BS Chapter 03 The Macro Environment

chapter 3
The macro environment

Contents
Introduction Examination context Topic List 1 2 3 4 5 The business environment Environmental dynamics PESTEL analysis The international business context Limits to globalisation of business
Summary and Self-test Answers to Self-test Answers to Interactive questions
The Institute of Chartered Accountants in England and Wales, March 2009
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Introduction
Learning objectives
Explain how a business collects and distributes environmental information in order to manage its strategy Analyse for a given situation the external factors which may impact on a business's performance and identify significant issues in the following areas: Sustainable development Global macroeconomic forces International trade and financial systems Government policies Cultural environment
Tick off
Identify the risks attached to operating a global business
Specific syllabus references for this chapter are: 1b, 3g.
Practical significance
The wealth of many European countries, and of the businesses within them, can be attributed to their early industrialisation and imperialism commencing in the 17th century. The USA caught up and overtook Europe during the early 20th century. From the mid 20th century those gains have been gradually superseded by the development of emerging economies in Asia and Latin America. These have brought new markets and new challenges which must be addressed by businesses from the developed economies if they are to survive.
Stop and think

You are early in your career as a professional accountant. Where in the world should you be working in order to make the best of the opportunities over the next 40 years? Which industries around you are likely to thrive and which to die? Exactly the same questions are facing business strategists, albeit on a grander scale.
Working context
Many of your clients will be global businesses, or at least have some form of buying and selling relationship with overseas firms. Your firm may be required to: Assist in transnational audits alongside professional colleagues from outside of your home country Assess the extra risks the client runs as a consequence of operating internationally Advise on taking-on international contracts
Syllabus links
Environmental analysis was covered in your Business and Finance paper under section 6 of the syllabus. However its coverage was at the level of core knowledge. In the Business Strategy examination you will be required to apply it.
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THE MACRO ENVIRONMENT
Examination context
Exam requirements
The scenarios in the majority of exam questions will require you to absorb and understand information about the external environment in which an organisation operates. You will also need to assess the implications of the environment and changes in the environment for the strategic positioning and strategic decisions of an organisation. To do this you will need to apply your knowledge of the tools and ideas covered in this chapter.
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1 The business environment

Section overview
Strategy is concerned with matching the organisation to the threats and opportunities in its environment. The process of gathering and disseminating the necessary knowledge about a firm's external environment is a specific example of knowledge management.
1.1
Importance of management understanding business environment

The environment contains those factors 'surrounding the organisation'. Therefore it includes more than the 'ecological' environment. In your answers you must ensure you discuss environmental factors such as competitors and legislation as well as factors such as environmental pollution and recycling.
To be viable (e.g. able to sustain itself through time) the organisation must achieve an appropriate 'fit' with this environment. This includes: Results that meet the expectations of its owners (shareholders, government, members etc) Products and services that meet its clients' expectations at least as well as rivals' Ability to remain within the legal and ethical codes of the societies it works in Attractive as a place to work for its staff Satisfying the needs of other powerful or influential stakeholders
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EXTERNAL ANALYSIS
INTERNAL ANALYSIS
CORPORATE APPRAISAL MISSION AND OBJECTIVES REVIEW AND CONTROL STRATEGIC ANALYSIS
GAP
STRATEGIC CHOICE STRATEGY IMPLEMENTATION
STRATEGIC CHOICE STRATEGY IMPLEMENTATION
Rational planning approach: Environmental appraisal is a one-off assessment which establishes the forces acting on the business at present and forecasts how these may develop during the years of the plan. Strategic management approach: The need for environmental scanning. This is a continuous awareness by management of environmental issues enabling them to be routinely considered in decision making.
Interactive question 1 Considering the business environment

[Difficulty level: Intermediate] For a professional accountancy practice, answer the following questions. (a) What are the main external factors, in your view?
(b) How do these main environmental/external factors affect the strategies of the practice? (c) In your view, how do managers perceive the environment of the organisation?
(d) How do you think managers incorporate environmental/external issues into decision-making? See Answer at the end of this chapter.
1.2
Gathering and disseminating environmental information

An effective system: Gathers environmental information Validates and corroborates the information Disseminates the information so that people who need it can find it.
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1.2.1
Sources of environmental information

Internal sources include: Employees: Some will be following developments affecting the firm or their field of work, or have past experiences and networks of contacts that can provide insights. Internal records system: This will reveal comments of sales teams at meetings, revenue and cost trends at different locations, customer requests or complaints etc. Formal information resources: Many firms may employ information resources specialists to create current awareness reports e.g. large accountancy firms have technical departments that monitor changes to regulations and the outcomes of adjudications, test cases and appeals.
External sources include: Trade media: The magazines and journals specific to the industry or to particular business functions Published accounts of rivals, suppliers and clients Government statistical reports On-line resources: Subscriptions to business information vendors, current awareness services (emails from vendors who monitor the media for articles containing keywords specified by management) Market reports: Published research from investment analysts, market researchers, trade departments of governments etc.
1.2.2
Validating environmental information

Methods: Appointing an Information Officer with skills of 'librarianship'. to act as a central point of contact for obtaining, sifting and relaying information Appointing a database administrator for information stored and disseminated electronically, e.g. via an intranet, to check on the validity of postings.
Issues to consider in validating environmental information include: Integrity of the source: internet gossip and market rumours lack integrity on their own Forecasting and predictive record in the past Degree of substantiation: is there more than one report or instance of this from independent sources? Age of the information: how up to date is it? Motivation of provider: does the provider have something to gain from convincing the firm of this information?
1.2.3
Disseminating environmental information

Tacit knowledge refers to 'information the organisation does not know it has' i.e. it is known to very few people and not easily available to the organisation as a whole. Explicit knowledge is information that has been disseminated more widely. Dissemination can be assisted by: A well designed intranet with clear files and a search facility Periodic briefing reports with a digest of the most significant information Periodic seminars to brief management Annual management development sessions at an internal or external business school to introduce and discuss new environmental issues
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2 Environmental dynamics
Section overview
The ability of the business to plan, and its requirement for environmental information, will be influenced by how predictable its environment is. In Business Strategy the factors affecting this are given very precise meanings.
2.1
Complexity, predictability and turbulence

The intensity of environmental issues varies from sector to sector and company to company.
Definition
Turbulence: How changeable the environment is and how easy it is to predict.
Lynch (Corporate Strategy) presents turbulence as Changeability Predictability Changeability Is the environment likely to change? There are two aspects to changeability. Complexity: The variety of influences and conditions. These include regulatory, social and political factors, technological change and internationalisation. Novelty: The degree to which the environment presents new situations to be dealt with.
Predictability Is it possible to forecast trends in the environment or at least make sensible predictions of discontinuous change? Again there are two aspects: Rate of change: In relation to the firm's ability to respond (slow to fast) to this (in other words, does the environment change at a slower pace than the organisation's ability to respond to it?) 'Visibility of the future': Is there reliable information to make forecasts for decision making?
The degree of turbulence will affect the amount of resources devoted to environmental assessment. For example, investment banks employ substantial research departments and each day begins with dissemination of relevant environmental information to traders and managers. Airlines also have research departments which 'red flag' issues on a regular basis and also provide reports and forecasts as inputs into their strategic planning process.
2.2
Scenario planning
Definition
Scenario planning: The development of pictures of potential futures for the purposes of managerial learning and the development of strategic responses.
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2.2.1
Introduction
Scenario planning is useful where a long-term view of strategy is needed and where there are a few key factors influencing the success of the strategy, e.g. in the oil industry there may be a need to form a view of the business environment up to 25 years ahead, and issues such as crude oil availability, price and economic conditions are critical. For example, Shell was the only major oil company to have prepared its management for dealing with the shock of the 1970s oil crisis through scenario planning and was able to respond faster than its competitors. Precision is not possible, but it is important to develop a view of the future against which to evaluate and evolve strategies. Scenario building attempts to create possible future situations using the key factors. The aim is to produce a limited number of scenarios so that strategies can be examined against them in terms of 'what if ...?' and 'what is the effect of ...?' (basically a form of sensitivity analysis). A car manufacturer could assess the impact of a 'Green Scenario' or a 'High Value Sterling Scenario' on its business. Financial models of the firm are often used in conjunction with this approach to assess impact on profit. Although these provide a useful approach, it is important not to become too committed to one scenario; after all, they are only forecasts which might not in the event be valid.
2.2.2
Steps
Identify key forces, using techniques such as PEST analysis (see later) Understand the historic trend in respect of the key forces Build future scenarios, e.g. optimistic, pessimistic and most likely.
The scenarios generated are then 'plots' to be played out making managers consider future possibilities and encouraging them to think about strategy more flexibly.
Interactive question 2: Oil industry scenarios

