Unit-II

Understanding the Macro Environment: PESTEL

Analysis,
Industrial Organization (IO) & the Structure Conduct
Performance (SCP) approach,
Porter’s Five Forces Model,
Understanding the Micro Environment: Resource
Based View (RBV) Analysis,
VRIO Framework,
Using resources to gain Competitive advantage & its
sustainability,
Value Chain Analysis.
Case Studies and Latest Updates.
 Concept of Environment

• Environment literally means surroundings, external

objects, influences or circumstances under which
someone or something exist.

• Environment of any organization is “ the aggregate of all

conditions, event and influence that surround and affect
it.
• The development of mission and objectives involves
analysis and appraisal of environment.

• The results of internal and external appraisals will help

managers determine what goals and mission they can or
should adopt, and the strategic options that are available.

• Therefore, in formulating a strategy, the effective general

manager makes strategic choices which are consistent with
environmental factors. The biases or preferences for action
shape the decision makers' view of the situation.
• The Factors That Shape Strategy
 Organizations do not exist in a vacuum. Many factors enter
into the forming of a company's strategy. Each exists within
a complex network of environmental forces.

 These forces, conditions, situations, events, and relationships

over which the organization has little control are referred to
collectively as the organization's environment.
• In general terms, environment can be broken down into three
areas:
 the macro environment, or general environment (remote
environment) - that is, economic, social, political and legal
systems in the country;
 operating environment - that is, competitors, markets,
customers, regulatory agencies, and stakeholders; and
 the internal environment - that is, employees, managers,
union, and board directors.

 In formulating a strategy, the strategic decision makers must

analyze conditions internal to the organization as well as
conditions in the external environment.
 Micro-Environment

Marketing Market Types Market Demand

Intermediaries Competition

Micro-Environment Suppliers

Regulatory Financial
Provisions Availability of skilled Institutions
Industrial relation
Climate Man power
 Characteristics of Environment
• Business environment exhibits many characteristics.

• Environment is complex:-
The environment consists of a number of factors, events,
conditions and influences arising from different sources.
All in all, environment is a complex phenomenon-
relatively easier to understand in parts but difficult to grasp
in totality.
 Environment is Dynamic:-
The environment is constantly changing in nature.

 Environment is multi-faceted:-
What shape and character an environment assumes depends
on the perception of the observer.

 Environment has a Far-reaching impact:-

The growth and profitability of the organization depends
critically on the environment in which it exist.
 Internal and External Environment

• Since the environment is complex, dynamic, multifaceted

and has a far-reaching impact, dividing in to external and
internal components.

• Internal Environments:-
The internal environment refers to all factors within an
organization that impact strength and weakness of a strategic
nature.
 Strength is an inherent capacity which an organization can
use to gain strategic advantage. Example of strength are:
good reputation among customers, resources, assets, people,
experience, knowledge, data and capabilities
• Weakness is an inherent limitation or constraint which
creates strategic disadvantages. Examples of weakness are:
gaps in capabilities, financial deadlines, low morale and
overdependence on a single product line

• External Environment:-
The external environment includes all the factors outside
the organization which provide opportunity or pose threats
to the organization.
• Opportunity is a favorable condition in the organization’s
environment which enables it to consolidate and strengthen
its position. Examples of opportunity are: economic boom,
arrival new technologies, loosening of regulations,
favorable global influences and unfulfilled customer needs.

• Threat is an unfavorable condition in the organization’s

environment which crates a risk for , or causes damage to,
the organization. Examples of threat are: economic
downturn, demographic shifts, new competitors,
unexpected shift in consumer tastes, demanding new
regulations, unfavorable political or legislation, new
technology and loss of key staff.
 External Environment
• External analysis is the broader activity of understanding
the changing external environment that may impact the
organization.

• In describing external analysis, Fahey and Narayanan

(1986) suggest that organizations scan the environment to
identify changing trends and patterns, monitor specific
trends and patterns, forecast the future direction of these
changes and patterns, and assess their organizational
impact.
 Environmental Scanning
• Environmental scanning is process of gathering,
analyzing, and dispensing information for tactical and
strategic purpose.

• Environmental scanning is a concept from business

management by which businesses gather information
from the environment, to better achieve a sustainable
competitive advantage.

