Organisation as an open system

ENVIRONMENTAL ANALYSIS
“It is not the strongest of the species that survive,
nor the most intelligent, but the one most responsive
to change.” – Charles Darwin

Professor . Pradeep Dharmadasa, Dean , Faculty of

Management and Finance, University of Colombo

Factors that determine a company’s situation Components of a firm’s environment

 Diagnosing a company’s situation has two facets

 Company’s external or macro-environment
 Industry and competitive conditions
 Forces acting to reshape this environment
 Company’s internal or micro-environment
 Market position and competitiveness
 Competencies, capabilities, resource strengths and
weaknesses, and competitiveness
 Why External Analysis? ENVIRONMENTAL ANALYSIS?

The external environmental analysis process should be

External analysis allows firms to: conducted on a continuous basis. This process includes four
activities:
 discover threats and opportunities
Scanning Identifying early signals of environmental changes
and trends
 see if above normal profits are likely in an industry
Monitoring Detecting meaning through ongoing observations of
 better understand the nature of competition in an industry environmental changes and trends
Forecasting Developing projections of anticipated outcomes based
on monitored changes and trends
 make more informed strategic choices
Assessing Determining the timing and importance of
environmental changes and trends for firms' strategies
and their management

General Environment The Industrial Organization (I/O) View

The general environment can have a positive (opportunity)

or negative (threat) impact on the industry. It includes the The Industrial Organization (I/O) approach to
following sectors: competitive advantage advocates that external
 Economic forces (industry) factors are more important than internal
 Social, cultural, demographic, and natural environment factors in a firm for achieving competitive advantage.
forces
 Political, governmental, and legal forces
 Technological forces
 Competitive forces
The Industrial Organization (I/O) View Economic

 Firm performance is based more on industry properties

 The economic sector includes macro-economic data that
reflect what is happening with the overall economy
Economies of scale
 It includes current statistics and forecasted trends and
Barriers to market entry changes
Product differentiation  It provides information of both opportunities and threats

The economy

Level of competitiveness

Economic Economic

 Major economic data include:

 Interest rates
 Exchange rates and value of the dollar
 Budget deficit or surplus
 Trade deficit or surplus
 Inflation rate
 GDP and GNP
 Consumer confidence, spending and debt
 Employment/unemployment levels
Economic
 Viewing economic data requires interpretation
 What does the data mean for the business?
 Is it good or bad?
 Does it affect the business and the industry?
 An organization’s performance is determined by how it
responds to the various economic opportunities and
threats
 The biggest challenge is finding available and reliable data
Demographics
 Population statistics require interpretive analysis to
enable understanding of what trends might mean for
the business:
 Population is increasing
 It is aging, there are more people over 30 than under
 It is becoming more educated
 More female
 Facts
 World population 7 billion
 World population = 8 billion by 2028
 World population = 9 billion by 2054
Demographics
 Understanding the trends that affect demographics is
essential to benefiting or suffering from the outcome of
the trends
 Included in the demographic sector are current
statistical data and trends in population characteristics
 Gender, age, income levels, ethnic makeup, education,
family composition, geographic location, birth rates,
employment status
Demographics
 Other demographic factors to consider:
 Which age group has the fastest growing income?
 What geographic areas have the greatest concentration of
senior citizens?
 Of particular note are the baby boomers because of their
size and historical influence
 Demographic information transcends geographic borders
and, as shifts and trends can be identified, helps target
consumers
Sociocultural Sociocultural

 Refers to a country’s culture and includes:

 Traditions  It is not only about what the culture is, but how it’s
changing
 Lifestyles
 Values  Such trends are not obvious or as easy to determine as
demographic changes
 Attitudes
 Measuring and interpreting peoples opinions, values,
 Beliefs
attitudes, likes or dislikes is more challenging
 Tastes
 Patterns of behavior

