The Pestel Model

Depending on the firm’s strategy, these forces can affect its performance ina positive and negative
fashion.

The forces at the most macro level are

• Political, (P)

• Economic, (E)

• Sociocultural, (S)

• Technological, (T)

• Ecological, (E) and

• Legal (L)

which form the acronym PESTEL.

Although many of the factors are inter dependent, the PESTEL Model provides a relatively
straightforward. way to categorize and analyze the important external forces that might 1
impinge upon a firm.

The Pestel Framework

Understanding the forces in the external environment allows managers to mitigate threats and
leverage opportunities.

As Figure 5.1 shows, a firm is embedded in different layers i in ‘its environment, The firm falls
into a strategic group, the set of companies that pursue a similar strategy within a specific
industry.

The strategic group; in essence consists of the firm’s closest competitors. Just Outside the
strategic group is the industry in which the company operates. Industries differ along important
structural dimensions such as the number and size of competitors in an industry and the types
of products or services offered. - Depending on the firm’s strategy, these forces can affect its
performance in a positive or negative fashion.
A brief discussion of these PESTEL forces follows:

Political Factors

The political environment describes the processes and actions of government bodies that can
influence the decisions and behavior of firms. Government, for example, can affect firm
performance by exerting political pressure on companies.

Economic Factors

The economic factors in the external environment are largely macroeconomic, affecting economy
wide phenomena. Managers need to consider how the following five macroeconomic factors can
affect firm strategy:

1) Growth rates

2) Interest rates

3) Levels of employment

4) Price stability (inflation and deflation)

5) Currency exchange rates.

Sociocultural factors

Capture a society’s cultures, norms, and values. Because sociocultural forces not only are constantly
in flux but also differ across groups, managers need to closely monitor such trends and consider the
implications for firm strategy. Changing sociocultural factors create opportunities as well as threats.

Demographic trends are also important sociocultural forces. They capture characteristics in a
population related to age, gender, family size, ethnicity, sexual orientation, religion, and
socioeconomic class, Like other sociocultural factors, demographic trends present opportunities but
can also pose threats.

Technological Factors

Technological factors capture the application of knowledge to create new - processes and products.
Recent innovation in process technology includes lean manufacturing. Technological progress is
relentless and seems to be picking up Speed over time. Think about the Internet or advancements in
biotechnology and nanotechnology. Shopping online has radically altered business and consumer
behavior. The revolution in nanotechnology is just beginning, but promises major upheaval in a vast
array of industries ranging from tiny medical devices to new, age materials for earthquake-resistant
buildings.

Ecological Factors

Ecological factors concern broad environmental issues such as the natural environment, global
warming and sustainable economic growth. Managers can no longer separate the natural and the
business worlds; they are inextricably linked.

Three dimensions — economic. social, and ecological make up the triple bottom line. Achieving
results in all three areas can lead to a sustainable strategy. Like the balanced scorecard, the triple
bottom line takes a more integrative and holistic vie in assessing a company's performance. Using a
triple-bottom-line approach, Managers audit their company’s fulfillment of its social and ecological
obligation, to stakeholders such as employees, customers, suppliers, and communities in ag Serious
a way as they track its financial performance.

Legal Factors

The legal environment captures the official outcomes of the political processes ay manifested in
laws, mandates, regulations, and court decisions. These tn turn can have a direct bearing on a firm’s
bottom line. Regulatory changes tend to affect entire industries. Companies are not only influenced
by forces in their environment Sut can also influence the development of those forces

The structure-conduct-performance (SCP) model is a theoretical framework. developed in industrial

organization economics, that explains difference in industry performance. According to the SCP
model, the underlying industry structure determines firm conduct, which concerns the firm‘s ability
to differentiate its goods and services and thus to influence the price it can charge: Industry
structure and firm conduct combine to determine firm performance.

Figure 5.2 shows different industry types along a continuum from fragmented to consolidated
structures. At one extreme, fragmented industry structures consists of many small firms and tend to
generate low profitability. At the other end of the continuum, consolidated industry structures are
dominated by a few firms, or even just one firm, and tend to be highly profitable. The SCP model
categorizes industry | structure into four main industry types: (1) perfect competition, (2)
monopolistic competition, (3) oligopoly, and (4) monopoly.

Figure 5.2: Industry Structures along the Continuum from Fragmented to Consolidated

COMPETITIVE FORCES AND FIRM? MODEL: RM’S STRATEGY: THE FIVE

FORCES

FIVE FORCES AFFECTING COMPETITION IN AN INDUSTRY

A highly influential five forces developed by Michael Porter, The Five Kep Competitive forces
that managers need to consider when analyzing the industry environment and formulating
strategy are