• To sustain competitive advantage the company must also

respond to the information gathered from environmental
scanning by altering its strategies and plans when the
need arises.
 Environmental Scanning

• In this section we turn to the methods and techniques

employed by the organizations to monitor their
environment and to gather data to derive information
about the opportunities and threats that affect their
business.

“Environmental scanning can be define as the process by

which organizations monitor their relevant environment
to identify opportunities and threats affecting their
business for the purpose of taking strategic decisions”.
• Factors to be Considered for Environmental Scanning:

• Events are important and specific occurrence taking place

in different environmental sectors.

• Trends are general tendencies or the courses of action along

which events take place.

• Issues are the current concerns that arise in response to

events and trends. demands made by interested groups in
the light of their concerns for issues
 Environmental Scanning & Monitoring- Techniques

• SWOT
• PEST
• Industry Analysis
• Competitor Analysis
 Appraising The Environment

• Factors affecting environmental appraisal:-

Given the same environmental condition, no two

strategists or two organization would appraise the
environment in a similar fashion.

This is due to the many factors that affect the process of

environmental appraisal. We identify these factors by
classifying into three categories:
1. Strategist-related factors:-
There are many factors related to the strategists, which
affect the process of environmental appraisal.

Since strategists play a central role in the formulation of

strategies, their characteristics such as age, education,
experience, motivation level, cognitive styles, ability to
withstand time pressures and strain the responsibility
have an impact on the extent to which they are able to
appraise their organization’s environment and how well
they are able to do it.
2. Organization-related factors:-

Like those of strategists, many characteristics of the

organization also have an impact on the environmental
appraise process. These characteristics are:
 the nature of the business the organization is in,
 its age , size, complexity, the nature of markets
 its operate and product or services that it provides.

 Another variable identified is of information climate,

which as assessed through the information infrastructure
implemented i.e. process, technologies and people used in
information acquisition and handling.
3. Environment-related factors:-
The nature of environment facing an organization
determines how its appraisal could be done.

The nature of the environment depends on its complexity,

volatility or turbulence, hostility and diversity. Information
processing perspective suggests that scanning activity will
increase in response to increasing environmental
uncertainty.

 In sum how well environmental appraisal is done depends

on the strategists, their organization and the environment in
which their organization and the environment in which
their organization exists.
• Identifying the environmental factors:-

Environmental scanning results in a mass of

information related to different sectors of the
environment.

A feasible approach to identify the important

environmental factors is to test each factor with regards
to its impact on the business of the organization and the
probability of such impact.

 Critical issues are those which have a high impact on

the business and a high probability of occurrence and
need immediate attention of the strategists.
 Impact on Business
__________________________________________
Probability of High Medium Low
Impact
__________________________________________
High Critical High Priority
Low Priority

Medium High Priority High Priority Low Priority

Low To be watched Low Priority Low

Priority
 High priority issues are those which have a “high or
medium impact” on the business and “high and medium”
probability of occurrence.
And those currently having a high level of impact on the
business and low probability of occurrence need to be kept
under watch.

 All other issues could be considered as being low priority

but still requiring continuous monitoring as condition may
change later.
 PESTEL Analysis

• A PESTEL analysis is a strategic framework commonly

used to evaluate the business environment in which a firm
operates.

• PESTEL analysis is a very popular tool among management

consultants to help their clients develop innovate product
and market initiatives.

• A PESTEL analysis studies the key external factors

(Political, Economic, Sociological, Technological, Legal
and Environmental) that influence the an organization.
 Political Environment
 Some of the important factors and influences operating in
the political environment are:

 The political system and its feature like nature of political

system, ideological forces, political parties and centre of
power.

 The political structure, its goals and stability.

 Political process like operation of the party system, elections,
funding of elections and legislation with respect to economic and
industrial promotion and regulation.

 Political philosophy, government’s role in the business, its

policies and interventions in economic and business
development.