Oil producers use scenario planning extensively. Requirements (a)
[Difficulty level: Intermediate]
Identify the factors that make scenario planning popular with oil industries.
(b) Suggest some alternative scenarios that an oil producer might consider in its strategic planning.
3 PESTEL analysis
Section overview
In your Business and Finance paper, you will have encountered PESTEL factors in your studies of the environment of business. This section looks in each PESTEL factor in more detail and identifies how each may impact on the strategy of the organisation. Later sections extend analysis to the global business environment.
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3.1
PESTEL analysis and underlying assumptions

PESTEL is a handy checklist environmental factors. Political Economic Social/cultural Technological Ecological/environmental Legal
Worked example: Software in India

The rapid emergence of the software industry in Bangalore in India has been made possible by a combination of technology (cheap and reliable telecommunications), economics (low labour costs in India compared to industrialised nations) and political/social factors (the high level of education and the widespread use of English).
Economic factors Globalisation Business cycles Interest rates Inflation Unemployment Exchange rates Environmental factors Sustainability issues, eg energy, natural resources Pollution, etc Green issues, etc
Technology Government and EU investment and R&D policy New discoveries: products and methods of production Speed of technology transfer Levels of R&D spending by competitors Developments in other industries that could transfer across
PEST ANALYSIS
Social/demographic factors Income distribution Social mobility Levels of education/health Size of population Location Age distribution Lifestyle changes Consumerism Attitudes to work and leisure Green issues, etc
Economic factors Globalisation Business cycles Interest rates Inflation Unemployment Exchange rates Environmental factors Sustainability issues, eg energy, natural resources Pollution, etc Green issues, etc
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3.2
Political factors
Political factors relate to the distribution of power locally, nationally and internationally. Political risk is the possibility that political factors will have an impact on the business's environment or prospects. The impact could be positive or negative, the issue is the uncertainty created. Types of risk include the following. Ownership risk: A company or its assets might be expropriated (or nationalised) by the state, normally with compensation. Confiscation is, effectively, expropriation without compensation. Operating risk: Indigenisation/domestication. The firm may be required to take local partners. There may be a guaranteed minimum shareholding for local investors. Transfer risk may affect the company's ability to transfer funds or repatriate profits. Political risk: The government of the host country may change taxes or seek a stake in the business to increase its power or to satisfy local public opinion.
Worked example: Oil companies in Russia

Drilling for oil and gas has never been for the faint hearted and as most of the easily recoverable fields are now rapidly being run down, energy giants are being forced to confront bigger and bigger risks in an effort to replenish their reserves. Once again, though, Russia has demonstrated that the political risks involved in ensuring that an oil giant has a viable future can be every bit as challenging as the physical hurdles. By subjecting Shell to an almost paralysing blizzard of ecological complaints on the giant Sakhalin project, Moscow has succeeded in securing control for its own Gazprom. However, Shell and its Japanese partners simply cannot make Sakhalin work without Russian cooperation, so ceding 50% of the project to Gazprom is regarded as an acceptable price. Walking away was not an option. Shell has already invested billions of dollars in this 'elephant' project and even if it were ready to take such a large financial hit, the long-term need to find new sources of oil and gas means compromise is a necessity. Following Shell's experience, BP is expected to face similar pressures on its joint venture with the Russian company TNK. Gazprom has its eyes on TNK's 50% and would like to secure majority control by taking part of BP's share too. While the challenges are great, they are nothing new. Muddling through with hostile political regimes is dayto-day stuff for oil giants. As BP's chief executive, Lord Browne, remarked when discussing the difficulties of doing business in Russia, if not there then the alternative was violent, war-ravaged Africa. Looked at from this perspective, Russia appears eminently hospitable. Extract from article in UK Daily Mail 17 December 2006
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Sources of political risk Source The country This covers government stability, international relations, the ideology of the government in power, the need for contacts, favouritism for local suppliers, political violence, governments' ability to change the law and operating conditions, governments' need to appease powerful stakeholders. Consumer/basic products. High-tech components may have national security or armaments implications. Oil extraction in some countries places the oil companies near regions of ethnic or political conflict. Size, connections, reputation, influence on the environment.
The product
The company
Managing political risk Companies, especially transnational corporations, might take measures to reduce political risk. These include: Detailed risks assessments prior to investing in the country Seeking protection from legal agreements with the host country or from bi-lateral trade agreements between nations Partnering with a local business to increase acceptance of the project and to lobby for political support Raising finance for projects from host country to put local pressure on politicians to help safeguard investment Operate under the auspices of international bodies e.g. World Health Organisation, UNICEF etc. Share project with other firms to spread the risks between them Avoid total reliance on one country e.g. oil companies extract oil from many countries to offset risks of interrupted supplies or spiralling costs Lobbying for political support from home government for projects and to resolve issues Support for political groups in host country that are favourable to the project
3.3
Economic factors
A typical economic factor that should be considered in strategic decision-making is the economic structure of a country. Countries typically progress from reliance on primary industries (e.g. agriculture, minerals, forestry) through manufacturing to tertiary services (e.g. financial and commercial sectors). Lesser developed countries Reliant on a small number of products (e.g. crops or minerals) as the main export earner. Infrastructure is poor. Implications: Wealth and foreign exchange rate depend on yield of product and world price of product. Political actions aimed at securing control over incomes from product either domestically (e.g. insurgent liberation forces) or externally (e.g. develop cartels, invasion etc). Newly industrialising countries Rapid industrialisation and manufacturing base grows Implications: Infrastructure struggles to keep pace (e.g. power shortages, lack of housing, lack of roads, ports etc). Large shifts in population towards areas of industry and away from villages. Advanced industrial country There is a wide industrial base and a well developed service sector.
These affect overall wealth, financial stability and patterns of demand.
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Business strategy Business cycle
Growth rate %
Recovery
Boom
Recession
+ 0 Depression
Long-term trend Time
The long-term trend of industrialised economies is one of positive growth. The different phases of the cycle have the following characteristics: Recovery phase Increased business confidence and investment causes growth to increase. Unemployment declines and consumer confidence/spending rises. Boom phase Growth exceeds the long-term trend. Demand is too great, leading to rising prices of goods, balance of trade deficits (as exports fall, imports rise), labour shortages and wage/factory price increases. Recession phase Demand falls, leading to increased unemployment and falling investment and business/consumer confidence. Recession is often first seen in building and capital goods sectors. Depression phase Weak consumer and business spending/confidence. Unemployment in excess of normal levels with falling (or even negative) inflation and wage cuts. In setting strategy an organisation needs to consider where the economy is currently and where it is heading. Long-term exchange rates' behaviour affect the relative competitiveness of imported and domestically produced products and exports. A falling domestic exchange rate makes firm's exports more competitive and imported inputs more expensive. This may be determined by the value of key exports such as oil, minerals, crops, manufactured goods etc. Interest rates (long-term and short-term) affect cost of finance and also levels of demand in the economy. The economic infrastructure, for example access to payments systems, consumer and trade credit, access to venture and other capital, the quality of the stock exchanges.
3.4
Social/cultural factors
These factors affect strategy in several ways: They affect the market for products, e.g. religious proscriptions on food, financial services They affect promotional strategies, e.g. language of adverts, considerations of imagery and decency They affect methods of conducting business in countries, e.g. conventions of negotiation, giving and receiving of gifts, ensuring 'face' for contacts (i.e. maintaining self-respect and status) They affect methods of managing staff, e.g. language differences, attitudes to managerial authority They affect expectations of business conduct, e.g. extent of engagement with CSR, time horizon of investment, engagement in political matters.
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Social factors include Make-up of population: e.g. growth rate, proportion of old and young people Family structure and size; the importance (or lack of it) of the extended family and relationships with non family members; the extended family provides contacts and work. The role of women in the labour force and in society as a whole (expectations vary from society to society). In different cultures, gender stereotypes are more sharply drawn than in the industrialised west. Extent of social mobility: the degree of social stratification and difference within each society and whether people can move between them, the changes in size, wealth and/or status of different groups within the population and the geographical distribution of the population between regions and urban, suburban and rural areas.
Cultural factors are identified in the diagram below.
Worked example: EuroDisney

