TOPIC THREE

BUSINESS ENVIRONMENT
 Before any organization formulates a strategy, it needs to conduct an environmental
analysis.
 Every organization, whether business or non-business has an environment in which it
operates. Environment of an organization consists of its surroundings - anything that
affects its operations whether favorably or unfavorably.
 Business managers must understand the various facets of the impacts the environmental
forces creates on the business and undertake environmental analysis on regular basis.
They need to understand changes in the remote environment, industry, and operational
environment.
 Conducting environmental analysis has many benefits:

i. Managers can isolate those factors, especially in the external environment,

which are of specific interest to the organization.

ii. Managers can take preparation to deal with predicted crisis any of the factors
in the environment. They can develop crisis plans for overcoming crises that
affect organization.

iii. The key to achieving organizational effectiveness understands of the

environment in which the firm operates its business. Lack of knowledge of
inadequate knowledge is very likely to lead managers to ineffectiveness.

iv. It reduces risks that may affect the business hence reducing organization
liability.

v. It helps in development and improvement of growth and diversification

resources while making effective resource allocations

For an organization to be aware of its environment. It should do the following:

a) Environmental scanning – Surveillance of a firms external environment to predict
environmental changes and detect changes already underway. This is also involves
observing trends which are made possible by knowing your customers, your business
and observing market leaders.

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 b) Environmental monitoring –This involves tracking the evolution trends and sequences
of events and stream of activities. This allows a firm evaluate how environmental
trends are changing the competitive landscape.
c) Competitive intelligence- these are a firm activities of collecting and interpreting data
on competitors and understanding the industry in identifying competitors’ strength
and weaknesses.
d) Environmental forecasting: the development of plausible projections about the
direction, scope, speed and intensity of environmental changes. However, managers
should be careful because environmental trends are uncertain and have a fall back
plan incase things goes otherwise on their strategy.
Fig. 2.1 Environmental Analysis

Source: Dess et al (2012)

Types of Environment

Business operations are normally affected by:

 External Environment
 Internal Environment

External Environment

External factors consist of organization’s external factors that affect its business directly.
These factors can lead to either opportunities or threats. The external environment consists of
the general environment (remote) and industry environment.

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 I. The General (Remote) Environment

The general environment is normally analyzed using PESTLED model, which is an acronym
meaning Political, Economic, Social cultural, Technological, legal, ecological and
demographic factors.

a) Political Environment

The government of every country normally intervenes in national and economic issues
through setting business policies and regulations. In Changes in patent laws, antitrust
legislation, tax rates, and lobbying activities can affect firms significantly. Managers must
understand the implication they are likely to likely to have on the business. The increasing
global interdependence among economies, markets, governments, and organizations makes it
imperative that firms consider the possible impact of political variables on the formulation
and implementation of competitive strategies. Things like political ideology, political
stability, strength of opposition parties, government attitudes towards foreign firms, foreign
policy etc.

b) Economic Environment

The economic factors affect the market attractiveness. the factor analysis, where the attention
is drawn to the following: growth in gross domestic product, the organization‘s decisions
cannot be the same in both good economic times and bad economic times. Important
indicators are also inflation, unemployment, interest rates, exchange rate fluctuations,
investment climate, and consumption.

Economic environment analysis assesses ‘national health’ and this helps an organization
determine how is going to affect the purchasing power. Purchasing power depends on
income, prices, savings, and debt availability of credit. Purchasing power depend on income,
prices, savings, debt and availability of credit. Therefore, the organization must pay attention
to the income and consumption patterns of the customers. However, all the economic
variables in the economy must be treated holistically for clear envisioning of the
entire economy and the market.

c) Sociocultural Environment

These include culture, language, lifestyle changes, social mobility, attitudes towards
technology, and people’s values, opinion, beliefs etc. These forces dictate aparticular set of

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values and attitudes with resultant lifestyles. Society’s values and attitudes form the
cornerstone of a society. They often drive the other conditions and changes. The demand
for many products changes with the changes in social attitudes. Socio-cultural factors differ
across countries. In many countries, worker diversity is now a common phenomenon.
Therefore, it is very important for managers of business organizations to study and predict the
impact of social and cultural changes on the future of business operations in terms of meeting
consumer needs and interests. Business firms must offer products in the society that
correspond to its values and attitudes

d) Technological Environment
Technological dimensions include information technology, the internet, biotechnology etc.
Technology has a major impact on the development of the product, organizational processes
and efficiencies. Strategic managers need to study technological changes that are taking place
in the industry, adopt, improve their products, and maintain their market share.

