CHAPTER THREE
ENVIRONMENTAL SCANNING AND INDUSTRY ANALYSIS
3.1. ENVIRONMENTAL SCANNING
Before an organization can begin strategy formulation, it must scan the external environment to
identify possible opportunities and threats and its internal environment for strengths and
weaknesses. In more simple term, SWOT analysis is an essential part of strategic management
especially at its first stage. As you can remember, SWOT analysis is a system used to identify
and evaluate an organization in terms of its potential strengths, weaknesses, opportunities and
threats. So carrying out such an analysis using the SWOT framework helps managers to focus
their activities into areas where the organization is strong and where the greatest opportunities
lay requiring consideration. Moreover, such an analysis reminds the company to be watchful of
its weakness in the effort to take due consideration for the threats coming from the environment.
So, SWOT analyses involve both internal and external environment analysis. Opportunity is a
major favorable situation in a firm’s environment. Threat is a major unfavorable situation in the
firm’s environment. Strength is a resource advantage relative to competitors and the needs of
the markets a firm serves or expects to serve. Weakness is a limitation or deficiency in one or
more resources or competencies relative to competitors that impedes a firm’s effective
performance. Environmental scanning is the monitoring, evaluating, and disseminating of
information from the external and internal environments to key people within the corporation. It
is a tool that a corporation uses to avoid strategic surprise and ensure long-term health. Research
has found a positive relationship between environmental scanning and profits.
3.1.1 External Environment Analysis
The external environment analysis considers factors that are beyond the control of the
organization and either brings an opportunity or pose threats to the organizations. Detailed
analysis for external factors will be made in the upcoming sections of this chapter. Now I shall
focus on sources of opportunities and threats:
Source of Opportunities and threats
a) Unexpected Events
Unexpected events such as political turmoil, war breaks, government policy changes, floods and
other natural or manmade changes can provide opportunities to a business organization. The
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event can be unexpected success (good news) or an expected failure (bad news). For example, if
war breaks out where it is unexpected, it changes the economics and demand structure of the
warring parties and their populations. This can provide opportunity if it is ethically pursued.
b) The process need
This opportunity has its source in technology’s inability to provide the “big breakthrough “.
Currently, efforts are being made in areas of super conductivity, fusion, interconnectivity and the
search for a treatment and cure for AIDS
c) Changes in Technology
Change in technology, changes market and industry structures by altering costs, quality
requirements and volume capabilities. This alteration can potentially make existing firms
obsolete, which are not adjusted to it and are inflexible. But changes in technology may create
opportunity for those who make themselves ready for the new technology.
d) Demographic Changes
Demographic changes are changes in the population or subpopulation of society. These can be
changes in the size, age, structure, employment, education, or incomes of these groups. Such
changes influence all industries and firms by changing the mix of products and services
demanded the volume of products and services, and the buying power of customers. Some of
these changes are predictable since people who will be older are already alive and birth and death
rates stay fairly stable over time.
e) Change in Perception
People hold different perceptions of the same reality, and these differences affect the products
and services they demand and the amount they spend. Some groups feel powerful and rich,
others disenfranchised and poor. Some people think they are thin when they are not, others think
they are too fat when they are not. The manager can sell power and status to the rich and
powerful, and sell relief and comfort to the poor and oppressed/demoralized customers.
f) New Knowledge
New Knowledge is often seen as the ‘superstar’ of business opportunity. It is not enough to have
new knowledge but there must also be a way to make products from it and to protect the profits
of those products from competition as the knowledge is spread to others. In additions, timing is
critical. It frequently takes the convergence of many piece of new knowledge to make a product.
