External Environment

Analysis
Dr. SQK
External Environment Analysis
• External environment analysis is undertaken to discover
opportunities/ Threats, evolving around the organization's needs.
• An analysis of the external environment can be broken down into
three key steps each becoming more specific to the organization.
• The first step is an analysis of the macro-environmental influences
that the organization faces.
• This is followed by an examination of the competitive (micro)
environment the organization operates within.
• Finally, a specific competitive analysis is undertaken
Environmental Scanning
• The environmental audit is reliant on the monitoring activity that is undertaken by
the organization. The process is normally referred to as scanning. There are four
forms of scanning according to Aguilar (1967). They are as follows:
• 1 Undirected viewing: This activity concerns the viewer exploring information in
general without carrying a specific agenda. The viewer is exposed to a large amount
of varied information but this is not an active search looking for particular issues,
just a broad attempt to be aware of factors or areas that may have changed.
• 2 Conditional viewing: Again this is not an organized search but the viewer is
sensitive to information that identifies changes in specific areas of activity.
• 3 Informal search: This is an organized but limited search for information to support
a specific goal.
• 4 Formal search: This type of search is actively pursued and specifically designed to
seek particular information.
• Managers search for information in five broad areas (Aguilar, 1967)
(see Figure 2.2):
• 1 Market intelligence
• 2 Technical intelligence
• 3 Acquisition intelligence
• 4 Broad issues
• 5 Other intelligence
Macro environment Analysis
The macro-environment audit examines the broad range of
environmental issues that may affect the organization.
This will include political/legal issues, economic factors, social/cultural
issues, and technological developments. This is normally referred to as
a PEST (Political, Economic, Social, and Technological) analysis, although
some writers use the alternative acronym of STEP analysis (see Figure
2.3).
The aim of this analysis is to identify the critical issues in the external
environment that may affect the organization. Before moving on to
judge the impact they may have on the organization
Political/Legal Issues
• There is a range of political organizations that have to be considered
when looking at influences in this area of the audit.
• The structure of a political system defines the centers of political
influence. A state with a federal political structure will differ from a
unitary political system.
 Economic Analysis
• Similarly, economic factors have to be viewed from a wider
perspective than the organization’s domestic economy.
• In the global economy, domestic economic conditions are heavily
influenced by events in other areas of the world. Economics is
concerned with the allocation of resources.
• Therefore issues such as the conservation of natural resources, costs
of pollution, energy consumption, and the whole area of the
management of natural resources should be considered under this
heading
Social/Cultural Issues
• Demographic changes are important and can be used as lead
indicators in certain areas, such as health care and education.
However other critical areas such as social/cultural values and beliefs
that are central to changes in consumer behaviour are harder to
predict and can be subject to more dramatic shifts.
Technological Developments
There is a great danger in using a particular technology to define an
industry. In a situation where technological developments are fast-
moving it is critical to understand the fundamental consumer needs
that the organization’s technology is currently serving.
Identifying new technology that can service that consumer’s needs
more completely or economically is the critical part of this area of the
analysis.
Industry Analysis
• A useful framework, that can be utilized when undertaking this
analysis, is Porter’s ‘five forces model of establishing industry
attractiveness for a business (see Figure 2.4).
• This analysis should be conducted at the level of the individual
strategic business unit (SBU) rather than at the level of the
organization as a whole, otherwise, the range of relationships facing a
company with several divisions, causes the analysis to lose focus.
• Porter identified five factors that affect the level of competition and
therefore profitability within an industry
Suppliers
• Suppliers: The power of suppliers is liable to be strong where:
Control over supplies is concentrated in the hands of a few players.
The costs of switching to a new source of supply are high.
If the supplier has a strong brand.
The supplier is in an industry with a large number of smaller disparate
customers.
Buyers
• The power of buyers is liable to be strong where:
A few buyers control a large percentage of a volume market.
For example, grocery and electrical goods retailers in the UK dominate the market
and are in a very strong position versus their suppliers as a result.
There are a large number of small suppliers. In the meat industry in the UK there are
a large number of small farmers supplying a retail sector dominated by a small
number of large supermarkets.
• sector dominated by a small number of large supermarkets.