• Political factors include government regulations and legal issues

and define both formal and informal rules under which the firm
must operate.
 Tax policy
 Employment laws
 Environmental regulations
 Trade restrictions and tariffs
 Political stability
 Economic Environment:
The economic environment consists of macro-level factors
related to the means of production and distribution of
wealth that have an impact on the business of an
organization.

a. The economic stage in which a country exists at a given

point of time.

b. The economic structure adopted, such as a capitalistic,

socialistic or mixed economy.

c. Economic policies such as industrial, monetary and fiscal

policies.
d. Economic planning such as five-years plans, annual
budgets.

e. Economic indices like national income, distribution of

income, rate of saving and investment, per capita income,
disposal personal income, value of exports and imports.

f. Infrastructural factors such as financial institutions, banks,

modes of transportation and communications facilities, etc.
• Economic factors affect the purchasing power of potential
customers and the firm.

• The following are examples of factors in the

macro economy

 Economic growth
 Interest rates
 Exchange rates
 Inflation rate
 Disposable income
 Inflation
 Socio-Cultural Environment
 Some of the important factors and influences operating in
the social environment are:

 Demographic characteristics, such as population, its density

and distribution, changes in populations and age
composition, inter-state migration and rural-urban mobility
and income distribution.

 Socio-cultural concerns such as environmental pollutions,

consumerism, corruption, use of mass media and the role of
business in society.
 Socio-cultural attitudes and values, such as expectations of
society from business, social customs, beliefs, rituals and
practices, lifestyle patterns and materialism.

 Family Structure and changes in it, attitudes towards and

within the family and family values.

 Role and position of men, women, children, adolescent and

aged in the family and society.

 Educational levels, awareness and consciousness of rights,

work ethic of the members of the society and attitude
towards minority and disadvantaged groups.
• Religious factor
• Major world event
• Demographics
• Consumer opinion
• Trends
• Education
• Brand preferences
 Technological Environment

• Technological Environment change can make established

products obsolete overnight and simultaneously create a
host of new product possibilities. Thus technological
change is both creative and destructive. Both an
opportunity and threat.

• The internet has changed the structure of many industries.

• Another example of medical industry.
• Technological development
• Research and development
• Associated Technology
• Patents
• Licensing
• Information technology
• Communication
 Regulatory Environment
• Some of the important factors and influences operating in
the regulatory environment are as follows:

 The constitutional framework, directive principles,

fundamental rights and division of legislative powers
between the Central, State and local governments.

 Policies related to licensing, monopolies and pricing and

their control.

 Other policies related to the public sector, small-scale

industries, sick industries, development of back war
areas, control of environmental pollutions and consumer
protection.
• Employment Law
• Consumer Protection
• Industry specific regulations
• Competitive regulations
• Environmental regulation
 Environmental Factor

• Environmental factors have to do with geographical

locations and other related environmental factors that may
influence upon the nature of trade. For example agri-
business hugely depend on this form of analysis.
• Ecological
• Environmental issues
• Environmental regulations
 Industrial Organization
• Industrial organization is a field of economics dealing with the
strategic behavior of firms, regulatory policy, antitrust policy
and market competition.

• It is the study of how to best organize an industry for

maximum profits. It is crucial concept in business
management because it helps companies gain a competitive
advantage. It examines both the economic and technical
aspects.

• Industrial organizations should be understood as a

combination of market structure, economic policy and social
structure that influences a firm’s performance within a market.
 Types of Industrial Organization
• Industrial organization structure is the type of business
structure that firms employ to organize their operations. The
main types of industrial organization are:

• Partnership Organization: Formed by two or more people

who work together for profit making or profit sharing.

• Sole Proprietorship: Owned and controlled only by one

person and not incorporated and organized under civil law
and not subject to company law or other legal entity law.
• Corporate Organization: Formed by a group of
individuals who combine their financial resources to buy
a company with the goal of profit maximization.

• First two have similar responsibilities while a corporation

has greater legal protection and can receive funding from
outside sources.
• Industrial Organization and Policy:
• The study of industrial organization and policy includes the analysis
of the operating environment and legal and political aspects of
economic activity.

• The goal is to produce efficiency through aligning incentives and by

regulating market forces that can be detrimental to consumer of firms.

• Industrial Organization Markets and Strategy:

• The study of industrial organization markets and strategy is concerned
with how firms in a particular industry create, maintain, and exploit
their market power.

