CHAPTER THREE

3. ENVIRONMENTAL ANALYSIS AND APPRAISAL

3.1 Why Environmental analyses?
Strategic managers need to analyze the environment, since environmental factors are primary influencers of
strategy. Environmental analysis gives the strategic manager time to anticipate opportunities and to plan
alternative responses to those opportunities. It also helps them to develop an early warning system either to
prevent threats or develop strategies which may turn a threat to the organization’s advantage.
Apart from knowing the environment itself, the behavior of the environment has also to be understood as the
response pattern depend upon behavioral situations. Depending up on the behavior, reactions or responses from
the organization could be as under:
 Reactive, i.e., to respond after something has happened.
 Inactive, i.e., no response at all
 Preactive, i.e., to predict and prepare
 Proactive, i.e., to influence the decision and plan accordingly.
The primary responsibility for environmental analysis rests with the top management. If the firm is a multi-
business firm, the responsibility is also shared by the heads of the strategic business units. Research staff usually
helps and advise top management. The environment of any organization is “the aggregate of all conditions,
events and influences that surround and affect it”. Since the environment influences an organization in
multitudinous ways, it is of crucial importance to understand it.
The concept of environment can be understood by looking at some of its characteristics. Environment exhibits
many characteristics. Some of the important, and obvious, characteristics are briefly described here.
1. Environment is complex. The environment consists of a number of factors, events, conditions, and
influences arising from different sources. All these do not exist in isolation but interact with each other to create
entirely new sets of influences. It is difficult to comprehend at once what factors constitute a given environment.
All in all, environment is a complex phenomenon relatively easier to understand in parts but difficult to grasp in
its totality.
2. Environment is dynamic. The environment is constantly changing in nature. Due to the many and varied
influence operating, there is dynamism in the environment, causing it to change its shape and character
continuously.
3. Environment is multifaceted. What shape and character an environment will assume depends on the
perception of the observer. A particular change in the environment, or a new development, may be viewed
differently by different observers.
4. Environment has a far-reaching impact. The growth and profitability of an organization depends critically
on the environment in which it exists.

3.2 External Environmental Analysis/ An External Audit

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An external audit focuses on identifying and evaluating trends and events beyond the control of a single firm,
such as increased foreign competition, information technology, and the computer revolution. An external audit
reveals key opportunities and threats confronting an organization so that managers can formulate strategies to
take advantage of the opportunities and avoid or reduce the impact of threats.
The purpose of an external audit is to develop a finite list of opportunities that could benefit a firm and threats
that should be avoided. As the term finite suggests, the external audit is not aimed at developing an exhaustive
list of every possible factor that could influence the business; rather, it is aimed at identifying key variables that
offer actionable responses. Firms should be able to respond either offensively or defensively to the factors by
formulating strategies that take advantage of external opportunities or that minimize the impact of potential
threats.
The external environmental analysis consists of:
• The general environment
• The industry environment
General/ Macro Environment
Macro environment can be divided into five broad categories: Economic environment, Social- cultural,
demographic environment, Political and legal environment, Technological environment, and natural
environments. External trends and events significantly affect all products, services, markets, and organizations
in the world. Changes in external forces translate into changes in consumer demand for both industrial and
consumer products and services. External forces affect the types of products developed, the nature of positioning
and market segmentation strategies, the types of services offered, and the choice of businesses to acquire or sell.
In addition, macro environment directly affect both suppliers and distributors. Identifying and evaluating
external opportunities and threats enables organizations to develop a clear mission, to design strategies to
achieve long-term objectives, and to develop policies to achieve annual objectives.
1. Economic Environments:
Key Economic Variables to Be Monitored
 Availability of credit  Federal government budget deficits
 Level of disposable income  Import/export factors
 Propensity of people to spend  Price fluctuations
 Interest rates  Monetary policies
 Inflation rates  Fiscal policies
 Money market rates  Tax rates
2. Socio- Cultural and Demographic Environments; social forces involve the beliefs, values, attitudes,
opinions and life styles of those in firm’s external environment as developed from ecological, demographic,
religious, educational, and ethnic conditioning.
Social, cultural, and demographic changes have a major impact upon virtually all products (Preferences
change), services, markets, and customers. Small, large, for-profit and nonprofit organizations in all
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 industries are being staggered and challenged by the opportunities and threats arising from changes in social,
cultural, and demographic variables
Key Social, Cultural, and Demographic variables

