Explain the importance of the external context for strategy and firm performance
- The External Context of Strategy. Explained: The external environment must be thoroughly understood to formulate an effective strategy that can help one in achieving company objectives. The external environment provides business opportunities to the firm as well as threats that may impede the successful implementation of a strategy. Knowing what industry and firm-specific factors affect a firm is critical to understanding a firm’s competitive position and to determining what strategies are viable. The proper use of tools to analyze the external environment will help to identify some of the major reasons industries differ so much in their long-term profitability. Characteristics of the external environment are the factors that are relevant to the firm’s performance at a given point in time so to avoid blind spots in industry analysis, managers should always integrate their analysis of a firm’s industry with a broader stakeholder analysis. Managers must remain focused on the industry and not on a particular firm operating in it.
- The external environment has two major components: The Macro Environment (Political, Economic, Sociocultural, Technological, Environmental, and Legal factors, known as PESTEL). The industry environment is comprised of strategic groups of firms that seem to be more similar in certain ways than other members of the larger industry.
Use PESTEL to identify the macro characteristics of the external contextt
What is PESTEL?
- PESTEL is a tool for analyzing the larger political, economic, sociocultural, technological, environmental, and legal issues that confront the firm. A firm needs to understand the macro environment to ensure that its strategy is aligned with the powerful forces of change that are affecting its business landscape. PESTEL helps managers to Gain a better understanding of the opportunities and threats they face Build a better vision of the future business landscape and how the firm might operate profitably Avoid strategies that may be doomed to failure for reasons beyond their control Have a good starting point when entering a new country or region
- PESTEL has three steps, namely:
-
- consider the relevance of each pestel factor to your particular context.
- identify and categorize the information that applies to these factors.
- Analyze the data and draw conclusions
- PESTEL Analysed
Political Factors
Political factors influence businesses and consumer confidence, as well as consumer and business spending The stability of the political environment, is important for companies entering new markets. Political Factors include:
- Government policies
- Regulations
- Taxations
- Regional trading blocks
- Fair-trade decisions
- Tax programs
- Minimum wage legislation
- Pollution and pricing policies
For example:
How stable is the political environment?
What are the foreign-trade regulations?
Tax policies, etc.?
Economic Factors
Managers need to consider the macro-economic factors that will have a short and long-term effect on the success of pursued strategies. Economic Factors include:
- Inflation rates
- Interest rates
- Tariffs
- Growth of local and foreign national economies
- Exchange rates
- Unemployment rates
- Local labor costs
- Availability of critical labor
- Outsourcing
For example:
Projected interest rates?
Sociocultural Factors
Sociocultural Factors vary from country to country
Represents beliefs and values, attitudes and opinions, and lifestyles Sociocultural
Factors include:
- Local languages
- Dominant religions
- Leisure time
- Age
- Lifespan demographics
- Attitudes towards:
-
- Consumerism
- Environmentalism
- Role of men and women
For example:
Lifestyle trends?
Demographic changes?
Technological Factors
Technological factors have a major bearing on the threats and opportunities that firms encounter
Technological factors include:
- Lower costs
- Better standard of quality
- Opportunity for more innovation
- Reduce communication costs
- Increase remote working
- Distribution of products and services
For Example:
Level of government research funding?
How mature is technology?
Environmental Factors
Refers to the relationships among human beings and other living things and the air, soil, and water that support them.
Environmental factors include:
- Environmental legislation
- Loss of habitat and biodiversity
- Waste
- Pollution
- Direct and indirect operating costs
- Biodegradable or recyclable packaging
For example:
Eco-efficiency?
Environmental legislation?
Legal Factors
Legal factors reflect the laws and regulations relevant to the region and the organization. Legal factors include:
- Law established
- Change of laws and regulations
- Cost of regulatory compliance
- Influence businesses and consumer confidence and also consumer/business spending Government policies
- Tax programs
- Min. wage legislation
- How stable is the political environment?
For example:
Is the intellectual property protected?
Relevant consumer laws?
