Business and Strategy: Oxford

Gillespie: Foundations of Economics
Additional Chapter on Business Strategy
Business and strategy
• Business as a transformation process

• Forms of business
• Why buy shares?
• Mission statements
• Objectives
• Strategy
• The functions of business
• Business and the environment
• Analysing the micro-environment
• Porter's Five Forces analysis of market structure
• PESTEL analysis of the macro-environment
• Opportunities and Threats
• Using PESTEL analysis
• Influencing the PESTEL environment
• Developing a strategy: SWOT analysis
In this section we consider a number of areas of business activity and consider how an
analysis of economic issues fits in with the study of business. To begin with we outline the
basic business process of taking resources and transforming them into outputs that
hopefully are wanted by the customer. We then consider the various forms of business
that exist and the difference between a mission, an objective and a strategy. We then
analyse the activities that occur within a business, namely marketing, operations, finance
and human resource management. Having looked internally we then consider the factors
in the external environment of business such as competition, the economy and social
trends.
Once we have analysed the internal and external environments we consider how a firm's
strategy is derived from matching its internal strengths and weaknesses to outside
opportunities and threats. This is known as SWOT analysis.
Our book "Foundations of Economics" obviously focuses on the economic environment of

business considering both micro and macro economic factors. This particular unit shows
how economic factors fit in with the overall environment in which firms operate and how
changes in the external environment might influence the strategy a firm adopts.
Business as a transformation process

All organisations are involved in some form of transformation process. They take inputs
such as land, labour, capital and entrepreneurship and turn them into outputs such as
physical goods and intangible services. In many cases the output of a business is a
combination of goods and services; for example in a restaurant you are buying a meal but
also the environment and the service. The aim of all organisations is to add value i.e. to
create outputs that are worth more than the inputs. In many cases the value of inputs is
measured in financial terms in which case we say that organisations aim to make a profit.
A profit occurs when the revenue generated by sales exceeds the costs of providing the
OXFORD H i g h e r Education
© Oxford University Press, 2007. All rights reserved.
product. In the case of non profit organisations such as schools and hospitals, other
indicators are used to measure the value added. League tables of schools' performances,
for example, might measure exam results and compare the grades achieved by students
with their levels of achievement when they joined the school to measure the progress.
The nature of the transformation process obviously differs enormously from business to
business. For example, it may involve manufacturing or providing services, it may be
capital or labour intensive or be based on a single site or multi site. However whatever the
nature of the business managers are constantly looking for new ways of adding value
either by providing benefits and products that customers are willing to pay more for or by
combining resources more efficiently to reduce costs.
To increase efficiency managers are always seeking ways of producing more with the
same level of inputs or producing the same amount with less inputs. This can be achieved
in a variety of ways: changing working practices, investing in new technology, motivating
and inspiring staff more effectively and changing the way items are produced. For
example, an important development in manufacturing in the last twenty years is known as
lean production. This seeks to reduce wastage at all stages of the production process. It
includes Just in Time production in which items are produced to order rather than in
advance. This reduces stock levels because materials are only ordered and used when
needed - they do not wait around in stock. Similarly finished goods are made to order and
despatched immediately rather than being produced and then waiting for someone to buy
them. Just in time production therefore removes the costs involved in storing and
protecting stock. Lean production also includes a technique known as kaizen which aims
to use the knowledge of employees to find ways of continuously improving the way things
are done. Small, incremental changes are used to reduce costs on an ongoing basis.
Adding value can also occur by generating outputs that customers are willing to pay more
for. In marketing the role of the brand has become even more important in recent years as
firms attempt to get customers to identify with particular values, a lifestyle and a set of
aspirations. Through effective branding items can be sold for more. Just think of a basic,
plain T shirt and the effect on the price that can be charged if you add a particular brand
name or logo to it. Think Prada, think Armani, think Gucci and you can see the value of a
brand. Also the design features of a product can generate benefits that customers will pay
more for (think of Dysons vacuum cleaners, Duralit toasters and Jimmy Choo shoes) as
well as factors such as the speed of delivery (1 hour opticians and photo processing),
convenience (think home delivery) and flexibility (think top restaurant compared to a fast
food chain).
Organisations are continually reviewing what they provide and how they provide it to try
and add more value. Given ongoing changes in the competitive environment with new
competitors, new demands and new technologies adding value is a dynamic process.
Your parents probably bought a CD and played it at home on a CD player. You download
and listen on an iPod. The world of music provision and retailing has changed radically
forcing organisations such as EMI to rethink their business model. Your parents probably
went to a travel agent to book their holiday with a package holiday company. You go
online and tailor make your own holiday. They probably went on holiday mainly within their
own country or to relatively few locations overseas. You travel the world.
Organisations operate in a restless world and managers need to be looking constantly at
the business environment to identify changes that could be of value to them or could
possibly harm them. Interestingly any change will have different effects on different
organisations. The banning of smoking in public places may damage sales of tobacco but
boost sales on patches to help you give up smoking, for example. Later on we will
examine the external environment of business in more detail but first we examine the
different forms of business that exist and the internal activities that occur within an
organisation.
Forms of business
There are several different forms of business enterprise. The simplest is that of a sole
trader. A sole trader is someone who starts up their own business. They are the owner
and make all the decisions (although they might employ people to help get some of the
work done). Many entrepreneurs and small businesses (such as window cleaners,
plumbers and web designers) start off as sole traders.
The advantages of being a sole trader include:

• Decision making is quick enabling the business to be flexible and respond to
changes without lots of committees to discuss things with and without lots of forms
to fill in.
• The sole trader is likely to have a sense of achievement because it is his or her
own business - something they have created.
• The affairs of the business are private; the firm's accounts do not have to be
registered anywhere public and profits do not have to be declared to outsiders.
The disadvantages of being a sole trader include:

• It can be very demanding running your own business; the individual involved has to
take all the decisions in many different areas and this can be stressful. The person
concerned may be strong in one particular field such as marketing but will have to
learn how to cope with making decisions in other areas such as finance as well.
• There is no distinction in law between the person who sets up the business and the
business itself. This means there is unlimited liability. If there are financial problems
with the business the sole trader is personally liable for all money owed. Everything
the sole trader owns is potentially at stake if there are difficulties.
• The business ends when the sole trader dies or decides to stop.
An alternative form of business is that of a company. A company has a separate legal

existence in law from its owners. The company can own assets in its own right; it can sue
and be sued. To create a company in the UK the owners must register the business at
Companies House and complete documents including the Articles of Association and the
Memorandum of Association. These documents provide information about the business
such as details of its owners, the company name, where the head office is based, the
purpose of the business and the rules on electing company officials.
The benefits of creating a company include:

• The company has limited liability. The company is liable for all its own debts and
therefore investors can only lose the funds they have invested. There is, therefore,
a limit to how much they can lose. This is a vital advantage of setting up a company
because it means you are more likely to attract investors because they know
exactly what the downside is if it goes wrong. If there was unlimited liability you
would be wary of investing in any company unless you had very tight control over
the business. This is because everything you owned could be at risk. With limited
liability you can invest a certain sum and let this be managed by others; obviously
you will want to know what they are doing with your money but at least you know
the maximum you can lose if it goes wrong and therefore you don't need to have
information on absolutely every decision that is being made. With limited liability
those with funds can invest them for managers to use without having to be party to
every single decision. Those with funds can invest for managers to use to generate
profits and returns.
• The business outlives the founders. If the original owners die or want to end their
relationship with the business they can sell their shares to others and the company
continues. Many companies such as WHSmith, Marks and Spencer, Cadbury have
little or nothing to do with the families that originally set them up. (There are
exceptions- the Mars family and the Ford family, for example, are still big
shareholders of their businesses). When the founders of a company die or sell up
the ownership of the company simply moves to others.
One significant disadvantage of being a company is that the accounts of a company have
to be checked each year by an outside accountant (called an auditor) and then sent to
Companies House, This means they are available to others to investigate and "outsiders"
can see what has been earned in a given year.
In the UK there are in fact two types of company: private limited companies (these are
called ltds and are in the majority by far) and public limited companies (plcs). Public
limited companies can advertise their shares and so have access to far more investors.
They will usually be listed on the Stock Exchange and tend to be the high profile
companies such as BT, BP, Tesco, Sainsbury's and Marks and Spencer. By being able to
advertise shares to the general public plcs may be able to raise millions of pounds of
finance. However, because more shareholders are involved plcs are more regulated than
private companies. Their accounts have to be more detailed, for example, and there are
more regulations concerning what information must be made available. Also, whereas in a
private company you can restrict who shares are sold to (e.g. to keep the business under
the control of family members), in a public limited company there are no restrictions on the
sales of shares. This means that some of the existing owners of a company can decide to
sell their shares and the others cannot stop them; this can lead to a company being
takeover if the majority of shareholders sell even if it is against the wishes of some of the
other owners.
Plcs tend to have many millions of shares and because they are traded on the Stock
Market they are being bought and sold every day in huge quantities. At any moment the
price of the shares can be seen and so the overall value of the business is known. This
can show whether a takeover is likely to desirable or not. You will regularly hear on the
news of takeover bids being made for public limited companies; a bidder has decided the
share price does not reflect the full potential value of the business and therefore it is worth
trying to gain control of the business by gaining a majority of the shares. With a private
company the sale of shares is far less frequent and there is no daily market for them;
therefore the price is not immediately visible - if you want to buy you will need to negotiate
with the owner of the share. A "sudden" takeover is therefore less likely.
There are, of course, other forms of business. For example, partnerships occur when
individuals join together to start a business. This means they can share their skills and
funds and benefit from each others' knowledge. However, it does mean each partner is
very reliant on the others and has to trust them not to make mistakes because they will be
liable for each other's actions.
Not for profit organisation also exist. These include some schools, environmental groups
and sports clubs. Many of these are charities, which means they are regulated by the
Charity Commission and have a special tax status but must invest their funds in agreed
causes and not make a profit.
When choosing a business form the individuals concerned must consider factors such as:
• Their willingness to share control
• Their willingness to publish information about the business
• The importance of limited liability
• The scale of investment needed to set up and run the business
The decision on the right form of business may change over time. For example, if the
owners of a private company want to expand the business and bring in many more
investors they may turn it into a plc and "float" it on the Stock Exchange. In some cases
the main owners decide they want complete control and they buy up all the shares and
make the company private again. This is what happened when Malcolm Glazer bought
Manchester United in 2005 and turned it from a public company to a private company.
To read about Malcolm Glazer winning control of Manchester United you can visit
http://news.bbc.co.uk/1/hi/business/4540939.stm
Why buy shares?

A shareholder is an owner of a business. If you buy an ordinary share you get one vote for
each share you hold. If you have 20% of the shares you have 20% ownership of the
company and 20% of the votes. However, there are other types of shares that have more
or less privileges e.g. some shares do not having voting rights.
By being an owner it means you can influence what the company does (assuming you do
have voting rights) and can benefit from its success. One form of reward is dividends.
When the company makes a profit the shareholders vote on how much is to be retained
(i.e. kept back for investment) and how much is to be paid out to the owners in the form of
dividends.
The other way in which owners can benefit is if the value of the company increases. As a
company grows your shares (e.g your 20% of the company) become worth more and so
your wealth has increased. However, as the adverts and your financial advisers always tell
you the price of shares can go down as well as up so buying a share involves risk. That's
why investors will look for higher potential returns than they would putting their money in
the bank because there is more risk involved.
Many shares in the UK are owned by financial institutions, such as banks and insurance
companies . They have their own investors and are buying shares because of the return
they provide. This means there is a great deal of pressure on managers to deliver good
results. If they do not they may be fired.
For information on share ownership in the UK visit:

www.statistics.gov.uk/cci/nugget.asp?id=107
Mission statements
The mission of an organisation is the reason why it exists, what it sees as its essential
purpose.
This is often written down in the form of a mission statement. A mission statement
expresses the underlying aim of the business and often incorporates something regarding:
- the scope of its activities e.g. to be a UK, European or global business
- its competitive strategy e.g. to be a luxury provider or low cost operator
- its values e.g. to serve its investors or to help the community
Johnson and Johnson