EuroDisney (Disneyland theme park and resort hotels) opened outside Paris, France, in April 1992. The American company, celebrating the success of theme parks in Los Angeles (California), and Orlando (Florida), and Tokyo (Japan 1983) thought that Western Europe was the next step. (Curwen, 1995). Europeans, especially Britons, liked Disney's American parks, the sunshine, the amenities near the parks, and the reasonable accommodation costs. However, Paris was chosen as the European location because it
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Business strategy was at the centre of Europe's wealthiest region, and the French government offered inducements. Despite opposition from French intellectuals, the project went ahead. Disney owned 49 percent of the shares. The project plans assumed there would be a large number of visitors who would want to stay in the vicinity of the park. The park opened on 12 April 1992. However, queues formed for rides that did not work and 'many of the employees appeared to be struggling with the need to conform to Walt Disney's code of acceptable behaviour'. (Curwen, 1995) Curwen (1995) identified a number of difficulties, which we have listed below. Some were bad luck and some were of Disney's own making. In 1992, when the park opened, mainland Europe was entering a recession. The value of the French franc rose, increasing the costs to Italian and British holidaymakers. (The UK left the exchange rate mechanism in 1992, and Italy was temporarily suspended). The weather EuroDisney should have considered this factor. Paris is in northern Europe. Why should holidaymakers go to a rain-drenched version of a Disney theme park when they could experience the 'real thing' in sunny Florida (or California)? A trip to EuroDisney would rarely provide more than a couple of days' outing: hence attendance figures were optimistic. Hotel occupancy rates were low (in part because of the excellent transport facilities to Paris). Admission charges were seen as too high, and visitors 'broke the rules' by smuggling in their own food and drink. Price resistance was a key issue. Labour turnover was very high. French employees did not behave like Americans.
Cultural issues Alcohol, as in the US theme parks, was banned. This impacted on the traditional French Sunday Lunch which is relaxed, conversational and where wine is served. Thus the full service restaurants saw reduced trade. The management team were American, there were no European representatives. At one point the French media called it a 'Cultural Chernobyl'.
The first year was catastrophic. The Disney corporation reconsidered its plans for further expansion of the site. However, the French government, the bankers and Disney itself had good reasons for business to continue, and were able to persuade a wealthy Saudi investor to contribute. Recovery After this disastrous start, the company began to turn around, and it reported a profit in 1995. As well as financial support from a Saudi investor, and Disney's agreement to forego royalties the company began to change. Pierre Bourguignon, the CEO, also attempted to institute cultural and structural change, and to change the marketing. The chain of command with reduced employees were empowered to take decisions. There were 220 small groups with total profit responsibility. All managers have to work on the front line once a week. Admission prices were cut by 20 percent and cost of staying in the cheaper hotels was cut. The catering was improved, with lower prices, more fast food, drinks and so on.
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Cultural issues Reflecting greater sensitivity to national factors, EuroDisney targeted its marketing and promotional offers more closely to those factors.
The 'low-price' marketing strategy did not conform with the USA's strategy of offering a 'premium' quality product, but the strategy brought in more people. However, attracting people to the more expensive hotels has been difficult. By 1996 EuroDisney, by then renamed Disneyland Resort Paris, had become France's most-visited tourist attraction. Management embarked on an ambitious expansion scheme opening Walt Disney Studios in 2002. Hong Kong In 2005 Disney opened its fifth, and smallest, Disney park on reclaimed land in Hong Kong. Disney owns 43% and the Hong Kong government 57%. Initial cultural adaptation problems included: Significant overcrowding at Chinese New Year as a an unanticipated wave of visitors arrived from mainland China Protests from global environmental groups at the inclusion of shark's fin soup on the wedding menus at Disneyland HK Criticisms from guests of wait times and overcrowding which had been endured more quietly at other Disney resorts Guests not respecting no-smoking and alcohol-free regulations.
In May 2007 it was reported that declining attendances at Disneyland HK and revenues below targets were jeopardising Disney's ability to raise finance to continue the planned investments in the resort. Management was contemplating significant promotional activity to turn it around.
3.5
Technology
Technological differences and change operate at three levels: 1. 2. 3. Apparatus, technique and organisation: How technology is used in the business, e.g. the use of ICT within the firm . Invention and innovation: These affect the products being offered, e.g. the impact of higher power handsets on the development from mobile phone handsets to Personal Digital Assistants. Metatechnology: A technology that can have a variety of applications, e.g. lasers are a technology that have found uses in industry (welding), surgery (corrective eye surgery, key hole surgery), recorded music and software (CD, CD-ROM and DVD), and visual displays and light shows.
The strategic significance of the technological environment includes: Technological base, and therefore customer and staff familiarity with it, varies across countries. Operations will have to take this into account. Technological change challenges existing industry structure and competitive advantages and so strategies to harness or evade it are necessary. Technological change can render existing products obsolete. Therefore continuous R&D and learning is necessary to remain competitive. Technological change creates uncertainty which may influence the approach to strategy formulation that is adopted.
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Worked example: Pulp and paper

Reports of the death of paper were rampant in the 1990s. However the paperless office never materialised nor yet have e-books. Even so the vast paper-and-pulp multinationals have been hard hit by the electronic age, especially in America. Mills are closing to buoy prices. Newsprint has been worst hit as circulation and classified advertising at newspapers fall and the Wall Street Journal and other papers grow skinnier. 'The only grade of paper immune to technological substitution is tissue' such as bathroom or facial tissue says investments analysts D.A. Davidson. Restructuring in the paper industry is proceeding at a furious pace and have included: Mergers between producers to eliminate slack capacity Closure of capacity Selling off of lumber farms and associated businesses (e.g. plywood, cartons, home furniture) Development of businesses in non-affected areas such as corrugated cardboard used in packaging and export industries.
As they thrash around for new direction, the pulp-and-paper giants of America and Europe must also deal with the forces of globalisation. Brazil, with fast-growing eucalyptus trees, is the cheapest place to make paper and China has recently gone from being a net importer to being a net exporter of newsprint. At the same time, emerging economies also represent new markets that are not as hooked on email as the developed world. However BlackBerrys and Dells will not keep a low profile in Brazil for ever. Source: Economist March 2007
3.6
Ecological environment factors

