
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 Competitor Analysis
 Competitor analysis focuses on each company
against which a firm directly competes.
 Analysis of competitors is focused on predicting the
dynamics of competitors' actions, responses &
intentions
 Competing firms are keenly interested in
understanding each other’s objectives, strategies,
assumptions and capabilities.
 Furthermore, intense rivalry creates a strong need to
understand competitors.

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 Competitor Analysis cont’d …
In a competitor analysis, the firm seeks to understand:
 What drives the competitor, as shown by its future
objectives.
 What the competitor is doing and can do, as revealed
by its current strategy.
 What the competitor believes about its own firm and
the industry, as shown by its assumptions.
 What the competitor’s capabilities are, as shown by
its strengths and weaknesses.
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Competitor analysis components

Chapter 4 ‐ Industry& Comp Analysis  53
 Competitor Analysis cont’d …
 Competitor intelligence is used to get data
and information about competing firms.
 It can be used to better understand and anticipate
competitor’s objectives, strategies, assumptions and
capabilities.
 It helps the firm to prepare an anticipate response
profile for each competitor.
 Thus, the result of an effective competitor analysis
helps a firm to understand, interpret and predict its
competitors’ actions and responses.
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 Competitor Array
One common and useful technique is constructing a
competitor array. The steps include:
1. Define your industry - scope and nature of the
industry
2. Determine who your competitors are
3. Determine who your customers are and what
benefits they expect
4. Determine what the key success factors are in your
industry
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 Competitor Array cont’d …
5. Rank the key success factors by giving each one a
weight - The sum of all the weightings must add
up to one.
6. Rate each competitor on each of the key success
factors
7. Multiply each cell in the matrix by the factor
weighting.
8. Sum columns for a weighted assessment of the
overall strength of each competitor relative to
each other

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End of Chapter
Two