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, and changing the historical trade-off
between production standardization and flexibility. The Internet is altering economies of
scale, changing entry barriers, and redefining the relationship between industries and various
suppliers, creditors, customers, and competitors

The following are example of how wireless network is used in business

Airlines—Many airlines now offer wireless technology in flight.
Banking—Visa sends text message alerts after unusual transactions.
Energy—Smart meters now provide power on demand in your home or business, ebill etc
Health Care—Patients use mobile devices to monitor their own health, such as calories
consumed.
Hotels—Days Inn sends daily specials and coupons to hotel guests via text messages.
Market Research—Cell phone respondents provide more honest answers, perhaps because
they
are away from eavesdropping ears.

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Politics—President Obama won the election partly by mobilizing Facebook and MySpace
users,
revolutionizing political campaigns. Obama announced his vice presidential selection of Joe
Biden by a text message.
Publishing—eBooks are increasingly available.
S o u r c e : Based on Joe Mullich, “10 Industries That Wireless Will Change,” W all Street Jo ur nal
(April 1, 2009): A12.

e) Legal Environment
The legal environment consists of laws and regulatory framework that guides businesses
operations e.g industrial laws, labour laws, taxation, patent trademark laws, operating licenses
and so on. The business must be up to date of the regulations affecting their businesses and
ensure they are compliant. Business laws protect business from unfair competition and
consumers from unfair business practices.

f) Ecological Environment
Strategy makers need to analyze the environmental trends before they make decisions. Some
of the pertinent issues that strategists needs to consider is the availability and cost of raw
materials, energy and other inputs, pollution and role of the government in environmental
protection. Similarly, businesses need to participate in environmental sustainability by setting
strategies like using renewable energy, recycling materials and proper waste management and
disposal.

g) Demographic Environment
This covers human populations in terms of size, density, location, age, gender, race,
occupation, and other statistics. Demographic changes are normally very evident and
strategic managers must consider such factors before making strategic decisions and moves.
h) Global Segment
This involves influences from foreign countries, including foreign market opportunities,
foreign-based competition, and expanded capital markets. This involves assessing every
factor above in non-domestic market.

How Organizations respond to External Environmental forces

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Environmental forces can retard the growth of the business or boost it so it important for
strategic managers to know how to react on the forces of the environment. Business
organization can employ several ways to respond to its environment:

a) Lobbying
An organization can use strong lobbyist to bargain with regulators to change laws or prevent
them from enacting new laws that can adversely affect business operations.
b) Influencing customers
This can be done through introduction of new products, product innovation and taking away
clients from competitors.
c) Influencing Suppliers
This can be done by establishing long-term relationships with suppliers, for example by
signing long-term contracts with fixed prices. This will be a hedge against inflation. An
organization can also establish backward linkage (producing their own products) e.g if it is
producing water it can also start producing its bottles.
d) Boundary Spanning
A firm may engage itself in boundary spanning for learning about what organizations are
doing. A boundary spanner collects information outside the organization while he or she is on
the field. The best employs to use as boundary spanners are salespeople, purchasing agents,
relationship managers etc.
e) Environmental Scanning
An organization can influence external environmental forces through regular environmental
analysis is called environmental scanning. Using both boundary spanning and scanning
organizations can gather relevant information necessary for making strategic decisions.
f) Strategic Response
This involves ensuring strategic fit in the current prevailing environmental forces. The
strategic response is done through adopting a very different strategy, making small changes
on the initial strategy or maintaining the status quo.
g) Organizational Combinations
An organization may decide to enter new markets or uphold prominence in the market by a
merger, acquisition, alliances or takeover.