Economic
Consider macro-economic factors that have a short and long term effect on the success of strategies
- Inflation rates
- Interest rates
- Growth of local and foreign national economies
- Unemployment rates
- Availability of labor
What is the projected interest rate?
Sociocultural
Represents values and beliefs, attitudes and opinions, and lifestyles in a specific country Dominant Religions
- Demographics
- Age
- Leisure time
- Lifestyle trends?
- Demographic changes?
Technological
Have a major bearing on the threats and opportunities firms encounter
- Lower costs
- Better standard of quality
- Reduce communication costs
- Distribution of products/services
What are the new technological capabilities and their probable impacts?
Environmental
Relationships among human beings and other living things and the air, soil, and water that support them.
- Waste
- Pollution
- Access to raw materials
- Direct and indirect operating costs
What is environmental legislation?
Legal
Laws and regulations relevant to the region and the organization
- Law established
- Change of laws and regulations
- Cost of regulatory compliance
- Is the intellectual property protected?
Identify the major features of an industry and the forces that affect industry profitability
The Industry Environment (Porter’s 5 forces model). Porter’s model explains the five forces that shape competition in an industry (these forces are never static). In short, Porters five forces model is a framework for evaluating industry structure according to the effects of:
- Rivalry;
- Threat entry;
- Supplier power;
- Buyer power; and
- Threats to substitute.
Helps managers to evaluate the general attractiveness of an industry and specific opportunities as well as threats firms face in their local segment
A high-quality strategy will help to:
- Minimize buyer power
- Offset supplier power
- Avoid excessive rivalry
- Raise the barriers to entry; and
- Reduce the threat of substitutions.
Porter’s Five Forces Model
- Force
- Description
- Role Players
- Effect
- Example
- Rivalry
- Is the intensity of competition
- Most aggressive forms of competition include price wars
- Rivalry among competing sellers: Competitive pressures created by jockeying for better market position increased sales and market share, and competitive advantage
- Higher degrees of rivalry results in lower levels of average industry profitability (as price competition increase, the average price declines, resulting in lower levels of profit)
- When competitors are of relatively equal size and power, so the rivalry is affected not only by the number of firms competing but also by how similar they are Threat of Entry
- The degree to which new competitors can enter an industry and the intensity of rivalry Barriers/conditions that make it difficult to enter the industry
New Entrants:
- Competitive pressures coming from the threat of entry of new rivals Industries with consistently high average profitability tend to be the most difficult to enter
- The higher the degree of entry in an industry, the lower the potential competition by limiting supply and reducing rivalry Industry Characteristics that affect barriers to entry:
- Strong Brands
- Proprietary technologies
- Product differentiation
- Restricted access to investment capital
- Distribution channels constitute
- Supplier Power
- The degree to which firms in the supply industry can dictate favorable contract terms and thereby extract some of the profit that would otherwise be available to competitors in the local industry
Suppliers are powerful when they control factors such as:
- Price
- Delivery lead times
- Minimum orders
- Post-purchase service
- Payment terms
Suppliers of Raw Materials, Parts, Components, or Resource inputs: Competitive pressures stemming from supplier bargaining and supplier seller collaboration Supplier power is increased when:
- The suppliers are relatively concentrated, controls scare input, or are simply bigger than their customer’s Firms in the local industry face significant switching costs when changing suppliers
- When firms in the supply industry present a threat of forwarding integration manufacturing finished products instead of just selling the components to manufacturers.
- The degree to which firms in the buyer’s industry can dictate favorable terms on purchase agreements that extract some of the profit that would otherwise be available to competitors in the local industry Buyers
- Competitive pressures stemming from buyer bargaining power and buyer-seller collaboration Many suppliers + few buyers = buyers capture a greater share of profits
- In industries characterized by many suppliers and few buyers, buyers often capture a greater share of profits
Factors that increase buyer power:
- When buyers are prestigious and when their purchases represent a significant portion of the seller’s sales
- When prices and products are easy to compare
- When buyers have numerous choice
- Access to information
- Threat of Substitutes
- The degree to which products of one industry can satisfy the same demand as those of another
A substitute is any product that satisfies a common need or desire Firms in other industries offering substitute products: Competitive pressures come from the attempts of companies outside the industry to win buyers over their products. The prevalence of viable substitute products from other industries places pressure on the prices that can be changed in the local industry When there are no viable substitutes, there is less pressure on price
Complementors
Complementors are firms in an industry that provides products or services which tend to increase sales in another. Complementor: Any factor that makes it more attractive for suppliers to supply industry on favorable terms or that makes it more attractive for buyers to purchase products or services from the industry at prices higher than it would pay to absent the Complementor.
