Organisation as an open system

ENVIRONMENTAL ANALYSIS
“It is not the strongest of the species that survive,
nor the most intelligent, but the one most responsive
to change.” – Charles Darwin

Dr. Pradeep Dharmadasa, Department of Marketing , Faculty

Lesson Five of Management and Finance, University of Colombo

Factors that determine a company’s situation Components of a firm’s environment

Diagnosing a company’s situation has two facets

Company’s external or macro-environment

Industry and competitive conditions

Forces acting to reshape this environment

Company’s internal or micro-environment

Market position and competitiveness

Competencies, capabilities, resource strengths and
weaknesses, and competitiveness
Why External Analysis? ENVIRONMENTAL ANALYSIS?

The external environmental analysis process should be

External analysis allows firms to: conducted on a continuous basis. This process includes four
activities:

discover threats and opportunities
Scanning Identifying early signals of environmental changes

see if above normal profits are likely in an industry and trends

Monitoring Detecting meaning through ongoing observations of

better understand the nature of competition in environmental changes and trends

an industry
Forecasting Developing projections of anticipated outcomes based
on monitored changes and trends

make more informed strategic choices
Assessing Determining the timing and importance of
environmental changes and trends for firms'
strategies and their management

General Environment The Industrial Organization (I/O) View

The general environment can have a positive (opportunity)

or negative (threat) impact on the industry. It includes the The Industrial Organization (I/O) approach to
following sectors: competitive advantage advocates that external

Economic forces (industry) factors are more important than internal

Social, cultural, demographic, and natural environment factors in a firm for achieving competitive advantage.
forces

Political, governmental, and legal forces

Technological forces

Competitive forces
The Industrial Organization (I/O) View Economic

 Firm performance is based more on industry properties

The economic sector includes macro-economic data that
reflect what is happening with the overall economy
Economies of scale

It includes current statistics and forecasted trends and
Barriers to market entry changes
Product differentiation
It provides information of both opportunities and threats

The economy

Level of competitiveness

Economic Economic

Major economic data include:

Interest rates

Exchange rates and value of the dollar

Budget deficit or surplus

Trade deficit or surplus

Inflation rate

GDP and GNP

Consumer confidence, spending and debt

Employment/unemployment levels
Economic

Viewing economic data requires interpretation

What does the data mean for the business?

Is it good or bad?

Does it affect the business and the industry?

An organization’s performance is determined by how it
responds to the various economic opportunities and
threats

The biggest challenge is finding available and reliable data
Demographics

Population statistics require interpretive analysis to
enable understanding of what trends might mean for
the business:

Population is increasing

It is aging, there are more people over 30 than under

It is becoming more educated

More female

Facts

World population 7 billion

World population = 8 billion by 2028

World population = 9 billion by 2054
Demographics

Understanding the trends that affect demographics is
essential to benefiting or suffering from the outcome of
the trends

Included in the demographic sector are current
statistical data and trends in population characteristics

Gender, age, income levels, ethnic makeup, education,
family composition, geographic location, birth rates,
employment status
Demographics

Other demographic factors to consider:

Which age group has the fastest growing income?

What geographic areas have the greatest concentration of
senior citizens?

Of particular note are the baby boomers because of their
size and historical influence

Demographic information transcends geographic borders
and, as shifts and trends can be identified, helps target
consumers
Sociocultural Sociocultural

Refers to a country’s culture and includes:

Traditions
It is not only about what the culture is, but how it’s
changing

Lifestyles

Values
Such trends are not obvious or as easy to determine as
demographic changes

Attitudes

Measuring and interpreting peoples opinions, values,

Beliefs
attitudes, likes or dislikes is more challenging

Tastes

Patterns of behavior

Sociocultural Sociocultural

In evaluating this sector, it is important to look at

It is important for strategic decision makers to
determine what is happening in the sociocultural
sector

Cultural values reflect individual freedom, work ethic, and
equality of opportunity

Cultural values influence people’s behavior in the way
they work, shop, raise families
changes or trends in people’s activities, behavior, and
purchases

This enables firms to respond to consumers changing
tastes

Due to the absence of standard governmental collection,
the challenge to decision makers is in gathering accurate
data in this sector on a global basis
Political-Legal

