ISL457U-STRATEGIC MANAGEMENT
Chapter 3: External Environment Analysis
Introduction
It is important for the companies to analyze the consumer consciousness, competitive pressures, and technological developments to develop strategies for the future of the organization and to see the threats and the opportunities. For example, ten years ago, companies such as Netflix, which predicted that online technologies would replace older technologies, such as television, have become successful today. Many successful multi-national companies such as Amazon and Coca Cola become successful because they efficiently make use of external environmental analysis and predictions on future developments. Companies should make use of both internal and external analyses to be able to compete and keep sustainability. This unit focuses on external environmental analysis but internal analysis is equally important.
Types of External Environment
The environment is full of both opportunities and threats for companies. In order to be able to be prepared for opportunities and threats, the environment must be defined appropriately. While, internal factors can be controlled by organizations, external factors are dynamic and beyond the control of companies. The external environment consists of a combination of all factors surrounding an organization from the outside. For example, companies cannot control government policies. The external factors can be assessed along two dimensions:
1. Changeability of markets: Changeability may depend on the product. For example, bottled water market is not changeable, while PC market has high changeability. 2. Predictability of changes: An environment can be predictable due to the regular pattern or not. For example, smart devices markets are predictable, while biogenetics market is not.
The external environment has two main types of external environment: an industry environment and a general environment.
The Industry environment is the environment outside the business, which interacts directly with the business. It is also known as task, near, or microenvironment. The dimensions of the industry environment can be classified into three main constituents.
1. Customers 2. Competitors 3. Suppliers
The general environment is an environment that indirectly influences the long-term decisions and activities of a company. General environment is also known as a societal or far environment and it does not immediately influence a firm’s activities. The dimensions of the general environment are: Political, Economic, Socio-cultural, Technological, and Environmental.
Activities of External Environment Analysis
The four basic activities that businesses should consider in the external environment are scanning, monitoring, forecasting, and assessing. Each activity is related to each other and must be performed one after another.
Scanning
Environmental scanning is carried out by collecting data on the changes in the external environment of the firm. This process of data collection and its analysis is also called industry analysis In this way, companies investigate the current status of the external environment and potential changes in the future. This type of analysis is beneficial if carried out regularly especially in highly competitive settings. A company must determine opportunities and threats in their internal and external environment and then strategies are developed based on these. For example, a successful company Samsung is constantly scanning both its environment, i.e. its major competitors such as Apple and Huawei and its internal setting, i.e. its own resources. Many companies regularly collect information about consumer behaviors. This information is necessary in order to determine their strategies on sales activities in the future. Such a data collection process is also an example of scanning.
Monitoring
Monitoring is used to develop effective strategies for the future. It also helps increasing the productivity of a company considering customers and clients, economic conditions, and market trends. Scanning and monitoring activities also provide information if a new trend is emerging.
Forecasting
Companies must be able to make long-term plans based on the data they constantly collect through scanning. Even though companies cannot know much about the future, they should continue to predict the future by analysis on might happen in the future, based on data, information, changes, and trends detected through screening and monitoring in the forecasting process. In forecasting, inferences and predictions are made at almost any organizational level inside the company in order to determine thnd e budget, allocate the resources and make strategic long-term plans accordingly.
Forecasting Techniques
Forecasting techniques can be quantitative and qualitative techniques. Qualitative techniques are based on consumer and expert comments, such as Brainstorming, In-depth Interviewing, Delphi Technique, and Expert Opinion. Industry scenario, is also a qualitative technique in which “a scenario that is developed by analyzing the probable impact of future society forces on key groups in a particular industry”. On the other hand, quantitaive techniques aim to uncover cause-effect relationships by investigating certain variables.
Assessing
This process is assessing the external environment of the company. The main objective is to determine the timing and significance of the effects of environmental changes that have been identified through previous phases.
It should always be kept in mind that no forecasting technique has a guarantee to predict the future completely.
Analysis of Industry (Micro) Environment: Porter’s Five Forces Model
A microenvironment is the environment where companies sell their products, interact with competitors, and provide the materials they need for the production process. It is also referred to as the “operation environment”. Activities of companies that are in the same industry affect the others. For example, if a car business increases the prices of its products, it forces others to do the same. Because of the fact that companies’ influence the activities of others, this environment is also called a “competitive environment”.
Porter’s Approach to Industry Analysis
Porter’s Five Forces model is developed to determine the attractiveness of an industry. It is the process of collecting data and analyzing the data about the competitors. The main purposes of an industry analysis are:
• to review the factors that influence the way the industry develops, • to investigate the status of competitors, • to detect the threats or opportunities • to understand the firm’s position in comparison to other companies
Threat of New Entrants
A company that wants to enter the market is a risk to the current market share and profitability of the existing companies. So, the existing companies try to discourage new-comers to enter the market; while new-comers try to deal with the strategies of the established firms. It is, therefore, important to collect data about the competitors.