For Example:
Hot Dogs + Buns = More Sales
Music + MP3 Player = More attractive offering
Exit Barriers
Exit barriers are obstacles or impediments that prevent a company from exiting a market. Typical barriers to exit include:
- Highly specialized assets, which may be difficult to sell or relocate Huge exit costs, such as asset write-offs and closure costs
- Loss of customer goodwill.
- In short, exit barriers make it infeasible to sell a firm in a particular industry. E. Porter’s Five Forces of Industry Structure
Understand the dynamic characteristics of the external context
Drivers of Change: Making the Five-Forces Model Dynamic
The Industry Life Cycle (ILC)
The ILC is a model that describes the evolution from inception through to its current state and possible future states New industries emerge when entirely new products are developed that satisfy customer demands in ways that existing products and technologies could not. The ILC is a powerful driver of industry dynamics because it’s a phenomenon characterized by change
Commoditization:
Is the process during industry evolution by which sales eventually come to depend less on unique product features and more on price
Disruptive Technology:
Breakthrough product- or process-related technology that destroys the competencies of incumbent firms in an industry A disruptive change introduced by a new technology also has the effect of altering the industry life cycle. The industry is reinvigorated and rather than proceeding into decline accelerates into new phases of growth Disruptive technologies can be process-related (TQM) as well as product-related.
Innovator’s Dilemma
When incumbents avoid investing in innovative and disruptive technologies because those innovations do not satisfy the needs of their mainstream and most profitable clients Occur in established industries when incumbents continue to develop competency-enhancing innovations, while new entrants develop disruptive innovations
The Industry Life Cycle:
- Dynamics of Industry Structure
- Porter’s Five Forces
- Cause
- Effect
- Industry Rivalry
- Increase in industry growth
- Globalization of industry
- Reduced rivalry and less pressure on prices
- Increased rivalry as new foreign players enter the market, pressure for scale economies leading to consolidation, and market domination by fewer but larger companies Threat of new entrants
A decline in scale necessary to compete effectively - Increases in customer heterogeneity
- Increased customer concentration
Increased rivalry because its easier for start-ups to enter and compete - Easier entry because some customer segments are likely to be underserved
- Reduces threat of entry, causing less pressure to compete on price Bargaining Power of Suppliers
- Increase concentration of firms in supply industries
- Forward integration by key suppliers
- The emergence of substitute inputs that satisfy basic needs
- Greater supplier power and possibly reduced profitability in the focal industry
- Loss of power in the focal industry because of reduction in the number of viable suppliers
- Reduction of supplier power and increased profits for the focal industry
- Bargaining Power of Buyers Improvement in buyer information
- The emergence of new distribution channels
- Increased fragmentation of buyers’ industry
- Increased buyer power because of the ability to compare
- Reduction in buyer power because the focal industry has more options
- Reduction in buyer power as nr of potential buyers increase and size of buyer industry declines relative to the size of focal industry Threat of Substitute Emergence of a new substitute
- The decline in the relative price performance of a substitute
- Reduced ability to maintain high prices due to more buyer alternatives
- Reduces threat of substitutes and pressure to maintain lower prices Role of Complementors
- The emergence of new Complementors
- Higher barriers to entry in Complementor industry
- Lower barriers to entry in Complementor industry Increase demand and less pressure on prices in the focal industry
- Greater Complementor leverage and ability to profit from the complementary relationship
- Reduction in Complementor leverage leading to the net increase of possible firms who can serve as Complementors and increase demand