 Childbirth rates  Number of births

 Number of special interest groups  Number of deaths
 Number of marriages  Immigration and emigration rates
 Number of divorces  Social security programs
3. Political Environment
The Key variables of Political forces to be monitored include;

 Government regulations or deregulations  Voter participation rates

 Changes in tax laws  Number, severity, and location of government
 Special tariffs protests
 Political action committees  Number of patents
4. Technological Environments
Technology can be simply defined as the application of knowledge to practical solutions or tasks. To avoid
obsolescence and promote innovation, a firm must be aware of technological changes that might influence its
industry. Creative technological adaptations can affect planning in that new products may be suggested or

existing ones improved; manufacturing and marketing techniques may also improve. Some examples of the
technological environment include disruptive technologies, artificial intelligence, IoT, new production processes,
and machine learning.
5. Natural environment
Natural environment also affects strategies. Positive climatic conditions may favor some firms. To support this
we give the example. The chairman stated. “Monsoon has also been kind and the excellent rains will give a boost
to agricultural production and consequently to the sale of fertilizers. The company chairman further stated: our
company is also considering setting up a foundation for environmental research, education information and eco-
regeneration.” All this is being done with a view to prepare the company to face the future environmental laws
and the emerging needs.
Micro-Environment/Industry analysis
Analysis of the industry environment is focused on the factors & conditions influencing the firm’s profitability
in the industry. An industry is a group of firms producing products that are close substitutes Firms that influence
one another including a rich mix of competitive strategies that companies use in pursuing strategic
competitiveness & above-average returns. Compared to the general environment, the industry environment has a
more direct effect on the firm’s strategic competitiveness and above-average returns

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 3.3 Porter’s Five Forces’ Model of Industry Analysis
Michael E. Porter of the Harvard School of Business Administration has developed a framework that helps
managers for analyzing the nature and extent of competition within an industry. He says that there are five
competitive forces, which determine the degree of competition within an industry. And the framework is known
as the Porter’s five forces model. This model focuses on five forces that shape competition within an industry.
The Porter’s “Five-Force” competition Model: - A key Analytical Tool

1. The Threat of New Entrants to the Industry

A new entrant into industry represents a competitive threat to existing firms. It adds new production capacity and
potential to erode the market share of the existing industry. New entrants into the industry are potential
competitors. Existing (established) organizations try to discourage potential competitors from entering, since the
more organizations enter an industry, the more difficult it becomes for established organizations to hold their
share of the market and to generate success. Thus a high risk of entry by potential competitors represents a threat
to the profitability of established organizations.

On the other hand, if the risk of new entry is low, established organizations could take advantage of this
opportunity to raise prices and earn greater returns. The strength of the competitive forces of potential rivals is
largely a function of the height of barriers to entry. The concept of barriers to entry implies that there are
significant costs in joining an industry. The greater the costs that potential competitors must bear, the greater are
the barriers to entry. High entry barriers keep potential competitors out of an industry even when industry returns
are high.

