INTRODUCTION

Strategic analysis is basically concerned with the structuring of the relationship between a business and
its environment. The environment in which business operates has a greater influence on their successes
or failures. There is a strong linkage between the changing environment, the strategic response of the
business to such changes and the performance. It is therefore important to understand the forces of
external environment the way they influence this linkage. The external environment which is dynamic
and changing holds both opportunities and threats for the organisations. The organisations while
attempting at strategic realignments, try to capture these opportunities and avoid the emerging threats. At
the same time the changes in the environment affect the attractiveness or risk levels of various
investments of the organizations or the investors.

BROAD DIMENSIONS OF EXTERNAL ENVIRONMENT
The macro environment in which all organizations operate broadly consist of the economic environment,
the political and legal environment, the socio cultural aspects and the environment related issues like
pollution, sustainability etc. The technological temper and its progress has been the key driver behind the
major changes witnessed in the external environment making it increasingly complex.

Strategic Analysis These factors often overlap and the developments in one area may influence
developments in other. For example, the opening up of economy integrated the markets globally and
increased the competition between private and public firms. This forced the Indian government to revisit
its economic policies. Under its new liberalization policy and economic reforms of 1991, regulations like
MRTP, which restricted the size of the business and therefore inhibited their efficiency and competitive
levels, were removed with a positive impact on the indigenous industries. However, the delay in
addressing to the policies like Indian companies act or Exim policies, organizations both from domestic
and abroad still find the Indian business environment not so conducive for business. The current political
developments are sure to have more uncertainties in the minds of business people regarding the future
policy direction in certain sectors. The social considerations in the context of a developing country like
India also plays a critical role in deciding the broad dynamics of the business environment. The clash of
ideologies between preserving the Indian ethos and culture and giving a freedom of choice to people
often create problems and confusion for business.

PESTEL FRAMEWORK
Careful analysis of the above factors will help in identifying major trends for different industries.
Exhibit-1 shows the PESTEL framework which is most popularly used for such analysis.

The external forces can be classified into six broad categories: Political, Economic, Social,
Technological, Environmental and Legal Forces. Changes in these external forces affect the changes in
consumer demand for both industrial and consumer products and services. These external forces affect
the types of products produced, the nature of positioning them and market segmentation strategies, the
types of services offered, and choice of business. Therefore, it becomes important for the organizations
to identify and evaluate external opportunities and
threats so as to develop a clear mission, designing strategies to achieve long-term objectives and develop
policies to achieve short-term goals. Here, we will discuss all the six forces individually and then try to
come to the conclusion regarding environmental analysis.

Few indicative points are listed to guide you to find the key forces at work in the general environment.
While the framework may be used to understand the most important factors at the present time, it should
be primarily used to look into the future impact which may be different from their present or past impact.

The PESTEL Framework Macro-environmental influences. The framework primarily involves the
following two areas:

1. The environmental factors affecting the organization;
2. The important factors relevant in the present context and in the years to come.

Political
1. Government stability
2. Political values and beliefs shaping policies
3. Regulations towards trade and global business
4. Taxation policies
5. Priorities in social sector

Environmental Analysis Economic Factors
1. GNP trends
2. Interest rates/savings rate
3. Money supply
4. Inflation rate
5. Unemployment
6. Disposable income
7. Business cycles
8. Trade deficit/surplus

Socio-cultural Factors
1. Population demographics
l ethnic composition
l aging of population
l regional changes in population growth and decline
2. Social mobility
3. Lifestyle changes
4. Attitudes to work and leisure
5. Education spread or erosion of educational standards
6. Health and fitness awareness
7. Multiple income families

Technological
1. Biotechnology
2. Process innovation
3. Digital revolution
4. Government spending on research
5. Government and industry focus on technological effort
6. New discoveries/development
7. Speed of technology transfer
8. Rates of obsolescence

Legal
1. Monopolies legislation/Antitrust regulation
2. Employment law
3. Health and safety
4. Product safety

Political: Politics has a serious impact on the economic environment of a country. Political ideology and
political stability or instability strongly influence the pace and direction of the economic growth. Also it
contribuies to the economic environment which is conducive for some businesses to grow or remains
indifferent for some businesses and at times is a hurdle. Subsequent to general elections of 2004 in the
country, there has been a change in the government at the centre. A new coalition United Progressive
Alliance (UPA) led by the Congress party and supported by Left is ruling at the centre and the
implications on business can be seen through few of the policy statements announced by the government.
Even though the broad policy direction is in line with the policy of an open economy and private sector
initiative, the Strategic Analysis Common Minimum Programme has identified few priority areas which
is going to an impact different than before. Particularly when there are certain ideologies which view
differently the issues like FDI and privatization, the future of different sectors like insurance and
banking, aviation and telecommunication have become uncertain.