Climate change The 2007 report of the Intergovernmental Panel on Climate Change (IPCC) has forecast that global average temperatures by the end of the 21st century will have risen between 1.4C and 6.4C above the average for 1990. Global warming is forecast to cause polar ice caps to melt, leading to a chain of events including rises in sea levels and climate change. The IPCC regards the actual level of average temperature at the end of the century to be dependent upon: Actions taken by governments to reduce emission of carbon dioxide and ozone depleting gases into the atmosphere. The availability and use of technologies to reflect the sun's rays back into space such as vast reflectors in low earth orbit or reflective particles scattered into low earth orbit. The actual feedback mechanism in the ecosystem which may accelerate global warming as ice sheets cease to reflect sunlight, forests disappear and plants under stress become carbon dioxide producing rather than carbon dioxide absorbing.
Various socio-political consequences have been forecast. Much greater cross-national cooperation to combat this common threat. Re-mergence of state-funded nuclear energy as a solution following its international abandonment after the Chernobyl explosion in 1986 and the consequent escalating costs of safety. Political conflicts are breaking out between developed countries and emerging economies over carbon emissions. Inter-racial conflict and rise of fascism as populations migrate towards higher or more temperate climates and are rejected by indigenous people.
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Land grab wars between USA, China and European states over Siberia and Alaska. Increasing blame heaped on industrialised nations by impoverished states leading to calls for aid or other countries using and to gain political influence. Breakdown in civil order as population squabbles over diminishing food and water supplies.
Main government policies are: Reduce carbon emissions through targets set in cross governmental accords such as Kyoto agreements. Penalisation of carbon creating industries through taxes levied on emissions or on fossil fuels used. Investment in non-carbon creating technologies such as nuclear energy, wind and wave power and electric or hybrid cars. Making foreign aid dependent on acceptance of environmental policies by recipient countries.
Other ecological issues Energy gap as fossil fuels diminish at a time when India and China are growing rapidly and demand more energy. Waste recycling issues as developed countries recognise the forecast use of landfill and also realise that much landfill is hazardous waste (e.g. NiCad batteries, electronic circuitry, oil and solvents in car engines). Bio-diversity issues as growing of cash crops and destruction of forests for grazing or building land also destroys species of plant, insects and animals. Introduction of genetically modified organisms into the food chain leading to loss of species and potentially hazardous future effects.
Implications for business strategy Need to accept 'polluter pays' costs taxes on emissions and requirements that firms buy certificates from refuse firms confirming recovery or destruction of materials the firm introduces into the supply chain Increased emphasis on businesses acceptance of CSR and of principles of sustainable development; Potential for economic gain from cleaning-up operations and selling surplus 'permits to pollute' to firms that have not cleaned up Potential competitive advantage from development of products that ecologically conscious buyers will favour Need to monitor ecology-related geo-political and legislative developments closely
3.7
Legal factors
Legal factors relate to the role of law in society and its role in business relationships. This can be assessed in terms of: Systemic factors: How effective is the legal system at enforcing contracts? To what extent are legal decisions likely to be interfered with by politicians i.e. are the courts independent of government? How easy is it to get hold of legal advice? How speedy are the courts? To what extent is regulation delegated? Are rights of private property genuinely enforceable? Cultural factors: To what extent are business relationships conducted formally or informally? The USA is regarded as a litigious society; in Japan (partly because the small size of the legal profession), business is widely believed to be based more on long-term relationships. Context and regulatory factors: cover civil and criminal law, laws relating to consumer protection and advertising, employment and so forth. Furthermore, to what extent is competition promoted, regulated and enforced? Intellectual property rights are examples of specific issues which need to be considered.
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Interactive question 3: Newspaper industry
[Difficulty level: Exam standard]
On 12 June 1993 The London-based newspaper The Sun dropped its cover price from 25p to 20p, claiming that this would help its readers in the recession. The Daily Mirror responded quickly, cutting its price for a single day to 10p, in an attempt to maintain circulation at the expense of lost revenue. The resulting increased circulation of The Sun was no surprise for the tabloid market. However, how would the circulation of the quality papers be affected by a similar strategy? It has always been felt that broadsheets are price insensitive and therefore that a similar strategy adopted by a broadsheet publication would be of no benefit: branding was too strong. However, Peter Stothard, editor of The Times, had begun to disagree, feeling that readers did have brand loyalty but were also very much interested in value for money. A drop in price, he felt, could enhance a publication's value for money and therefore on 6 September 1993 the price of The Times dropped from 45p to 30p. Media analysts were unconvinced, maintaining that any resulting increased circulation would not offset the decreased revenue, hence losses are the obvious result: CU200,000 for The Times and CU700,000 for The Sun per week (estimated). Analysts struggled to work out the rationale behind increased circulation bids. One justification was that it was needed to combat the overall decline in the newspaper market a 20% fall over the previous thirty years according to leading accountants. The worst affected by this decline had been the tabloids. Another argument was that it was done in order to affect Mirror Group Newspapers adversely during the sale of 55% of its shares in September. Whatever the reason, the worry was that the price of The Sun would rise again and when it did the success or failure of the strategy would be shown by how many of the new readers (300,000) were retained. As the tabloid market is price sensitive, the signs were not good. The outlook for The Times was slightly different: city analysts felt that a cut in price was necessary as the paper was on a downward spiral, having lost its previous image. The price cut, they felt, was there to stay: it was envisaged that more money would flow in from advertisers due to increased circulation. Advertising was a major concern for newspapers in the recession: a typical tabloid received 20% of its revenues from circulation, with the rest coming from advertising. Broadsheets, on the other hand, had a 50:50 split. The total split on advertising spend had changed dramatically in the previous decade. Newspapers Television Radio 1981 66% 20% 14% 1993 51% 36% 13%
The initial reaction to this was to increase newspaper prices but obviously this had limited effect, hence the cuts by News International. Rupert Murdoch, it was felt, could sustain initial losses from profits elsewhere: his competitors would not be able to do so. In 1993 The Daily Telegraph remained number one in the UK broadsheet market, its revenue declining by only 1% compared with the previous year. This was achieved by a series of promotions including discounted holidays, as well as by its readers showing remarkable loyalty and an unwillingness to move. The circulation of The Guardian had fallen by 5.6% and its market position had been affected as The Times overtook it in the race for second position. However, the paper still remained popular. The Independent, however, had been hardest hit. It was felt that the strategy of The Times could potentially squeeze it out of the market. If this were to be the result The Times was sure to benefit. The situation appeared to be mirroring the experience of the London Daily News a few years previously when it was driven out of business by the Evening News. Indeed, The Times would benefit both from increased circulation and increased advertising revenue if The Independent were to be terminated. However, The Independent was struggling before The Times cut its price. Its circulation had declined significantly since 1988 (20%) and it had been perceived as being 'weak' due to the lack of colour photographs. Although this was corrected it meant that the price of The Independent had to be increased to
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compensate. This 5p rise was unfortunate, since it was implemented a matter of weeks after the reduction by The Times. The Independent panicked and contacted the Office of Fair Trading, claiming that the price cut by The Times amounted to predatory pricing and that this was not allowed. This complaint was not upheld: it would have to be proved that the cut was aimed solely at The Independent and this would have been difficult to establish. Furthermore, The Independent was not one of the financially strongest companies, having made a loss approaching CU500,000 in the previous year. A takeover appeared to be a logical next step as The Independent did have a small niche in the market. However, whoever bought it would have to overcome the recent batterings which had left it with an image problem. If newspapers had been allowed to expand into TV, then the competitive picture would have changed completely. Requirement Discuss the environmental factors that affected the newspaper industry, using the following headings. (a) Political and Economic
(b) Social (c) Technological
(d) Ecological (e) Legal
See Answer at the end of this chapter.
4 The international business context

Section overview
Few if any businesses are unaffected by global influences from competition, new markets or, at the very least, cheaper sources of supply. The view that certain nations have built-in advantages from low costs or harder-working staff has given way to a more sophisticated view that home factors may configure to give advantages to a handful of specific industries. This is illustrated using the Porter Diamond model.
4.1
The importance of the global business environment

The rapid industrialisation from the 18th century was a consequence of early involvement of merchants and businesses in trade. In the 21st century improved transportation and communications and cross-border business ownership have created, for most industries, a global business environment. Global competition affects firms in several ways: It provides the opportunities of new markets to exploit It presents the threat of new sources of competition in the home economy from foreign firms It offers an opportunity of relocating parts of business activity (or supply chain) to countries able to perform them better or more cheaply It may drive cross border acquisitions and alliances
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Business strategy This leads management to make significant strategic investment decisions that rely on assessments of the stability and trends of the global business environment: Development of products for international markets Advancing credit to clients in international markets or investing in businesses and assets in host countries Reliance of international sources for supplies of crucial inputs
Worked examples: Vehicle manufacture and call centres

Case study (1) Global vehicle manufacturing The history of vehicle manufacturing is an example of internationalisation and, to an degree, globalisation. According to Dicken, world output of motor vehicles in 1960 was c 13m units. In 2006 it had risen to 67m. Fuelling this quantitative increase was vehicle production in Asia, Latin America and, in recent years, countries such as China and Thailand. According to the Economist (in 2005), global capacity stood at 80 million units but actual production was 60 million, yet capacity utilisation needs to be 80% for most plants to generate any decent profits. Today the global automobile industry is characterised by extended global supply chains and cross national alliances between manufacturers. The Economist (January 2007) cites the example of vehicle development in General Motors: 'At the 2006 [North American International Auto Show] only one question seemed to matter; how soon would the giant American car manufacturer go bust? At this year's show [2007] the subject of choice was the firm's nascent turnaround. The revival of the Saturn division cast light on some of the changes. Saturn [US] has consolidated its vehicle development efforts with those of GM's European arm, Opel and more broadly the car maker's previously autonomous regional operations are now working together coherently. North America is developing the big pick-up trucks that dominate the market and Europe will handle mainstream passenger cars. The car unit of South Korea's Daewoo, now a GM subsidiary, will work on entry level models and Holden, and Australian subsidiary, will develop big saloons. If GM can make this approach work it will achieve economies of scale that only Toyota can match.' Case study (2) Call centres and 'offshoring' Call centres are being used increasingly by organisations seeking to centralise their customer service functions. Increasingly call centres are located overseas. Some firms that locate call centres in India, for reasons of the lower cost of graduate labour, give their staff elocution lessons in the appropriate regional accents, and update their staff on sporting events and soap opera plot lines for the sake of small talk. An example is GE Capital, whose US, UK and Australian arms have set up call centres in India. In some cases, more sophisticated functions are sent offshore.
4.2
The global corporation

Definition
Globalisation: The production and distribution of products and services of a homogenous type and quality on a worldwide basis.
Levitt (The Globalisation of Markets 1983) described the development of a 'global village' in which consumers around the world would have the same needs and attitudes and use the same products. A global corporation would be one that operated as if the entire world was one entity, to be sold the same things everywhere.
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Levitt's focus was on the marketing aspects of globalisation. The global business corporation will also be characterised by Extended supply chains: Instead of making the product at home and exporting it, or setting up a factory in the host country to make it, the global corporation may factor out production so that different parts of the product (or service) originate in different countries. Womack et al (The Machine That Changed The World) suggest that the globalisation of the automobile industry led the way for this model. Global human resource management: This involves pan-national recruitment and development of human resources. [Difficulty level: Easy]
Interactive question 4: A global corporation?
Some would say that such purely global organisations are rare. Industry structures change and foreign markets are culturally diverse. Even within the USA, there is an enormous variety of cultural differences. Can you think of a global corporation that fulfils the requirements of the definition given above? See Answer at the end of this chapter.
4.3
Ohmae's five Cs: factors encouraging development of global business

