Unit 10: Analysis of The Business Environment of Smes: Entrepreneurship/Leadership/Innovation-MGT 2251Y

Entrepreneurship/Leadership/Innovation- MGT 2251Y
UNIT 10: ANALYSIS OF THE BUSINESS ENVIRONMENT OF SMES

Unit Structure 10.0 10.1 10.2 10.3 Overview Learning Objectives Introduction Influences on Small Firm Formation and Survival 10.3.1 Push and Pull Factors in Business Start-up 10.3.2 Personal Attitudes 10.3.3 Industry Analysis The Five Forces Model 10.3.3.1 Potential Competitors 10.3.3.2 Rivalry among Established Companies 10.3.3.3 10.3.3.4 Power of Buyers Power of Suppliers
10.3.3.5 Threat of Substitute Products 10.3.3.6 Relative Power of Unions, Governments and Interest Groups 10.4 Competitor Analysis 10.4.1 Competitor Identification 10.5 Analysis of the External Environment 10.5.1 The PEST Framework 10.5.1.1 Political, Governmental and Legal Forces 10.5.1.2 Economic Forces 10.5.1.3 Socio-cultural, Demographic and Environmental Forces 10.5.1.4 Technological Forces 10.6 10.7 Summary References
10.0 OVERVIEW
In this Unit, the various elements constituting the internal environment of the business are analysed with a view to uncover its strengths and weaknesses. The components of the competitive environment are identified and assessed using competitor analysis. The Porter's Five Forces framework is presented as a tool for measuring industry attractiveness while the PEST framework uncovers opportunities and threats in the external environment.
10.1 LEARNING OBJECTIVES

By the end of this Unit, you should be able to do the following: 1. Explain the influences on small firms birth and survival. 2. Analyse the Porter's Five Forces Model as a tool for measuring industry attractiveness. 3. Identify competitor strengths and weaknesses via competitor analysis. 4. Identify strengths and weaknesses of the business following internal analysis. 5. Analyse the external environment of industry using the PEST framework to identify opportunities and threats.
10.2 INTRODUCTION
Small businesses form a turbulent part of the national economy because of the dynamic movements in and out of the SME sector as many new businesses are formed and are closed each year. The fittest survive and it is good for the economy to have resilient businesses remaining.
A number of factors in business environment, (some related to the enterprise, some to the external environment) affect the births and deaths of small firms, some factors being outside the direct control of firms. Internal factors, however, can be largely controlled by entrepreneurs through their personal attributes, technical skills, competencies and
behaviours. These factors decide first whether the new firm can start up and later on, its chances of survival.
Going into business is influenced by either pull factors such as a desire for independence and autonomy and push factors such as lack (or loss) of employment. Cromie, 1991 reports that research into the management problems faced by young small firms revealed that they experience problems, particularly in the areas of marketing, accounting and finance and the management of people.
10.3 INFLUENCES SURVIVAL
ON
SMALL
FIRM
FORMATION
AND
Internal influences Owner-manager motives Personal attributes Technical skills Management competencies especially in: Marketing Finance Management of people Entrepreneurial management behaviours, including: Opportunity discovery and exploitation Resource acquisition and coordination Entrepreneurial networking Entrepreneurial decision-making
External influences Macro environment Political Economic Social Technological
Micro environment Local economy Market sector Competitors Customers
Likelihood of small formation and survival
business
(Source: Stokes & Wilson, 2006)
Internal influences stem from the inner motivations, personal attributes, skills, competencies and attitudes of the entrepreneur. Once the business is set up, how the firm grows will depend on the entrepreneurs ability to match his/her strengths and weaknesses with the business environments opportunities and threats.
10.3.1 Push and Pull Factors in Business Start-up