Looking back into the history due to certain ideological beliefs prevalent in some section of politics,
foreign companies like Coca Cola and IBM had to move out of India in the late 70s. Entry barriers,
protectionist policies, high tariffs, nationalist pursuits all worked towards a closed economy which
continued till the time liberlization policies were introduced in 1991. This situation had a cumulative
effect on making the economy weak and the businesses were hardly competitive as compared to the
international standards. However in subsequent years, the political consensus developed on issues such
as labour reforms, power sector reforms, importance of infrastructure sector is doing a lot good for
business. Nevertheless, the deteriorating standards in politics, increasing corruption and the criminal
nexus are creating hurdles for business in certain areas.

Common Economic Indicators
A. National Income
B. Policy Initiatives
GNP Monetary policy
Personal disposable Income Fiscal policy
Personal consumption Labour and employment policy
C. Savings
D. Foreign Sector
Personal savings Exchange rates
Corporate savings Exports/Imports
Balance of Payments
E. Industry
F. Sectoral Growth
Industry Investment Agriculture
FDI flows Industry
Services
Infrastructure
G. Capital Market H. Prices, Wages, Productivity
Equity market Inflation
Bond market Labour productivity

Economic factors throw light on the nature and direction of the economy in which a Environmental
Analysis firm operates. The firms must focus on economic trends in segments that affect their industry.
For example the present trend of low interest rates on personal savings may compel individuals to move
towards equity and bond markets leading to a boom in the capital market activity and the mutual fund
industry. Consumption patterns are usually governed by the relative affluence of market segments and
firms must understand them through the level of disposable income and the tendency of people to spend.
Interest rates, inflation rates, unemployment rates and trends in the gross national product, government
policies and sectoral growth rates are other economic influences it must consider.

The services sectors contribution to national income is increasing year after year and the family incomes
are rising faster than individual incomes, job opportunities are more diverse and therefore these speak for
different types of opportunities and challenges which are emerging before the business. With the opening
up of theeconomy, trends in global market needs a careful look.

The above needs to be analyzed and incorporated in your inferences for the general environment and its
other forces and how all these together may influence business.
Social Demographic Factors: Demographic characteristics such as population, age distribution, literacy
levels, inter-state migration, rural-urban mobility, income distribution etc. are the key indicators for
understanding the demographic impact on environment. The shifts in age distribution caused by
improved birth control methods have created opportunities for youth centric products ranging from
clothes to entertainment to media. The growing number of senior citizens and their livelihood needs have
been highlighted and the government is being forced to pay more attention in the form of social security
benefits etc.

Considering Literacy and the composition of literates in the country creates opportunities for particular
type of industries and type of jobs. For example on one hand, the presence of a large number of English
speaking engineers encouraged many software giants to set up shops in India and on the other, the
availability of cheap labour, India becomes a destination for labour intensive projects. Moreover, large
labour mobility across different occupations and regions, in recent times, has cut down wage differentials
greatly and this has an impact for business which needs to be understood.

Cultural Factors: Social attitudes, values, customs, beliefs, rituals and practices also influence business
practices in a major way. Festivals in India offer great business opportunity for certain industries like
clothes and garments, jewellery, gift items, sweetmeats and many others, the list could be endless. Social
values and beliefs are important as they affect our buying behaviour. For example, Mc Donalds does not
serve the beef burgers in India because Indians do not

Strategic Analysis have cow meat since the animal is considered holy and sacred. A related example of
Walt Disney also brings out clearly, the impact different cultures may bring to business. Walt Disney
which has been so suffcessful in US market could not be so similarly successful in European countries
because of the difference in the way in which people entertain themselves there. Walt Disney had to
customize its offerings in order to be successful in these markets. The spread of consumerism, the rise of
the middle class with high disposable income, the flashy lifestyles of people working in software,
telecom, media and multinational companies seem to have changed the socio-cultural scenario and this
needs to be understood deeply. Values in society also determines the work culture, approach towards
stakeholders and the various responsibilites the organization thinks of owing to its stockholders and the
society.

