Amy’s
work on Chapter 2 External environment analysis:
Assessment of opportunities and threats
2.1
Introduction
style='color:black'>Every organization depends on linkages with its environment
to get the human, financial, technical and material resources it needs.
environment” has taken on a specialised meaning: it involves ‘green’ issue and
the positioning of our planet by human activity. These concerns also are a part
of topic in this thesis, but the term ‘environment’ will be used in a much
broader sense to describe everything and everyone who is beyond the industry
and organisation in this chapter, it includes customers, competitors,
suppliers, distributors, government and social institution.
elements that lie outside the firm but more or less influence the decisions the
company’s executive must make if they are to obtain long-term above average
returns. In order
to develop the future strategies, an organisation has to be familiar with the
factors in the external environment that are likely to affect the organization.
To do this, it is important that the organisations distinguish between two
levels of environment: the general/macro-environment and the industry /
microenvironment.
style='mso-fareast-language:ZH-CN'>PESTL framework shows some of the
general/macro-environment influences, which might affect organisations. It is
not intended to provide an exhaustive list, but it gives examples of ways in
which strategies are affected by such influences and some of ways in which
organisations seek to handle aspects of their environment. (Fahey and
Narayanan, 1986) Itstyle='color:black;mso-fareast-language:ZH-CN'> categorises environmental
influences into six main types: political, economic, social, technological,
environmental and legal.
summery of some of the questions to ask about key forces at work in the general/macro-environment.
impact on the organization whilst certain events may influence how the
organization changes over time. Because events or trends favourable or harmful
to the organization may develop in the macro-environment, it is necessary to
know how to identify them, either to take advantage of them or to try to
counter them.
The
of factors that directly influences an organization and its actions and
responses (Hansel, et al, 2001). The term is
concerned with all the external stakeholders such as partners, regulators and
competitors etc., which are in direct contact with an organization. These
players influence the actions of the organization. Some have a positive effect
by creating demand or supplying resources, while others have a negative impact
by imposing constraints upon the organisation or by being detrimental to the
organisation’s development.
style='color:black'>Therefore, the organization's external environmental
context is made up of all the conditions and factors external to the
organizations, which can positively or negatively affect the life,
orientations, structures, development and the future of the organizations.
In today’s business world, the environmental conditions facing firms in
the global economy differ from those firms faced previously.
processing capabilities demand more timely and effective competitive actions
and responses. (Fombrun,
the nature of products demanded by increasingly diverse consumers. Governmental
policies and laws affect where and how firms choose to compete.
and local government changes affect the general competitive environment, as
well as the strategic decisions that will be made by organization competing
internationally. All of these make the organisation’s
external context increasingly difficult to interpret. To cope with often
incomplete and ambiguous contextual data, and to increase their understanding
of the general external context, organizations engage in a process called
'external environmental analysis' (Hanson et al, 2001)
2.2 Process of external environmental
analysis
The process is conducted on a
continuous basis, including four activities: scanning, monitoring, forecasting
and assessing (see Table 2.1). It is difficult, yet significant, activity to
complete this analysis of the external environment.
Table 2.1 Process of the external environmental analysis
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Scanning
Identifying early signals of environmental changes and
trends
Monitoring
Detecting meaning through ongoing observations of
environmental changes and trends
Forecasting
Developing projections of anticipated outcomes based on
monitored changes and trends
Assessing
Determining the timing and importance of environmental
changes and trends for firms’ strategies and their management
Scanning entails the study of all segments in the general
environment. Through scanning, firms identify early signals of potential
changes in the general environment and detect changes that are already under
way style='mso-bidi-font-size:10.0pt;line-height:150%;color:black;mso-ansi-language:
EN-GB'>(Elenkow, 1997).
firm often deals with ambiguous, incomplete or unconnected data and
information. Environmental scanning is critically important for firms competing
in highly volatile environments (Hilmetz
1999). In addition, scanning activities must be aligned with the
mso-ansi-language:EN-GB'> organisational context.
When monitoring, analysts observe environmental changes to see if
an important trend is emerging from among those spotted by scanning
mso-ansi-language:EN-GB'>(Aggarwal, 1999). Critical to successful monitoring is the
ability to detect meaning in different environmental events. For example, a new
law permitting shopping on Sunday for ‘tourist items’ was introduced in eastern
The limited Sunday store openings were a challenge to the nation’s restrictive
rules on shopping hours. Popular initially with consumers, the Sunday openings
might spread beyond the economically stricken east, even though the move
towards longer hours was strongly opposed by the service sector union
mso-ansi-language:EN-GB'>(Simonian, 1999) German retailers should monitor this
change in their selling environment to determine if an important trend in
shopping patterns might emerge.