• Industrial organization are concerned with selling products and selling

their image and brand, which involves advertising, marketing, public
relations, strategy development and all other aspects of marketing.
 Structure Conduct Performance Model
• The structure conduct performance model refers to an
analytical framework that explains the connection between
economic or market structure, market conduct and its
performance.

• This is a concept or model in Industrial Organization

Economics that examines and describes the interaction
between organization structure (environment), organizational
conduct (behavior) and organizational performance
(achievement).

• The Structure Conduct Performance Model presents a casual

theory explanation of these three concepts.
• The structure-conduct-performance (SCP) paradigm argues
that market structure is a determinant of firm conduct which
in turn determines performance.

• Market structure can be measured by a number of factors

such as the number of competitors in an industry, the
heterogeneity of products, and the cost of entry and exit.

• Conduct refers to the specific actions taken by firms such as

price-taking, product differentiation, and exploitation of
market power.

• The performance of a firm can be reflected by a number of

indicators such as productive efficiency, allocative efficiency
and profitability.
 Resource Based View Analysis (RBV)

• The resource based view is a managerial framework used

to determine the strategic resources a firm can exploit to
achieve sustainable competitive advantage.

• According to resource-based theory organizations that

own “strategic resources” have important competitive
advantages over organizations that do not.

• A resource is strategic that is valuable, rare, difficult to

imitate, and organized to capture value.
• Resources and capabilities are the basic building blocks that
organizations use to create strategies. These two building
blocks are tightly linked—capabilities from using resources
over time.

• Resources can be divided into two main types: tangible and

intangible. Physical assets such as plant and equipment are
considered to be tangible resources. Intangible resources
include knowledge and skills of employee, a firm reputation
and culture.

• In comparing the two types of resources are more likely to

meet the criteria for strategic resources (i.e., valuable, rare,
difficult to imitate, and organized to capture value) than are
tangible resources.
• Executives who wish to achieve long-term competitive
advantages should therefore trying to nurture and develop
their firms’ tangible resources.

• Capabilities are another key concept within resource-

based theory.

• An effective way to distinguish resources and capabilities

is this: resources refer to what the organization own,
capabilities refer to what the organization can do.
Capabilities tend to arise over time as a firm takes actions
that build on its strategic resources.
 Organizational Analysis

• All organizations have strengths and weakness that lead

to their having capabilities. These capabilities stand the
organizations in good stead when they compete for
resources, customers and market share.

• In strategic management, we give a lot of importance to

an organization’s capabilities as these are central to their
achieving strategic advantage for gaining long term
success.
• Dynamics of Internal Environment
Strategic Advantage

Organizational
Capability

Competencies

Synergistic

Strength and Weakness

Organizational Organizational
Resources Behaviour
• An organization uses different types of resources and
exhibits a certain type of behavior.

• The interplay of these different resources along with

the prevalent behavior produces synergy and dysergy
within an organization, which leads to the
development of strengths and weakness over a period
of time.

• The resources, behavior, strength and weakness,

synergistic effects and competencies of an
organization determine the nature of its internal
environment.
 VRIO Model
• The VRIO model is a strategic analysis framework
applied during the internal analysis of strategic planning.
The framework is based on the evaluation of resources
and capabilities of an organization.

• VRIO is acronym for four basic questions the framework

evaluates over the capabilities and resources. These are
• Value
• Rarity
• Imitability
• Organization
• Value: Does the resources/capability enables the
organization to exploit an opportunity or block the an
external threat. If it does, the resources can be considered
a strength of the organization.

• Rarity: Does control of this resources in hands of a few.

The rarity concept of the VRIO framework requires that
the resources labeled meet the short supply and
persistence over time condition. If these are not met, the
resource cannot generate a sustainable competitive
advantages.
• Imitability: Is the resources difficult to imitate? Does this
resource generate a cost advantage to the competing
organizations trying to obtain or develop? Imitation can
occur in two ways: by directly imitating the resource or by
providing the substituting with a comparable resource.

• Organization: Is the organization structured, built and able

to exploit the resources? The resource capability do not
guarantee any competitive advantage for an organization by
itself. The firm needs to be organized to capture the value
from them. The organization is based on management
system, processes, policies, structure and culture.
 Value Chain Analysis
• Porter (1985) is credited with the introduction of the
framework called value chain. This is a method for assessing
the strengths and weaknesses of an organization based on an
understanding of the series of activities it performs.