Starting a business is hard work without guaranteed results. This may be the reason why many people have ideas but do not go on materialising them. Whether they do so or not may also be influenced by the push or pull factors. Push factors are those that force people in self-employment. This can result from redundancy, unemployment or simply retirement. Push factors, being somewhat involuntary rarely give rise to thriving businesses.
A growth firm is more likely to result from a pull, voluntary factor because of the positive motivation. Pull factors include the need for achievement and recognition, need for independence and pursuance of wealth or otherwise the wish to materialise on motivation.
Despite these push or pull triggers, to-be entrepreneurs may face a number of barriers which may curb their enthusiasm, for example, the need for a regular income and lack of capital. Many of these barriers can be overcome by the entrepreneur through his/her personal strengths.
10.3.2
Personal Attitudes
The smaller the business, the more qualities the entrepreneur will need to run the operations. These include hard work ethics, the energy to run the business day and night, foregoing rest and holidays etc. For such dedication to the venture, the owner/manager will be committed enough to make the above mentioned sacrifices. Entrepreneurial people also show resilience, that is, the ability to bounce back persistently and a strong tolerance for risk and uncertainty.
Cooper (1981) proposed a framework for classification of start-up influences: 1. The antecedent influences on entrepreneurs: their background, family, age, education, job experience and so on. 2. The incubator organisation in which they have previously been working: its location, market sector, skills required and so forth. 3. The environmental factors external to the individual: the economy, role models, availability of finance, staff and other support and so on.
Elements of the external environment will be dealt with in a subsequent section.
Activity 1
How far do you think the University Placement programmes at UoM (SWEP, WBL, Practicum and so on) serve the above purpose? Is a module on Entrepreneurship and SME Management across all Programmes (in all faculties) warranted?
10.3.3
Industry Analysis
An industry is a group of firms that produce a similar product or service. Industry analysis is an analysis of important stakeholder groups such as customers and suppliers.
Michael Porter contends that the intensity of competition within an industry is determined by a number of basic competitive forces, namely, rivalry among existing firms, power of buyers, power of suppliers, threat from substitute products, potential entrants and relative power of other stakeholders such as Unions, Governments and Special Interest Groups (for example, consumer associations).
Risk of entry by potential competitors
Bargaining power of suppliers Rivalry Among Established Competitors
Bargaining power of buyers
Relative Power of Unions, Governments and Interest Groups
Threat of substitute products
Figure 1: Porters Five Forces Model
(Source: Wheelen & Hunger, 2008).
Activity 2
Identify a set of substitute products/services.
According to Porter, the stronger any of the forces mentioned above, the more limited is the ability of the company to reap greater profit or market share.
From the same model, it follows that managers need to closely follow changes in the given competitive forces and if possible to alter any of them to their advantage. The Five Forces will now be discussed in detail.
10.3.3.1
Potential Competitors
These are companies which are not currently competing in the industry, but have the potential to do so. Managers have to assess if the risk of a competitive move by one firm can be expected to have a noticeable effect on other firms and thus cause any retaliation.
Small firms can tackle the problem by erecting: Brand loyalty: buyers preference for the products of established companies. Competitors will find it a difficult and/or too costly task to break down wellanchored consumer preferences. Absolute Cost Advantages, for example, Cost Advantages can arise from superior production techniques e.g. control on costs of intrants such as materials, labour, equipment, funds and so on. Some companies may produce their own raw materials. Economies of Scale, that is, Cost advantages associated with company size and mass production of a standard output. In this situation, these companies benefit from bulk discount in purchase of intrants, they can spread their fixed costs over a longer volume, they may also benefit from economies of scale in advertising.
This last strategy as well as erecting barriers to entry (for example, R & D costs) applies to large firms in general, small firms being unable to access the same advantage.
10.3.3.2
Rivalry among Established Companies
If rivalry in the industry is strong, this can give rise to intense competition, which can result in price wars. Mail order companies such as Dell and Gateway increased the level of competitive activity so much that the PC industry dominated by Apple, IBM and Compaq had to reduce prices drastically.
The extent of rivalry in an industry depends on three factors: (1) Industry structure. (2) Demand conditions. (3) Exit barriers in the industry.
Industry Structure
The industry can range from a pure monopoly to a fully fragmented one.
Firstly, a monopolistic situation is where only one dominant firm exists without competitors.
Secondly, apart from this extreme, there can be a situation where a few companies dominate the industry, whereby an oligopoly.
Thirdly, a fragmented industry consists of a large group of companies without any dominant one serving the market. Barriers of entry are low and whenever demand increases, new entrants flood the industry creating a Boom and Bust cycle. A fragmented industry therefore constitutes a threat because of ease of entry and the risk of price wars.
In consolidated industry structures (oligopoly), although threat from new entrants is low, any competitive action taken by one company is going to affect the market share of the other ones. This happens often in the retail clothing industry when a number of retailers open outlets in the same location thus taking sales away from each other. (Wheeler & Hunger, 2008).
There is competitive interdependence whereby if one reduces prices, the market share position is going to shift. Therefore companies tend either to follow the leader or else to agree tacitly on prices (Explicit price agreement is illegal).
Demand Conditions
Demand grows when the market increases in size. Therefore companies can grow without taking market share from competitors. However, when demand declines, companies grow by taking market share from competitors.
Exit Barriers
Exit barriers keep a company from leaving an industry. Some companies persist to remain in the industry when returns are declining. This can be due to a number of factors e.g. emotional attachments, economic or strategic reasons. Exit Barriers include: High investment in Equipment e.g. in the brewing industry. High costs of closing down e.g. severance payment. Emotional reasons e.g. family businesses. Strategic relationships between business units in the same firm e.g. provide inputs to a profitable sub unit. Lack of diversification, i.e. dependence on a unique product.
10.3.3.3
Power of Buyers
Buyers have bargaining power when they can threaten to shift to another supplier, for example, by asking for lower prices, better quality and customer care (higher operating costs). There are a number of situations which can give rise to buyer power, for instance, Few institutional (large) buyers and a large number of providers. Small entrepreneur poultry industries in Mauritius sell to a few poultry
processing plants. Buyers buy in large quantities and demand bulk discounts, for example, hypermarkets buying soft drinks. Supply industries have developed dependence on buyers.
Buyers can threaten to produce their own intrants (vertical integration), for example, the soft drinks industry starts producing sugar.
10.3.3.4
Power of Suppliers
Powerful Suppliers can unilaterally decide to increase and impose their prices and quality (low) on the company.
Porter proposes the following situations where suppliers are powerful: When the product supplied is of vital importance for the company and cannot be substituted for. When the companys industry is not an important customer for the supplier. When the company depends on the supplier for a customised product/intrant. When suppliers can easily resort to vertical integration and become competitors, that is, suppliers of raw materials enter the manufacturing industry.
10.3.3.5 Threat of Substitute Products

