Notes: Unit 1

In simple terms, environment refers to the surroundings, external objects,

influences or circumstances under which someone or something exists. Famous
management scientist Keith Davis has defined environment as "the aggregate of all
conditions, events and influences that surround and affect it."

We do not include internal environment while discussing environment for the

simple reason that internal environment is controllable but external environment is
non-controllable.

Characteristics of Business Environment:

The following are the major characteristics of Business Environment:
1. It is a sum total of both internal and external forces.
2. It includes specific (to the firm) as well as general forces (Common to all firms).
3. It is dynamic (always changing) in nature.
4. Since prediction of future is difficult, it is always uncertain.
5. It varies from region to region due to STEEPLE.
More specific aims/Importance is to:

 Understand the importance of a business environment

All organisations must work within their business environment, which consists of
all the external factors that affect its operations, but which it cannot control. This
is a very complex concept, with many competing stakeholders. Managers have to
assess their environment, and then design a strategy that allows the organisation to
work successfully within it.

 Describe the factors that form an environment

The environment is a complex combination of the economic system, political
system, legal restraints, society, industry, labour relations, customer expectations,
markets, competition, technology, culture, history, infrastructure, state of the
economy, shareholder demands, natural environment, labour conditions, and so on.
We can classify these factors into five categories of the physical environment,
political and legal factors, economic factors, social and socio-cultural factors, and
technological factors. Alternatively we can consider inherent or macro factors that
give the infrastructure and framework, and competitive or micro factors that are set
by the industry and market.

 Appreciate the economic context of operations.

The type of economic system is probably the dominant factor in an organisation’s
macro environment, as it defines the basic relationships between supply and
demand. We assume that most organisations work in some kind of market
economy. Then economic analyses give a lot of essential information about costs,
supply, demand, competition, and so on.

 Discuss the concept of an industry and the features that make it attractive to an
organisation.
An industry is a group of organisations that use similar resources to make
equivalent products to satisfy the same customer demand. When planning its
products, an organisation implicitly makes a choice about the industry it works in.
many features can make an industry attractive, including the size of market,
financial performance, type of products, point in their life cycles, number and
features of customers, patterns of demand, state of competitors, basis of
competition, resource requirements, efficiency, economies of scale, levels of
technology, seasonal variations, entry and exit barriers, relations in the supply
chain, risks, and so on.

 Discuss the concept of a market and the features that make it attractive to an
organisation.
The market is the set of customers who buy – or might buy – a particular type of
product. As a rule, organisations do not like working in markets that are
aggressively competitive. This means that in more attractive markets Porter’s five
competitive forces are all weak – in other words, there is little competition from
existing organisations, weak suppliers and customers, and low chance of substitute
products and new entrants. But the market does not have to look like this, and a
well-designed strategy can allow an organisation to succeed in even the most
hostile market.

 Consider the ways that managers respond to changes in the environment.

There are continuous changes in the environment and managers have to make
appropriate responses. In effect, they have to assess potential events in the future,
and then make decisions based on the likelihood of these events occurring, and the
consequences if they do occur. Several analyses can help here, particularly
decision rules and expected values (or utilities). Then the chapter lists nine
possible reactions, ranging from ignoring potential changes (particularly if they are
unlikely to happen or if the consequences are minor) to moving to another
environment (if changes are very likely to happen and have serious consequences).

Types of Environments:

1. Macro/Contextual/General and Task Environments:

In terms of levels, environment can be categorized as general environment (also
known as the societal environment, the far environment or the macro environment)
and task environment. Forces in the general environment have a major impact at
the level of the industry.
These forces include national culture, including historical background, ideologies
and values; scientific and technological developments; the level of education; legal
and political processes; demographic factors; available resources, the international
environment; and the general economic, social and industrial structure of the
country. The task environment covers the forces relevant to an individual
organization within an industry. These include consumers, suppliers, competitors,
regulators, the local labour market, and specific technologies.
2. Micro/Immediate/Operational Environment

An organization's internal environment is composed of the elements within the

organization, including current employees, management, and especially corporate
culture, which defines employee behavior. Although some elements affect the
organization as a whole, others affect only the manager. A manager's philosophical
or leadership style directly impacts employees. Traditional managers give explicit
instructions to employees, while progressive managers empower employees to
make many of their own decisions. Changes in philosophy and/or leadership style
are under the control of the manager. The following sections describe some of the
elements that make up the internal environment.

