The External Environment PDF

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The External Environment Layers of the Business Environment

An Overview of Tools used to Analyse the Environment Layer of the Environment Macro-Environment Industry-Environment Competitor / Market-Environment

Organisational Environment

Tool PESTEL SPENT Industry Life Cycle Porter’s Five Forces Porter’s Diamond SWOT Competitor Analysis Strategic Groups Strategy Canvas Value Chain Analysis VRIO / RBV / DC Intellectual Capital Portfolio Analysis

Macro-Level Analysis PESTEL Analysis The PESTEL framework categorises environmental factors into key types: P E S T E L

Politics highlights the role of the state and other political forces. Economics refers to macro-economic factors such as exchange rates, business cycles and differential economic growth rates around the world. Social influences include changing cultures and demographics. Technological influences refer to influences such as the internet, nanotechnology, or the rise of composite materials. Ecological stands specifically for green environmental issues, such as pollution, waste and climate change. Legal focuses on legislative and regulatory constraints or changes.

Note: Analysing these factors and their interrelationships can produce long and complex lists. Rather than getting overwhelmed by a multitude of details, it is necessary to identify the key drivers for change. Key drivers for change are the environmental factors likely to have a high impact on the future success or failure of strategy.

Scenario Building on PESTEL Analysis What is Scenario Building? Scenario analyses are carried out to allow for different possibilities and help prevent managers from closing their minds to alternatives. Thus, scenarios offer plausible alternative views of how the business environment might develop in the future. Scenarios typically build on PESTEL analyses and key drivers for change, but do not offer a single forecast of how the environment will change. The point is not to predict, but to encourage managers to be alert to a range of possible futures. For this reason, analyses typically produce three or four distinct scenarios. Effective scenario-building can help build strategies that are robust in the face of environmental change. The Five Typical Basic Steps of Scenario Building 1. Defining scenario scope. Scope refers to the subject of the scenario analyses and the time span e.g. a whole industry, or particular geographical regions and markets. 2. Identifying the key drivers for change. Here PESTEL analysis can be used to uncover issues likely to have a major impact upon the future of the industry, region or market. 3. Developing scenario stories. Having selected opposing key drivers for change, it is necessary to knit together plausible stories that incorporate both key drivers and other factors into a coherent whole. 4. Identifying impacts of alternative scenarios on organisations. 5. Establishing early warning systems. Once the various scenarios are drawn up, organisations should identify indicators that might give early warning about the final direction of the environmental change, and at the same time monitor these. Effective monitoring of wellchosen indicators should facilitate prompt and appropriate responses.

SPENT Analysis What is it? S P E N T

Sociodemographic Political, government, legal and regulatory Economic Natural Technological

Sociodemographic Influences Analysis of the sociodemographic environment is concerned with understanding the potential impacts of society and social changes on a business, its industry and markets. For most analyses, analysis of the social environment will require consideration of: •

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Social culture (values, attitudes, and beliefs): the cultures of the countries in which a business operates can be of a particular importance. The culture of a country consists of the values, attitudes and beliefs of its people, which, in turn, will affect the way they act and behave. There are Important cultural differences between all countries. Impacts of culture include: o Demand for products and services o Attitudes to work o Education and training o Corruption and ethics o The social role of a business in society Demography: concerned with the impact of the size and structure of the population on the workforce and patterns of demand. The size of the population will be a determinant of the size of the workforce and the potential size of markets. Whereas the structure will determine the size of particular segments and also the size of the working population. Social structure: refers to the ways in which the social groups in a population are organised and concerns its impact on attitudes to work and certain products. There are a number of ways of defining social structure, such as by sociodemographic groupings, by age, gender, location, population density (the number of people living in each unit of area) in different areas etc. the social structure will affect people’s lifestyles and expectations and so will strongly influence their attitudes to work and their demand for particular products.

Political, Government, Legal and Regulatory Influences The political environment is that part of the macroenvironment that is either under the direct control or influence of the government and / or the state. ‘Government’ is a loosely defined term and can be considered at three levels: • • •

National level: the government of a particular country. Subnational level: local government based in regions, states etc. Supranational (means multinational / worldwide) level: political bodies that exert influence on several national governments e.g. European Union (EU), United Nations (UN), North American Free Trade Agreement (NAFTA) etc.

