A PT E R 

C H
R N A L
E XTE T
R O N M E N
ENVI S
Y S I
ANAL

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 Learning objectives:
• At the end of this section, you will be able to:
 Explain the major components of external
environment
 Discuss the Porter’s five forces model and how they
influence competition
 Appreciate how external environmental analysis is
valuable for strategic decision making

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 INTRODUCTION
• External environment is critical to a firm’s survival and
success.
• This is because, it influences the firm’s strategic
alternatives and decisions made in choosing best
alternative/s.
• The firm’s knowledge of external environment is
matched with knowledge about its internal environment
to form its vision, to develop its mission, and takes
action that result in strategic competitiveness and above-
average returns.

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 Basic Concepts of External Environment
• The external environment comprises concentric strata of influences
that can affect an organization from outside.
• It includes all the factors outside the organization which provide
opportunities or pose threats to the organization.
 An opportunity is a condition in a general environment that, if
exploited, helps a company achieves strategic competitiveness.
 A threat is a condition in the general environment that may hinder a
company’s efforts to achieve strategic competitiveness.
 In short, opportunities suggest competitive possibilities, while threats
are potential constraints.
• The firm must conduct macro-environmental analysis to capitalize on
opportunities and minimize/avoid the effect of threats.

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 Key External Forces
• External forces can be divided into five broad
categories:
1) Economic forces;
2) Social, cultural, demographic, and natural
environment forces;
3) Political, governmental, and legal forces;
4) Technological forces; and
5) Competitive forces.

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 1. The Economic Environment (Economic forces)
• There is a close relationship between business and its economic
environment.
• Economical factors indicate the direction of the economy in which the
organization operates.
• Examples of components of these factors include;
 Economic growth,  Federal Government
 GDP of the country in budget defects,
 unemployment trends,
which the organization
 consumption trends,
exists,  stock market trends,
 Rate of inflation,  demand shifts,
 Interest rate,  price fluctuations,
 Availability of credit,  tax rates, etc.
 level of disposal income,
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 2. The socio- cultural Environment (Social forces)
• As with technological changes, social changes create opportunities and threats.
 Social forces include factors that relate to the values, attitudes, and demographic
characteristics of an organization’s customers.
• This means, the social environment of a business consists of the;

Population density, Growth of educational

Class structure,
Rural-urban mobility,
Inter-state migration,
Nature of social organization,
Development of social
institutions,
opportunities,
change in lifestyle,
women’s participation in the work
force,
consumer behaviour,
value and attitude of people
towards work, wealth, family,
religion and ethics.

•Therefore, business environment should identify these cultural

differences and produces such products and services, which are
suitable
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to a particular culture.By Dr. Bogale A. 7
 3. The political-legal environment
(political or regulatory forces)

• The political forces have an important influence

on strategic planning.
In broad sense it promotes and controls the
business actions.
• Stable, honest, efficient and dynamic political
system ensures personal security to the people.
• On the other hand, unstable, bad and
dishonest political system may affect the
business decision very badly.

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 Continued…
• In the regulatory environment, federal, state, and local governments
have increasingly passed laws that affect the operation of business.
 The legal environment is concerned with;
 How an organization does business and covers the hiring and firing
of employee,
 Compensations,
 Working hours, and working conditions.
• Laws also influence
 Advertising practices,
 The pricing of products, and
 Corporate growth by mergers and acquisitions.
• Generally, based on information about these factors an organization
can formulate its future strategy.

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 4. The Technological Environment (Technological forces)

• This is an area in which change takes place

very rapidly and the organizations need to
be consistently aware of what is going on.
• Technology refers to the means chose to do
useful work.
• J.K. Galbraith defines technology as a
systematic application of scientific or other
organized knowledge to practical tasks.

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Continued…
• Technological forces include not only the glamorous invention
that revolutionizes our lives but also the gradual improvements
in methods, in materials, in design, in application, in diffusion
into new industries, and in efficiency.
• Example Technological changes can make established products
obsolete overnight, and at the same time it can create a host of
new product possibilities.
• The effects of technological changes are felt in following ways.
 New product or services.
 Alternative processing methods, raw materials, and service
delivery.
 Changes in complementary products or services.

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 5. Competitive forces
• The industry environment combines forces that
are particularly relevant to a firm's strategy,
including competitors (existing and potential),
customers, and suppliers.

• The "five forces" model by Porter, is the most

commonly utilized analytical tool for
examining how the competitive environment,
shape strategies and affect performance.