An organization's mission statement describes what the organization stands for

and why it exists. It explains the overall purpose of the organization and includes
the attributes that distinguish it from other organizations of its type.
A mission statement should be more than words on a piece of paper; it should
reveal a company's philosophy, as well as its purpose. This declaration should be a
living, breathing document that provides information and inspiration for the
members of the organization. A mission statement should answer the questions,
“What are our values?” and “What do we stand for?” This statement provides
focus for an organization by rallying its members to work together to achieve its
common goals.

But not all mission statements are effective in America's businesses. Effective
mission statements lead to effective efforts. In today's quality‐conscious and highly
competitive environments, an effective mission statement's purpose is centered on
serving the needs of customers. A good mission statement is precise in identifying
the following intents of a company:

Customers — who will be served

Products/services — what will be produced

Location — where the products/services will be produced

Philosophy — what ideology will be followed

Company policies are guidelines that govern how certain organizational situations

are addressed. Just as colleges maintain policies about admittance, grade appeals,
prerequisites, and waivers, companies establish policies to provide guidance to
managers who must make decisions about circumstances that occur frequently
within their organization. Company policies are an indication of an organization's
personality and should coincide with its mission statement.

The formal structure of an organization is the hierarchical arrangement of tasks

and people. This structure determines how information flows within the
organization, which departments are responsible for which activities, and where
the decision‐making power rests.

Some organizations use a chart to simplify the breakdown of its formal structure.
This organizational chart is a pictorial display of the official lines of authority
and communication within an organization.

The organizational culture is an organization's personality. Just as each person

has a distinct personality, so does each organization. The culture of an organization
distinguishes it from others and shapes the actions of its members.
Four main components make up an organization's culture:

Values

Heroes

Rites and rituals

Social network

Values are the basic beliefs that define employees' successes in an organization.

For example, many universities place high values on professors being published. If
a faculty member is published in a professional journal, for example, his or her
chances of receiving tenure may be enhanced. The university wants to ensure that a
published professor stays with the university for the duration of his or her
academic career — and this professor's ability to write for publications is a value.

The second component is heroes. A hero is an exemplary person who reflects the
image, attitudes, or values of the organization and serves as a role model to other
employees. A hero is sometimes the founder of the organization (think Sam
Walton of Wal‐Mart). However, the hero of a company doesn't have to be the
founder; it can be an everyday worker, such as hard‐working paralegal Erin
Brockovich, who had a tremendous impact on the organization.

Rites and rituals, the third component, are routines or ceremonies that the company
uses to recognize high‐performing employees. Awards banquets, company
gatherings, and quarterly meetings can acknowledge distinguished employees for
outstanding service. The honorees are meant to exemplify and inspire all
employees of the company during the rest of the year.

The final component, the social network, is the informal means of communication

within an organization. This network, sometimes referred to as the company
grapevine, carries the stories of both heroes and those who have failed. It is
through this network that employees really learn about the organization's culture
and values.

A byproduct of the company's culture is the organizational climate. The overall

tone of the workplace and the morale of its workers are elements of daily climate.
Worker attitudes dictate the positive or negative “atmosphere” of the workplace.
The daily relationships and interactions of employees are indicative of an
organization's climate.
Resources are the people, information, facilities, infrastructure, machinery,
equipment, supplies, and finances at an organization's disposal. People are the
paramount resource of all organizations. Information, facilities, machinery
equipment, materials, supplies, and finances are supporting, nonhuman resources
that complement workers in their quests to accomplish the organization's mission
statement. The availability of resources and the way that managers value the
human and nonhuman resources impact the organization's environment.

Philosophy of management is the manager's set of personal beliefs and values

about people and work and as such, is something that the manager can control.
McGregor emphasized that a manager's philosophy creates a self‐fulfilling
prophecy. Theory X managers treat employees almost as children who need
constant direction, while Theory Y managers treat employees as competent adults
capable of participating in work‐related decisions. These managerial philosophies
then have a subsequent effect on employee behavior, leading to the self‐fulfilling
prophecy. As a result, organizational philosophies and managerial philosophies
need to be in harmony.