Sociocultural Sociocultural

 In evaluating this sector, it is important to look at

 It is important for strategic decision makers to
determine what is happening in the sociocultural
sector
 Cultural values reflect individual freedom, work ethics,
and equality of opportunity
 Cultural values influence people’s behavior in the way
they work, shop, raise families
changes or trends in people’s activities, behavior, and
purchases
 This enables firms to respond to consumers changing
tastes
 Due to the absence of standard governmental collection,
the challenge to decision makers is in gathering accurate
data in this sector on a global basis
Political-Legal
 In this sector, various laws, regulations, judicial
decisions, and political forces at the federal, state, and
local levels of government are analyzed
 Examples of this sector include:
 Changes in bankruptcy laws that made it tougher for
individuals to wipe out debt; which helped credit card
companies reduce write-offs
 Trade agreements between countries
Technological
The Internet has changed the very nature of
opportunities and threats by:
 altering the life cycles of products,
 increasing the speed of distribution,
 creating new products and services,
 erasing limitations of traditional geographic markets,
 changing the historical trade-off between production
standardization and flexibility.
Political-Legal
 Other areas of importance to understand in this sector
that can influence profitability:
 Changes in patent laws that affect idea ownership
 Governmental regulations of business that can influence
taxation, minimum wage, labeling of products/safety laws
 Immigration and worker visas
 Global warming
 Executive compensation
Technological
 Computerization is one of the most important of the
technological innovations
 It continues to affect organizational work processes and
product development
 Retailers use it to link to suppliers, airlines to aid customer
selections of destinations and fares
 Innovations in lasers, robotics, biotech, medicine, consumer
electronics, telecommunications have improve products and
consumer choices

Technological
Technological advancements can:
 Create new markets
 Result in a proliferation of new and improved products
 Change the relative competitive cost positions in an
industry
 Render existing products and services obsolete
Finding Information on the External Environment
and Evaluating it
External information can be found using informal and
unscientific observations; as well as formal and systematic
searches
 Examples of informal approaches
 Discussions with customers and suppliers
 Reading industry journals or news periodicals
 Examples of formal approaches
 Surveys
 Scientific analysis
Finding Information on the External Environment
and Evaluating it
Finding valuable information and interpreting it is essential
to organizational success. Examples include:
 Data specific to the context
 Statistics
 Analyses
 Trends
 Predictions and forecasts
 Inferences or statements by experts
Finding Information on the External Environment
and Evaluating it
 External information system
 Is information system that provides managers with needed
external information on regular basis
 Purpose is to identify potential trends and changes that might
positively or negatively impact organizational performance
 Information is valuable because external environment is
complex and dynamic
 The challenge: having enough, but not too much information
Benefits of Doing an External Analysis
 Enables managers to be proactive, not reactive
 Anticipate change
 Create plans for those changes
 Influence the organizational performance
 External analysis is key
 To providing information to use in planning, decision making,
and strategy formulation
Benefits of Doing an External Analysis
 Environment is a source of resource
 The ability to acquire and control needed resources depends
on understanding the environment and taking advantage of
the resources available
 Dynamic environment requires awareness of
 Turbulent and fragmented markets
 Changing customer tastes
 Innovative technologies
Benefits of Doing an External Analysis
 External analysis enables strategists to
 Adapt to opportunities and threats
 Neutralize competitor moves
 Improve organizational opportunities
 Altering strategies should align the organization based on
information about:
 Markets
 Customers
 Technology
Benefits of Doing an External Analysis
 Intense global competition makes it imperative to complete
an external analysis
 Research shows that firms doing an external analysis have
higher performance
 Performance evaluated on financial measures like return on
assets or increased profit
The Structure-Conduct-Performance Model
Industry Analysis - The five forces framework
Industry Analysis
Porter’s five forces framework helps identify the
attractiveness of an industry in terms of five competitive
forces:
 threat of entry,
 threat of substitutes,
 bargaining power of buyers,
 bargaining power of suppliers and
 extent of rivalry between competitors.
The five forces constitute an industry’s ‘structure’.
The five forces framework
The Threat of Entry & Barriers to Entry
 The threat of entry is low when the barriers to entry are high and vice
versa.
 The main barriers to entry are:
 Economies of scale/high fixed costs
 Experience and learning
 Access to supply and distribution channels
 Differentiation and market penetration costs
 Government restrictions (e.g. licensing)
 Entrants must also consider the expected retaliation from organisations
already in the market
The five forces framework
Threat of Substitutes
Substitutes are products or services that offer a similar benefit
to an industry’s products or services, but by a different
process.
Customers will switch to alternatives (and thus the threat
increases) if:
 The price/performance ratio of the substitute is superior
(e.g. aluminium maybe more expensive than steel but it is
more cost efficient for some car parts)
 The substitute benefits from an innovation that improves
customer satisfaction
The five forces framework
The bargaining power of suppliers
Suppliers are those who supply what organisations need to
produce the product or service. Powerful suppliers can eat into
an organisation’s profits.
Supplier power is likely to be high when:
 The suppliers are concentrated (few of them).
 Suppliers provide a specialist or rare input.
 Switching costs are high (it is disruptive or expensive to
change suppliers).
 Suppliers can integrate forwards
The five forces framework
The bargaining power of buyers
Buyers are the organisation’s immediate customers, not
necessarily the ultimate consumers.
If buyers are powerful, then they can demand cheap prices
or product / service improvements to reduce profits .
Buyer power is likely to be high when:
 Buyers are concentrated
 Buyers have low switching costs
 Buyers can supply their own inputs (backward vertical
integration)
The five forces framework
Rivalry between competitors
Competitive rivals are organisations with similar products and services
aimed at the same customer group and are direct competitors in the same
industry/market
The degree of rivalry is increased when :
 Competitors are of roughly equal size
 Competitors are aggressive in seeking leadership
 The market is mature or declining
 There are high fixed costs
 The exit barriers are high
 There is a low level of differentiation
Implications of five forces analysis
 Identifies the attractiveness of industries – which
industries/markets to enter or leave.
 Identifies strategies to influence the impact of the
forces, for example, building barriers to entry by
becoming more vertically integrated.
 The forces may have a different impact on different
organisations e.g. large firms can deal with barriers to
entry more easily than small firms.
Competitors - Key Questions About Competitors
 What are the major competitors’ strengths?
 What are the major competitors’ weaknesses?
 What are the major competitors’ objectives and strategies?
 How will the major competitors most likely respond to current economic,
social, cultural, demographic, environmental, political, governmental,
legal, technological, and competitive trends affecting our industry?
 What key factors have resulted in our present competitive position in
this industry?
 How have the sales and profit rankings of major competitors in the
industry changed over recent years?
 What is the nature of supplier and distributor relationships in this
industry?
 To what extent could substitute products or services be a threat to
competitors in this industry?
Issues in five forces analysis
 Apply at the most appropriate level – not necessarily the
whole industry. E.g. the Asian low cost airline industry
rather than airlines globally.
 Note the convergence of industries – particularly in the
high tech sectors (e.g. digital industries - mobile
phones/cameras/mp3 players).
 Note the importance of complementary products and
services (e.g. Microsoft windows and McAfee computer
security systems are complements). This can almost be
considered as a sixth force.
Types of industry
 Monopolistic industries - an industry with one firm and
therefore no competitive rivalry. A firm has ‘monopoly power’ if it
has a dominant position in the market.
 Oligopolistic industries - an industry dominated by a few firms
with limited rivalry and in which firms have power over buyers
and suppliers.
 Perfectly competitive industries - where barriers to entry are
low, there are many equal rivals each with very similar products,
and information about competitors is freely available. Few (if
any) markets are ‘perfect’ but may have features of highly
competitive markets.
 What Are the Key Factors for Competitive
The Industry Life Cycle
Success?