The principal sources of barriers to entry are:

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  Brand loyalty and switching cost  Access to distribution channels
 Capital requirement  Government and legal barriers
 Product differentiation  Retaliation by established producers
2. The Threat of Substitute Products
In many industries, firms are in close competition with producers of substitute products in other industries. The
presence of substitute products puts a ceiling on the price that can be charged before the consumers will switch
to the substitute product. Competitive pressures arising from substitute products increase as the relative price of
substitute products declines and as consumers’ switching costs decrease.
3. The Bargaining Power of Buyers
Buyers of an industry product can exert bargaining power over that industry by forcing prices down, by reducing
the amount of good they purchased from the industry, and by demanding better quality for the same price.
When customers are concentrated, large, or buy in volume, their bargaining power represents a major forces
affecting intensity of competition in an industry. Rival firms may offer extended warranties or special services
to gain customer loyalty whenever the bargaining power of consumer is substantial.
Bargaining power of consumers is also higher when the products being purchased are standard or
undifferentiated. When this is the case, consumers can often negotiate selling price, warranty coverage, and
necessary packages to a greater extent.
4. The Bargaining Power of Suppliers
The bargaining power of suppliers that can be viewed as a threat when they are able to force up the price that an
organization must pay for input or reduce the quality of goods supplied, thereby depressing the organization’s
success. Alternatively, week supplies give a company the opportunity to force down prices and demand higher
quality.
The power of suppliers is high in the following situations:
 There are few suppliers who are more concentrated than their customers
 Suppliers’ product is differentiated
 Customers switching costs are high
 There is little pressure on suppliers to protect themselves from substitutes or replacements for their
product
5. Rivalry among Established/Existing Organizations
It describes the intensity of rivalry among competitors or established organizations within in the industry. If this
competitive force is weak, organizations have an opportunity to raise prices and earn grater profits. But if it is
strong, significant price competition, including price wars, may result from the intense rivalry. Price competition
limits profitability by reducing the margins that can be earned on sales.
Porter argues that
 The stronger each of these forces, the more limited is the ability of established organizations to raise
prices and earn greater profits.
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  Within porter’s framework, a strong competitive force can be regarded as a threat since it depresses
success.
 A weak competitive force can be viewed as an opportunity, for it allows an organization to get better
success. Because of factors beyond an organization direct control, such as industry evolution, the
strength of the five forces may change through time. In such circumstances, the task facing strategic
managers is to recognize opportunities and threats as they arise and to formulate appropriate strategic
responses.
 In addition, it is possible for organizations, through its strategy, to alter the strength of one or more of
the five forces to its advantages.
3.4 Internal Assessment/ Internal Audit
Involvement in performing an internal strategic-management audit provides vehicle for understanding nature and
effect of decisions in other functional business areas of the firm. All organizations have strengths and
weaknesses in the functional areas of business. No enterprise is equally strong or weak in all areas. Internal
strengths/weaknesses, coupled with external opportunities/threats and a clear statement of mission, provide the
basis for establishing objectives and strategies. Objectives and strategies are established with the intention of
capitalizing upon internal strengths and overcoming weaknesses.
Internal audit creates an environment of coordination and understanding among managers from all functional
areas. Internal audit is parallels process of external audit. It gathers & assimilates information from:
 Management
 Marketing
 Finance/accounting
 Production/operations
 Research & development
 Management information systems
1) MANAGEMENT
The functions of management consist of five basic activities: planning, organizing, motivating, staffing, and
controlling.
Planning- Planning consists of all those managerial activities related to preparing for the future. Specific tasks
include forecasting, establishing objectives, devising strategies, developing policies, and setting goals. Strategy
Formulation
Organizing- Organizing includes all those managerial activities that result in a structure of task and authority
relationships. Specific areas include organizational design, job specialization, job descriptions, job
specifications, span of the control, and unity of command, coordination, job design, and job analysis.
Motivating- Motivating involves efforts directed toward shaping human behavior. Specific topics include
leadership, communication, work groups, behavior modification, and delegation of authority, job enrichment,
job satisfaction, needs fulfillment, organizational change, employee morale, and managerial morale.
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Staffing- Staffing activities are centered on personnel or human resource management. Included are wage and
salary administration, employee benefits, interviewing, hiring, firing, training, management development,
employee safety, affirmative action, equal employment opportunity, union relations, career development,
personnel research, discipline policies, grievance procedures, and public relations.
Controlling- Controlling refers to all those managerial activities directed toward ensuring that actual results are
consistent with planned results. Key areas of concern include quality control, financial control, sales control,
inventory control, and expense control, analysis of variances, rewards, and sanctions.
2) MARKETING
Marketing can be described as the process of defining, anticipating, creating, and fulfilling customers' needs and
wants for products and services.
There are seven basic functions of marketing:
(1) Customer analysis, (5) Distribution,
(2) Selling products/services, (6) Marketing research, and
(3) Product and service planning, (7) Opportunity analysis.
(4) Pricing,
Understanding these functions helps strategists identify and evaluate marketing strengths and weaknesses.
Customer Analysis
Customer analysis—the examination and evaluation of consumer needs, desires, and wants—involves
administering customer surveys, analyzing consumer information, evaluating market positioning strategies,
developing customer profiles, and determining optimal market segmentation strategies. The information
generated by customer analysis can be essential in developing an effective mission statement. Customer profiles
can reveal the demographic characteristics of an organization's customers. Buyers, sellers, distributors,
salespeople, managers, wholesalers, retailers, suppliers, and creditors can all participate in gathering information
to identify customers' needs and wants successfully. Successful organizations continually monitor present and
potential customers' buying patterns.
Selling Products/Services Successful strategy implementation generally rests upon the ability of an
organization to sell some product or service.
Selling includes many marketing activities such as advertising, sales promotion, publicity, personal selling, sales
force management, customer relations, and dealer relations. These activities are especially critical when a firm
pursues a market penetration strategy. The effectiveness of various selling tools for consumer and industrial
products varies. Determining organizational strengths and weaknesses in the selling function of marketing is an
important part of performing an internal strategic management audit.
Product and Service Planning Product and service planning includes activities such as test marketing; product
and brand positioning; devising warranties; packaging; determining product options, product features, product
style, and product quality; deleting old products; and providing for customer service.
Pricing
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Five major stakeholders affect pricing decisions:

 Consumers,  Distributors,
 Governments,  Competitors.
 Suppliers,
Distribution
Distribution includes warehousing, distribution channels, distribution coverage, retail site locations, sales
territories, inventory levels and location, transportation carriers, wholesaling, and retailing.
Marketing Research Marketing research is the systematic gathering, recording, and analyzing of data about
problems relating to the marketing of goods and services. Marketing research can uncover critical strengths and
weaknesses, and marketing researchers employ numerous scales, instruments, procedures, concepts, and
techniques to gather information. Marketing research activities support all of the major business functions of an
organization. Organizations that possess excellent marketing research skills have a definite strength in pursuing
generic strategies.
Opportunity Analysis
The seventh function of marketing is opportunity analysis, which involves assessing the costs, benefits, and risks
associated with marketing decisions. Three steps are required to perform a cost/benefit analysis:
 Compute the total costs associated with a decision,
 Estimate the total benefits from the decision, and
 Compare the total costs with the total benefits. As expected benefits exceed total costs, an opportunity
becomes more attractive. Sometimes the variables included in a cost/benefit analysis cannot be
quantified or even measured, but usually reasonable estimates can be made to allow the analysis to be
performed. One key factor to be considered is risk. Cost/benefit analyses should also be performed when
a company is evaluating alternative ways to be socially responsible.