Ohmae (The Borderless World) has identified a number of reasons which might encourage a firm to act globally arranged into a 'five C's' framework. (recall in Chapter 1 the discussion of three of these C's under Ohmae's prescriptions for strategic thinking. By adding an extra two C's Ohmae extends his analysis into global business). The customer The company itself Competition Are consumer tastes across the world converging upon similar product characteristics? Selling in a number of markets enables fixed costs to be spread over a larger sales volume. The presence of global competitors, who are enjoying the benefits of global commitment, could encourage a previously local or regional operator to expand its activities. Setting up assembly overseas is a way of reducing the exchange rate risks inherent in exporting and may also help to get around government imposed trade barriers. Locating business activities overseas may provide cheaper access to labour, materials and finance, along with the goodwill of host governments.
Currency volatility
Country
The continuing political acceptance of free-trade by international economies is essential to the success of these strategic investments.
4.4
Porter: The Competitive Advantage of Nations

Management developing strategy in a global environment needs to understand the competitive advantages they have over firms from other countries. Porter (The Competitive Advantage of Nations) seeks to 'isolate the national attributes that foster competitive advantage in an industry'. Porter identifies determinants of national competitive advantage which are outlined in the following diagram. Porter refers to this as the Diamond.
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Business strategy
Role of factor conditions Human resources skills, (price, motivation, industrial relations) Physical resources (land, minerals, climate, location relative to other nations) Knowledge (scientific and technical know-how, educational institutions) Capital (i.e. amounts available for investment, how it is deployed?) Infrastructure (transport, communications, housing) Role of demand conditions The home market determines how firms perceive, interpret and respond to buyer needs. This information puts pressure on firms to innovate and provides a launch pad for global ambitions.
Basic factors Basic factors include: natural resources, climate, semi-skilled and unskilled labour. Basic factors are inherited, or at best their creation involves little investment.
Advanced factors Advanced factors include modern digital communications, highly educated personnel, research laboratories and so forth. They are necessary to achieve high order competitive advantages such as differentiated products and proprietary production technology.
Comment There are few cultural impediments to communication in the home market. The segmentation of the home market shapes a firm's priorities: companies will generally be successful globally in segments which are similar to the home market. Sophisticated and demanding buyers set standards. Anticipatory buyer needs: if consumer needs are expressed in the home market earlier than in the world market, the firm benefits from experience. The rate of growth: slow growing home markets do not encourage the adoption of state of the art technology. Early saturation of the home market will encourage a firm to export.
Role of related and supporting industries Competitive success in one industry is often linked to success in related industries. Domestic suppliers are preferable to foreign suppliers, as 'proximity of managerial and technical personnel, along with cultural similarity, tends to facilitate free and open information flow' at an early stage.
Comment This facilitates the generation of clusters. These are concentrations of many companies in the same industry in one area, together with industries to support them. For example, London in the UK is a global financial services centre, with a concentration of banks, legal services, accounting services and a depth of specialist expertise. Silicon Valley is a further example.
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Role of strategy, structure and rivalry Structure
Comment National cultural factors create certain tendencies to orientate business people to certain industries. German firms have a strong presence in industries with a high technical content. Industries in different countries have different time horizons, funding needs and so forth. National capital markets set different goals for performance. In some countries, banks are the main source of capital, not equity shareholders. When an industry faces difficult times, it can either innovate within the industry, to sustain competitive position or shift resources from one industry to another (e.g. diversification).
Strategy
Domestic rivalry
With little domestic rivalry, firms are happy to rely on the home market. Tough domestic rivals teach a firm about competitive success. Each rival can try a different strategic approach.
Two other variables, chance events and the role of government, also play their part in determining the competitive environment.
4.4.1
Interactions between the determinants

The factors in the 'Diamond' are interrelated. Competitive advantage in an industry rarely rests on a single determinant. Related industries affect demand conditions for an industry. For example 'piggy-back' exporting is when an exporting company also exports some of the products of related industries. Domestic rivalry can encourage the creation of more specialised supplier industries.
4.4.2
Clusters
Related business and industries are geographically clustered. A cluster is a linking of industries through relationships which are either vertical (buyer-supplier) or horizontal (common customers, technology, skills). Clusters are supposedly a key factor in the competitive advantage of nations.
Within a country, the industry may be clustered in a particular area. The Indian software industry is based in Bangalore. The UK investment banking industry is largely based in London.
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Interactive question 5: Why do banks cluster?
[Difficulty level: Easy]
It is easy to see why mining companies should congregate in a cluster around coal seams, or shipping services would congregate around ports, but why should banks and software companies be clustered in the same way, given plentiful IT and broad bandwidth communications? See Answer at the end of this chapter.
4.4.3
Using Porter's Diamond to develop business strategies

Porter claims that firms gain competitive advantage from either of two sources. Lower costs of supply to customers which result in higher profitability (cost leadership). Differentiated service or reputation resulting in higher prices and sales revenues (differentiation).
This is covered in more detail in Chapter 6. Porter advises management to consider the diamond factors in their home country and to compare them with the diamond factors available to rivals from other countries. He offers the following prescription. If the home diamond factors give a comparative cost advantage over those of foreign rivals then management should adopt strategies based on overall cost leadership. This may explain the strategies of South Korean car manufacturers like Hyundai/Kia, Daewoo and SsangYong (the latter two being respectively offshoots of General Motors and Daimler Chrysler). If the home diamond factors give a differentiation advantage over foreign rivals management should adopt strategies based on differentiation. This may explain why car manufacturers Mercedes, BMW and Audi tend to develop and initially produce their limousines in Germany but build vans and utility cars in Spain, South Africa and Brazil. If the diamond does not confer advantage over rivals then management must focus on sub-sections of the industry which large players may have overlooked or not be able to exploit commercially. This may explain the large number of private banks in Switzerland or the boutique sports car makers in Italy (Ferrari, Lamborghini, Maserati etc). [Difficulty level: Intermediate]
Interactive question 6: Chinese car industry
At the Beijing Auto Show (in November 2006) China's car makers felt confident enough to show off not just their newest low-cost runabouts, but also luxury and sports models, 'concept cars' showing future possible designs and even a few hybrid and electric vehicles. Local car makers in the world's third largest and fastest-growing car market would appear to have come of age. Until recently many Chinese car makers built thinly-disguised copies of vehicles made by Volkswagen, GM and Toyota. In the past few years things have changed. In preparation for a push overseas local firms such as Chery, Great Wall and Geely have proved they can develop their own vehicles too. Buying designs from international specialists and installing fancy robotic production lines means more than 100 new models will be introduced in China this year. Their car makers have captured 27% of the market in China and will export 75,000 vehicles to over 100 countries this year. Foreign car makers are worried by the Chinese firms' ultra low prices. The latest Shanghai Maple, for example, with leather seats, anti-lock brakes, air conditioning and a 2 year warranty costs a mere $6,500. Foreign firms grumble that they cannot even buy the steel needed to make the car for that price. How much of this miracle is the result of good business sense rather than special treatment granted to local firms is not entirely clear. A lot of early technology was borrowed. The government also offered support to fledgling firms via direct investments and guaranteed loans. Universities provided technical help, especially in the development of expensive engines. The authorities even considered a law that would mandate a 50% share for local firms by 2010. Future legislation is likely to force foreign firms to do more
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research and development in conjunction with Chinese partners to ensure continued access to cutting-edge engineering skills. In a market where buyers are unashamedly experimental, brands have little value so far, except in the luxury segment. For most buyers cost is more important. With average retail process falling by $1,250 a year producers are racing to cut costs, not improve quality. The number of faults per 100 cars made rose from 246 in 2005 to 338 in 2006. Reliability is likely to deteriorate further. Chinese cars exported today mostly go to Africa, south-east Asia and the Middle East where expectations are lower and price matters more. Requirements (a) Identify, using Porter's Diamond, the sources and nature of any competitive advantage enjoyed by Chinese car manufacturers.
(b) Recommend a strategy for Chinese car makers based on this analysis. See Answer at the end of this chapter.
5 Limits to globalisation of business

Section overview
Despite the forecasts there are many impediments to the development of global businesses such as protectionism. These are reviewed here. Pursuing a global strategy is a source of risk to a business, either because the forecast opportunity doesn't come about or because host governments change their policies towards 'foreign' investment and render it no-longer valuable.
5.1
Political risks in international business

The development of plans for international business will depend on the following factors: 1. 2. 3. 4. The stability of the government. Rapid changes or political unrest make it difficult to estimate reactions to an importer or a foreign business. International relations. The government's attitude to the firm's home government or country may affect trading relations. The ideology of the government and its role in the economy will affect the way in which the company may be allowed to trade, and this might be embodied in legislation. Informal relations between government officials and businesses are important in some countries. Cultivation of the right political contacts may be essential for decisions to be made in your favour.
Political risk is still relevant with regard to overseas investment, especially in large infrastructure projects overseas. History contains dismal tales of investment projects that went wrong, and were expropriated (nationalised) by the local government. Suspicion of foreign ownership is still rife, especially when prices are raised. Opposition politicians can appeal to nationalism by claiming the government sold out to foreigners. Governments might want to re-negotiate a deal to get a better bargain, at a later date, thereby affecting return on investment.
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Business strategy In addition to expropriation, there are other dangers: Restrictions on profit repatriation (for example, for currency reasons) 'Cronyism' and corruption leading to unfair favouring of some companies over others Arbitrary changes in taxation Pressure group activity
Worked example: China's failure to attract new investment