• The term value chain refers to the various business activities

and processes involved in creating a product or performing a
service.

• Value chain analysis is a means of evaluating each of the

activities in a company's value chain to understand
where opportunities for improvement lie.
• A value chain can consist of multiple stages of a product or
service’s lifecycle, including research and development,
sales, and everything in between.

• “A value chain analysis is a set of interlinked value-creating

activities performed by an organization”.

• These activities may begin with the procurement of basic

raw materials and go through processing in various stages
right up to the end products marketed to the ultimate
consumer.
 Components of a Value Chain

• The value chain of a company may be linked to the

value chain of its upstream supplier and downstream
buyers, forming a series of chain that Porter terms as
the value system.

• According to Porter’s definition, all of the activities

that make up a firm's value chain can be split into two
categories that contribute to its margin: primary
activities and support activities.
 Firm Infrastructure
(Company overhead, Management etc.)

Human Resource Management

(Recruitment, Selection, Training, Compensation etc.)
Support
Activities Technology Development
(Research & Development, Product design, Market Profit
Research etc.) margin
Procurement
(Sourcing of raw material, Component, Equipment etc.)

Inbound Operation Marketing

Outbound
Logistic And
Logistic Service
Sales

Primary Activities
• Porter divided the value chain of a manufacturing
organization in to primary and support activities. Primary
activities are directly related to the flow of the product to
the customer and include five sub-activities as listed
below:

 Inbound Logistics:
All activities that an organization uses for receiving,
storing and transporting inputs going into the production
process.
Typical inbound logistics activities performed in
organizations are:
 material handling,
 warehousing and
 inventory control.
 Operations:
All activities required for transformation of raw materials to
finished products.
Typical operations activities performed in organizations are
assembling, fabricating, machining, maintaining and
packaging.

 Outbound Logistics:
All activities that an organization uses for receiving , storing
and transporting out-puts going out of the production process.
Typical outbound logistics activities performed in an
organization are of
material handling, order processing, physical distribution,
and ware housing.
 Marketing and Sales:
All activities that an organization uses to market and sell
its products to customer.

Typical marketing and sales activities performed by an

organizations are of pricing, developing products,
advertising, promoting and distributing.

 Service:
All activities that an organization uses for enhancing and
maintaining a product’s value.

Typical service activities performed by organizations are

installation, repair, maintenance and customer training.
• Support activities are provided to sustain the primary
activities. These consist of:

 Firm Infrastructure:
All activities that an organization uses for ascertaining
the external opportunities and threats, identifying
strengths and weaknesses and generally managing the
organization for achieving its objectives.

Typical firm infrastructure activities performed by

organizations are of accounting, finance, planning,
general management, legal support and managing
government relations.
 Human Resource Management:
All activities that an organization uses for managing
human resources. Typical human resource management
activities performed by organizations are of recruitment,
selection and training, developing, appraising and
compensating employees.

 Technology Development:
All activities that an organization uses for creating,
developing and improving products and services.
Typical technology development activities performed by
organizations are research and development, product
design, process design, equipment design and servicing
procedure.
 Procurement:
All activities that an organization uses for
procuring inputs needed to produce products
or provide services. Typical procurement
activities performed by organizations are
purchasing fixed assets such as machinery and
equipments, raw materials and supplies.
• The value chain analysis requires:
 Identifying the activities that make up the
organization’s value chain and classifying them into
primary and support activities.

 Identifying the things done in those activities that

contribute to providing value for the customer.

 Identifying how the value contribution can be increased

so that it costs less to provide the same or more value
there by increasing the profit margin for the
organization

 Identifying how the value configuration could be

improved by innovatively reconfiguring or
recombining activities.
• The technique of value chain analysis has some
limitations:
 The technique is deceptively simple but
difficult to implement.

 It applies to industrial organizations and needs

to be adapted for application to service
organizations.

 The concept of value is hazy. It is difficult to

say what constitutes value for the customer.
 The determination of cost cannot rely on
traditional cost accounting methods. Activity-
based costing is required to assess the correct
estimates of costs.