Governments (at whatever level) have direct control or influence, to a greater or lesser extent, over:

Legislation and regulation: this covers laws that influence employment, consumer protection, health and safety at work, contract and trading, trade unions, monopolies and mergers, and tax. Economic policy: particularly fiscal policy i.e. government spending and taxation. Government-owned business (nationalized industries): some governments retain control over key strategic industries and the way in which these are controlled can have knock-on / indirect effects to other parts of the country. Government international policy: government intervention to influence exchange rate and international change. A government’s objectives towards the regulation of business will depend in large part on the political leaning of the governing party. Most governments have, however, sought to construct policy over a number of key areas of business activity. These include: • • • • • • •

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Control of inflation Promotion of economic growth and investment Control of unemployment Control of interest rates Control of balance of payments Control of monopoly power, both for businesses and trade unions Provision of public (non-reject able, non-rivalrous / diminishable, non-excludable) and merit goods (under consumed and underproduced in free market thus typically provided by governments) Control of pollution and environmental protection Consumer protection Regulation of working conditions Regulation of trade

To varying degrees, all businesses will be affected by political influences. So, it is important for managers to monitor government policy to detect changes early so as to respond effectively. Political risk and its potential effect on business is another important aspect of the political environment. While Europe and North America are comparatively politically stable, other parts of the world, like Eastern Europe, South America, and parts of the Middle East and Africa, have undergone periods of political instability. It is therefore necessary to monitor closely the political situation in these areas when trading with them as the political risks are large. Even in more stable areas, political uncertainty can be higher during, for instance, election times. Economic Influences Analysis of the economic environment centres on changes in the macroeconomy and their effects on business and consumers. Broadly speaking, the regulation of a national economy is brought about by fiscal and monetary policy. These policy instruments, alongside influences from international markets, determine the economic climate in the country in which a business competes. When the effects of fiscal and monetary policy work themselves out in the economy, they can affect any or all of the following economic factors: •

Economic growth rates

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Levels of income in the economy Levels of productivity in the economy Wage levels and the rate of increase in wages Levels of inflation Levels of unemployment Balance of payments Exchange rates

Economic growth, exchange rates, levels of income, inflation and unemployment will all affect people’s ability to pay for products and services and hence affect levels and patterns of demand. Similarly, exchange rates and levels of productivity, wages and inflation will affect the costs of production and competitiveness. All these indicators must be monitored in comparison to those faced by competitors abroad to provide indications of changes in international competitiveness. Natural Influences The natural environment is able to exert significant influence on business in some situations, although for other businesses, it may have no influence at all. Natural events include: • • • • • • • • • •

Earthquakes Landslides Avalanches Hurricanes Floods Tsunamis (tidal waves) Deforestation Droughts Freezes Volcanic eruptions

On a more day-to-day basis, the weather can determine demand for goods such as ice creams, umbrellas and clothes, and services such as travel. There are two observations about natural events: • •

Their impact on business activity can be powerful and, in almost all cases, the events are difficult to predict or avoid. The risk of certain natural events occurring varies by geographical location.

Natural influences can occur on any scale, from very small to very large. A rainy spell may trigger an increase in demand for umbrellas and wellington boots, while a sunny spell may stimulate demand for ice cream, sunscreen and shorts. A river in flood, on the other hand, may cause damage to homes, pubs, farms, and other small businesses along its banks. Technological Influences Analysis of the technological environment involves developing an understanding of the effects of changes in technology and their impact on all areas of an industry, its members and their activities, including: •

Goods and services: changes in technology affect the products available to consumers and businesses, the quality of the products and their functionality. For example, the

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development of the microprocessor has made possible the development of many new products including PCs. Production processes: production processes in many industries have been transformed and automated by wireless technology (Wi-Fi), broadband, computer-aided design (CAD) and computer-aided manufacturing (CAM). This has speeded up design processes, transformed working practices and increased the efficiency of production. Information and communications: developments in information and communications technology (ICT), like the development of PCs, satellite, cable, networks, and the internet, together with rapid advances in software, have contributed to revolutionizing the way that business is conducted in many industries. Activities are now better coordinated, research and development (R&D) is speeded up and many businesses are much more flexible, connected and responsive. Transport and distribution: changes in transport technology have revolutionized business and have changed societies and cultures. It is possible to transport materials, components, and products with far greater speed and at much lower cost as a result of developments in road, rail, sea, and air transport. These improvement in transport have also increased the amount of personal and business travel that people undertake. Increased personal travel has had significant influence on the patterns of consumption in many countries e.g. travel foods and drinks. Society, politics and economics.

It is important to note, however, that not all technology is electronic. At its simplest, a technology is an innovation that in some way advances human understanding e.g. the bow and arrow, the invention of gunpowder, the discovery of the forces at work in an arched bridge and innovations leading to the shaping of a modern car are all examples of technology. It is important that organizations monitor changes in the technologies that can affect their operations or their markets. In most industries, organizations must be flexible and be ready to innovate and to adopt new technologies as they come along. The way in which, and the extent to which, organizations do or do not employ the latest technology can be an important determinant of its competitive advantage. Note: a macroenvironmental analysis should recognize the ways in which the five SPENT factors might be linked to each other e.g. political impact on economic, technological impact on sociodemographic etc.