In eight months (of 2006) Intel committed more money to building production capacity in Vietnam than it committed to China in whole previous 10 years. Flextronics, a manufacturer of computer printers for Hewlett-Packard already has vast facilities in China but it chose Malaysia for its latest investment. Yue Yuen, a Hong-Kong based shoemaker, has been ramping up output of trainers for Nike and Adidas and production is increasing at the firm's factories in China and Vietnam, but output in Indonesia is growing the fastest. These companies are not alone. In the calculus of costs, risks, customers and logistics that goes into building global operations, an increasing number of firms are coming to the conclusion that China is not necessarily the best place to make things. Analysts give two big reasons for why China is not top of the list for new factories. Rising costs: Most development has taken place on China's Eastern costal strip and now costs of land, office space, utilities and labour are rising. Firms cannot find or retain managers versed in international production techniques and this causes rampant poaching and wage inflation. Diversification: Many firms are reluctant to put more eggs in the same basket. Many firms are adopting a 'China + 1 other country' strategy. Risks include increasing civil disturbances in China as the have-nots get left behind by the haves; growing protectionist talk from the USA and EU which has already resulted in 'anti-dumping duties' being imposed by the EU in October 2006. Another risk is the lack of legal protection for intellectual property in China which has led to designs being churned out by local factories under different brand names. Capital intensive industries where cheap labour is not so valuable, such as chemicals, prefer Singapore. The rising currency (6.5% rise 2005-2006 and projected to rise 5% during 2007) is also another concern because it will make exports from China less competitive. Source: Economist January 2007
5.2
Protectionism in international trade

Protectionism is the discouraging of imports by, for example, raising tariff barriers and imposing quotas in order to favour local producers. It is rife in agriculture.
Worked example: Sugar

Agriculture receives subsidies and government support in two of the world's most important areas, the USA and the EU, despite the fact that this sector employs decreasing numbers of people (unlike Africa and India, where people live on the land). Sugar is one of the most heavily protected. According to the World Bank, reform of sugar policy could benefit global welfare by $4.7bn pa. The US maintains price controls and high prices costing US consumers $2bn per year. The sugar industry, accounting for 61,000 jobs, is an intensive lobbyist. Florida, a sensitive state electorally, is a big culprit. The sugar lobby successfully excluded sugar from a free trade deal the US was negotiating with Australia and CAFTA (Central American Free Trade Agreement) Some have suggested that the sugar-lobby was behind the US's reluctance to endorse the World Health Authority's advice to limit sugar intake. The EU has proposed reducing its subsidies to sugar companies by 39% for 2009, owing to a WTO ruling that the EU's subsidy regime broke legal limits.
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Agriculture is a serious issue: campaigners such as Oxfam argue that opening agricultural markets to developing country producers could significantly alleviate global poverty. Sugar might find another use, as fuel alcohol.
Protectionist measures include: Tariffs or customs duties: A tax on imports where the importer is required to pay either a percentage of the value of the imported good (an ad valorem duty), or per unit of the good imported (a specific duty). Non-tariff barriers: Restrictions on the quantity of product allowed to be imported into a country. The restrictions can be imposed by import licences (in which case the government gets additional revenue) or simply by granting the right to import only to certain producers. Minimum local content rules: A specified minimum local content of products should be made in the country or region in which they are sold to qualify as being 'home made' and so avoid other restrictions on imports. This leads manufacturers to set up factories in the country. Minimum prices and anti-dumping action: To stop the sale of a product in an overseas market at a price lower than charged in the domestic market, anti-dumping measures including establishing quotas, minimum prices or extra excise duties are used Embargoes: A total ban or zero quota. Subsidies for domestic producers: Financial help and assistance from government departments that give the domestic producer a cost advantage over foreign producers in export as well as domestic markets. Exchange controls and exchange rate policy: Regulations designed to make it difficult for importers to obtain the currency they need to buy foreign goods. Unofficial non-tariff barriers: Administrative controls such as slow inspection procedures or changing product standards which are hard for foreign suppliers to anticipate and respond to.
5.3
Trade blocks and triads

Trading blocks Currently, a number of regional trading arrangements (or 'blocks') exist, as well as global trading arrangements. These regional trading groups take three forms. 1. 2. 3. Free trade areas members in these arrangements agree to lower barriers to trade amongst themselves. Customs unions these agree a common policy on barriers to external countries. Tariffs, taxes and duties are harmonised amongst members. Common markets in effect, the members become one trading area. There is free movement of all factors of production. The European Union has economic union as an aim.
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Business strategy Some major regional trade organisations are as follows. Name North American Free Trade Agreement www.nafta-sec-alena.org European Free Trade Association European Union http://europa.eu.int Acronym NAFTA EFTA EU Participating countries US, Canada and Mexico. Norway, Switzerland, Iceland, Liechtenstein. Ireland, Britain, France, Germany, Italy, Spain, Portugal, Finland, Sweden, Denmark, Luxembourg, Belgium, the Netherlands, Austria, Greece. In May 2004, Poland, Hungary, the Czech Republic, Malta, Cyprus, Estonia, Latvia, Lithuania, Slovakia and Slovenia. Brazil, Argentina, Paraguay and Uruguay (Chile is an associate). SADC Angola, Botswana, Lesotho, Malawi, Mozambique, Mauritius, Namibia, South Africa, Swaziland, Tanzania, Swaziland, Zimbabwe. Ivory Cost, Burkina Faso, Niger, Togo, Senegal, Benin and Mali. India, Pakistan, Sri Lanka, Bangladesh, the Maldives, Bhutan and Nepal. Venezuela, Colombia, Ecuador, Peru and Bolivia. ASEAN Indonesia, Malaysia, Philippines, Singapore and Thailand.
Mercosur www.mercosur.org Southern African Development Community www.sadc.int
West African Economic and Monetary Union www.uemoa.int South Asian Association for Regional Co-operation www.saarc-sec.org Andean Community www.comunidadandina.org Association of Southeast Asian Nations www.aseansec.org
UEMOA SAARC
Regional blocks such as those shown above only extend the benefits of free trade to their members. They may distort, and certainly do not represent, truly global trading patterns. Triad theory describes the international business environment as a limited number of 'superblocks'.
Worked example: Trading blocks