Scanning
and monitoring are concerned with events in the general environment at a point
in time. When forecasting, analysts develop feasible
projections of what might happen, and how quickly, as a result of the changes
and trends detected through scanning and monitoring (Fahey, 1999)
EN-GB'>For example, analysts might forecast the time that
will be required for a new technology to reach the marketplace, the length of
time before different corporate training procedures are required to deal with
anticipated changes in the composition of the workforce, or how much time will
elapse before changes in governmental taxation policies affect consumers’
purchasing patterns.
The objective of
assessing is to determine the timing and significance of the effects of
environmental changes and trends on the strategic management of a firm (Fahey,
1999).
analysts are able to understand the general environment. Going a step further,
the intent of assessment is to specify the implications of that understanding
for the organisation
assessment, the firm is left with data that are interesting, but of unknown
competitive relevance. In the
automobile industry, Ford, General Motors andstyle='mso-bidi-font-size:10.0pt;line-height:150%;color:black;mso-ansi-language:
EN-GB'> DaimlerChrysler are selling increasing numbers of trucks, sport
utility vehicles and minivans. However, all three firms have lost market share
in car sales to competitors such as Honda,
firms understand that if petrol costs were to rise substantially, or if
consumer preferences shift from trucks to cars, they could be in trouble.
However, shifting some production capacity to cars is a difficult decision for
these companies, in that profits per unit on trucks, sport utility vehicles and
minivans vastly exceed those earned on cars. Thus, the challenge for those firms is to continually assess
the significance of possible decreases in demand for their most profitable products
and to understand changes that would be necessary in their strategies to deal
successfully with shifts in consumer preferences.
2.3 Function
of external environment analysis
An important
objective of studying the external environment is identifying opportunities and
threats (Hanson et al, 2001). An
opportunity is conditions in the external environment that may help an
organisation achieve strategic competitiveness.
Opportunities
advantage of conditions in its external environment to formulate and implement
strategies that enable it to improve performance. A threat is a condition in the general environment that may
hinder a company’s efforts to achieve strategic competitiveness (Prior, 1999).
external environment endanger the integrity of the organization's activities
A number of
models exist that can help managers in analysing the external environment. Such models provide a
framework to identify external opportunities and threats. Among these models,
the typical ones are
general environment analysis and Porter’s Five Forces Model regarding industry
environment analysis.
2.4 External environment
Before examining
the models of industry environment analysis, it is necessary to have general
understanding of the composition of the external environment. According to
Hanson et al (2001), an organization's external environment has two major
parts: 1) general /macro-environment
and 2) Industry/Microenvironment. Figure 2.1 outlines the composition of the
external environment.
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v:shapes="_x0000_s1040">
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v:shapes="_x0000_s1037"> Social
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padding:0in'>New entrants
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v:shapes="_x0000_s1028">src="file:///C:\DOCUME~1\COMP02~1.COM\LOCALS~1\Temp\msohtml1\01\clip_image008.gif"
v:shapes="_x0000_s1026">Power of Suppliers
padding:0in'>Power of buyers
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padding:0in'>Product/service substitutes
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Technology
Economic
General environment
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Source:
Hanson et al, (2001)
As demonstrated
in figure 2.1, the general environment
political and technological elements in the broader society that can influence
an industry and the organizations within it.
The industry environment
is the set of factors that directly influences an organization and its actions
and responses. Managers have to
analyse competitive forces in an industry's environment in order to
identify the opportunities and threats confronting an organization. A popular
framework for doing this is Michael Porter's 'five-forces' model. This model
identifies five competitive forces that shape industry's profit potential: (1)
the bargaining power of suppliers, (2) the threat of new entrants, (3) the
threat of product substitutes, (4) the bargaining power of buyers and (5) the
intensity of rivalry among established organizations within an industry
(Porter, 1980)
2.5 General
environment analysis: PEST analysis
The general environment is
composed of elements in the broader society that can influence an industry and
the organizations within it. These elements are grouped into four environmental
segments. Examples of elements
analysed in each of these segments are shown in table 2.1.
Table 2.2 the general
environment: segments and elements
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Political/legal segment
- Antitrust laws
- Taxation laws
- Deregulation philosophies style='mso-ansi-language:EN-GB'>
- Labour
training laws - Educational philosophies and policies
Economic segment
- Inflation rates
- Interest rates
- Trade deficits or surpluses
- Budget deficits or surpluses
- Personal savings rate
- Business savings rates
- Gross domestic product
Socio-cultural segment
- Women in the workforce
- Workforce diversity
- Attitudes about the quality of work life
- Concerns about the environment
- Shifts in work and career preference
- Shifts in preferences regarding product and service
characteristics
Technological segment
- Product innovations
- Applications of knowledge
- New communication technologies
- Focus of private and government-supported R&D
expenditures
Source: Hanson
et al, (2001)
The political/legal segment is the arena where
mso-ansi-language:EN-GB'> organisations compete for attention, resources and a
voice in overseeing the body of laws and regulations guiding the interactions
among nations. Essentially, this segment represents howstyle='mso-bidi-font-size:10.0pt;line-height:150%;color:black;mso-ansi-language:
EN-GB'> organisations try to influence government and how governments influence
them. Constantly changing, the segment influences the nature of competition. In
terms of this, organizations must carefullystyle='mso-bidi-font-size:10.0pt;line-height:150%;color:black;mso-ansi-language:
EN-GB'> analyse a new administration’s business-related policies and
philosophies. Antitrust laws, taxation laws, industries chosen for
deregulation, labour
the degree of commitment to educational institutions are areas where an
administration’s policies can affect the operations and profitability of
industries and individual firms.