Industry Environment

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 Industry environment is sometimes referred to as Task or competitive environment.
These factors pertain to an industry and affect a firm’s strategy. According to Pearse &
Robinson (2011), industry environment is the general conditions for competition that
influence all businesses that provide similar products and services.
 The performance and profitability of a firm is normally influenced by the developments
in the competitive environment and how it has positioned itself in the industry
environment.
 The competitive/industry environment consists of many factors that affect firm strategies.
These factors include competitors (both existing and potential), customers and suppliers.
Potential competitors may include a supplier that considering forward integration.
 When analyzing the competitive environment strategists should not only concentrate on
the major competitors but they should also consider:
- Potential entrants
- Small competitors
- Intangible assets of the competitors like top management
- Customer needs and expectations
- And anticipate unexpected strategic moves of the competitors

 Michael E. Porter developed a tool know as Porter’s fives forces model that has been a
common tool used in examining industry level competitive environment.

Porter’s Five –Forces Model of Industry Competition

This model describes the environment in terms of five basic competitive forces:
a) The threat of new entrants
b) Bargaining power of buyers
c) Bargaining power of suppliers
d) Threats of substitute products and services
e) The intensity of rivalry among competitors in an industry

Threat of New Entrants in the Market.

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This refers to the possibility of established firms in the industry will be eroded by the new
competitors. This normally depend on existing barriers to entry and the combined reactions
from existing competitors. Barriers are the conditions that a firm must satisfy to enter into the
market. If the barriers are too high, the new entrant may not pose a serious threat to the
competitors. This deter the new entrants by coming with a large scale and risk strong reaction
from existing competitors or small scale and accept cost disadvantage, both which are
undesirable options.
The major barriers are:
a) Economies of Scale
Economies of scale refers to spreading the cost of production over the number of units
produced. The cost of production normally increases as the absolute volume per period
increases. Companies within the industry achieve this savings due to increased volume. This
is normally due to technological advancement, long-term contractual agreements with
suppliers, enhanced employee performance etc.

b) Product Differentiation
The extent to which customers perceive differences among products and services. This can be
done through advertising, being first in the industry, customer services and product
differences.
c) Capital Requirement
The need to invest large financial resources to compete and create a barrier to entry,
particularly if heavy capital is required for unrecoverable expenditure in things like
advertising and Research & Development. Capital is also required in things like fixed assets,
customer credit, inventory and absorbing customer loses.
f) Cost disadvantages Independent of Size
Some competitors may have advantages that are independent of size or economies of scale.
These derive from:
i. Propriety products
ii. Favorable access to raw materials
iii. Government subsidies
iv. Favorable government policies

g) Switching costs
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These are one-time costs that a buyer/supplier faces when they switching from one supplier/
buyer to another.

h) Access to Distribution Channels

The new entrant’s need to secure a distribution for its product can create a barrier to entry.
Bargaining Power of Buyers
The threat that buyers may force down prices, bargain for higher quality or more services and
play competitors against each other.
Buyers are normally powerful when:
a) They purchase more that the sellers can produce.
b) The buyers faces few switching costs
c) The products it purchases from the industry is standard and undifferentiated i.e they
can always find alternative suppliers.
d) Buyers pose a credible threat of backward integration.
e) The industry product is less important to the quality of the buyers or services
f) It earns low profits
Bargaining Power of Suppliers
The threat that the suppliers may raise the prices or lower the quality of purchased goods and
services.
Suppliers will be powerful when:
a) The supplier group is dominated by a few companies and is more concentrated than
the industry it sells to Suppliers selling fragmented industries influence prices, quality
and terms
b) The industry is not an important customer of the supplier
c) The supplier product is an important input of buyer’s product.
d) Suppliers group products are differentiated or it has built switching costs
e) They pose a threat of forward integration.
The Threat of Substitute Products and Services
Substitute products are those that serve the same customer needs as the industry that serve the
same customer needs Substitutes limit the potential returns of an industry by placing a ceiling
on the prices that the firm in that industry can charge. Substitutes that that deserve strategic
attention are those that are subject to trends improving their price- performance trade-offs and
those produced by industries earning high profits.