The factors that make an industry attractive are as in the following:
• Industry Structure • Legal Incentives • High Growth Rate Potential • High Profitability Potential • Low Risk Status • Low Competition Level • Low Uncertainty Degree • Demand Balance
There are some difficulties that a new company may face when they enter a new sector. These difficulties are called barriers to entry. One of these barriers is that there are no distribution channels and it is expensive to establish a new distribution channel for new companies. High investment costs and economies of scale are other factors that are
among the difficulties. In addition, businesses need to go into mass production for some time to reduce the unit cost. Another barrier is the level of brand loyalty of consumers to the products or services of existing companies. Established firms’ lower cost advantage may discourage new competitors to enter the market. Government policies can be another factor that makes it difficult for new competitors to enter the market. For example, legal regulations are created to prevent foreign brands from entering the market in some countries.
The Threats of Substitute Products
A substitute product is one that is used with the same purpose as the original product in the market. Firms operating in a specific market compete with each other by producing substitute products, because substitution products typically meet the needs of the same consumer group in different ways. Therefore, in some cases, directing consumers to substitute products may decrease the sales of the original product.
The threat of substitute goods to the business depends on two main conditions:
• Changing consumer trends • Cost of substitution products
Consumers who prefer substitution products for some reason may pose a threat to businesses. The changing lifestyle and technology lead them to new products and services. For example, consumers may prefer to buy tablets instead of laptops or mobile phones instead of cameras.
Bargaining Power of Suppliers
Some conditions, such as the status and the number of suppliers and resources, affect the nature of the competition. The high bargaining power changes based on several factors, such as being one of the few suppliers and having unique products, and the absence of substitute products. In addition, a strong position such as skilled labor, capital, equipment, and other components can greatly influence the structure of the industry.
Bargaining Power of Buyers
Today consumers have many options to choose from and this makes competition harder. Therefore, consumers have become very important in the modern marketing era. Consumers want to meet their social needs and services in addition to their mandatory needs. They look for factors such as experience seeking, shopping pleasure, being different, having authentic and unique products. That is why consumers have become powerful actors in the market. Thus, a buyer group may be a threat, because consumers will cause businesses to lower their prices and be more careful about their products and services.
Intensity of Rivalry Among Established Firms
Every company has a main competitor in the market. Coca-Cola has Pepsi, Apple has Samsung. The strategies
of the major competition between rivals affect not only each other but the whole market. So, companies try to obtain information about their competitors’ future investments, current strategies, and so to predict the future of the industry as a whole. The competition level in an industry depends on different variables:
• The large number of competitors with the same capabilities in the industry: this causes severe competition • Low market growth rate • Barriers to exit: Some businesses may decide to leave the market, which affects the level of competition in the market.
Other Factors Affecting the Industry Environment
In the industry environment analysis, the relationships with the following constituents are also important:
• Strategic Groups: Firms in the same industry with different positions and activities • Customers • Unions defend the rights of workers and their quality of life. Managing relations with unions is also important for the firms. • Financial Institutions provide capital and funding for the firms.
Analysis of General (Macro) Environment: PESTE Analysis
The general environment of the business is a wider environment that also affects the industrial environment. In this analysis, factors such as economic indicators are investigated.
There are some advantages and disadvantages of a general environment analysis. Cost effectiveness is an advantage. Alertness level is another advantage because businesses can improve alertness levels by detecting threats to external environmental factors in advance. This also provides firms with a competitive advantage. A general environment analysis facilitates product and market adaptation, which helps the business adapt to the realities in new markets.
PESTE Analysis
A PESTE analysis, which aims to identify the opportunities and threats in the external environment, firms can develop more effective strategies. A PESTE analysis is carried out by a simple brainstorming approach. PESTE includes five environmental factors in the following:
P: Political E: Economic S: Sociocultural T: Technological E: Ecological
PESTE should be repeated at regular stages to identify changes in the general environment.
Political Factors
The political environment is related to the political organizations. Its analysis focuses on legal regulations, government policies, and political relations with foreign countries.. The main factors to consider are:
• Tax policies, • Labor laws, • Environmental regulations, • Commercial restrictions, • Customs tariffs, • Political stability.
Economic Factors
Economic factors are related to issues such as production, distribution, consumption, and reproduction. Economic factors can be listed as business cycles, inflation, national income, monetary and fiscal policies, production factor costs, balance of external payments.
Sociocultural Factors
Businesses try to increase their interactions with their target audiences so they should be able to correctly determine consumer desires and needs. the sociocultural environment contains factors such as people’s value judgments, attitudes, behaviors, cultural characteristics, habits, and lifestyles.
Technological Factors
These factors are related to technological conditions. The factors that affect the technological environmental elements of the business as:
• R&D studies • IT use • Using the Internet • Automation • Technology incentives • Technological development speed • Technology transfers
Ecological Environment
The ecological environment is “a system of many parameters such as nutrients, food, temperature, material resources and social behavior. The ecological environment also includes energy sources, climate change, animal rights, biodiversity, and environmental pollution in the natural environment of the firm. The environmental awareness of today’s consumer is increasing. Consumers tend to buy environmentally friendly products. Emphasis on concepts such as sustainability, green products, natural products, and natural production processes provides a competitive advantage to the business.