Technology: Technological factors represent major opportunities and threats which must be taken into
account while formulating strategies. Technological breakthroughs can dramatically influence the
organisations products, services markets, suppliers, distributors, competitorss, customers, manufacturing
processes, marketing practices and competitive position. Technological advancements can open up new
markets, change the relative position of an industry and render existing products and services obsolete.
Technological changes can reduce or elimiate cost barriers between businesses, create shorter production
runs, create shortages in technical skills and result in changing values and expectations of customers and
employees. The impact of information technology (IT) which combines fruits of both
telecommunications and computers has been revolutionary in every field. Not only has it opened up new
vistas of business but also has changed the way the businesses are done. IT has specifically brought in
another dimension Speed which organizations recognize as the additional source of competitive
advantage beyond low cost and differentiation. Manufacturers, bankers and retailers have used IT to
carry out their traditional tasks at lower costs and deliver higher value added products and services.

Environment: Environment conservation and protection is an issue, which Environmental Analysis has
gained prominence because of deteriorating environmental balance which is threatening the
sustainability of life and nature. Largely, business is also held responsible for such situations as
emissions from industries poluting the air, excessive chemical affluents drained out in water making it
poisonous and unfit for use, usage of bio non-degradable resources affecting the bio-chain adversely and
exposure of employees to hazardous radiations bring their life in danger. All these have been taken very
seriously by different stakeholders in the society including the government and legislations and
movements are creating pressure for an environment friendly business. These have far reaching
implications for business ranging from the kind of business, the product being manufactured, how it is
manufactured and how friendly it is for mankind and nature. Big companies like Coca Cola and Pepsi
have also come under the purview of the society regarding the environmental hazards. If the charges on
them of using chemicals beyond accepted levels for manufacturing soft drinks are confirmed, they will
have a black spot on their names and business. So, it is important for the organisations to take care of the
environment as well.

Legal: Licensing policies, quota restrictions, import duties, Forex regulations, restrictions on FDI flows,
controls on distribution and pricing of commodities together made business difficult during license
permit raj before the liberalization policy of 1991. However, with economic reforms things have changed
and legal formalities have eased. Nevertheless with globalization, the rules of competition, trade mark
rights and patents, WTO rules and implications, price controls and product quality laws and a number of
other legal issues in individual countries have become important and therefore they need to be included
while understanding the general environment.

GENERAL ENVIRONMENT AND ORGANIZATIONS STRATEGY
As a next important step the manager needs to analyze the kind of impact the change may bring in their
own industry as the impacts are never same for all industries. For example, the emerging younger
demographic profile of India will have very different consequences for businesses say in health care or
entertainment. While the former will face an adverse effect, the latter will have a positive effect and this
needs to be analyzed and integrated into strategic decision making. In response to these assessments of
differential impacts, managers will be able to take advantages of the opportunities or guard themselves of
the threats. Exhibit 4 shows in how different ways various industries get affected by the different
environmental trends. Responding to these various impacts with new strategic initiatives the managers
must take notice of the fact that if the changes are significant, it may have the potential of changing the
competitive rules of the game in the industry. For example, in India the Strategic Analysis competitive
rules of the game for sectors like telecom, banking and insurance etc. in the post liberalization period
changed specially in last two years. With the easing of FDI and particiption of major global players,
norms have changed dramatically which is reflected in the strategies of most of the firms in the sector.
These changes can be seen in the area of technology and pricing, intensity of advertising and promotions,
their business alliances and network in the country. Managers need to be cautious of the fact that there
may be developments, which are not so easy to be predicted and therefore need further attention so that
they can be incorporated in their strategy. In the global context, the managers must see the kind of impact
any single change will have in different markets. It is quite possible that they are very different both in
degree and their nature.

