1.

1 THE BUSINESS ENVIRONMENTAL ANALYSIS

An organization is surrounded by forces emanating from within or outside the business. These forces are
largely referred to as the business environment. The business environment is divided into two; The
Internal environment Analysis and The External environment Analysis

1.1.1 THE EXTERNAL ENVIRONMENT ANALYSIS

The external environmental forces refer to a host of forces outside the organization that have the potential
to significantly influence the likely success of product or services. The factors which constitute the
external environment can be divided into:

1. Factors in the remote environment

2. Factors in the industry environment

1.1.2 FACTORS IN THE REMOTE ENVIRONMENT

The remote environment comprises factors that originate beyond and usually irrespective of any single
firms operating situation i.e. they are factors outside the control of the business.

The PESTLE framework is often used to analyze the remote environment of an organisation. PESTEL
framework categorizes environmental influences into six main types: political, economic, social,
technological, environmental and legal.

P - Political

E - Economic

S - Social

T - Technology

E - Environmental

L - Legal

1.1.2.1 Political influence

Composed of the legislature, the judiciary and the executive and poses the following implications:
This refers to how and to what degree the government intervenes in the economy. The government have
two types of objectives, social and economic objectives .its social objectives include citizen access to
health, education, water and sanitation, security, good housing facilities etc. Its economic objectives
include low inflation rate, good balance of payment and reduced unemployment rates. In order to achieve
the above the government must use the following three policies

 Monetary policy
 Fiscal policy
 Direct control

a) Monetary policy
Controlling the amount of money in the economy. This can be done using interest rates and
money supply

 Money supply
This is the actual amount of cash available in the economy. If more money is available people
will spend more

 Interest rates
This is the cost of borrowing money, if interest rates increases people will spend less, if interest
rates decreases people will spend more.

b) Fiscal policy
It related to the government decisions about how much it should taxes and how much it should
spend. If the government wants to spend it can obtain funds through borrowing or through
taxation

 Taxation
There are two types of taxes

Direct taxes and indirect taxes

Direct taxes- taxes charged on individuals or businesses they are paid directly to the government.
They are collected by KRA e.g. income tax, corporation tax
 Indirect tax -Taxes charged on goods and services they are paid through a third party first. (E.g.
shops) so they can be passed to the government e.g value added tax, stump duty e.t.c

If the government increases income tax it means consumers receive less and can only spend less.
If it increases VAT it means the prices will go up and they can only afford to spend less.

c) Direct control
The government can also affect businesses through legislations(the minimum wage rate ) and direct
policies( offering grants and cheap rent for locating in areas of high unemployment, not taxing
business located in underdeveloped areas such as north eastern and Tana delta)

The state and county government is major regulators, deregulators, subsidizers, employers and
organizations customers. These factors can provide opportunities and threats for both small and large
organizations. For industries that depend heavily on government contract or subsidies political
forecasting can be an important part of the external audit.

Below are some political factors that affect business, using an example of a business you are familiar
with find out if they are threats or opportunities for your business.

 Government regulations or deregulations

 Special tariff
 Political action committees
 Voters participation rates
 Numbers, severity and local government protests
 Level of government subsidies
 East Africa community relationships
 Import export regulations
 Government fiscal and monetary policy changes
 Political conditions in the neighboring countries
 Lobbying activities
 Size of government budget
  World oil, currency and labor markets
 Terrorist activities
 National elections
 changes in tax laws

1.1.2.2 Technological influence

Technology is constantly changing businesses must change to keep up with it. This affects businesses in
three ways, production ,workers and marketing.

a) Production

New technology can be used to improve production in the following ways

CAD/CAM &CIM

Automated factories means more can be produced in less time their is less wastage and the
business is more competitive

Robotics

They can work 24 hrs a day, they do not need a break, they are usually quick, consistent and
accurate they can also do boring jobs. They can also work in dangerous situations such as bomb
disposals.

b) workers

Technology can have both negative and positive effect on workers some of the positive effects are;
Jobs became less boring, employees are motivated, it creates the need for skills this means better
wages for the workers ,it also create s a save working environment

Let’s look at the negative effects; some workers may loose their jobs, employees who do not have the
skills become demotivated, Staff may need to be trained to cope with technology.
 c) marketing

New technology has changed the way firms market their

 Products –new products have came up and the firm must change, improve or
develop new products in order to cope with competition and stay in business or be
swept out .
 Price –access to information is much easier, with E-business the customer can
access a wide range of products. To be competitive firms are forced to sell their
products at lower prices.
 Place – distribution channels have changed even small firms can sell
internationally using the internet
 Promotion – new technology has created a variety of places to advertise, you
tube, face book
\