Source of Threats
The forces that can provide opportunity for an organization may sometime pose threat to
business. Some of the sources of threats are discussed below.
a) Threat of Substitute
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When managers propose long term plans to launch new products, they are not clear whether
other competitors will substitute their product and service or not. Hence, a potential threat will
originate from the possibility of their product being replaced easily and early. So, it is important
for managers to understand the nature of substitute products for these reasons.
b) Threat of Integration
A threatening environment will be created when competitors have strong relationship with
suppliers, customers and the community. The customers will neglect the new proposal if
competitors have strong relationship with their supplier, regardless of the quality of product
offered by the new firm. And sometimes, the community, surrounding the business, will reject
the products of the venture due to strong relationship with the existing firms.
3.1.1 External Environmental Variables
The external environment analysis considers factors that are beyond the control of the
organization and either brings an opportunity or pose threats to the organizations.
In undertaking environmental scanning, strategic managers must first be aware of the many
variables within a corporation’s natural, societal, and task environments. The natural
environment includes physical resources, wildlife, and climate that are an inherent part of
existence on Earth. These factors form an ecological system of interrelated life. The societal
environment is mankind’s social system that includes general forces that do not directly touch
on the short-run activities of the organization that can, and often do, influence its long-run
decisions. These forces, shown in Figure 2.1, are as follows:
Figure Environmental variables
• Economic forces regulate the exchange of materials, money, energy, and information. Trends
in the economic part of the societal environment can have an obvious impact on business
activity. For example, an increase in interest rates means fewer sales of major home appliances
because a rising interest rate tends to be reflected in higher mortgage rates. Because higher
mortgage rates increase the cost of buying a house, the demand for new and used houses tends to
fall. Because most major home appliances are sold when people change houses, a reduction in
house sales soon translates into a decline in sales of refrigerators, stoves, and dishwashers and
reduced profits for everyone in that industry.
• Technological forces generate problem-solving inventions. Changes in the technological part
of the societal environment can also have a great impact on multiple industries. For example,
improvements in computer microprocessors have not only led to the widespread use of home
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computers, but also to better automobile engine performance in terms of power and fuel
economy through the use of microprocessors to monitor fuel injection.
• Political–legal forces allocate power and provide constraining and protecting laws and
regulations. Trends in the political–legal part of the societal environment have a significant
impact on business firms. For example, periods of strict enforcement of U.S. antitrust laws
directly affect corporate growth strategy. As large companies find it more difficult to acquire
another firm in the same or in a related industry, they are typically driven to diversify into
unrelated industries. In Europe, the formation of the European Union has led to an increase in
merger activity across national boundaries.
• Socio-cultural forces regulate the values, mores, and customs of society.
.
Table 3.1 some important variables in the societal environment
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The task environment includes those elements or groups that directly affect the corporation and,
in turn, are affected by it. These include governments, local communities, suppliers, competitors,
customers, creditors, employees, shareholders, labor unions, special-interest groups, and trade
associations. A corporation’s task environment can be thought of as the industry within which it
operates. Industry analysis refers to an in-depth examination of key factors within a
corporation’s task environment. The natural, societal, and task environments must be monitored
so that strategic factors that are likely to have a strong impact on corporate success or failure can
be detected.
International Societal Considerations
Each country or group of countries in which a company operates presents a unique societal
environment with a different set of economic, technological, political–legal, and socio cultural
variables for the company to face. This is especially an issue for a multinational corporation
(MNC), a company having significant manufacturing and marketing operations in multiple
countries.
International societal environments vary so widely that a corporation’s internal environment and
strategic management process must be very flexible. Cultural trends in Germany, for example,
have resulted in the inclusion of worker representatives in corporate strategic planning.
Differences in societal environments strongly affect the ways in which an MNC conducts its
marketing, financial, manufacturing, and other functional activities. For example, the existence
of regional associations like the European Union, the North American Free Trade Zone, the
Central American Free Trade Zone and the Association of Southeast Asian Nations, has a
significant impact on the competitive “rules of the game” for both the MNCs operating within
and those that want to enter these areas.
Before a company plans its strategy for a particular international location, it must scan the
particular country’s societal environment in question for opportunities and threats and compare
them to its own organizational strengths and weaknesses.