Exhibit 4
Environmental Potentially positive Probably neutral Probably negative Trends effects effects effects
1. Aging population medical services minerals colleges and schools
2. Multiple income fast food machine tools grocers supplies families
3. Deregulation shipping financial sector
4. Increased waste management software leather environmental lelgislation
5. Growing global telecommunication competition mining small scale/handicrafts

Structural Drivers to Change
The PESTEL analysis gives a number of factors and their likely influences. However it is important to
identify the specific factors which may influence an industry and force them towards competitive
adjustments. These factors are termed as structural drivers of change which have the likely effect on the
structure of an industry or on the competitive environment. As a first step based on PESTEL analysis, the
key driving forces need to be identified and then impact of the combined effect of these forces should
also be made. Increasing globalization of the industry and the E enabled era could be such driving forces
capable of affecting the structure of an industry or its environment.

ENVIRONMENTAL SCANNING
The factors or the forces understood under PESTEL framework put together, present a highly complex
and uncertain environment which are difficult to predict or foresee. From a long term view of strategy
however, reaching somewhat closer to such forces are important in understanding the key factors
influencing the success of such strategies. Environmental scanning is one of the few ways to detect
future driving forces early and this involves studying and interpreting the developments of social,
political, economic, ecological and technical events that could become driving forces. It attempts to
figure out few radical happendings or path breaking developments which may be catching on and see
their possible implications 5 to 20 years into the future. The purpose of the environmental scanning is to
raise the consciousness of managers about potential developments that could have an impact on industry
conditions and bring in new threats or opportunities.

Environmental scanning is normally accomplished by systematically monitoring and Environmental
Analysis studying current events, constructing scenarios and employing the Delphi method (a technique
for finding consensus among a group of knowledgeable experts). Constructing scenarios involves a
detailed plausible view of how the business environment of an organization might develop in the future
based on the groupings of key environmental influences and drivers of change about which there is high
level of uncertainty. For example in industries like energy, transportation, defence equipment etc. there is
a need for views of the business environment of more than 1015 years and factors like raw materials,
substitutes, consumption patterns, geo politics etc. would be of crucial importance. Foreseeing precisely
for such a longer duration may be very difficult but drawing up possible futures may be possible. It is not
unnatural to believe that several scenarios could unfold overtime and these need to be understood.
Scenario Planning technique is briefly discussed in Unit 5 under the competitive environment.

SUMMARY
Understanding of the general environment in which an organization operates is the foremost pre-requisite
towards strategy formulation. The six broad dimensions which the PESTEL framework provides of the
environment-political, economic, sociocultural, technological, environmental and legal are capaable of
giving a comprehensive overview of how things may be unfolding. The objective of the analysis out of
this framework however should not only restrict to the present and past but the real focus should be on
projecting the trends into future in order to get the real feel of the environment then. This shall enable the
firm to proactively strategize for future considering the general environment, it is going to face and the
issues which will be of importance.


REFERENCES AND FURTHER READINGS
Johnson, Gerrry & Scholes, Kevan. (2004). Exploring Corporate Strategy. Sixth
edition, Prentice-Hall of India, New Delhi.
Thompson, A. Arthur, Jr. and Strickland, A.J. III. (2003). Strategic Management,
Concepts and Cases, Thirteenth edition. Tata McGraw Hill Publishing, New Delhi.
Miller, Alex. Strategic Management, Third edition. Irwin McGraw Hill.
Peters, Thomas J. and Robert, H. Waterman, Jr. (1982). In Search of Excellence:
Lessons from Americas Best-Run Companies, New York: Harper and Row.
David, R. Fred. (1997). Concepts of Strategic Management. Prentice Hall
International Inc.

Source: www.ignou.edu

Process of Business Environment Analysis

Background
Environmental analysis is a systematic process that starts from identification of environmental factors,
assessing their nature and impact, auditing them to find their impact to the business, and making various
profiles for positioning. A common process of environmental analysis or scanning is discussed in the
following section.

Environmental Analysis Process
A business manager should be able to analyze the environment to grasp opportunities or face the threats.
Organizations need to build strength and repair their weakness available in the business environment.
Therefore, this process consists not only a single steps but a process of various steps. Environmental
analysis comprises scanning, monitoring, analyzing, and forecasting the business situation. Scanning is
to get the relevant information from the information overload. It is to focus on the most relevant
information. Monitoring is to check the nature of the environmental factors. Analyzing requires data
collection and use of different required tools and techniques. Forecasting is to find the future possibilities
based on the past results and present scenario.

