LECTURE 3

External Environmental Audit

 Topic Outline
I. Introduction
II. The macro-environment
III. Industries and sectors
IV. Competitors and markets
V. Opportunities and threats
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 I. Introduction

Figure 2.1: Layers of the business environment (course book)

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 Layers of business environment (1)
1. The macro-environment (the highest-level
layer): this consists of broad environmental
factors that impact to a greater or lesser extent
on almost organizations.
à PESTEL analysis
2. Industry or sector (the next layer within the
broad general environment): this is made up of
organizations producing the same sorts of
products or services
à Porter’s five forces model
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 Layers of business environment (2)
3. Competitors and markets (the most
intermediate layer surrounding organizations):
• Strategic groups à identify different kinds of
competitors
• Customers’ expectations à create market
segments
• Strategy canvas à analyze competitors’ relative
positions & Blue Ocean opportunities in the
market place
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 II. The macro-environment
1. The PESTLE framework
a) The framework
b) Key drivers for change
c) Using the PESTLE framework
2. Building scenarios

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 a. The PESTEL framework (1)
The PESTEL framework categorises environmental
influences into six main types:
political, economic,
social, technological,
environmental legal

Thus PESTEL provides a comprehensive list of

influences on the possible success or failure of
particular strategies.
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 The PESTEL framework (2)
• Political Factors: For example, Government policies,
taxation changes, foreign trade regulations, political
risk in foreign markets, changes in trade blocks (EU).

• Economic Factors: For example, business cycles,

interest rates, personal disposable income, exchange
rates, unemployment rates, GDP trends.

• Socio-cultural Factors: For example, population

changes, income distribution, lifestyle changes,
consumerism, changes in culture and fashion.

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 The PESTEL framework (3)
• Technological Factors: For example, new discoveries
and technology developments, ICT innovations, rates
of obsolescence, increased spending on R&D.
• Environmental (‘Green’) Factors: For example,
environmental protection regulations, energy
consumption, global warming, waste disposal and re-
cycling.
• Legal Factors: For example, competition laws, health
and safety laws, employment laws, licensing laws, IPR
laws.

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 b. Key drivers of change
Key drivers for change:
• The environmental factors likely to have a high
impact on the success or failure of strategy.
• For example, the birth rate is a key driver for those
planning nursery education provision in the public
sector.
• Typically key drivers vary by industry or sector.

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 c. Using the PESTEL framework
• Apply selectively –identify specific factors which impact
on the industry, market and organisation in question.
• Identify factors which are important currently but also
consider which will become more important in the next
few years.
• Use data to support the points and analyse trends
using up to date information
• Identify opportunities and threats – the main point of
the exercise!

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 d. Example of PESTLE analysis
• Illustration 2.1 (course book, p.36): BP’s
PESTLE
• Group discussion to answer the following
questions:
– Which of the above PESTEL factors offer the most
opportunities to BP, and which are the most important
threats?

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 Class activity 1
Read the case example and answer the
questions at the end
“Alibaba – the Yangtze river crocodile”
(Course book, p.58-60)

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 2. Building scenarios
Scenarios are detailed and plausible views of how the
environment of an organisation might develop in the
future based on key drivers of change about which there
is a high level of uncertainty.

• Build on PESTEL analysis .

• Do not offer a single forecast of how the environment
will change.
• An organisation should develop a few alternative
scenarios (2–4) to analyse future strategic options.
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 Carrying out scenario analysis (1)
• Identify the most relevant scope of the study – the
relevant product/market and time span.
• Identify key drivers of change – PESTEL factors that
have the most impact in the future but have uncertain
outcomes.
• For each key driver select opposing outcomes where
each leads to very different consequences.

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 Carrying out scenario analysis (2)
• Develop scenario ‘stories’ - That is, coherent and
plausible descriptions of the environment that
result from opposing outcomes
• Identify the impact of each scenario on the
organisation and evaluate future strategies in the
light of the anticipated scenarios.
• Scenario analysis is used in industries with long
planning horizons for example, the oil industry or
airlines.
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E.g. Scenarios for the global financial
system, 2020

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E.g. Scenarios for travel industry

What is the best and the worst scenario among those above?

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 II. Industries and sectors
1. The Five Forces framework
a) Key definitions
b) Porter’s five forces framework
c) Implications of five forces analysis
d) Issues in five forces analysis
2. The dynamics of industry structure
a) Types of industries
b) The industry life cycle
c) Comparative industry structure analyses
d) Structure – conduct – performance model
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 1. The Five Forces framework
a. Key definitions
A sector is a broad groupings of companies with
similar economic characteristics. A sector is broken
down into subcategories known as industry. (See link
in the note for examples)
An industry is a group of firms producing products and
services that are essentially the same. For example,
automobile industry and airline industry.
A market is a group of customers for specific products
or services that are essentially the same (e.g. the
market for luxury cars in Germany).
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 b. Porter’s five forces framework (1)
Porter’s five forces framework helps identify the
attractiveness of an industry in terms of five competitive
forces:
• the threat of entry,
• the threat of substitutes,
• the bargaining power of buyers,
• the bargaining power of suppliers and
• the extent of rivalry between competitors.
The five forces constitute an industry’s ‘structure’.
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The five forces framework (2)