Johnson and Johnson is a large provider of healthcare products and services. The
company's founder wrote a statement of its values called "our Credo" in 1943 and this still
dominates the company's culture. Although it does not call it a mission statement it
performs a similar function:
Our Credo
We believe our first responsibility is to the doctors, nurses and patients, to mothers and
fathers and all others who use our products and services.
In meeting their needs everything we do must be of high quality.
We must constantly strive to reduce our costs in order to maintain reasonable prices.
Customers' orders must be serviced promptly and accurately.
Our suppliers and distributors must have an opportunity to make a fair profit.
We are responsible to our employees, the men and women who work with us throughout
the world.
Everyone must be considered as an individual.
We must respect their dignity and recognize their merit.
They must have a sense of security in their jobs.
Compensation must be fair and adequate, and working conditions clean, orderly and safe.
We must be mindful of ways to help our employees fulfil their family responsibilities.
Employees must feel free to make suggestions and complaints.
There must be equal opportunity for employment, development and advancement for
those qualified.
We must provide competent management, and their actions must be just and ethical.
We are responsible to the communities in which we live and work and to the world
community as well.
We must be good citizens – support good works and charities and bear our fair share of
taxes.
We must encourage civic improvements and better health and education.
We must maintain in good order the property we are privileged to use, protecting the
environment and natural resources.
Our final responsibility is to our stockholders.
Business must make a sound profit.

We must experiment with new ideas.
Research must be carried on, innovative programs developed and mistakes paid for.
New equipment must be purchased, new facilities provided and new products launched.
Reserves must be created to provide for adverse times.
When we operate according to these principles, the stockholders should realize a fair
return.
www.jnj.com/
Q. How do you think "Our Credo" influences the way employees at Johnson and Johnson
behave? How do you think this determines the success of the business?
Just as every individual has his or her own personality, values and ambitions so does
every business. As a result the mission of each organisation is unique. To get an idea of
the variety of the missions of different companies you might want to look online at some of
the websites of large companies as many of these, such as Johnson and Johnson, include
their mission statements. For example, why not start with:
• AOL www.corp.aol.com/whoweare/mission.shtml
• Ford www.ford.co.uk/ie/corporateinfo
• Google www.google.com/corporate/tenthings.html
• Greenpeace www.greenpeace.org/international/about/our-mission
• McAfee www.mcafee.com/uk/about/mission_statement.html
Objectives
Whilst a mission statement may show the general purpose of the business and indeed
may inspire those who read it, it does not itself necessarily provide much practical use to
managers. A firm's mission really needs to be turned into something more focused and
less general i.e. the managers need to set out the firm's objectives. Objectives are specific
targets. They set out precisely what a firm wants to achieve by a given time. For example,
"to be the best sports goods business in the world" might be the mission statement of a
firm whereas to "increase market share by 20% in 5 years" is an objective.
To be effective an objective should be SMART; this means it should be:

• Specific: i.e. managers must clearly define what the focus is
• Measurable so that a target can be set and reviewed
• Agreed so that those who set it and those who have to achieve it agree to it. There
is little point forcing a target on someone - if they do not accept it they will be
unlikely to work very hard to make it happen
• Realistic so it is achievable rather than being a target that everyone knows cannot
be hit. Unrealistic targets tend to be demoralising and can do more harm than good
• Time specific meaning that there is a clear time horizon by which the target should
be achieved
Typical business objectives focus on profits, growth, market share and cash flow.
Increasingly firms are also including objectives that relate to social responsibility focusing
on areas such as their contribution to the community, the support given to suppliers and
targets to reduce any negative impact on the environment. In recent years there has been
a growth in the interest of firms and their customers, employees and partners in Corporate
Social Responsibility (CSR). CSR focuses on the role of a business as a citizen within
society and considers the impact of an organisation on society as a whole. Companies
that behave socially responsibly accept obligations to society over and above their legal
requirements; they do not do the bare minimum because they see the value of doing more
than this and working with others. For example, socially responsibility might include:
- Aiming to ensure a good quality of working life for employees
- Enabling employees to have a positive work/life balance
- Minimising the adverse impact of your activities on the environment
- Investing in the local community
- Helping disadvantaged groups
- Treating suppliers with respect
To read about the UK government's view of the benefits of Corporate Social Responsibility
visit: www.csr.gov.uk
Strategy
To achieve an objective, managers must develop a suitable strategy. A strategy is a long
term plan setting out how an objective will be reached. For example, if the objective is to
reduce costs, the strategy could involve relocating or reducing the labour force. If the
objective is to boost revenue, the strategy may be to launch new products or to invest in a
big promotional campaign.
A strategy will usually:

• Involve relatively large sums of money
• Be relatively difficult to reverse. Once you have started to pursue a particular
strategy it may not be easy switch resources in another direction
• Be relatively high risk. If you get the strategy wrong this could be costly in many
ways for the business
• Set out the markets the firm wants to compete in, the products it wants to offer and
how it wants to compete (e.g. by focusing on low cost or by differentiating its
offering)
One method of analysing strategies is known as the Ansoff Matrix
Existing products New products

Existing markets Market penetration New product
development
New markets Market development Diversification
• Market penetration occurs when firms focus on their existing customers and sell
their existing products. For example, activities may concentrate on marketing
activities to try and boost market share.
• Market development occurs when firms target their products at new segments of
the market. This could be different geographical markets or different age groups or
types of customer. This involves gaining an understanding of how the requirements

of the customers in these segments differ.
• New product development involves an investment in innovation and research and
development. This can be risky in that much investment into new products does not
lead to anything and many new products launched on to the market fail to survive.
However this sort of strategy is important in industries where there is constant
product development such as consumer electronics.
• Diversification occurs when firms move into completely new areas with new
products. Over the years, for example, Nokia has transformed itself from a paper
company to a communications business. 3M has moved from mining to adhesives.
Diversification can be very risky from a management perspective because it is
dealing with unfamiliar resources, challenges and decisions. However it may be
important to keep the business successful as conditions change. Timpsons is an
interesting business in the UK that has moved into new sectors (from shoe repair to
key cutting, engraving to watch repair) as a way of maintaining sales.
Organisations are often made up of several different business units (e.g. they operate in
different markets and in different regions) and the strategies adopted by each of these
may well differ.
The functions of business