Using the SPENT analysis When carrying out a SPENT analysis as part of a strategic analysis, you should typically examine how each factor might impact on: •

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The industry in which the organization competes: the effects of SPENT factors on the five competitive forces (buyer power, supplier power, threat of entry, threat of substitutes, and competitive rivalry). An organization’s markets: the effects of SPENT factors on product markets, for example market size, structure, segments, customer wants etc. and the resource markets in which organisations gain their inputs. The internal parts of an organisation: the effects of SPENT factors on the organisation’s core competences, strategies, resources, and value systems.

(Source: Campbell et al, 2011 ‘Business Strategy: An Introduction')

Industry Analysis Porter’s Five Forces Purpose of the Five Forces Framework Porter’s Five Forces Framework helps identify the attractiveness of an industry in terms of five competitive forces: (i) threat of entry, (ii) threat of substitutes, (iii) power of buyers, (iv) power of suppliers and (v) extent of rivalry between competitors. For Porter, an attractive industry structure is one that offers good profit potential. Where the five forces are high, industries are not attractive to compete in.

The Five Forces Threat of entry How easy it is to enter the industry influences the degree of competition. The greater the threat of entry, the worse it is for incumbents in an industry. Five important entry barriers are: •

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Scale and experience: economies of scale. Experience curve effects that give incumbents a cost advantage because they have learnt how to do things more efficiently than inexperienced new entrants. Access to supply distribution channels: in many industries manufacturers have had control over supply and or distribution channels. Sometimes this has been through direct ownership (vertical integration), sometimes just through customer or supplier loyalty. Expected retaliation: if an organisation considering entering an industry believes that the retaliation of an existing firm will be so great as to prevent entry, or mean that entry would be too costly, this is also a barrier. Legislation or government action: patents, regulations, tariffs etc. Differentiation: differentiation means providing a product or service with higher perceived value than the competition.

The threat of substitutes These are products or services that offer a similar benefit to an industry’s products or services but have a different nature. There are two important points to bear in mind about substitutes: •

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The price/performance ratio is critical to substitution threats: a substitute is still an effective threat even if more expensive, so long as it offers performance advantages that customers value. Extra-industry effects: substitutes come from outside the incumbents’ industry and should not be confused with competitors’ threats from within the industry. The value of the substitution concept is to force managers to look outside their own industry to consider more distant threats and constraints.

The power of buyers These are the organisation’s immediate customers e.g. supermarkets for a shampoo manufacturer. If buyers are powerful, then they can demand cheap prices or product or service improvements liable to reduce profits. Buyer power is likely to be high when: •

Concentrated buyers: where a few large customers account for the majority of sales, buyer power is increased.

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Low switching costs: where buyers can easily switch between one supplier and another. Buyer competition threat: if the buyer has the capability to supply itself, or if it has the possibility of acquiring such a capability (known as backward vertical integration).

The power of suppliers Those who supply the organisation with what it needs to produce the product or service e.g. raw material, fuel, labour etc. Supplier power is likely to be high where: • • •

Concentrated suppliers: where just a few producers dominate supply, suppliers have more power over buyers. High switching costs. Supplier competition threat: suppliers have increased power where they are able to cut out buyers who are acting as intermediaries (known as forward vertical integration).

Competitive rivalry Competitive rivals are organisations with similar products and services aimed at the same customer group. Five factors tend to define the extent of rivalry in an industry or market: • •

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Competitor balance: where competitors are of roughly equal size there is the danger of intensely rivalrous behaviour as one competitor attempts to gain dominance over others. Industry growth rate: in situations of strong growth, an organisation can grow with the market, but in situations of low growth or decline, any growth is likely to be at the expense of a rival and met with fierce resistance. High fixed costs: industries with high fixed costs tend to be highly rivalrous. High exit barriers: the existence of high barriers to industry exit tends to increase rivalry, especially in declining industries. Low differentiation: where products or services are poorly differentiated, rivalry is increased because there is little to stop customers switching between competitors and the only way to compete is on price.

Supplementing the Five Forces with the Value Net Five Forces analysis can be supplemented by analysis of complementors. An organisation is your complementor if it enhances your business attractiveness to customers (value your product more when they have the complementors) or suppliers (attractive to supply to you when have complementors). Opportunities for cooperation can be seen through a value net (a map of organisations in a business environment demonstrating opportunities for value-creating cooperation as well as competition.

Supplementing the Five Forces with the Industry Life Cycle The power of the Five Forces typically varies with the stages of the industry life cycle. Stages of the Industry Life Cycle • Development: entry into the market, few competitors, little direct rivalry, highly differentiated products, little profits. • Growth: lots of opportunities to grow, strong power of suppliers. • Shake-out: increased rivalry, the weakest player leaves the market, new opportunities for competitors. • Maturity: economies of scale and experience curve benefits. • Decline: declining demand for products, shrinking profit margins, thinning of product lines.

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