Figure 2.4: The five forces framework (course book)

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 The five forces framework (3)
The Threat of Entry & Barriers to Entry
• The threat of entry is low when the barriers to entry are
high and vice versa.
• The main barriers to entry are:
Ø Economies of scale/high fixed costs
Ø Experience and learning
Ø Access to supply and distribution channels
Ø Differentiation and market penetration costs
Ø Government restrictions (e.g. licensing)
• Entrants must also consider the expected retaliation
from organisations already in the market

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 The five forces framework (4)
Threat of Substitutes
Substitutes are products or services that offer a similar
benefit to an industry’s products or services, but by a
different process.
Customers will switch to alternatives (and thus the threat
increases) if:
• The price/performance ratio of the substitute is
superior (e.g. aluminium maybe more expensive than
steel but it is more cost efficient for some car parts)
• The substitute benefits from an innovation that
improves customer satisfaction (e.g. high speed trains
can be quicker than airlines from city centre to city
centre)
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 The five forces framework (5)
The bargaining power of buyers
Buyers are the organisation’s immediate customers,
not necessarily the ultimate consumers.
If buyers are powerful, then they can demand cheap
prices or product / service improvements to reduce
profits .
Buyer power is likely to be high when:
Ø Buyers are concentrated
Ø Buyers have low switching costs
Ø Buyers can supply their own inputs (backward vertical
integration)
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 The five forces framework (6)
The bargaining power of suppliers
Suppliers are those who supply what organisations
need to produce the product or service. Powerful
suppliers can eat into an organisation’s profits.
Supplier power is likely to be high when:
Ø The suppliers are concentrated (few of them).
Ø Suppliers provide a specialist or rare input.
Ø Switching costs are high (it is disruptive or expensive to
change suppliers).
Ø Suppliers can integrate forwards (e.g. low cost airlines have
cut out the use of travel agents).
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 The five forces framework (7)
Rivalry between competitors
Competitive rivals are organisations with similar products and
services aimed at the same customer group and are direct
competitors in the same industry/market (they are distinct from
substitutes).
The degree of rivalry is increased when :
Ø Competitors are of roughly equal size
Ø Competitors are aggressive in seeking leadership
Ø The market is mature or declining
Ø There are high fixed costs
Ø The exit barriers are high
Ø There is a low level of differentiation 27
 c. Implications of five forces analysis
• Identifies the attractiveness of industries – which
industries/markets to enter or leave.
• Identifies strategies to influence the impact of the
forces, for example, building barriers to entry by
becoming more vertically integrated.
• The forces may have a different impact on different
organisations e.g. large firms can deal with barriers
to entry more easily than small firms.

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 d. Issues in five forces analysis
• Apply at the most appropriate level – not necessarily
the whole industry. E.g. the European low cost airline
industry rather than airlines globally.
• Note the convergence of industries – particularly in the
high tech sectors (e.g. digital industries - mobile
phones/cameras/mp3 players).
• Note the importance of complementary products and
services (e.g. Microsoft windows and McAfee computer
security systems are complements). This can almost be
considered as a sixth force.
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 Figure 2.5: The value net (course book)

Value net: a map of organizations in a business environment demonstrating

opportunities for value creating cooperation as well as competition.
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 Class activity 2
Read the case example and answer the
questions at the end
“Global forces and the advertising industry”
(Course book, p.92-95)

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 2. The dynamics of industry structures
a. Types of industries (1)
• Monopolistic industries - an industry with one firm and
therefore no competitive rivalry. A firm has ‘monopoly power’
if it has a dominant position in the market. For example, BT in
the UK fixed line telephone market.
• Oligopolistic industries - an industry dominated by a few firms
with limited rivalry and in which firms have power over buyers
and suppliers.
• Perfectly competitive industries - where barriers to entry are
low, there are many equal rivals each with very similar
products, and information about competitors is freely
available. Few (if any) markets are ‘perfect’ but may have
features of highly competitive markets, for example, mini-cabs
in London.
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 Types of industry (2)

• Hypercompetitive industries - where the frequency,

boldness and aggression of competitor interactions
accelerate to create a condition of constant
disequilibrium and change.
• Hypercompetition often breaks out in otherwise
oligopolistic industries (e.g. mobile phones).
• Organisations interact in a series of competitive moves
in hypercompetition which often becomes extremely
rapid and aggressive as firms vie for market leadership.
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b. The industry life cycle

Figure 2.6 The industry life cycle (course book)

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c. Comparative industry structure analysis

Figure 2.7 Comparative industry structure analysis (course book)

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 c. Structure – Conduct – Performance
model (SCP)
• SCP is used as an analytical framework to
make relations among market structure,
conduct and market performance.
• SCP was developed by Joe S. Bain Jr. in 1959
in his book “Industrial Organization”.
• Most influential 1950-1970s.