3) Accounting / Finance
Financial condition is often considered the single best measure of a firm's competitive position and overall
attractiveness to investors. Determining an organization's financial strengths and weaknesses is essential to
formulating strategies effectively. A firm's liquidity, leverage, working capital, profitability, asset utilization,
cash flow, and equity can eliminate some strategies as being feasible alternatives. Financial factors often alter
existing strategies and change implementation plans.
Finance/Accounting Functions
 Determining financial strengths and weaknesses key to strategy formulation
 Investment decision (Capital budgeting)
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  Financing decision
 Dividend decision
4) Production/Operations
The production/operations function of a business consists of all those activities that transform inputs into goods
and services. Production/operations management deals with inputs, transformations, and outputs that vary across
industries and markets. A manufacturing operation transforms or converts inputs such as raw materials, labor,
capital, machines, and facilities into finished goods and services.
5) Research And Development
The fifth major area of internal operations that should be examined for specific strengths and weaknesses is
research and development (R&D). Many firms today conduct no R&D, and yet many other companies depend
on successful R&D activities for survival. Firms pursuing a product development strategy especially need to
have a strong R&D orientation. The purpose of research and development are as follows:
 Development of new products before competition
 Improving product quality
 Improving manufacturing processes to reduce costs. Organizations invest in R&D because they believe
that such investment will lead to superior product or services and give them competitive advantages.
Research and development expenditures are directed at developing new products before competitors do,
improving product quality, or improving manufacturing processes to reduce costs.
6) Management Information Systems
MIS is a general name for the academic discipline covering the application of information technology to
business problems. As an area of study it is also referred to as information technology management. The study of
information systems is usually a commerce and business administration discipline, and frequently involves
software engineering, but also distinguishes itself by concentrating on the integration of computer systems with
the aims of the organization.
The area of study should not be confused with computer science which is more theoretical in nature and deals
mainly with software creation, or computer engineering, which focuses more on the design of computer
hardware. IT service management is a practitioner-focused discipline centering on the same general domain. In
business, information systems support business processes and operations, decision-making, and competitive
strategies.
Value Chain Analysis (VCA)
Value chain analysis (VCA) refers to the process whereby a firm determines the costs associated with
organizational activities from purchasing raw materials to manufacturing product(s) to marketing those products.
VCA aims to identify where low-cost advantages or disadvantages exist anywhere along the value chain from
raw material to customer service activities. VCA can enable a firm to better identify its own strengths and
weaknesses, especially as compared to competitors’ value chain analyses and their own data examined over
time.
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In order to better understand the activities leading to a competitive advantage, one can begin with the generic
value chain and then identify the relevant firm-specific activities. A linkage exists if the performance or cost of
one activity affects that of another. Competitive advantage may be obtained by optimizing and coordinating
linked activities. The value chain also is useful in outsourcing decisions.
Michael Porter suggested that the activities of a business could be grouped under two headings
(1) Primary Activities- those that are directly concerned with creating and delivering a product (e.g.
component assembly); and
(2) Support Activities which whilst they are not directly involved in production, may increase effectiveness or
efficiency (e.g. HRM). It is rare for a business to undertake all primary and support activities.

Value Chain Analysis is one way of identifying which activities are best undertaken by a business and which are
best provided by others ("out sourced"). The value chain shows how a product moves from the raw-material
stage to the final customer.
The goal of these activities is to create value that exceeds the cost of providing the product or service, thus
generating a profit margin.
• Inbound logistics include the receiving, warehousing, and inventory control of input materials.
• Operations are the value-creating activities that transform the inputs into the final product.

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 • Outbound logistics are the activities required to get the finished product to the customer,
including warehousing, order fulfillment, etc.
• Marketing & Sales are those activities associated with getting buyers to purchase the product,
including channel selection, advertising, pricing, etc.
• Service activities are those that maintain and enhance the product's value including customer
support, repair services, etc.
Support Activities
The primary value chain activities described above are facilitated by support activities. Porter identified
four generic categories of support activities, the details of which are industry-specific
• Procurement the function of purchasing the raw materials and other inputs used in the value-
creating activities
• Technology Development includes research and development, process automation, and other
technology development used to support the value-chain activities
• Human Resource Management the activities associated with recruiting development, and
compensation of employees
• Firm Infrastructure includes activities such as finance, legal, quality management, etc
Benchmarking
Benchmarking is an analytical tool used to determine whether a firm’s value chain activities are
competitive compared to rivals and thus conducive to winning in the marketplace. Benchmarking entails
measuring costs of value chain activities across an industry to determine “best practices” among
competing firms for the purpose of duplicating or improving upon those best practices. Benchmarking
enables a firm to take action to improve its competitiveness by identifying (and improving upon) value
chain activities where rival firms have comparative advantages in cost, service, reputation, or operation.

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