External Strategic Factors
Companies often respond differently to the same environmental changes because of differences
in the ability of managers to recognize and understand external strategic issues and factors. Few
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firms can successfully monitor all important external factors. Even though managers agree that
strategic importance determines what variables are consistently tracked, they sometimes miss or
choose to ignore crucial new developments. Personal values of a corporation’s managers and the
success of current strategies are likely to bias both their perception of what is important to
monitor in the external environment and their interpretations of what they perceive. This is
known as strategic myopia: the willingness to reject unfamiliar as well as negative information.
One way to identify and analyze developments in the external environment is to use the issues
priority matrix, provided in Figure 3.2:
1. Identify a number of likely trends emerging in the natural, societal, and task environments.
These are strategic environmental issues—those important trends that, if they happen, will
determine what various industries will look like in the near future.
2. Assess the probability of these trends actually occurring, from low to medium to high.
3. Attempt to ascertain the likely impact (from low to high) of each of these trends on the
corporation.
Figure 3.2 Issues in Priority Matrix
A corporation’s external strategic factors are the key environmental trends that are judged to
have both a medium to high probability of occurrence and a medium to high probability of
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impact on the corporation. The issues priority matrix can then be used to help managers decide
which environmental trends should be merely scanned (low priority) and which should be
monitored as strategic factors (high priority). Those environmental trends judged to be a
corporation’s strategic factors are then categorized as potential opportunities and threats and are
included in strategy formulation.
3.2. INDUSTRY ANALYSIS
An industry is a group of firms producing a similar product or service, such as financial services
or soft drinks. An examination of the important stakeholder groups, such as suppliers and
customers, in the task environment of a particular corporation is a part of industry analysis.
3.2.1. Michael Porter’s Approach to Industry Analysis
Michael Porter, an authority on competitive strategy, contends that a corporation is most
concerned with the intensity of competition within its industry. Basic competitive forces, which
are depicted in Figure 2.3, determine the intensity level. “The collective strength of these
forces,” he contends, “determines the ultimate profit potential in the industry, where profit
potential is measured in terms of long-run return on invested capital.” The stronger each of these
forces is, the more companies are limited in their ability to raise prices and earn greater profits.
Although Porter mentions only five forces, a sixth—other stakeholders—is added here to reflect
the power that governments, local communities, and other groups from the task environment
wield over industry activities.
Using the model in Figure 2.3, a strong force can be regarded as a threat because it is likely to
reduce profits. In contrast, a weak force can be viewed as an opportunity because it may allow
the company to earn greater profits.
In carefully scanning its industry, the corporation must assess the importance to its success of
each of the following six forces: threat of new entrants, rivalry among existing firms, threat of
substitute products, bargaining power of buyers, bargaining power of suppliers, and relative
power of other stakeholders.
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FIGURE 3.3 Forces Driving Industry Competition
.A. Threat of New Entrants
New entrants are newcomers to an existing industry. They typically bring new capacity, a desire
to gain market share, and substantial resources. Therefore, they are threats to an established
corporation. The threat of entry depends on the presence of entry barriers and the reaction that
can be expected from existing competitors. An entry barrier is an obstruction that makes it
difficult for a company to enter an industry.
• Economies of Scale: Scale economies in the production and sale of microprocessors, for
example, gave Intel a significant cost advantage over any new rival.
• Product Differentiation:
• Capital Requirements: The need to invest huge financial resources in manufacturing facilities
in order to produce large commercial airplanes creates a significant barrier to entry to any new
competitor for Boeing and Airbus.
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• Switching Costs: Once a software program like Excel or Word becomes established in an
office, office managers are very reluctant to switch to a new program because of the high
training costs.
• Access to Distribution Channels: Small entrepreneurs often have difficulty obtaining
supermarket shelf space for their goods because large retailers charge for space on their shelves
and give priority to the established firms who can pay for the advertising needed to generate high
customer demand.
• Government Policy: Governments can limit entry into an industry through licensing
requirements by restricting access to raw materials, such as offshore oil drilling sites.
