CH4 – Strategic analysis:

E3 - Strategic Management
External Environmental Analysis

Chapter 4
Strategic analysis: External
Environmental Analysis

Chapter learning objectives:

Lead Component Indicative syllabus content

A.1 Evaluate the (a) Evaluate the • Different organisation environments (including
influence of key external influence and impact of profit and not-for-profit organisations).
factors the external • The key environmental drivers of organisational
on an organisation’s environment on an change and their prioritisation.
strategy. organisation and its Note: The emphasis should be on the
strategy. evaluation and prioritisation of the
environmental drivers specific to the
organisation and not upon the production of a
generic PEST analysis.
B.1 Evaluate the (b) Recommend • The identification and evaluation of strategic
process of strategy strategic options. options, including the application of the
formulation. suitability, acceptability and feasibility
framework.

B.2 Evaluate tools and (a) Evaluate strategic • Audit of key resources and capabilities needed
techniques used in analysis tools. for strategy implementation.
strategy • Forecasting and the various techniques used:
formulation. trend analysis, system modelling, in-depth
consultation with experts (e.g. the Delphi
method).

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1. Introduction

Purpose of environmental analysis

• To characterise the environment that can influence the business.
• To identify threats and be prepared to handle them appropriately.
• To identify opportunities and be prepared to benefit from them in a timely manner.
• To identify competitive strengths and weaknesses.
• To recognise competition in the market and how to compete more effectively.
• To identify stakeholders and what they require from the organisation.

Drawbacks of environmental analysis

• New technology constantly changes the competitive environment by introducing
new products and their placement in the markets.
• A continuously weakening global economy has led to problems with the
predictability of demand.
• An increasing number of factors affect an organisation as national borders blur.
• The emergence of high-growth economies (BRIC).
• Regular environmental analysis is necessary if it is to have any relevance to the
organisation.

Tools

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2. PEST analysis

• Assesses the general environment.

• Specifically considers market conditions, i.e. growing or declining.
• Can also be used to identify opportunities and threats (SWOT).
• Focuses on four parameters:
- Political factors
- Economic factors
- Social factors
- Technological factors
• Other variations of PEST include:
- SLEPT (social, legal economic, political, technological).
- PESTLE/PESTEL (political, economic, social, technological, legal,
environmental).

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Drawbacks of PEST analysis

• PEST will quickly become irrelevant in industries where conditions change quickly.
• The opinions of different managers limit the objectivity of the analysis.
• It is impossible to identify each and every factor that is important for an
organisation.

3. Porter’s Five Forces analysis

• This model focuses on conditions within a specific industry.
• The five forces decide whether or not a business in that industry is profitable.
• Generally, the greater the forces, the lower the prospective profit potential.
• Success lies in minimising these forces so as to increase one’s profit potential.

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Power of buyers
• This is the bargaining power.
• Bargaining power is high when:
- There are many buyers
- There are many suppliers
- Switching costs are low

Power of suppliers
• This is the bargaining power of suppliers, i.e. the influence of suppliers on the
customer.
• Power is high when:
- There are few suppliers, i.e. a monopoly
- The product is crucial to the customer
- Switching costs are high

Threat of new entrants

• This is dependent upon the barriers to entry in an industry.
• An organisation must know whether it is trying to enter or trying to prevent others
from entering an industry.
• The barriers need to be identified.
• If the organisation seeks to enter, they will wish to be able to overcome these
barriers.
• If it is trying to prevent others from entering, it will try to intensify these barriers or
paint the barriers as too difficult to overcome.
• Some of the barriers may be:
- Economies of scale
- High capital requirements
- Difficult access to distribution networks
- Long-standing relationships of the companies in the industry
- Expectation of retaliation from market leaders
- Cumbersome legal requirements
- Strong product differentiation
- High switching costs for customers

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Threat of substitutes
• Substitutes fulfil essentially similar needs or uses.
• Substitutes may be in direct or indirect competition.
• For instance:
- Juices or soft drinks
- Luxury car or luxury bike
- A vacation or a home theatre

Rivalry among competitors

• Competition among similar products, e.g. Coke and Pepsi
• Competition may be intense where:
- Competing organisations are of similar size.
- Competitors have a similar market share.
- The market is mature – the further along the life cycle, the greater the
competition.
- Differentiation of products is low, leading to greater rivalry on price.
- Storage costs or capacity are high, necessitating the lowering of prices to
increase sales.
- There are high exit barriers, generating a fiercer need to stay and compete.

Drawbacks of Porter’s model

• Customers are perceived as competitors (power of buyers).
• Its usefulness is low in dynamic industries where circumstances keep changing
rapidly.
• It is difficult to apply to companies with specific differentiated competences.
• It is important to consider influential government actions in addition to these five
forces.
• This model is based on the assumption that there are no alliances in business,
which is false.
• Not suitable for not-for-profit organisations as it focuses on profitability.

