CHAPTER 2

THE EXTERNAL AND INTERNAL

ENVIRONMENTS
LEARNING OUTCOMES

• Describe how environmental forces influence organizations and how organizations can
influence their environment.
• Distinguish between the macroenvironment and the competitive environment along with
identifying their elements.
• Summarize how organizations respond to environmental uncertainty.
• Define elements of organization’s culture.
• Discuss how an organization’s culture and climate affects its response to its external
environment.
 SYSTEMS THEORY
• Organizations are open systems: that are affected by and that affect their environment.
• External Environment: All forces outside environment’s boundaries such as competitors,
customers, the government and economy.
 GENERAL / TASK/ MACRO ENVIRONMENT

Economic: Interest rates, Unemployment, Inflation, Growth, stock market

Social/Demographics: Proportion of women workforce, education & skill levels of workforce,

immigration

Technology: Tools for advanced production, MIS, telecommunication

Environmental: Environmental restrictions, climate change, sustainability, deforestation,

Political/Legal Tax Laws, Legal Protection, Regulators, pricing policies, minimum wage
legislation
IF YOU WANT TO START A CAR MANUFACTURING COMPANY IN PAKISTAN, HOW
WILL YOU GO ABOUT IT?

• Political/Legal factors
• Licensing of car
• Tax on manufacturer
• Political unrest
• Copyright and trademark
• Legal contract
• Labor laws
• Economic factors
• Interest rates: KIBOR
• GDP & Inflation
• Social/Demographic factors
• Perception
• Taste of people
• Technology factors
• Automated cars
• Environmental factors
• Air pollution
• Battery driven car
PESTEL ANALYSIS EXAMPLE UBER
• Political factors:
– Have to deal with bans in many countries
– Have to follow minimum wage rules
• Economic factors:
– Easily accessible
– Affordable fare charges
• Social Factor
– Gives better experience than taxis
– User friendly
• Technological Factor
– Excellent mobile application for users
– Using social media for promotion
• Legal Factors
– Need to prevent ban in many countries
– Need to follow labor and employee safety laws
• Environmental Factor
– Fuel consumption may increase
– Traffic congestion is a concern
THE COMPETITIVE ENVIRONMENT

• Porters Model
THREATS OF NEW ENTRY

• In which industry it would be easier to start a business?

• Fast food OR Book Shop?
THREAT OF NEW ENTRY

• If a new businesses can be easily started up in your sector without substantial investment ‐ then
this is a threat.
• The Internet has made this a reality in many sectors. So ask yourself the questions:
• What’s the threat of new businesses starting in this sector?
• How easy is it to start up in this business?
• What are the rules and regulations?
• What finance would be needed to start‐up?
• Are there barriers to entry which give you greater power? (Trade agreements, patents)
BUYER POWER

• Who are the people who will buy what you are offering:

– Business to business customers (intermediate customers)

– End users
• Where there are fewer buyers, they often control the market. Questions here include:
• How powerful are the buyers?
• How many are there?
• Can the buyers get costs down?
• Do they have the power to dictate terms?
SUPPLIER POWER

• Markets where there are few suppliers means the suppliers retain the power
• Examine how many suppliers are in the market?
• Are there a few who control prices? Or many so prices are lower?
• Do your suppliers hold the power?
• How easy is it to switch, what’s the cost?
SUPPLIER POWER

• Switching cost: High switching cost can result in increase dependence on a supplier and
potential vulnerability.
• Resource Dependency—What can go wrong if your business is too dependent on one
supplier?
• Supply chain management:

– Companies can work with suppliers to create more efficient and

low cost products
– They can also dictate terms once suppliers are specialized.
SUPPLIER POWER

• What would happen if you are a chicken farmer suppling to a processed meat company and are
in a trade deal with them?
• How big corporations (Boeing, Apple) create monopoly over service of their products?
COMPETITION AND SUBSTITUTION