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Intensity of Competitive Rivalry
This is the threat that customers will switch their business to competitors within the industry.
Rivalry normally occurs when factors in the industry forces an organization to defend or
improve its position.
They use tactics like competition, price cuts, advertising, product introductions, increased
customer warranties etc. It is important to note that rivalry normally differs from industry to
industry.
Intensity of rivalry is normally because of:
a) Numerous or equally balanced competitors.
b) Slow industry growth – fights for market share
c) High fixed or storage costs
d) Lack of differentiation or switching cost
e) Capacity augmented in large increments
f) High exit barriers –specialized assets, fixed cost of exit, strategic interrelationships,
government and social pressures etc.

Operating Environment
Factors in the immediate competitive environment that affects a firm’s success in acquiring
needed resources. This refers to external stakeholders that an organization deals with
including customers, suppliers, creditors, competitors, labor market and human resource
requirements, interest groups etc.

INTERNAL ENVIRONMENT
It is not enough to analyze the external environment for opportunities, threats, strategists
must look within and identify critical strength, and weaknesses that will enable an
organization take advantage of opportunities while avoiding threats. This internal scanning,
also referred to as organizational analysis, is concerned with identifying and developing an
organization’s resources and competencies.

a) SWOT (Strength, Weaknesses, Opportunities, Threats) ANALYSIS

To understand the business environment you need to analyze both general and the firm’s
competitive environment. SWOT analysis is a basic for analyzing a company’s internal and
external strength, which stands for Strength, weaknesses, opportunities and threats.

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The main aim of conducting SWOT analysis is to:
a) Build on the strength
b) Remedy the weaknesses
c) Identify opportunities
d) Proactively respond to the threats
Strength- a resource capability controlled by or available to a firm that gives it an advantage
over its competitors. These normally arises from the resources and competencies of a frim.

Weaknesses - This a limitation or deficiency in one or more of a firm’s resources or

capabilities relative to its competitors that create a disadvantage in effectively meeting a
customer needs. E.g financial capacity.

Opportunity- A major favorable situation in a firm’s environment. These may include

overlooked market segment, technological changes, improved buyer supplier relationship.

Threats – Is a major unfavorable situation in a firm’s environment. They are impediments to

the firm’s current or desired position. These could include new competitors, slow market
growth etc

Fig 2.2: SWOT Analysis

Numerous
environmental
opportunities

Support a Support an
turnaround – aggressive
oriented strategy strategy

Critical internal Substantial

weaknesses internal strength

Support a Support a
defensive diversificatio
strategy n strategy

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 Major environmental
threats

Source: Pearce & Robinson (2011)

b) Value Chain Analysis

 This is a strategic analysis of an organization that uses value-creating activities. Value –
chain analysis view the organization as a sequential process of value creating activities.
This approach is useful in understanding the building blocks of competitive advantages.
A competitive advantage of an organization lies in its ability to perform crucial activities
along the value chain better than its competitors.
 Value is the amount that buyer are willing to pay for what the firms provides and is
measured by the total revenue.
 Porter divided the activities in two; primary activities and support activities.

Primary activities
These are sequential activities of the value chain that refer to the physical creation of the
product or service, its sale to the buyer and its service after the sell including inbound
logistics, operations, outbound logistics, marketing and sales and service.

a) Inbound Logistics
These are activities concerned with receiving, storing and distributing inputs to the product. It
includes material handling, warehousing, inventory control, vehicle scheduling and returns to
the suppliers

b) Operations
These are the activities, costs and assets related to the production of products and services.
All activities associated with transforming inputs into the final product. These include

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production, assembly, packaging, equipment maintenance, facilities, quality assurance and
environmental protection etc.

c) Outbound Logistics
These are all the activities concerned with distributing the final product and/or service to the
customers. These include finished goods warehousing, order processing, order picking and
packing, shipping, delivery etc.

d) Marketing and Sales

This functional area essentially analyses the needs, wants of customers, and is responsible for
creating awareness among the target audience of the company about the firm’s products and
services. Companies make use of marketing communications tools like advertising, sales
promotions etc. to attract customers to their products. This also include activities and assets
used in marketing research and dealer/distributor support.

e) Service
There is often a need to provide services like pre-installation or after-sales service before or
after the sale of the product or service, buyers’ inquiries and handling customer complaints
and feedback.