 The application of information technology

upsets the calculations in the value chain
analysis as often, it results in increasing value
and reducing costs simultaneously.
 Industry Analysis
• An industry is defined as a group companies offering
products or services that are close substitutes of each
other.

• Michael E Porter hats made immense contribution to the

development of the ideas of industry and competitor
analysis, and their relevance to the formulation of
competitive strategies.

• He advocates that a structural analysis of industries be

made so that a firm is in a better position to identify its
strength and weakness.
• A model consisting of five competitive forces
has been proposed-
1. Threat of new entrants

2. Rivalry among competitors

3. Bargaining power of suppliers

4. Bargaining power of buyers

5. Threat of substitute products

 Potential threats from
Firm’s which make
Substitutes products
Or service

Suppliers Forces of competition Buyer’s

Bargaining Power Created by rivalry Bargaining Power

Potential threat from

Entry of new firms
• Threat of new entrants:
Any industry that is perceived as being profitable tends
to attract new entrants.

These new entrants are firms that are interested in

investing in the industry to share the growth prospects.

The chance that new entrants will enter into an industry

depends on two factors:
1.The entry barriers to an industry
2. Expected retaliations from existing firms
• The concept of entry barriers implies that there are
substantial costs involved in entering into a new
industry.

• The higher the entry barriers in an industry, the less

likely are the new entrants to enter that industry.

• So higher entry barriers serve to keep out potential

entrants into an industry.

• The entry barriers may arise as a consequence of

several factors such as:

 Capital requirement being very high may prevent new

entrants from making investment.
 Switching costs from the existing products or services
to a new one may discourage customers from making
new commitments owing to the costs incurred in
buying new ancillary equipment, retraining employees
or establishing a new network of relationship.

 Product differentiation by existing firms based on

perceived distinctiveness by the customers based on
effective advertising, reputation as a service provider,
brand loyalty of customers towards existing firms or
some such other factor.
• Besides the entry barriers, the expected
retaliations to the new entrants from the existing
firms may be a potential threat to entry.

• For example, an existing firm with a large stake

in the industry may lower its price to create a
difficult situations for the new entrants.
 Rivalry among competitors
• Firms with an industry are mutually dependent. The
situation in an industry keeps changing with the action
and reaction of the constituent firms.

• The desire to be the market leader or to corner a large

market share leads to rivalry among competitors.

• The extent of rivalry among competitors in an industry

affects the competition within that industry.

• When the rivalry is weak, there is likely to be the lesser

competition; when such rivalry is high, the level of
competition is higher.
• The dimensions of such rivalry among competitors
are several. Some of the major ones are described
below:

 Competitive structure refers to the number of

competitors, their size, and their diversity. Different
types of competitive structures have different
implications for the existing firms and for new
entrants. Structures vary from being fragmented to
consolidated. A fragmented structures means that
there are a large number of small or medium sized
companies, none of them in a position to dominate
the industry.
This structure is characterized by low entry barriers
and less or no differentiation, leading to products
becoming commodities.

Competition is intense and industry faces booms and

busts leading to frequent changes in the industry.

A consolidated structure consists of a few large

companies (an Oligopolistic market) or just one large
firm (Monopoly).
 Bargaining Power of Buyers
• The bargaining power of buyers constitutes the ability of
the buyer individually or collectively, to force a
reduction in prices of products or services, demand a
higher quality or better services or to seek more value
for their purchase in any way.

• A higher buyer bargaining power constitutes a negative

feature for existing or new entrants.
 Bargaining Power of Suppliers
• The bargaining power of suppliers constituent their
ability, individually or collectively to force an increase
in the price of products or services or make the buyer
accept a lower quality of product or level of service.

• The bargaining power of suppliers is high under these

conditions:
 When the suppliers are few and the buyers are many.
 When the services or products are unique and are not
commonly available.
 When the substitutes of the products and
services supplied are not freely available.

 When the switching costs of a supplier from

one buyer to the other is low.
 Threat of Substitute Products

• Substitute products or services are those that

apparently are different, but satisfy the same set of
customers needs.

• We refer to the example of tea and coffee. Other

example of substitute product or services could be
alternative transport modes, postal, fax and courier
services and electric gadgets like bulbs and tube lights.