Although organisations differ considerably in their activities, their strategies and the way in
which they seek to add value we can identify some functions which they usually have in
common.
For example:
• Operations: this involves the actual production and delivery of the product or
service. In the primary sector this may mean growing the product (e.g. farming) or
extracting it (e.g. oil); in the secondary sector this involves activities such as
assembly, manufacture and construction and in the tertiary sector this involves
providing a service such as tourism, education and insurance. Operational
decisions include deciding where to produce, how to produce (e.g. what
combination of resources to use and how much to produce yourself compared to
how much to buy in), what volume and range of products to produce and what
quality and cost targets to achieve. It also involves research and development into
new products and processes.
• Marketing: the marketing activities of business begin with identifying customer

needs. This may be through primary market research (which involves collecting
new data e.g. through surveys) or secondary market research (which uses data
that already exists such as government statistics or industry surveys). Having
identified customers' requirements marketing activities aim to satisfy these needs
through ensuring the firm provides the right products, at the right place and price
and at the right time. Firstly, a marketing strategy must be decided: for example,
managers must decide on what markets to compete in and what range of products
to offer. Secondly, the strategy is implemented via the marketing mix. The
marketing mix involves the 4Ps: deciding on the price, the product itself, the
promotion (what is communicated about the product and how it is communicated)

and the place (i.e. how it is distributed from the firm to the customer).
• Finance: organisations need to raise finance to get started and to invest into new
projects. For example, a company may raise finance by selling shares to investors
or by taking out a loan. The former involves a loss of control as the number of
owners is increased. The latter will incur interest charges as the loan will have to be
repaid. Firms also need to set financial targets and allocate money within the
business; this is known as budgeting. Budgets will be set for a given period in the
future and then compared with the actual outcomes to examine why differences
occurred; this is known as variance analysis. Organisations will also produce
financial reports to their investors such as balance sheets (which show what a firm
owns and owes on a given day) and the profit and loss account (which shows the
income and profit of a company over the last year).
• Human resource management (HRM): all organisations rely on their employees

and HRM refers to the way in which people are managed. HRM involves activities
such as the recruitment and selection of staff, the training of people and the
development and implementation of appropriate reward systems. The nature of
these activities can have a big impact on the way people perform. A payment
system based on commission, for example, will inevitably make employees focus
on sales; a profit sharing scheme might make them focus on costs as well. The way
that people are managed will influence whether they turn up for work, how
productive they are and their openness to change.
These functions may be undertaken by specialist departments or in the case of smaller

businesses it may be that many roles are combined. A sole trader has to undertake all
these different activities for him or herself, for example.
The activities of the different functions will be derived from the overall plan of the business
as a whole. This is known as the corporate strategy. The corporate strategy might be to
enter international markets, for example. This would require marketing to gain an
understanding of the demands and requirements of the overseas markets. Operations
would need to consider the implications in terms of what is produced and where it is
produced. HRM might have to recruit staff internationally and finance might have to gain a
greater understanding of exchange rate issues. Within any business the various functions
need to be integrated and in an effective business they will complement each other fully.
For example, a desired boost in sales generated by marketing may need to be supported
by additional finance to launch a promotional campaign, an increase in capacity to
increase production and the recruitment of additional staff.
An organisation is therefore a complex mechanism made up of interrelating parts. What

the organisation is designed to do is its objective; how it intends to do this is the strategy
and the actual activities are carried out by the various functions. The relative importance
of the functions and areas within them will vary from organisation to organisation. In
pharmaceuticals research and development is extremely important. In banking the
effective use of information technology is particularly crucial. In the National Health
Service there are hundreds of thousands of employees and so HRM is a much more
complex and significant aspect of the organisation compared to a sole trader.
Business and the environment

The business transformation process does not take place in a vacuum. Firms operate in a
particular context and they are influenced by and are able to influence this environment.
The business environment can be divided into:

• The micro-environment: this the involves individuals or organisations that a firm
deals with on a regular basis. For example, suppliers, distributors, competitors,
customers and employees are all members of the micro-environment. These
groups are stakeholders of the business. They all have a direct interest in the
activities of the firm and are clearly affected by its actions. Managers regularly
interact with others in the micro-environment and their decisions have a direct
effect on them e.g. a decision to expand may mean an increase in supplies, an
increase in overtime, more deliveries and greater profits. At the same time these
stakeholder groups can have a direct impact on the firm. Labour shortages in the
local labour market may make it more expensive to recruit, competitors launching
new products may take away market share and changes in customer tastes may
require a rethinking of the marketing strategy. Delays by suppliers may lead to
cash-flow problems and problems with distributors may hit sales. The micro
environment therefore plays a critical role in the success and behaviour of a
business.
• The macro-environment. This involves factors outside of the direct control of the
business. These macro-factors such as the economy, government policy and social
change can have a significant effect on a firm's success but the relationship is fairly
one way. A change in the exchange rate can affect the ability of a firm to sell
abroad; for example, the pound rose in value to nearly 2 dollars in 2007 making UK
exports expensive in America. The increasing interest in healthy eating has
boosted organic sales. The ageing population has increased demand for healthcare
resources. However, whilst these macro factors can fundamentally change the
environment of an organisation one individual business can rarely do much on its
own to shape them. One firm is unlikely to be able to influence government taxation
policy or new legislation, for example. The macro-environment can be analysed
using PESTEL analysis which is outlined later.
Analysing the micro-environment