In this sector, various laws, regulations, judicial
decisions, and political forces at the federal, state, and
local levels of government are analyzed

Examples of this sector include:

Changes in bankruptcy laws that made it tougher for
individuals to wipe out debt; which helped credit card
companies reduce write-offs

Trade agreements between countries
Technological
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 production
standardization and flexibility.
Political-Legal

Other areas of importance to understand in this sector
that can influence profitability:

Changes in patent laws that affect idea ownership

Governmental regulation of business that can influence
taxation, minimum wage, labeling of products/safety laws

Immigration and worker visas

Global warming

Executive compensation
Technological

Computerization is one of the most important of the
technological innovations

It continues to affect organizational work processes and
product development

Retailers use it to link to suppliers, airlines to aid customer
selections of destinations and fares

Innovations in lasers, robotics, biotech, medicine, consumer
electronics, telecommunications have improve products and
consumer choices

Technological
Technological advancements can:

Create new markets

Result in a proliferation of new and improved

products

Change the relative competitive cost positions in

an industry

Render existing products and services obsolete
Finding Information on the External Environment
and Evaluating it

External information can be found using informal and
unscientific observations; as well as formal and
systematic searches

Examples of informal approaches

Discussions with customers and suppliers

Reading industry journals or news periodicals

Examples of formal approaches

Surveys

Scientific analysis
Finding Information on the External Environment
and Evaluating it

Finding valuable information and interpreting it is
essential to organizational success. Examples include:

Data specific to the context

Statistics

Analyses

Trends

Predictions and forecasts

Inferences or statements by experts
Finding Information on the External Environment
and Evaluating it

External information system

Is information system that provides managers with needed
external information on regular basis

Purpose is to identify potential trends and changes that might
positively or negatively impact organizational performance

Information is valuable because external environment is
complex and dynamic

The challenge: having enough, but not too much information
Benefits of Doing an External Analysis Benefits of Doing an External Analysis

Enables managers to be proactive, not reactive
External analysis enables strategies to

Adapt to opportunities and threats

Anticipate change

Neutralize competitor moves

Create plans for those changes

Improve organizational opportunities

Influence the organizational performance

External analysis is key
Altering strategies should align the organization based
on information about:

To providing information to use in planning, decision making,
and strategy formulation
Markets

Customers

Technology

Benefits of Doing an External Analysis Benefits of Doing an External Analysis

Environment is a source of resource
Intense global competition makes it imperative to

The ability to acquire and control needed resources depends complete an external analysis
on understanding the environment and taking advantage of

Research shows that firms doing an external analysis
the resources available
have higher performance

Dynamic environment requires awareness of

Performance evaluated on financial measures like return on

Turbulent and fragmented markets assets or increased profit

Changing customer tastes

Innovative technologies
The Structure-Conduct-Performance Model
Industry Analysis - The five forces framework
Industry Analysis
Porter’s five forces framework helps identify the
attractiveness of an industry in terms of five competitive
forces:

the threat of entry,

the threat of substitutes,

the bargaining power of buyers,

the bargaining power of suppliers and

the extent of rivalry between competitors.
The five forces constitute an industry’s ‘structure’.
The five forces framework
The Threat of Entry & Barriers to Entry

The threat of entry is low when the barriers to entry are high and vice
versa.

The main barriers to entry are:

Economies of scale/high fixed costs

Experience and learning

Access to supply and distribution channels

Differentiation and market penetration costs

Government restrictions (e.g. licensing)

Entrants must also consider the expected retaliation from organisations
already in the market
The five forces framework
Threat of Substitutes
Substitutes are products or services that offer a similar benefit
to an industry’s products or services, but by a different
process.
Customers will switch to alternatives (and thus the threat
increases) if:

The price/performance ratio of the substitute is superior
(e.g. aluminium maybe more expensive than steel but it is
more cost efficient for some car parts)

The substitute benefits from an innovation that improves
customer satisfaction
The five forces framework
The bargaining power of suppliers
Suppliers are those who supply what organisations need to
produce the product or service. Powerful suppliers can eat into
an organisation’s profits.
Supplier power is likely to be high when:

The suppliers are concentrated (few of them).