Below are some examples of the ways technology have affected various business

i. Airline –most airlines now offer wireless technology

ii. Automotives – vehicles are becoming wireless
iii. Banking –visa send text messages alert after unusual transaction
iv. Energy –smart meters now provide power on demand in your homes or businesses
v. Health care-patients use mobile devices to monitor their own health such as
calories consumed
vi. Hotels- day inns send daily specials and coupons to hotel guests via text messages
vii. Market research –cell phones respondents provide more honest answers because
they are away from eavesdropping ears
viii. Politics – president Obama won election by mobilizing face book MySpace users
revolutionizing political campaigns

1.1.2.3 Social cultural environment

The market in which businesses operate will constantly change; some of these changes are quantifiable,
they include social and cultural factors

Social factors include demographics while cultural factors include lifestyle and working hours

a) Social factors
Demographics is one of the factors that affect, there are two areas that businesses are concern with

 The general population- the total number of people living in certain area this will affect
the demand for products
 the working population- this are people who are of working age and are able to work, this
determine the umber of workers available to a firm

The structure of the population has continued to change in the last fifty years since Kenyan
independence this continues to change. The changes in the population are a major concern to the
business since it have an effect to the target customers.

b) Cultural factors
It refers to the behaviour of people which is determined by social interactions. This generally refers to
the trends. Two recent examples will be

 Increased awareness of health issues this has lead to changes in eating habits in addition
gym membership has increased.
 changes in working hours,- working hours are more flexible, many people choose to
work for less hours giving them more time for leisure
Social cultural changes have a major impact on virtually all products, services, markets and
customers, small and large firms are being staggered and challenged by opportunities and threats
arising from changes in cultural and social environmental variables .Kenya today is much different
than it was yesterday and tomorrow promises even more greater changes

Below is a summary of important social and cultural variables that represent opportunities or threats
for virtually all organization.

 Child bearing rates

 Number of special interest groups
 Number of marriages
 Number of divorces
 Number of births
 Number of deaths
 Immigration and emigration rates
 Social security programmes
 Life expectancy rates
 Per capita income
 Location of retailing, manufacturing and service businesses
 Lifestyles
 Traffic congestion
 Inner-city environment
 Average disposable income
 Trust in the government
 Attitudes toward the government
 Attitude towards work
 Buying habits
 Ethical concern
 Attitude toward saving
 Sex roles
 Attitude towards investing
 Racial equity
 Use of birth control
 Average level of education
 Government regulation
 Attitude toward retirement
 Attitude towards leisure time
 Attitude toward product quality
 Attitude towards customer service
 Attitude toward foreign people
 Number of churches
 Number of church members
 Social responsibility
  Attitude toward careers
 Population by race ,age ,sex and level of affluence
 Attitude toward authority
 Population by city ,country, state ,region and county
 Value placed on leisure time
 Regional changes in tastes and preferences
 Number of woman and minority workers
 Number of high school and college graduates per geographical area.

1.1.2.4 Economic influences

Businesses are affected by the economy. An economy if defined by how the government spends its
money. This is determined by economic growth, balance of payment, unemployment, inflation and
exchange rate. The government’s main economic aims are: increased production of goods and services in
the economy. Ensuring that prices that are not rising too fast. Creating jobs and ensuring as many people
employed as possible.

Economic growth

This measures how much extra the economy has produced the current year compared to the previous
years. The total amount produced is referred to as the gross domestic product

Business cycle

The growth of an economy will increase but this normally varies. This is referred to as business cycle and
it is shown below.
Boom
Graph

GDP

GROWTH
 Recession

Slump

 Boom: is characterized high level of consumer spending, business confidence, profits and
investment, unemployment is also law.
 Recession –falling levels of consumer spending and lower profits for business
 slump/depression-a prolonged period of declining GDP

Inflation

This is a general and sustained increase in prices.(when prices keeps going up becoming expensive ) it is
measured by looking at the prices of a basket of goods bought by people every month .it is quoted as a
percentage annual figure e.g. inflation of 5% means that on average things are 5% more expensive this
year than they were last year. In order to help business the government will like inflation to be low. The
question is. Why is inflation seen to have negative impact on the businesses? Higher prices means the
costs are high, people are worse off resulting to a reduction in demand of good

Unemployment

It is an economic conditions marked by the fact that individuals actively seeking jobs remain unhired.
Unemployment has both bad and good effects to businesses. more people are looking for work means
businesses’ have more to choose from, and will also pay less wages. The negative effect is people have
less money the demand will fall and profits will also go down.

