External

Environment

UNIT 3:

STRATEGIC MANAGEMENT
Analyzing a Company’ s
External Environment
– Learning Objectives
– On completion of this chapter you should be able to:
– • To understand the nature of environment in which an organisation operates
and the role of its analysis in strategy formulation.
– • To understand the changing nature of Indian business environment and its
implications for strategy formulation.
– • Concept of environmental analysis and the Role of environmental analysis
– • Concept of environment * Nature of environment * Impact of environment
Environmental Analysis
– Environmental analysis is a part of SWOT analysis. SWOT is’ acronym of
strengths, weaknesses, opportunities, and threats. While opportunities and
threats are external to an organisation, strengths and weaknesses are internal
to the organisation.
– 1. Opportunity. An opportunity is a favourable condition in the organisation’s
environment which enables it to strengthen its position.
– 2. Threat. A threat is an unfavourable condition in the organisation’s
environment which causes a risk for, or damage to, the organisation’s position.
– 3. Strength. A strength is an inherent capability of the organisation which it can
use to gain strategic advantage over its competitors.
– 4. Weakness. A weakness is an inherent limitation or constraint of the
organisation which creates strategic disadvantage to it.
Concept of Environmental Analysis

– Environmental analysis, also known as environmental scanning or appraisal, is

the process through which an organisation monitors and comprehends various
environmental factors and determines the opportunities and threats that are
provided by these factors.
– Thus, there are two aspects involved in environmental analysis:
– 1. Monitoring the environment, i.e. environmental search and
– 2. Identifying opportunities and threats based on environmental monitoring,
i.e. environmental diagnosis.
Following features of environmental
analysis may be identified:

– 1. Environmental analysis is a holistic exercise in which total view of

environment is taken rather than viewing trends piecemeal. Though for
environmental analysis, the environment is divided into different components
to find out their nature, function, and relationship for searching opportunities
and threats and determining where they come from, ultimately the analysis of
these components is aggregated to have a total view of the environment.
– 2. Environmental analysis is a heuristic or exploratory process. Since futures are
unknown, the analysis emphasises on ‘what could happen and not necessarily
what will happen.’
– 3. Environmental analysis must be a continuous process rather than being an
intermittent scanning system. In this process, there is continuous scanning of
the environment to pick up the new signals or triggers in the overall pattern of
developing trends.
Role of Environmental Analysis
– 1. The environment changes so fast that new opportunities and threats are
created which may result disequilibrium into organisation’s existing equilibrium.
– Therefore, the strategists have to analyze the environment to determine what
factors in the environment present opportunities for greater accomplishment of
organisational objectives and what factors in the environment present threats
to the organisation’s objective accomplishment so that suitable adjustment in
strategies can be made to derive maximum benefits.
– 2. Environmental analysis allows strategists time to anticipate opportunities and
plan to take optional responses to these opportunities. Similarly, it helps to
develop an early warning system to prevent the .threats or to develop strategies
which can turn the threats to the organisation’s advantage.
– 3. Environmental analysis helps strategists to narrow the range of available
alternatives and eliminate options that are clearly inconsistent with forecast
opportunities of threats. The analysis helps in eliminating unsuitable
alternatives and to process most promising alternatives.
Concept of
Environment
– An organisation, being a system, operates in
some contexts which lie outside it and is called
as external environment or simply
environment. Thus, environment consists of all
the conditions, circumstances, and influences
surrounding and affecting art organisation in its
totality or any of its subsystems.
– In order to define and identify the relevant
environment, let us go through the exogenous
nature of environment which has been
presented in the Figure
– Based on the nature of this impact, various environmental factors are grouped
into two categories: general and specific.
– General Environment: General environment, also known as societal, remote,
macro or indirect-action environment, consists of those factors which affect the
business of a country and, therefore, they have homogenizing effect.
– In the general environment, we can include natural and ecological factors at the
first level.
– Natural factors are important to the economic activities of a country because’
either they provide opportunities or threats to the economic system. For
example, agriculture depends on nature , manufacturing depends on physical
inputs; mining and drilling depend on natural deposits; transportation and
communication depend on geographical factors; and so on.
Industry
Analysis - what
factors are
driving industry
change and its
impact
– At the second level, comparatively, more influencial factors come in the form of
economic, political-legal, technological, and social-cultural factors.
– Specific Environment: Specific environment, also known as task, operating,
micro or direct-action environment, affects individual organisations differently.
Since a particular organisation operates in an industry or limited number of
industries, it is directly affected by the nature of industry concerned and the
type of competition prevailing therein. Thus, the specific environment includes
those forces lying outside the organisation directly relevant to decision making
about input acquisition, transformation process, and export of output.
Nature of Environment