Environmental analysis process is not static but a dynamic process. It may differ depending on the
situation. However, a general process with few common steps can be identified as the process of
environmental analysis these are a) Monitoring or identifying environmental factors, b) Scanning and
selecting the relevant factors and grouping them, c) Defining variables for analysis, d) Using different
methods, tools, and techniques for analysis, e) Analyzing environmental factors and forecasting, f)
Designing profiles, and g) Strategic positioning and writing a report. Brief discussion is made on each of
the step of this environmental analysis process.

Identifying environmental factors
First of all a strategist should identify all the relevant factors that might affect his or her business. In this
process, one should first know what the internal areas of the business are. This includes all the systems,
internal structure, strategies followed, and culture of the organization. All these areas can be covered into
the five functional areas in classical approach. Similarly, a business daily interacts with the close
environmental components outside the business such as customer, competitor, and supplier. It might
cover all other stakeholders such as trade union, media, and pressure group. Furthermore, general such
business environment factors as political-legal, economic, sociocultural, and technological factors are to
be identified

Scanning and selecting relevant and key factors
Out of all the business environmental factors, a strategist should focus only on
the relevant factors for further analysis. All the factors are not equally
important and affecting to the business. In this context, a strategist has to scan
the environmental trend to select only the most affecting environmental factors
from the information overload. This step paves the way of environment
analysis and forecasting.

Defining Variables for Analysis
Selected environmental factors are to be further specified into the variables. A concept can be interpreted
into different variables. For example, political situation can be measured using few variables such as
instability, reliability, and long-term effect. Economic environment might cover many variables such as
Per Capita, GDP, and Economic policies that can be further classified into many other variables.
Variables are the basis of measurement in environmental analysis process. Variables can be compared,
grouped, correlated, and predicted to find the clearer picture of the broader concept. It is, therefore,
necessary to define the variables first in any kind of analysis including the environmental analysis.

Using Different Methods, Techniques, and Tools
Different types of methods, tools, and techniques are used for analysis. Some of the major methods of
analysis can be Scenario Building, Benchmarking, and Network methods. Scenario presents overall
picture of its total system with affecting factors. Benchmarking is to find the best standard in an industry
and to compare the ones strengths and weakness with the standard. Network method is to assess
organizational systems and its outside environment to find
the strength and weakness, opportunity and threats of an organization.

Some of the techniques of primary information collection can be Delphi, Brainstorming, Survey, and
Historical enquiry. Delphi technique collects independent information from the experts without mixing
them. Brainstorming is information collection technique being open minded without criticizing others.
Survey is to design questions and to ask them to the participants whereas the historical enquiry is a kind
of case analysis of past period. Analysis tools can be statistical such general descriptive tools as mean,
median, mode, frequency. Tools can be inferential as ANOVA, correlation, regression, factor, cluster,
and multiple regression analysis. There are many tools of analyzing functional areas. Finance and
accounting use mostly profitability, leverage, fund flow and other similar accounting and financial tools
for analysis. Human resources use employee turnover, training, satisfaction and many others as the basis
of evaluating strength and weakness. Production area is assessed using quality control, productivity,
breakdown, and many others. Similarly, marketing effectiveness is judged from the sales volume and
market coverage. Research and development is perceived successful if it can really develop the strength
in an organization.

Forecasting Environmental Factors
Collecting relevant information from the selected areas and to identify the variables in such areas are the
basics of analysis. Analyzing the past information to predict the future is the main objective of this step.
As discussed earlier, use of different methods, techniques, and tools comes under the analysis process. It
is, therefore, a comprehensive process that analyzes collected information using different tools and
techniques.

Designing Profiles After analyzing the environmental factors they are recorded into the profiles. Such
profiles record each component or variables into left side and their positive, negative, or neutral
indicators including their statement in the right side. Internal areas are recorded in Strategic Advantages
Profile (SAP) and external areas are recorded in Environmental Threat and Opportunity Profile (ETOP).
Strength, Weakness, Opportunity, and Threat (SWOT) profile can be designed combining both of these
two profiles into one.