The costs of switching to a new supplier are low.
The supplier’s product is relatively undifferentiated, effectively lowering barriers to
alternative sources of supply.
Potential Entrants
• The threat of potential entrants will be determined by a number of barriers to entry that may exist in any
given industry.
● The capital investment necessary to enter the industry can be very high in areas such as electrical power
generation or chemical production.
● A well-entrenched competitor who moved into the industry early may have established cost advantages
irrespective of the size of their operation. They have had time to establish crucial aspects of their operation
such as effective sources of supply, the best locations, and customer franchises.
● Achieving economies of scale in production, distribution or marketing can be a necessity in certain
industries.
● Gaining access to appropriate distribution channels can be difficult. Peugeot/Citroen bought Chrysler’s entire
UK operations in order to gain an effective dealership network in Britain.
● Government legislation and policies such as patent protection, trade relations with other states and state-
owned monopolies can all act to restrict the entry of competitors.
● The prospect of a well-established company’s hostile reactions to a new competitor’s entry into the market
may be enough to act as a deterrent
Substitutes
• Substitution can arise in several ways:
• A new product or service may eradicate the need for a previous
process. Insurance services delivered directly by producers over the
phone or the Internet are substitutes for the services of the
independent insurance broker.
• A new product replaces an existing product or service. Cassette tapes
replaced vinyl records, only to be replaced by compact discs.
• All products and services, to some extent, suffer from generic
substitution. Consumers may choose to substitute buying a car to
purchase an expensive holiday instead.
Competitive Rivalry
• The intensity of competition in the industry will be determined by a range of
factors:
• The stage of the industry life cycle will have an effect. Natural growth reaches a
plateau once an industry reaches maturity; the only way an organization can
continue to grow in the industry is to take market share off its rivals.
• The relative size of competitors is an important factor. In an industry where rivals
are of similar size, competition is likely to be intense as they each strive for a
dominant position. Industries that already have a clear dominant player tend to be
less competitive.
• In industries that suffer from high-fixed costs, companies will try to gain as much
volume throughput as possible, this may create competition based on price
discounting.
• There may be barriers that prevent companies withdrawing from an
industry. This may be plant and machinery that is specialist in nature
and therefore cannot be transferred to other uses. The workforce may
have non-transferable specialist skills. If the industry is in maturity,
moving towards decline, and rivals cannot easily leave the industry
then competition inevitably will increase
• This model allows an organization to identify the major forces that are
present in the industry sector. This can be related to the critical
factors that were identified by the PEST analysis. Several issues then
need to be considered:
• What is the likelihood that the nature of the relationships identified
by the ‘five forces’ model will change given the trends in the external
environment? Are there ways of benefiting from these potential
changes
• What actions can the organization undertake that will improve its
position against the current forces in the industry?
• Can the company increase its power, relative to suppliers or buyers? Can
actions be taken to reduce competitive rivalry, or are there ways of
building barriers to dissuade companies from considering entering the
industry? Are there ways of making substitute products less attractive?
The organization will also need to consider its competitors.
Given the forces in the industry, what is the relative position of the
organization’s rivals?
Do conditions favor one particular operator?
Competitors Analysis
• The ‘five forces analysis has examined the overall industry and is a
starting point in assessing a company’s competitive position. This is
likely to be a rather broad definition of industry and contains a
number of companies that would not be direct competitors. Toyota is
likely to have a number of natural direct competitors, and Aston
Martin is not likely to be one of them, although both companies are in
the car industry.
• Companies that are direct competitors in terms of products and
customer profiles are seen as being in a strategic group. The car
industry would be made up of a number of strategic groups.
• Strategic groups:
• Strategic groups comprise organizations within the same industry
that are pursuing equivalent strategies targeting groups of customers
with similar profiles. Aston Martin’s strategic group is likely to contain
Ferrari, Lotus, Lamborghini, etc.
• All these companies are following similar strategies and facing similar
strategic questions. They are also aiming at very similar market
segments.