Suppliers provide a specialist or rare input.

Switching costs are high (it is disruptive or expensive to
change suppliers).

Suppliers can integrate forwards
The five forces framework
The bargaining power of buyers
Buyers are the organisation’s immediate customers, not
necessarily the ultimate consumers.
If buyers are powerful, then they can demand cheap prices
or product / service improvements to reduce profits .
Buyer power is likely to be high when:

Buyers are concentrated

Buyers have low switching costs

Buyers can supply their own inputs (backward vertical
integration)
The five forces framework
Rivalry between competitors
Competitive rivals are organisations with similar products and services
aimed at the same customer group and are direct competitors in the same
industry/market
The degree of rivalry is increased when :

Competitors are of roughly equal size

Competitors are aggressive in seeking leadership

The market is mature or declining

There are high fixed costs

The exit barriers are high

There is a low level of differentiation
Implications of five forces analysis

Identifies the attractiveness of industries – which
industries/markets to enter or leave.

Identifies strategies to influence the impact of the
forces, for example, building barriers to entry by
becoming more vertically integrated.

The forces may have a different impact on different
organisations e.g. large firms can deal with barriers to
entry more easily than small firms.
Competitors - Key Questions About Competitors

What are the major competitors’ strengths?

What are the major competitors’ weaknesses?

What are the major competitors’ objectives and strategies?

How will the major competitors most likely respond to current economic,
social, cultural, demographic, environmental, political, governmental,
legal, technological, and competitive trends affecting our industry?

What key factors have resulted in our present competitive position in
this industry?

How have the sales and profit rankings of major competitors in the
industry changed over recent years?

What is the nature of supplier and distributor relationships in this
industry?

To what extent could substitute products or services be a threat to
competitors in this industry?
Issues in five forces analysis

Apply at the most appropriate level – not necessarily the
whole industry. E.g. the Asian low cost airline industry
rather than airlines globally.

Note the convergence of industries – particularly in the
high tech sectors (e.g. digital industries - mobile
phones/cameras/mp3 players).

Note the importance of complementary products and
services (e.g. Microsoft windows and McAfee computer
security systems are complements). This can almost be
considered as a sixth force.
Types of industry

Monopolistic industries - an industry with one firm and
therefore no competitive rivalry. A firm has ‘monopoly power’ if it
has a dominant position in the market.

Oligopolistic industries - an industry dominated by a few firms
with limited rivalry and in which firms have power over buyers
and suppliers.

Perfectly competitive industries - where barriers to entry are
low, there are many equal rivals each with very similar products,
and information about competitors is freely available. Few (if
any) markets are ‘perfect’ but may have features of highly
competitive markets.
 What Are the Key Factors for Competitive
The Industry Life Cycle
Success?

KSFs are those competitive factors most affecting every

industry member’s ability to prosper

KSFs concern

Specific strategy elements

Product attributes

Resources

Competencies

Competitive capabilities

that a company needs to be competitively successful

KSFs are attributes that spell the difference between

Profit and loss

Competitive success or failure

Identifying Key Success Factors Managerial Implications

Pinpointing KSFs involves determining

On what basis do customers choose between competing
Which industries should we enter or leave?
brands of sellers?
What influence can we exert?

What resources and competitive capabilities does a seller
How are competitors differently affected?
need to have to be competitively successful?

What does it take for sellers to achieve a sustainable
competitive advantage?

KSFs consist of the major determinants for success

Rarely are there more than 5 - 6 factors that are truly key to
the future financial and competitive success of industry
members
Forecasting Tools and Techniques The External Factor Evaluation (EFE) Matrix

Forecasts are educated assumptions about future

trends and events
Economic
Political

Quantitative techniques – most appropriate when
Social
Governmental
historical data is available and there is a constant
Cultural
Technological
relationship
Demographic
Competitive

Qualitative techniques

Environmental
Legal

EFE Matrix Steps Competitive Profile Matrix (CPM)

1. List key external factors  Identifies firm’s major competitors and their
2. Weight from 0 to 1 strengths & weaknesses in relation to a
3. Rate effectiveness of current strategies sample firm’s strategic positions
4. Multiply weight * rating
5. Sum weighted scores  Critical success factors include internal and
external issues