Balance of payment

It measures the level of international trade that takes place,

Balance of payment = Revenue from exports – expenses from imports

If a country spends more on imports than it receives on exports it is referred to as a deficit and If a
country receives more from exports than it spend on exports it is referred to as a surplus

Exchange rate

The price of one currency in relation to another currency. its effect depends on whether a company buys
or sells products abroad .A low value currency means imports becomes expensive and exports cheap.

A summary of economic variables that often represents opportunities and threats for an organization is
provided below’

 Shift to a service economy in Kenya

 Availability of credit
 Level of disposable income
 Propensity of people to spend
 Interest rates
 Inflation rates
 Money market rates
 Government budget deficit
 Gross domestic product trends
 Worker productivity levels
 Consumption patterns
 Unemployment trends
 Value of the shilling in the world markets
 Stock market trends
 Foreign countries economic conditions
 Import /export factors
 Demand shift for different categories of goods and services
 Income differences by region and consumer groups
 Price fluctuations
 Export labour and capital from Kenya
  Monetary policies
 Fiscal policies
 Tax rate

1.1.2.5 Environmental factors:

These factors include weather, climate, and climate change which may especially affect industries such as
tourism, farming, and insurance. Furthermore, growing awareness to climate change is affecting how
companies operate and the products they offer--it is both creating new markets and diminishing or
destroying existing ones. The growing desire to protect the environment has increased among Consumers
and most of them are demanding environmental friendly products alone.

1.1.2.6 Legal factors

This refers to a country laws and how they affect a business. Business operates in an environment
controlled by legislation. Laws can be imposed by the central government or the county government.

The main areas of legislation that affect businesses are:

 Employment law
 Consumer protection
 Competition law
 Local government laws

Employment law

This is aimed at protecting the rights of employees that is the working conditions and employee
compensation for example Employers must provide safe building and machinery. They must ensure that
workers health is not affected by their work.

Consumer Protection law

This is aimed at protecting the rights of consumers – especially since consumers are sometimes in a much
weaker financial position. The examples of consumer protection legislations are

Sale and Supply of Goods Act (this states that goods must be of satisfactory quality)
Trade Description Act (goods and services must perform in the way advertised by the business)

Consumer protection imposes additional costs to businesses since they have to comply with the laws. If
they do not comply they risk fines and ultimately being put out of business by the courts of law.

Competition law

Competition law aims to ensure that fair competition takes place in each industry. Governments believe
that greater competition leads to lower prices, better quality goods and a wider variety of products. E.g
The government may implement antimonopoly legislations to encourage competition between firms.

The county government laws

A firm must take into account local bylaws and rules. The local authorities are responsible for looking
after the interests of local residents. Business are constrained by a wide range of local influences this
include environmental protection and planning permission specifications.

1.1.3 THE COMPETITIVE ENVIRONMENT (INDUSTRY ANALYSIS)

An importation part of external audit is identifying rival firms and determine their strength, weakness,
capabilities opportunities threats objectives and strategies, collecting and evaluating information on
competitors is essential for successful strategy formulation. Competition is in virtually all industries can
be intense and sometimes as cutthroat.

Good competitive intelligence in business is one of the keys to success. The more information and
knowledge a firm obtains about its competitors the more likely it is that it can formulate and implement
effective strategies. Major competitor’s weakness can represent external opportunities and major
competitor’s strengths may represent threats

Below are some of the key questions one need to ask about competitors

 What are the major competitor strengths?

 What is competitor’s weakness?
 What are the major objectives and strategies?
  How will the major competitor most likely respond to the current economic, social,
cultural, demographic, political, technological and competitive trends affecting the
industry?
 How vulnerable are major competitors to our alternative company strategies?
 How are our products or services positioned relative to major competitors?
 To what extent are new firms entering and old firms leaving this industry?
 How have the sales and profits ranking of competitors in the industry changed over recent
years why have this ranking change that way?
 What is the nature of suppliers and distributors relationship in this industry?
 To what extent could substitute products or services be a threat to competitor in this
industry ?