• Threat of entry

• Power of suppliers

• Power of buyers

• Threat of substitutes

• Rivalry among existing competitors

Poster’s model aims to enable managers not only to understand their industry environment but also
to shape their firm’s strategy. As a rule of thumb, the stronger the five forces, the lower the
industry’s profit potential — making the industry less attractive to competitors. The reverse also is
true: The weaker the five forces, the greater the industry’s profit potential ~ making the industry
more attractive. The model’s perspective is that of the manager of an existing (incumbent) firm
competing for advantage in an established industry, Managers need to position their company in an
industry in a way that relaxes the constraints of strong forces and leverages weak forces. Figure 5.2
shows Poster's Five Forces Model.
Figure 5.2 Poster’s Five forces Model

Threat of Entry
Entry barriers are obstacles that determine how easily a firm can enter an industry They are often
one of the most significant predictors of industry profitability would be advisable to remember that
the Threat of Entry is High when:

a) Customer switching costs are low.

b) Capital requirements are low.

c) Incumbents do not possess:

• Proprietary technology

• Established brand equity

d) New entrants expect that incumbents will not or cannot retaliate.

The Power of Suppliers

The bargaining power of suppliers captures pressures that industry suppliers can exert on an
industry’s, and therefore a company’s, profitability. Inputs into the production process include raw
materials and components, labor (may be individuals or labor unions, when the industry faces
collective bargaining), and services. Powerful suppliers can raise the cost of production by
demanding higher prices or delivering lower-quality products.

Suppliers are powerful relative to the firms in the industry if there are only few substitutes available
for the products and services supplied. For example, crude oil is still a critical input in many
 industries,
and oil suppliers are fairly powerful io raising prices and squeezing industry profitability where
products and services rely heavily on oil inputs such as fertilizers or plastics. Suppliers are also in a
more powerful position when the extent of competition among suppliers is low, which often goes
along with a small number of large suppliers. Supplier power is further enhanced when the supplied
product is unique and differentiated or when the companies in the industry face significant
switching costs. Supplier power is also strengthened when suppliers provide a credible and threat
of forwardly integrating into the industry (i.e., moving into their buyer’s market), or when the
companies in the industry buy only small quantities from the suppliers.

In short, the power of suppliers is high when:

a) Incumbent firms face significant switching costs when changing suppliers

b) Suppliers offer products that are differentiated.

c) There are no readily available substitutes for the products or services that the suppliers offer.

d) Suppliers can credibly threaten to forward-integrate into the industry.

The Power of Buyers

The bargaining power of buyers concerns the pressure buyers can put on the margins of producers
in the industry, by demanding a lower price or higher product ‘quality. When buyers successfully
obtain price discounts, it reduces a firm’s top line (revenue). When buyers demand higher quality
and more service, it generally raises production costs. Strong buyers can therefore reduce industry
profitability and with it, a firm’s Profitability.

Buyers have strong bargaining power when they purchase in large quantities and control many
access points to the final customer. Buyer power also increases when the buyer’s switching costs
are low. Buyers also tend to be quite powerful when they are only customer buying a certain
product. Buyers are also powerful when they can incredibly threaten backward integration.
Backward integration occurs when a buyer moves upstream in the industry value chain, into the
seller’s business.

In other words, the power of buyers is high when:

a) There are a few large buyers.

b) Each buyer purchases large quantities relative to the size of a single seller.

c) The industry’s products are standardized or undifferentiated commodities.

d) Buyers face little or no switching costs.

e) Buyers can credibly threaten to backward-integrate into the industry.

Threat of Substitutes
The threat of substitutes is the data that products or services available from outside the given
industry will come close to meeting the needs of current customers. The existence of substitutes
that have attractive price and performance characteristics result in low switching costs, increasing
the strength if this threat. For example, if the price of coffee increased significantly, customers
might switch to tea or other caffeinated beverages to meet their needs. Other examples of
substitute are: video conferencing vs. business travel; e-mail vs. express mail; plastic vs. aluminum
containers; and gasoline vs. biofuel.

Also, the threat of substitute is high when:

a) The substitute offers an attractive price-performance trade-off.

b) The buyer’s cost of switching to the substitute is low.

Rivalry among Existing Competitors

Rivalry among existing competitors describes the intensity with which companies an industry jockey
for market share and profitability. It can range from genteel to cut-throat.

When managers understand the strength or weakness of the five forces that aff the competition in
an industry, they are better able to position the company in 4 way that protects it from the strong
forces and exploits the weak forces. The goa is of course to improve the firm’s ability a competitive
advantage.

The rivalry among existing competitors is high when

a) There are many competitors in the industry.

b) The competitors are roughly of the equal size.

c) Industry growth is slow, zero, or even negative.

d) Exit barriers are high.

e) Products and services are direct substitutes.

Companies in the same industry are the most obvious and prominent source of competition.
The Strategic Role of Components: Adding a Sixth Force

As valuable as the five forces model is for explaining the profitability and attractiveness of industries,
some have suggested extensions of it and could be further enhanced if one also considers the
availability of complements.

A complement is a product, service, or competency that adds value to the original product offering
when the two are used in tandem. Complements increase demand for the primary product, thereby
enhancing the profit potential for the industry and the firm. A company is a complementor to you
company if customers value your product or service offering more when they are able to combine it
with the other company’s product or service. Firms may choose to provide the complements
themselves or work with another company to accomplish this.