Support activities
these are activities that assist the firm as a whole by providing infrastructure or inputs that
allow primary activities to take place.

a) Procurement
This function is responsible for purchasing the materials that are necessary for the company’s
operations. An efficient procurement department should be able to obtain the highest quality
goods at the lowest prices.

b) Human Resource Management

This is a function concerned with recruiting, training, motivating and rewarding the
workforce of the company. Human resources are increasingly becoming an important way of
attaining sustainable competitive advantage.

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 c) Technology, research & systems
This is the area that is concerned with technological innovation, training and knowledge is
crucial for most companies today in order to survive. These include activities and assets used
for Research & Development, process design improvements, telecommunication systems,
computer software, database capabilities and computerized support systems.

d) Procurement
Activities, costs and assets associated with purchasing and providing raw materials, supplies,
services and outsourcing necessary to support the firm and its activities. Sometimes it is
assigned as the firm inbound logistics

e) General Administration
These are activities, costs and assets relating to general management of a firm. This includes
planning and control systems, such as finance, accounting, legal and regulatory affairs, safety
etc.

Source: Porter (1985)

See appendix attached overleaf

RESOURCE BASED VIEW (RBV)

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This is a method of analyzing and identifying a firm’s strategic advantages based on
examining its distinct combination of assets, skills, capabilities and intangibles as an
organization. The RBV normally combines two perspectives:
1) An internal analysis of the firm
2) An external analysis of the industry and its competitive environment.
A firm resource must be evaluated in terms of how valuable, rare and inimitable it is to
competitors otherwise the firms only attain competitive parity.
Resources are always identified as:
Core competence

Types of Firms Resources

Firm’s resources are all assets, capabilities, organizational process, information, knowledge
and so forth controlled by a firm that enable it to develop and implement value-creating
strategies.

a) Tangible Resources
These are organizational assets that easy to identify including physical assets, financial
resources, organizational resources and technological resources. Among them are financial
resources (firm’s cash, accounts receivable, and ability to borrow funds) and physical
resources (plants, equipment, machinery and proximity to customers)
b) Intangible Resources
Organizational resources that are difficult to identify and account and are typically embedded
in unique routines and practices, including human resources (Managerial skills, experience of
employees and effectiveness of work teams), innovation resources (Technical and scientific
expertise) and reputation resources (brand name, reputation with suppliers, reliability and
quality of products as perceived by customers).

c) Organizational Capabilities
The competencies that a firm employs to transform inputs into outputs. It is the ability to
combine assets, people and process in converting firm’s inputs into outputs. Examples are
outstanding customer service, excellent product development capabilities, superb innovation

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etc. When these capabilities are constantly being changed and reconfigured to make them
more adaptive to an uncertain environment, they are called dynamic capabilities.

Firms Resources and Sustainable Competitive Advantages

Once a firm classifies its resources in tangible, intangible and capabilities, it will then
determine which ones are valuable. According to RBV a firm develops it’s resources into the
following:
Competence- A competency is a cross-functional integration and coordination of
capabilities.
Core Competence - A core competency is a collection of competencies that crosses
divisional boundaries, is widespread within the corporation, and is something that the
corporation can do exceedingly well.
Distinctive Competency -When core competencies are superior to those of the
competition.
Distinctive competencies are competencies that are very difficult for others to
replicate and therefore are a source of enduring advantage.