The economic environment is concerned with the nature
and direction of the economy where a firm competes or may compete. The health
of a country’s economy affects the performance of specific organizations and
industries. Because of this, companies study the economic environment to
identify changes, trends and their strategic implications. Owing to the
interconnectedness among countries that is resulting from the global economy,
organizations need to scan, monitor, forecast and assess the health of
economies outside their host nation.
The socio-cultural segment refers to a society’s
attitudes and cultural values. Because attitudes and values form the
cornerstone of a society, they often drive demographic, economic,
political/legal and technological conditions and changes.
The technological segment includes the institutions
and activities involved with creating new knowledge and translating that
knowledge into new outputs, products, processes and materials. It is pervasive
and diversified in scope that technological changes affect many parts of
societies. Their effects occur primarily through new products, processes and
materials.
The general environment is composed of segments that are external to the
firm (see Table 2.1). Although the degree of impact varies, these environmental
segments affect each industry and organizations within it. The challenge is to
scan, monitor, forecast and assess those elements in each segment that are of
the greatest importance. This process of analyzing the general environment is
labeled as
should recognise environmental changes, trends, opportunities and
threats. Opportunities are then matched with a firm’s core competencies.
Through proper matches, the firm achieves strategic competitiveness and earns
above-average returns.
In short, PEST analysis help the strategists to examine the
mso-ansi-language:EN-GB'> macro-environmental factors affecting an industry, recognize
the key factors affecting an industry’s competitive environment and then
identify strengthen and weakness, opportunities and threats in the industry as
well. It is believed that the
analysis of the external environment surrounding an industry.
2.6 Industry
environment analysis: Five Force Model
An industry is a group of firms producing products
that are close substitutes. In the course of competition, these firms influence
one another (Hanson et al, 2001). Typically, industries include a rich mix of
competitive strategies that companies use in pursuing strategic competitiveness
and above-average returns. In part, these strategies are chosen because of the
influence of the effects of an industry’s characteristics (Brush,
mso-ansi-language:EN-GB'> Bromiley and Hendrickx
The industry environment is the set of factors such as the threat
of new entrants, suppliers, buyers, product substitutes and the intensity of
rivalry among competitors, which directly influences an organization and its
competitive actions and responses. Generally the interactions among these five
factors determine an industry’s profit potential. The challenge is to locate a
position within an industry where an organization canstyle='mso-bidi-font-size:10.0pt;line-height:150%;mso-ansi-language:EN-GB'>
favourably
influence those factors or where it can successfully
defend against their influence. The greater a firm’s capacity to
mso-ansi-language:EN-GB'> favourably influence its industry environment, the
greater is the likelihood that the firm will earn above-average returns.
In comparison to the general environment, the industry
environment has a more direct effect on strategic competitiveness and
above-average returns. The intensity of industry competition and an industry’s
profit potential are a function of five competitive forces: the threats posed
by new entrants, suppliers, buyers, product substitutes, and the intensity of
rivalry among competitors (see Figure 2.2).
Figure 2.2 the five forces model of competition
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Source: Porter, 1980
2.6.1 Threat of new entrants
Evidence suggests that companies have always found it
difficult to identify new competitors (McGahan
a pity that new entrants often have the potential to be quite threatening to
incumbents. One reason new entrants pose such a threat is that they bring
additional production capacity. If the demand for a good or service is not
increasing, additional capacity holds consumers’ costs down, resulting in less
revenue and lower returns for an industry’s organizations. New entrants often
have substantial resources and a keen interest in getting a large market share.
As a result, new competitors may force existing organizations to be more
effective and efficient and to learn how to compete on new dimensions. The
likelihood that organizations will enter an industry is a function of two
factors: barriers to entry and the retaliation expected from current industry
participants. Normally entry barriers exist when organizations find entry into
a new industry difficult, or when they are at a competitive disadvantage
entering a new industry.