There are varieties of reporting formats or profiles used for external and internal business environment
analysis. Environmental Threat and Opportunity Profile (ETOP) is commonly used to report the external
environmental situation whereas Strategic Advantages Profile (SAP) to report the internal environmental
situation1. Both of these profiles can be merged into Strength- Weakness-Opportunity-Threat (SWOT)
profile. David used External Factor Evaluation (EFE) Matrix to present weighted score of external
environmental factors. Similarly, he used Internal Factor Evaluation (IFE) Matrix to make the reporting
of internal environmental audit. Whellen & Hunger used External Factors Analysis Summary (EFAS)
and Internal Factors Analysis Summary (IFAS) as described. Environmental threats and opportunities
profile (ETOP) is a commonly used profile related to external business environment. Strategic
advantages profile
(SAP) is related to internal business environment. Nowadays, strength & weakness and opportunities &
threats (SWOT) profile has become very popular. Present writing pursued the approach of reporting
external and internal business environment using the same approach.

Preparing ETOP
Environmental threat and opportunity profile is referred as ETOP profile. It dentifies the relevant
environmental factors. Such factors might be general environmental factors and task environment
factors. Thereafter, it is necessary to identify their nature. Some factors are positive to the organization
whereas others are negative. Therefore, it is necessary to find out their impact to the organization.
Positive, neutral, and negative sign in ETOP denotes the relevant impact of environmental factors.

Preparing SAP
Strategic advantage profile is known as SAP. It shows strength and weakness of an organization.
Preparation of SAP is very similar process to the ETOP. There are generally five functional areas in most
of the organizations. These areas are Production or Operation, Finance or Accounting, Marketing or
Distribution, Human Resource & Corporate Planning, and Research & Development. These functional
areas are listed to identify their relative strength and weakness in SAP. Very similar to the ETOP,
positive, neutral, and negative signs are denoted and brief description is written in SAP profile. Each
functional area is very broad having many components inside.

All these above described profiles provide a clear picture to understand the strategic position of an
organization.

Strategic Position and Report Writing
After analysis of business environment a strategist knows the actual situation and can make some future
forecasting based on the environmental analysis. After preparing the profiles strategists prepare formal
report that describes the business environment. The report might present issues and best strengths of
business environment in a systematic process. One can draw future strategies based on the strategic
analysis followed.

In conclusion, a strategist or a manager first identifies the relevant environmental factors then analyzes
using different tools and techniques to find out the actual situation. This overall process is sometimes
known as SWOT analysis, environmental scanning, environmental analysis, or monitoring-forecasting.
This process is very important for a manager to make his or her organization success by choosing the
best available alternative strategy.

Editors Note: In 1979, Harvard Business Review published How Competitive Forces Shape
Strategy by a young economist and associate professor, Michael E. Porter. It was his first HBR
article, and it
started a revolution in the strategy field. In subsequent decades, Porter has brought his
signature economic rigor to the study of competitive strategy for corporations, regions, nations,
and, more recently, health care and philanthropy. Porters five forces have shaped a
generation of academic research and business practice. With prodding and assistance from
Harvard Business School Professor Jan Rivkin and longtime colleague Joan Magretta, Porter
here reaffirms, updates, and extends the classic work. He also addresses common
misunderstandings, provides practical guidance for users of the framework, and offers a deeper
view of its implications for strategy today.
In essence, the job of the strategist is to understand and cope with competition. Often, however,
managers define competition too narrowly, as if it occurred only among todays direct
competitors. Yet competition for profits goes beyond established industry rivals to include four
other competitive forces as well: customers, suppliers, potential entrants, and substitute
products. The extended rivalry that results from all five forces defines an industrys structure and
shapes the nature of competitive interaction within an industry.
As different from one another as industries might appear on the surface, the underlying drivers
of profitability are the same. The global auto industry, for instance, appears to have nothing in
common with the worldwide market for art masterpieces or the heavily regulated health-care
delivery industry in Europe. But to understand industry competition and profitability in each of
those three cases, one must analyze the industrys underlying structure in terms of the five
forces. (See the exhibit The Five Forces That Shape Industry Competition.)