1.1.4 MICHAEL PORTER AND THE COMPETITIVE FORCES MODEL

Potters five force model of competitive analysis is widely used approach for developing strategies in
many industries .according to porter the nature of competitiveness in a given industry can be viewed as a
composite of five forces

 Rivalry among competing firms

 Potential entry of new competitors
 Potential development of substitutes products
 Bargaining power of suppliers
 Bargaining power of consumers

POTENTIAL
ENTRANTS

Threats of
new
entrants

Bargaining power of
buyers
INDUSTRY
SUPPLIERS COMPETITORS BUYERS

RIVALS AMONG
EXISTING FIRMS
 Bargaining
power of
suppliers Threat of
substitute’s
products or
services

SUBSTITUTES

Rivalry among competing firms

Rivalry among competing firm is usually the most powerful of the five forces. The strategies pursued by
one firm can be successful only the extent that they provide competitive over the strategies pursued by the
rival firms. Changes in strategy by one firm can be met with retaliatory countermoves such as lowering
prices enhancing quality,

Adding features providing services extending warranties and increasing advertisements.

The intensity of rivalry among competing firms tend to increase

1. As the number of competitors increases,

2. As competitor becomes more equal in size and capability ,
3. As demand for industry products decline and as price cutting becomes common.
4. Primarily also increases when consumers can switch brands easily,
5. When barriers to leaving the market are high
6. When the product is perishable
7. When consumer demand is slowly or declines such that rivals have excess capacity and
or inventory
8. when products sold are commodities not easily differentiated
 9. when rival firms diverse in strategies ,origin and culture and when merger and
acquisitions are common in the industry

as rivalry among competing firms intensifies ,industry profits declines ,in some cases to the point
where an industry becomes inherently unattractive ,when rival firms senses weakness they will
intensify both marketing and production efforts to capitalize on the opportunities

Potential entry of new competitors

New entrants to an industry bring new capacity, a desire to gain market share and position and very often
new approaches to serving customers needs. The threat of entry depends on the extent to which there are
barriers to entry. Barriers to entry are factors that need to be overcome by new entrants if they are to
compete successfully. The typical barriers are:

(i) Economies of scale – Firms already enjoying economies of scale may make it difficult for
new firms to penetrate the market e.g Coca-Cola.
(ii) The capital requirements of entry – The capital cost of entry will vary according to
technology and scale. Technology driven industries e.g mobile phone service provision,
often require high capital base.
(iii) Access to distribution channels – Established companies normally finance distribution
outlets making it difficult for new companies to distribute their products e.g EABL.
(iv) Experience – Early entrants into the market gain experience sooner than others. This
gives them an advantage in terms of cost, customers and suppliers.
(v) Expected retaliation – If an organization considering entering a market believes that the
retaliation of an existing firm will be so great as to prevent entry, or would be too costly,
this becomes a barrier e.g EABL Vs Castle Larger.
(vi) Legislation or government action – Legal restraints on competition vary from patent
protection to regulation of markets e.g pharmaceuticals and sugar industry in Kenya.
(vii) Differentiation – This means the provision of a product or service regarded by the user as
unique from and of higher perceived value than the competition. The lower the degree of
differentiation the higher the barrier to market entry.
Despite numerous barriers to entry new firms sometimes enter industries with higher quality products,
lower prices, and substantial marketing resources. The strategist’s job therefore is to identify potential
new firms entering the market, monitor the new rival’s firm’s strategies, to counterattack as needed, and
capitalize on existing strengths and opportunities. When threats of new firms entering the market is strong
incumbent firms generally fortify their position and take action to deter ne entrants such as lowering
prices, extending warranties adding features and offering financial specials

Potential development of substitute’s products

The availability of substitute products places limits on the market prices leaders can charge
before consumers can switch o substitute products. Price ceiling equates to profit ceiling and
more intense competition among rivals. This implies substitution reduces demand for a particular
class of products as customers switch to the alternatives especially when they perceive the
substitute to be higher value or benefit. competitive pressures arising from substitutes products
increases as the relative price of substitute product decline and as consumers switching costs
decreases,

Substitution may take the following forms

(i) Product for product substitution – Technological advancement may render a product
superfluous (obsolete) e.g. e-mail substitution for postal service.
(ii) Indirect substitution – Occurs when a need is substituted for by a new product e.g. instead
of hiring home guards, install surveillance camera, use a fax machine instead of a
telephone etc.
(iii) Direct substitution – Occurs when one product is substituted for by another product that
serves the same purpose e.g tea substituting coffee, a Dell computer is substituted by a
compact computer.
(iv) Generic substitution – occurs where products or services compete for the disposable
income e.g your income being hotly pursued by an electronic seller and a furniture dealer.

Key questions

 Does the substitute pose the threat of obsolescence of the company’s products?
  Can buyers switch to substitutes easily in terms of cost?
 How can you reduce risk of substitutes?