The number of coworkers involved within a problem‐solving or decision‐making

process reflects the manager's leadership style. Empowerment means delegating to
subordinates decision‐making authority, freedom, knowledge, autonomy, and
skills. Fortunately, most organizations and managers are making the move toward
the active participation and teamwork that empowerment entails.

When guided properly, an empowered workforce may lead to heightened

productivity and quality, reduced costs, more innovation, improved customer
service, and greater commitment from the employees of the organization. In
addition, response time may improve, because information and decisions need not
be passed up and down the hierarchy. Empowering employees makes good sense
because employees closest to the actual problem to be solved or the customer to be
served can make the necessary decisions more easily than a supervisor or manager
removed from the scene.
Some of the popular techniques of environment analysis are described below

1. SWOTAnalysis

It is a systematic identification or analysis of Strengths (S) Weaknesses (W)

Opportunities (O) and Threats (T) in the environment that exist internal or external

to the organisation and the strategy that reflects the best match between them. It

bases on the assumption that an effective strategy maximises a business’s strengths

and opportunities but at the same time, minimises its weaknesses and threats.

SWOT is the cornerstone of business policy formulation; which determine the

course of action to ensure the survival and growth of the firm. Economic

Technological Business Socio-cultural International Political Natural

Uses of SWOTAnalysis

• Corporate planning

• Competitor evaluation

• Business and product development

• Set objectives–defining what the organisation is intending to do.

• Environmental scanning.
• Internal appraisals of the organizations SWOT, this needs to include an

assessment of the present situation as well as a portfolio of products/services and

an analysis of the product/service life cycle.

• Analysis of existing strategies, this should determine relevance from the results

of an internal/external appraisal.

• Develop new/revised strategies – revised analysis of strategic issues may mean

the objectives need to change.

• Preparation of operational, resource, projects plans for strategy implementation.

• Monitoring results – mapping against plans, taking corrective action which may

mean amending objectives/strategies.

2. PETELS / PESTLE / PEST Analysis

PESTEL stands for Political, Economic, Social, Technological, Environmental and

Legal. Traditionally PESTEL analysis was known as the PEST (sometime

rearranged as STEP) analysis. In modern time PESTLE came into being by

splitting the social part of the PEST into environmental and economic factor into

legal factor as these factors have a significant role in the strategic management

these days. It is a strategic planning technique that provides a useful framework for

analysing the environmental pressures on an organisation. To have upper hand on

the competitors every company should do the PESTEL analysis frequently to make

necessary changes in the goals and take appropriate decisions to be alive in the

market.

3. Industry Analysis

An industry analysis is a business function completed by business owners and

other individuals to assess the current business environment. This analysis helps

businesses to understand various economic pieces of the market place and how

these pieces may be used to gain a competitive advantage. Although, business

owners may conduct an industry analysis according to their specific needs, a few

basic standards exist for conducting this important business function.

4. Competitor’s Analysis

The competitive structure of industries is a very important business environment.

Identification of forces affecting the competitive dynamics of an industry will be

very useful in formulating business strategies. According to Michael Porter’s,

“The state of competition in an industry depends on five basic competitive forces

which provides a simple perspective for assessing and analysing the competitive

strength and position of a business organisation,” which are as

1. Existing competitive rivalry between suppliers

2. Threat of new market entrants

3. Bargaining power of buyers

4. Power of suppliers

5. Threat of substitute products (including technology change)

Porter's Five Forces Model/ Five external industry forces affecting an

organization.

Porter’s five forces model is an analysis tool that uses five industry forces
to determine the intensity of competition in an industry and its profitability level.

Understanding the tool

Five forces model was created by M. Porter in 1979 to understand how five key
competitive forces are affecting an industry. The five forces identified are:
 These forces determine an industry structure and the level of competition in
that industry. The stronger competitive forces in the industry are the less profitable
it is. An industry with low barriers to enter, having few buyers and suppliers but
many substitute products and competitors will be seen as very competitive and
thus, not so attractive due to its low profitability.