The micro-environment consists of stakeholder groups that a firm has regular dealings
with. The way these relationships develop can affect the costs, quality and overall success
of a business. Issues in the micro-environment include:
• Suppliers: can they provide high quality products at a good price? Can they do this
reliably in the volumes required? Have they got the flexibility to respond to a firm's
demands? What is the bargaining power of these suppliers? How dependent is the
firm on them? Does their approach to their staff and resources fit with your ethics?
Firms must decide on issues such as who to use to supply them, on the
responsibility it takes for these suppliers and on the terms and conditions it adopts.
Some firms take quite an aggressive attitude towards their suppliers by trying to
push down the prices and delay payments. Others view the relationship more as a
partnership in which they are working together with suppliers and that by helping
each other both can benefit. The importance of suppliers can be seen if things go
wrong. In 2000 Ford's image was damaged when tyres on its Explorer vehicles
started exploding. These tyres were produced by Bridgestone and the supplier
ended up re-calling over 6.5 million tyres. In 2007 Sony batteries in several Dell
laptops caught fire which caused a terrible public relations issue for the computer
manufacturer and led to over 4 million laptop batteries being recalled.
• Distributors: often getting products to the end customers can be a major issue for
firms. Imagine you sell shampoo - what you need to sell this is to get it on the
shelves in the leading chemists and supermarkets but this means moving someone
else's products off the shelves! So the challenge is to get stores to stock your
products; this may be achieved by good negotiating skills and offering appropriate
incentives. The distributors used will determine the final price of the product and
how it is presented to the end customer. When selling via retailers, for example, the
retailer has control over where the products are displayed, how they are priced and
how much they are promoted in-store. You can also gain a competitive advantage
by using changing distribution channels. Banks, insurance companies, holiday
firms, hotels and many others businesses have seen the opportunities created by
the internet. Direct Line insurance, Dell computers and Amazon have reduced
costs by selling direct. Some firms such as Betterware and Avon have used
alternative distribution channels to their competitors by selling door to door; Ann
Summers' products have sold well via parties.
• Customers: customers are obviously the key to sales. Managers must monitor
customer needs and try to anticipate how these will develop so that they can meet
these requirements effectively now and in the future. To help understand their
customers firms are increasingly trying to gather information on them through
mechanisms such as loyalty cards. By gathering data on shopping patterns and
matching this to data on the individual shoppers firms can build up detailed pictures
of their buyers and then offer them appropriate deals. Many firms are also trying to
develop relationships with customers to help ensure they come back time and time
again. Loyalty cards, frequent flyer programmes and frequent shopper incentives
are all aimed at rewarding customers who buy a firm's product regularly.
Newsletters, email lists and recommendations to online shoppers of what else they
might be interested in are all ways of trying to build a relationship with customers.
Of course, potential buyers usually have many choices and so may be able to use
their bargaining power in relation to firms. The growth of the internet has enabled
customers to search quickly for alternatives and compare deals more easily; this
puts pressure on firms to provide better value for money or they will lose their
customers.
• Competition: the success and behaviour of any business will depend on the degree
of competition in its market. In some markets one firm is dominant. This is called a
monopoly. Technically in the UK a monopoly exists when a firm has a market share
of over 25%. If you are in a monopoly position this may allow you to exploit the
consumer with relatively high prices (assuming your position is protected in some
way) and you may be able to offer an inferior service if customers have no other
choices. In other markets a few firms dominate; this type of market structure is
called an oligopoly. In oligopolistic markets there is a high degree of
interdependence and so firms will think carefully how their rivals might react to any
actions they take. This can lead to an emphasis on non price competition; a price
change is relatively easy to imitate and so firms may rely more on methods such as
branding or product development. Oligopolies exist in many markets in the UK such
as insurance, banking, car manufacturing, supermarkets. In more competitive
markets where there are many firms providing similar products customers have
more choice; this may put downward pressure on prices and means that excellent
customer service is essential.
Porter's Five Forces analysis of market structure

The competitive structure of an industry can be analysed using Porter's five forces.
This model attempts to analyse the attractiveness of an industry by considering five forces
within a market.
According to Porter (1980) the likelihood of firms making profits in a given industry
depends on five factors:
1. The likelihood of new entry i.e. the extent to which barriers to entry exist. The more
difficult it is for other firms to enter a market the more likely it is that existing firms can
make relatively high profits.
The likelihood of entering a market would be lower if:

- the entry costs are high e.g. if heavy investment is required in marketing or equipment
- there are major advantages to firms that have been operating in the industry already in
terms of their experience and understanding of how the market works (this is known as
the "learning effect")
- government policy prevents entry or makes it more difficult; for example, protectionist
measures may mean a tax is placed on foreign products or there is a limit to the number
of overseas goods that can be sold. This would make it difficult for a foreign firm to enter a
market
- the existing brands have a high level of loyalty
- the existing firms may react aggressively to any new entrant e.g. with a price war
- the existing firms have control of the supplies .e.g. entering the diamond industry might
be difficult because the majority of known sources of diamonds are controlled by
companies such as De Beers.
2. The power of buyers.

The stronger the power of buyers in an industry the more likely it is that they will be able to
force down prices and reduce the profits of firms that provide the product.
Buyer power will be higher if:

- there are a few, big buyers so each one is very important to the firm
- the buyers can easily switch to other providers so the provider needs to provide a high
quality service at a good price
- the buyers are in position to take over the firm. If they have the resources to buy the
provider this threat can lead to a better service because they have real negotiating power
3. The power of suppliers.

The stronger the power of suppliers in an industry the more difficult it is for firms within
that sector to make a profit because suppliers can determine the terms and conditions on
which business is conducted.
Suppliers will be more powerful if

- there are relatively few of them (so the buyer has few alternatives)
- switching to another supplier is difficult and/or expensive
- the supplier can threaten to buy the existing firms so is in a strong negotiating position
4. The degree of rivalry

This measures the degree of competition between existing firms. The higher the degree of
rivalry the more difficult it is for existing firms to generate high profits.
Rivalry will be higher if:

- there are a large number of similar sized firms (rather than a few dominant firms) all
competing with each other for customers
- the costs of leaving the industry are high e.g. because of high levels of investment. This
means that existing firms will fight hard to survive because they cannot easily transfer their
resources elsewhere
- the level of capacity utilisation. If there are high levels of capacity being underutilised the
existing firms will be very competitive to try and win sales to boost their own demand
- the market is shrinking so firms are fighting for their share of falling sales
- there is little brand loyalty so customer are likely to switch easily between products
5. The substitute threat.