• A substitute is a potential threat; customers use it as an alternative, buying less of one kind of
product but more of another.
• A complement is a potential opportunity because customers buy more of a given product if
they also demand more of the complementary product.
 SUBSTITUTES AND COMPLEMENTS
If the product is…. Its substitute might Its complement might
be…. be…
Coca-Cola Water, Pepsi, chai Fast food, biryani
coffee
Samsung Phone iPhone, Huawei, Oppo Phone cases, pens,
blue tooth head sets,
digital watches and
exercise monitors
AIRLINE INDUSTRY IN US
THREAT OF COMPETITORS

• High:
• High:
• High: switching cost low
• Price competition is really high
THREAT OF NEW ENTRANTS

• Low: difficult to enter

• Low: High investment cost
• Low: strict govt regulations
• Low: Research and development cost is high
• Low: High risk involved
THREAT OF SUBSTITUTES

• High to Low
• Low: road travel or railway
• Low:
BARGAINING POWER OF BUYERS

• High: too competitors

• High:
• Medium to Low
BARGAINING POWER OF SUPPLIERS

• High
EXAMPLE: AIRLINE INDUSTRY

Porter’s Five Forces Intensity

Threat of New Entrants Low
Threat of Substitutes High to Low
Threat of Competitors Medium to High
Power of Buyers Low to High
Power of Suppliers High
ENVIRONMENTAL ANALYSIS
ALFATAH DEPARTMENTAL STORE

• Environmental Scanning
• Scenario Development
• Forecasting
• Benchmarking
ENVIRONMENTAL SCANNING
• Searching out information that is unavailable to most people
• Sorting through that information
• Interpreting what is important and what is not
• Done using Porter’s model
• Questions asked by managers may be:
– Who are our current competitors?
– Are there few or many entry barriers to our industry?
– What substitutes exist for our product or service?
• Competitive Intelligence is developed: Information necessary to decide how best to manage in the
competitive environment identified.
• Example: The PepsiCo company is planning to shift its investment from producing beverages to
producing healthier and functional foods
Environmental Factor Unattractive Attractive

Competitors
Threat of Entry
Substitutes
Suppliers
Customers
DEVELOPING COMPETITIVE INTELLIGENCE
AL FATAH

Environmental Unattractive Attractive

Factor

Competitors Many

Threat of Entry High; few barriers

Substitutes Many

Suppliers Many

Customers Many
SCENARIO DEVELOPMENT
• Scenarios create alternative combinations of different factors into a total picture of the
environment and the firm.
– Best case scenario: the occurrence of events favorable to firm
– Worst case scenario: the occurrence of unfavorable events
• Development of contingency plans by managers

Best case: Worst case:

Al-Fatah retains its
competitive advantage and Hyperstar opens in Y block
continues to grow
FORECASTING
• Predicting how some variables will change in future i.e. sales
BENCHMARKING
• Identifying best in class performance by a manger in a given area
• Making comparison to that benchmark
• Example
– Hyperstar – after sales service
– Walmart – low cost supplies, effective inventory
management systems
RESPONDING TO THE
ENVIRONMENT

CHANGING

INFLUENCING

ADAPTING Domain
Selection
Independent
Action
Diversification
Empowerment
Cooperative Merger/
Buffering Action Acquisition

Smoothing Divestiture

Flexible STRATEGIC
processes MANEUVERIN
G
CHANGING THE ENVIRONMENT

• Domain selection: Entrance by company into another suitable market e.g. PepsiCo decision to
sell yogurts; Engro into Power sector though its main business is fertilizer.
• Diversification: Investing in different type of businesses e.g. Apple, Banks
• Merger/Acquisition: Combination of two or more firms e.g. Uber and Careem
• Divestiture: A firm selling one or more businesses e.g. Unilever divesting beauty products and
brands
ADAPTING TO THE ENVIRONMENT:
CHANGING YOURSELF
• Adapting at the Boundaries
• Buffering: Creating supplies of excess resources in case of unpredictable needs, for instance,
contingent workers.
• Smoothing: Leveling normal fluctuations at the boundaries of the environment, for instance,
sales done at the end of season.
• Flexible processes: Methods for adapting the technical core to changes in the environment.
INFLUENCING ENVIRONMENT
FEEDBACK