The beverages industry is a good example where consumers can frequently and easily shift from one product to a close substitute in case one is unavailable or becomes more expensive.
Depending on price of coffee (unstable) people shift from coffee to tea which is more stable in price. Nowadays, people tend to shift from soft drinks due to health concerns. The existence of close substitutes presents a threat, limiting the price a company can charge and hence its profitability.
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10.3.3.6 Groups
Relative Power of Unions, Governments and Interest
Depending on membership, size and subsequent bargaining power, Unions can have influence on firms freedom to take corporate decisions. Fostering good employment relations in a tripartite fashion with Government can promote healthy industrial relations, an intangible asset for companies. Special interest groups can similarly influence the industry, for example, Consumer association and Green movements. One proactive strategy to be adopted by firms is to take such interest groups views on board when making corporate decisions.
The issues discussed earlier are expected to provide valuable insights as to the strengths and weaknesses of the organisation (or of the entrepreneur). Strengths arise from the resources and competencies possessed by the firm.
Management performs internal analysis and diagnosis to identify clearly the current strengths and weaknesses of the firm. Management also examines the most probable future strengths and weaknesses. (Jauch & Glueck, 1998).
Together with an understanding of the dynamics of the industry, the Five Forces Model gives an insight on whether the firm should enter the industry and whether it can carve an attractive position within the industry. For example, if several of the threats to industry profitability are high, the firm may reconsider entering the industry or think more carefully about the position it will be able to occupy in the industry.
10.4 COMPETITOR ANALYSIS