If the forces are intense, as they are in such industries as airlines, textiles, and hotels, almost no
company earns attractive returns on investment. If the forces are benign, as they are in
industries such as software, soft drinks, and toiletries, many companies are profitable. Industry
structure drives competition and profitability, not whether an industry produces a product or
service, is emerging or mature, high tech or low tech, regulated or unregulated. While a myriad
of factors can affect industry profitability in the short runincluding the weather and the
business cycleindustry structure, manifested in the competitive forces, sets industry
profitability in the medium and long run. (See the exhibit Differences in Industry Profitability.)
Differences in Industry Profitability
Understanding the competitive forces, and their underlying causes, reveals the roots of an
industrys current profitability while providing a framework for anticipating and influencing
competition (and profitability) over time. A healthy industry structure should be as much a
competitive concern to strategists as their companys own position. Understanding industry
structure is also essential to effective strategic positioning. As we will see, defending against the
competitive forces and shaping them in a companys favor are crucial to strategy.
Forces That Shape Competition
The configuration of the five forces differs by industry. In the market for commercial aircraft,
fierce rivalry between dominant producers Airbus and Boeing and the bargaining power of the
airlines that place huge orders for aircraft are strong, while the threat of entry, the threat of
substitutes, and the power of suppliers are more benign. In the movie theater industry, the
proliferation of substitute forms of entertainment and the power of the movie producers and
distributors who supply movies, the critical input, are important.
The strongest competitive force or forces determine the profitability of an industry and become
the most important to strategy formulation. The most salient force, however, is not always
obvious.
For example, even though rivalry is often fierce in commodity industries, it may not be the factor
limiting profitability. Low returns in the photographic film industry, for instance, are the result of a
superior substitute productas Kodak and Fuji, the worlds leading producers of photographic
film, learned with the advent of digital photography. In such a situation, coping with the
substitute product becomes the number one strategic priority.
Industry structure grows out of a set of economic and technical characteristics that determine
the strength of each competitive force. We will examine these drivers in the pages that follow,
taking the perspective of an incumbent, or a company already present in the industry. The
analysis can be readily extended to understand the challenges facing a potential entrant.
porter's five forces model
Michael E Porter's five forces of competitive position model and diagrams
Michael Porter's famous Five Forces of Competitive Position model provides a simple
perspective for assessing and analysing the competitive strength and position of a corporation
or business organization. A free Five Forces diagram in MSWord is available here. (Porter's
Five Forces diagram pdf here.)
American Michael Porter was born in 1947. After initially graduating in aeronautical engineering,
Porter achieved an economics doctorate at Harvard, where he was subsequently awarded
university professorship, a position he continues to fulfil at Harvard Business School. His
research group is based at the Harvard Business School, and separately he co-founded with
Mark Kramer the Foundation Strategy Group, 'a mission-driven social enterprise, dedicated to
advancing the practice of philanthropy and corporate social investment, through consulting to
foundations and corporations'. A prime example of someone operating at a self-actualization
level if ever there was one.
After his earlier work on corporate strategy Porter extended the application of his ideas and
theories to international economies and the competitive positioning of nations, as featured in his
later books. In fact in 1985 Porter was appointed to President Ronald Reagan's Commission on
Industrial Competitiveness, which marked the widening of his perspective to national
economies. By the 1990's Porter had established a reputation as a strategy guru on the
international speaking circuit second only to Tom Peters, and was among the world's highest
earning academics.
Porter's first book Competitive Strategy (1980), which he wrote in his thirties, became an
international best seller, and is considered by many to be a seminal and definitive work on
corporate strategy. The book, which has been published in nineteen languages and re-printed
approaching sixty times, changed the way business leaders thought and remains a guide of
choice for strategic managers the world over.
Aside from his innovative thinking, Porter has a special ability to represent complex concepts in
relatively easily accessible formats, notably his Five Forces model, in which market factors can
be analysed so as to make a strategic assessment of the competitive position of a given
supplier in a given market. The five forces that Porter suggests drive competition are:
porter's five forces
1. Existing competitive rivalry between suppliers
2. Threat of new market entrants
3. Bargaining power of buyers
4. Power of suppliers
5. Threat of substitute products (including
technology change)
Typically this five forces model is shown as a series of five boxes in a cross formation, item 1
being central. (Pdf diagram here, MSWord diagram here.)
Porter's Five Forces model can be used to good analytical effect alongside other models such
as the SWOT and PEST analysis tools.
Porter's Five Forces model provides suggested points under each main heading, by which you
can develop a broad and sophisticated analysis of competitive position, as might be used when
creating strategy, plans, or making investment decisions about a business or organization.