 KSFs are those competitive factors most affecting every

industry member’s ability to prosper
 KSFs concern
 Specific strategy elements
 Product attributes
 Resources
 Competencies
 Competitive capabilities
 that a company needs to be competitively successful
 KSFs are attributes that spell the difference between
 Profit and loss
 Competitive success or failure

Identifying Key Success Factors Managerial Implications

 Pinpointing KSFs involves determining

 On what basis do customers choose between competing  Which industries should we enter or leave?
brands of sellers?  What influence can we exert?
 What resources and competitive capabilities does a seller  How are competitors differently affected?
need to have to be competitively successful?
 What does it take for sellers to achieve a sustainable
competitive advantage?
 KSFs consist of the major determinants for success
 Rarely are there more than 5 - 6 factors that are truly key to
the future financial and competitive success of industry
members
Forecasting Tools and Techniques The External Factor Evaluation (EFE) Matrix

 Forecasts are educated assumptions about future

trends and events  Economic  Political
 Quantitative techniques – most appropriate  Social  Governmental
when historical data is available and there is a  Cultural  Technological
constant relationship  Demographic  Competitive
 Qualitative techniques
 Environmental  Legal

EFE Matrix Steps Competitive Profile Matrix (CPM)

1. List key external factors  Identifies firm’s major competitors and their
2. Weight from 0 to 1 strengths & weaknesses in relation to a
3. Rate effectiveness of current strategies sample firm’s strategic positions
4. Multiply weight * rating
5. Sum weighted scores  Critical success factors include internal and
external issues