INTRODUCTIONStrategic 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 ENVIRONMENTThe 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 FRAMEWORKCareful 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 andthreats 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.

Political1. Government stability2. Political values and beliefs shaping policies3. Regulations towards trade and global business4. Taxation policies5. Priorities in social sector

Environmental Analysis Economic Factors1. GNP trends2. Interest rates/savings rate3. Money supply4. Inflation rate5. Unemployment6. Disposable income7. Business cycles8. Trade deficit/surplus

Socio-cultural Factors1. Population demographicsl ethnic compositionl aging of populationl regional changes in population growth and decline2. Social mobility3. Lifestyle changes4. Attitudes to work and leisure5. Education – spread or erosion of educational standards6. Health and fitness awareness7. Multiple income families

Technological1. Biotechnology2. Process innovation3. Digital revolution4. Government spending on research5. Government and industry focus on technological effort6. New discoveries/development7. Speed of technology transfer8. Rates of obsolescence

Legal1. Monopolies legislation/Antitrust regulation2. Employment law3. Health and safety4. 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 IndicatorsA. National Income B. Policy InitiativesGNP Monetary policyPersonal disposable Income Fiscal policyPersonal consumption Labour and employment policyC. Savings D. Foreign SectorPersonal savings Exchange ratesCorporate savings Exports/ImportsBalance of PaymentsE. Industry F. Sectoral GrowthIndustry Investment AgricultureFDI flows IndustryServicesInfrastructureG. Capital Market H. Prices, Wages, ProductivityEquity market InflationBond 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 sector’s 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 organisation’s 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’ STRATEGYAs 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 4Environmental Potentially positive Probably neutral Probably negative Trends effects effects effects1. Aging population medical services minerals colleges and schools2. Multiple income fast food machine tools grocer’s supplies families3. Deregulation shipping financial sector4. Increased waste management software leather environmental lelgislation5. Growing global telecommunication competition mining small scale/handicrafts

Structural Drivers to ChangeThe 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 SCANNINGThe 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 10–15 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.

SUMMARYUnderstanding 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 READINGSJohnson, Gerrry & Scholes, Kevan. (2004). Exploring Corporate Strategy. Sixthedition, 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 America’s Best-Run Companies, New York: Harper and Row.David, R. Fred. (1997). Concepts of Strategic Management. Prentice HallInternational Inc.

Source: www.ignou.edu

Process of Business Environment Analysis

BackgroundEnvironmental 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 ProcessA 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 factorsFirst 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 factorsOut of all the business environmental factors, a strategist should focus only onthe relevant factors for further analysis. All the factors are not equallyimportant and affecting to the business. In this context, a strategist has to scanthe environmental trend to select only the most affecting environmental factorsfrom the information overload. This step paves the way of environmentanalysis and forecasting.

Defining Variables for AnalysisSelected 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 ToolsDifferent 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 one’s strengths and weakness with the standard. Network method is to assess organizational systems and its outside environment to findthe 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 FactorsCollecting 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 ETOPEnvironmental 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 SAPStrategic 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 WritingAfter 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.

Editor’s 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. “Porter’s 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 today’s 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 industry’s 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 industry’s 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 run—including the weather and the business cycle—industry 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 industry’s 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 company’s 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 company’s 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 product—as Kodak and Fuji, the world’s 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 suppliers2. Threat of new market entrants3. Bargaining power of buyers4. Power of suppliers5. 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. Porter’s five forces help to identify where power lies in a business situation. This is useful both in understanding the strength of an organisation’s current competitive position, and the strength of a position that an organisation may look to move into.

Strategic analysts often use Porter’s 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.

Porter’s 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 Porter’s 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

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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.