Business Policy and Strategic Management

MICHAEL PORTER’S FIVE FORCES MODEL

TECHNICAL
ENVIRONMENT
POLITICAL LEGAL
ENVIRONMENT

POTENTIAL
COMPETITORS

SUPPLIER’S RIVALRY AMONG BUYER’S

POWER FIRMS POWER
SOCIAL
ENVIRONMENT

THREAT OF SUBSTITUTES

MACRO
DEMOGRAPHIC ENVIRONMENT
ENVIRONMENT

FIVE FORCES MODEL OF EXTERNAL

1
 Business Policy and Strategic Management

FIVE FORCES MODEL OF EXTERNAL

Environment (Threats)

The strongest competitive force or forces determines the profitability of an industry and
so are of greatest importance in strategy formulation.

A) THREAT OF ENTRY

New entrants to an industry bring new capacity, the desire to gain market share and
often-substantial resources. Companies diversifying through acquisition into the industry
from other markets often leverage their resources.
The seriousness of the threat of entry depends on the barriers present and on the
reaction from existing competitors that the entrant can expect.

Major Sources of Barriers to Entry

1. Economies of scale: -

These economies deter entry by forcing the aspirant either to come is on a large
scale or to accept a cost disadvantage. Economies of scale an also act as hurdles in
distribution, utilization of the sales forces, financing and nearly any other part of a
business.

2. Product Differentiation: -

Brand identification creates a barrier by forcing entrants to spend heavily to

overcome customer loyalty. It is perhaps the most important entry barrier in soft
drinks, over the counter drugs cosmetics.

3. Capital Requirements: -

Capital is necessary not only for fixed facilities but also for customer credit,
inventories and absorbing star up losses. The need to invest large financial
resources in order to compete creates a barrier to entry. Particularly if the capital is
required for activities. Like R&D

4. Cost Disadvantages Independent of Size: -

Entrenched companies may have cost advantages not available to potential rivals,
no matter what their size and attainable economies of scale. These advantages can
stem from the effects of the learning curve, proprietory technology, and access to
the best raw materials resources, govt subsidies or favorable locations.

2
 Business Policy and Strategic Management

5. Access to Distribution Channels: -

A new food product, for example, must displace others from the supermarket shelf
via price breaks, promotions, intense selling efforts etc. The more limited the
wholesale or retail channels are and the more that existing competitors have these
tied up, obviously the tougher that entry into the industry will be.

6. Govt Policy: -

The govt can limit or even foreclose entry to industries with such controls as license
requirements and limits on access to raw materials.

B) Powerful Suppliers And Buyers: -

A supplier group is powerful if

1. If is dominated by a few companies and is more concentrated than the industry it

sells to.
2. Its product is unique or at least differentiated or if it has built up switching cost.
Switching costs are fixed costs buyers face in changing suppliers.
3. It poses a credible threat of integrating forward into the industry’s business.
4. The industry is not an important customer of the supplier group.

A buyer group is powerful if

1. If purchases in large volumes.

2. The products it purchases from the industry are standard or undifferentiated.
3. It earns low profits, which create great incentive to lower its purchasing costs.
4. The industry’s product is unimportant to the quality of the buyers products or
services e.g. can an aero plane industry afford to buy a low quality product.
5. The buyer poses a credible threat of integrating backward.

In the ready to wear clothing industry, as the buyers (Departmental stores) have
become more concentrated and control has passed to large chains the industry has
come under increasing pressure and suffered falling margins. The industry has been
unable to differentiate its product or increase switching cost that lock in its buyers
enough to neutralize these trends.

C) Threat of substitute Product: -

The existence of close substitutes presents a strong competitive threat, limiting the
price a company can charge and thus its profitability. However, if a company’s products
have few close substitutes then, other things being equal, the company has the
opportunity to raise prices and earn additional
profits. Consequently, its strategies should be designed to take advantage of this fact.

3
 Business Policy and Strategic Management

For example, companies in the coffee industry compete indirectly with those in the tea
and soft drink industry. The price that companies in the coffee industry can charge are
limited by the existence of substitutes such as tea and soft drinks

1. Rivalry among established companies: - If this competitive force is weak

companies have an opportunity to raise prices and earn greater profits. Price
competition limits profitability by reducing the margins that can be earned on
sale. The extent of rivalry among established companies within an industry is
largely a function of three factors.

1. Industry competitive structure

2. Demand conditions
3. The height of exit barriers in the industry

1.Industry Competitive Structure: -

This refers to the number and size distribution of companies in an industry. Structures
vary from fragmented to consolidated. A fragmented industry contains a large number of
small companies, none of which is in a position to dominate the industry. (Perfect
competition) .A consolidated industry is dominated by a small number of large
companies(oligopoly).Fragmented industry includes agriculture, health clubs, real estate
brokers etc. Consolidated industry includes aerospace, automobiles, pharmaceutical
etc.