2. Buyer Power
Buyers affect the industry through their ability to force down prices, bargain for higher quality or
more services and play competitors against each other

The ultimate aim of industrial customers is to pay the lowest possible price for products or
services that it uses as inputs. Buyer power is likely to be high when some of the following
conditions prevail:

(i) There is a concentration of buyers and purchase in volumes e.g. wholesalers or

distributors.
(ii) The supplying industry comprises a large number of small operators.
(iii) There are alternative sources of supply perhaps because the product required is
undifferentiated between suppliers.
(iv) The cost of switching a supplier is low or involves little risk.
(v) There is a threat of backward integration by the buyers e.g. by acquiring a supplier.

 Supplier Power

Suppliers can affect the industry through their ability to raise prices or to reduce the
quality of purchases goods and services.

Supplier power is likely to be high when:

(i) There is a concentration of suppliers rather than a fragmented source of supply e.g a
group of banks in one street, or industries producing similar products concentrated in
industrial area.
(ii) The switching cost from one supplier to another is high. Common with chemical
products suppliers.
(iii) The brand of the supplier is powerful – for example a retailer in Kenya might not be able
to do without Coca-Cola, blue band etc.
 (iv) There is the possibility of the supplier integrating forwards if it does not obtain a good
price and hence the profit margin it seeks.
(v) The supplier’s customers are highly fragmented.
(vi) Many manufacturers faced with competitive demands for lower prices and hence the need
to reduce costs forcing the number of suppliers to reduce.

1.1.5 The External factor evaluation matrix (EFE)

An external factor evaluation (EFE) matrix allows strategists to summarize and evaluate economic, social,
cultural, demographic, environmental political and other external environmental factors

Steps in developing an EFE

1. List key external factors as identified in the external audit. Use a total of 10-20 internal
factors Including both opportunities and threats. list opportunities first then the
threats ,be as specific as possible using percentages ratios, and comparative numbers
2. Assign weigh of 0.0 (not important) to 1.0 (important) all to each factor. The weight
assigned to each factor indicates relative importance to the factor to being successful in
the firm industry. Irrespective of whether the key factor is a opportunity or threat. The
factors considered to have the greatest influence on the organization performance should
be assigned the highest weight. The sum of all weight must equal 1
3. assign a 1-4 rating to each factor to indicate how effective the current strategy respond to
the factor, the response is poor (rating=1) the response is average (rating =2)a the
response is above average (rating =3)and a the response is superior (rating=4)
4. multiply each factors weigh by its rating to determine a weighted score for each variable
5. sum the weighted score for each variable to determine the total weighted score for the
organization

Below is an example of an external factor evaluation matrix for a small tailoring shop.

Key external factor weighted Rating weighted

score
Opportunities

Access to international market using ecommerce 0.07 4 0.07

Favourable government regulation 0.08 4 0.32

New production technology introduced in the market 0.08 3 0.24

Reduction in tax rates 0.07 2 0.14

Exit of a major competitor 0.09 4 0.36

Decline in unemployment rate 0.06 3 0.18

Increase in disposable income 0.03 2 0.06

Threats

Increase Inflation rates 0.1 4 0.40

High Interest rates 0.06 2 0.12

number of competitors increases 0.06 3 0.18

Religious groups objection of the product 0.04 2 0.12

Ecommerce opened market to international competitors 0.08 2 0.16

Obsolete machines 0.04 3 0.12

Unfavourable legislation (increase in minimum wage rate ) 0.08 2 0.16

Changes in fashion trends 0.06 1 0.06

Total 1 0.02
 1.1.6 ENVIRONMENTAL UNCERTAINTY
Because strategic management deals with a wide variety of environmental issues, there is a great
likelihood of decisional uncertainty. Environmental uncertainty is classified using three variables:

1. Simple or complex

2. Stable or unstable

3. Dynamic

Simple Environment

a) A business environment that is relatively straight forward to understand and is not undergoing
significant change.
b) Example: raw material supplies and mass manufacturing companies.

Dynamic Environment

Is one characterized by a high degree of uncertainty thus encouraging active sensing of environmental
changes?

Example: Technology driven organizations like Microsoft, internet service providers etc.

Complex Environment

a) If an organization faces complex environment where it finds itself in a situation difficult to

comprehend. An environment that is both highly uncertain and dynamic.
b) Common amongst firms in the electronic industry. A multinational company faced with diversity
can equally find itself in a complex environment.

Stable Environment
The business environment is stable where there is little change emanating from environmental forces.
The degree of uncertainty is low and it is easy to comprehend the environmental charges.

Other Dimensions of Evaluating Certainty

1. Stable and Certain

2. Stable and Uncertain
3. Unstable but Certain
4. Unstable but Uncertain etc.