It is every strategist’s job to evaluate company’s competitive position in the

industry and to identify what strengths or weakness can be exploited to strengthen
that position. The tool is very useful in formulating firm’s strategy as it reveals
how powerful each of the five key forces is in a particular industry.

1. Threat of new entrants. 

This force determines how easy (or not) it is to enter a particular industry. If an
industry is profitable and there are few barriers to enter, rivalry soon intensifies.
When more organizations compete for the same market share, profits start to fall. It
is essential for existing organizations to create high barriers to enter to deter new
entrants. Threat of new entrants is high when:

 Low amount of capital is required to enter a market

 Existing companies can do little to retaliate;
 Existing firms do not possess patents, trademarks or do not have established
brand reputation;
 There is no government regulation;
 Customer switching costs are low (it doesn’t cost a lot of money for a firm
to switch to other industries);
 There is low customer loyalty
 Products are nearly identical;
 Economies of scale can be easily achieved.

2. Bargaining power of suppliers. 

Strong bargaining power allows suppliers to sell higher priced or low quality raw
materials to their buyers. This directly affects the buying firms’ profits because it
has to pay more for materials. Suppliers have strong bargaining power when:

 There are few suppliers but many buyers;

 Suppliers are large and threaten to forward integrate
 Few substitute raw materials exist;
  Suppliers hold scarce resources;
 Cost of switching raw materials is especially high.

3. Bargaining power of buyers. 

Buyers have the power to demand lower price or higher product quality from
industry producers when their bargaining power is strong. Lower price means
lower revenues for the producer, while higher quality products usually raise
production costs. Both scenarios result in lower profits for producers. Buyers exert
strong bargaining power when:

 Buying in large quantities or control many access points to the final

customer;
 Only few buyers exist
 Switching costs to other supplier are low
 They threaten to backward integrate;
 There are many substitutes;
 Buyers are price sensitive.

4. Threat of substitutes. 

This force is especially threatening when buyers can easily find substitute products
with attractive prices or better quality and when buyers can switch from one
product or service to another with little cost. For example, to switch from coffee to
tea doesn’t cost anything, unlike switching from car to bicycle.

5. Rivalry among existing competitors. 

This force is the major determinant on how competitive and profitable an industry
is. In competitive industry, firms have to compete aggressively for a market share,
which results in low profits. Rivalry among competitors is intense when:

 There are many competitors;

 Exit barriers are high;
 Industry of growth is slow or negative;
 Products are not differentiated and can be easily substituted;
 Competitors are of equal size;
 Low customer loyalty.
Although, Porter originally introduced five forces affecting an industry, scholars
have suggested including the sixth force: complements. Complements increase the
demand of the primary product with which they are used, thus, increasing firm’s
and industry’s profit potential. For example, iTunes was created to complement
iPod and added value for both products. As a result, both iTunes and iPod sales
increased, increasing Apple’s profits.

Using the tool

We now understand that Porter’s five forces framework is used to analyze

industry’s competitive forces and to shape organization’s strategy according to the
results of the analysis. But how to use this tool? We have identified the following
steps:

 Step 1. Gather the information on each of the five forces

 Step 2. Analyze the results and display them on a diagram
 Step 3. Formulate strategies based on the conclusions

Step1. Gather the information on each of the five forces. 

What managers should do during this step is to gather information about

their industry and to check it against each of the factors (such as “number of
competitors in the industry”) influencing the force. We have already identified the
most important factors in the table below.

Step 2. Analyze the results and display them on a diagram. 

After gathering all the information, you should analyze it and determine how
each force is affecting an industry. For example, if there are many companies of
equal size operating in the slow growth industry, it means that rivalry between
existing companies is strong. Remember that five forces affect different industries
differently so don’t use the same results of analysis for even similar industries!

Step 3. Formulate strategies based on the conclusions. 

At this stage, managers should formulate firm’s strategies using the results
of the analysis For example, if it is hard to achieve economies of scale in the
market, the company should pursue cost leadership strategy. Product development
strategy should be used if the current market growth is slow and the market is
saturated.