Low entry barriers and commodity type products that are hard to differentiate
characterize fragmented industry. The combination of these traits tends to result in
boom and bust because of the ease of new entry and will be followed by price wars and
bankruptcies. Since differentiation is often difficult in these industries, the best strategy
for a company to pursue in such circumstances may be one of cost minimization. This
strategy allows a company to rack up high returns in a boom and survive any
subsequent bust.

Consolidated industries are interdependent. Competitive actions of one company

directly affects the profitability of others in the industry. Price wars constitute a major
threat. Companies reduce this threat by following the price lead set by a dominant
company in the industry. When price wars are a threat, companies compete on non-
price factors such as product quality and design features. This type of competition
constitutes an attempt to build brand loyalty.

4
 Business Policy and Strategic Management

2. Demand Conditions. –
Growing demand tends to moderate competition by providing greater room for
expansion. Demand grows when the market as a whole is growing through the addition
of new consumers or when existing consumers are purchasing more of an industry’s
products. When demand is growing companies can increase revenues without taking
market share away from other companies.
Thus growing demand gives a company a major opportunity to expand
operations.
When demand is declining, a company can attain a growth only by taking market share
away from other companies.

3. Exit Barriers:-

Exit barriers are a serious competitive threat when industry demand is declining. Exit
barriers are economic, strategic and emotional factors that keep companies competing
in an industry even when returns are low. Common exit barriers include the following.

1. Investments in plan- equipment that have no alternative uses.

2. High fixed costs of exits such as compensation to employees.
3. Emotional attachments to an industry.
4. Strategic relationship between business units.

Threat in an international context

Non-domestic competition is an important consideration in five forces analysis of the

attractiveness of the industries.

Swiss mechanical watch industry underestimated the threat from U.S and Japanese
electronics firms who developed electronic time keeping devices. It took several years
for the Swiss watch industry to recover from this unanticipated threat.

U.S automobile industry also underestimated the threat posed by Japanese Car
manufactures.

5
 Business Policy and Strategic Management

What Is Competitiveness

The ability to learn faster than your competitor may be the only sustainable competitive
advantage. Competitiveness is about relooking at your business every day. It is not
about leading today. It is about tomorrow. The unique combination of quality, service
and price (QSP) has to be continuously fine tuned to turn satisfied customers into
delighted customers.

How Competitive Is Your Business

1. Which customers are you serving today, how will your future customers be
different?
2. Who are your competitors today, who will they be tomorrow?
3. What is the basis of your competitiveness advantage today? What will that be in
future?
4. Where do your margins come from today? Where will they come from tomorrow?
5. What skills or capability make you unique today? What will make you unique
tomorrow?

Competitiveness is a basket with excellence in all fields – planning, manufacturing,

marketing and service. It means being truly world class at all points of time. This
includes efficiency, performance, productivity and growth.

ENVIRONMENTAL ANALYSIS

The environment of any organisation is ’the aggregate of all conditions , events and
influences the surround and affect it’.

Characteristics of environment:

1. Complex: The environment consists of a number of factors, events, conditions

and influences arising from different sources. These forces interact with each
other and which makes it complex. The more complex the environment, the more
variables have to be taken into consideration and hence more difficult to make
effective decisions.
2. Dynamic: The environment is never static, it is constantly changing. Due to
change in environmental factors the organisation has to change its direction quite
often.

6
 Business Policy and Strategic Management

3. Uncertain: Environmental uncertainty means the degree of complexity plus the

degree of change existing in an organisation’s external environment.
On the one hand environmental uncertainty is a threat to strategic managers
while on the other hand environmental uncertainty provides opportunity.
4. Environment has a far reaching effect: The growth and profitability of an
organisation depends critically on the environment in which it exists. Any change
in environment has an impact on the organisation.

ENVIRONMENTAL ANALYSIS:

Environmental analysis is the process by which strategists monitor the environmental

sectors to determine opportunities for and threats to their firm.

Environmental diagnosis consists of managerial decisions made by assessing the

significance of the data (opportunities and threats) of the environment analysis.

These decisions lead other decisions like whether to react, ignore, try to influence or
anticipate the opportunities or threats discovered. Thus, manager’s perception of the
environment may differ from its objective condition.

In effect, diagnosis is an opinion resulting from an analysis of the facts to determine the
nature of a problem with a view to act to take advantage of an opportunity to effectively
manage a threat.