– Environment provides both, opportunities and threats. In order to know whether there
is-an opportunity or threat, we have to look at the nature of environment in terms of
its complexity and variability.
– Environmental Complexity: Environmental, complexity is referred to the heterogeneity
and range of activities which are relevant to an organisation’s operations.
– Thus, more diverse the relevant environmental activities and more these are, the
higher is the complexity.
– The heterogeneity relates to the variety of activities in the environment affecting the
organisation.
– Complexity or non-complexity of environment is a matter of perception.
– Environmental Variability: The degree of environmental variability is an
important determinant of organisational functioning.
– In fact, the environment, being dynamic, changes over the period of time, but it
is the rate of change which is a matter of concern.
– There can be low or high change rate, though again it is matter of perception.
– Both low and high change rates can be dichotomised further into stable and
unstable rates.
– The basic effect of uncertainty is to limit the ability of the organisation to
preplan or to make decisions about activities in advance of their execution.
– Taking both dimensions of the nature of environment complexity and variability,
environment may be seen in terms of a continuum ranging from turbulent to simple
with varying degree of complex
Degree of complexity
High low
Turbulent Environment simple environment
High low
Degree of variability
Figure: Continuum of environmental complexity and variability as shown in the figure.
Industry
Environment

PORTER’S FIVE
FORCES MODEL
INDUSTRY ENVIRONMENT ANALYSIS
– An industry is a group of firms producing products that are close substitutes. In the course of
competition, these firms influence one another.
– Compared with general environment, the industry environment has a more direct effect on the firm’s
strategic competitiveness and ability to earn above-average returns.
– THREAT OF NEW ENTRANTS: They threaten the market share of the existing competitors.
– They bring additional production capacity
– New competitors may force existing firms to be more efficient and to learn how to compete on new
dimensions
– The likelihood that firms will enter an industry is a function of two factors: Barriers to entry and
retaliation expected from current industry participants. Thus firms that are competing successfully in
an industry want to maintain high entry barriers in order to discourage potential competitors from
deciding to enter the industry.
BARRIERS TO ENTRY:
– ECONOMIES OF SCALE: Increasing economies of scale increases a firm’s flexibility.
Experience curve effect: Higher efficiencies as a result of experience a firm gains through
higher cumulative experience.
– PRODUCT DIFFERENTIATION: Customers over a period of time may come to believe that a
firm’s product is unique. HUL, P&G, Colgate Palmolive
– CAPITAL REQUIREMENT: In addition to physical facilities, capital is needed for inventories ,
marketing activities, and other critical business functions. Steel, oil exploration, refining and
marketing, fertilizers and airlines
– SWITCHING COSTS: One-time costs which customers incur when they buy from a different
supplier. Cost of buying new ancillary equipment and of retraining employees, and even
psychological costs of ending a relationship. Commercial vehicle industry-Tata, Ashok
Leyland
– ACCESS TO DISTRIBUTION CHANNELS: Consumer non-durable goods industry( e.g. in grocery
stores where shelf space is limited) and in international market. New entrants will have to
persuade distributors to carry their products either in addition to or in place of those currently
distributed.
– COST DISADVANTAGES INDEPENDENT OF SCALE: Proprietary product technology. Favourable
access to raw materials, desirable locations, and government subsidiaries are examples. Delivering
purchases directly t o the buyer can counter the advantage of a desirable location; new food
established in an undesirable location often follow this practice.
– GOVERNMENT POLICY: Licensing and permit requirements government can control entry into an
industry. Liquor retailing, Radio and TV broadcasting, Banking. To provide quality service or
protect jobs .
– EXPECTED RETALIATION: An expectation of swift and vigorous competitive responses reduces the
likelihood of entry. Can happen when the existing firm has a major stake in the industry, when it
has substantial resources, or when industry growth is slow or constrained
BARGAINING POWERS OF SUPPLIERS
– Increasing prices and reducing the quality of their products are potential means suppliers use to
exert power over firms competing within an industry. If a firm is unable to recover cost increases
by its suppliers through its own pricing structure, its profitability is decreased by its suppliers’
actions. A supplier group is powerful when:
– Dominated by a few large companies and more concentrated than the industry to which it sells
– Satisfactory substitute products are not available
– Industry firms are not a significant customer for the supplier group
– Effectiveness of suppliers’ products has created a high switching costs for industry firms
– It poses a credible threat to integrate forward into the buyer’s industry
– Airline industry(Boeing, Airbus ), JSW Steel
BARGAINING POWER OF BUYERS
– Firms seek to maximize the return on their invested capital. Alternatively, buyers (customers of an
industry or a firm) want to buy products at the lowest possible price- the point 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.
– Buyer groups are powerful when:
– They purchase a large portion of an industry’s output
– Sales of the product being purchased account fr a significant portion of the sellers’s annual revenue
– They could switch to another product at little, or ni cost
– Industry’s products are undifferentiated or standardized and the buyers pose a credible threat if
they were to integrate backward into the sellers’ industry
THREAT OF SUBSTITUTE PRODUCTS
– Substitute products are goods or services from outside a given industry that perform similar or the same
functions as a product that the industry produces. Email and Fax machines replace postal mail; video
conferencing can substitute travel; Newspapers can be substituted by Internet news