These trading blocks differ in their degree of integration and effectiveness. The EU is the only such block with an elected parliament and a common currency (for some of its members). The USA has a common currency between its individual states. The ASEAN Free Trade Area has a total population of over 500 million, and a maximum tariff of 5 percent (The Economist, 2 March 2002).
The EU has resisted the scrapping of agricultural subsidies. However, Mercosur is focusing on market access. This renewed negotiations resulting from the failure of the WTO negotiations at Cancun, and waning enthusiasm for a Free Trade Area of the Americas. Argentina, a member of Mercosur, is desperate to expand exports in order to generate growth to overcome its current financial crisis. Mercosur appears to accept that it is pointless trying to change the EU's Common Agricultural Policy.
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The Triad Rather than a globalised world or a federalised world of trading blocks some commentators see economic activity as principally occurring in three main economic blocks: the USA, the EU and Japan. These do the biggest value of their trade with each other. Triad theory rejects the idea that homogenous products can be developed and sold throughout the world. Multinationals have to develop their products for the circumstances of each triad. The Triad theory may be out of date. Japan was, in effect, in recession for 20 years from the mid 1980s whilst emerging markets, particularly those of China and India, but also Brazil, are likely to be some of the world's largest and fastest growing markets. They still have a long way to go before per capita incomes reach the level of the Triad countries. They may form the fourth and fifth trading blocks, or perhaps the triad will be superseded by their faster economic growth.
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Summary and Self-test
Summary
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Self-test
Answer the following questions. 1 PDB Motors Ltd is a major UK car manufacturer with plants in the UK and Europe. It is seeking to exploit both the buoyant North American and Brazilian markets for car sales. Suggest two reasons why it would be a logical strategy for PDB Motors Ltd to build an assembly plant in Mexico. 2 Social and technological factors always need to be assessed when analysing the environment within which a business operates. Give two examples of each of these factors which would be relevant to Busline Ltd, a UK operator of coach tours to Scarborough and Whitby. Suggest how each of your factors may impact future demand. 3 Dunvegan Ltd Dunvegan Ltd is a forestry company operating in the UK, mainly in Scotland. In addition to forests at various stages of maturity, the company also owns many hectares of undeveloped land. So far Dunvegan Ltd's timber has consisted almost exclusively of spruce trees which produce softwood used extensively in building work. Spruce sells for the equivalent of about CU200 per cubic metre. However, genetic engineering has produced a remarkable new tree which has the growth characteristics of spruce, but which produces hard wood with the appearance and qualities of mahogany. This species, the Maho spruce, should grow quite happily in Scotland and produce worthwhile crops after ten years, each Maho spruce tree producing about 2 cubic metres. Currently, mahogany sells for the equivalent of CU900 per cubic metre. The company which developed the Maho spruce has ensured that the trees are sterile and has also successfully applied for world-wide patents on the genetic material. Seedlings are available only from that company at a cost of CU200 each. Dunvegan Ltd is considering whether to invest in Maho spruce. Land already owned by the company would be used and the company's planting and drainage equipment would be assigned temporarily to the project. Because the seedlings are so expensive, relatively light planting would be used at 1,500 seedlings per hectare. Annual maintenance and security would be CU1,000/hectare for each of the ten years of the project. Dunvegan Ltd is considering planting 1,000 hectares with Maho spruce. In the UK Dunvegan Ltd has three main competitors; mahogany is also imported from four countries in the tropics where it is a valuable export. Some of the wood is from managed plantations, but some is from natural forest. Recently the price of mahogany has been rising as supplies become short and plantations have to be renewed. Dunvegan Ltd's accountant has read an article in a recent edition of Lumber About, the monthly trade paper of the timber business, in which the economic effects of the Maho spruce were discussed. If around 3,000-4,000 hectares were planted in the UK, then the price of mahogany would be CU500 per cubic metre at the end of ten years. If around 2,000 hectares only were planted, then the price would be CU800 per cubic metre. Requirement From the viewpoint of an independent consultant, write a memorandum to the directors of Dunvegan Ltd on the proposed Maho spruce plantation. Your memorandum should include an environmental analysis. (20 marks)
Now, go back to the Learning Objectives in the Introduction. If you are satisfied that you have achieved these objectives, please tick them off.
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Answers to Self-test
1 Two reasons from the following: 2 This would allow PDB to take advantage of low labour costs in Mexico. The location would be close to potential major markets, cutting transport costs and reducing lead time. The NAFTA will avoid sales to the USA and Canada being subject to import restrictions. It delivers sales growth prospects to a company facing a saturated European market.
Social factors Two examples form the following: Increasing car ownership (lower demand) Higher proportion of older people in society (higher demand) Cheap overseas packages available (lower demand).
Technological factors Two examples from the following: 3 Development of high speed trains (lower demand) More comfortable coaches being developed (higher demand) Greater internet accessibility, creating more awareness of other travel options (lower demand).
Memorandum To From Date The Directors of Dunvegan Ltd Independent Consultant Today
Subject Proposed Maho spruce plantation The trading environment The Maho spruce project is a ten-year project and it is important to try to predict how the trading environment may change by the time the timber is ready to harvest. However, the time scale obviously makes any predictions unreliable. The environment can first be analysed under the headings Political, Economic, Social, Technological. Political Mahogany currently comes from four countries in the tropics. As it is a valuable export, these countries can be expected to be willing to sell mahogany irrespective of local political changes. In the UK, however, there is growing concern about the deforestation of the tropics and suspicion about the source of many hardwoods. It is possible that the UK or EC will tighten import legislation. Locally grown, renewable mahogany-substitute should be favoured in this ecologically-aware age. Economic Mahogany is principally used for building (window frames, etc) and furniture (veneers). Both of these industries are very sensitive to the health of the economy. It is difficult to predict the economic health of the country ten years hence and so the project will have considerable risk and uncertainty.
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Social If home-owning continues to grow, it is to be expected that demand for high quality materials will also grow. As mentioned under the political paragraph, using tropical hardwoods could become socially unacceptable and it would appear that the Maho spruce should provide a politically correct substitute. However, some people may object to using genetically-engineered material. Technological Although Maho spruce has been patented, there is no reason why other manufacturers could not develop similar products. That would drive down the cost of seedlings (a major cost of the undertaking) and hence the price that would eventually have to be achieved to make the investment pay. Size of investment The proposed investment is large, especially as there are many important factors which could change over the project's life: the project is high risk even if not using innovative technology. Risk could be reduced by planting over several years rather than 1,000 hectares at one time. In that way the economics of the investment could be monitored and decisions taken about each slice of investment. Naturally, this approach would delay the maturity of some of the crop. There is a risk that this would reduce the final income (if mahogany prices were to fall) but prices could also rise (strong reaction against natural mahogany, economic upturn). Delaying planting could also reduce the initial price of seedlings as other bioengineering companies launch new products. Summary Insofar as environmental factors can be judged it would seem that Maho spruce should be a popular product. The main risk arises from technological advances which could produce similar cheaper timber. However, the economics of the project are very dependent on the future price of Maho spruce timber, its substitutes and the reactions of rivals. My advice is as follows: (i) (ii) Attempt to get the suppliers of Maho spruce to regulate sales of the seedlings. Consider spreading out the investment instead of committing so much expenditure in the first year.
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Answers to Interactive questions
Answer to Interactive question 1

(a) External factors would include: Rival accounting firms seeking to take clients themselves Other professional practices which may direct work toward us Regulations such as tax laws, accounting standards and audit standards The labour market for post-qualified and qualified accountants The general state of the economy and its effect on business
(b) These factors create opportunities and threats. New regulations create a need for professional advisers to provide guidance to clients. Competitors or a thriving labour market with higher pay create threats (incidentally notice how you changed your perspective on the last point because you would like to have the higher pay but you are calling it a threat for your firm). This illustrates how flawed the distinction between 'internal' and 'external' is when we discuss environmental analysis. (c) This will depend on the managers psychological make-up. Some will see it as a tiresome bind that makes them have to keep changing things and also which makes it hard to plan or feel certain. Others will see it as invigorating. A very interesting test of management is the extent to which they see themselves as powerless in the faces of environmental changes or whether they believe they can shape and respond to them. (d) Again, this varies. Some will avoid making decisions which could be affected by environmental uncertainty, and will wait till it settles down (hence incrementalism). Some will simply ignore environmental issues that cannot be proven. Perhaps a more balanced approach is to adopt strategies that would still deliver benefit under a number of environmental developments or perhaps have several courses of action running at the same time, with each one designed to take advantage of different environments. In another context, energy companies invest in several different technologies because they do not know how oil prices and environmental regulations will develop.

(a) Oil producers adapted scenario planning techniques from their original military applications (notably in planning for the aftermath of thermonuclear war) during the 1970s. This followed the oil price shock when the Arab states then at the centre of OPEC massively increased the price of oil and caused inflation and recession in industrialised Europe and North America. This decision was itself justified in part as a response to the perceived support of oil consuming Western countries for support of the occupation of Palestine and Egypt. It was a response to the high turbulence (e.g. political shifts, vulnerability to economic factors etc.) and dynamism (e.g. speed of change of political landscape) in the oil industry. Furthermore the very long investment periods in the industry necessitated long-term strategic plans based on assumptions about the future. (b) Possible scenarios would incorporate a combination of: War in the oil producing countries of the Middle East Aggressive energy politics by countries such as Russia and Venezuela, holders of large reserves of oil and gas High energy demand from newly industrialising countries such as China and India Increasing legislation in industrialised nations aimed at reducing use of carbon dioxide producing fuels
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Development of new energy sources such as clean coal, biomass fuel, wave and wind, and reemergence of nuclear power Discovery of new oil or energy reserves