NEED FOR ENVIRONMENTAL ANALYSIS:

1. To detect key trends and events in the environment

2. To develop forecasts the scenarios.
3. To identify opportunities and threats
4. To get information in the competitive environment
5. To set appropriate objectives
6. To avoid strategic surprise and to ensure long- term health.
7. To analyse and evaluate strategic alternatives.
8. To formulate winning strategies responsive to competitive forces.
9. To develop sustainable advantages.

GENERAL VS. RELEVANT ENVIRONMENT:

The wider perception of the environment is generally designated as general

environment. It consists of international, national and local economy, social change,
demographic variables, political systems, technology, and attitude towards business,
energy sources, raw materials and many other factors.

7
 Business Policy and Strategic Management

All organisation in some way or the other, are concerned about the general
environment. But the immediate concerns of any organisation are confined to just a part
of the general environment which is of high strategic relevance to the organisation. This
part of the environment could be termed as relevant environment.

The organisation identifies the relevant environment and systematically appraises and
incorporates its result into strategic planning.

ENVIRONMENTAL SECTORS:

The classification of general environment into sectors helps an organisaiton to cope with
its complexity; comprehend the different influences operating and relating the
environmental changes to its strategic management process.

The following are the important environmental sectors:

1. Economic Environment: the state of the economy at present and in future can
affect the fortunes aand strategy of the firm. The specific economic factors that
many firms analyse and diagnose include:
i. The stages of business cycle: The economy can be classified as being in
a depression, recession, and recovery or boom stage.
ii. The inflationary or deflationary trend in the process of goods and services.
iii. Monetary policy, interest rates and devaluation or revaluation of the
currency in relation to other currency.
iv. Fiscal policies: Tax rates for firms and individuals.
v. Balance of payments: surplus or deficit in relation to foreign trade
vi. Unemployment rates and trends in the gross national product, sectoral
growth – rates of agriculture, industry , services etc.

Each of these facets of the economy can help or hinder the achievement of a firm’s
objectives and lead to success or failure for the strategy.

2. International Environment: The international or global environment consists of

all those factors that operate at the transnational, cross-cultural and across the
border level, having an impact on the business of an organisation.
Some of the important factors and influences operating in the international
environment are as follows:
 Globalisation
 Global economic forces
 Global trade and commerce
 Global financial systems

8
 Business Policy and Strategic Management

 Global demographic pattern

 Global information system
 Global technological system
 Global legal system etc.

The international environment is a special case of the general and industry

environments deserving special attention by strategists. That is all the other
factors like socio-economic, government, customer, competitor etc. all apply
here.

3. Market environment: The market environment consists of factors related to the

groups and other organisations that competes with and have impact on
organisation’s business.

Some of the important factors and influences operating in market environment

are as follows:

 Consumer behavior related factors.

 Product related factors
 Marketing channel related factors
 Competition related factors etc.

Effect of marketing environment is largely depend on type of industry structure. In

monopolies and oligopolies the effect of market environment is lesser than what
it is under pure competition.

4. Political Environment: The political environment consists of factors related to

management of public affairs and their impact on the business of an
organisation. The factors that influence the political environment may be political
system, political parties, centre of power, elections, funding of elections,
legislations with respect to economic and industrial promotion and regulation etc.

Most government decisions related to business are based on political

considerations in line with the political philosophy followed by ruling party at the
centre and the state level.

5. Regulatory and legal environment: The regulatory environment consists of

factors related to planning, promotion and regulation of economic activities by the
government. Regulatory environment factor can be policies related to foreign
investment, licensing import and export etc.
The legal environment consists of the legal system, legislations, ordinances etc.
Factors affecting legal environment may be business related laws, industrial
laws, taxation laws etc.

9
 Business Policy and Strategic Management

6. Socio-cultural environment: The socio-cultural environment consists of factors

related to human relationships within the society, the development, forms and
functions of such a relationship and shared behavior of groups of human being
having impact on business organisation.

Socio-economic factors focuses on the values and attitudes, customs, beliefs,

rituals and practice of people (customers & employees) which can affect strategy.
These values translate into lifestyle changes which affect the demand for
products and services like dresses, books, leisure activities etc.

7. Supplier environment: The supplier environment consists of factors related to

the cost, reliability and availability of the factors of production or service that have
an impact on the business of an organisation.

Factors influencing supplier environment are supply of raw a material , parts and
components , availability of finance and energy, availability of human resources,
bargaining power of suppliers and existence of substitutes.

8. Technical Environment: The technological environment consist of those factors

related to knowledge applied and the material and machines used in the
production of goods and services that have and impact on the business of an
organisation.
Technological factors may be source of technology, stage of technological
development, environmental effect of technology etc.
Strategists cannot ignore this because it is one of the dimension of business
definition.