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 Continued…
• The Five-Forces Model of Competition are: A key
Analytical Tools for Diagnosing the Competitive
Environment.
• The five basic forces according to Michael E. Porter
(Harvard School of Business Administration) are:
1. The threat of new entrants to your market (the risk of
new entry by potential competitor)
2. The bargaining power of your firm's suppliers. (The
bargaining power of suppliers)
3. The bargaining power of your firm's customers. (the
bargaining power of buyers)

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Continued…
4. The threat of substitute products.
5. The intensity of rivalry among firms that
compete directly with yours (the degree of
rivalry among established companies within
an industry)

• Together, these forces determine the nature

and extent of competition and shape the
strategies of firms in their particular
competitive environments.
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 CHARACTERISTICS OF AN ORGANIZATION’S
EXTERNAL ENVIRONMENT
• Business environment (or simply environment) exhibits
many characteristics.
• Some basic characteristics of the external environment
need to be understood are:
a. Environment is complex
b. Environment is dynamic
c. Environment is multi-faceted
d. Environment has a far-reaching impact: The growth and
profitability of an organization depends critically on the
environment in which it exists.
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 THE COMPONENTS (LAYERS) OF
EXTERNAL ENVIRONMENT
• An organization’s external environment
consists of the remote (far) and the near
environments.
• The external environment analysis consists
of:
The general environment
The industry environment
The competitors analysis
Strategic group analysis
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Continued…
• The layers of environment are described as follows.
 Strategic groups are organizations within an industry
with similar strategic characteristics, following similar
strategy or competing on similar bases.
 Industries are networks of related organizations which
share common assumptions, values and ways of
conducting things.
 The general environment is the macro-environment
that affects all business firms in an industry which
includes Political, Economical, Social, Technological,
Ecological (physical environment) and Legal.
• Accordingly, different acronyms are used such as
PESTEL, PEST and STEP.
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 Components of Competitor Analysis
• A competitor response profile can be built on the
basis of the four components of competitor analysis.
• These four components are:
a. Future goals of competitor,
b. Its current strategy,
c. The key assumptions that the competitor makes
about itself and
d. About the industry, and its capabilities in terms of
strengths and weaknesses.

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 Continued…
• Based on a thorough analysis of these components, a response
profile can be prepared for each competitor that can help predict
their likely strategic move which can be either of an offensive or
defensive type.
• The response profile could be based on a firm posing questions
such as these to itself:
 What will our competitors do in the future?
 Where do we hold an advantage over our competitors? and
 Will this change our relationship with our competitors?
• This information collected in the response profile is vital input for
the purpose of business strategy formulation by any organization.

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 Types of Business Environment
• Four types of business environment
which have been recognized are:
a. Simple environment
b. Complex environment
c. Static environment and
d. Dynamic environment

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 Continued…
a. Simple environment: some organizations are fortunate to
operate in business environments in which they only have to
cope with relatively few uncertainties or change agents.
• It could be said that these organizations are in simple
environments.
b. Complex environment: the more complex an organization's
environment is, in other words the more variables there are
that can change, the more uncertainty it faces.
• Complexity usually relates to the diversity of the environment
segments, and the extent to which they are interrelated.

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Continued…
c. Static environment: an organization operating in a
static environment faces no change of significance or
relatively little change in the variables that give rise to
uncertainty.
• The organization is thus able to place confidence in
its forecasts and assumptions.
• The forecasting methods will, in the main, be
statistical by nature based on projecting from past
trends.
• There is, however, still a danger of unanticipated or
unpredicted change, which should not be ignored.

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 Continued…
d. Dynamic environment: the degree of
environment dynamism relates to the rate
and frequency of change of the factors that
give rise to uncertainty.
• An organization that operates in an
extremely dynamic environment is faced by
rapid and probably novel change, and
thus plans of its future facing uncertainty.

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Continued…
• Generally, we can see from this that
different types of environments can be
classified based on:
Speed and nature of change (static or
dynamic), and
By convolution / difficulty or the number
and interaction among the factors (simple
or complex)

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 CRITICAL SUCCESS FACTORS
• Many industries have a relatively small but
extremely important, set of factors that are
essential for successfully gaining and
maintaining a competitive advantage.

• Critical success factors (CSFs) are those areas in

which good results will help ensure an
organization's successful competition and in
which poor results usually lead to declining
performance.
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Continued…
• The CSFs may be;
 Manufacturing cost,
 After-sales services,
 Product image, or
 Anything that can give rise to a competitive advantage.
• While specific CSFs vary from business to business, research
has identified four major sources of CSFs in general.
a. Industry characteristics
b. Competitive position
c. General environment and
d. Organizational development

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 Stakeholder Theory
• Definition of Stakeholders
• Groups or individuals that have an interest in the well-
being of the company and/or are affected by the goals,
operations or activities of the organization or the
behavior of its members.
• They have a ‘stake’ in what the organization does.

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 Cont’d…
• Stakeholders can be broadly categorized
into:
 Internal stakeholders– employees,
management
 Connected stakeholders – customers,
suppliers, competitors, shareholders
 External stakeholders – government,
pressure groups.

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 Benefits of external analysis
• Benefits of external analysis include;
 Increasing managerial awareness of environmental
changes.
 Increasing understanding of the context in which
industries and markets function.
 Increasing understanding of multinational settings.
 Improving resource allocation decisions.
 Facilitating risk management.
 Focusing attention on the primary influences on strategic
change.
 Acting as an early warning system.
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 e c hap te r !
End of th

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