INTENSITY OF RIVALRY AMONG COMPETITORS

Because an industry’s firms are mutually dependent, actions taken by one company usually invite
competitive responses. Competitive rivalry intensifies when a firm is challenged by a competitor’s actions or
when a company recognizes an opportunity to improve its market position.
Common dimensions on which rivalry is based include price, service after the sale and innovation.
Equally balanced competitors: Pepsi- Coca cola
Slow industry growth: Power industry, equipment industry
High fixed cost or High Storage Costs: US automobile industry, Indian telecom industry, Perishable products
– Lack of Differentiation or Low switching costs: Firms that develop and sustain a differentiated
product that cannot be easily imitated by competitors often earns higher returns.
– Personal computers are a commodity product. Hence rivalry between Dell, HP and other computer
manufacturers is strong.

– HIGH STRATEGIC STAKES: Competitive rivalry is likely to be high when it is important for several of
the competitors to perform well in the market.
– Samsung has targeted market leadership in the consumer electronics market and doing well. Sony,
Hitachi, Mitsubishi are also major competitors
– High strategic stakes can also exist in geographical locations. For e.g. Japanese automobile
manufacturers are committed to a significance presence in the US marketplace because it is the
world’s largest single market for automobiles and trucks.
HIGH EXIT BARRIERS
– Sometimes companies continue competing in an industry even though the returns on their
investment is low or negative. They face high exit barriers, which include economic, strategic and
emotional factors causing them to remain in the industry.
– Common exit barriers include:
– Specialized assets )linked to a particular business or location)
– Fixed costs of exit (labour agreements)
– Strategic interrelationships (mutual dependence between one business and other parts of a
company’s operations, including shared facilities and access to financial markets)
– Emotional barriers (fear for one’s own career, loyalty to employees)
– Government and social restrictions (based on government concern for job losses and regional
economic effects)
Analysis of Five forces in the industry allows the firm to:

– Determine industry’s attractiveness in terms of the potential to earn adequate or superior returns
– Stronger the competitive forces, lower the profit potential for an industry’s firms
– An unattractive industry has low entry barriers, suppliers and buyers with strong bargaining powers ,
strong competitive threat from product substitutes and intense rivalry among competitors.
– These characteristics make it difficult for firms to achieve strategic competitiveness and earn above-
average returns.
– An attractive industry has high entry barriers, suppliers and buyers with little bargaining powers, few
competitive threats from product substitutes, and relatively moderate rivalry