This measures the ease with which buyers can switch to another product that does the
same thing e.g. aluminium cans rather than glass or plastic bottles. The ease of switching
depends on what costs would be involved (e.g. transferring all your data to a new
database system and retraining staff could be expensive) and how similar customers
perceive the alternatives to be.
Using Porter's analysis firms are likely to generate higher returns if the industry:
• Is difficult to enter
• There is limited rivalry
• Buyers are relatively weak
• Suppliers are relatively weak
• There are few substitutes.
On the other hands returns are likely to be low if:

• The industry is easy to enter
• There is a high degree of rivalry between firms within the industry
• Buyers are strong
• Suppliers are strong
• It is easy to switch to alternatives
The implication of Porter's analysis for managers is that they should examine these five
factors before choosing an industry to move into. They should also consider ways of
changing the five factors to make them more favourable.
For example:
• if firms merge together this can reduce the degree of rivalry . This has happened a
great deal in industries such as automobiles, pharmaceuticals and banking where
firms have joined together to remove competitors
• if firms buy up distributors (this is called forward vertical integration) they can gain
more control over buyers
• if firms differentiate their product perhaps by trying to generate some form of
Unique Selling Proposition (USP) that makes it stand out from the competition. This
lies at the heart of many marketing and brand building activities. Coca Cola, for
example, has fought hard to promote itself as "the real thing"; everything else is just
imitation!
• if they react aggressively to a firm that enters its market this may deter potential
entrants in the future
The five forces will change over time as market conditions alter. For example, more
information is available nowadays to enable customers to compare offerings and prices;
this gives buyers more power. The opening up of world markets (for example through the
efforts of the World Trade Organisation to reduce protectionist measures that limit trade
and the expansion of the European Union enabling free trade between more countries)
has led to much more rivalry in markets in recent years. In North America, for example,
the sales of Japanese firms such as Toyota have gradually been reducing the market
share of American producers such as General Motors as consumers have more choice.
Meanwhile, the success of the internet has made it easier for producers to enter many
markets such as finance, book retailing and clothes retailing; the ability to start selling
online has reduced a major barrier to entry which was the investment required to set up a
network of shops. As ever the business world is not static and the conditions in any
industry will always be changing. As this happens the various elements of the five forces
are always shifting requiring established firms and potential entrants to review their
strategies.
PESTEL analysis of the macro-environment

There are many factors in the macro-environment that will effect the decisions of the
managers of any organisation. Tax changes, new laws, trade barriers, demographic
change and government policy changes are all examples of macro change. To help
analyse these factors managers can categorise them using the PESTEL model. This
classification distinguishes between:
• Political factors. These refer to government policy such as the degree of

intervention in the economy. What goods and services does a government want to
provide? To what extent does it believe in subsidising firms? What are its priorities
in terms of business support? Political decisions can impact on many vital areas for
business such as the education of the workforce, the health of the nation and the
quality of the infrastructure of the economy such as the road and rail system.
• Economic factors. These include interest rates, taxation changes, economic

growth, inflation and exchange rates. As you will see throughout the "Foundations
of Economics" book economic change can have a major impact on a firm's
behaviour. For example:
- higher interest rates may deter investment because it costs more to borrow
- a strong currency may make exporting more difficult because it may raise the price in
terms of foreign currency
- inflation may provoke higher wage demands from employees and raise costs
- higher national income growth may boost demand for a firm's products
• Social factors. Changes in social trends can impact on the demand for a firm's
products and the availability and willingness of individuals to work. In the UK, for
example, the population has been ageing. This has increased the costs for firms
who are committed to pension payments for their employees because their staff are
living longer. It also means some firms such as Asda have started to recruit older
employees to tap into this growing labour pool. The ageing population also has
impact on demand: for example, demand for sheltered accommodation and
medicines has increased whereas demand for toys is falling.
• Technological factors: new technologies create new products and new processes.
MP3 players, computer games, online gambling and high definition TVs are all new
markets created by technological advances. Online shopping, bar coding and
computer aided design are all improvements to the way we do business as a result
of better technology. Technology can reduce costs, improve quality and lead to
innovation. These developments can benefit consumers as well as the
organisations providing the products.
• Environmental factors: environmental factors include the weather and climate

change. Changes in temperature can impact on many industries including farming,
tourism and insurance. With major climate changes occurring due to global
warming and with greater environmental awareness this external factor is becoming
a significant issue for firms to consider. The growing desire to protect the
environment is having an impact on many industries such as the travel and
transportation industries (for example, more taxes being placed on air travel and
the success of hybrid cars) and the general move towards more environmentally
friendly products and processes is affecting demand patterns and creating business
opportunities.
• Legal factors: these are related to the legal environment in which firms operate. In
recent years in the UK there have been many significant legal changes that have
affected firms' behaviour. The introduction of age discrimination and disability
discrimination legislation, an increase in the minimum wage and greater
requirements for firms to recycle are examples of relatively recent laws that affect
an organisation's actions. Legal changes can affect a firm's costs (e.g. if new
systems and procedures have to be developed) and demand (e.g. if the law affects
the likelihood of customers buying the good or using the service).
Different categories of law include:

- consumer laws; these are designed to protect customers against unfair practices
such as misleading descriptions of the product
- competition laws; these are aimed at protecting small firms against bullying by
larger firms and ensuring customers are not exploited by firms with monopoly
power
- employment laws; these cover areas such as redundancy, dismissal, working hours
and minimum wages. They aim to protect employees against the abuse of power
by managers
- health and safety legislation; these laws are aimed at ensuring the workplace is as
safe as is reasonably practical. They cover issues such as training, reporting
accidents and the appropriate provision of safety equipment
Typical PESTEL factors to consider include:

Factor Could include:
Political e.g. EU enlargement, the euro, international trade, taxation
policy
Economic e.g. interest rates, exchange rates, national income,
inflation, unemployment, Stock Market
Social e.g. ageing population, attitudes to work, income distribution
Technological e.g. innovation, new product development, rate of
technological obsolescence
Environmental e.g. global warming, environmental issues
Legal e.g. competition law, health and safety, employment law
By using the PESTEL framework we can analyse the many different factors in a firm's
macro environment. In some cases particular issues may fit in several categories. For
example, the creation of the Monetary Policy Committee by the Labour government in
1997 as a body that was independent of government but had the ability to set interest
rates was a political decision but has economic consequences; meanwhile government
economic policy can influence investment in technology via taxes and tax credits. If a
factor can appear in several categories managers simply make a decision of where they
think it best belongs.
However, it is important not to just list PESTEL factors because this does not in itself tell
managers very much. What managers need to do is to think about which factors are most
likely to change and which ones will have the greatest impact on them i.e. each firm must
identify the key factors in their own environment. For some such as pharmaceutical
companies government regulation may be critical; for others, perhaps firms that have
borrowed heavily, interest rate changes may be a huge issue. Managers must decide on
the relative importance of various factors and one way of doing this is to rank or score the
likelihood of a change occurring and also rate the impact if it did. The higher the likelihood
of a change occurring and the greater the impact of any change the more significant this
factor will be to the firm's planning.
It is also important when using PESTEL analysis to consider the level at which it is
applied. When analysing companies such as Sony, Chrysler, Coca Cola, BP and Disney it
is important to remember that they have many different parts to their overall business -
they include many different divisions and in some cases many different brands. Whilst it
may be useful to consider the whole business when using PESTEL in that it may highlight
some important factors, managers may want to narrow it down to a particular part of the
business (e.g. a specific division of Sony); this may be more useful because it will focus
on the factors relevant to that part of the business. They may also want to differentiate
between factors which are very local, other which are national and those which are global.
For example, a retailer undertaking PESTEL analysis may consider:

- Local factors such as planning permission and local economic growth rates
- National factors such as UK laws on retailer opening hours and trade descriptions
legislation and UK interest rates
- Global factors such as the opening up of new markets making trade easier. The
entry of Bulgaria and Rumania into the European Union might make it easier to
enter that market in terms of meeting the various regulations and provide new
expansion opportunities. It might also change the labour force within the UK and
recruitment opportunities.
This version of PESTEL analysis is called LoNGPESTEL. This is illustrated below:
LOCAL NATIONAL GLOBAL

POLITICAL Provision of UK government World trade
services by local policy on agreements e.g.
council subsidies further expansion
of the EU
ECONOMIC Local income UK interest rates Overseas
economic growth
SOCIAL Local population
Demographic Migration flows
growth change (e.g.
ageing
population)
TECHNOLOGICAL Improvements in UK wide International
local technologies technology e.g. technological
e.g. availability of UK online breakthroughs
Digital TV services e.g. internet
ENVIRONMENTAL Local waste UK weather Global climate
issues change
LEGAL Local UK law International
licences/planning agreements on
permission human rights or
environmental
policy
In "Foundations of Economics" we focus on the economic environment. We examine

issues such as the effect of interest rate changes, changes in exchange rates, changes in
trade policy, government intervention in an economy via spending and taxation and
economic growth rates. These can be incredibly important factors in a firm's macro-
environment. The growth of China and India, for example, have had massive effects on
many organisations. Firms can relocate production there to benefit from lower costs; these
emerging markets are also providing enormous markets for firms to aim their products at.
With a population of over 1 billion, for example, the Chinese market is not one you would
want to ignore; at the same time Chinese producers should not be ignored either.
However, the relative importance of economic factors compared to other factors will
depend on the particular position of a business. Exchange rate fluctuations may be
critically important to a multinational but less significant to a local window cleaner. Rapid
economic growth or economic decline may be very significant to a construction business
that depends heavily on the level of income in the economy but may be slightly less
significant to a milk producer whose product is less sensitive to income. So whilst the
economy is important to all firms on both the supply side (e.g. unemployment levels affect
the ease of recruitment) and demand side (e.g. income tax affects spending power) the
relative importance of specific economic factors and the relative importance of the
economy compared to, say, regulation or social trends will vary. Whilst we hope this book
provides a good insight into the economy and the possible effects of economic change on
a business these must be considered in the light of other macro and micro factors that
influence a firms' decisions and success.
Opportunities and Threats

Some changes in the macro environment will create opportunities for a business. The
expansion of the European Union has made it easier to export to markets such as
Bulgaria and Romania. The boom in China has created a major new market. Other
changes may create threats. The growth of the internet has threatened traditional package
holiday companies as consumers book directly for themselves; this is why this industry
has seen substantial consolidation as firms rationalise to become more efficient. Whether
a particular change is an opportunity or threat depends on the specific position of a
business- is it able to exploit the opportunities created? Has it anticipated the change
already and prepared for it or has it been taken by surprise? Does it have the skills and
resources required to meet changing customer needs?
When considering the external changes that may occur and deciding whether they are
significant opportunities or threats managers must consider the internal functions of their
business. This process of matching the internal position of a business to the external
environment is called SWOT analysis and is examined below.
Using PESTEL analysis

The external environment is tremendously complex and dynamic. Take your eyes off it for
a moment and you may find there has been a significant change in the competitive
landscape. This is why PESTEL analysis really needs to be undertaken on a regular
basis. However, even then it does not ensure that every significant change will be
identified. Have you ever been waiting to meet someone in a crowded place and not
noticed there were there until they were almost directly in front of you? You were too busy
looking at someone else or for something else (you were sure they would be wearing a
particular coat, for example). The same can happen to managers scouring the external
environment - there is a lot going on in many different places and it is perfectly possible
that they miss the changes that later turn out to be incredibly important. This is particularly
likely when people have already decided in their minds what should be happening. They
"know" their friend will be coming from a particular direction so that's the only place they
look. This is fine if the friend does come from this direction but not so good if he or she
chooses a different route. When using PESTEL analysis managers must be prepared to
look all around them and question their assumptions!
Influencing the PESTEL environment