Porter is also known for his simple identification of five generic descriptions of industries:
1. Fragmented (eg, shoe repairs, gift shops)
2. Emerging (eg, space travel)
3. Mature (eg, automotive)
4. Declining (eg, solid fuels)
5. Global (eg, micro-processors)
And Porter is also particularly recognised for his competitive 'diamond' model, used for
assessing relative competitive strength of nations, and by implication their industries:
1. Factor Conditions: production factors required
for a given industry, eg., skilled labour, logistics
and infrastructure.
2. Demand Conditions: extent and nature of
demand within the nation concerned for the
product or service.
3. Related Industries: the existence, extent and
international competitive strength of other
industries in the nation concerned that support or
assist the industry in question.
4. Corporate Strategy, Structure and Rivalry: the
conditions in the home market that affect how
corporations are created, managed and grown;
the idea being that firms that have to fight hard in
their home market are more likely to be able to
succeed in international markets.
What is it?
Framework/theory
Porter's Five Forces of Competitive Position Analysis were developed in 1979 by Michael E
Porter of Harvard Business School as a simple framework for assessing and evaluating the
competitive strength and position of a business organisation.
This theory is based on the concept that there are five forces that determine the competitive
intensity and attractiveness of a market. Porters five forces help to identify where power lies in
a business situation. This is useful both in understanding the strength of an organisations
current competitive position, and the strength of a position that an organisation may look to
move into.
Strategic analysts often use Porters five forces to understand whether new products or services
are potentially profitable. By understanding where power lies, the theory can also be used to
identify areas of strength, to improve weaknesses and to avoid mistakes.
Porters five forces of competitive position analysis:

The five forces are:
1. Supplier power. An assessment of how easy it is for suppliers to drive up prices. This is
driven by the: number of suppliers of each essential input; uniqueness of their product or
service; relative size and strength of the supplier; and cost of switching from one supplier to
another.
2. Buyer power. An assessment of how easy it is for buyers to drive prices down. This is driven
by the: number of buyers in the market; importance of each individual buyer to the organisation;
and cost to the buyer of switching from one supplier to another. If a business has just a few
powerful buyers, they are often able to dictate terms.
3. Competitive rivalry. The main driver is the number and capability of competitors in the
market. Many competitors, offering undifferentiated products and services, will reduce market
attractiveness.
4. Threat of substitution. Where close substitute products exist in a market, it increases the
likelihood of customers switching to alternatives in response to price increases. This reduces
both the power of suppliers and the attractiveness of the market.
5. Threat of new entry. Profitable markets attract new entrants, which erodes profitability.
Unless incumbents have strong and durable barriers to entry, for example, patents, economies
of scale, capital requirements or government policies, then profitability will decline to a
competitive rate.
Arguably, regulation, taxation and trade policies make government a sixth force for many
industries.
What benefits does Porters Five Forces analysis provide?
Five forces analysis helps organisations to understand the factors affecting profitability in a
specific industry, and can help to inform decisions relating to: whether to enter a specific
industry; whether to increase capacity in a specific industry; and developing competitive
strategies.
Actions to take / Dos Actions to Avoid / Don'ts
Use this model where there
are at least three competitors
in the market
Consider the impact that
government has or may have
on the industry
Consider the industry lifecycle
stage earlier stages will be
more turbulent
Consider the
dynamic/changing
characteristics of the industry
Avoid using the model for an
individual firm; it is designed
for use on an industry basis

In practice:
Porter's Five Forces of Competitive Position Analysis


Analysis of the Indian business environment
Download full case study
In the June 2010 issue of Financial Management magazine, the Five
Forces model was applied to the emerging Indian business environment in
comparison with more developed markets. The analysis found that factors
such as state protectionism and a lack of infrastructure are greater barriers
to entry in India than they are in more developed nations, where market
forces are more powerful.
The analysis highlighted many issues affecting competition in emerging
economies and compared them to those that are more prevalent in more
developed markets.
One factor that could play a crucial role in India is public opinion, which
exerts a considerable influence on the government. A good example of this
is a campaign by local retailers against Walmart, who feel that the arrival of
the US retail giant could put them out of business. Walmart has made huge
investments in India, but is having to find ways around stringent regulations
that prevent it from doing things as basic as putting its brand name on
stores.