• There is a range of attributes that can be used to identify strategic
groups. Some examples are as follows:
● Size of the company
● Assets and skills
● Scope of the operation
● Breadth of the product range
● Choice of distribution channel
● Relative product quality
● Brand image
• Tools used to analyze the internal environment, such as
• The value chain, can be used to analyze competitors (see Chapter 8). For each
competitor in their strategic group, an organization needs, as far as possible, to
establish the following:
• Competitors’ objectives: can be identified by analyzing three important factors.
They are as follows:
1. Whether the competitor’s current performance is likely to be fulfilling their
objectives. If not the competitor may initiate a change of strategy.
2. How likely the competitor is to commit further investment to the business?
 Financial objectives: Investment is more likely from companies that have
objectives, which are long-term in nature, such as market share and sales growth,
rather than organizations under pressure to produce short-term profitability.
• This also reveals potential trade-offs the competitor may be willing to take. If
short-term profitability is the key objective, then the rival is likely to lose market
share in the short term to achieve its profitability targets.
• The likely future direction of the competitor’s strategy.
• The organization may have non-financial objectives, such as gaining
technology leadership.
• Competitors’ current and past strategies: Three areas should be explored to
establish a competitor’s current activities. They are as follows:
a) Identify the current markets, or market segments, within which the
competitor operates. This will indicate the scope of the business.
b) 2 Identification of the way the competitor has chosen to compete in those
markets. Is it based on the quality of service, brand image, or on price? This
may be an indication of whether a low-cost or differentiation strategy is
being pursued (see Chapter 8).
• 3 Comparison between the current strategy and past strategies can be
instructive.
• Competitor’s capabilities: An analysis of a competitor’s assets and
competencies allow a judgment to be made about how well-equipped
they are to address the market, given the dynamics in the industry
and the trends in the external environment.
• Management capabilities:
• The level of centralization or de-centralization of management
decisions will also affect decision-making.
• Recruitment and promotion policies
• The remuneration and rewards scheme, all give an indication as to the
culture and style of the management team.
• Marketing capabilities:
a) There are a number of questions that can be asked:
b) How good is the competitor’s product line?
c) Do they have a strong brand image?
d) Is their advertising effective?
e) How good are their distribution channels? How strong is their relationship with
customers?
● Innovation capabilities:
Evaluating a competitor’s ability to innovate allows an organization to judge how
likely the rival is
f) To introduce new products and services or even new technology.
g) Assessing the quality of a competitor’s technical staff, its technical facilities, and its
level of investment in research and development will all help indicate their likely
potential in this area.
• Production capabilities:
• The configuration of a competitor’s production infrastructure can highlight areas that may place
them at an advantage or conversely point out areas that are problematic to a competitor.
Such factors could be
• The geographic spread of plants,
• level of vertical integration or level of capacity utilization.
• Low-capacity utilization can increase fixed costs,
• Per unit of manufacture.
• On the other hand, it External analysis offers a competitor’s production capacity for new
products. The flexibility of production staff is also an important issue to identify.
• In the service sector, capacity and staff flexibility are just as important. Factors such as the ability
to pull in additional staff on a temporary basis gives a service company an important capability.
● Financial capabilities:
The ability to finance developments is a critical area.
Competitors that have strong cash flows, or are a division of a major group, may have the ability to
finance investments not available to other competitors.
Competitors future strategies and reactions:
• The aim of analyzing competitors future strategies are:
To gather information on rivals to establish their likely future strategy.
To evaluate competitors’ likely reactions to any strategic moves the
organization might instigate.
The reactions of organizations are of four types
1.Certain retaliation: The competitor is guaranteed to react in an
aggressive manner to any challenge.
Market leaders, in particular, are likely to react in this manner against
any threat to their dominant position.
2. Failure to react: Competitors can be lulled into a false sense of
security in an industry that, over a long period of time, has seen very lit
• Subtle change. In this situation, companies can be extremely slow to
react to a competitive move.
• The classic example is British motorcycle companies failing to react to
the entry of Japanese manufacturers into the lower end of the
market.
3. Specific reactions: Some competitors may react, but only to
competitive moves in certain areas. For instance, they may always react
to any price reductions, or sales promotions, as they believe these will
have an important impact on their business.
4. Inconsistent reactions: These companies’ reactions are simply not
predictable. They react aggressively on occasion but at other times
ignore similar competitive challenges