Many organisations neither seriously nor regularly consider their competitors. Even public sector bodies which may not be competing for customers, do compete for scarce resources. In a global economy, it is vital to systematically monitor the environment so that one is
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aware of competitors strengths and weaknesses and other changing opportunities and threats.
It is seldom necessary to resort to industrial espionage or any other illegal methods to do competitor analysis. There are many sources of cheap information for small firms: Attending conferences and trade shows where latest trends are displayed Reading trade journals and web sites Talking to customers and suppliers to capture valuable competitor information, for example, advantages and disadvantages of competitor products Purchasing competitors products to assess their customer value or weaknesses Watching competitors web sites for information on any new products, and so on.
This is done by getting people at all levels to capture and interprete competitor data especially at customer interface levels. Such type of sensitive activities can be built into job descriptions and appraisal systems whereby frontline staff and supervisors are trained to ask sensitive questions to customers, suppliers and, indirectly, competitors. Managers can be trained to scan the media regularly, as part of their job. All the information and analysis can then go on the intranet to make it available as a cost effective competitive intelligence source.
10.4.1 Competitor Identification

Who your competitor is might appear to be a simple question to answer. This is more difficult than one might think. For example, a company which sells flowers is not only in the flower business because, since flowers are offered as gifts, the company is also in the gift business. Identifying competitors using this perspective gives a very different outlook on competitor analysis.
Competitors can be direct, indirect or future competitors. Direct competitors offer products similar or identical to the firms, therefore targeting the same customers Indirect competitors offer close substitutes which target the same basic need that is
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met by the new firms product. According to the former CEO of Coca-Cola, the average consumer buys only 2% of his/her daily fluid intake as Coke, the competitors being water, coffee, tea and so on. Future competitors are neither direct, nor indirect competitors. They are yet to move in as new competitors.
Conversely, competitor analysis can uncover avenues for collaboration, especially when it is a question of survival. Cooperation among competitors is sometimes essential for survival of the community of related businesses. Domestic firms, for example, can join forces with competing firms for mutual benefit.
Activity 3
Explain the Grandes Surfaces Reunies model in the retail business in Mauritius.
10.5 ANALYSIS OF THE EXTERNAL ENVIRONMENT

The external analysis of the business environment includes an analysis of the Macro environment, the PEST framework. Changes in the PEST framework can result in Opportunities and/or Threats.
External forces can be broadly categorised as: Political, governmental and legal forces. Economic forces. Social, cultural and environmental forces. Technological forces.
In order to survive, organisations have to recognise and take advantage of external opportunities. The process must involve managers and employees leading to commitment
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from the whole organisation.
To perform external scanning, companies first gather competitive intelligence as mentioned earlier and information pertaining to socio-cultural, economic, politico-legal and technological trends. The sources of such information include newspapers, magazines and trade journals and on line sources.
10.5.1
The PEST Framework 10.5.1.1 Political, Governmental and Legal Forces
These can present both opportunities and threats. If firms depend heavily on government contracts, political forecasts are going to be a major variable in external scanning. Issues such as genetic engineering, animal testing, euthanasia and so on are quite controversial and divide opinion. Such political issues have a profound influence on, for example, pharmaceutical industry.
Political and legal influences are linked because in democratic countries, politicians in power make laws in Parliament. One significant worldwide trend is Deregulation (Airlines, telecommunications, Electricity/Water Distribution etc.). This has opened numerous opportunities although the Entry Barriers are sometimes quite high.
Concerns about the Natural Environment have also prompted Parliaments to pass laws to protect the environment, for example, on the Ozone layer, Seas and other Water Bodies and recently Climate change.
Managers need to anticipate regulations and take prompt action so as to convert threats into opportunities.
Multinational firms heavily rely on political forecasts, especially if they depend on certain countries for natural resources or simply for a market. Strategists therefore compete on correctly forecasting and/or influencing public policy. Conversely, many companies have changed or abandoned strategies because of governmental actions.
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Examples of governmental actions are: Government regulation (or deregulation). Tax laws. Equal opportunity laws. Import-Export regulations. Political conditions in foreign countries.
10.5.1.2
Economic Forces
Economic factors (as shown in economic indicators) have a direct impact on the potential attractiveness of business strategies. One example is interest rates. If interest rates rise, funds needed for capital expenditure become more expensive, discretionary income declines and as a result, demand for discretionary goods falls.
Similarly, trends in the value of foreign currency have significant effects on exports and imports (and tourism).
In the USA, job loss during recession is considered as a blessing in disguise. Laid off workers are encouraged to become entrepreneurs, whereby they take charge of themselves and may even create jobs.
Examples of economic variables are given below: Availability of credit Inflation rates Consumption patterns Tax Rates Shift to service/knowledge economy Worker productivity levels
Activity 4
Explain how each one of the above can present opportunities and/or threats.
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10.5.1.3 Socio-cultural, Demographic and Environmental Forces