APPROACHES TO ENVIRONMENTAL SCANNING:

There are three approaches for sorting out information for environmental scanning:

1. Systematic approach: Under this approach information for environmental

scanning is collected systematically. Information related to markets and
customers, changes in legislation and regulations that have a direct impact on an
organisation’s activities, government policy statement pertaining to the
organisation’s business and industry etc. could be collected continuously to
monitor changes and take the relevant factor into account.
2. Ad hoc approach: Using this approach an organisation may conduct special
surveys and studies to deal with specific environmental issues from time to time.
Such studies may be conducted, for instance, when an organisation has to
undertake special projects, evaluate existing strategies or devise new strategies.

10
 Business Policy and Strategic Management

3. Processed - form approach: In this approach the organisation uses information

in a processed form, available from different sources both inside and outside the
organisation. When an organisation uses information supplied by government
agencies or private institutions, it uses secondary sources of data and the
information is available in processed form.

Techniques for Environmental Analysis or Scanning:

Some of the techniques which area generally used for carrying out environmental
analysis are:

1. PESTEL ANALYSIS
2. PEST ANALYSIS
3. STEEP ANALYSIS
4. SWOT ANALYSIS
5. TOWS ANALYSIS
6. QUEST
7. EFE MATRIX
8. CPM

Method 1, 2 and 3 are related with the factors or the environment that is political
environment, economic environment, socio-cultural environment, technological
environment, ecological environment and legal environment. Basically the information
related to the environment in real time situation is analysed with the help of these three
methods.

SWOT AND TOWS method of environment analysis takes into account not only
external environmental factors but also the internal environmental factors of the
organization.

QUEST: Quick Environment Scanning Technique – QUEST is a four step process,

which uses scenario building for environmental analysis.

The four major steps are:

I. Managers make observations about major events and trends in the

environment.
II. They speculate on a wide range of issues that are likely to affect the future of
the business enterprise.

11
 Business Policy and Strategic Management

III. A report is prepared summarizing the issues and their implications to the firm
together with II and III scenarios.
IV. The report and scenarios are reviewed by strategists based on which they
identify feasible options.

Thus QUEST helps in generating feasible alternative strategies for consideration of

the management.

EFE Matrix: The External Factor Evaluation Matrix helps to summarise and evaluate
the various components of external environment. The EFE matrix can be developed in
five steps:

I. List 10 to 20 important factors.

II. Assign a weight to each factor from 0.0(not important) to 1.0 (most
important) . The higher the weight, the more important is the factor to the
current and future success of the company.
III. Assign a rating to each factor 1 (poor), 2(average), 3(above average),
4(superior). The rating indicates how effectively the firm’s current strategies
respond to that particular factor.
IV. Multiply each factor’s weight by its rating to determine a weighted score.
V. Finally add the individual weighted scores for all the external factors to
determine the total weighted score for the organisation.

CPM: Competitive Profile Matrix: - This is a competitor analysis, which focuses on each
company against whom a firm competes directly. It helps to identify the strengths and
weaknesses of the major competitors of the firm, vis-à-vis, the firm. Generally in this
critical success factors (CSFs) are compared.

ETOP: Environmental Threat Opportunity Profile: ETOP gives a summarised picture of

environmental factors and their likely impact on the organisation. The preparation of
ETOP involved in dividing the environment into different sectors and then analyzing the
impact of each sector on the organisation. A comprehensive ETOP requires subdividing
each environmental sector into sub-factors and then the impact of each sub-factor on
the organisation is described in the form of a statement. A summary ETOP may only
show the major factors for the sake of simplicity.

12
 Business Policy and Strategic Management

Example of ETOP:

Environmental Factors Impact of each factor

Economic Factors (+)Rising income levels
(-) Price competition
Social factors (-) Change in life style
(-) Change in consumer tastes
Technological factors (+)Product becomes unique
(-)Acquisition of new technology is
expensive.
Customer (+) Loyalty is high
(+)Buyer preference for differentiated
products.
Supplier (-)High input costs
(+)Improved quality

From the example of ETOP we can see that a company can capitalize on rising income
levels , buyer’s loyalty to the firm’s products and buyer preference for differential
products even though the price is high. But this would depend on the firm’s acquisition
of latest technology, which is expensive.

Thus, preparation of ETOP provides the strategists with a clear picture of which
environmental factors have a favorable impact on the firm and which have an
unfavorable or adverse effect. With the help of an ETOP, a firm can judge where it
stand s in respect of its environment and such an understanding is helpful in formulating
appropriate strategies.

13