2.6.2 Bargaining power of suppliers
Increasing prices and reducing the quality of products sold
are potential means through which suppliers can exert power over firms
competing within an industry. Unless an organization is able to recover cost
increases through its pricing structure, its profitability is reduced by its
suppliers’ actions. A supplier group is powerful when:
- It is dominated by a few large companies and is more concentrated
than the industry to which it sells; - Satisfactory substitute products are not available to industry
firms; - Industry firms are not a significant customer for the supplier
group; - Suppliers’ goods are critical to buyers’ marketplace success;
- The effectiveness of suppliers’ products has created high switching
costs for industry firms; and - Suppliers are a credible threat
to integrate forward into the buyers’ industry.
when suppliers have substantial resources and provide the industry’s firms
with a highly differentiated product.
(Source: Hanson et al, 2001, p62)
2.6.3 Bargaining power of
buyers
Organizations seek tostyle='mso-bidi-font-size:10.0pt;line-height:150%;color:black;mso-ansi-language:
EN-GB'> maximise the return on their invested capital. Buyers want to buy products
at the lowest possible price, at which the industry earns the lowest acceptable
rate of return on its invested capital. To reduce their costs, buyers bargain
for higher quality, greater levels of service and lower prices. These outcomes
are achieved by encouraging competitive battles among the industry’s firms.
mso-ansi-language:EN-GB'>Buyer groups are powerful when:
• They purchase a large
portion of an industry’s total output.
• The product being purchased from an industry accounts for a
significant portion of the buyers’ costs;
• They could switch to another product at little, if any,
cost; and
• The industry’s products are undifferentiated or
mso-ansi-language:EN-GB'> standardised, and the buyers pose a credible threat if
they were to integrate backward into the sellers’ industry.
(Source: Hanson et al, 2001, p62)
2.6.4 Threat of substitute
products
Substitute products are different goods or services from
outside a given industry that perform similar or the same functions as a
product that the industry produces. For example, as a sugar substitute,
mso-ansi-language:EN-GB'> Nutrasweet places an upper limit on sugar
manufacturers’ prices (that is, Nutrasweet and sugar perform the same function,
but with different characteristics). Other product substitutes include plastic
containers rather than glass jars, paper bags in place of plastic bags, and tea
substituted for coffee (Browder
substitutes are a strong threat to an organization when customers face few
switching costs and when the substitute product’s price is lower or its quality
and performance capabilities are equal to or greater than those of the
competing product. Differentiating a product along
dimensions that customer’s value reduces a substitute’s attractiveness.
2.6.5 Intensity of rivalry
among competitors
Because an industry’s organizations are mutually dependent, actions taken
by a company normally invite competitive retaliation. style='mso-bidi-font-size:10.0pt;line-height:150%;mso-ansi-language:EN-GB'>Therefore,
in many industries organizations compete actively and vigorously when they
pursue strategic competitiveness and above average returns. Competitive rivalry
intensifies while an organization is challenged by a competitor’s actions or
when an opportunity to improve a market position is recognised.
rivalry is based include price, quality and innovation. Typically,
organizations seek to differentiate their products from competitors’ offerings
in terms of dimensions that customer’s value and where the organizations have a
competitive advantage.
The above discussion demonstrates that the five forces model of
competition expands the arena for competitive analysis. Historically, when
studying the competitive environment, organizations concentrated on companies
with which they competed directly. However, today competition is viewed as a
grouping of alternative ways for customers to obtain the value they desire,
instead of as a battle among direct competitors. This is particularly
important, because in recent years industry boundaries have become blurred. For
example, telecommunications companies now compete with broadcasters, software
manufacturers also provide personal financial services and automobile
manufacturers sell insurance and provide financing (Hanson et al, 2001).
In sum, the Five Force Model helps to investigate how the organization
needs to form its strategy in order to effectively and efficiently develop
opportunities in its environment and protect itself against competition and
other threats. It is still an effective and efficient industry analysis method
in spite of some critical comments.
2.7 conclusion
environment is challenging and complex. The external environment has two major
parts: (1) the general environment (elements in the broader society that affect
industries and their firms); (2) the industry environment (factors that
influence a firm, its competitive actions and responses and the industry’s
profit potential; the threats of entry, suppliers, buyers and product
substitutes; and the intensity of rivalry among competitors). Because of the
effect the external environment has on performance, organizations must develop
the skills required to identify opportunities and threats existing in that
environment.
point in the analysis of the environment. In addition to this, the five forces
model of competition includes characteristics that determine the industry’s
profit potential. By studying these forces, the firm finds a position in an
industry whereby it can influence the forces in itsstyle='mso-bidi-font-size:9.5pt;line-height:150%;mso-ansi-language:EN-GB'>
favour or
whereby it can isolate itself from the power of the forces to reduce its
ability to earn above-average returns. In short, through effective
external environment analysis, opportunities and threats in a specific industry
can be identified which is vital for the development of all the industry’s
organizations.
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