It is estimated that persons aged 65 and older in the U.S will rise from 12.7 per cent of the population to 18.5 per cent between 1997 and 2025 David, 1999. Expected trends are that consumers will become more and more educated and we will be faced with an ageing population phenomenon. Furthermore, more attention will be given to the natural environment and more women will enter the workplace and take top positions in organisations.
The ageing American population has triggered opportunities in the residential building sector, for example, in the form of apartment complexes with served meals. The elder population will be the market for business initiatives like health care, financial services, travel, crime prevention and leisure.
Examples of such variables are: Life expectancy rates Buying habits Ethical concerns Pollution control Ozone depletion Endangered species Per capita income Attitudes towards product quality Social responsibility
10.5.1.4 Technological Forces

Business operations are currently being revolutionised by innovations such as robotics, Internet connectivity, fibre optics, satellite networks and so on. Enabling amongst others, electronic funds transfer, space communications, telemedicine and so on.
Technological forces can dramatically affect the way products/services are designed, manufactured, distributed and sold. They can create new markets and change competitive cost positions in an industry.
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Technology can therefore uncover opportunities and sometimes threats.
Activity 5
Give an appropriate example of how new technology can present a threat to an established industry.
Companies must continuously operate a technology watch to keep pace with changes. Firms which fail to manage technology can find themselves being managed by technology in future.
Technological change can be disruptive in the sense that an innovation can make a product become obsolete overnight. Technology can greatly affect barriers of entry and exit and can therefore reshape a whole industry. Technology can therefore be both an opportunity and a threat.
Activity 6
Give an example of technological obsolescence which has reduced barriers of entry.
Activity 7
Research on the Harvard Business Review article of Theodore Levitt, Marketing Myopia and comment on the lessons learnt.
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10.7 SUMMARY
Analysing the internal environment uncovers the strengths and weaknesses of the organisation while external analysis shows the opportunities and threats. Competitor analysis, using a number of low cost competitor intelligence methods were seen to be more appropriate for SMEs. Competitor analysis may also uncover avenues of cooperation between firms.
10.8 REFERENCES
1. Jauch & Glueck. (1998). Strategic Management. 2. Cooper, A. (1981). Strategic Management: New Ventures and Small Business, Long Range Planning, 14(5). 3. Cromie, S. (1991). The Problems experienced by young firms, International Small Business Journal 19(3). 4. Stokes, D. & Wilson, N. (2006). Small Business Management Entrepreneurship. 5. Wheelen, T. & Hunger, D. (2008). Strategic Management and Business Policy.
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Entrepreneurship/Leadership/Innovation- MGT 2251Y