B. Rivalry Among Existing Firms
Rivalry is the amount of direct competition in an industry. In most industries, corporations are
mutually dependent. A competitive move by one firm can be expected to have a noticeable effect
on its competitors and thus may cause retaliation or counter efforts. According to Porter, intense
rivalry is related to the presence of the following factors:
• Number of Competitors: When competitors are few and roughly equal in size, such as in the
auto and major home appliance industries, they watch each other carefully to make sure that any
move by another firm is matched by an equal countermove.
• Rate of Industry Growth: Any slowing in passenger traffic tends to set off price wars in the
airline industry.
• Product or Service Characteristics.
• Amount of Fixed Costs. Because airlines must fly their planes on a schedule regardless of the
number of paying passengers for any one flight, they offer cheap standby fares whenever a plane
has empty seats.
• Capacity. If the only way a manufacturer can increase capacity is in a large increment by
building a new plant (as in the paper industry), it will run that new plant at full capacity to keep
its unit costs as low as possible—thus producing so much that the selling price falls throughout
the industry.
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• Height of Exit Barriers. Exit barriers keep a company from leaving an industry. The brewing
industry, for example, has a low percentage of companies that leave the industry because
breweries are specialized assets with few uses except for making beer.
• Diversity of Rivals. Rivals that have very different ideas of how to compete are likely to cross
paths often and unknowingly challenge each other’s position.
This happens often in retailing.
C. Threat of Substitute Products or Services
Substitute products are those products that appear to be different but can satisfy the same need
as another product. According to Porter, “Substitutes limit the potential returns of an industry by
placing a ceiling on the prices firms in the industry can profitably charge.” To the extent that
switching costs are low, substitutes may have a strong effect on an industry. Tea can be
considered a substitute for coffee. If the price of coffee goes up high enough, coffee drinkers will
slowly begin switching to tea. The price of tea thus puts a price ceiling on the price of coffee.
D. Bargaining Power of Buyers
Buyers affect an industry through their ability to force down prices, bargain for higher quality or
more services, and play competitors against each other. A buyer or distributor is powerful if
some of the following factors hold true:
• A buyer purchases a large proportion of the seller’s product or service
• A buyer has the potential to integrate backward by producing the product itself
• Alternative suppliers are plentiful because the product is standard or undifferentiated
• Changing suppliers costs very little
• The purchased product represents a high percentage of a buyer’s costs, thus providing an
incentive to shop around for a lower price
• A buyer earns low profits and is thus very sensitive to costs and service differences
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• The purchased product is unimportant to the final quality or price of a buyer’s products or
services and thus can be easily substituted without adversely affecting the final product
E. Bargaining Power of Suppliers
Suppliers can affect an industry through their ability to raise prices or reduce the quality of
purchased goods and services. A supplier or supplier group is powerful if some of the following
factors apply:
• The supplier industry is dominated by a few companies, but it sells too many
• Its product or service is unique or it has built up switching costs
• Substitutes are not readily available
• Suppliers are able to integrate forward and compete directly with their present customers
• A purchasing industry buys only a small portion of the supplier group’s goods and services and
is thus unimportant to the supplier
F. Relative Power of Other Stakeholders
A sixth force should be added to Porter’s list to include a variety of stakeholder groups from the
task environment. Some of these other stakeholders are governments (If not explicitly included
elsewhere), local communities, creditors (if not included with suppliers), trade associations,
special-interest groups, shareholders, and complementors.
A complementor is a company or an industry whose product works well with a firm’s product
and without which the product would lose much of its value. The importance of these
stakeholders varies by industry.
Do Industries Evolve Over Time?
Most industries evolve over time through a series of stages from growth through maturity to
eventual decline. The strength of each of the six competitive forces described in the preceding
section varies according to the stage of industry evolution. The industry life cycle is useful for
explaining and predicting trends among the six forces that drive industry competition. For
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example, when an industry is new, people often buy the product regardless of price because it
fulfills a unique need. This usually occurs in a fragmented industry in which no firm has large
market share and each firm serves only a small piece of the total market in competition with
others (e.g., cleaning services). As new competitors enter the industry, prices drop as a result of
competition.