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 The SCP paradigm
• The SCP assumes a casual relationship between
structure, conduct and performance

Source: Lipczynski, Wilson & Goddard, 2013)

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 III. Competitors and markets
1. Strategic groups
2. Market segments
3. Competitor analysis and ‘Blue Oceans’

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 1. Strategic Groups
Strategic groups are organisations within an industry or sector
with similar strategic characteristics, following similar strategies or
competing on similar bases.
• These characteristics are different from those in other
strategic groups in the same industry or sector.
• There are many different characteristics that distinguish
between strategic groups.
• Strategic groups can be mapped on to two dimensional
charts – maps. These can be useful tools of analysis.

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 Characteristics for identifying strategic groups

Figure 2.8 Some characteristics for identifying strategic groups (course book)
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E.g. Strategic groups in the Indian pharmaceutical
industry

Figure 2.9 Strategic groups in the Indian pharmaceutical industry (course book)
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 Uses of strategic group analysis
• Understanding competition - enables focus on direct
competitors within a strategic group, rather than the
whole industry. (E.g. Tesco will focus on Sainsburys and
Asda)
• Analysis of strategic opportunities - helps identify
attractive ‘strategic spaces’ within an industry.
• Analysis of ‘mobility barriers’ i.e. obstacles to
movement from one strategic group to another. These
barriers can be overcome to enter more attractive
groups. Barriers can be built to defend an attractive
position in a strategic group.
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 2. Market segments
A market segment is a group of customers who have similar
needs that are different from customer needs in other parts of
the market.
• Where these customer groups are relatively small, such
market segments are called ‘niches’.
• Customer needs vary. Focusing on customer needs that are
highly distinctive is one means of building a secure segment
strategy.
• Customer needs vary for a variety of reasons -these
factors can be used to identify distinct market segments.
• Not all segments are attractive or viable market
opportunities – evaluation is essential.

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Bases of market segmentation

Table 2.1 Some bases of market segmentation (course book) 44

 Who are the strategic customers?

A strategic customer is the person(s) at whom the

strategy is primarily addressed because they have the
most influence over which goods or services are
purchased.
Examples:
• For a food manufacturer it is the multiple retailers (e.g.
Tesco) that are the strategic customers not the
ultimate consumer.
• For a pharmaceutical manufacturer it is the health
authorities and hospitals not the final patient.
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 3. Competitor analysis and ‘Blue Oceans’
W. Chan Kim & Renee Mauborgne at INSEAD
propose two concepts that help think about the
relative positioning of competitors in the
environment:
a) The strategy canvas
b) ‘Blue Ocean’

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 a. Strategy canvas
• Strategy canvas compares competitors according
to their performance on key success factors in
order to establish the extent of differentiation.
• Critical success factors are those factors that are
either particularly valued by customers or which
provide a significant advantage in terms of cost.
ü Critical success factors are likely to be an important source of
competitive advantage if an organisation has them (or a
disadvantage if an organisation lacks them).
ü Different industries and markets will have different critical
success factors (e.g. in low cost airlines the CSFs will be
punctuality and value for money whereas in full service
airlines it is all about quality of service).
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 E.g. Strategy canvas

Figure 2.9 Strategy canvas for electrical components companies (course book)
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 b. Blue ocean thinking
• ‘Blue oceans’ are new market spaces where
competition is minimised.
• ‘Red Oceans’ are where industries are already
well defined and rivalry is intense.
• Blue Ocean thinking encourages entrepreneurs
and managers to be different by finding or
creating market spaces that are not currently
being served.

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 V. Opportunities and threats (1)
• Opportunities and threats form half of SWOT
analysis that shape many companies’ strategy
formulation.
• In responding strategically to the
environment, the goal is to reduce identified
threats and take advantage of the best
opportunities.

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 V. Opportunities and threats (2)
• The techniques and concepts in this lecture help
identify environmental threats and opportunities, for
instance:
– PESTEL analysis of macro-environment may reveal threats and
opportunities presented by technological change, or shifts in market
demographics.
– Identification of key drivers for change can help generate different
scenarios for managerial discussion, some more threatening, some
more favorable.
– Porter’s analysis might, e.g. identify a rise or fall in barriers to entry, or
opportunities to reduce industry rivalry, perhaps by acquisition of
competitors.
– Blue Ocean thinking might reveal where companies can create new
market spaces; alternatively it could help identify success factors
which new entrants might attack to turn ‘Blue Oceans’ into ‘Red
Ocean’s.
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Essential readings:
• Chapter 2: Macro-environment analysis
• Chapter 3: Industry and sector analysis
Course book: Johnson, G. et al (2017). Exploring
strategy: text and cases. Harlow: Pearson.
• Case study for group discussion in tutorials for
assignment 1:
“Global forces and the advertising industry” (course
book, p.92-95).
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