A core distinctive competency -is a distinctive competency whose presence is

crucial for goal achievement (because of its linkages to goals) and, precisely because
it is hard to emulate, critical to the long-term success of the organization.
According to RBV, strategic resources must exhibit the following characteristics to sustain an
advantage
1. Valuable (V): Resources are valuable if it provides strategic value to the firm.
Resources provide value if it helps firms in exploiting market opportunities or helps in
reducing market threats. There is no advantage of possessing a resource if it does not
add or enhance value of the firm.
2. Rare (R): Resources must be difficult to find among the existing and potential
competitors of the firm. Hence, resources must be rare or unique to offer competitive
advantages. Resources that are possessed by a several firms in the market place
cannot provide competitive advantage, as they cannot design and execute a unique
business strategy in comparison with other competitors;
3. Inimitability (I): Imperfect imitability means making copy or imitate the resources
will not be feasible. Bottlenecks for imperfect imitability can be many viz.,
difficulties in acquiring resource, ambiguous relationship between capability and

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 competitive advantage or complexity of resources. Resources can be basis of
sustained competitive advantage only if firms that do not hold these resources cannot
acquire them;
Inimitability is normally achieved through the following isolating mechanisms:
a) Physical uniqueness – Physical uniqueness that is difficult to copy.
b) Path dependency- Characteristics of resources that is developed and/or
accumulated through a unique series of event.
c) Casual Ambiguity-A characteristics of firm’s resources that is costly to imitate
because the competitor cannot determine how it can be re-created.
d) Social Complexity –Characteristics of a firm’s resources that is costly to imitate
because the social engineering required is beyond the capability of the
competitors. This may include interpersonal relations, organizational culture and
reputation with suppliers and customers.

4. Non-Substitutability (N): Non-substitutability of resources implies that resources

cannot be substituted by another alternative resource. Here, competitor can’t achieve
same performance by replacing resources with other alternative resources
Evaluation Firm Performance
This is done through the following methods Financial Ratio Analysis and Balanced Score
Card.
a) Financial Analysis
This is generally aimed at establishing a firm’s financial position. It involves the following
i. Computing and analyzing different types of ratios
 Short term solvency or liquidity
 Long term solvency measures
 Asset management (turnover ratios)
 Profitability
 Market Value
(See attached appendix for ratio calculations)
ii. Historical comparison- Meaningful ratio analysis must go beyond the calculation and
interpretation. They must look at how they change overtime as well as how they are
interrelated

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 iii. Comparison with industry norms – How a particular business is supposed to be
performing in a particular industry.
iv. Comparison with Key competitors- this is looking at the performance of key
competitors who belong in the same strategic group (firms with same strategies)

b) The Balanced Score Card

 A new approach to strategic management was developed in the early 1990's by Drs.
Robert Kaplan (Harvard Business School) and David Norton. They named this system
the 'balanced scorecard'. The balanced scorecard approach provides a clear
prescription as to what companies should measure in order to 'balance' the financial
perspective.
 The balanced scorecard enables managers to consider their businesses in four
perspectives:
a) Customer Perspective
This measures firm performance in terms of how well they are satisfying their customers. It
required that it translate their mission statement on customers’ service into measures that
reflect factors that really matter to customers. It entails articulating customer satisfaction
goals in terms of time, quality, performance, service and cost.
b) Internal Business perspective
Measures of firms’ performance in terms of how well internal processes, decisions and
actions are contributing to customer’s satisfaction. This include cycle time, quality employ
skills and productivity. They must also identify key resources and skills for continued
success.

c) Innovation and learning

Measures of firm’s performance in terms of how well it is changing its product and service
offerings to adapt to changes in the internal and external environment. Firms ability to do
well in innovation and learning is dependent of intangible assets like human capital (skills,
talent and knowledge), informational capital (information systems) and organization capital
(culture, leadership etc)

d) Financial Perspective

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Measures financial performance that indicate how well strategy implementation and
execution are contributing to bottom line improvement.
Limitations of a balanced score card
Balanced scorecard is a useful tool however there many factors that can short circuit it:
a) Lack of clear strategy.
b) Lack of leadership support
c) Too much emphasis on financial measures while ignoring non-financial measures.
d) Poor data on actual performance
e) Inappropriate links of scorecard measures to compensation – can lead to dysfunctional
managers looking to cash in.

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