Competitors try to differentiate their products from one another’s to avoid the fierce price
competition common to a maturing industry.
By the time an industry enters maturity, products tend to become more like commodities. This is
now a consolidated industry —dominated by a few large firms, each of which struggles to
differentiate its products from the competitors. As buyers become more sophisticated over time,
they base their purchasing decisions on better information. Products become more like
commodities in which price becomes a dominant concern given a minimum level of quality and
features, and profit margins decline. The automobile, petroleum, and major home appliance
industries are current examples of mature, consolidated industries, each controlled by a few large
competitors.
As an industry moves through maturity toward possible decline, the growth rate of its products’
sales slows and may even begin to decrease. To the extent that exit barriers are low, firms will
begin converting their facilities to alternative uses or will sell them to another firm. The industry
tends to consolidate around fewer but larger competitors. The tobacco industry is an example of
an industry currently in decline.
Category of International Industries
World industries vary on a continuum from multi-domestic to global. A multi domestic
industry is a collection of essentially domestic industries, like retailing and insurance, in which
products or services are tailored specifically for a particular country. In each country, the MNC
tailors its products or services to the very specific needs of consumers in that particular country.
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FIGURE 3.4 Continuums of International Industries
A global industry, in contrast, operates worldwide, with MNCs making only small adjustments
for country-specific circumstances. A global industry is one in which the activities of an MNC in
one country are significantly affected by its activities in other countries. MNCs produce products
or services in various locations throughout the world and sell them all over the world, making
only minor adjustments for specific country requirements.
Strategic Group
A strategic group is a set of business units or firms that “pursue similar strategies with similar
resources.” Categorizing firms in any one industry into a set of strategic groups is very useful to
strategic managers as a way of better understanding the competitive environment. Because a
corporation’s structure and culture tend to reflect the kinds of strategies it follows, companies or
business units belonging to a particular strategic group within the same industry tend to be strong
rivals and more similar to each other than to competitors in other strategic groups within the
same industry.
In analyzing the level of competitive intensity within a particular industry or strategic group, it is
useful to characterize the various competitors for predictive purposes. A strategic type is a
category of firms based on a common strategic orientation and a combination of structure,
culture, and processes consistent with that strategy.
According to Miles and Snow, competing firms within a single industry can be categorized on
the basis of their general strategic orientation into one of four basic types: defenders, prospectors,
analyzers, and reactors. This distinction helps explain why companies facing similar situations
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behave differently and why they continue to do so over a long period of time. These general
types have the following characteristics:
• Defenders are companies with a limited product line that focus on improving the efficiency of
their existing operations. This cost orientation makes them unlikely to innovate in new areas. An
example would be Dean Foods, a company specializing in making low-cost imitations of leading
products marketed by supermarkets and drug stores.
• Prospectors are companies with fairly broad product lines that focus on product innovation
and market opportunities. This sales orientation makes them somewhat inefficient. They tend to
emphasize creativity over efficiency. PepsiCo, with its “shotgun approach” (ready, fire, aim) to
new product introduction is a good example of a prospector.
• Analyzers are companies that operate in at least two different product-market areas, one stable
and one variable. In the stable areas, efficiency is emphasized; in the variable areas, innovation
is emphasized. With its many consumer products in multiple markets and careful approach to
product development (“ready, aim, fire”), Procter & Gamble is a typical analyzer.
• Reactors are companies that lack a consistent strategy-structure-culture relationship. Their
(often ineffective) responses to environmental pressures tend to be piecemeal strategic changes.
By allowing Target to take the high end of the discount market and Wal-Mart the low end, Kmart
was left with no identity and no market of its own.
Dividing the competition into these four categories enables the strategic manager not only to
monitor the effectiveness of certain strategic orientations, but also to develop scenarios of future
industry developments
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