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5. Industry life cycle analysis

• There are several stages in a product’s life cycle.
• This analysis allows the implementation of different strategies at different stages to
gain maximum benefit.
• This life cycle analysis can be applied to both products and industries.
• The life cycle comprises the following stages:
- Introduction
- Growth
- Maturity
- Decline

Introduction stage
• New product introduced in the market.
• Low awareness of product.
• Low initial demand for new product.
• Production is, therefore, low at this stage.
• Costs are likely to be high at this stage, e.g. research & development and
promotional costs.
• Competition is low.

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• Pricing strategies could be either:

- Penetration price: setting a low price to gain market share.
- Price skimming: setting a high price to gain maximum benefit in the initial
stages.

Growth stage
• Awareness of product increases.
• Demand levels increase.
• Market as a whole grows.
• Production levels consequently increase.
• This might result in economies of scale.
• There might be price competition as competition grows.
• New competitors enter the market.
• Profitability and cash flows increase.
• It is likely that initial costs are recovered.
• It is important to develop brand loyalty at this stage.
• Products may be differentiated as more rivals enter the market.

Maturity stage
• Market growth reduces.
• Market becomes saturated.
• Competition becomes fiercer.
• Market share can only be increased at the expense of another.
• Extension strategies are sought for the product.
• Market niches may be developed or exploited.
• New product variations may be developed.

Decline stage
• Market shrinks.
• Buyers reduce.
• Demand lowers.
• Smaller suppliers exit.
• Prices are lowered (price cutting) to gain any share from leaving competitors.

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How to benefit from life cycle analysis

• Have a mix of products at various stages.
• The cash flows of a mature product enable the funding of a new product.
• Profit from the novelty of a new product.
• Profit from low costs and economies of scale of mature products.
• SWOT is likely to be different at different stages.
• Adapt strategies according to the stage of the product.

Advantages of life cycle analysis

• Better strategic planning – more focused strategies can be implemented according
to the stage, for instance, pricing strategies can differ at different stages.
• Helps budget better – helps understand the stages where costs will be incurred
and where inflows can be expected.
• Proactive strategies – strategies can be implemented at the first sign of the product
moving to the next stage for maximum profitability.

6. Competitor analysis
• Seeks to understand competition.
• Aims to define a company’s own position relative to its competitors regarding:
- Competitive advantage
- Current strategies
- Prospective strategies
- Competitor behaviour

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7. Global markets

Reasons for entering global markets

• Further expansion is not possible domestically.
• Emerging opportunities in foreign markets.
• Lowering of trade restrictions in foreign countries.
• Shareholder pressure to increase returns.

Risks in global expansion

• Cultural differences cannot be ignored.
• Exchange rate volatility considerations.
• Different cost structures and factor quality.
• Level of competition in the foreign country.
• Political stability and government involvement.
• Conditions for entering the foreign country for trade.

Advantages of global expansion

• Benefit from economies of scale.
• Access to cheaper resources.
• Access to new markets.
• Opportunity for managers to experience different cultures.
• Risk-reduction in different economies.
• Governments may offer incentives for foreign investment.

8. Porter’s Diamond (competitive advantage of nations)

• This model identifies the reason why nations excel in competition over others.
• It also identifies why specific industries cluster in specific areas in a country.
• It basically determines the competitive advantage of nations.
• It identifies the factors that cause some industries to succeed and not others.
• It can help assess factor conditions in a foreign country for expansion.
• Governments can use it to attract investment in specific industries.

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• Porter identified four factors in his diamond model:

- Factor conditions
- Demand conditions
- Strategy, structure and rivalry
- Related and supporting industry
• He also identified two other influential factors:
- The role of government
- The role of chance events

Factor conditions
• Factor conditions mean the quality of supply factors.
• The factors that contribute to competitive advantage are not easy to duplicate.
• Generally, basic factors like unskilled labour are easily replicable.
• It is the advanced factors that help gain competitive advantage.
• These factors include specific expertise in human, physical, knowledge and capital
resources.

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Demand conditions
• Cultured domestic customers lead to the development of competitive advantage.
• Leads to the development of extension strategies for declining products to extend
their life.
• For instance, sophisticated Japanese electrical customers help Japanese
companies excel in unsophisticated markets.

Strategy, structure and rivalry

• This focuses on the competition element in the industry.
• The level and type of competition in the domestic industry can have a positive
effect on companies.
• The stiffness of competition teaches companies how to better respond to
competition.
• Government policy also influences the level of competition.

Related and supporting industry

• The presence of industries that support a specific business.
• A developed supporting industry helps develop the business.
• A developed supply industry also develops the customer business.

Other factors
• The role of government influences the development of national industries.
• The role of chance events can also help develop certain industries, e.g. wars lead
to development in the ammunition industry.
• Extensive research is necessary before entering a foreign market.
• Organisations would prefer to expand into the foreign countries that are most
favourable to them.
• Need to know the barriers to entering a foreign market.

Drawbacks of Porter’s Diamond

• Porter’s research for this model only included developed economies.
• Porter assumed incorrectly that domestic businesses cannot compete with foreign
investment.
• Porter’s Diamond does not factor in the success of multinational corporations.
• Every business in a country does not achieve success, which throws into doubt the
importance of the Diamond alone for success.

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9. Chapter summary

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