3 Environmental analysis The factors in the surrounding environment obviously played a significant part in the state of the newspaper industry at that time. They were largely external and as such outside the control of the individual newspaper companies, resulting in a reactive approach by the companies to such factors. (a) Political and economic One the major factors that influenced the industry was the recession. The industry had and still has two main sources of income revenue from individual sales coupled with revenue from advertising. The tabloid newspapers were heavily reliant on advertising revenue (representing 80% of their income) whilst the broadsheets had a more even split. Both sources, however, suffered severely in the recession as disposable income fell. Redundancies, pay freezes, and low inflation all resulted in a decrease in the income of the individual. The individual therefore cut back on what he perceived to be non-essential items, which may include his newspaper. Alternatively he will search for a cheaper alternative the tabloid or the free issue ('freebie'). Probably the broadsheets were relatively more influenced by government policies such as increased taxes, which were aimed directly at individuals, decreasing their disposable income and hence decreasing demand for the more expensive newspaper. This obviously resulted in the price drop for The Times. To some extent this price drop prevented broadsheet customers deserting to cheaper tabloids, and also hit very hard the higher priced broadsheets, such as The Independent. The decrease in the individual's net disposable income would have had a knock-on effect on the advertisers: if the target market had less disposable income than previously was the case, companies would be less willing to advertise in newspapers, as it may not have been costefficient. The overall effect was a sharp fall in revenues for newspaper companies. In order to overcome this the newspapers attempted to increase volume by dropping sales price, hoping that the increased volume would compensate for the overall decrease in revenues. (b) Social At that time, the newspaper market was split into two distinct sections the tabloids and the broadsheets. Historically those individuals with lower incomes tended to buy the tabloids and those with higher incomes tended to buy the broadsheets. Furthermore, the tabloids are intended to be sold to a more 'lower class' market than the broadsheets. How the recession would have affected this is arguable. Some held that the 'higher class' image attached to the broadsheets would prevent a switch by such readers to the cheaper 'lower class' tabloid. However, the tabloid editors believed that this was not the case: people are moneydriven and the broadsheet readers would be just as price-sensitive as those of the tabloids hence a switch would be feasible. General levels of literacy have declined and the public are less inclined to obtain their news from newspapers but instead rely on news bursts in the middle of radio and television programming. (c) Technological Changes in technology at that time had a considerable effect on the newspaper industry. Colour photographs, although not too recent an innovation, were considered by then to be the norm for national newspapers and therefore became a necessity if a newspaper was to compete at a national level. This was borne out by the experience of The Independent which initially had no
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Business strategy colour pictures, resulting in an uncompetitive stance. The technology required to upgrade the paper to colour printing was very expensive, necessitating an increase in the price of the paper at a time when a price war was emerging. Since then the emergence of on-line services such as news websites and 24 hour-news programming on digital TV have increased the competition to newspapers. As we live in an age where television is the focal point of many people's lives, the accessibility of news/sport and television information has rendered it less important for people to have a newspaper on a daily basis. Newspaper companies have also encountered further costs due to increased technology in the typesetting area which is now centrally controlled and downloaded to regional areas where the printing is done. Once again, to compete on a national basis, this has involved major capital outlay for most companies, which has to be recouped by increased circulation, increased selling prices or increased efficiencies. Given that newspapers are often bought to while away boredom on journeys to and from work etc the development of compact multimedia devices such as MP3 music and video players will reduce the casual purchase of newspapers. (d) Ecological Newspaper production and distribution has many ecological impacts. The raw material is timber and the manufacture of paper involves large amounts of water and bleaches. Print ink was solvent based originally. It is an industry that requires substantial logistics and so leaves a carbon footprint. Regulations affecting pollutants, the recycling of paper, and the carbon emissions from a business would impact sharply on the costs of the newspaper industry. (e) Legal During the recession, in order to boost sales, the tabloids in particular tended to search for more 'popular' stories such as the Royal family and scandals about prominent people. This, however, resulted in an increase in law suits, as a struggle emerged as to whether the private lives of prominent individuals were indeed 'private'. The current ruling is that anything that is in the public interest may be published. However, there remains a grey area as to what is in the 'public interest'. This was then coupled with the manoeuvring by newspapers on the issue of publishing sensitive photographs. Some published in order to obtain a short-term boost to their circulation whereas others decided to publish their 'disgust at those seizing the opportunity' in the hope of a longerterm increase in circulation. The legal issues surrounding the competitive nature of the industry also came to the fore, particularly as to whether the price cuts were an attempt at predatory pricing in order to force a competitor out of business. Conclusion The newspaper industry was in a particularly turbulent phase in the 1990s. This was mainly caused by the recession and the effect this had on disposable incomes. Moreover, with technology everimproving since that time, television and radio have taken increasing shares of the media market away from newspapers.

Levitt cited examples such as Coca-Cola in his article. More recently, examples such as Starbucks, Mercedes Benz, Microsoft and Disney have been called global businesses. In practice, these corporations offer subtly different products in different markets and their appeal is not global. For example, Coca-Cola has suffered badly from an anti-American sentiment and Disney has not been as successful in Europe as it had hoped.
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The reasons cited for geographical clustering of Financial and IT businesses are: Proximity to educational and research centres. For example, in USA the IT industry clusters around its universities. Networking and mutual exchanging of staff.

(a) The scenario suggests the following sources of the Cost Leadership advantages enjoyed by the Chinese car industry: 1. Demand conditions: China is a very large market (third largest) and fast growing. This enables firms to gain significant economies of scale and also to justify investment in the new models (100 next year) and production equipment. With the exception of the luxury segment the demand is for low price cars and this has forced car makers to concentrate on reducing costs. Related industries: The only cited example is the assistance from universities in R&D. This provides significant cost advantages compared with in-house development. The low price of the Shanghai Maple suggests that steel and other components are being sourced cheaply too. Factor conditions: China clearly has a good technical education system. It is also known for having abundant cheap labour and land available for building car plants. It has good sea links and freight handling for the purposes of exporting. Firm strategy, structure and rivalry: The scenario mentions only three firms which, between them, share 27% of the Chinese market. The Chinese government wishes this to increase to 50%. This will give each significant economies of scale and an incentive to invest in product and process improvement. That foreign-made cars are allowed into China gives a stimulus to product development and the search for competitive advantage. It is noticeable that the predominant mode of competition is price/cost and not quality. The industry seeks to build a me-too version of a foreign car but at a lower price.
2.
3.
4.
(b) The attempt by Chinese car manufacturers to go 'up-market' and develop unique designs and distinctive brands for export is a mistake. It suggests a vanity that could sacrifice the industry's competitive advantage. The appropriate strategy for the industry is to remain a low cost player. It has huge internal markets available to it that value its present offerings. Its low cost position may enable it to focus on export markets such as other developing economies where low cost is also important. However its advantages are location specific and it should access these markets by exporting rather than, say, setting up factories outside China. The poor quality of its products should be addressed. The number of faults is rising and by giving a two-year warranty the firms are bearing the substantial costs of rectifying these. It may be cheaper to stop the faults happening than it is to fix them and it would improve customer perception at home and abroad.
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Business strategy
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BS Chapter 03 The Macro Environment

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chapter 3

The macro environment

Summary and Self-test Answers to Self-test Answers to Interactive questions

The Institute of Chartered Accountants in England and Wales, March 2009

Identify the risks attached to operating a global business

Specific syllabus references for this chapter are: 1b, 3g.

Stop and think

The Institute of Chartered Accountants in England and Wales, March 2009

THE MACRO ENVIRONMENT

The Institute of Chartered Accountants in England and Wales, March 2009

1 The business environment

Importance of management understanding business environment

The Institute of Chartered Accountants in England and Wales, March 2009

THE MACRO ENVIRONMENT

STRATEGIC CHOICE STRATEGY IMPLEMENTATION

STRATEGIC CHOICE STRATEGY IMPLEMENTATION

Interactive question 1 Considering the business environment

Gathering and disseminating environmental information

The Institute of Chartered Accountants in England and Wales, March 2009

Sources of environmental information

Validating environmental information

Disseminating environmental information

The Institute of Chartered Accountants in England and Wales, March 2009

THE MACRO ENVIRONMENT

Complexity, predictability and turbulence

The Institute of Chartered Accountants in England and Wales, March 2009

Interactive question 2: Oil industry scenarios

[Difficulty level: Intermediate]

The Institute of Chartered Accountants in England and Wales, March 2009

THE MACRO ENVIRONMENT

PESTEL analysis and underlying assumptions

Worked example: Software in India

The Institute of Chartered Accountants in England and Wales, March 2009

Worked example: Oil companies in Russia

The Institute of Chartered Accountants in England and Wales, March 2009

THE MACRO ENVIRONMENT

These affect overall wealth, financial stability and patterns of demand.

The Institute of Chartered Accountants in England and Wales, March 2009

Business strategy Business cycle

Long-term trend Time

The Institute of Chartered Accountants in England and Wales, March 2009

THE MACRO ENVIRONMENT

Cultural factors are identified in the diagram below.

Worked example: EuroDisney

The Institute of Chartered Accountants in England and Wales, March 2009

The Institute of Chartered Accountants in England and Wales, March 2009

THE MACRO ENVIRONMENT

The Institute of Chartered Accountants in England and Wales, March 2009

Worked example: Pulp and paper

Ecological environment factors

The Institute of Chartered Accountants in England and Wales, March 2009

THE MACRO ENVIRONMENT

The Institute of Chartered Accountants in England and Wales, March 2009

Interactive question 3: Newspaper industry

[Difficulty level: Exam standard]

The Institute of Chartered Accountants in England and Wales, March 2009

THE MACRO ENVIRONMENT

(b) Social (c) Technological

(d) Ecological (e) Legal

See Answer at the end of this chapter.

4 The international business context

The importance of the global business environment