Although, Porter’s five forces is a great tool to analyze industry’s structure and use
the results to formulate firm’s strategy, it has its limitations and requires further
analysis to be done, such as SWOT, PEST or Value Chain analysis.

5. QUEST Analysis

It is a quick environmental scanning technique which is proposed by B Nanus.

It is a four step process

1. Observe the major events and trends in the industry.

2. Speculate on a wide range of important issue.

3. Prepare a report summarising the major issues and their implications.

4. Identify feasible strategic options to deal with the evolving environment.

6. Change with Environments Changes

An organisation may use several techniques to change with its environments.

This technique is used to soften the impact of environment on the organisation.

Stocking materials, preventive maintenance, employee training, building inventory

are some of the examples of buffering. It involves allocating organisational

resources according to a system of priorities. On the one hand, buffering absorbs

environment fluctuations and on the other levelling is an attempts to reduce

fluctuations in the environment. e.g., retail firms faced with seasonal fluctuations

offer price cuts in order to spread sales more evenly throughout the year.

Under this method organisation tries to control events in the environment and

reduce its dependence on them. It mean acquiring information about probable

changes in the environment. An organisation may change itself, its operations and

output.

Benefits of Understanding the Environment

Early identification of opportunities helps an enterprise to be the first to exploit

them instead of loosing them to competitors. Environmental understanding provide

enough information regarding the need and expectation of the customer and helps

business organisation to focus towards their customers. Keeping an eye on

environment provide relevant information to the organisation in formulation of

strategy.

It makes a firm aware of the impending threat or crises, so that the firm can take

timely action to minimise the adverse effects. A business firm can improve its

image by showing that it is sensitive to its environment and responsive to the

aspiration of public.
Enterprises that continuously monitoring their environment and adopt suitable

business practices not only improve their present performance, but also succeed in

the market for a longer period.

Business leaders act as agents of change. They create a drive for change at the

gross root level. In order to decide the direction and nature of change, the leaders

need to understand the aspirations of people and other environmental forces

through environment scanning.

Environmental study helps us in getting updates regarding technological changes

and helps in making action plans to cope with such changes.

Summary:

In the process of transforming inputs into output, business organisations operate in

a multifaceted environment which affects and is affected by their activities. This

environment tends to be complex and volatile and comprises influences which are

of both a general and an immediate kind and which operate at different spatial

levels. Understanding this environment and its effects on business operations is of

vital importance to the study and practice of business.

Summary of Key Points

  Business activity is essentially concerned with transforming inputs into

outputs for consumption purposes.

 All businesses operate within an external environment which shapes their

operations and decisions.

 This environment comprises influences which are both operational and

general.

 The operational environment of business is concerned with such factors as

customers, suppliers, creditors and competitors.

 The general environment focuses on what are known as the PESTLE factors.

 In analysing a firm’s external environment attention needs to be paid to the

interaction between the different environmental variables, environmental

complexity, volatility and change and to the spatial influences.

 While all firms are affected by the environment in which they exist and

operate, at times they help to shape that environment by their activities and

behaviour.

Baileys, An Example

Aim: to give an example of the way that a major company responds to its

environment – and can even change it.

 In the 1970s, Diageo noticed an opportunity in its Dublin operations to take

advantage of a local surplus of milk – using this in an entirely new cream liqueur

that they called Baileys. This proved so successful over the next 20 years that it

used all the surplus milk around Dublin, and began to create a shortage. The

operations of Diageo were so large that they changed the features of their

environment – and particularly affecting the economics of local dairy farming.

Their next stage was carefully planned, and consisted of steps to increase the

efficiency of farmers, raising their productivity and lowering costs. Their impact

on the environment went wider, ranging from social changes as agriculture became

more attractive, to competitive forces as customers increased demand for different

types of drinks.

Questions to be discussed?

1. Some people say that organisations do not succeed by fitting their strategy to

opportunities in an existing environment, but by developing strengths to create

entirely new opportunities. What does this mean?

2. If you ask senior managers what they do, they say that they analyse

circumstances to design and implement strategies. If you watch what they do,

they spend most time reviewing past performance and justifying their previous

decisions. Why is this?