For most firms there is little hope of influencing the PESTEL environment on their own, at
least on a global scale; they may have more success on a local scale where they might
play a relatively important role in the local economy. However, managers will naturally try
where they can to shape the external environment in their favour. This may be more
feasible through industry associations that are formed to protect their interests and
represent a particular sector such as cars or printing. These bodies represent many firms
and therefore may have more power than any individual firm when it comes to influencing
government. The larger organisations may also have their own public relations
departments or agencies and will work with lobbying companies to try and introduce or
delay particular forms of legislation. The tobacco companies, for example, fought long and
hard to prevent any statements that clearly linked smoking to cancer; they then fought
equally hard to limit restrictions of their marketing and on the size of warnings on tobacco
products.
Within the UK the Confederation of British Industry (CBI) also represents the interests of
British firms in discussions with government on a wide range of issues such as economic
policy, Europe and environmental issues. More information on the CBI can be found at
www.cbi.org.uk
Developing a strategy: SWOT analysis

In an earlier part of this section we outlined what was meant by a strategy. We now
consider how a strategy may be formed. To determine what their strategy should be
managers must consider the internal strengths and weaknesses of their organisation and
compare these with the external opportunities and threats. This process is known as
SWOT analysis.
Strengths are internal factors that a firm may build on to develop a strategy. For example,
they may include:
• Marketing strengths e.g. a strong brand or access to a good distribution network
• Financial strengths e.g. a high level of cash, access to loan capital if needed and a
good credit rating
• Operations strengths e.g. a high level of efficiency, flexible production systems and
high quality levels
• HRM strengths e.g. a well trained workforce, a creative and motivated workforce
and good employer-ee relations
Weaknesses are internal factors that a firm may need to protect itself against such as:
• Marketing weaknesses such as limited distribution, a poor product range and
ineffective promotion
• Financial weaknesses such as high levels of borrowing and low rates of return
• Operational weaknesses such as old, inefficient equipment and poor quality
• HRM weaknesses such as a high rate of labour turnover and industrial disputes
Managers must identify the specific strengths and weaknesses of their business and rate
these according to how significant they are. They should then compare these with the
external opportunities and threats identified by PESTEL analysis. This is SWOT analysis.
A strategy may be developed by using a firm's strengths to exploit the opportunities that
exist. For example, a strong brand name may be used to extend a firm's products into new
markets. It may also use these strengths to protect itself against threats; for example, a
retailer may use its finance to acquire key locations to prevent a competitor buying them.
A firm may also want to protect itself against its weaknesses. For example, it may try to
find alternative suppliers to reduce an over-reliance on a particular one; it may invest in a
rebranding exercise to reposition itself.
Undertaking a SWOT analysis effectively is not as easy as it may seem. First managers
have to correctly identify what all the relevant factors are and how important each one is.
Too often managers have their own perspective on a situation and therefore may only see
what they want to see (as with PESTEL analysis). This is known as "perceptual filtering".
Kodak's managers spent several years watching other camera manufacturers when they
should have been watching consumer electronics firms such as Sony who were
developing digital cameras.
Secondly, managers need to work out the most appropriate strategy that combines the
strengths and opportunities and actually implement the plan successfully. Putting a plan
into action can be more difficult than coming up with it in the first place due to resistance
from staff or unexpected problems getting things done.
It is also important to undertake this type of analysis regularly because the competitive
landscape and the internal situation will be constantly changing.
The importance of strategy should not be underestimated. Changing the price of an item,
changing the distribution strategy and investing in new equipment are all important
decisions but if you are fighting in the wrong market with the wrong products then the
details are almost irrelevant. The strategy sets out where and how the battles will be
fought and a good strategy is essential to business success. This involves an
understanding not only of what happens within the firm but also the ability to forecast
changes in the external environment and their significance successfully.
As the internal and external environments change so must a firm's strategy to maintain an
appropriate fit. In "Foundations of Economics" you will read about all kinds of economic
factors that can change; these will alter a firm's playing field and the rules of the game.
This in turn means that managers need to consider carefully what team they pick and how
they decide to play the match. i.e as the economy changes the strategy may need to
change as well.

Business and Strategy: Oxford

Uploaded by

Document Informationclick to expand document information

Copyright:

Available Formats

Business and Strategy: Oxford

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Business and Strategy: Oxford

Uploaded by

Copyright:

Available Formats

Gillespie: Foundations of Economics

Additional Chapter on Business Strategy

Business and strategy

• Business as a transformation process

Our book "Foundations of Economics" obviously focuses on the economic environment of

Business as a transformation process

The advantages of being a sole trader include:

The disadvantages of being a sole trader include:

An alternative form of business is that of a company. A company has a separate legal

The benefits of creating a company include:

Why buy shares?

For information on share ownership in the UK visit:

Johnson and Johnson

Our final responsibility is to our stockholders.

Business must make a sound profit.

To be effective an objective should be SMART; this means it should be:

A strategy will usually:

One method of analysing strategies is known as the Ansoff Matrix

Existing products New products

New markets Market development Diversification

types of customer. This involves gaining an understanding of how the requirements

The functions of business

• Marketing: the marketing activities of business begin with identifying customer

promotion (what is communicated about the product and how it is communicated)

• Human resource management (HRM): all organisations rely on their employees

These functions may be undertaken by specialist departments or in the case of smaller

An organisation is therefore a complex mechanism made up of interrelating parts. What

Business and the environment

The business environment can be divided into:

Analysing the micro-environment

Porter's Five Forces analysis of market structure

The likelihood of entering a market would be lower if:

2. The power of buyers.

Buyer power will be higher if:

3. The power of suppliers.

Suppliers will be more powerful if

4. The degree of rivalry

Rivalry will be higher if:

5. The substitute threat.

On the other hands returns are likely to be low if:

PESTEL analysis of the macro-environment

• Political factors. These refer to government policy such as the degree of

• Economic factors. These include interest rates, taxation changes, economic

• Environmental factors: environmental factors include the weather and climate

Different categories of law include:

Typical PESTEL factors to consider include:

For example, a retailer undertaking PESTEL analysis may consider:

This version of PESTEL analysis is called LoNGPESTEL. This is illustrated below:

LOCAL NATIONAL GLOBAL

In "Foundations of Economics" we focus on the economic environment. We examine

Opportunities and Threats

Using PESTEL analysis

Influencing the PESTEL environment

Developing a strategy: SWOT analysis

You might also like